By: Dividend Sensei
I recently posted about the futility of calling market tops and bottoms, and why it’s important to stay invested all the time. In that article I introduced a test portfolio that I have been experimenting with, which I call the Deep Value Dividend Growth Index , or DVDGI.
Basically it’s a simple rule based portfolio that:
1. Starts with a core of quality high-yield companies (to start generating immediate cash flow to be reinvested later)
2. Adds opportunistically from companies on my master watch list (carefully crafted over thousands of hours of research over the last three years) from companies hitting 52 week lows, or experiencing random, short-term volatility, such as after a disappointing earnings report.
3. Adds to each position as its cost basis declines to -10%, in rising increments of 125%, 150%, 175%, ect of the initial position size (in order to lower the cost basis and lock in a higher yield on invested capital).
4. Each month I add more to whatever is 20% or more undervalued.
5. Only sells if the investment thesis breaks, for example if the dividend is suddenly cut.
The point of this experiment is to show that beating the market, and thus 95% of all professional money managers, doesn’t require speculating in high risk tech, biotech, or some other little known micro caps. Rather simple long-term buy and hold, (and add on the dip) investing in quality dividend growth stocks, with reinvestment of the dividends, is all that’s needed to generate not just generous, secure, and growing income, but market thrashing returns as well.
In other words the key to winning on Wall Street, and achieving financial independence for yourself and your family, is to invest smarter, not harder. In fact, the reason I decided to eventually grow this test portfolio to 200 holdings is to essentially make it an index fund, and show that even with such a broad portfolio you can generate strong returns consistently over time.
So let’s get to it then. What does the DVDGI look like now? And how is it doing since it launched 3 weeks ago?
Holdings: 127 (note how many cheap stocks I was able to find despite the market melting upwards) With position sizes ranging from 0.56% for the smallest position, (Solar Utility 8Point3 Energy Partners), to the largest position, defense contracting giant Lockheed Martin, at 1.44%.
Portfolio Yield: 3.60% made up of yields ranging from a low of 0.38% (MercadoLibre) to 9.66% (Icahn Enterprises) and 80% above the 2% yield of the S&P 500.
PE: 16.1 (14% below S&P 500)
FCF Margin: 18.7% (rich in free cash flow is rich in dividends)
Return on Assets: 7.4% (11% above S&P 500 average)
Return on Equity: 52.7% (149% above S&P 500 average)
Market Cap: $18.4 billion (76% below S&P 500 average)
Projected 5 Year EPS growth: 8.9% (4% above S&P 500 average)
Projected Annual Total Return: 12.5% (37% above the market’s historic CAGR since 1871)
So basically we have here a diversified portfolio of highly cash flow rich companies, with great profitability, below average size (as a whole), faster than average growth rates, in beaten down industries.
As for the industry composition?
Basic Materials: 0.9%
Consumer Cyclicals: 12.7%
Real Estate: 26.4% (the most undervalued industry in the market right now)
Energy: 9.5% (thanks to oil crash)
Industrials: 9.0% (due to industrial firms sales to energy companies being at multi-year lows)
Consumer Defensive: 13.0% (rising interest rates have sent bond alternatives such as Coke to 52 week lows)
Healthcare: 10.3% (pharma has gotten pounded in recent months)
Performance so far
Now I’ll be the first to admit that 3 weeks is a pretty insignificant time horizon. BUT let’s go over how I’ll be tracking the performance of this index over time. I’m using the annualized total return method, which is how mutual funds track their returns, because they isolate returns per transaction from changes in cash flows (ie dilution of investors putting money in).
So basically when I add to a position in this index, my tracking software (Morningstar Premium) will take an equivalent amount of money and pretend I invested it instead into the S&P 500.
This allows you to truly see how your portfolio does over time compared to the default of a low cost market ETF.
So, how has the DVDGI done so far, while the market has been enjoying the Santa Trump bump?
DVDGI: 5.02% annualized total return
S&P 500: 3.07%
So far so good. Now over time the amount of alpha (how much you beat the market by) will fluctuate of course, but I expect that the straight forward, disciplined, and methodical rule based nature of this portfolio will result in significant outperformance. Best of all? It takes very little work to maintain, merely checking in on a quarterly basis to make sure that the investment thesis of the companies are intact. Other than that its sit back, relax, and let corporate America and the magic of dividend hyper compounding work for you.