Special Dividends, 2008 Forecast, Adding Portfolio Income

'Tis the season for special dividends. These one-off wonders are often used to distribute capital gains or otherwise to reward shareholders at the end of the year.

We choose to exclude these from our QDV and yield calculations, because they should not be counted on as regular dividends and to include them would distort what is happening to growth of the regular dividend. One should pay close attention to the classification of special dividends as well, meaning their tax treatment. They may or may not qualify for the lower tax rate, particularly if it is a return of capital.

Last January, I made a prediction for end of year yield on the dividendsrus portfolio, which was 3.8%. Well, we came up a bit short at 3.53%, at least as of today. No excuses, but an explanation is in order. Partly this shortfall resulted from too much portfolio turnover in 2007. Also, when we make new investments to the portfolio, these are obviously placed at an 'initial' (and usually lower) rate -- ditto when adding to existing positions. At any rate, this year we will have to restrain our optimism by discounting for these two factors. The good news is that nominal cash flow will still be increasing at an accelerated rate due to the underlying dividend growth. For example, we looked at our annualized trailing dividend cash flow ending November 2007 and compared it with November 2006. It is 27.5% higher despite the fact that portfolio yield increased “only” to 3.53% today.

If end of year yield on cost is 3.53%, and portfolio QDV is around 21%, then the indicated yield at the end of 2008 should be about 4.27%. But this assumes we do no transactions and do no reinvestment of dividend income. So, we will have to make some kind of adjustment that assumes some turnover rate, and assumes a 'reset' yield average for new investment. Further, we will have to adjust for added investments. So, we will scale back our forecast for indicated yield to 4% for the end of 2008. We’ll see if we can do better next year. Of course, 2007 was not really a bad year at all, despite the housing turmoil.

Finally, one strategy you may wish to consider for conservatively adding income to your portfolio is to write out of the money calls against it.

It would work like this -- say you have a diversified portfolio worth about $150K. You would write SPY (S&P 500 index ETF) calls against the total value of that portfolio. If SPY is trading at $148 a share, then 1000 shares of SPY ($148K) is approximately equivalent to that portfolio value. The strategy is to write ‘far-out-of-the-money’ calls each month for additional modest income. Today, SPY closed at about $148. Jan calls expire in about 28 days. If you review SPY's trading history, you will see that it rarely moves more than 5.5% within a 28 day period. So, if you write (short) calls at $156 (which is around 5.5% higher than SPY is today), they will most likely expire worthless by January's expiration. That means you get to keep the option premium. Since the current bid for Jan 156 calls is around $0.28, and the hypothetical portfolio is equivalent to 1000 shares of SPY, you could write 10 contracts with a total value of $280. That amount would be credited to your account, and become your income if those contracts expire worthless.

One big issue with this strategy is that you do not actually own SPY, and so most brokers will not allow you to write 'naked' calls on it, even though your portfolio is a close facsimile.

Assuming you can get some latitude your broker might allow you to write call spreads first. This approach is not nearly as attractive. In this case, you would be forced to take another action. You would have to buy an equivalent number of calls against the calls you wrote, at a higher strike price. This will reduce your income. In this example, you might buy a spread $5 higher than the Jan 156 calls you sold. So you would buy 10 contracts of SPY with a strike of $161 (156 + 5). Fortunately, they cost you only $0.04, but it still reduces your income by $40, and now you have to make two trades, with two commissions. So instead of $280 in income, you have $280 - $40, and then about -$45 more in commissions, so your income has been reduced to around $195 (then as the final insult, that amount gets taxed). The reason your broker prefers this is that your potential loss is limited to the $5 difference in the spread, whereas using the first strategy without the spread opens you to 'potentially unlimited losses'. Actually, that is not the case as we will soon see.

About the risk of writing naked calls -- If for some reason the stock market rockets 10% in one month, you are basically giving up 4.5% of your portfolio's move via the loss on the short calls, but you will have also made 5.5% on the underlying portfolio (10% - 4.5% loss on the options) assuming your portfolio has a high correlation to the index. It had better if you are considering this strategy. In the event you get 'assigned' while naked, which means you do not own the underlying stock, your broker will short 1000 shares of SPY, using your margin account, so he can deliver the called shares. You will then be short 1000 shares of SPY, and have a neutral market position (long the value of your portfolio, and short a roughly equivalent amount of SPY). By the way, if the market has moved up that far and that fast, maybe it would be a good thing to be hedged.

If you decide instead to just write calls on each of your individual stocks, you will have even more transaction costs to eat up your profits, plus the volatility of individual stocks is so much higher. Chances are higher that some of those stock positions will be called away.

I think the only profitable way to make money at this is to do the spreads for a period of time, then request and obtain broker approval for a higher risk level to write naked calls. Then, it will be a single transaction with only one commission. The point here is that using options this way can generate some modest additional monthly income, and can be used to effectively increase the portfolio yield. If you have a $150K portfolio earning 3.5% in annual dividend income ($5,250), then you could be adding around $2400 which would increase your portfolio yield to about 5.1%.

Is the risk, not to mention the accounting and tax hassles, worth doing it for? Maybe yes, maybe no, but it certainly is a viable approach for conservative investors who can tolerate the risk.

The "R" Word

There sure are a lot of internet 'experts' calling for recession, if not the end of the world as we know it.

Certainly recessions happen from time to time, and yet from a long term perspective, they are rare events. The saying 'this time it is different' applies somewhat, because we have never had a slowdown of global proportions in the global economy. Sure the Great Depression had a global impact, but the world was not as interdependent as it is today.

It's almost as if people tried to assign to the whole U.S. real estate market a single direction, while not taking into account that each region has different economic and demographic conditions driving supply and demand. Wait minute...people have been doing that.

Anyway, I think the global economy is the same way. Yes, we are interdependent, but as long as we have sovereign nations, there will be sovereign economies with different economic goals, priorities, demographics, and demands.

Practically speaking, I do think the economy is vulnerable right now, but I would not state that we are in a recession...not yet. If you study longer term stock trends, it does not appear the bull is dead yet. It is a time to watch carefully and assess what is happening, and also prepare in the event it does happen. That does not mean to run to the hills, but it does mean exercise some caution.

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More Buys Amidst the Carnage

Picked some more small stakes over the last few days, but I haven't had time to update the portfolio yet. Added were American Capital Strategies (ACAS), Carnival Cruise Lines (CCL), and Federated Investors 'B' (FII).

Watching the long term trend. Technically, we have not yet entered bear market territory, but it is at the point that I am checking my long term charts daily. Until Mr. Market tells me otherwise, I will grin and bear it!

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Preparing for 2008

This is a good time to make final adjustments for next year's portfolio composition. Added were Eaton (ETN, QDV 15.35%), Greif (GEF, QDV 45.17%), and Steelcase (SCS, QDV 36.32%). We added to our positions in Altria (MO) and Eaton Vance's Global Dividend ETF (ETO) as well.

It's comforting to have a diversified portfolio with an average dividend growth rate of over 20% per year. In the unfortunate event that we have a recession in 2008, the dividends and the defensive tilt of the holdings will make the pain a bit more "bear"-able.

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New Adds - PCU and AEO

We owned Southern Copper (PCU, QDV 29.5%) before and made a lot on it. Well, after the very large pullback, this looks like an entry point for this VERY volatile stock. Also, we have been waiting for a long term entry for American Eagle Outfitters (AEO, QDV 27%) and this looks like the time.

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Achieving Balance of Cash Flow and QDV

Ideally you want to have stable, regular, and growing cash flow from your stock holdings.

The first step in doing that involves evaluating the timing of (mostly) quarterly dividend payments.

First, a bit of background...companies first declare the dividend. They identify the record date, which is the date by which one must be a shareholder of record in order to receive the dividend, they identify the ex-dividend date, which signifies that the market price of the stock now reflects payment of said dividend to shareholders, and they identify the payment date. It's a good idea to check whether your broker is actually crediting your account on the same day as the payment date.

Identify for each holding the payment date, and which of three quarterly cycles it belongs: Jan/Apr/Jul/Oct, Feb/May/Aug/Nov, or Mar/Jun/Sep/Dec. More companies prefer that last cycle since it aligns with the end of the calendar year. But, there are still many that pay during the other two cycles.

Once you identify the holdings in each of these three groups, then compute how much in dividends is paid out in each, and then total them for each group. Ideally, you want the total in each group to be as close to equal as possible. It doesn't mean to select stocks based solely on this criteria, but it is a consideration.

The second step is to look at average QDV for each of the three groups. Why? Because if the payment stream is close, you also want the growth rate of that monthly stream to be close as well. In other words, you want the increases to be at about the same rate.

Compute a "weighted QDV value" based on the "dividend contribution" for each holding as a percentage of the total dividend contribution of each of the three groups. Ideally, you want the QDV for each of the groups to be as close as possible.

If you can achieve this balance as you build the portfolio over time, cash flow becomes much more predictable. You can then apply portfolio level QDV to predict average monthly growth in dividend payments with a higher degree of accuracy.

The ultimate benefit is that when you retire, you will have a predictable and growing income stream.

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Some Small Cap Finds

You have to look hard, but if you do you can find some fine little companies with excellent dividend growth. Today we added Movado Group (MOV, QDV 27.5%), Applied Industrial Tech (AIT, QDV 15.1%) and Manpower (MAN, QDV 16.3%). We also added to our position in Bank of America (BAC) as it has much less exposure to the riskier side of the financial sector and is a solid, globally diversified company. It is now our top holding with GE a close second.

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Raising More Cash

Today we sold three positions. First was Wrigley (WWY). A great company, and pretty decent but not high QDV of 12.6%. After a rapid run came the sell recommendations from S&P and Goldman, so we took decent profits of around 19% plus dividends. We will look to reacquire as we think prices will trend lower over the intermediate term.

Next was Meridian Bio (VIVO) which has had a spectacular run, but we were getting concerned from a valuation perspective. At over 10X sales, price to cash flow of 54, and dividend payout of over 70%, we decided to cash out here. Great company with great growth and high QDV, but it is looking a bit rich here.

Finally, we unloaded Merrill Lynch (MER), which we though was bought cheap last week, but as you may have heard, has a lot of loan losses coming, and far more than anticipated.

Our cash position now stands at around 24%.

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Revisiting the Rules

With any investment approach, there needs to be some rules. This helps to temper the emotions. We stated our rules at the outset. Since we have made it through the first year, let's revisit those rules and try to expand on them a bit more.

1. Stick with what you know. Basically we should know what the business does. This is known as the "Warren Buffet" rule. His basic philosophy was that "if you don't understand what the business does, why would you invest in it?"

2. Quality - Good measures of quality are hard to find. Wall St. research is extremely biased since their motives are impure. The purpose of those firms is to promote the purchase of stocks since these same firms underwrite what is sold. Most short side research is done by smaller independent firms. A few well-known firms are generally considered more reliable, such as S&P and Schwab. I trust them more, but still you have to be careful how you treat the information. And unfortunately, not all firms we are interested in are covered. Most common of these are smaller companies. We are finding some of the high QDV stocks lack coverage. This means we have to be more selective, and it means we take smaller positions and build them slowly over time if/when they prove worthy, as evidenced by price and dividend appreciation. For Schwab, "A" and "B" ratings are preferred, and for S&P, 4 or 5 "Stars" is preferred. Ideally, you like to see both, but outside of the large caps, you are lucky to get one or the other.

3. As we stated at the beginning, 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. We are having some difficulty following this rule of late. Some sectors do not have a history of growing dividends, at least not at the rate we are looking for. Telecom performed very well over the last 12 months, and we made a lot, but the companies comprising the Telecom HLDRs (TTH) just don't grow their dividends. This is a real Hobson's choice, since if we hadn't broke our rule on dividend growth, we would not have captured the appreciation and yield over the last 12 months. We are currently looking at a couple of small and new issue telecoms, which will be a better trade-off. We would rather have firms that are growing dividends and sacrifice not having more dividend history, then to stay with those that have demonstrated they will not increase dividends at an adequate rate. Utilities pay higher yields, but they tend to grow at a lower rate. Right now two utilities we own are ONEOK (OKE, QDV 14.5%) and Entergy (ETR, QDV 9.7%). This looks a bit light since many other sectors have companies with 20+% QDVs, but this is a trade-off to have adequate diversification across sectors. This is the most difficult rule to follow, since there are trade-offs.

4. This brings us to rule four, which is the most important rule - own only companies that have good dividend growth. We have invented the term "QDV," or Quarterly Dividend Velocity to better measure the rate at which companies increase their dividends over time. Our portfolio now lists QDV for every holding, and now lists QDV at the portfolio level. The benefit of doing this is that it allows you to better estimate dividend cash flows in the future, and it focuses your attention on what is most important. If a company's QDV drops too much, you investigate why and if necessary, sell the stock, particularly if you can find a similar one with a higher QDV.

Certainly QDV alone is not going to do it. Two important indicators to weigh are payout ratios and cash flow. Why? Because they are essential in measuring the likelihood of continued dividend increases. For example, is cash flow and profits keeping up with the rate of dividend increases?

5. I am adding a fifth rule, which is long term growth. Does the stock price have a strong long term growth trend? Particularly if it has a long trading history. The idea is that if the company is doing such a great job growing earnings, cash flow, and dividends, then the stock market should be increasing the value of those cash flows over time. Ideally you want the market trend to confirm the company's prospects. A dividend investing approach is usually considered to be a "value approach," but in practice it is really just about growth. We just think that a good portion of that growth should be passed on as shareholder cash flow.

I hope this helps you with your strategy. The point is to have a plan and to follow it as closely as possible.

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More Activity

Picked up small positions in Merrill Lynch (MER, QDV 32.69%), Pepsi Bottling Group (PBG, QDV 28.41%), Buckle Inc (BKE, QDV 41.1%), and Republic Services Group (RSG, QDV 17.67%). None have very high yields, with BKE the highest at 2.4%. But they all have great dividend growth rates and all have good long term growth trends. They also have good quality rankings from either S&P, Schwab, or both.

I didn't get the best prices of the day, which affirms that my timing pretty much sucks.

Cash position is now around 17%.

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Lots More Adjustments

In keeping with our focus on stocks with high QDVs and good growth prospects, we sold more positions into this rally. Sold today were PEY, UPS, C, TTH, and TCHC.

Some random thoughts...

I have noticed that the participants in this recent move up have been a selective group, and our relative performance has suffered.

Still, this trimming is a healthy approach and the result is that we have now a "weighted QDV" of 21%. In other words, at the portfolio level dividends are growing at greater than a 20% annual rate.

It's not easy to find high QDV candidates that are also not trading at too high a premium; not without venturing into much smaller cap companies. I don't mind doing that some, but I won't risk much capital for them. And, we already hold more than a few small caps.

It was a difficult decision to sell our Telecom HLDRs ETF (TTH), because it has been a great performer and has had a decent yield. But, if our policy is to stick with dividend growers, TTH is just not a viable candidate. Frankly, none of the telecoms have a decent track record when it comes to growing much less maintaining dividends. This is unfortunate since we lose some sector diversification by passing them by.

Also, since selling Chevron, we don't have any energy exposure right now.

Cash position is up to 23.6% right now. We may or may not get a correction, but the market just doesn't seem to be screaming to be bought right now. On the other hand, I really suck at timing , especially short term timing, so I will just buy the best quality QDV candidates and hope the timing is right on at least some of them.

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Buys - Safety Insurance (SAFT) and Oneok (OKE)

Having sold Allstate, Safety Insurance (SAFT) looks to be a superior replacement. It has a higher yield at 4.3%, and a higher QDV of 39.5%. Our second purchase is Oneok (OKE), a natural gas company, which provides a second utility to the portfolio, and it has a decent QDV of 14%. That is great for a utility. It is hard to find utilities that have decent dividend growth rates, probably because they are regulated. Entergy (ETR), which is our other utility, barely reaches a QDV of 10%.

Looks like Yum! Brands beat earnings estimates after the close today, and it is trading higher after hours. China growth looks good for YUM.

But, Microchip (MCHP) warned and it is lower...bought a bit more on the tankage.

The dollar has been getting a good bounce lately...let's see if it continues.

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Raising More Cash

We continue to build up cash and liquidate holdings with lower QDV or less compelling growth in stock price long term. Gone are Kraft and Allstate. Kraft may yet turn into a more robust grower, but with a QDV of only 9% and with the long term trend sideways we took this bounce as an opportunity to exit for now. We will revisit if things improve. Allstate's QDV dropped to 8.5% from over 10% only a few quarters ago, and although it has a long term uptrend, it trades wide and loose. Too bad. It had a pretty good dividend yield.

We have increased our cash position from near zero to around 15% into this rally. There are some excellent QDV candidates out there that we will await attractive entries to add to our leaner portfolio.

On a side note, we are now at our anniversary date from when we started, which was Oct 04, 2006. In actuality, we took a few weeks to build up all of the positions, but we had most of them in place by that time. Anyway, based on unrealized gains and index-weighted realized gains, we have a 20% return on invested capital for the last 12 months. This does not include roughly 3% in dividends. We outperformed the Wilshire 5000 by around 2.5% during the period. In short much of this return is market return, and not anything special we did.

Needless to say, I am happy with how things have turned out so far.

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More on the Dollar

According to Robert Gilpin in Global Political Economy: Understanding the International Economic Order (2001): "Somewhere between 40 and 60 percent of international financial transactions are denominated in dollars. For decades the dollar has also been the world's principle reserve currency; in 1996, the dollar accounted for approximately two-thirds of the world's foreign exchange reserves."

Maybe let's not count out the dollar entirely.

Meanwhile, we are raising dollars into this rally. Particularly, we sold the remainder of Chevron (CVX) and last week we sold KTC Corp (KTC) and Home Depot (HD). We also reduced our holdings in ADP. We think this rally is a good place to raise cash and look for other places to put the proceeds.

Any suggestions?

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What should we do about the Dollar?

It is not news that the US dollar has been shrinking considerably against most major currencies, most notably the Euro and the Japanese yen. If we are looking at US wealth relative to other countries in the world, and relative to imported goods, particularly oil, this has had a significant impact. For example, if the USD has lost 5% versus the euro, and oil today is priced at $82, we can say that the relative price differential of oil is over $4 a barrel in the course of one year. (Granted, the Europeans have for years been paying a fortune for gasoline, but a big part of that price is higher taxes). By the way, the US dollar index has fallen more than 5% in the last 12 months.

What does that mean for investors? That's hard to answer, but let's look at some major points.

1. Companies who have a large portion of their revenues outside of the U.S. will derive higher earnings, at least when they are 'repatriated' and denominated in USD. Earnings accrue in the foreign currency and translate into more dollars when that currency is more highly valued than the dollar. Also goods produced here can be sold cheaper to foreign customers and so market share can increase.

2. As just mentioned, imported goods cost more because it takes more dollars to buy same amount of foreign goods produced by a country whose currency is more valued. This has a ripple effect because many products produced here contain foreign parts or materials. The US auto market comes to mind right away. In short, a weaker dollar can be inflationary, and a rapidly declining dollar can be hyper-inflationary. This was not such an issue fifty years ago when almost everything produced and purchased in the USA came from the USA, but today, with global trade, and with the demand for materials coming from China, the US economy is far more vulnerable than it has been before.

3. Let's temper #3 with this: a large number of companies based in the USA are Multinational Corporations such as Exxon, GE, Pepsi, Intel, etc. So, if we own these types of companies, in addition to having some exposure to foreign stocks, the increased earnings from currency translation of earnings ought to make up for at least a portion of the inflation.

4. There is quite a bit of discussion about a USD crash. Certainly, the US federal debt and deficit spending are the biggest reason. Add to this the problems currently in the housing market and you've got trouble. The fear is that if there is an economic slowdown combined with inflation (yes, stagflation), the percentage of tax revenues used to pay interest on the federal debt will climb. The second part to this scary story is that if foreign investors dump their US debt holdings in response to the declining USD and falling bond prices, the interest the US pays on its debt will rise significantly as our maturing debt is renewed at the newer, higher interest rates. In other words, the interest payments will be rising at the same time tax revenues will be falling.

5. The Fed, by cutting borrowing costs, has essentially made a Hobson's choice between stimulating growth versus stimulating inflation. They made the right choice. By increasing GDP albeit by inflationary means, we are inflating our way out of debt via a decline in the dollar. Simply put, interest on the debt is paid in 'nominal dollars' (except for inflation protected bonds, that is). This approach assures that the percentage of tax revenues used to pay interest on the debt will decline since tax revenues are likely to increase at a faster rate. The decline in the dollar will "transfer" a lot of the pain to foreign debt holders. However, recently many foreign Governments (such as China) have started diversifying out of the dollar, so it would be less damaging to other countries if they eventually abandon US debt. This is a concern.

6. In short, diversify into assets other than just USD-based.

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Staying Focused on Stock Market Basics

I've recently been reading about a number of investment "systems" designed to 'help' you beat the market using options or other hedging strategies. I am not going to say they are all worthless, but they do require a lot of extra work and time - something you may or may not have. Most are designed to benefit the writers, not those using these systems.

Many people don't want to even think about having to manage their investments. Can you blame them? To the average person Wall St. seems like a rigged crap game - no more than gambling. It helps if you have a business background, or better yet some education on the financial markets, but the truth is that with stocks the 'house' (albeit some exceptions, such as Worldcom and Enron) is mostly on your side.

There are some time-tested rules about investing, and they really aren't in serious risk of being challenged any time soon:

1. Stocks are risky investments. There is no free lunch.
2. Diversification across multiple companies, industries, sectors, and even asset classes reduces overall risk at the portfolio level (but also reduces overall potential returns).
3. The longer the holding period, i.e. 3-5+ years instead of 3-6 months, the greater the chance that your investments in stocks will net a positive return overall.

Now, along with these basic tenets, I have a few of my own...

4. Own quality companies that pay increasing dividends, and that have the capacity to continue to grow their dividends faster than the rate of inflation. Own companies whose management is willing to pass on the profits of the
company directly to the shareholders (via dividends of course) while
retaining a more modest portion of profits for future growth. If the company changes from that approach, sell the stock and buy one that will.
5. Focus not on the day-to-day performance of individual stocks in the portfolio, but instead track how well or poorly the overall portfolio performs relative to a major market index, e.g. Wilshire 5000. Then make individual adjustments on that basis, if needed.
6. Look at the portfolio not as a capital appreciation vehicle per se, but as a cash flow growth vehicle. Chart your monthly cash flow, and concentrate on how to consistently grow that cash flow. Time is on your side. If you are just starting out, reinvest all dividends. If you have a sizable portfolio, collect enough dividend cash to buy a (100 share) lot of a new position or add to an existing one.
7. Mutual funds or ETFs can add easy diversification to complement individual stock holdings, but they do not come without a price, and that price is operating/ management fees. For me it makes sense to use them to obtain foreign stock or 'other asset' diversification, but little else.
8. Demand a higher yield for foreign stocks. You should expect a better cushion for the higher risk you are taking.
9. Most importantly...be patient. Be long-term focused (Warren Buffet is, and look how old he is), and trust time-tested approaches to investing. There is no free lunch, but expect long term rewards for your patience, persistence, and perseverance with weathering the risks of stocks. That's the closest thing to a credible guarantee you will ever find in the stock market.

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Home Depot's Dutch Auction

Mr. Market sometimes makes little sense. Take Home Depot, for example.

They just completed a Dutch Auction where they bought back 289 mil shares, all acquired at the low end of the price range. This was more than the 250 mil shares estimated. So let's see...it is a bad thing that they have removed more shares from circulation and at lower prices than estimated?

Yes, it means more people were willing to part with their shares since they got acquired at the lowest prices. And, it must mean there are more sellers out there who didn't get their shares bought. Does this mean they will end up selling their shares? Could it represent latent selling pressure? I'm not so sure about the logic. Isn't the whole point of the Dutch Auction for investors to offer their shares based on what they thought it was worth? Since 289 mil shares reportedly got offered and accepted at $37, the low end of the range, one can say shareholders were more willing to part with their shares for a lower price. Since yesterday's price was well above the $37 range, we have tankola.

But, doesn't it also mean that the company got a better deal in the process, and it's financial results will only be better, having acquired more shares and for lower prices?

To add to the market pessimism, Raymond James indicated in a Wall St. Journal article that the share buyback will cause stock index funds to reduce their holdings to adjust for the lower share count, which will also lower the share price short term.

Is it just me or does all of this seem like really, really short term thinking?

Home Depot's performance is tied to the housing market in that it sells to homebuilders, and subprime is usually the prime reason given for selling the stock. But, HD's market isn't just new home construction. Also, when people decide not to, or can't buy a new home, I would imagine many compromise by fixing up their existing home. Isn't that somewhat of an offset?

The company is on sound financial footing. S&P maintains a "strong buy" rating on the stock, and they rate their financial stability as an A+.

Some have expressed criticism that HD's selling off their wholesale distribution business was shortsighted, that it was the best future growth driver, but HD retained a 12.5% stake in that operation. The reason for it is to allow them to focus on their retail operations. Sounds like a smart move to me.

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Ignoring the Trees...and the Lemmings

You've probably heard someone proclaim they "can't see the forest for the trees." We are human, so this cliche has a ring of truth to it. Often it is easy to lose sight of the 'big picture.'

It is especially hard when you follow stocks. When markets are volatile stock quotes have a real hypnotic quality. It's like watching a suspense thriller - you can't take your eyes away because you just know something very important is about to happen.

Yet, when you look at the 'forest' - the portfolio level - individual stock price movements become just a lot of noise, because at the portfolio level everything hums along very nicely or ugly just like the overall market.

During the last few weeks, stock prices have been all over the map, and the Vix (volatility index) has been spiking higher and higher. But, it hasn't made very much difference when you look at just the bottom line performance of the portfolio.

What has your portfolio done vs. the overall market? Does it really matter if you lost three percent if the market is down four or five? I suppose it matters if you need the money now, but that kind of money should never be in the market in the first place. That argument doesn't make much sense to me.

If you are properly diversified across economic sectors, and you have selected quality stocks, chances are that you will at least pace the market's performance. In our case, we have always been slightly overweighted in defensive stocks, but not excessively so. This approach is ok with the fact that we may lag a bit during bull markets but outperform (catch up) during corrections. The reward is less volatility.

If, over time we don't meet our performance goals, we will go easy on ourselves. Performance in the stock market is not a verdict on your intelligence, or even your skill as a 'finance wizard'. It only is how you view risk versus value. In the end, it doesn't even matter what the market 'thinks.' At least when you view it from the time horizon Warren Buffet and others do. Now that is what I call seeing the forest for the trees. The smart guys use diversification, quality, and most importantly - time, to their advantage.

Now certainly we invest for a reason, and it is usually to buy some freedom, wealth, security, charity, etc. for those we love - and, o.k. some for us, too. And, we'd like it during our lifetime, thank you.

This is pretty much the entire basis for the concept of asset allocation. And it's why investment people tell us to adjust it as we grow older. It does makes sense, and we should understand this approach, but it is not Gospel. It is advice intended to get us to think in terms of what we invest in, how we manage risk, and why. For example our portfolio is "under-weighted" in fixed income investments, but our philosophy considers defensive stocks to be equivalent to bonds, at least the ones we have. Why? Becasue they grow their dividends. And we can choose to do this because we have the luxury of time. If you ask me when I am 65, or if you ask someone else with a lower tolerance for risk, you may get a different answer.

If we decide to look at any trees, they ought to be the individual payout ones - meaning the dividends of the companies, not their daily stock price movements. It doesn't mean that you don't monitor the company's ability to continue paying and increasing dividends, and then make prudent decisions accordingly. It does mean you effectively decide where your time and energy is most productively focused. And my energy is not focused on what the lemmings say one of my individual stocks is worth today.

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Some Minor Adjustments

Since Nuveen (JNC) is getting fairly close to its buyout price, and since S&P indicates that it is not likely to get a sweeter offer, it was sold, and purchased was VF Corp (VFC), a company that has been on our radar for a long time. It is still somewhat a risk in this market climate, but not as overvalued as it was. It is an excellent dividend grower, and it's a quality company. Another purchase, Entergy (ETR), is filling the void we have had ever since we sold PPL Corp (PPL). Now we finally have a utility stock again. Both PPL and Entergy are utilities that have a non-regulated growth component to them. I think Entergy is the better value at this point, although PPL could continue to appreciate from here as well. We also sold a third of our position in Chevron (CVX).

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An Ugly Correction, but...

Hard to find anything positive about this kind of carnage in the markets, but the portfolio continues to outperform the Wilshire 5000 and at ever higher margins. Although this is consistent with the defensive structure of the portfolio, the fact that we have a much higher percentage of finance and insurance companies than most yet still managed to outperform leaves me happy.

The beauty of having a dividend-rich portfolio is that it becomes easier to just collect the dividends and wait it out.

Not only that, I have a hard time buying the bear argument that the subprime contagion will extend as broadly as the index performance suggests. I understand that the consumer is the engine of the economy, and that if a segment of homeowners pulls back, it can affect economic growth. Having a lot of consumer staple stocks certainly dampens my fear, but apart from that, what about the falling dollar and what that is doing for exports?

Just as a lot of the prior bullishness was not founded in reality, so too is a lot of the bearishness we are seeing today.

A final note is that in looking at long term indicators we have not entered a bear market. Certainly if that changes, some portfolio adjustments will be made. But, let us not jump the gun when the evidence does not merit more drastic action.

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Time for ETO

Well, this correction is providing a decent opportunity I missed during the big runup on ETO. At less than $31 and a yield of around 7%, it's not a bad ETF to have around.

Although the lending market is pretty crappy right now, I don't think it is a big enough impact to kill the U.S. economy. Corporate earnings are good and valuations are not excessive, especially after the last two weeks of market 'repricing'.

Our portfolio is holding up well relative to the Wilshire 5000 while we enjoy a yield greater than any major market index.

All in all, I am happy with the portfolio's performance in this volatile environment.

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Why Dividends Are Important

1. Issuance of dividends usually means the company has significant positive cash flow.

2. The consideration of payout ratio and rate of dividend growth when viewed together are a good measurement of the company’s health.

3. They motivate management to focus on generation and growth of both earnings and cash flow.

4. Income investors enjoy less volatility with little to no sacrifice of total return vs. non-dividend stocks. Dividend stocks tend to have lower betas.

5. For now, there is a tax advantage for dividends over capital gains.

6. Investors can generate growing cash flow at a rate far exceeding inflation by careful selection of stocks with increasing dividends.

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Volatility Rules

Well, besides Home Depot (HD) announcing a major share buyback and asset sale, Nuveen (JNC) getting a buyout offer, and the Wilshire 5000 dropping 200 points in one day, it's really boring out there.

Throughout all of this fuss, the portfolio keeps plugging along, and even with all the turmoil, we are still beating the Wilshire by around 2%, not counting dividends. I suppose we could do worse...

ETFs and More Added

Well, I finally gave in to adding some ETFs. Looking at the riskier foreign end and high yield end of the dividend growth spectrum, this made a lot of sense to me. The number of these funds that have increasing payouts is quite small actually. A lot of the ETF managers do not consider payouts to be of highest concern despite the supposed focus of their funds. The best of these funds is Alpine Global Dynamic Dividend Fund. Sporting an impressive 8.2% yield, it pays monthly dividends. It does not have a long trading history, which does merit some caution, so my initial position is not that large.

The other ETF I added is PowerShares HighYield Dividend Achievers. It also pays monthly, and although it yields 'only' about 3%, it is one of the few funds I found that has coverage in areas not represented by the rest of my portfolio. Not one of its top ten holdings is currently in my portfolio. I like getting all this added diversification and what looks like a focus on increasing dividend payments over time.

One of the best 'high QDV' stocks out there is Zenith National. Although we already have more than enough insurance company holdings, I couldn't resist adding this one. Insurance stocks are just such great long term investments. This one has a 3.5% yield and a strong up-trending QDV which is pushing 35%.

Finally, our position in Automatic Data Processing was just doubled, given its large moat to competition. It's closest competitor, Paychex, also one of our holdings, and ADP combined, dominates the payroll processing industry. Owning these two companies, both with growing dividends and great growth prospects, is one of the greatest investment stories for long term growth out there today.

More Changes

Made a number of portfolio adjustments. Added were Home Depot and Intel. Sold were PPL (could not pass by a quick 40%+ gain), CHT, BLK, and a little of KTC.

On a net basis I have been raising some cash hoping for some decent entries later.

TCHC is bouncing back some today after losing almost half its value. Management announced a share buyback today.

That's all for now...

Taxation of Dividends

A friend recently told me that the capital gains rate is actually lower than the the tax rate for ordinary income. This is true. I goofed on the explanation in my first blog post, but the tax benefit of dividends remains. Here is the correction:

Most people in middle tax brackets or higher want their dividends taxed at the capital gains rate, which is 15%, not the ordinary income rate, which varies but is roughly in the 24-28% area for middle to upper brackets.

However, almost all dividends paid to holders of individual stocks are "qualified dividends."

What is a qualified dividend? It is simply a dividend that "qualifies" for taxation at the lower capital gains rate. There are three criteria for this treatment:

1. The dividend must have been paid by an American company or a qualifying foreign company.
2. The dividends are not listed with the IRS as dividends that do not qualify.
3. The required dividend holding period has been met.

Although most dividends paid on individual stocks are "qualified," be careful about ETFs and mutual funds, because these are more likely to issue "ordinary dividends." Recently more funds are being marketed as "tax efficient" and these are more likely to issue qualified dividends.

The tax law providing this favorable treatment was going to be sunsetted (is that a word?) at the end of 2008, but Congress recently extended it to 2010, so (for now) the tax break is safe.

Congress ought to make this treatment permanent and provide the nation's taxpayers a real incentive to save. The savings rate in the USA is abysmal, and punitive tax law is in part to blame.

More Dividend Hikes

We have a number of dividend increases announced this week - Microchip (MCHP) which also surged around 7% Friday, Johnson & Johnson (JNJ), and a slight increase from Meridian Bio (VIVO).

Current buy candidates with great QDV are RVSB, FNLC, CGI, PCU, ROH, IEX, and RY. I am waiting for a pullback for better prices. I wonder if we'll get one?

Quite a few changes

Many portfolio changes to report - Most changes were made to improve the overall QDV, yield, or both.

One shift was made to sell Metlife (MET) and replace it with Chubb (CB) insurance. Why the switch? Both insurance companies are excellent stocks, both are highly rated by S&P, and both have good dividend growth. But Chubb's yield was higher, and it pays the dividend quarterly, while Metlife only pays annually. It was a tough decision to sell MET, since it a great stock, but I decided that Chubb was a smarter choice, and I wanted to stay with Allstate and Chubb. I didn't want a third major insurer now.

Last week I had made plans to buy Yum! Brands (YUM), 21st Century Holdings (TCHC), and Commerce Group (CGI). Unfortunately I waited one day too long to buy CGI, since yesterday it went up over 8% in one day. This surge was due to its shares just being added to the S&P 400 Midcap index. It was down a little today, but not enough to get me to buy just yet. I did pick up the other two though. All three have excellent QDV.

Proctor & Gamble (PG) Dividend increase

PG announced that they upped their dividend by around 13% today. It's been awhile since the last announcement was heard for our overall potfolio holdings.

Citigroup beat earnings expectations today as well.

Quarterly Dividend Velocity (QDV)

We already know what dividend growth is. If a stock's dividend goes from $1.00 to $1.10, the dividend growth rate is 10%. That doesn't tell the whole story.

Let's compare two fictional stocks, ABC Corp and CDE Corp. Both companies started the year with a $0.25 quarterly dividend, or a $1.00 per-year indicated rate, and both increased their dividend to $1.40 indicated rate by the end of the year - a 40% increase, right?

Let's look at the total payout of the two stocks:

ABC - Qtr 1: 0.25, Qtr 2: 0.31, Qtr 3: 0.33, Qtr 4: 0.35
CDE - Qtr 1: 0.25, Qtr 2: 0.25, Qtr 3: 0.25, Qtr 4: 0.35

Both stocks ended the year with a indicated annual dividend of $1.40, but ABC actually paid more (ABC paid $1.24 while CDE paid only $1.10). Why? Because ABC's quarterly dividend velocity (QDV) was higher.

The first lesson is that the indicated rate doesn't tell us everything we need to know about a company's rate of dividend growth.

So, how do we go about measuring and thus capturing the difference? In other words, how do we go about calculating QDV?

If we just ignored the indicated rate and looked at what was actually paid out each year, would that do it? Let's see. If both companies actually paid out $1.00 total over the previous four quarters, then ABC's actual increase in payout for the following 12 months was 24% ($1.24 vs. $1.00), while CDE's was 10% ($1.10 vs. $1.00). That doesn't really tell the story either, but it is way better information than what the indicated dividend 'increase' of 40% tells us.

Yahoo! Finance seems to 'get' there is a difference. They cite in their "Key Statistics" section both the "Trailing Annual Dividend Rate" (for our ABC example, $1.24) and the "Forward Annual Dividend Rate" ($1.40 for both of our examples).

So to summarize, it is pretty obvious the trailing dividend information is important, not just the forward rate.

Still, if we are trying to develop a better measure of growth - one that would tell us ABC corp is a better investment (from a dividend growth point of view) than CDE, we need to capture the trailing dividend values for each over time (something Yahoo does give us but we have to work for it) and then compare the historical growth rate in dividends.

If you have studied finance, you know it is better to get $50 today than $50 a year from now. Therefore, we also need to take into account the 'quarterly timing of payments' in the QDV calculation (their net present value).

The easiest way I have found to take all of this into account is to calculate a 'rolling historical annual payout' then look at the 'average annual rate of change'.

Here's the QDV calculation for Pepsi:

Date	Dividends	Avg Qtrly Div	Avg Qtrly Increase	Annual Increase (QDV)
6/5/2002	0.15
9/4/2002	0.15
12/4/2002	0.15
3/12/2003	0.15	0.15
6/11/2003	0.16	0.1525	1.67%
9/10/2003	0.16	0.155	1.64%
12/10/2003	0.16	0.1575	1.61%
3/10/2004	0.16	0.16	1.59%	6.51%
6/9/2004	0.23	0.1775	10.94%	15.78%
9/8/2004	0.23	0.195	9.86%	24.00%
12/8/2004	0.23	0.2125	8.97%	31.36%
3/9/2005	0.23	0.23	8.24%	38.01%
6/8/2005	0.26	0.2375	3.26%	30.33%
9/7/2005	0.26	0.245	3.16%	23.63%
12/7/2005	0.26	0.2525	3.06%	17.72%
3/8/2006	0.26	0.26	2.97%	12.45%
6/7/2006	0.3	0.27	3.85%	13.04%
9/6/2006	0.3	0.28	3.70%	13.58%
12/6/2006	0.3	0.29	3.57%	14.09%
3/7/2007	0.3	0.3	3.45%	14.57%

As you can see, the dividend went up around 1.6% quarterly, on average, to start. The last column is the annualized rate of dividend growth. Happily, Pepsi shareholders are seeing double digit annualized increases in the rate of average quarterly dividends. The annual has backed off from the quarter ending Mar 2007 compared with Sept 2005. Quarterly Dividend (growth) Velocity, or QDV, has declined to 14.57% from the 23.63% level in Sep 2005. In summary, the rate of change is declining over that period, however dividends are still being increased at a double digit average rate.

The take-away is that you can use the 14% figure to estimate future growth, but you need to consider the 'velocity effect'. If you look at the most recent quarters, QDV has started going back up (from 12.45% Mar 2006 to 14.57% today), so in this example, I might estimate 15% growth, or 3.5% average quarterly growth, over the next four quarters for PEP. This is the best way I have found for measuring dividend growth, and best for use in forecasting.

GE Gives a Market Signal

I think GE is a pretty good barometer of the overall market environment. After all, it is this huge mega-conglomerate that is in probably every economic sector imaginable. Anyway, they were quite optimistic that their numbers would be on track for the year, and that probably lent a lot of support to markets.

Made a lot more changes - I 'cried uncle' on the short hedge. That China sell-off fooled me but good. Also, took the opportunity today to get some picks I've been eyeing for some time, like Health Care Services Group (HCSG), Meridian Bioscience (VIVO) and Waste Management (WMI), and also added to the 'spun-off' shares of Kraft gotten from the Altria spin-off.

Hope you haven't been getting too whipsawed!

Spin-Off Monday Coming Up

Just so you are not surprised, the portfolio numbers will not look right on Monday (and maybe Tuesday as well) due to two spin-offs, Altria (MO) spinning off Kraft (KFT), and Automatic Data Processing (ADP) spinning off Broadridge Financial (BR).

This is an interesting piece on how dividend growers outpace the rest of the market.

I made quite a few changes on Friday - bought were Allstate (ALL), Nuveen (JNC), Jabil Circuit (JBL), and Pacer Tech (PACR). I eased up a little on SDS (Double Short S&P), but remain defensive and expecting more pain.

Hope this finds you without pain. Till next time...

Altria's Kraft Spin-off finalized

It's finally set: Altria will spin off Kraft on Mar 30th

Meanwhile, I have been raising more cash (by selling a bit of TTH, MCHP, and JNJ) and sticking to a hedged position. I know this doesn't look very smart with the last two day's rallying going on, but the technicals rarely lie, and they are saying that drop awhile back 'ain't no blip.'

I do think oils are due for better action, so I picked up Total SA, which, contrary to Yahoo Finance, actually pays around a 4% yield, before foreign taxes.

Eaton Vance Tax Advantaged Global Dividend Opportunities Fund (ETO) got away from me before I could get it, and I am not chasing it now. If it pulls back I would reconsider another try. Also, I found a couple more ETFs that take a 'dividend growth' approach. The expense ratios are much lower than ETO, although the expected dividend isn't as rich (because these aren't leveraged). They are Wisdom Tree Mid Cap Dividend and Small Cap Dividend. I was troubled by the prospectus initially because it was not clear on the frequency of dividend distributions, so I asked. They replied that domestic funds are quarterly, foreign is annual. The funds have a short history, but they claim to match their dividend growth index in yield and performance. The index yields are in the 3.75-4.0% range.

See I Told You So

As mentioned last Friday, the correction was not likely over. Today was rather devastating, but looking at the big picture, not so bad considering SDS was there to bear hedge the portfolio. The result was that on a day when the Wilshire 5000 lost 2%, our portfolio lost "only" 0.95%. Painful, to be sure, but much less so than for those who did not prepare for a storm that you could see coming.

The financial press is getting almost hysterical about its claims that the subprime meltdown does not affect the overall economy much. Fair enough, but tell that to the financial sector, which comprises a very large percentage of the S&P 500 (and of this portfolio as well) and is getting unmercilessly hammered by the fallout.

Anyway, I'll reiterate that when things start settling down, it'll be time for snatching up shares at bargain prices, and the beauty of hedging a portfolio is that it provides you cash to help build it back up without excessive pain.

Until then, we will continue to grin and 'bear' it...

Continuation of Volatility?

Sorry, but I am not buying that the rally we got this week marks a resumption of the bull - at least not yet. I won't go so far as to say the bull is dead, but this ain't no "pause" either.

It doesn't take a chart expert to see that the ferocity of last week's decline - specifically the 'velocity' of the decline and associated volume - looks to me like the sudden drop was not based on a 'fluke' or happenstance.

Besides the China explanation - why did it happen, and what happens next?

First theory - Alan Greenspan implied a recession is just around the corner. If you go by the 'six month rule' which is that the stock market discounts a recession six months in adavance, then a recession should hit around the first of September.

Second theory - A normal correction is overdue, since we've been getting a more or less non-stop run since around Aug 2006. Markets never go up in a straight line. The bull is intact, but a 10% correction now is normal and maybe even expected at this point. Load up after the next wave down.

Third Theory - The bull is officially dead. Although it is an election year, the bull market has been going since March of 2003. We just hit the four year mark. It's not unusual to get a bear market after this long. The 1990s were a fluke.

Fourth Theory - The drop is over and it will be remembered as just a blip in the continuing bull market.

Which theory will bear out is anyone's guess. If I knew I would already be retired.

In dividend news...Colgate Palmolive just increased their dividend 13% - I like it!

What to do?

I bet that Wednesday's rally was simply a reflexive bounce, and that we could have more pain to come, and judging by Friday's action it looks like that is the case.

That is not to say it is my philosophy to bail out of the market whenever it catches a cold, but some smart adjustments are in order. First, you may have noticed my caution a couple weeks ago. Wednesday I used the lukewarm rally to take a short position in SDS which is an ETF that is 2X short the S&P 500.

It certainly won't eliminate portfolio losses in the event of a major correction, but it will certainly make sleeping at night easier while I am waiting it out. Ideally this will provide a nice pile of cash to buy cheaper stocks when the dust clears.

See my last few posts for the companies on the radar as buy candidates. Also, I like Eaton Vance Tax Advantaged Global Dividend Opportunities Fund (ETO). Although ETFs are not better than proper stock selection, this fund has a low turnover rate, and its selection of holdings are complimentary rather than redundant to my individual stock holdings. It currently yields around 6.2% and has growing dividends.

Oh, also Bank of Montreal just increased their dividend by over 22%.

Market Gets Hammered

The markets were roiled by China and a number of other reasons domestically, but Black Rock upped their dividend around 60%. Kinda puts things in perspective, doesn't it?

PPL Corp. (PPL) Raises Dividend

Wouldn't it be nice if we got these announcements every day? In any case, it happens more often when you select companies with a track record of upping dividends. Today it's PPL Corp

Lazy Investing?

You may have heard the term "Lazy Investing" before. If not, it means selecting a group of different ETFs or mutual funds in such a way that the combination gives you diversification against the entire universe of asset classes. Some good ETFs that apply to our dividend growth approach are iShares Dow Jones Select Dividend Index (DVY) and SPDR S&P Dividend (SDY)

Although you may want to consider having one of these along with individual stocks, I would argue that it is usually worth the 'extra' effort to focus more on individual stocks, particularly those that are managed with shareholder interests in mind. It's really not that much work anyway to find quality companies that have good earnings growth and that regularly increase their dividends. While you are doing that, you also need to pay attention to selecting companies across all sectors, including foreign ADRs.

What about bonds? Don't you need them to have proper diversification? The textbook answer is "yes," but my view is that unless you are very near to your retirement date (within a few years), consider that proper selection of these kinds of stocks will pay a yield far better than bonds after a 3-6 year holding period. Better yet is the yield increases with each succeeding year, at least at the portfolio level. If you select right, it will happen on each holding as well.

It takes a mental adjustment, but start thinking of stocks not as a price appreciation vehicle per se, but as a cash flow machine that rewards you with more and more cash with each year you hold it.

That is not to say you should 'just set it and forget it'. Look at the market for dividend candidates better than what you currently have, and don't be afraid to upgrade.

For example, today I sold a number of stocks. One was Pfizer, which S&P now only rates a hold (3 stars). They paid a good dividend and have been growing dividends for a number of years, but there is concern over how long earnings growth can sustain the dividend growth. The others were Rohm & Haas (ROH)(3 stars), Cato (CTR)(not covered by S&P), Southern Copper (PCU)(not covered) which had a nice gain of 35%+, and Eaton (ETN)(3 stars).

Considering the nice run the market has had, it a good idea to trim the lower ranked stocks and prepare to buy some better quality alternatives when we get a real pullback (it could be soon).

I'm looking at Yum! Brands, rated 5 stars with a 2% yield, Tsakos Energy (TNP), rated 4 stars with a 5.4% yield, Taiwan Semi (TSM), rated 4 stars and a 3.3% yield, and Eni Spa (E), rated 4 stars and a 4.7% yield. All of these have good dividend growth as well.

Portfolio Adjustments

Today we sold Clarcor (CLC), which had a decent run, but it has lagged the Wilshire and didn't have dividend growth or yield that matched better candidates, Hartford Financial Services Group Inc. (HIG) and William Wrigley Jr. Co. (WWY). These two were added.

Suntrust Dividend Increase

Early in the new year is when we get a lot of dividend increase announcements, and now it's Suntrust's turn. A 20% hike...I like.

UPS 'UPS' its Dividend

UPS Increases its Dividend and Stock Buyback Program

Not a good week for the markets, but we are hanging tough. Dividend growth candidates at the top of the buy list are Healthcare Services Group (HCSG) and Chubb (CB) The current correction should provide a decent entry, but we shall see.

Profit Margins

Here is a rather disturbing view about profit margins

Microchip Tech Increases Its Dividend

Besides issuing a decent earnings report, MCHP increased its annual dividend rate from $1.00 to $1.06, or $0.265 per quarter. Six percent increase doesn't sound like much, but they have increased their dividend rate every quarter since August 2003.

Problems with Google Docs

We were having problems with Google spreadsheets, and for awhile we were without portfolio data. Looks like they fixed it. We'll see if this beta project gets more stable.

I can tell from daily tracking that our relative performance to the Wilshire hasn't been very good lately. We'll see if things can improve over the next couple weeks.

In the meantime here's an article you may want to check out...

Dividend Increases Falling Behind

Various Items

"Four Stocks Take a (dividend) Hike" from Motley Fool

Microsoft's Intrinsic Value

Eaton is Hammered

Ugly day for the markets...

Eaton (ETN) Ups its Dividend

Also they announced a share buyback program. Earnings met expectations, but they project flat sales in 2007. The dividend was increased 10 percent.

Tracking Relative Performance

We can see how well a given portfolio composition stacks up to a benchmark index using graphical tools, such as Excel. Simply take the daily portfolio values for a given period of time, and calculate the daily percent change. Then, do the same for the benchmark index. Once you do that, calculate the difference in percent change between the portfolio and the benchmark index. In this example we are comparing our portfolio to the Wilshire 5000. This chart has two different measures. One is the daily portfolio performance relative to the Wilshire 5000. The other is the cumulative relative performance. It is then easy to see how well a given portfolio stacks up versus the index over time. Of course you want to see the cumulative performance line going up over time, not down. Our current portfolio composition has performed well relative to the benchmark, at least historically, but is recently lagging. My guess is that the banks are to blame.

Adding UPS

I added UPS to the portfolio today. Why not Fedex? Well, both are extraordinary companies, but UPS' dividend growth rate was the deciding factor. A 2% yield, but around a 17% dividend growth rate. Also, transportation stocks as a sector look pretty good about now.

A Chart of the Portfolio

I wrote a cool little program that can graphically track portfolio performance like you would for an individual stock. This covers 143 trading days, and shows a very consistent rate of price appreciation over time. It is not likely that this trend line will hold forever, but this could show the break when it happens, and that would provide some kind of notice that a more defensive posture is warranted.

Note also the low rate of volatility. I have a separate program that tracks portfolio beta relative to the Wilshire 5000 and whether historically the total composition has outperformed the index over time.

I exclude dividend payments from these charting calculations and performance calculations because my hope is that we can outperform the Wilshire on price appreciation alone. Perhaps I should track both ways.

Banks' Recent Underperformance

Bank stocks have been laggards of late. Maybe I shouldn't be surprised. The yield curve is inverted, Fed sentiment is tilting toward raising of rates, not easing them, and economic growth is moderating compared with last year's energetic pace.

The portfolio's bank holdings consist of:

Bank of America (BAC)
Citigroup (C)
Bank of Montreal (BMO)
Suntrust Banks (STI)
Bank of Nova Scotia (BNS)

Only Suntrust is showing a gain in our bank group. It didn't help that the timing of acquiring these positions was more than a bit late. These positions were all picked up in October 2006 or later. In the case of Citigroup and particularly Bank of Montreal, we missed a huge run-up, and just caught the downdraft.

It helps to think about the high quality of earnings these banks all have, and it really helps to imagine what dividends lie ahead. All of them have superior growth in dividends.

While waiting for banks to recover, it is reassuring that financials and insurance are all doing just fine. Diversification is a wonderful thing.

Citigroup will be posting earnings tomorrow. We'll see if they can jump start the group. It's due for some good news for a change.

2007 Dividend Yield Prediction

For the record, our estimate for the portfolio's 'historical' yield by the end of calendar 2007 is 3.8%. We'll check back next January to see how close or far we were from this call.

On a different note, here is a superb blog piece from the American Shareholders Association on dividend trends for 2006. A real eye-opener to say the least.

Juicing Dividend Growth

Quite a few changes in the portfolio to report. Sold Ford for a quick 8% profit, and sold our hedge too early in SDS, but made a small gain anyway. Added Citigroup (C), Eaton (ETN), Black Rock (BLK), and some small positions in foreign (and volatile) ADRs to juice up the yield while considering potential for dividend growth. Added were Chungwa Telecom (CHT), Bank of Nova Scotia (BNS), and Southern Copper (PCU).

The table below illustrates the improvement in yield from using the dividend growth strategy. Based on current holdings, and prices at which the positions were acquired, we can see how the yield has improved in the last few years. Although it is not clear how much the yield will improve in future years, it looks quite positive. Note that the 2006 yield is not the current 'indicated' yield, which is 3.35% based on acquisition cost. '% Alloc' means the percentage of the portfolio of a given holding.