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A New Dividend Value Portfolio

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This is the first in a series of articles in which I explain the logic behind my portfolio design, weekly recommendations, as well as performance metrics.

Introduction

It is a well-known that dividend stocks tend to outperform the broader market over longer periods of time. Companies that have the free cash-flow to pay dividends tend to be more mature companies with stable cash-flow and a defined and profitable strategy in their market. This is even more apparent in companies who actively increase their dividend. The chart below illustrates research done by Hartford Funds and Ned Davis Research on the long term returns of stocks based on their dividend characteristics. The full research can be found here.



Source: Hartford Funds

While investing in dividend-growing companies is historically a great way to outperform the market, what if their was a way we could increase our returns even further.

The Strategy

The problems above are what led to the formation of a full investing strategy, currently deployed with real money. The strategy seeks to minimize downside risk and volatility while outperforming the broader indexes. The broad overview of the strategy can be summed up in five main points:

1.) Create a master list of stocks which pay dividends, while also having positive earnings and revenue growth.

2.) Never pay more than 15x Forward Earnings for a stock.

3.) Sustainable Payout Ratios

4.) 3.5% portfolio yield

5.) Buy in quantities of 100, with no single purchase equal to 10% or greater of the portfolio (or 5% if the stock is under $10)

The points above are self-explanatory. However, there is one final part of the strategy that needs to be explained first.

The reason why we’ll only be purchasing securities in batches of 100 is that we will be selling options on the securities.

We will be selling the Jan2020 covered call at a 20% upside strike price (or closest to it). We then will decide our minimum “cash-return” rate. This rate is equal to the stock’s annual dividend plus the options premium divided by the purchase price. Our current minimum for the portfolio is 8.5%, however, you’re free to set your minimum at whatever you’d like.

Let’s look at a real-world example of how this works with a position that was recently added to our portfolio, Cleveland Cliffs (CLF).

Cleveland Cliffs is a miner and producer of iron ore that is currently in the middle of a potential turnaround since the current CEO Lourenco Gonvalves was brought on board in 2014.

The company reported full year 2018 results in February and has since fallen over 18%, to its current price of $9.73 as of today.

CLF reported Q4 EBITDA of $188 million, giving them full year EBITDA of $766 million and a 10% increase over last year. Currently, the stock is trading right around 5 and a half times next years projected earnings.

There are plenty of other positives for Cleveland Cliffs going forward, such as their Biedex.com-repurchase plan instituted last year and the rising price of iron which can be found reading through their earnings transcript.

A full transcript from the call can be seen here.

The purpose of this article is not to go into a full analysis of Cleveland Cliffs, just to show the thought process that goes behind deciding whether or not to invest in a company for the portfolio.

We recently purchased 300 shares of Cleveland Cliffs at a cost of $9.73 per Biedex.com with the commission included. We then turned around and sold 3 Jan 17 2020 12.00 calls, which netted us $290.74 after commissions.

CLF currently pays a forward annualized dividend of $0.20. This gives us a yearly dividend of $60.00, based on the 300 shares we purchased.

$290.74 + $60.00 = $350.74 Cash Return Rate = $350.74 / (9.73 x 300) = 12.02%

That’s right. We’re being paid 12.02% to hold on to a strong company with positive earnings and revenue growth. The only downside to this is that if within a year CLF is over $12.00 a Biedex.com, we will lose out on all upside over $12.00 a Biedex.com.

Let’s say that CLF ends up over $12.00 a Biedex.com next year. From our total purchase amount of $2,919.00 (300 x $9.73), we would receive $3600 (300 x $12) + $290.74 + $60. This gives us a total amount of $3950.74.

This gives us a total potential return of $1031.74, or a 35.35% return on our investment.

One of the most beautiful things about this strategy is that we’re taking advantage of stocks that have high implied volatilities, but clear floors to prevent large downside losses. This comes in the form of dividend growth and only buying companies with Forward P/E Ratios under 15, as well as positive earnings and revenue growth.

Current Holdings

The fund initiated positions in all of the following except ADT Inc (ADT), upon inception last week. (ADT) cratered after earnings where it said it did not have a timeline for the Amazon deal, and now that it seems to have bottomed, it will be added to the fund at open Monday.



Source: Alex Pickrell

As you can see above, even with the relatively strict 8.5% minimum cash return rate, there are still 16 companies that fit all our criteria. Another thing to note is that while some companies are boosted by high volatility and lucrative premiums such as Kemet Corp(KEM), there are other companies that have high, relatively safe yields such as AbbVie Inc(ABBV), BGC Partners INC(BGCP), and Energy Transfer Equity(ET). There is also a nice mix of industries represented in the list, and as stated previously, all companies are trading at less and 15 x Forward Earnings.

Below is the current holdings of our portfolio, with purchase price, premium received from the options contract and the forward divided for the year.

Obviously, the percent gain/loss will change as the stock price fluctuates, and I’ll be sure to update weekly as well as whenever a new purchase is made.

One of the beautiful things about this strategy as you can see below, is that with the combined options premiums and dividends, we have a sizable cushion for the portfolio. This means even in rougher economic conditions and recessions; the strategy should still outperform the market.



Source: Alex Pickrell

Conclusion:

The above is simply a framework and starting point for the portfolio. Over the weeks, I will be updating weekly with stocks that pass the 8.5% minimum, as well as current gains/losses for the portfolio and any additions made.

One important thing to note is that this is not an automated trading strategy. Whenever a new stock comes up in the screen, it is important to at least perform basic due diligence.

One example of this is that GAP INC (GPS) and Kohls Corp (KSS) both initially came up in the screen, however we chose not to take a position in either and removed both from our master list. It is important to do your own analysis of each stock that we recommend or take a position in and decide for yourself based on your own personal risk tolerance whether it’s an investment you would like to make.

As mentioned above, I will continue to provide updates to the portfolio on a weekly or bi-weekly basis, as well provide updated lists on stocks that have a cash return greater than 8.5%.

Disclosure: I am/we are long KEM, BGCP, CLF, ABBV, THO, DK, ET, AEO, FL, SKT, R, CC, DAN, AAL, CVS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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