I can remember very well the beginnings of my investment journey. Things fundamentally changed in early May 2015. It was the time when I’ve decided to throw my trading strategy overboard and instead started focusing on building wealth by investing in dividend growth stocks. I swapped a thrilling short-term approach for a boring long-term strategy. For a good reason. The track record of my prior approach was more than poor. Like 95% of all traders, I ended up losing money.
You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future.
In retrospect, the failure at trading was the best thing that could ever happen to me. Yes, I’ve lost money and yes, it was painful. However, this lesson brought me where I am today. It was something like an initial spark. If I had never failed at trading, I probably would have never started with DGI. And suddenly this negative experience converts into something good. You can only connect the dots looking backward.
About gardening and trees
Today, I couldn’t be happier with this decision. I bought my first share almost four years ago. Since then I have consistently added wonderful companies to my stock basket. Metaphorically speaking, I like to consider my portfolio as a garden and businesses that I own as trees. In fact, gardening and investing require a similar set of attributes. By selecting the right seeds and taking care of the trees, both parties seek to reap a harvest from a carefully tended set of assets.
Since the beginning, I have planted 29 different trees in my dividend garden. The number of stocks has grown pretty big in a relatively short amount of time. As a consequence, I am facing some fundamental questions that need to be answered going forward. How many individual stocks do I plan to own in my portfolio? What is the desired equity allocation? And last but not least: which individual holdings do I consider for my SF portfolio in the long run?
A gardener shapes the garden according to a plan. Most certainly, he has a bold idea of the end result already in his mind. Investors behave in a similar way. Personally, I have a vision for my portfolio, too. This vision is based on my personal preferences and beliefs. Below I have summarized some major aspects that stand behind my portfolio vision.
Choose how many trees to plant
Let’s start with the most controversial one: How many stocks make a well-diversified portfolio? Oh boy, you can basically fill libraries with the books written on that specific topic. And I promise you won’t find an objective answer. No chance. Go ahead and ask ten experts and the odds are high that you will hear more than five different opinions. Deciding how many stocks to own is ultimately a very personal decision.
In my individual case, I derive the number of stocks to own by answering two questions. 1) How many stocks are needed to absorb a potential dividend cut of one or two companies? And 2) What is the maximum number of holdings that I am able to monitor on a regular basis?
Let’s assume you aim to plant a garden and live from the fruits of your trees. Let’s also assume that there is no limitation in space. How many trees would you plant? Just a few? 20? 100? I allege that having just two or three of them is probably not the best option. Even though these trees might be strong and fertile, the decease of just one plant would put the complete crop at high risk. On the contrary, having too many trees is not an optimal solution, either. Keep in mind, maintaining the garden requires a lot of work. You will have to look after each individual tree. That is why it makes great sense to focus on a manageable amount of plants.
As of the moment of this writing, my dividend garden is equipped with 29 individual positions. Taking the above considerations into account, I aim to build a portfolio of 40-50 stocks in total. I consider this a healthy number that provides a good sweet spot between risk (in case a company will cut its dividend) and effort (the work and time needed to monitor the portfolio).
Selecting for quality
After defining the number of stocks in the portfolio, an investor must select high-quality companies. First and foremost, I invest in dividend growth stocks. These are companies that are growing their dividend payment year after year. In case you need some inspiration, visit the Daily Trade Alert website. The well-known Dividend Champions, Contenders and Challengers database catalogs more than 800 companies that managed to increase the dividend at least for five consecutive years. Personally, the CCC list is my ultimate starting point for any further research.
All that follows then only serves one aim – selecting for quality. Or to say it in the gardener’s words: I want to find high-quality seeds. Because great trees will emerge from these seeds. Trees that destined to grow in size and beauty. This is exactly what I want for the stocks in my portfolio, too. For that reason, I have established my own quality rating. I use it to identify high-class businesses.
In case you don’t know how to select for quality, no problem. Thankfully other people have done tremendous work and share their knowledge with us. One of them is David Van Knapp, a fellow dividend growth investor. David employed five widely used quality indicators to come up with a selection of some of the finest names in the entire stock market. I highly recommend taking a close look at the Seeking Alpha article published by David.
Apple trees, orange trees, lemon trees…
The next step is about defining what kind of stocks to own. Personally, I like to have a diverse set of investments in my dividend growth garden. Let’s divide the equity market into sectors. Consumer Staples can represent apple trees, Utilities may be our orange trees and so on. In times when a specific industry works through a rough patch, our assets from other sectors will help us to survive the bad times. That is the reason why I aim to cover different segments of the economy. To do so, I use the weighting of the S&P 500 as a rough guideline.
The above picture shows the latest sector weighting of my portfolio compared to the S&P 500. As you can see, almost 40% of the market value of my portfolio is defensive in its nature. This is much higher than in the overall index (almost 26%). The reason for that can be found in the dividend quality of defensive businesses. Companies whose dividends have grown consistently for the last several decades often come from non-cyclical sectors such as Consumer Staples, Health Care or Utilities. They cover basic needs and offer reliable earnings and cash flows. No matter of the economic cycle, people will always need food, medicine, and energy.
In contrast, more cyclical sectors (such as Technology or Industrials) may have a harder time showing consistent dividend growth. This is especially true in times of economic downturns. Nevertheless, there are plenty of cyclical companies that have managed to grow their dividend for decades. MMM, ITW, GD or LOW just to name a few. When targeting a healthy portfolio mix, I don’t want to miss the opportunity to own some high-quality cyclical stocks, either.
After defining the number of stocks in the portfolio, selecting for quality, and deciding on the sector allocation, it is high time to nominate the long-term picks. What are the highest quality dividend growth stocks that I aim to own in my SF portfolio? Utilizing some widely used quality indicators, as well as my own quality metrics, I have created a table of my personal TOP 50 dividend growth stocks.
DEFENSIVE SENSITIVE CYCLICAL
*) Stocks that I own in my SF portfolio
Here it is, my long-term DGI watchlist. To say it upfront: It’s very unlikely that I end up owning every single name from this list. Some stocks might never reach a reasonable valuation. Some might be added, while others might disappear. My views can change, businesses can fall apart, consumers’ behavior can reverse. Nothing ever is guaranteed. Wouldn’t it be naive then to presume that this table is set in stone? I think so! So keep in mind, this is a living list. A guideline for me to follow when building an empire of high-quality stocks.
By answering some of the fundamental questions, I wanted to define a vision for my further investment journey. The main idea is to target a portfolio of 40-50 individual stocks and maintain a high focus on quality aspects. In this respect, It can make good sense to consult some widely used quality indicators such as credit ratings or safety scores. Beyond that, I require my investment portfolio to cover varied parts of the economy. Basically, the S&P 500 can be a good reference point as far as sector allocation is concerned. However, personally, I like to have a stronger focus on defensive businesses. Companies from defensive sectors such as JNJ, PEP or PG have proven to be reliable dividend growers, no matter of the economic situation.
Taking the above considerations into account, I derived a selection of my personal long-term picks. This, in a manner of speaking, is my long-term DGI watchlist. Although some names might change as time goes by, these stocks represent the groundwork of my portfolio vision. These companies are like trees planted by the water. Destined to flourish and grow in size and beauty for a long time to come.