TXN - The $100000 Market-Crushing HIGH-Yield Portfolio

Summary

• In this article, I discuss my $100,000 high-yield model portfolio, which comes with both a high yield and high dividend growth.
• The portfolio not only confirms theoretical expectations, but also blows them out of the water as it crushes the market with subdued volatility - all while offering a high yield.
• While past results are no guarantee of anything, I am fairly certain that this portfolio will continue to do really well, especially in light of a changed economic environment.

Introduction

On December 19, I wrote an article titled "Building A $100,000 Market-Crushing Dividend Portfolio". That article was a huge success as it started one of the most in-depth discussions about investment strategies I've ever had with existing and new followers. So, thank you for that!

Hence, I tried to incorporate as many requests as possible in this article.

As you may have noticed (of course, you have), the title of this article is similar to the one used in my prior article. However, this article is about a high-yield portfolio. If there's one thing I got from my discussions this month, it's that (a lot of) readers want investments with higher yields.

That's perfectly fine. Hence, in this article, I present a 10-stock $100,000 model portfolio that aims to capture a serious high-yield investing strategy.

While I am not a big fan of high-yield investments due to my age and investment horizon, I have to say that I was extremely surprised by the findings of my research. I'm tooting my own horn, but I think I have found a fantastic mix between high yield and dividend growth: a portfolio that provides income, (expected) long-term outperformance, and safety.

It's a portfolio that suits the needs of both dividend-growth investors and income-oriented investors.

With all of that being said, I will start this article with a theoretical background, explaining the details of successful dividend investing. After that, I will show you the model portfolio, which, I believe, will add great value to your research and investing process.

So, let's get to it!

( High -Quality) Dividend Investing Is The Way To Go

One of the most frequent "complaints" I get after covering stocks with somewhat low dividend yields is that people start to compare price action to a dividend yield. For example, let's assume a fast-growing dividend company pays a 1.1% yield. After a 2% stock price decline on a random day, I get comments saying we just lost almost two years' worth of dividends.

Ignoring dividend growth, it's a correct assessment, mathematically speaking.

When I started trading the market when I was 15 with the money I made cleaning cars at my local car dealership, I thought dividend investors were boring people who missed the point. Why go for a 3% yield if you can actively trade the market, making way more than that?

However, just like the first example (losing two years' worth of dividends), I completely missed the point. Not only did I lose money trading (that was a blessing in hindsight), but it also completely misses the underlying fundamentals that make high-quality dividend investing so powerful.

Now I have more than 90% of my net worth in dividend stocks. I also haven't lost a second of sleep during this volatile year.

That is based on the value dividend strategies unlock.

But before we discuss that, let me say something confrontational.

A dividend does not create wealth.

Wait, what? It's technically true. A dividend is nothing but a capital budgeting decision. The moment a stock goes ex-dividend, the share price is adjusted for the dividend amount. Therefore, the dividend transaction does not create net wealth. After all, the cash is now not in the bank account of the company you "own" but in your bank account. It's just a simple transfer. Even worse, our beloved governments want their share of your dividends as well.

Moreover, capital spent on dividends (and buybacks) cannot be reinvested in the business.

In other words, we always need to approach these investment decisions from a total-return point of view.

That's the bad news. Now we will discuss why a solid dividend strategy is more or less unbeatable. As the chart below shows, Vanguard found that companies with higher yields (income return) had similar returns to companies with high capital returns. In other words, investors who are good at stock picking can find high-yielding stocks that do NOT come with a high probability of buying a pet rock.

I just explained that dividends do not create value. At least not a short-term monetary value.

However, if a company can pay a dividend without borrowing funds, it shows that the company is doing something right. This is what I wrote in the aforementioned $100,000 dividend growth article:

[...] it's fair to say that paying a dividend gets companies a stamp of approval. After all, distributing a dividend means being able to successfully operate in a competitive business environment. Even better, it means companies have excess cash they can share with their owners (after all, that should be the point of running a business).

Dividend growth stocks are even better. These companies not only pay a dividend, they even consistently grow that dividend. It means these companies stand the test of time, new innovations, new competitors, you name it.

Looking at the graph below, we see that a $100 investment in the equal-weight S&P 500 in 1973 would have turned into $4,744 in 2021. That's a compounding return of 8.2% per year if my math is correct.

That's very decent. However, dividend payers returned 9.6% per year. Dividend growers returned even more. Stocks that consistently grew their payout returned 10.7% per year.

One of the reasons why dividend stocks outperform the market is downside protection. While most of these stocks will fall during bear markets, they will likely outperform the market in tough times. After all, when the economy starts tanking, investors sell low-quality stocks first.

Hence, both dividend growth and high-yield equities outperform global equities with subdued volatility.

The Nuveen chart below displays the favorable risk/reward of dividend stocks as well.

Especially in times of economic turmoil, it feels good to own high-quality stocks that will at least provide you some form of income while we wait for capital returns to pick up again. Morgan Stanley seems to agree with that as the investment bank makes a case for dividend stocks in this market environment:

Market turmoil, rising recession fears and increasing concerns about the global economy’s growth outlook have most investors searching for ways to defend their portfolios and find pockets of upside. Investors with long time horizons and relatively low appetites for risk may want to consider dividend-paying stocks, which offer companies’ shareholders regular payments as a share of profits. With the right mix of stocks, dividends can provide cumulative growth as the earnings can be reinvested back into the portfolio or be used to buy additional dividend-paying shares—a tried and true investing tactic that becomes even more favorable amid economic uncertainty.

On December 14, I wrote (what I believe is) one of the most important articles going into 2023. In that article, I highlighted the high risks of a prolonged stock market sideways trend as the market continues to struggle with persistent inflation, secular headwinds like de-globalization, energy shortages, and a Federal Reserve trying to keep inflation at 2% (once it gets inflation down).

Hence, I am fine-tuning my portfolio in the quarters ahead (it's a slow process).

The only thing I'm changing is that I keep a bit more cash to buy bigger corrections. Also, I'm buying more high-yield than I did prior to the second half of 2022.

So, the timing could not be better to discuss a high-yield portfolio.

What's A High Yield? Also, What's Quality?

Before we dive into the model portfolio, there's more stuff we need to discuss. For example, what's a high yield?

There is no clear definition. That makes sense as the definition varies over time.

I like to use benchmarks to define high yield. Here are two of the largest (high-yield) dividend ETFs:

• Schwab U.S. Dividend Equity ETF ( SCHD ) - 3.4% yield
• Vanguard High Dividend Yield Index Fund ( VYM ) - 3.0% yield

Based on that, I would argue that a high yield starts in the low 3% range. Also, note that high-yield stocks were yielding less than 3.0% before the surge in yields. That makes sense, as investors now require a higher return.

In the case of the model portfolio, I'm about to show you, the average yield is 4.4%. I decided to avoid going for an average close to 6-7% (or even higher) as I wanted to incorporate dividend growth as well. I wanted to construct a portfolio that suits the demands of income-oriented and dividend-growth investors.

4.4% is a decent number as it means we don't have to go dumpster diving. While there are some decent ultra-high-yielding stocks, I included just a few stocks with very high yields. Moreover, if you want $40,000 in (pre-tax) passive annual income, an investment of $910,000 in this model portfolio will do the trick. That's a lot of money, but it's better than investing less and going for ultra-high-yield stocks.

Also, it shows that building a $100,000 dividend portfolio isn't just a good target to have for starting investors, it can also bear some fruit. That's $4,400 in pre-tax dividends in the case of my model portfolio. You won't retire on that, but it's a very decent number.

One of the biggest mistakes people make is picking stocks based on their yield. Given the extremely high quality of comments and messages I receive on a daily basis, I doubt it applies to most people reading this article. However, I see it a lot. People buy high yields (sometimes up to 20%) without knowing that it's not sustainable. The stock price falls, the dividend is cut, and the total return goes down the toilet.

I've noticed that this happens a lot in lower-income segments. People with low monthly income (salaries) prefer stocks with high yields as it has a high impact on their monthly income. However, most of them are still better off buying dividend growth stocks or high-quality high-yield stocks. While the impact on income is lower now, it will be much higher in the future.

With that said, I talk a lot about high-quality dividend stocks. One reason why I sleep well at night is that I own companies that won't go belly up unless something extremely bad happens to the global economy. It also allows me to average down. Averaging down is a terrible strategy when dealing with risky and low-quality assets. However, when dealing with high-quality dividend stocks, investors increase their yields, while benefiting from the next (expected) upswing in stock prices.

While there are many ways to define quality, I like to focus on:

• The ability to withstand pressure from competitors.
• The products/services are important (transportation, technology, basic materials, you name it).
• Sustainable free cash flow, which covers the dividend even during recessions.
• The potential to grow on a long-term basis (I don't want pet rock companies).
• A healthy balance sheet.
• A company that benefits from the government (defense) or a company that is too strong to be harmed by the government (oil & gas).

Consistently averaging down on low-quality stocks needs to be avoided at all costs.

The Market Crushing $100,000 High-Yield Portfolio

The following $100,000 model portfolio consists of ten individual stocks. I decided to stick with ten stocks as this shows that investors do not need a huge selection of stocks to get the job done. It also keeps transaction costs low.

This is the sector breakdown of the portfolio:

• Financial services: 20.0%
• Technology: 20.0%
• Real estate: 10.0%
• Consumer defensive: 10.0%
• Healthcare: 10.0%
• Utilities: 10.0%
• Communication services: 10.0%
• Energy: 10.0%

Moreover, here are two key stats, I think you'll enjoy.

• Average dividend yield: 4.40% (I already gave that one away)
• Average weighted 10-year dividend CAGR: 10.50%

While predicting the past is easy, I found a portfolio composition that not only has a high yield, but also high (and consistent!) dividend growth. Even if dividend growth comes down to 8%, that would still be a huge deal for a portfolio yielding close to 5%. It not only beats long-term inflation estimates, but it also turns a 4.6% yield into a 9.9% yield on cost ten years from now (using 8.0% annual dividend growth).

Also, bear in mind that I'm using a weighted dividend growth rate. This is way more accurate. For example, let's assume you own just two dividend stocks. One of them yields 10%, and the other yields 1%. The average yield is 5.5%. The low-yielding stock grows its dividend by 50%. The high-yielding stock grows its dividend by 2%. The average dividend growth rate is 26%. However, your dividend income will not grow by 26%. After all, the 50% growth rate is almost neglectable as it only impacts the 1% yield.

This portfolio has a weighted average dividend growth rate of 10.5% per year over the past ten years. Non-weighted, it would be 12.0%

Now, let me show you its holdings.

The table below shows the companies, their industries, their current dividend yield, and the 10-year average annual dividend growth rate. The data source of the dividend growth rate is Seeking Alpha.

* I used AVGO's 3-year average dividend growth rate. The 10Y number is 40%, which was temporary and would have seriously skewed the portfolio average.

Before we dive into the performance of this portfolio, let me briefly discuss this stock selection. Just like last time, I'm going to keep this a bit short and use links to Seeking Alpha articles to allow you to quickly get more info on these stocks.

I have to say that picking these stocks took me at least three times as long as coming up with a list of suitable dividend growth stocks with lower yields. As I mentioned in this article, I wanted a mix of a high yield and decent growth. I wanted to avoid going overweight slow-growing stocks at all costs. It's tricky to find high-quality stocks with a high yield and decent growth.

However, J.P. Morgan is a good stock to build a high-yield dividend growth portfolio. It's an incredibly well-run bank with a decent yield, a focus on sustainable shareholder returns, and the ability to withstand competition. Moreover, the bank includes asset management, investment banking, and other areas that most banks cannot compete with.

I also included Huntington Bancshares. It's my only bank holding. I bought it in 2020 after the pandemic crash. The bank has a high yield and an impressive business transition consisting of mergers and an expansion into investment banking and advice. It also helps that HBAN has a large footprint in the Midwest. I'm bullish on that region due to supply chain re-shoring.

Texas Instruments was also a holding of my lower-yield dividend growth portfolio. However, the stock is also a great pick for this portfolio, thanks to its decent yield and high dividend growth. The company is a high-quality chip maker with high free cash flow, efficient R&D, and a huge moat, protecting investors against mayhem.

The Southern Company does not have high dividend growth. However, it has a high yield and a business model that's absolutely bulletproof. Moreover, thanks to the upcoming completion of its nuclear units Vogtle 3 and Vogtle 4, it is about to improve free cash flow dramatically, allowing it to improve its balance sheet and accelerate dividend growth.

Broadcom is impressive. This fast-growing semiconductor company has a great yield, high dividend growth, and a healthy balance sheet. The company has great management and the ability to outperform in bull markets while protecting investors again mayhem in bear markets.

Just like Texas Instruments, Amgen was also a part of my dividend growth article. AMGN combines a high yield and high dividend growth in a sector where it has strong pricing power. It has a strong product pipeline and a lot of room for long-term dividend growth.

I started covering Altria this year. The company is the definition of a high-yielding stock with extremely slow growth. However, it excels at generating free cash flow, which has supported dividend growth. While cigarettes will (likely) never become a growth market again, the company has become a reliable source of high income. Hence, it's a great addition to this portfolio.

Valero Energy is one of my current holdings. It's one of America's largest refinery companies, focused on the production of gasoline, diesel, renewable fuels, ethanol, and everything related to that. The company hasn't hiked its dividend since the pandemic. However, the company is in a terrific spot to resume high dividend growth - on top of an already elevated yield.

Note that I did NOT add oil producers with high variable dividends. While I believe that these will be great income tools for years to come, it's not what the theory behind this portfolio is based on. Hence, I went with downstream (refinery) exposure, excluding upstream (drilling).

Realty Income might be one of the most well-known stocks. This monthly dividend payer is one of the world's largest retail REITs with increasing exposure in areas like leisure. While dividend growth has come down recently, it has a decent yield, an A-rated balance sheet, and a safe dividend.

Last but not least, Verizon is offering a decent yield (although dividend growth is slow). The company's growth is very flat, yet the company has a very high free cash flow yield, a healthy balance sheet, and an attractive valuation thanks to the rise in rates that pressured so-called safe "yield plays".

Now, onto the performance !

There's one major drawdown to backtesting this portfolio. Broadcom wasn't a public stock before 2010, which means we backtest 12 years. That's not a huge sample size, yet it includes at least a few economic cycles, including commodity and rate upswings and declines.

Going back to 2010, a $100,000 investment in these stocks would have resulted in a 17.5% annual return (including dividends)! It would have turned a $100,000 investment into more than $800,000 without investors having to add a single penny in additional capital. The S&P 500 returned 12.6% per year during this period. That is impressive but 500 basis points lower than the model portfolio return. Even better, the standard deviations (volatility) of the portfolio and the S&P 500 are both 14.8%. This gives this portfolio a terrific volatility-adjusted performance. It sounds a bit cheesy, but it almost doesn't get better than this.

It also needs to be said that almost the entire period we're backtesting was highly favorable for tech stocks like the FANG+ names. The S&P 500 is overweight tech stocks. The fact that this high-yield portfolio still managed to outperform is really impressive. It's also what gives me even more confidence going forward as I expect a new environment less favorable for tech stocks (as discussed in the first half of this article).

When discussing these numbers, it is important to acknowledge that our backtesting starts in 2010. Back then, the economy was broken, valuations were low, which made the risk/reward for long-term investing absolutely terrific.

Hence, it is good to know that this portfolio continued to do well. The data below shows that this $100,000 high-yield portfolio has done well over the past 1, 3, 5, and 10 years as well, outperforming the market in almost every time period with similar volatility.

Moreover, our theoretical framework continues to be confirmed. While the model portfolio does not outperform the market in every strong year (i.e., in 2019, 2020, or 2021), it still outperforms the market as it does better when market weakness hits. The portfolio is up in 2022, it outperformed in 2018, and it did very well during the manufacturing recession in 2015 and 2016.

To highlight this point again, the portfolio underperformed in 2019 (a bit), 2020 (a lot), and 2021 (a bit), yet the outperformance in 2022 is resulting in a similar 3-year performance. Over the past five years, the portfolio outperformed the market.

Moreover, if needed, investors can stop reinvesting their dividends and enjoy a very decent high yield! Especially if investors bought years ago, they are sitting on a yield on cost of more than 7% thanks to high dividend growth.

With that said, let me elaborate a bit on the portfolio's drawdowns. Looking at the chart below, it's fair to say that the portfolio doesn't have random outliers. In other words, if the market is expected to do well, we can expect this portfolio to do well. The one thing that strikes is that the portfolio had a steeper drawdown in 2020 compared to the market. The market had (and still has) more tech exposure. It allowed the market to fall less far and rebound more quickly (thanks to the Fed's QE program). However, in 2022, that turned into a headwind, and I do not expect the market to gain a competitive advantage over this portfolio for years to come.

Moreover, the worst year for the S&P 500 during this backtesting period was -13.2%. The portfolio's worst year was -3.11%.

With that said when ERASING Broadcom from the portfolio, we can backtest going back to the year I was born (1995). What is now a 9-stock portfolio is still confirming our hypothesis.

The portfolio has returned 15.4% per year since 1995. The market has returned 10.0%. The standard deviations are 15.2% and 15.3%, respectively. Now, even the max drawdown of the portfolio is beating the market by 7 points (-44% versus -51%). This shows that the portfolio also did better during the Great Financial Crisis.

The chart below shows this so well. The portfolio is far less prone to steep drawdowns. When adding strong bull markets, the portfolio is a total beast.

And again, do not forget that we're dealing with a portfolio that can deliver the income needed for sufficient passive income. It's a high-yield portfolio beating the market. Not a high-growth portfolio.

That's what makes this portfolio so impressive!

It Also Beats SCHD

The only reason I am including this part is because it was requested. My goal is NOT to keep you from investing in great ETFs like SCHD. For most people, ETFs are much better than stock picking. They often lack the knowledge to pick good stocks, which can result in a lot of drama.

SCHD is a terrific ETF for income-oriented investors as it performs almost as well as my model portfolio. Going back to 2012 (when SCHD became listed), the ETF has returned 14.0% per year. The model portfolio has returned 15.6%. The standard deviation of the model portfolio was 14.6% during this period. The ETF was a bit less volatile with a standard deviation of 13.8%.

Hence, the portfolio performs slightly better on a volatility/adjusted basis - despite consisting of just ten stocks.

But then again, I doubt that this outperformance is enough to push the average Joe into single stocks.

Please note that I'm not making fun of people who cannot pick individual stocks. There is nothing wrong with that. While I believe that almost all of my readers are capable of building impressive portfolios, I sleep better knowing that some people invest in ETFs.

Heck, I would be buying ETFs if I had a job in a different sector that consumed all of my time.

And, let's not forget that these people do really well. Just look at how well SCHD is doing!

Takeaway

This article was all about showing investors the power of high-yield investing. In this case, I used a $100,000 high-yield model portfolio including stocks that come with both high yields and high dividend growth.

I believe it's the most impressive portfolio I've ever covered on Seeking Alpha.

The 4.6% yielding portfolio with 10.5% weighted average dividend growth showed that there is a way to benefit from income-generating companies, while beating the market on a long-term basis with subdued volatility.

The portfolio not only confirms the theories we discussed, it exceeded my wildest expectations. If I were much more dependent on income from my investments, I would not hesitate to copy this portfolio.

Given my view, which includes a prolonged period of high inflation, hawkish central banks, and unfavorable conditions for high-growth stocks, I will definitely copy parts of this model portfolio by incorporating more high-yield in my current portfolio.

All things considered, I hope I was able to answer some of your questions and incorporate your requests.

As always, please bomb the comment section with your questions and remarks.

• What would you do differently?
• What did you like about this portfolio?
• Are you changing anything going into 2023?
• Etc.

Thank you for reading!

For further details see:

The $100,000 Market-Crushing HIGH-Yield Portfolio