FERG - 4-Factor Dividend Growth Portfolio - Sour Month

2023-04-19 12:35:32 ET

Summary

• The 4-factor dividend growth portfolio was launched on November 1st, 2022, and despite a poor start to April the long term return is still attractive.
• The portfolio outperformed the S&P 500 Total Return by 29 bps during the month of March.
• Since inception, the portfolio is beating the S&P 500 TR by 5.74%.

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 April 18th, 2023 including each position, the number of shares, current market value, estimated annual dividend, current allocation and target allocation.

March 2023 Results.

The portfolio started the year trailing the S&P 500 total return by 11 basis points in January, albeit it still offered a strong gain of 6.17%. Nearly half of these gains were taken back in February as the portfolio shed 2.78% and trailed its benchmark by 34 basis points. Not the best start to the new year, fortunately the last two months of 2022, the first 2 months for this portfolio, built up ample alpha to weather this minor setback. At the end of January the portfolio was 7.89% ahead of the S&P 500 TR since inception. Following February this cushion shrank to 7.31%. March was the first win for the portfolio over the S&P 500 this year, the portfolio finished the month with a gain of 3.97% outpacing the index by 29 basis points. The strong performance converted to an improved alpha of 7.9% after Q1 2023.

April started off just fine but the portfolio hit rough waters and mid-month finds itself trailing the S&P by 196 basis points. As of April 18th the long term alpha has shrunk to 5.74%.

The portfolio is top heavy, with the 7 largest holdings making up 46.69% of the target allocation. These 7 positions posted a better than average gain in March of 3.85%, and were the primary drivers of outperformance. The 10 largest holdings make up 64.82% of the target allocation and had an average gain of 5.11% last month. The smallest positions in the portfolio performed the weakest in March with the smallest 10 stocks seeing an average gain of 1.92%.

The average gain in March for all 30 holdings was 3.15%, and the strategic asset allocation lead to a positive outcome since the portfolio finished the month with a gain of 3.79%.

Since inception the actual allocation has drifted away from the target allocation, at the moment the absolute drift is 6.66%. This is a minor increase from the absolute drift a month ago which was 6.41%. 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 March for each holding. In the table below you can see the ticker symbol for each holding, the target allocation weight, the total return for March and the respective allocation return in the portfolio.

You will notice that only two of the top seven holdings enjoyed a strong return last month when compared to the S&P 500. ASML Holdings ( ASML ) posted a gain of 10.20%, contributing 0.68% to the total portfolio return. Taiwan Semiconductor ( TSM ) posted a gain of 7.37%, contributing 0.49% to the total portfolio return. Notable gains also came from Lam Research ( LRCX ) with a gain of 9.46%, Texas Instruments (TXN) with a gain of 8.49%, Cisco ( CSCO ) with a gain of 7.97% and Accenture ( ACN ) with a gain of 7.63%.

There were 7 losers that posted losses last month. Ferguson PLC ( FERG ) fell by 6.64%, Best Buy ( BBY ) fell by 4.68%, Lowe's (LOW) fell by 2.81%, Infosys ( INFY ) fell by 2.79%, BlackRock ( BLK ) fell by 2.24%, Snap-on ( SNA ) fell by 0.72% and Lockheed Martin (LMT) fell by 0.32%.

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 7 holdings accounted for about 46% of the gain in March. And the top 20 holdings accounted for nearly the entire return.

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

After this good month 17 out of the 30 positions in this portfolio have thus far generated double digit total returns, I think that is pretty great. The best performers are:

1. TSM +52.78%
2. MPWR +48.05%
3. ASML +44.86%
4. AMAT +39.79%
5. SWKS +38.86%.

The average return of the top 7 holdings is 19.32% compared to an average return of just 15.24% for all 30 positions in the portfolio.

5 holdings have thus far generated an overall loss for the portfolio, this is one less than a month ago. The losers are:

1. ROL -10.20%
2. ADP -6.92%
3. INFY -6.88%
4. PAYX -1.82%
5. LMT -1.65%.

The target allocation for these 6 positions is 11.61%, with the worst holding, Rollins, having the smallest allocation weight of just 0.37%.

Long-Term Performance

Finally the two month losing streak was broken in March as the portfolio added some much anticipated alpha. Despite another setback here in early April the long term alpha is still strong.

Through April 18th my portfolio has a loss of 0.79% compared to a gain of 1.17% for the S&P 500. This is a loss of 196 basis points of alpha, which will be a hard bridge to gap with less than half a month to go. The lost alpha from partial April pushes the cumulative return for my portfolio to 13.96% compared to 8.22% for the S&P 500. As a result, the alpha of 7.90% following the prior month decreases to 5.74% as of April 18th.

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 my portfolio finished quarter 1 trailing the S&P by 19 basis points. Quarter 2 is off to a poor start but I remain optimistic and long on this strategy.

Currently, the portfolio has a forward dividend yield of 2.21%, which is down from the 2.31% dividend yield a month ago. This is a direct result of the gains we saw in March. The portfolio generated $3.59 in dividend income during the month of March, these dividends were reinvested in a way to reduce the allocation drift. The total dividend income generated in 2022 was $6.08, 2023 has already surpassed this amount with total dividend income of $10.52 after March.

The projected dividend income for the next 12 months is $45.66; this figure has increased from $45.51 a month ago as a result of dividend increases and dividend reinvestment. That is a 0.33% 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.

First Insight - Update

I updated my long term return figures for all 30 chosen stocks through March, extending the amount of data from 4 to 5 months. The base case for adopting an equal weight allocation opposed to using a capped float adjusted market cap allocation still stands, but the margin of difference has shrunk from 1.42% to 0.49%.

If you happened to read my update last month you may recall that the first insight I made about this strategy was that stocks that ranked better in the 4 factor test were performing better. And perhaps adopting the allocation methodology of SCHD was not the optimal route to take.

Between November 2022 and March 2023 the average total return for the 15 highest ranked stocks using the 4 factor stock selection process was 22.74%. Whereas the next 15 stocks (positions 16-30) had an average return of just 7.73%. If we break these average returns down further, the top 5 ranked stocks had an average gain of 18.13%, the stocks ranked 6 through 10 had an average gain of 15.59% and the stocks ranked 10 through 15 had an average gain of 34.51%. Given that this is based on just 5 months of rather volatile market activity this could simply be a coincidence, but nevertheless I will be monitoring this going forward. Perhaps there is merit to dropping the original allocation methodology and trimming the number of positions in the portfolio to just the top 15 or 20 stocks.

As I accumulate more data about this portfolio and strategy I hope to build on the initial insights and share them with you by documenting the evolution of my actual portfolio in this series.

For further details see: