FERG - 4 Factor Dividend Growth Portfolio - January 2023 Update

Summary

• The 4 factor dividend growth portfolio was launched on November 1st, 2022, and is thus far off to a great start.
• The portfolio lost by 11 bps to the S&P 500 Total Return during the month of January.
• Since inception, the portfolio is beating the S&P 500 TR by 8.03%.

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 article . In a nutshell the strategy leverages the stock selection process of SCHD , or rather its underlying index, the Dow Jones 100 Dividend Index, with a few minor twists. The first major differentiation is the starting universe of stocks, I opted to create my own shortlist of 100+ dividend growth stocks with a history of stable growth and economic moats.

The second major difference is the replacement of the return on equity with the return on capital as one of the ranking criteria. I personally believe the return on capital is superior to the return on equity, you can read more of my thoughts on this in the original article referenced earlier.

Here is a snapshot of the actual portfolio as of February 13th, 2023 including each position, the number of shares, current market value, estimated annual dividend, current allocation and target allocation.

January 2023 Results

The new year started off with positive gains for equities and my portfolio was no exception. The portfolio generated a return of 6.17% to start off 2023, while this is a great monthly return it came up short of the S&P 500 total return. The S&P finished January with a total return of 6.28%, beating my portfolio by 11 basis points. Despite this narrow loss the long term alpha for my portfolio over the S&P increased last month. At the end of December my portfolio was 7.53% ahead of the S&P, after January the alpha ticks up to 7.89%. The explanation for this is that returns compound on each other as time goes on.

The portfolio is top heavy, with the 7 largest holdings making up 46.69% of the target allocation. These 7 positions enjoyed a better than average return in January of 7.82%, and were the primary drivers of alpha for the overall portfolio. The 10 largest holdings make up 64.82% of the target allocation and had an average return of 7.07% last month. The smallest positions in the portfolio actually performed the best in January with the lowest 6 stocks seeing an average gain of 11.20%. The bottom half of the portfolio also bested the top half with a return of 9.28% compared to just 5.28%

The average gain in January for all 30 holdings was 7.28%, and for the first time the strategic asset allocation did not lead to a positive outcome since the portfolio finished the month with a return of just 6.17%.

Since inception the actual allocation has drifted away from the target allocation, at the moment the absolute drift is 6.10%. This is a sizable increase from the absolute drift a month ago which was 4.82%. The minimal dividend stream this portfolio generates will be used to help minimize long term drift.

Individual Returns and Variations

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

You will notice that two of the top seven holdings enjoyed very favorable returns last month when compared to the S&P 500. ASML Holding (ASML) posted a gain of 20.94%, generating a return of 1.4% for the portfolio. And Taiwan Semiconductor ( TSM ) posted a gain of 24.49%, generating a return of 1.63% for the portfolio. These two stocks were the two best performing position in the portfolio last month. Notable gains also came from Monolithic Power Systems ( MPWR ) with a return of 20.63%, Skyworks Solutions ( SWKS ) with a return of 20.34% and Lam Research ( LRCX ) with a return of 18.99%.

A total of 5 stocks posted negative returns to start off the year. The worst return came from AbbVie ( ABBV ) with a loss of 7.69%, ADP ( ADP ) lost 5.46%, Lockheed Martin ( LMT ) lost 4.78%, Merck ( MRK ) lost 3.19% and Rollins (ROL) lost 0.38%.

Here is a breakdown of the portfolio by top "X" number of stocks, their weight in the portfolio, average return, contribution to the portfolio return and impact on the total portfolio return.

This data is based on the target weight and not the actual portfolio weights, however, the margin of difference is not significant. As you can see the top 10 holdings accounted for nearly 57% of the return in January. And a little more than 91% of the return can be attributed to just the top 20 holdings.

Here are the combined returns for each holding since November 2022.

19 out of the 30 positions in this portfolio have thus far generated double digit total returns, I think that is pretty phenomenal. The best performers are:

1. TSM +51.54%
2. ASML +40.31%
3. BBY +31.08%
4. FERG +31.05%
5. SWKS +28.35%

The average return of the top 7 holdings is 19.31% compared to an average return of just 13.65% for all 30 positions in the portfolio.

5 holdings have thus far generated an overall loss for the portfolio, the 5 losers are:

1. ROL -13.22%
2. ADP -6.13%
3. LMT -4.23%
4. PAYX -1.41%
5. ACN -1.32%

The target allocation for these 5 positions is 15.50%, with the worst holding, Rollins, having the smallest allocation weight of just 0.37%.

Long-Term Performance

Despite the small loss in January, overall, the portfolio is still fairing quite well when measured against the S&P 500 total return.

February is a much calmer month compared to January but the portfolio is holding its own. Through February 13th my portfolio has a gain of 1.58% compared to a gain of 1.56% for the S&P 500. This is an additional 2 basis points of alpha, which may not seem like much but it's a move in the right direction. The small edge in February pushes the cumulative return for my portfolio to 15.44% compared to 7.41% for the S&P 500. As a result, the alpha of 7.89% following the prior month increases to 8.03% as of February 13th.

I didn't expect this portfolio to do so well so quickly, but the journey for this young portfolio is long and this early lead can still fade. My hypothesis for the 4 factor stock selection strategy is that it can produce long term alpha over the S&P 500, and generate a growing passive dividend stream along the way.

Future Outlook

2023 just started, and who knows what this year has in store for quality dividend stocks. I'll take all of the gains I can get and embrace volatility with optimism that it will not last forever.

Currently, the portfolio has a forward dividend yield of 2.14%, which is down from the 2.16% dividend yield a month ago. This is a direct result of the gains observed in January and valuations pushing even higher in February. The portfolio generated $3.29 in dividend income during the month of January, these dividends were reinvested in a way to reduce the allocation drift. The total dividend income generated in 2022 was $6.08.

This includes dividends paid by the 4 factor strategy in November and December plus an additional $0.92 I received in this account in October from the prior asset allocation. The projected dividend income for the next 12 months is $44.76; this figure has increased from $43.62 a month ago as a result of dividend increases and dividend reinvestment. That is a 2.61% increase month over month. 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 these two factors. Once I have more dividend data, it will become its own section in this article series.

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