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2019-10-13 22:37:57

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Due to reader requests, I've decided to break up my weekly Best Dividend Stocks To Buy This Week series into two parts.

One will be the weekly watchlist article (with the best ideas for new money at any given time). The other will be a portfolio update.

To also make those more digestible, I'm breaking out the intro for the weekly series into a revised introduction and reference article on the 3 rules for using margin safely and profitably (which will no longer be included in those future articles).

To minimize reader confusion, I will be providing portfolio updates on a rotating tri-weekly schedule. This means an update every three weeks on:

My retirement portfolio (where I keep 100% of my life savings).The Best Dividend Aristocrats And Kings To Buy Now (based on the Dividend Kings valuation/total return potential model).My new What I'm Buying Next series, which explains what companies are on my immediate buy watchlist from which I make all weekly retirement portfolio buys.The 4 Trades I Made In My Retirement Portfolio Over The Last Three Weeks

Those who followed my retirement portfolio from the beginning know that I made plenty of mistakes early on. The biggest of which was poor risk management which meant that at one point I had 20% of my portfolio in high-risk Uniti Group (UNIT).

Fortunately, I was lucky enough to sell all my high-risk stocks (including Uniti at a 20% profit) three days before that REIT imploded (it's since down 65% and cut its dividend 92%). I no longer own any level 6/11 (below average or unsafe) quality companies and never plan to again.

Risk management has been what I've become ever more focused on, not just to avoid repeating my earlier mistakes, but due to my work with the Dividend Kings where our motto is quality first, valuation second and proper risk management always.

Over the past year, I've been fine-tuning my risk management approach, which includes my 11 point quality score (factors in dividend safety, business model and management quality/corporate culture).

After consulting with colleagues (who have 150 years of combined experience in asset management), I've designed the above risk management rules of thumb.

Those are what I use to manage the Dividend Kings' four model portfolios (High-Yield Blue Chip, Deep Value Blue Chip, Fortress, and our $1 Million Retirement Portfolio).

I've also made a lot of progress in recent months on improving my risk management for my retirement portfolio, with one major exception, Antero Midstream (AM).

When I bought Antero initially, both its MLP and GP (which have merged into one corporation), I considered its dividend to be above average safety (an 8/11 on my quality scoring system had it existed at the time).

However, I now rate it a 7/11, a more speculative company because of its near 100% reliance on Antero Resources (AR), for virtually all its cash flow.

The dividend remains safe for now, as long as Antero remains solvent and sticks to its current 10% production growth plan, which it claims it can execute on within operating cash flow at $2.15 natural gas prices. That's due to hedging 100% of 2019 production at $3.39, 90% of 2020 production at $2.87 and about 35% and 30% of 2021 and 2022 production at $2.88 to $3, respectively.

(Source: AM earnings presentation)

IF Antero Resources, which has 70% of capacity on Antero Midstream's systems contracted for with minimum volume commitments, sticks to its current plan, then AM will see about 15% to 18% DCF/share growth, which its management says will allow for 7% to 9% growth in capital returns (buybacks and dividends) annually. All while moving towards its long-term 2021 and beyond goal of a safe 1.3+ coverage ratio. The debt/EBITDA goal is low 3s or below by 2021 which is very low for the midstream industry.

(Source: AM earnings presentation)

The recent $300 million buyback authorization is likely where new capital returns will go since the DCF yield is 18% and thus repurchasing dirt-cheap shares is a great way to boost DCF/share and increase the coverage ratio.

For a self-funding midstream company, both long-term dividend safety metrics would be excellent and indeed support an above average safety rating. However, as long as AR is basically the only source of cash flow for Antero Midstream, which management indicates will always be the case, then it must always retain a 7/11 more speculative quality score.

For companies such as those, you need to buy at a high margin of safety (5.5 times DCF on AM qualifies) BUT limit your position size to a low level. One that allows you to sleep well at night even if the worst-case scenario happens, such as AR going bankrupt, defaulting on its contracts with AM or even AM going to zero.

The creation of AM out of AM and AMGP had me in a 5% position. That fell to 4% due to the share price crashing, but as painful as it was to realize those capital losses (and see my portfolio income drop $300), I decided that right-sizing my Antero position was the best way to practice regret minimization.

Note that according to FactSet, analysts expect AM to grow cash flow per share by 14% in 2020, 7% in 2021, and the long-term consensus is for between 6% and 50% (from Reuters which is certainly too high).

Now, at 2% of my portfolio, AM is generating strong dividends for me, which, barring gas prices falling and staying under $2, should remain safe over time.

Over the last three weeks, I...

I used the proceeds from the Antero sales to add to my initial 0.3% position in Imperial Brands, which is a 7/11 speculative tobacco company trading at half its historical fair value (which accounts for its lower quality and 3% long-term growth rate).

Unfortunately, I failed to take into account the nature of how my broker fills market orders for OTC stocks. My market order ended up getting filled $1 above the last closing price, which raised my cost basis on Imperial to $23.45 (initially it was $22.15).

Fortunately, my yield on cost is 10.5%, and as long as Imperial can deliver on my thesis, I'll earn generous and recession-resistant income from that 2% portfolio position.

(Sources: F.A.S.T Graphs, FactSet Research)

I initially bought my initial starter position after Imperial plunged 13% after cutting 2019 guidance to flat EPS growth for 2019. Analysts were already expecting -4% this year, followed by modest growth going forward.

The unexpected resignation of its CEO, likely due to its troubles with vaping (which caused the guidance cut), is not a thesis breaking event in my opinion. That's backed up by what Fitch just said about its revised outlook for tobacco companies.

Imperial Brands issued a profit warning in late September, principally because of the expected underperformance of NGPs in the US. This led to the announced departure of the company's CEO. Historically, the company's NGP push lagged behind its peers and only accelerated in 2018-2019. The company may benefit from a lower price point of its blu products compared to BAT's Vype, especially if price-sensitive customers start switching from unbranded open systems. Our deleveraging assumptions for the company remain unchanged and assets disposals would be crucial in achieving that. - Fitch (emphasis added)

All I need for my Imperial investment to pay off handsomely is for earnings and cash flow per share to remains stable over time. Management says it plans to grow the dividend at a modest rate (to retain its 11-year growth streak) while focusing on deleveraging and retaining more cash flow to invest in new growth products of NGP (vaping and other reduced-risk products).

Management's long-term growth guidance is for 4% to 8%, but my investment isn't based on that expected growth rate.

Reuters' consensus long-term growth rate: 8.1%FactSet consensus long-term growth rate: 4.2% (up from 3% a few weeks ago)

The FactSet Consensus for IMMBY's EPS growth is as follows

2019: -4% (4% below management's reduced guidance)2020: 5%2021: 2%2022: 9%Long-term 4.2% (low end of current management guidance)

If Imperial doesn't grow at all and maintains the current dividend, I'll earn 10.5% long-term total returns on my speculative 2% position.

If it grows at the more realistic FactSet Consensus (which I consider reasonable), then it will likely revert to its slow-growth average PE of 12.2, making 25% CAGR total returns possible.

(Source: F.A.S.T Graphs, FactSet Research)

This is why Imperial is also a Dividend Kings Deep Value portfolio holding, a 1% starter position (2.5% risk limit) bought at $22.15.

Since it appears that tobacco, in general, has bottomed, I have canceled my two limits on IMBBY (and four on one other company), since that would now exceed my risk cap on tobacco and there appears little chance of those filling.

Rather I added $1,000 worth of British American Tobacco, which is an 8/11 above-average quality tobacco company, which has been the last of the tobacco giants to start recovering from the worst industry bear market in a decade.

Here are the consensus growth rates on BTI

Reuters: 7% CAGR over timeYCharts: 7%FactSet: 8.4%

(Source: F.A.S.T Graphs, FactSet Research)

Those line up with the company's historical growth rates, its fundamental plans, and management's 7% to 9% long-term growth guidance.

Here's how BTI is expected to do over the next few years, according to FactSet's analyst consensus.

2019: 1% EPS growth2020: 9% growth2021: 6% growth2022: 11% growth (likely due to the resumption of buybacks following completion of deleveraging)

I'm modeling 6% to 9% long-term growth on BTI, which is a holding in three Dividend Kings portfolios.

(Source: F.A.S.T Graphs, FactSet Research)

BTI growing at 6% over time should nearly return to its 15.6 historical PE, but for the conservative end of the Dividend King's total return potential range, I'm using Chuck Carnevale/Ben Graham's 15.0 rule of thumb for reasonable multiples for most companies.

That slower than management guidance/consensus growth would still result in BTI potentially tripling our investment over the next five years.

(Source: F.A.S.T Graphs, FactSet Research)

In the realistic best-case scenario, BTI grows at 9%, the upper end of management guidance and returns to its historical 15.6 PE. That results in a 255% total return, or roughly three to five times what most asset managers expect the S&P 500 to deliver over this time period (5% to 8%).

The other standard weekly buy I made in recent weeks was UnitedHealth Group, a fast-growing 11/11 quality Super SWAN that the Dividend Kings Fortress portfolio (100% 11/11 quality companies) has been buying for several weeks.

(Source: F.A.S.T Graphs)

When I first bought UNH for Fortress, I didn't have my current 10-historical metric valuation model so our initial 3% purchase was modestly overvalued at $247. UNH is worth about $214 in 2019 and about $240 in 2020. So when it came down to next year's fair value, I considered it a reasonable time to add to this rapidly growing and defensive company. During the recent decline to 2019's fair value, we bought it twice more.

For my retirement portfolio, all of my UNH purchases have been opportunistic.

(Source: Morningstar)

I bought near fair value three times in April during the early 2019 healthcare correction, created by overblown fears of single-payer healthcare. Then recently I got the chance to lower my cost basis some more when I purchased UNH during another regulatory healthcare scare.

I now own 34 shares of United with a cost basis of $221.1, about 8% below its 2020 fair value.

A 2% yielding stock doesn't provide much current income, BUT the thesis behind UnitedHealth is that this 10% to 15% growing company will generate rivers of safe and exponentially rising dividends in the future.

Reuters' long-term consensus growth rate: 13.7% CAGRYCharts long-term consensus growth rate: 13.8%FactSet long-term consensus growth rate: 13.2%

(Source: F.A.S.T Graphs, Factset Research)

As you can see, 10% to 15% growth is well within the company's rolling growth rates. It's also supported by management's plan to target 85 million new potential customers and tap into a $1 trillion yet non-monetized market in managed care in future years.

(Source: F.A.S.T Graphs, Factset Research)

Here's the conservative return forecast for UNH growing at 10% and remaining at its ACA era 14.9 PE. 10% long-term returns are decent and far more than the market can deliver over time.

If UNH grows at 15%, the upper end of what I consider realistic, then the same 14.9 PE gets you 16% annualized total returns.

(Source: F.A.S.T Graphs, Factset Research)

10% to 16% CAGR return potential for such a high-quality and low-risk company is well worth investing in and fits with my long-term plan of making my portfolio:

30% Super SWANs (like UNH)30% high-yield (mostly deep value) stocks: like BTI30% double-digit dividend growers (like LOW, HD, V, MA, TXN)10% Brookfield Asset Management (BAM) - the Berkshire of global hard asset management and 15% to 20% CAGR long-term total return potential

There is a lot of overlap between these four categories of stocks. UNH is a double-digit growing Super SWAN. Broadcom (AVGO) is a high-yield stock growing the dividend at 10+% over time per both management guidance and analyst consensus, it's my favorite high-yield tech recommendation right now, and I'd love to opportunistically build up my position, potentially right up to my 10% risk limit.

I also am restarting my quarterly single share purchase of Amazon, the only non-dividend payer I plan to own (representing 2% to 3% of future investments).

Why Amazon? Because it happens to be one of the most undervalued hyper-growth stocks in America.

CompanyCurrent Price2019 Fair ValueApproximate 2020 Fair ValueDiscount To 2019 Fair ValueLong-Term CAGR Total Return PotentialAmazon$1,736$3,049$3,78143%21% to 53%

(Sources: F.A.S.T Graphs, Factset Research, Reuters', Ycharts, Gordon Dividend Growth Model)

Granted the fair value estimates on Amazon range from $1,263 based on owner earnings, to $4,761 based on operating earnings. But most of its fair value estimates cluster around $3,400 due to the high multiples appropriate for a company growing at 35%. The average of all seven estimates is $3,049 this year and based on 24% EBITDA growth expected in 2020 about $3,800 next year.

Reuters consensus long-term growth: 83% CAGR (not reasonable)YCharts consensus long-term growth: 41%FactSet consensus long-term growth: 34%realistic growth range: 25% to 40%

To err on the side of conservatism, I used slower than consensus growth on Amazon and modeled it on EBITDA, Chuck Carnevale's favorite intrinsic value metric. For my conservative estimate, I used a PEG of 1, so 25 times EBITDA for 25% growth.

(Source: F.A.S.T Graphs, Factset Research)

That still returns a total return potential of 21% CAGR, which is a fantastic return from one of America's greatest and highly undervalued growth stocks.

(Source: F.A.S.T Graphs, Factset Research)

If Amazon grows as the FactSet consensus estimate expects, then its historical 41 times EBITDA multiple will be justified and it could deliver even better returns.

Basically, my goal is to opportunistically buy above-average quality companies or better, at reasonable to attractive prices. That's why I built the 208 company (and counting) Dividend Kings valuation lists which highlight the fair value, good buy prices, yield and long-term total return potential range for:

all dividend aristocrats,all dividend kings,all 47 Super SWANs,all safe midstream/MLPs,all our model portfolio holdings,Alphabet (GOOG) (NASDAQ:GOOGL) and Amazon, andnumerous other dividend challengers and contenders (future aristocrats).

Knowing what's worth buying in the first place, what it's worth, a good price to buy with an appropriate margin of safety, and what kind of realistic returns a company can generate, is the foundation of making reasonable and prudent long-term investing decisions.

Plan Going Forward

In the coming weeks, I'm watching for a potential trade conflict freakout to hammer some of my favorite Super SWANs and tech names. Potential buy candidates include undervalued industrial Super SWANs 3M (MMM), and Caterpillar (CAT) which are reporting earnings on October 24th and 23rd, respectively.

Most likely results will be poor, guidance might be cut and the famously short-term focused market could send these dividend aristocrats cratering. I would be standing buy to opportunistically add and low my cost basis on both.

Broadcom might also be sent into a nosedive, and I stand ready to buy more if it does.

If there is no trade conflict freakout, then I will patiently keep watching for the best opportunities in any given week. BTI is a good potential buy candidate as it's below my cost basis and the only tobacco giant that has yet to start recovering from the bear market. I have room for up to six weekly buys before I hit my risk limit on tobacco.

Simon Property Group (SPG) is a Super SWAN that's yielding 5.7% and trading at its most attractive valuation in a decade. Simon gives me an opportunity to both lock in attractive income, and get me one step closer to my goal of 40+% Super SWANs (BAM is one as well).

What I've Been Buying Recently (Since March 13th)

(Source: Morningstar)

Here are my portfolio buys since March 13th, when I switched to my current strategy, based on quality scores and my risk management guidelines.

My Retirement Portfolio Today (33 Companies - Do NOT Mirror This Exactly)

(Source: Morningstar)

Do NOT mirror this portfolio exactly. Some of my holdings have become overvalued (like Texas Instruments (NASDAQ:TXN)). This portfolio represents over two years of opportunistic buying and is a never-ending journey of smart weekly buys that fit my personal risk profile and goals.

Those goals are centered around maximizing safe long-term income but over a multiple decade period of time.

Portfolio StatsAnnual Dividend Income: $18,239Average Monthly Dividend Income: $1,520Lowest Monthly Dividend Income: $1,100Highest Monthly Dividend Income: $2,200Average Daily Dividend Income: $49.97 (one penny every 17 seconds)Long-Term Expected earnings/cash flow/dividend growth: 7% to 8% CAGR

(Source: Morningstar)

My portfolio started out almost entirely with small-cap value stocks and has been getting more diversified over time. My high-risk profile means I can afford to be 100% in stocks, though in the future I'll be using bonds as a source of stable/appreciating assets to sell to buy undervalued dividend stocks per my diversification plan. That's during a bear market (65% probability we don't get one anytime soon).

Valuation Stats

weighted forward PE: 11.3 (vs. 17.3 for S&P 500)weighted price to cash flow: 9.1 (vs. 15 rule of thumb per Chuck Carnevale/Ben Graham)weighted yield: 5.8% (vs. 1.9% for S&P 500, 2% for most dividend growth ETFs, and 3% for most high-yield ETFs and mutual funds)

(Source: Morningstar)

Due to lots of opportunistic healthcare and tobacco buying this year, my portfolio is now heavily defensive. Not because I expect a bear market soon, that was just what was on sale. However, my portfolio weighted beta is now 0.84, and combined with my low valuation profile, I should do pretty well during any near-term downturn, at least relative to the broader and much more highly valued market.

When I started out, I was 59% in energy stocks. Now I've firmly within my 25% sector caps and 15% industry caps. I am leaving sufficient room under every sector's cap to buy opportunistically in future bear markets in individual companies and sectors.

Bottom Line: Proper Risk Management Is Crucial To Building A Portfolio That's Right For Your Needs And Can Let You Sleep Well At Night

A reminder that my retirement portfolio updates are an investing journal for me, highlighting what stocks I buy over time. My risk profile is very different than most peoples, and so you shouldn't mirror my buys exactly and certainly not try to copy my retirement portfolio's exact weightings.

Your risk profile determines what portfolio is right for you.

Risk requirement: how much risk do you require to reasonably achieve your goals.Risk capacity: how much risk can you afford to take (factoring in passive income, overall income, monthly expenses, etc) without threatening your goals.Risk tolerance: how much volatility and paper losses can you emotionally handle without losing sleep and making costly mistakes.

Once you know your risk profile, then you can start building your portfolio.

Starting with the proper asset allocation that allows you to survive inevitable market downturns without becoming a forced seller of quality stocks bought at reasonable to attractive valuations.Your stock portfolio should be diversified, with an appropriate position, industry and sector weightings for your needs and risk profile.

Once you have a reasonable and prudent portfolio most likely to achieve your financial goals, you can sit back and let your money work hard for you, so that one day you won't have to.

----------------------------------------------------------------------------------------Dividend Kings helps you determine the best safe dividend stocks to buy via our valuation/total return potential lists. Membership also includes

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Click here for a two-week free trial so we can help you achieve better long-term total returns and your financial dreams.

Disclosure: I am/we are long AM, IMBBY, BTI, UNH, AVGO, MMM, CAT, AMZN, TXN. 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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