TXN - 4 Factor Dividend Growth Portfolio - Delivering Strong Total Returns

2024-01-04 23:43:05 ET

Summary

• The 4-factor dividend growth portfolio is a strategy that leverages the stock selection process of Schwab U.S. Dividend Equity ETF, with a few minor twists.
• The portfolio returned 9.9% in December, outperforming the S&P 500 by 5.36%. In 2023, the portfolio was up 26.41%.
• Since its inception, the portfolio has generated 7.96% of alpha over the S&P 500 and 22.85% of alpha over SCHD, on an annualized basis.

4-Factor Dividend Growth Portfolio

I started the 4-factor dividend growth portfolio on November 1st, 2022. You can read about the strategy, stock selection process, and portfolio construction in this 4-Factor Dividend Growth Portfolio article . In a nutshell, the strategy leverages the stock selection process of Schwab U.S. Dividend Equity ETF™ ( SCHD ), or rather its underlying index, the Dow Jones 100 Dividend Index ( DJUSDIV ), with a few minor modifications.

The first major difference is the starting universe of stocks, I chose to create my own investable universe focused on high quality companies that have a history of above average dividend growth.

The second major difference is the modification to the ranking criteria, instead of using the return on equity, as the DJUSDIV, I chose to replace it with the return on capital. I personally believe that return on capital is a superior metric to return on equity.

On November 1, 2023 I rebalanced this portfolio with 25 newly selected stocks using the 4-factor strategy.

Here is a snapshot of the actual portfolio as of January 4th, 2024, including each position, the number of shares, current market value, estimated annual dividend, current allocation, and target allocation.

December 2023 Results

For any of you that read last month's update, you may recall that the portfolio kicked off fiscal year 2 on a positive note, returning 11.02% in November and outperforming the S&P 500 by 1.89%. It is also worthy to note that the portfolio beat SCHD by 4.72% in November. In December, the portfolio extended its excellent start with another outperformance of both the S&P 500 and SCHD. My strategy returned 9.9% last month, compared to 4.54% for the S&P 500 and 6.31% for SCHD. Since inception the portfolio has a CAGR of 29.59% and is outperforming the S&P 500 by 7.96% and SCHD by 22.85%.

Beating the S&P 500 is not a primary objective but it is useful to see how the portfolio fares compared to the broad U.S. Equity Market.

January thus far has seen mixed returns with the market starting the year on a small dip. It'll be interesting to see where we finish.

The portfolios return for fiscal year 2, following December, stands at an impressive 22.02%, compared to a return of 14.09% for the S&P 500 and 13.01% for SCHD. Similar to the prior year, the portfolio has built a large cushion to weather any market turbulence over the coming 10 months.

The average gain for all 25 holdings in December was 9.84%. The reason for the slight difference in return between the portfolio and the average return for all holdings is that it is very difficult to bring this portfolio back to equal weight. The rebalancing happens while the market is open and also causes some fluctuations in the final monthly return measured against the benchmark.

Individual Returns and Variations

Here are the individual returns from December for each holding. In the table below you can see the ticker symbol for each holding, the target allocation weight, the total return for December, and the respective allocation return in the portfolio.

23 out of the 25 stocks had a positive return last month which is fantastic.

Here are the best performers:

1. CNS +29.48%
2. AVGO +21.14%
3. SQM +21.08%
4. SWKS +15.98%
5. MPWR +15.14%

The average cumulative return for all 25 stocks for the period November & December 2023 is 21.45%, slightly lower than the actual portfolios return. 21 out of the 25 chosen stocks have double digit returns, with only 1 stock ( EOG ) seeing a negative return.

Here are the top 5 performers in fiscal year 2:

1. CNS +46.53%
2. MPWR +43.03%
3. WSM +34.30%
4. LRCX +33.53%
5. AVGO +33.29%

Breaking down the returns by the original ranking of the top 25 holdings chosen for inclusion in the portfolio, we can see that it's the mid-ranked stocks that continue to generate the highest returns.

In fiscal year one there was a clear correlation that higher ranked stocks performed better than their lower ranked counterparts. Thus far this trend has not held true in fiscal year 2.

Long-Term Performance

The portfolio achieved a 10.90% return in fiscal year one, outperforming the S&P 500 by 0.75%. The return for fiscal year two (Nov. 1, 2023 - Dec. 31, 2023) is 22.02% and puts the portfolio 7.92% ahead of the S&P 500. Since inception, on an annualized basis the portfolio has a return of 29.59% versus 21.63% for the S&P 500, resulting in nearly 8% of annualized alpha over the index.

Given that the inspiration for this strategy and portfolio was SCHD it's only fair that I compare the returns the portfolio attains to those of SCHD. SCHD did not perform well in 2023, with the exception of the last two months. The return for SCHD during fiscal year one (Nov. 2022 to Oct. 2023) was -4.51%, my portfolio outperformed SCHD by 15.41%. SCHD's return for the period November to December 2023 was 13.01%, my portfolio outperformed by 9.01%. Since inception my portfolio is beating SCHD by 22.85% on an annualized basis.

What I would like to see from this strategy is a strong total return (12% CAGR) over a long period of time, say 5 to 10 years. Fiscal year one came up a little short of this threshold but things are back on track in fiscal year two.

Dividend Review

Currently, the portfolio has a forward dividend yield of 2.13%, which is down from the 2.20% dividend yield a month ago. This is primarily driven by the excellent gains observed during December. The portfolio generated $4.99 in dividend income during the month of December, these dividends were reinvested in a way to reduce the allocation drift. The total dividend income generated in 2022 was $6.08, and $49.08 in 2023. Dividend income in fiscal year one was $42.21, fiscal year two should be significantly higher. Two months in and the dividend income for fiscal year 2, $12.95, is already more than 30% of fiscal year 1's total dividend income.

The projected dividend income for the next 12 months is $54.20; this figure has increased slightly from $54.01 a month ago as a result of the recent rebalancing. I'll be curious to see what impact the monthly rebalancing will have on potentially missed dividend income. Since I am not adding any new money to the portfolio, I will have a unique opportunity to track how the dividend income grows over time directly through dividend growth and dividend reinvestment.

New 4 Factor List

Since June of 2023, I have been running the 4 factor stock screener on a monthly basis and tracking the list of top-ranking stocks. I want to accumulate this data to run additional tests on more frequent rebalancing and to document how much the list changes from month to month.

Compiling the list is a 2 step process; the first part is generating a shortlist of dividend growth stocks; the second step is ranking them based on the 4 factors.

I will be sharing the performance results of that list as well as the three other 4 Factor Strategies I am tracking in a separate series. But I will continue sharing the top 25 chosen stocks for this strategy each month in this series.

Here are the criteria for the initial stock screener:

1. Payout Ratio of 80% or less.
2. 3 & 5-year Dividend Growth Rate of at least 5%.
3. 5-year Revenue and EPS Growth Rate of at least 5%.
4. Stock must trade on the NYSE or NASDAQ.
5. Wide or Narrow Economic Moat.
6. Exemplary or Standard Stewardship Rating.

I ran this screener on December 29th and 130 unique dividend growth stocks were selected for further analysis. I then applied the 4-factor stock selection process and narrowed the list down to just the top 25 ideas. The list is presented below with data shown as of December 29, 2023.

For further details see: