VZ - How To Build A Dividend Growth Portfolio As A 'Young Investor' With $100000

2024-01-08 15:34:35 ET

Summary

• Number of years left before retirement is an important factor to consider when planning investments, as it determines what is the best strategy to compound wealth.
• Young investors should focus on investing in durable businesses with high-quality earnings and prioritize dividend growth over high starting dividend yields.
• I present a sample portfolio with 10 securities focused on growth rather than dividend yield, exhibiting a 10-year EPS growth of 15% and a 5-year dividend growth of 13%.
• The sample portfolio serves as a solid starting point for young investors which should prioritize compounding with long time horizons ahead.

I believe age isn't the defining factor in life; it's more about how we feel. However, in investing, the number of years before retirement matters significantly to ensure we select the most optimal strategy to grow our hard-earned money.

For instance, as retirement approaches, our reliance shifts from job income to other sources like social security and dividends. This shift naturally leads investors to prioritize higher yields over growth to finance their golden years.

From my perspective, considering I have over 30 years ahead to actively invest and build my portfolio before retirement, I classify myself as a 'young investor'.

In practice that means that I prioritize investing in:

• Durable businesses
• Strong balance sheet
• High quality earnings
• Dividend growth over high dividend yield

Since I do not need to rely on investment income, I am reinvesting all the dividends, and naturally, investing my earned income.

When beginning as a young investor, getting ahold of $100,000 for investments might appear quite daunting initially. This is because one usually needs to allocate funds for education, housing, a car, and possibly starting a family around the age of 30.

As Charlie Munger said , accumulating the first $100,000 from a standing start, with no seed money, is the most difficult part of building wealth. Making the first million is the next big hurdle. To do that, a person must consistently underspend his income. Getting wealthy is like rolling a snowball. It helps to start on the top of a long hill—start early and try to roll that snowball for a very long time.

Just keep in mind that in today's world you can start investing with as little as $100, investing is a process and not a get rich quick scheme , but the quicker you get to $100,000 the quicker the snowball starts compounding.

Just consider this:

• 10% Return on $100,000 is $10,000
• 10% Return on $10,000 is only $1,000

This goes to show us that at the beginning, returns are not as important. Instead, the quicker you accumulate a large sum of money, the quicker you can start compounding your money.

Having said that, there is generally a big misconception out there that many investors prioritize high-yielding companies because of the appetizing income.

I myself am a dividend growth investor; however, young investors should always focus on total returns instead of chasing yield.

Imagine you $10,000 invested at the start of 2013 with all dividends reinvested:

• Investing in the S&P 500 ( SPY ) with today's yield of 1.4% would be worth $40,883 today
• $10,000 invested in Altria ( MO ) with today's yield of 9.5% would be worth $19,261 today
• $10,000 invested in Verizon ( VZ ) with today's yield of 6.6% would be worth $12,444 today

With that, let me present a sample dividend growth portfolio showing how I would invest $100,000 if I were starting from scratch today.

Dividend Growth Sample Portfolio

I usually steer clear of ETFs and focus on handpicking individual stocks, typically limiting my portfolio to around 25 of them. Beyond that, it becomes challenging to keep track of each one in detail.

However, for the sake of simplicity, I've included two ETFs that I favor in this sample portfolio. This inclusion ensures substantial diversification while keeping the portfolio limited to 10 securities. I believe this balance is a good starting point, especially for non-professional investors.

*FFO instead of EPS growth

You'll notice that I never allocate more than 5% of the entire portfolio to one stock, regardless of my confidence and all picks generate 10%+ EPS or FFO growth.

I even include Alphabet, which does not pay dividends. Limiting our stock picks solely to dividend-paying stocks would unnecessarily restrict our selection and force us to exclude great businesses generating billions in FCF. Yet, this sample portfolio boasts a 10-year EPS/FFO growth of 15% and an average yield of 2.0%.

While the yield might not seem high, the crucial factor here is the dividend growth rate, especially given the extended time for compounding. If this portfolio maintains its 13.1% dividend growth rate over the next decade, the yield on cost would reach 6.1% alongside strong capital appreciation. This indicates that a high initial yield isn't the primary success factor; instead, it's the power of compounding that truly matters.

1. Visa operates as the middleman in electronic payments, making it a sophisticated yet straightforward operation. They facilitate transactions between customers and businesses, functioning like a toll system. They make profits by taking a small portion from each transaction, much like a toll. For example, when you spend $100 at a store using your card, the card issuer pockets $0.30 from that transaction. The company benefits from the long-term trend toward a cashless society and the increasing supply of money. Presently, Visa's trading at a blended PE ratio of 28.63x, under its 10-year average of 31.24x. It's projected to yield a potential annual return of 17.9%. In contrast, its competitor Mastercard ( MA ) trades at a higher blended PE of 34.41x with a lower yield.

2. Lowe's stands as a pivotal home improvement retailer in the US and Canada, specializing in building materials, appliances, décor, and more. Its primary focus resides in the do-it-yourself or "DIY" market, contributing 75% of its revenue. However, the business has faced significant pressure since mortgage rates spiked above 6% for a 30-year mortgage in its key markets, resulting in a notable decline in existing home sales and a subsequent slowdown in remodeling and house flipping. As the Fed's pivot in 2024 is expected to drive down mortgage rates, prospects are optimistic for home improvement retailers like Lowe's and Home Depot ( HD ) to reverse their downward EPS trend. Presently, Lowe's trades at a blended PE ratio of 16.28x, contrasting with its 10-year average of 19.66x, potentially indicating a 16.44% total return over the next two years.

3. Prologis is a standout for me among REITs; it holds the title of the largest publicly traded REIT in the US, boasting a market cap nearing $122 billion. This company operates on a global scale in the logistics sector. Think vast warehouses with rows of truck bays, a common sight near major cities, and often managed by logistics REITs like Prologis. They're quite the juggernaut, overseeing a whopping 1.2 billion square feet across their owned and managed facilities. Prologis estimates that around 2.8% of the world's $95 trillion GDP in 2022 flows through its distribution centers. Currently, Prologis trades at a blended P/FFO of 23.32x, close to its 10-year average of 23.7x, signaling a fair valuation. If you're exploring alternatives, Realty Income ( O ) offers a higher yield at 5.31%, but its growth has been notably slower at 5.27% over the past decade.

4. Microsoft stands as a key player reaping the benefits of the AI revolution, not just through its investment in OpenAI's venture, but also through its own advancements. Take Microsoft 365, for instance—it boasts an impressive user base of around 345 million individuals, accounting for almost 5% of the world’s population. This massive customer base creates an unparalleled opportunity for enhancing business productivity, giving Microsoft room to charge more for new applications. Analysts are projecting staggering growth in the AI market, expected to soar to $2.58 trillion by 2032 from today's $538 million—truly highlighting the scale of potential. However, despite its exceptional quality, Microsoft isn't trading at a discount; its stock is currently priced at a blended PE of 34.97x, exceeding its 10-year average of 28.51x. Yet, as a tech company with a 20-year track record of increasing dividends, Microsoft remains an ultimate choice for dividend growth investors.

5. MSCI , or Morgan Stanley Capital International, is a leading financial company renowned for providing essential tools for investment decisions globally. Their focus on delivering detailed financial data, analytics, and indices empowers institutions and professionals in their investment strategies. MSCI stands as a blue-chip growth stock, maintaining a record of uninterrupted earnings growth since 2014. Trading at a current blended PE of 40.93x, it might seem pricey, but with a 10-year EPS growth rate of 21.73%, I anticipate a potential 13% annual return over three years, driven by growing global investment trends. For those seeking alternatives, BlackRock ( BLK ) at a PE of 21.22x and FactSet Research Systems ( FDS ) at 30.37x offer solid prospects with anticipated double-digit EPS growth.

6. Alphabet is presently trading with the cheapest valuation among the Magnificent 7 stocks. With a blended PE of 23.59x and a projected 16% EPS growth for both 2024 and 2025, its valuation looks highly favorable, boasting a PEG ratio of 1.47. Looking ahead , the upcoming US Presidential election in 2024 is expected to create tailwinds for ad businesses, driven by what seems to be a tightly contested election with heavy campaign spending. Another viable option alongside Alphabet is Meta Platforms ( META ), set to ride similar favorable tailwinds this year following its impressive comeback in 2023.

7. Broadcom's journey from hardware to semiconductor and now a shift toward a balanced mix of software and semiconductor/hardware marks a significant transformation. The recent approval for acquiring VMware ( VMW ) signals the onset of a new chapter. Historically, around 79% of their sales came from semiconductors or hardware, with a minimal 21% from software. However, with this acquisition, they foresee software contributing significantly, aiming for a 40% share by 2024. This marks a pivotal turning point for the company. As a result of Broadcom's impressive performance, boasting an 89% return in the last 12 months, its current blended PE of 24.39x stands notably higher than the 15.15x average over the last decade. Yet, accounting for the acquisition, the stock is trading at approximately 20x its earnings.

8. ASML holds the title as the third-largest European company, sporting a market capitalization of $278 billion and claiming the spot as the largest European tech company with a sharp focus on semiconductor lithography technology. Their ultraviolet lithography tech, known as "EUV," stands at the forefront, driving the production of cutting-edge microchips for industry leaders like Nvidia ( NVDA ) and AMD ( AMD ). Taiwan Semiconductor Company ( TSM ) stands as ASML's biggest client. Riding on the wave of increased chip consumption in our increasingly digital world, ASML's EUV machines dominate the market, standing out as the most advanced and efficient. Presently, ASML trades at a blended PE of 34.00x, slightly below its 10-year average of 35.18x, suggesting a modest discount. However, the real narrative lies in ASML's management forecast, anticipating 2% EPS growth in 2024 and a whopping 40% in 2025, with 2024 acting as a transitional year.

9. Vanguard Dividend Appreciation ETF tops my list for dividend growth ETFs, boasting 314 holdings distributed with 23% in Information Technology, 19% in Financials, and 15% in Healthcare, yielding an impressive return on equity of 25.9%. This passively managed ETF aims to mirror the S&P US Dividend Growers Index. Its top holdings include Microsoft at 5.52%, Apple ( AAPL ) at 4.54%, and UnitedHealth Group ( UNH ) at 3.49%. Currently, the ETF's blended PE ratio sits at 21.6x. For investors seeking a more aggressive growth strategy with a higher risk/reward profile, I'd recommend considering the Invesco QQQ Trust ETF ( QQQ ), providing exposure to non-dividend-paying stocks like Amazon ( AMZN ) and Tesla ( TSLA ).

10. Schwab US Dividend Equity ETF sets the bar as the go-to choice for dividend growth investors seeking sustainable and high-quality dividends. With a portfolio of 104 holdings and a blended PE of 15.14x, it presents a more valuation friendly option to tap into dividend growth. The ETF's impressive 37.9% return on equity signals the high quality of the underlying stocks. Unlike heavy IT exposure, its largest sectors encompass 17.7% in Industrials, 16.6% in Healthcare, and 15.1% in Financials. Its top holdings feature AbbVie ( ABBV ) at 4.37%, MRK ( MRK ) at 4.34%, and Amgen ( AMGN ) at 4.26%, indicating lower volatility with a focus on stability and consistent returns.

Investing $100,000 all at once can be quite challenging, but there's an alternative approach called dollar-cost-averaging, where you buy a fixed amount every week or month. This method helps smooth out your entry into a stock or ETF, reducing the risk of buying when prices are at their highest.

You might question why you should focus on building a dividend portfolio as a young investor instead of solely investing in growth stocks. Well, dividend stocks tend to be less volatile, offering a steady stream of income that you can reinvest strategically when opportunities arise. As your portfolio grows, you can rely on this consistent income without having to sell stocks, which could otherwise lead to realizing capital gains in taxable investment accounts, especially if those stocks have multiplied in value significantly.

Takeaway

Investing your first $100,000 is no easy feat, but once accomplished, the concept of compounding takes on a new significance, and the returns start to hold real meaning.

While it's crucial to gather a substantial sum early on for long-term compounding, investing should be seen as a journey, not a scheme to get rich quickly, and it's important to find joy in the process.

The sample portfolio I have created serves as a solid starting point for young investors to learn how to allocate funds, mostly toward companies with double-digit EPS growth and lower yields but robust dividend growth.

Remember, don't confine your investments solely to dividend-paying companies, even when constructing a "dividend growth portfolio." Doing so might cause you to overlook exceptional businesses. Ultimately, it's the overall yield that matters.

Always prioritize the resilience of the businesses you invest in, their strong balance sheet, high-quality earnings, and if you have a lengthy compounding horizon ahead, do not be afraid to opt for lower yields but faster dividend growth.

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