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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