DivGro Pulse: January 2018

This month I'm celebrating the 5^th anniversary of DivGro!

I founded DivGro in January 2013 to focus on dividend growth (DG) investing. Since then, my portfolio steadily has grown well beyond what I could have imagined!

Just this week, I hit my 10^th home run with DivGro, when my position McDonald's (MCD) crossed 100% in total returns. And, without giving everything away, on Friday three more positions earned home run status after some extraordinary price action! This market sure looks toppy now...

Once a month, I write a pulse article that focuses on strategy and monitors the health of my portfolio. I update the fair value estimates of DG stocks in my portfolio and use the information to identify undervalued DG stocks suitable for further investment. Finding undervalued stocks is quite challenging these days!

Some Changes

Before getting down to business, let me share some changes I'll be making in the next few months.

First, regular readers may have noticed that my portfolio has a new design and layout. I'm now using four codes to distinguish between different types of holdings:

•  D   Dividend growth stocks in David Fish's CCC List. By definition, these are Dividend Champions, Dividend Contenders, and Dividend Challengers with, respectively, at least 25 years, 10 years, and 5 consecutive years of higher dividend payments. 
•  E   Extra dividend-paying stocks not (yet) or no longer in the CCC List. These are dividend payers with short histories of dividend increases, erratic dividend payments, or frozen dividends. DG stocks that lost their CCC status due to exchange rate fluctuations are in this category.
•  F   Funds, including Closed-End Funds (CEFs) and Exchange-Traded Funds (ETFs). Unlike mutual funds, these are pooled investment funds that are listed and traded like stocks on a stock exchange. Funds are managed and have associated annual fees, expressed as expense ratios.
•  G   Growth stocks from companies expected to grow at above-average rates relative to the market. These companies usually don't pay dividends; instead, they reinvest retained earnings in capital projects or in mergers and acquisitions.

In the portfolio excerpt above, General Dynamics (GD)  is one of my DG stocks and happens to be a home run stock with total returns of at least 100%. Home runs are highlighted in green. Gilead Sciences (GILD) and Intel (INTC) are dividend-paying stocks with short histories of consecutive annual increases. In a couple of years, these stocks may be promoted to the DG category.

My investments in Funds and Growth Stocks are relatively small. After analyzing Dividend ETFs and Real Estate ETFs for Seeking Alpha articles, I decided to add a few ETFs to the CEFs I already owned, mainly to increase DivGro's diversification. Investing in the so-called FANG stocks has been fun and "profitable". Let's just say they're future DG stocks that I'm investing in prematurely...

In future, pulse articles exclusively will focus on the DG stocks in my portfolio. These holdings will remain the focus of DivGro, and I want to refocus my efforts on DG investing. My hope is to reduce DivGro's overall risk profile, continue to increase diversification and to work on improving the balance of my holdings.

Finally, I'm thinking about launching a subscription service for DG investors, focused on strategy, fair value analysis, and portfolio management. Essentially, these are the topics of my DivGro Pulse articles. When the subscription service is launched, I no longer will publish DivGro Pulse articles on my blog.

Recap

In December's pulse article, I had no positions on the chopping block and I thought Walgreens Boots Alliance (WBA) looked like the best candidate among my current holdings. For new positions, TJX Companies (TJX) looked promising after making consecutive appearances in my monthly top ten list of DG stocks. In fact, TJX took the top spot in January's top ten list, so I really need to make time for a thorough stock analysis!

So far, I have not had the time for due diligence research on TJX, but I'm hoping to do so soon. 

Position Sizes

From time-to-time, I like to look at the size of my DG stocks. Stocks that are underweight are good candidates for further investment. While I prefer to see a more balanced portfolio, I sell covered calls on a selection of DG stocks. To do so, I need to own 100 shares or multiples of 100 shares, so several positions are larger than those not involved in covered calls.
The red dashed line represents the average position size (1.48%) of the DG stocks in my portfolio. Stocks with weights less than 1% is underweight are good candidates for further investment.

Recent Performance

One way to assess a stock's recent performance is to plot the current price relative to its 52-week trading range. I color stocks trading below the 50% orange. These are stocks with poor recent performance.

With interest rates rising, REITs are struggling and two of my holdings, Realty Income (O) and Omega Health Investors (OHI) are no exceptions. On the other hand, Stanley Black & Decker (SWK), Johnson & Johnson (JNJ), and Apple (AAPL) are trading close to their 52-week highs.

Another way to look at recent performance is to compare recent returns to annualized returns over a longer time frame. The following chart compares 1-year returns to annualized 5-year returns:
Please note that the returns exclude dividends.

Three stocks stand out on this chart, T. Rowe Price (TROW), AbbVie (ABBV), and Wal-Mart (WMT). These stocks have performed exceptionally well in the past year compared to their annualized 5-year performances. Consider TROW, for example. Here is a 5-year price chart, courtesy of Google Finance:
TROW is trading 73% above its January 2017 share price!

On the other hand, the one-year performance of Hormel Foods (HRL) is poor relative to its annualized 5-year performance, as can be seen in the following 5-year price chart:
In fact, HRL has performed poorly for two straight years!

The reason I consider recent performance is two-fold. Stocks like TROW may be significantly overvalued and present an opportunity to trim or even close the position. I'd like to know when that happens and consider my options. Conversely, stocks like HRL may be undervalued or troubled and I'd like to know about that also. Of course, merely looking at the chart won't tell me if HRL is presenting a great opportunity or if the stock is in trouble. I'll have to dig deeper to understand the reasons for the share price decline.

Quality Stocks

To determine if stocks I own are trading at a discount, I estimate the fair value of stocks in my portfolio. A byproduct of the evaluation process is a 7-star rating for each stock and a score that I use to rank the DG stocks in my portfolio.

To estimate fair value, I perform a multi-stage Dividend Discount Model analysis, a Gordon Growth Model analysis, and an analysis of dividend safety. My final fair value estimates also consider fair value estimates and price targets available elsewhere, such as those from Morningstar, finbox.io, Simply Safe Dividends, and S&P Capital IQ.

Here are the top ten ranked stocks in DivGro for January 2017:

Hormel Foods  (HRL)	• Premium	0.26%	• rank   #1 •  ✭✭✭✭✭✭✩
Cummins  (CMI)	• Premium	13.06%	• rank   #2 •  ✭✭✭✭✭✭✩
CVS Health  (CVS)	• Discount	7.44%	• rank   #3 •  ✭✭✭✭✭✭✩
General Dynamics  (GD)	• Premium	15.83%	• rank   #4 •  ✭✭✭✭✭✭✩
Travelers  (TRV)	• Premium	17.33%	• rank   #5 •  ✭✭✭✭✭✭✩
Altria  (MO)	• Premium	4.46%	• rank   #6 •  ✭✭✭✭✭✭✩
Aflac  (AFL)	• Premium	16.16%	• rank   #7 •  ✭✭✭✭✭✭✩
UnitedHealth  (UNH)	• Premium	18.67%	• rank   #8 •  ✭✭✭✭✭✭✩
Texas Instruments  (TXN)	• Premium	27.15%	• rank   #9 •  ✭✭✭✭✭✩✩
Walt Disney  (DIS)	• Premium	9.89%	• rank #10 •  ✭✭✭✭✭✩✩

This month, eight of the top 10 ranked stocks earned 6-star ratings. Generally, I consider stocks rated 5-stars or better as worthy of further consideration. Only CVS Health (CVS) is trading at a discount to fair value, although HRL is trading just about at fair value. 

Discounted Stocks

I prefer to buy stocks when they're available at discounts of at least 10%. Finding quality stocks trading at such discounts is becoming increasingly hard. Nevertheless, here are the ten DG stocks with at or near fair value, as of 26 January 2017. In addition to each stock's discount and rating, I include its rank out of 45 DG stocks:

Hannon Armstrong Sustainable Infrastructure Capital (HASI)	• Discount	8.18%	• rank #44 •  ✭✭✩✩✩✩✩
CVS Health  (CVS)	• Discount	7.44%	• rank   #3 •  ✭✭✭✭✭✭✩
AT&T  (T)	• Discount	4.87%	• rank #23 •  ✭✭✭✭✭✩✩
Omega Healthcare Investors (OHI)	• Discount	4.83%	• rank #45 •  ✭✭✩✩✩✩✩
Realty Income  (O)	• Discount	0.85%	• rank #42 •  ✭✭✭✩✩✩✩
National Retail Properties (NNN)	• Discount	0.28%	• rank #41 •  ✭✭✭✩✩✩✩
Walgreens Boots Alliance (WBA)	• Premium	0.13%	• rank #12 •  ✭✭✭✭✭✩✩
Hormel Foods  (HRL)	• Premium	0.26%	• rank   #1 •  ✭✭✭✭✭✭✩
Dominion Resources (D)	• Premium	1.37%	• rank #39 •  ✭✭✭✩✩✩✩
International Business Machines  (IBM)	• Premium	2.00%	• rank #17 •  ✭✭✭✭✭✩✩

I'm not really interested in adding to positions of stocks rated 5-stars or worse, so the only candidates worth a serious look are CVS and HRL.

The following chart shows the percentage discount to fair value of the DG stocks in my portfolio. Green bars represent discounts, while red bars represent premiums (or negative discounts):

Only six DG stocks are trading at a discount to fair value, versus seven stocks that traded at a discount last month. The markets continue to make new highs and it remains challenging to find good DG stocks trading at or below fair value.

Yield Channels

Last year, I presented a tool for dividend growth investors to assess market valuation relative to historical yield patterns, called Yield Channel Charts.

Yield channels can be seen as safety zones for stock prices. As long as the stock price stays in the yield channel, the stock is fairly valued. If the stock price moves outside the yield channel to the upside, the stock is overvalued and the yield is low, historically. Conversely, if the stock price moves outside the yield channel to the downside, the stock is undervalued and the yield is high, historically.

To get a comprehensive view of historical dividend yield patterns, I collect stock price and dividend data for at least seven years. This covers the average length of a business cycle, estimated to last about six years. For stocks with long histories of dividend increases, I use up to twelve years of data.

Positions to Boost?

HRL is a Dividend Champion with a track record of 52 years of higher dividend payments. The stock yields 2.16% at $34.66 and has an impressive 5-year dividend growth rate of 17.8%.

HRL is one of my smaller positions and the stock is ranked #1 this month, although it is not trading at a discount to fair value. It is trading at about fair value, though, so is it a good time to boost my HRL position?

Let's consider HRL's yield channel chart:
In October, HRL traded near $30 per share, pretty close to the undervalued yield of 2.5%. Of course, the stock price increased to a new 52-week high of $37.70 on 4 December before pulling back to the current price of $34.66.

My conclusion is to hold off on buying more HRL shares until the stock trades closer to $30 per share. Specifically, if HRL trades below $30.75 per share before 1 July 2018, I'd consider it a buy.

CVS is a Dividend Contender with 14 consecutive years of higher dividend payments. The stock yields 2.44% at $82.01 and has a 5-year dividend growth rate of 25.2%.

Here is the yield channel chart for CVS:
I use seven years for CVS because of the stock's relatively shorter history of dividend increases.

CVS moved outside the yield channel to the downside in late 2017, meaning the stock briefly traded above its undervalued yield of 2.72%. I added 50 shares to my CVS position on 27 November 2017 at an initial yield on cost (YoC) of 2.83%.

My CVS position is just about equal to the average position size (1.48%) of the DG stocks in my portfolio, so I don't want to add any shares at this time.

Positions To Close?

I have no positions to close at this time, but let's consider TROW's yield channel chart anyway:
Because TROW is a Financials sector stock, I trimmed the yield channel chart to exclude the carnage of the 2008/9 recession. (Otherwise, the yield channel is excessively skewed to the upside).

TROW is rapidly approaching the overvalued yield level of 1.74%, so I need to monitor further price action. If the stock trades above $135 before 1 July 2018, I would consider closing my position.

New Positions?

I mentioned earlier that TJX looks promising after repeatedly making my monthly top ten list of DG stocks and topping January 2018's top ten list. So let's see what the yield channel chart shows:
While still a Dividend Contender with 21 years of higher dividend payments, TJX is closing in on the coveted Dividend Champion status. The stock yields 1.55% at $80.51, still well below the undervalued yield level of 1.97%. Twice last year the stock got close to touching the green line, but not quite!

If TJX trades below $70.50 before 1 July 2018, the stock would be undervalued relative to its 12-year dividend yield history. I can't say if TJX would be a buy for me if that happens because I still need to do a thorough stock analysis.

Concluding Remarks

I'm making some changes to the format and content of my DivGro Pulse articles. In future, I'll be focusing on DG stocks in my portfolio and, eventually, expand to include more DG stocks in the CCC list. I'll continue to present fair value estimates for stocks in my portfolio and any candidates I deem worthy of further analysis.

Additionally, I'll create and present yield channel charts to determine potential buy and sell levels based on the historical dividend yield patterns of individual stocks. I believe yield channel charts will prove to be a great tool for identifying undervalued stocks. Perhaps I'll even use yield channel charts to guide sell decisions.

Thanks for reading and take care, everybody!