In December 2010, I created a screen/hypothetical portfolio called the “High Yield Dividend Champion Portfolio.” The screen is tracked publicly as a continuous hypothetical portfolio with a starting balance of $100,000 on Scott’s Investments (see the right hand column for a link to the spreadsheet).
Some studies have shown that the, highest yielding, low payout stocks perform better over time than stocks with higher payouts and lower yields.
This portfolio attempts to capture the best high yield, low payout stocks with a history of raising dividends. There are numerous ways to gauge the “best” high yield/low payout stocks. The list starts with the “Dividend Champions” as compiled by DRIP Investing. The list is comprised of stocks that have increased their dividend payout for at least 25 consecutive years
The Dividend Champions are the starting point and we first rank them based on yield. The highest 1/3 yielding stocks are kept and the rest are eliminated. With the remaining high yielding stocks we eliminate half with the highest payout ratio. The remaining stocks are then assigned a rank based on the ratio of their dividend yield to payout ratio (the same as a trailing earnings/price ratio, or the inverse of the trailing P/E ratio).
The top 10 stocks based on this ratio make the portfolio. Stocks will be sold at the re-balance date (generally around the 5th of the month) when they drop out of the top 12 (to limit turnover) and are replaced with the next highest rated stock.
For June 6th we are selling 212 shares of Consolidated Edison (ED), which was purchased at the portfolio inception over a year ago (12/6/2010) and sold for a capital gain of 15.34% (excluding dividends). The proceeds were used to purchased Nucor (NUE), which currently yields 3.97% and has a payout ratio of 61%.
In April the Dividend Champion Portfolio update stated “The technical analyst in me has seen momentum in US equities slow the past few weeks. This particular portfolio has returned over 27% since inception but now may be a time to temper expectations.”
May was a difficult month for equities and the forward technical picture for equities still looks precarious. The High Yield Dividend Champion Portfolio was designed to be fully invested at all times regardless of market conditions. However, as part of a larger portfolio there may be additional steps an investor can take to reduce risk and diversify strategies. Additional hedging or diversification techniques can serve to reduce risk but may also reduce potential capital gains.
For example, using Born To Sell we can explore potential covered call opportunities on stocks in the portfolio. At the time of writing last month the CVX June $105 calls had bid of $1.74 and the June $110 calls had a bid of $.38. With CVX now trading below $100 and option expiration next Friday, those calls have declined significantly in value. An investor could roll the covered calls on CVX by closing the existing position (the $105 strike at $.15 or the $110 at $.05) and selling a July 105 call for $.93 or a July 100 call for $2.98 (Quotes reflect today’s closing bid/asks).
The equity curve of the portfolio is plotted below and since inception it is up over 27%. All discussions of returns are strictly hypothetical and exclude commissions and taxes.
The top 17 rated stocks for the purposes of this portfolio’s criteria are listed below:
|Mercury General Corp.||MCY||5.60||64.89||0.086|
|Tompkins Financial Corp.||TMP||3.93||46.60||0.084|
|Community Trust Banc.||CTBI||3.75||46.10||0.081|
|Eagle Financial Services||EFSI||3.31||48.98||0.068|
|Sonoco Products Co.||SON||3.90||60.30||0.065|
|Johnson & Johnson||JNJ||3.91||67.03||0.058|
|MGE Energy Inc.||MGEE||3.39||59.78||0.057|
|Procter & Gamble Co.||PG||3.61||70.03||0.052|