Current Buy Candidates (Updated)

After closer review only the following companies have the dividend growth rates we are looking for:

Name	Yld	2000	2001	2002	2003	2004	2005	2006 E		3 yr avg	5 yr avg
NUVEEN INVEST (JNC)	1.90%	0.41	0.47	0.5	0.56	0.69	0.78	0.93
Annual div increase (%)			14.63%	6.38%	12.00%	23.21%	13.04%	19.23%		18.50%	14.77%
JOHNSON CONTROLS (JCI)	1.50%	0.56	0.62	0.66	0.72	0.9	1	1.12
Annual div increase (%)			10.71%	6.45%	9.09%	25.00%	11.11%	12.00%		16.04%	12.73%
EATON (ETN)	2.10%	0.88	0.88	0.88	0.92	1.08	1.24	1.48
Annual div increase (%)			0.00%	0.00%	4.55%	17.39%	14.81%	19.35%		17.19%	11.22%
UPS	2.00%	0.81	0.76	0.76	0.92	1.12	1.32	1.52
Annual div increase (%)			-6.17%	0.00%	21.05%	21.74%	17.86%	15.15%		18.25%	15.16%
MARATHON OIL CORP	1.70%	0.88	0.92	0.92	0.96	1.03	1.22	1.53
Annual div increase (%)			4.55%	0.00%	4.35%	7.29%	18.45%	25.41%		17.05%	11.10%
CULLEN FROST	2.40%	0.76	0.84	0.88	0.94	1.04	1.17	1.32
Annual div increase (%)			10.53%	4.76%	6.82%	10.64%	12.50%	12.82%		11.99%	9.51%

Some Adjustments

MOSTLY SELLS

There are some adjustments to the portfolio for Friday 29 Dec.

Sold are:

Kraft (KFT) - this was downgraded to a 'sell' a week or so ago by S&P.
BASF (BF) - has had a huge run of 19.5% since October, and looks ripe for a hefty pullback
Marathon Oil (MRO) - an even larger run of 21.4%. Keeping CVX but it is time to lighten up in oils for now.
Microsoft (MSFT) - had a 5% run, but did not increase its dividend rate, so I sold it (on 26 Dec).

Bought were:

Microchip Technology Inc. (MCHP), which looked better in growth and dividend growth prospects than MSFT. Also, it is a tech stock with a current 3% yield. Tech may do well in 2007, and so I bought it (back) on 26 Dec for $33.10.

Took a hedge against the market near term by buying Profunds Ultrashort S&P 500 (SDS), which is a leveraged '2X short' the S&P. This is a minor hedge compared to the overall portfolio, but the stock market is looking pretty tired right now.

CALCULATING PERFORMANCE

It's was a challenge to figure out how to track the portfolio's performance relative to the Wilshire 5000, but once the light bulb (a G.E. 40 watt) lit up, the basic approach was pretty simple: get the Wilshire value for the date each stock was acquired, then calculate the 'weighted' value of the index.

For example, TTH was 5% of the portfolio when purchased, and the closing value of the Wilshire 5000 on the stock's purchase date was 13213.4, so the TTH 'contribution' to our weighted Wilshire computation is 660.17. You then add the 'contributed' values for every remaining stock holding, add them up, and now you have the weighted 'buy' value for the total Wilshire 5000 Index. This value gives you an 'apples to apples' comparison of performance between your portfolio and the performance of the Wilshire 5000 index.

WHAT MAKES IT COMPLICATED

It gets more difficult when you account for stock sales. First, I thought about whether to adjust the Wilshire computation, the portfolio computation, or both.

What if you could calculate a 'weighted' profit on the stock sale and then apply that to the cost basis of the portfolio? You then wouldn't need to adjust the Wilshire computation because the 'Wilshire' adjustment is already reflected via the portfolio adjustment.

For example, BASF profit upon its sale was 19.48%. Remember we noted the Wilshire value at time of acquisition. What was the Wilshire 5000 initial value and its subsequent 'return' for the same period we held BASF? It was 5.65%. When we subtract that return from the BASF return, we get an adjusted return of 13.83%. This percentage return is then applied to the cost of the BASF stock. The resulting profit amount is the amount of profit that exceeded the Wilshire 5000. By subtracting that amount from the current cost basis of the portfolio, the 'outperformance' is captured in the overall portfolio return. Pretty cool.

ODDS AND ENDS

Great Article from Miller/Herman on Dividends

Some more potential buy candidates:

Arthur J Gallagher & Co. (AJG) 4% yld

Angelica Corp. (AGL) 1.7% yld

Pacer International Inc. (PACR) 2% yld

UGI Corp. (UGI) 2.6% yld

Linear Technology Corp. (LLTC) 2% yld

Xilinx Inc. (XLNX) 1.5% yld

QUALCOMM Inc. (QCOM) 1.3% yld

Syngenta AG (SYT) 2.1% yld

The Crystal Ball - 2007

Here are a few thoughts about what I think may drive financial markets in 2007.

Currencies

The free-floating currency system has been relatively stable, but Thailand has been in the news lately with the Government trying to stop the rise in the baht. It sent their markets crashing and sent a shudder through world markets. I think that was a "sneeze." A much darker scenario could materialize in 2007.

What could precipitate the disaster? How about China 'diversifying' its currency holdings out of the US$? The weak dollar (so far) has been perceived as a boon to U.S. exporters - they can sell their products cheaper, meanwhile imports in the US cost more. This drives more consumers to buy from US firms instead. Sounds good, right? The markets have voted with a large rally late this year. But, what happens if the dollar goes into a 'free fall' in 2007?

First, what happens to the value of foreign debt after the lower currency translation? Foreign holders sell to stem losses, driving bond yields higher and stocks lower. US consumers will pull back on spending, and the world economy 'catches a cold.' America's overall debt owned by foreigners totals about $3 trillion, so the effect is not insignificant.

What would precipitate a 'free fall' in the dollar? Here's a laundry list which, if they all hit at the same time, could create a 'perfect storm' of global proportions.

(1) Foreign Governments allow their currencies to rise relative to the dollar. China, for example has already decided to 'diversify' its economy by moving more out of dollars. While Thailand demonstrates that doing the opposite (allowing the home currency to rise and hurt exports) won't sit well with the folks back in Thailand, major emerging economies such as China and India have more latitude to allow their currencies to rise without harming economic growth much.

(2) Slowing US economy - Slower economic growth is predicted for 2007. Helicopter Ben decides to loosen rates, which is normally good for bonds, but bad for the dollar. The lower dollar squeezes export growth in foreign economies, while at the same time offsetting US bond gains for foreign holders of US debt. Critical mass is reached when US rate cuts do not result in bond gains, setting off panic selling in the bond markets, and sending the dollar even lower.

(3) Housing slump - 2007 may be when the real pinch begins. This may be the main culprit for the slower economic growth.

Government

If there is stabilization in Iraq, the spending now going to fund the war would be stopped or reduced. Apart from Iraq, there is rhetoric from the Democrats about fiscal restraint (yeah, right) but since they are barely clinging to power it is not out of the realm of possibilities. These events could add up to a change from the recent recklessness in Government spending - obviously that would be very good for financial markets and very supportive of the dollar.

The Trend to Watch in 2007

2007 may mark the year investors realize how the aging baby boomer demographic impacts stock selection for those massive retirement portfolios. Yes, you guessed it. It's all about income. It won't be all in bonds - a lot will be in income producing stocks.

2006 marked only the beginning of a mega trend (that means it could last 10 years or more) powering dividend-paying blue chip stocks. The quality ones (translation: the ones that are increasing their dividend payouts and buying back stock) already started moving up in 2006.

I predict that over the next ten years that trend will accelerate significantly, and will accelerate so much that investors will have to pay close attention so that payout ratios of these stocks don't get too high.

Many of these companies are defensive in nature, and will have more staying power through either recessionary or inflationary periods. Dividend yields will ensure a higher floor in the event of a major correction or crisis.

A Short List

Finding Gems

Consider the number of companies that regularly raise their dividends. Then consider how many have done so over a long period of time. The list isn't very long. Then, consider how many of them have both good earnings quality and payout ratios that are sustainable. Then the list gets really short.

A big limiting factor is that a number of companies have had to cut their dividend at some point. This action, while sometimes necessary to preserve cash flow, says a lot about management's perception of the stability of cash flow and earnings. Contrast this with a company with a year or two of losses, but whose board decided to keep paying the existing dividend until earnings returned. The latter case says a lot about how management views shareholders.

The current portfolio has most of the best that meet this criteria. I only found a few companies remaining that are considered good candidates for future purchase. Anyone who has suggestions for more that are missing from the list or portfolio, please send them. I welcome your input!

Here is my current buy candidate list:

Brinker (EAT) - Best of the restaurant group; not the greatest yield, but we want restaurant coverage and this one is the best; I would have picked McDonald's (MCD) but for the huge run it has already had (in part due to its large dividend increases). If the stock price falls back MCD would then become the preferred choice.

Omnicom (OMC) - Great ad firm; also has a stingy yield, but is a quality company and it is increasing dividend payouts.

Universal Corp (UVV) - We currently own Altria (MO) so buying this leaf tobacco co. might be redundant, but if later we are inclined to buy more Altria, we'd pick up this one instead.

Carlisle Companies Inc. (CSL) - Quality conglomerate, like the above picks, has reliable earnings and shareholder's interests in mind.

We have good bank coverage, but also like Cullen/Frost Bankers Inc. (CFR) and Citigroup (C).

Some others I really like, but would not buy just yet are:

Nuveen Investments Inc. (JNC), FPL Group Inc. (FPL), Laidlaw International Inc. (LI), Johnson Controls Inc. (JCI), Eaton Corp. (ETN), and Eni SpA (E).

Where to Check for Dividends

Yahoo Finance lets you screen for dividends using its 'price history' area.

For example, here is a link to Citigroup's history.

In the box entitled "SET DATE RANGE," select the radio button for "Dividends Only." Now you have the company's dividend history.

These Don't Quite Fit

I just added Ford (F) to the portfolio. It is the smallest holding and I bought it as a turnaround play. They have cut their dividend a number of times, so it doesn't really fit our approach very well, but we're going to give it a (small) chance.

The telecoms have had a checkered past, particularly when it comes to dividends. But I needed to ensure we had this sector covered to ensure the portfolio has adequate diversification. The ETF approach fits the bill here. Telecom HLDRs (TTH) top ten holdings consist of (thanks, Yahoo!):

Name, Symbol, % of Portfolio
ALLTEL CP, AT, 3.16
AT&T INC., T, 31.29
B C E INC, BCE, 3.85
BELLSOUTH CP, BLS, 19.99
CENTURYTEL INC, CTL, 1.18
EMBARQ CORP, EQ, 1.18
QWEST COMM INTL INC, Q, 3.31
SPRINT NXTEL CP, S, 9.17
TELEPHONE + DATA SYS, TDS, 1.45
VERIZON COMMUN, VZ, 23.81

The dividend history is a bit erratic, but buying this ETF was the best dividend approach I could find for telecom coverage. Here is the dividend history for TTH:

2000 $0.71
2001 0.88
2002 2.84
2003 0.99
2004 2.21
2005 1.15
2006(Est.) 1.27

Certainly holding TTH (as well as Ford) adds a bit of instability to the mix at least from a dividend cash flow point of view. Daimler Chrysler (DCX) is probably the better play, but the U.S. auto industry is overdue for improvements, and Ford would be the largest benefactor of that trend in my view. Certainly you don't want to bet the farm. Delta Airlines was cheap at $0.70, but I only bought 900 and unloaded it at around $1.20. Things like Delta and Ford are just not something you hold onto very long or sink a lot of money in.

Motley Fool's take on 'dividend growth'

Motley Fool wrote up our approach back in 2002. They cover the idea pretty well. Also there are some good articles from Statesman.com and Investment U.

Why 'Dividend Growth' Stocks?

The purpose of this blog is to illustrate the benefits of selecting stocks for their dividend growth characteristics, and a way to track my performance over time.

What is 'dividend growth' exactly? It is quite simply selecting investment candidates based on the rate at which a company increases its dividends over time. It is easy to oversimplify by considering 'dividend growth' to be the only criteria, but as with all things Wall St., nothing is ever quite that simple.

I am a strong advocate of using the quality ratings of Schwab and especially S&P as a gauge of stock quality.

Rules – running the portfolio has some rules. The good news is they are easy to follow.

1) Stick with what you know. If you understand what the business does, particularly if it sells a tangible product (diapers) or understandable service (payroll processing) you meet this simple rule.

2) Quality – two measures. One is the S&P rating, and the other is the Schwab rating. Both are found on Schwab.com. The more important rating is S&P. S&P rates stocks from 1 star to 5 stars. You want 4 or 5 star companies. Sometimes an exception can be made to buy a 3 star, for example when Schwab rates the same stock as an “A” or “B”. Ideally the stock has 4 or 5 stars from S&P AND it is rated “A” or “B” by Schwab. These are guides. Use judgment in applying them. After all, the ratings themselves constitute a subjective judgment. S&P does a very good job though, and I can trust how they arrive at their ratings. Just read one of their reports and you will see.

3) Diversification – ensure you have at least 25 holdings that are diversified across all major economic sectors. Those are industrial, consumer, banking/finance, insurance, utility, foreign, telecom, materials, energy, and technology. The goal is to consistently outperform the broad market, as measured by the Wilshire 5000 index.

The most important rule is to select only companies that have good dividend growth. It is not just about selecting a company that pays a good dividend yield. In fact, low or high yield doesn’t matter very much (although 1.5% is a good minimum goal for initial yield). The idea is to earn higher and higher yields on your original investment over time. You may start out with a yield of around 3%, but five years from now the yield should be 5-6%, and in ten years 11-12%, and that is not counting unrealized capital gains. Collect dividends in cash - do not reinvest. Then, once you have collected $4-6,000, buy another stock or more of what you already have, using these criteria (revisit your diversification). Tax law favors dividend stocks. Dividends are taxed as regular income (not at a higher capital gains rate). You should not have to ever sell, but consider selling if the dividend growth rates slows a lot, or stops, the payout is more than the company’s income for three years in a row, or the company's long term prospects are diminished.

This is a real portfolio. Most of the positions were taken at the beginning of Oct 2006, and as you can see below, we have an unrealized gain of over 6% (as of 15 Dec 06). I'd like to take all the credit for that gain, but as you probably realize, it is largely a function of the stellar market performance we've had since October. The blog will track its performance, and any changes/additions made.

Here's the portfolio (prices and other calculations update every 5 mins during market hours, just refresh your browser):



And, here are the names and details for those companies (thanks to Yahoo!).

I hope you follow me on this journey. It may even be fun!