Dave Van Knapp’s Dividend Growth Portfolio Exceeds 10% Yield on Cost – What’s Next?

My Dividend Growth Portfolio (DGP) wrapped up 2020 in great shape. I’m now getting back in dividends more than 10% of the original money I invested…each year.

Here are the most important DGP accomplishments in 2020:

  • Yield on cost grew to 10.4%, a new record high. That figure exceeds my long-standing goal of hitting 10% yield on cost. And it’s still going up even as I write this.
  • Dividend income grew 10.8% over 2019 to $4748. That is also a new record high for a full year’s dividends.
  • Total value grew 5% to $146,493. That is also a record high for the end of any month since the portfolio began in 2008.

The DGP’s Objectives

The DGP is a real-time, real-money demonstration of dividend growth investing. It is not a back-test, model, or hypothetical.

The idea is to present actual situations and examples – of decisions, trades, and results reported in near-real time – that investors can relate to in their own investment lives.

The DGP has two financial goals.

The primary goal is to build a reliable, steadily increasing stream of dividends over many years that can eventually be used as income for retirement.

Obviously, this is a cash-flow goal, not a wealth goal. The main idea is to develop what I call an “optimal” income stream. I want the income to be large enough for retirement needs, reliable, and to grow every year.

The DGP has been successful in meeting that goal. Dividends received in the DGP’s first full year – 2009 – were $1568. By 2020, that amount grew to $4748, or more than triple the amount in 2009.

These results have been achieved without any new outside contributions since the portfolio kicked off in 2008. No additional monthly or quarterly deposits have ever been made into the DGP.

The results have come solely from:

  • the original stocks picked;
  • receipt and reinvestment of dividends; and
  • management of the portfolio – including the addition of more stocks – over the past 12+ years.

The dividends are all generated from within the portfolio itself. I call that “organic” income. I don’t have to sell shares to receive cash. The companies themselves send cash to me. My capital investment stays untouched.

The distinction between income and wealth objectives is important for several reasons:

  1. The income objective leads to a smoother ride. Dividends rarely go down, whereas prices go up and down all the time. You undoubtedly remember the market crash last February triggered by the Covid-19 pandemic. That crash had no impact on my income, even though it brought the DGP’s value down.
  2. The income objective influences the securities that I select. I look for stocks of excellent companies with good dividend track records, because they are likely to continue raising their dividends. These criteria invariably lead me to high-quality companies with solid, durable businesses.
  3. Portfolio management is simplified. With dividends being far more reliable than prices, there are fewer temptations to sell when prices are falling. In fact, weak prices become a reason to buy. There has been far less turnover in the DGP than in most portfolios.

The secondary goal of the DGP is to be competitive with the S&P 500 in total returns. That goal has been achieved until the last few months of 2020, as we will see later.

The Portfolio as 2021 Begins

These were the most important changes to the portfolio in 2020:

  1. The number of positions grew from 26 to 27.
  2. The portfolio’s income grew 10.8% to $4748.
  3. The portfolio’s total value grew 5% to $146,493.

In 2020, I made five dividend reinvestments and a couple of sales (with the proceeds being moved into other stocks). Dividend growth investing, at least the way I practice it, is not a high-turnover operation. If you are looking to day-trade or for the excitement of constant change, this is not the kind of investing for you.

As we enter 2021, the DGP is 12 years, 7 months old. Here is where it stands as we enter the new year.

In 2020, I got rid of Ventas and Dominion Energy. I added General Dynamics, Lockheed Martin, and Pinnacle West Capital. That increased the total number of positions by one to 27 stocks in the portfolio.

2020 Income Performance

In 2020:

  • The portfolio received $4748 in dividends, an increase of 10.8% over 2018 and a new annual high in dollars received.
  • There were 111 dividend payments, 30 dividend increases, and no cuts.

The following chart shows the annual dividends received each year since inception of the portfolio. Note that 2008 was a partial year.

This is my favorite chart, because it illustrates so well the possibilities of dividend growth investing.

The CAGR (compound annual growth rate) of the dividend stream from the beginning of 2009 through the end of 2020 was 10.6% per year. That is a fast growth rate for a portfolio with a yield over 3%.

Organic Income Growth

One of the traits of dividend growth investing is that you can expect to receive income increases each year.

As shown in the chart above, that is exactly what happens in the DGP. My stocks declared 30 dividend increases and no cuts in 2020. Those increases, combined with dividend reinvestments, grew the total income by $461 (10.8%) in one year.

All of that growth is organic, meaning that it comes from within the portfolio. None of it is the result of adding more outside money to the portfolio.

When you think or read about income growth, be sure that you understand the difference between organic growth and growth that comes from shares purchased with new outside money.

The reality for many (if not most) investors is that they are adding new money from outside the portfolio. They are working, setting aside money to invest, and investing it every month or two. So their income growth is enhanced by the new money being added.

The DGP is different. I am trying to demonstrate results from just the strategy itself, not from adding new money. I have never added a dime to the portfolio since its inception.

The dividend-growth strategy encompasses three elements that generate organic growth within the portfolio without new money.

  • Dividend increases. The companies in the portfolio announce regular raises. I benefited from 30 raises in 2020. (The portfolio contains 27 companies.)
  • Dividend reinvestments. I collect the dividends and buy new shares when the kitty reaches $1000. The new shares then generate more dividends.
  • Portfolio management. I occasionally make swaps that result in dividend growth.

Note that the first item (dividend increases) happens on its own – the companies declare increases. Indeed, I selected them for their propensity to do that.

But the second two items (reinvesting dividends and making occasional changes to the portfolio) are dependent on me: They are the result of decisions that I make.

Let me illustrate how these work with this graphic from Simply Safe Dividends. I have entered my portfolio into SSD’s portfolio function. They estimate this growth rate in portfolio income over the past five years for the stocks that I hold now:

In other words, the natural growth rate for the stocks in the DGP, when averaged out, has been less than 7% per year.

But my income rose more than 10% last year. What caused the difference? The three things mentioned above: Dividend increases; dividend reinvestments; and portfolio management.

Projected 2021 Income

The following projection for 2021 comes from Simply Safe Dividends:

The projection is based on information known now. Therefore, it:

  • Assumes that all dividends will be paid on their normal schedules;
  • there will be no dividend cuts; and
  • that dividend increases already declared will take place – note AMGN’s dividend increase, already declared but yet to be paid.

The tool makes no assumptions about dividend increases later in the year. That projection will prove to be wrong – many more dividend raises will come that aren’t known yet. Therefore, 2021’s income will be higher than the projection.

To illustrate how the annual total dividends are higher than early projections, we need look no further than the year just passed. The initial estimate for 2020’s dividends was $4543, whereas I actually received $4748 – almost 5% more than the estimate made last January.

Portfolio Yield(s)

“Yield” is a simple word, but it has nuances that can produce confusion if they are not understood.

The simple equation for yield is this:

Yield = One year’s dividends / Price

Confusion comes into play because different values can be selected for the numerator and denominator in that equation.

The differences depend on the timeframes covered. You choose values based upon what you want to measure.

This table compares three flavors of yield. All of them are valid, but you have to know which one you are talking about.

(1) Last Year’s Yield:

The first flavor is last year’s yield: How much did the portfolio yield in 2020?

To get that answer, divide 2020’s income by the DGP’s value at the beginning of 2020.

$4748 / $138,984 = 3.4%

The DGP yielded 3.4% to me last year, based on its value at the beginning of the year.

(2) Current Yield:

Current yield tells you what the portfolio is yielding right now. The current yield is the portfolio’s “speed” in generating income. If you were buying a certificate of deposit, this would be called APY: annual percentage yield. The math is the same with a stock portfolio.

To calculate current yield, divide the current dividend run-rate (the current 12-month estimate) by the portfolio’s current value.

$4882 / $146,493 = 3.3%

The current yield is lower than last year’s actual yield, because the numerator – estimated income for the year – is lower than it will end up being, as explained earlier.

(3) Yield on Cost:

Yield on cost (YOC) measures how much income the portfolio is generating compared to its original cost back in 2008. The numerator is the current run-rate. The denominator is the portfolio’s original value.

$4882 / $46,783 = 10.4%

That’s a new all-time high. What it means is that the DGP is now generating dividends at the rate of 10.4% of the original amount invested per year.

That is the kind of income power that was the original inspiration for the portfolio.

It also underscores why I believe that the DGP has proved the concepts of dividend growth investing in real life over its 12-year lifespan. Suppose that someone said in 2008, “Here’s $47,000. Create a portfolio that will generate more than $4800 cash per year in 2021 without adding any more money along the way.” The DGP has done that.

2020 Dividend Reinvestments

Unlike many dividend growth investors, I do not drip dividends. Instead, I let them accumulate to $1000 and then select a stock to invest in.

My main reason for doing that is always to invest in well-valued stocks. It also helps me start new positions. Remember, there is no new money coming from outside to fund new positions. They need to be funded internally, with resources already in the portfolio.

Each dividend is small compared to the value of the portfolio, so sometimes it is easy to forget how much they add up and the significant impact that reinvesting them has on returns over the long haul.

So far in this portfolio, more than $37,000 worth of dividends has been reinvested.  That’s 80% of the original starting amount.

I made five reinvestments in 2020:

  • January: Added to position in Texas Instruments (see article).
  • March: Added again to Texas Instruments (see article).
  • May: Opened new position in General Dynamics (see article).
  • August: Added more shares to General Dynamics (see article).
  • November: Opened new position in Lockheed Martin (see article).

2020 Sales and Turnover

As I practice it, dividend growth investing is mostly about collecting stocks, without much trading or turnover. Most transactions are simple dividend reinvestments.

However, I make occasional trims or outright sales. When I do, I use the money to purchase other shares. I don’t hang onto it in cash. Here were the DGP’s sells and buys in 2020. Look below the table for the key to the color codes.

  • The 6 green dots denote the 5 dividend reinvestments discussed earlier. The last purchase (in November) was split into two pieces, which I tied together with a line on the table above.
  • The 2 red dots show that I sold out of two positions in January (see article) and July (see article).
  • The 2 blue dots denote the purchases that I made with the proceeds from the sales. They are described in the articles linked above.

The DGP is not a trading vehicle. In 2020, I made transactions on only seven dates.

The two sales (red dots) resulted in a portfolio turnover rate of about 5%. For comparison, here are the turnover rates reported by Morningstar for two common ETFs:

  • The largest S&P 500 tracking ETF – SPDR S&P 500 ETF Trust (SPY) – 2% reported turnover.
  • The largest dividend ETF – Vanguard Dividend Appreciation (VIG) – 14% reported turnover.

Total Return

While total return is not a primary focus of this portfolio, I do record it at the end of each month.

Overall, the DGP’s performance has been pretty impressive. Its starting value was $46,783. Its value at the end of 2020 is $146,493. The entire portfolio is a three-bagger (3.1 to be exact).

Here are the last two years.

Over the life of the portfolio, the DGP’s total return is +213% compared to SPY’s +246% (source), both with dividends reinvested.

If I had invested the original amount into SPY at the end of May, 2008 and reinvested its dividends since then, its total value would now be $161,869.  My portfolio’s actual value is $146,493.

Until this year, the DGP generally exceeded SPY’s total returns. That was gratifying, because my portfolio contains many “defensive” stocks and not many “growth” stocks.

In 2020, as you probably know, tech ruled the stock market. The most widely used market benchmark, the S&P 500, has no position-size limits. It is now dominated by its top-10 holdings, which make up 27% of the index and are mostly tech names plus Amazon and Tesla. Those holdings sported 2020 price returns in the mid-to-high double digits. Tesla’s return alone was more than 700%.

It is too early to tell whether the tech boom and dominance of the S&P 500 will evaporate as it did in 2000-2002 when the dot-com bubble collapsed.

The DGP holds several tech stocks, but other than Microsoft (MSFT), they are not the ones that are booming now. They are older “tech infrastructure” companies like Qualcomm (QCOM) and Texas Instruments (TXN) that offer good dividends, dividend growth, and moderate price increases.

The DGP’s current yield is 3.3% compared to SPY’s 1.6% (source).

Predictions for 2021

I don’t make predictions about what the market or prices will do.

By tradition, I use the following illustration each year to show the futility of predicting the future. It shows USA Today’s predictions for the NFL season that just ended. These predictions were made last May.

Actually, in 2020 USA Today got more calls right than they usually do. They correctly predicted 9 of the 14 teams to make the playoffs, including 6 of 7 in the AFC. Their batting average is usually around 50%.

That said, they still made their share of poor projections.

Prediction: The Cowboys would win the NFC East. Fact: The Cowboys did not make the playoffs. Nobody in their division even finished with a winning record.

Prediction: The 49ers would win the NFC West. Fact: The 49ers did not get into the playoffs either.

Prediction: The Broncos would get into the playoffs as a wild card selection. Fact: The KC Chiefs are the only team from the AFC West to make the playoffs.

Predicting is hard. So I confine my prognostications to things that I have a lot of confidence in or total control over. I have no control over the market.

Last year, here’s what I said that I expected for the DGP in 2020:

  • Prediction: The portfolio’s yield on cost would exceed 10%.
    What happened: Yield on cost hit 10% at the end of April and kept going up from there. It is now at 10.4%.
  • Prediction: I would make at least 4 dividend reinvestments, focusing on high-quality companies with decent yields and dividend growth rates.
    What happened: I made 5 reinvestments, as I collected just enough dividends by the end of the year to make an “extra” investment of $1000.
  • Prediction: As usual, I made no prediction about total return. My primary focus remained on optimizing the income stream.
    What happened: The S&P 500 surpassed the DGP in total return in 2020, as explained above.

What about 2021? Here are my predictions, based on what I can control and what I can’t.

  • Prediction: The portfolio’s dividend income will top $5000 for the first time in 2021 and surpass 11% yield on cost.
  • Prediction: I will expand the portfolio’s business plan to allow more than 30 stocks in the portfolio.
  • Prediction: In conjunction with that, I will reduce the maximum size of any position below the current allowable 10% in order to promote more diversification. Where necessary, I will trim current positions down below the new maximum size.
  • Prediction: I will begin making one dividend reinvestment per month (rather than waiting for cash to build to $1000). That will take advantage of the zero-commission world that we are now in. Future reinvestments will be smaller but more frequent than they have been until now.
  • Prediction: No prediction about total return. It will be interesting this year to see whether tech stocks fall back to earth or continue with prices that are, for the most part, at high altitudes.

The three predictions about changes to the business plan have already been posted. See the DGP’s new business plan here.

Thanks for reading. Please continue to follow the DGP’s progress via my monthly updates. In addition to those, I’ll write an article every time I buy or sell anything; you’ll see those articles in Daily Trade Alert’s and Dividends & Income’s newsletters and on their home pages.

To all my fellow investors: Have a happy, healthy, and prosperous 2021!

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— Dave Van Knapp

This article first appeared on Dividends & Income

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