DivGro Pulse: August 2018

In my monthly pulse articles, I focus on strategy and monitor the health of DivGro, my portfolio of dividend growth stocks. My aim is to reduce portfolio risk, to further diversify my holdings, and to improve the balance of my holdings.

To identify undervalued or overvalued stocks in my portfolio, I perform a comprehensive fair value analysis and update the fair value estimate of every dividend growth stock in my portfolio.

Undervalued stocks may be suitable for further investment and overvalued stocks are candidates to be trimmed or sold.

Recap

In last month's edition, I looked at yield channel charts for Cummins (CMI), Microsoft (MSFT), and Home Depot (HD).

• CMI's share price was near to the bottom edge of its yield channel, but not yet trading at undervalued yield levels. Since last month's report, the stock rallied a bit and now trades above $144 per share. CMI would have to drop about 17% before I would consider the stock a strong buy.
• MSFT traded above its yield channel in overvalued territory. I decided to sell 40 of my 140 shares and ride the somewhat smaller holding higher as long as the upward trend lasts. Microsoft is on of DivGro's home-run stocks, a designation I give to any stock with total returns of more than 100%. 
• I'm really interested in opening a position in HD, but its yield channel chart suggests that HD is trading at a premium to fair value. I consider $171 to be a suitable entry point, but HD is near $202 per share. That's 18% above my buy price, so I'll have to wait for a more suitable time to make a trade.

My goal for the third quarter of 2018 is to strengthen DivGro's risk profile. I'm using various tools to identify riskier positions with the view to trim or close them. In this month's edition, I'll present one such tool and the actions I'm taking to reduce risk.

Quality Stocks

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 from Morningstar, F.A.S.T. Graphs, and ValuEngine.

A byproduct of the evaluation process is a 7-star rating and a score that I use to rank the dividend growth stocks in my portfolio.

Here are the top ten ranked dividend growth stocks in my DivGro portfolio for August 24:
This month, four stocks earned 7-star ratings, while the other top 10 ranked stocks each earned a 6-star rating. Generally, I consider stocks rated 5-stars or better worthy of further consideration.

Three stocks trade at least 10% below my fair value estimates.

I'm happy to see that Comcast (CMCSA)'s stock price continues to recover. At the same time, the stock is trading well below my fair value estimate, so buying more shares seem appropriate. However, I'm happy with the size of my CMCSA holding and I'm not planning to add more shares at this time.

CVS Health (CVS) is trading about 29% below my fair value estimate. The company indicated that it WON'T be increasing its dividend until its balance sheet leverage is down to 3x following its purchase of Aetna (AET). I'm planning to hold my shares, but I'm not interested in adding any shares at this time.

I already mentioned CMI, which is recovering but still trading well below my fair value estimate. Even though CMI is trading at a discount, I don't want to add to my position unless the stock is also trading at undervalued yield levels. CMI now yields 3.15%, whereas I'd like to see a yield closer to 4%.

Discounted Stocks

I prefer to buy stocks when they're available at discounts of at least 10%. Here are the top ten discounted dividend growth stocks in my portfolio:
All ten of the top discounted stocks are discounted by at least 10%, but only seven of them have at least 5-star ratings.

I already mentioned CVS, CMI, and CMCSA.

AT&T (T) now yields 6.12% at $32.67 per share. In July I added 120 more shares, increasing my position to 400 shares. My average cost basis is $32.67, which happens to be what T is trading for now. I'm happy with my T investment and the fact that the stock is projected to delive annual dividends totaling $800!

Walgreens Boots Alliance (WBA) yields 2.54% at $69.28 per share. Annually, WBA will contribute $352 to DivGro's dividend income. At 1.95% of portfolio weight, I'm happy with the size of my WBA position, so I'm not interested in adding more shares at this time.

Altria (MO) just increased its dividend by 14.29% and now yields 5.47% at $58.45. My MO position is 1.45% of total portfolio value, so unless MO falls to below $51 per shares, I won't be adding more shares.

Finally, Starbucks (SBUX) has recovered a little to $53.05 per share, which is still well below my cost basis of $55.93. With my focus on reducing portfolio risk, I'm not going to look at the yield channel chart of SBUX this month (as mentioned last month). Instead, I'll do so in September's edition.

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

Last month, 24 dividend growth stocks traded at a discount to fair value, versus 29 stocks this month.

Position Sizes

I like to look at the relative size of positions in my portfolio because stocks that are underweight are good candidates for further investment. While I prefer to see a more balanced portfolio, I sell covered calls on select dividend growth 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 call trading.

I consider positions with weights less than 1% as underweight positions and therefore good candidates for further investment. In the chart above, the underweight positions are shaded light green.

Another way to look at position sizes is by proportional yield, which gives a completely different perspective! Omega Healthcare Investors (OHI) dominates with more than 6% of DivGro's yield, followed by Main Street Capital (MAIN) and Qualcomm (QCOM).

In the next few months, I'd like to reduce DivGro's overall risk profile, and addressing the imbalance of yield contribution is one way to reduce overall risk.

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% level orange. These are stocks with poor recent performance.

Microsoft (MSFT), T. Rowe Price (TROW), and UnitedHealth (UNH) are all trading near their respective 52-week highs.

In contrast, T, Illinois Tool Works (ITW), and CMI are trading near their respective 52-week lows.

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 these returns exclude dividends.

Three stocks stand out in this chart, TRWO, Valero Energy (VLO), and Ross (ROST). These stocks have performed exceptionally well in the past year compared to their annualized 5-year performances.

On the other hand, CMCSA, Hannon Armstrong Sustainable Infrastructure Capital (HASI), and WBA have performed rather poorly in the last year.

Reducing Risk

One way to reduce portfolio risk is to decrease exposure to riskier stocks. Of course, riskier can mean different things, such as the tendency of stocks with higher volatility to fall further and faster if the market as a whole falls. In this case, avoiding stocks with high beta coefficients should decrease portfolio risk. 

For dividend growth investors, dividend safety is an important metric. Investing in safer dividend-paying stocks should reduce the likelyhood of dividend cuts, which often are accompanied by severe stock price declines. 

Simply Safe Dividends provide Dividend Safety Scores with a great track record of predicting the likelyhood of dividend cuts. Created by Brian Bollinger, the scoring system analyzes each company's most important financial metrics (payout ratios, debt levels, recession performance, and much more) to determine the likelihood of a dividend cut. 

Below is an extract of evaluation metrics for dividend growth stocks in my portfolio, as provided by Simply Safe Dividends. Holdings are sorted by increasing dividend safety scores.

Not surprisingly, some of these Very Unsafe and Unsafe holdings are high yielding stocks!

Based on this asssessment (and other  factors), I've decided to close my position in Provident Financial Services (PFS). The stock's performance has been disappointing and I'm happy to part ways, even at a loss of about 10%.

I trimmed my position in HASI by 200 shares in June, and I'm selling another 100 shares to further reduce my exposure to this stock. The sustainable infrastructure REIT seems to be entering a consolidation phase with a likely dividend freeze.

I'm not yet ready to trim my OHI position, but I'll propably do so after securing the next dividend payment on or about 30 October. As mentioned above, OHI's dividend represents more than 6% of DivGro's total dividend income, which seems unhealthy for a stock with an Unsafe dividend assessment. One reason I'm willing to wait is that OHI's stock is trending up nicely. Another is that OHI's beta coefficient is quite low at 0.34.

With the capital I'm freeing up by closing PFS and trimming HASI, I'll be increasing my position in Kite Realty Group (KRG), which is only 0.49% of total portfolio value. Yield has to come from somewhere, and adding to my KRG position (with a Beta of 0.49) will compensate for trimming my 6.24%-yielding position in HASI.

Concluding Remarks

My DivGro Pulse articles are strategy-focused. Usually, I update fair value estimates with the view to identify undervalued stocks suitable for further investment or overvalued positions that should be trimmed or closed.

However, my goal for the third quarter of 2018 is to strengthen my portfolio's risk profile, so I'm presently focusing on reducing risk. To that end, I used the Dividend Safety Scores to identify stocks in my portfolio that have unsafe or very unsafe dividends.

I'm closing my position in PFS and trimming my position in HASI. And I'm planning on trimming my OHI position, probably sometime in November after OHI's next dividend payment. The stock's dividend represents more than 6% of DivGro's total dividend income, which seems unhealthy.

To compensate for the dividend income I'm giving up by selling PFS and HASI, I'm increasing my position in KRG despite its Unsafe dividend assessment. Presently, KRG represents only 0.49% of total portfolio value and delivers only 1.2% DivGro's total dividend income.

Thanks for reading and take care, everybody!