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Wednesday, September 26, 2018

DivGro Pulse: September 2018

I write monthly pulse articles that are strategy-focused and monitor the health of my portfolio. My overall aim is to reduce portfolio risk and to further diversify DivGro's holdings.

In the third quarter of 2018, I'm focusing specifically on strengthening my portfolio's risk profile. To that end, I'm closing or trimming riskier positions, looking to diversify across all sectors, and adding higher quality stocks.

I update the fair value estimates and rank the dividend growth stocks in my portfolio. Stocks that are fundamentally sound, yet undervalued, are candidates for further investment. Poor-performing stocks with low rankings probably should be sold.


In last month's edition, I looked at reducing portfolio risk by decreasing my exposure to stocks with Unsafe or Very Unsafe dividend safety scores (as assessed by Simply Safe Dividends). As a result, I closed my position in Provident Financial Services (PFS) and further trimmed my position in Hannon Armstrong Sustainable Infrastructure Capital (HASI) by 100 shares.

I'm planning on trimming my position in Omega Healthcare Investors (OHI) and I'll probably do so in November after securing OHI's next dividend payment. The stock's dividend represents more than 6% of DivGro's yield, which I consider unhealthy for a stock whose dividend is deemed Unsafe by Simply Safe Dividends.

In addition to reducing my exposure to riskier stocks, I'm also looking to add high-quality dividend growth stocks and to increase DivGro's sector diversification by considering top dividend growth stocks by sector.

Quality Stocks

I routinely rank the dividend growth stocks in my portfolio to see if any of highest ranked stocks are trading at a discount.

My ranking process uses data in the CCC spreadsheet and additional sources like Finviz.com, Morningstar, F.A.S.T. Graphs, finbox.io, and Simply Safe Dividends. It favors established dividend paying stocks with strong fundamentals and stocks potentially trading at or below fair value. Dividend safety is another important factor.

A byproduct of my ranking process is a 7-star rating. Based on past experience, I consider stocks with 5-star ratings or better worthy of further analysis.

Here are the top ten ranked dividend growth stocks in my DivGro portfolio for September 24:

Comcast (CMCSA) • Discount14.16%  • rank   #1 •  ✭✭✭✭✭✭✭
Lowes's (LOW) • Premium  9.63%  • rank   #2 •  ✭✭✭✭✭✭✭
Ross (ROST) • Premium19.36%  • rank   #3 •  ✭✭✭✭✭✭✭
Texas Instruments (TXN) • Premium  3.85%  • rank   #4 •  ✭✭✭✭✭✭✭
TJX (TJX) • Premium13.97%  • rank   #5 •  ✭✭✭✭✭✭✭
Home Depot (HD) • Premium10.24%  • rank   #6 •  ✭✭✭✭✭✭✭
UnitedHealth (UNH) • Premium  4.89%  • rank   #7 •  ✭✭✭✭✭✭✭
Cummins (CMI) • Discount15.47%  • rank   #8 •  ✭✭✭✭✭✭✭
Illinois Tool Works (ITW) • Premium  3.84%  • rank   #9 •  ✭✭✭✭✭✭✩
Hormel Foods (HRL) • Premium16.84%  • rank #10 •  ✭✭✭✭✭✭✩

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 MorningstarFinbox.io, and ValuEngine.

This month, eight stocks earned 7-star ratings and only two are trading at discounts to fair value. These are Comcast (CMCSA) and Cummins (CMI).

I'm currently reviewing my ranking system. While I'm confident that it does a good job ranking most stocks, it does not rank REITs (real estate investment trusts) well enough and especially not relative to other stocks. For REITs, there are more appropriate metrics to consider, including NAV (net asset value) and FFO (funds from operations).

Another issue with my ranking system is that it conflates quality, safety, growth, and valuation measures. So, for example, highly discounted stocks sometimes will rank higher than fairly-valued but higher quality stocks. I think ranking stocks purely based on quality, safety, and growth metrics would be preferable.

Excluding valuation would allow me to determine what to buy regardless of valuation. Then the question of when to buy can be based on valuation. (I'd like to thank one of Seeking Alpha's contributors, Robert Allan Schwartz, for so simply stating this two-step process in a comment on one of my recent articles).

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:

Kite Realty Trust (KRG) • Discount31.37%  • rank #60 •  ✭✭✩✩✩✩✩
CVS Health (CVS) • Discount16.80%  • rank #13 •  ✭✭✭✭✭✭✩
Cummins (CMI) • Discount15.47%  • rank   #8 •  ✭✭✭✭✭✭✭
Comcast (CMCSA) • Discount14.16%  • rank   #1 •  ✭✭✭✭✭✭✭
AT&T (T) • Discount13.06%  • rank #44 •  ✭✭✭✭✭✩✩
Omega Healthcare Investors (OHI) • Discount11.63%  • rank #58 •  ✭✭✭✩✩✩✩
Altria (MO) • Discount11.03%  • rank #33 •  ✭✭✭✭✭✩✩
Walgreens Boots Alliance (WBA) • Discount  9.87%  • rank #28 •  ✭✭✭✭✭✭✩
Verizon Communications (VZ) • Discount  8.04%  • rank #43 •  ✭✭✭✭✭✩✩
AbbVie (ABBV) • Discount  7.98%  • rank #41 •  ✭✭✭✭✭✩✩

Seven of these top discounted stocks are discounted by at least 10%. CVS Health (CVS) is the highest ranked stock outside the top ten ranked stocks that's trading at a healthy discount to fair value.

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, 29 dividend growth stocks traded at a discount to fair value, versus 21 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.

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.

Medtronic Plc (MDT), Cisco Systems (CSCO), and Microsoft (MSFT) are all trading near their respective 52-week highs. In contrast, AbbVie (ABBV), 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, Qualcomm (QCOM), Nike (NKE), and TJX (TJX). These stocks have performed exceptionally well in the past year compared to their annualized 5-year performances. On the other hand, HASI, NVIDIA (NVDA), and General Dynamics (GD) have performed rather poorly in the last year.

The reason I consider recent performance is two-fold. Stocks like QCOM, NKE, and TJX may be significantly overvalued, presenting an opportunity to trim or even close these positions. Conversely, stocks like HASI, NVDA, and GD may be undervalued (or troubled). Understanding why shares are pulling back is helpful in determining next steps (if any).

Positions to Trim?

Apple (AAPL) popped up on my screen of positions to consider trimming.

AAPL is a Dividend Contender with a track record of 7 years of higher dividend payments. The stock yields 1.32% at $220.79 per share and has a 5-year dividend growth rate of 26.6%.

At 3.15% of portfolio value, AAPL is one of my larger positions. The stock is ranked #15 this month and earned a 6-star rating. In the past year, AAPL has performed well compared to its annualized performance over the past five years. In fact, it is one of the best performers among my dividend growth stocks in this regard. Additionally, the stock is trading only about 10% below its 52-week high.

I'm not willing to trim or close my position at this time. I think AAPL has more room to grow, despite gaining more than 10% since becoming a $1 Trillion market cap company. Growth drivers include the increasing iPhone ASP (average share price) and the continued expansion of the company's services and "other" segments.

Given AAPL's plan of returning cash to shareholders, I want my (small) share of that cash rather than to forego it. And if the company decides to winnow down its cash pile, there's a lot more cash to return before becoming net-cash neutral!

New Positions

Earlier this month, I opened new positions in Home Depot (HD), Honeywell (HON), Union Pacific (UNP), and Visa (V) — all high-quality dividend growth stocks with Very Safe dividends according to Simply Safe Dividends. My investments are relatively small and I consider the positions starter positions, as these stocks are not available at my preferred discount of at least 10% to fair value. 

To pay for these investments, I closed my somewhat larger position in Anheuser-Busch InBev (BUD) for a loss of about 14%. The stock's performance has been rather disappointing, so I'm happy to exchange it for the four abovementioned dividend growth stocks. 

Another addition to my portfolio is Simon Property Group (SPG). I've been looking to open a position for a while and the recent pullback provided an opportunity to buy shares at a small discount to fair value. In exchange, I closed my Vanguard Real Estate ETF (VNQ) position for a small gain of 3%. SPG is a high-quality retail REIT yielding 4.5%, with an A-rated balance sheet and growth expectations of 8% (in funds from operations) in 2018.

Concluding Remarks

My DivGro Pulse articles are strategy-focused. I monitor the health of my portfolio and update fair value estimates. I also monitor the performance of individual stocks. Stocks that are fundamentally sound, yet undervalued, are candidates for further investment. Poor-performing stocks with low rankings probably should be sold.

In the third quarter of 2018, I'm focusing primarily on strengthening my portfolio's risk profile. I added high-quality dividend growth stocks like HD, HON, UNP, V, and SPG and got rid of the poorly-performing and somewhat riskier BUD.

DivGro now consists of 72 positions, including 60 dividend growth stocks, 5 dividend-paying stocks, 5 non-dividend-paying stocks, 1 closed-end-fund, and 1 exchange-traded fund.

Thanks for reading and take care, everybody!

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