PLTR - Why I Made Big Changes To My Dividend Growth Portfolio

2023-11-29 11:25:26 ET

Summary

• I've made significant changes to my portfolio due to buying a new house and selling stocks from my portfolio to raise cash.
• My goal is to prioritize building a passive income stream, but I recognize the value of investing in a new home for improved quality of life.
• In this article, I discuss different options to pay for the new home, including taking out a mortgage or selling more stock if mortgage rates remain high.

I've made big changes to my portfolio recently.

I bought a house that better meets the needs of my family, which has created a bit of a domino effect across my household balance sheet.

In recent months I've been a net seller in the stock market, having to raise cash for renovations on my current home (which will be sold soon) and the deposit for our new construction.

This has been a difficult process because, for years, my top priority when making investments has been to consistently build out and compound my passive income stream.

That meant buying stock and adding shares to blue-chip dividend growth stocks.

Every new share I added was another step towards financial freedom.

But, life isn't just about piling up shares of blue chip stocks.

My wife and I believe that our new home will improve our quality of life. And that's worth spending money on.

The deposit has been made, but the question remains: how do I pay for the rest of our new home?

I don't want to take out a mortgage at ~8%.

I'm not opposed to leveraging debt to my advantage, but I'm not a fan of high interest rates.

Thankfully, I don't have to make a decision on how to pay for the house until next summer.

Mortgage rates have fallen in recent weeks and if that trend continues over the coming months, then I'll happily go that route (ideally, I'd like to lock in a long-term rate of less than 6%).

But, if they remain elevated (or continue to rise) then I will likely sell more stock and pay for the house with cash.

I plan to sell my current home in between now and use the proceeds from that sale to make a hefty down payment on the new build. But, unless the sale price here is a lot more than several Realtors have suggested, I'll need to dip into my portfolio a bit more to be debt-free.

Yes, allocating the cash from a home sale towards our primary residence as opposed to income-producing assets will hurt my passive income stream; however, it will also reduce my monthly expenditures in a big way.

To me, having a paid-off mortgage is a big part of being financially free.

I've done analysis on several different scenarios with likely return potentials attached to my investments (relative to mortgage rates) and I'm prepared to be flexible here.

At this point in time, I'm at the mercy of the bond market (with regard to where mortgage rates will be in 6 months' time).

But, in the meantime, I wanted to write this article, highlighting the trades that I've made thus far, explaining their rationale, and discussing my plans moving forward (because I know that so many of you like to follow along with my portfolio management).

My Priorities When Making Sales

When thinking about my financial situation, there were several things I was not interested in doing.

First of all, I knew that I didn't want to dip into my emergency funds (roughly 6 months of spending for my family) to pay for the new house.

Spending that money would have reduced the quality of my sleep. With two young kids at home, it's poor already. I didn't want to make it worse (I did insist that the builder insulate the walls of the primary bedroom in the new build, so hopefully my sleep will improve in the coming months).

Right now this cash is earning ~5% in a money market fund and I'm content to leave it there until I truly need it.

I also wasn't interested in dipping into the cash that I've allocated towards bear markets.

As many of you know, when markets are hot I set cash aside every month that is earmarked for spending during the next broad market crash.

I have cash buckets that I plan to invest when the S&P 500 falls to -20%, -25%, -30%, -35%, and -40% levels relative to its all-time high.

I remain confident that the ROIs that I will generate when buying high-conviction stocks during a market crash will greatly exceed the ~8% returns that I could lock in by avoiding a mortgage right now.

Bear markets are when disciplined investors can make fortunes and I didn't want to reduce/eliminate my ability to take advantage of these unique opportunities by spending my bear market cash on a house that will, in all likelihood, appreciate at a mid-to-high single-digit rate over the long-term.

Once again, right now this cash is earning ~5% in a money market fund and I'm content to leave it there until we see a significant macro sell-off.

With regard to a higher ROI than the high single-digit mortgage rates that I'm seeing right now, I wasn't looking to sell any of my high-conviction secular growth stocks that have the potential to continue to compound their fundamentals (and their dividends) at a double-digit rate.

I've written a lot about my focus on accumulating perpetual compounders recently and those plans have not changed.

Looking at historical data, homes in the area where I bought have appreciated at a 6-8% annual clip (looking at 5, 10, and 15-year data sets). That's well above the national average of 4.8% (according to Case Schiller, looking at data from 1987-2023).

Knowing that I'm buying in a hot real estate market gives me peace of mind as well.

Historically, my local real estate market has been very resilient (due to several large institutions and a large public University that drive constant growth). Looking at these structural local demand drivers, I don't expect that trend to change anytime soon.

I'm thankful for that; however, I'm a realist. I know that the recent double-digit home price appreciation trends that we've experienced in recent years are not sustainable. Therefore, I don't want to trade in a stock that should compound at a 10%+ rate for an asset that is almost certain to underperform on a relative basis.

So, now that you know what I wasn't willing to do when making sales, let's talk about the goals that I wanted to achieve when selling stock to raise cash.

The first thing I wanted to do when deciding which stocks to sell here was to identify my lowest quality and conviction holdings and start there.

In general, I'm always a fan of holding onto winners (so long as they're not breaking asset allocation rules).

As the old saying goes, "You don't want to cut your flowers and water your weeds."

When I make trades, whether I'm buying or selling stock, I want to make sure that I'm improving the quality of my portfolio, overall. That's what my perpetual compounder focus is all about.

Along these same lines, I was also happy to lock in losses when selling relatively low-quality holdings because I'm still sitting on massive capital gains for the year due to my decision to trim my overweight Apple ( AAPL ) stake earlier in the year when its rally pushed its weighting well up above the 10% threshold.

As wonderful as Apple is, I didn't feel comfortable with that single-stock risk.

Generally, I hate the idea of locking in losses because when you own blue chips, way more often than not, unrealized losses become unrealized gains when you're patient. But, reducing my tax burden is nice, so in several cases, I was able to kill a couple of birds with one stone when it came to selling lower-quality holdings and canceling out some of my Apple gains.

Something else that I considered when selling shares was portfolio redundancy.

In the past, I've been happy to build baskets of like-companies when I couldn't pick a clear winner.

For instance, I own both Coca-Cola ( KO ) and PepsiCo ( PEP ). I own both Visa ( V ) and Mastercard ( MA ). I own Amgen ( AMGN ) and Merck ( MRK ). You get the picture.

Over time, these companies have all risen nicely, so I never felt the need to pick or choose.

But, when I think about my portfolio long-term, I don't mind the idea of simplifying things and reducing my number of holdings overall.

When you make big financial decisions (like buying a home), you end up thinking about your legacy.

Managing a portfolio with ~90 stocks isn't all that difficult for me because I've developed efficient systems for monitoring my holdings that coexist with my day job's duties (equity analyst). But, when my time on Earth is done I pass my passive income-producing machine to my wife and/or my kids, I don't want it to be overly complex (or time-consuming) for them.

My oldest child isn't quite old enough to learn about the stock market yet, but that time is drawing near. When it's time to teach her about investing and the family's finances, I don't want it to be intimidating or overwhelming.

I hope that she develops a passion for portfolio management because my goal here isn't just financial freedom for my wife and me, but for generations of Wards to come.

So, I'm happy to cut out some unnecessary redundancy throughout this process and make this portfolio less daunting to pass along at a later date.

This will take time. I didn't want to make any rash decisions or hastily rush out of positions. But, as you'll see in a moment, I've trimmed down the weightings on many lower conviction picks, and over time, I would expect to see this trend continue as I begin to allocate more money towards my top investment ideas.

The Trades I Made

So, with all of that being said, let's take a look at the trades that I've made as a part of this home-buying process.

Knowing that a move was in our future, I've been planning for this for months. I've been slowing building my cash position throughout 2023, providing the flexibility to make a move like this. But, when you sign a contract things get real. The need to pay a deposit was a major catalyst and the first trade that I made that was officially related to this home-buying process occurred on November 7th, 2023.

Buying APD & MAIN; Selling CMCSA & HRL

When Air Products and Chemicals dropped 10%+ after earnings, I knew I wanted to buy shares.

APD and its competitor Linde (LIN) are two of my highest conviction growth picks in the industrials sector. These industrial gas plays make the world go around…and they rarely sell-off.

Air Products' sales came in below expectations; however, the business still looks very healthy to me.

Historically, APD has produced annual earnings growth during 17 out of the last 20 years.

APD's annual EPS growth was in the double digits during 13 out of these 17 positive years.

And this reliable EPS growth has led directly to strong dividend growth.

During the last 20 years, APD's dividend growth CAGR is 11.3%.

APD's -10% plunge pushed its valuation down to the 20x forward level. That's below my 22x fair value target.

Here's the chart that I posted for subscribers on 11/7, showing APD's 10-year average P/E and upside towards the $300 level in the event of mean reversion here.

I added to my position at $258.32, expecting ~15% near-term upside potential. Today, APD shares traded for $269.99, so I'm glad that I didn't hesitate to buy this dip.

But, since the vast majority of my monthly cash savings are being allocated towards my renovation and down payment budgets, I was forced to sell something to raise funds to buy APD.

To buy more APD, I sold out of my Comcast ( CMCSA ) and Hormel ( HRL ) positions.

I sold CMCSA at $42.25 and $42.26, locking in overall gains of 17.6%.

I sold HRL at $32.62, locking in losses of ~20%, canceling out the CMCSA gains that I had in a taxable account.

I've been looking to exit the media/entertainment sector for a while now. I recently cut ties with Disney and ever since, Comcast was at the top of my sell-list. CMCSA's fundamental growth has been slowing for years now and the streaming wars, which continue to hurt margins and make cash flows unpredictable, aren't going anywhere anytime soon.

Hormel is a pretty good example of the type of stock that I'll be looking to sell in favor of the high single-digit ROI that I can lock in by paying cash for my new house, instead of a mortgage.

This is a solid company, but the growth prospects are relatively low and I favor a risk-free 7-8% return over the outlook of most mature consumer staples like this.

As a part of this trade, I also used the CMCSA/HRL proceeds to add to my Main Street Capital ( MAIN ) position at $40.14.

By adding MAIN's high yield to the equation, I was able to add to APD and pocket roughly 30% of the CMCSA/HRL proceeds (adding them to the house fund) without hurting my passive income stream.

Overall, the APD and MAIN shares that I bought allowed me to increase my passive income stream by roughly 2% (relative to the CMCSA/HRL shares that I sold).

I know I won't be able to maintain income entirely when liquidating assets for the home purchase, but it felt good to be able to with this trade.

A Slew of Sales

The next 16 trades that I made in November were all sales.

I'll admit, the timing here was unfortunate. I had to cut a check to my builder on 11/13 and the market had a nice rally on the 14th. I would have made a pretty penny had I been able to wait a day to sell these shares, but I also recognize that it's impossible to predict short-term macro moves like this…I'm not going to fret about things that are outside of my control.

Here's a list of the sales that I made:

These sales were all made in taxable accounts. In some cases, I still own shares of these companies in retirement accounts. I may exit these positions entirely over time, but there's no rush to do so and in the meantime, I'm happy to collect their growing dividends.

The REITs that I sold here (CPT, MAA, ESS, and ADC) all check three of the previously discussed boxes: tax loss harvesting opportunities, redundancy within my portfolio, and relatively low growth prospects.

Since this new home will result in physical real estate representing a larger portion of my net worth, I was happy to reduce the real estate exposure within my investment portfolio. With that in mind, I targeted my residential REITs.

I also cut ties with ADC, locking in losses in my taxable account. Realty Income is my largest REIT position and while I think ADC is a solid company, I'm content with O's larger and more diversified portfolio for commercial real estate exposure. In short, I decided I didn't need to own both and I decided to let ADC's poor 2023 performance work to my advantage a bit.

McCormick was a position that I've held near and dear to my heart for years now because it was the first investment that I made when I decided to go down the dividend growth investing path more than a decade ago. But, I know it's important not to fall in love with a stock, and looking at MKC's fundamentals, I was concerned about its total return prospects moving forward because of its high PEG ratio. MKC is a great company; however, like Hormel, I decided to take profits, since its relatively low growth prospects aren't very attractive relative to the prospects of canceling out debt with a high single-digit yield attached to it.

Diageo fits into this relatively low-growth, mature consumer staple trend as well. This has been a sleep well at night [SWAN] stock for me for years now. However, growth is slowing and the yield is relatively low. I admit, that after DEO's recent sell-off, the valuation attached to shares right now is attractive. But, even so, it remains one of my lower conviction holdings. I had to sell something. And in general, I was happy to lock in gains here, exiting the position entirely, and reducing my position count.

I sold all of the HD and LOW shares that I held in taxable accounts. Physical retail is a low-conviction industry for me (regarding long-term growth prospects). The eCommerce trend is still taking market share and in recent years, retail theft has arisen as yet another structural growth headwind that these companies face. These are both great companies; however, they're up against tough pandemic-era comps and their balance sheets have deteriorated a bit in recent years. So, I was content to reduce my exposure to both names.

Like physical retail, bio-pharma is an industry that I'm looking to reduce my exposure to moving forward. Historically, I've done well investing in blue-chip names in this space. But, the ever-present threat of patent cliffs and the unpredictable nature of drug pipelines means that these companies don't really mesh well with my perpetual compounder priorities these days. Pfizer was the lowest quality bio-pharma stock that I held, so I started there with my selling. I was also able to lock in losses, helping to reduce the tax burden of that Apple trade. Don't be surprised to see me selling more bio-pharma picks (especially those with substantial upcoming patent cliff concerns) in the coming months as I continue to raise cash.

Tobacco is another industry that I'm relatively bearish on moving forward. I continue to believe that the dividends from MO and BTI are safe; however, the growth prospects from both companies are poor, and therefore, even with the high yields in mind, I worry about the total return prospects from both companies moving forward. In short, I decided to side with the ~8% risk-free returns from the potential reduction of mortgage debt instead of sticking with the uncertain future that tobacco presents.

Lastly, we arrived at Otis, which was a relatively small position for me (an old UTX spin-off). This wasn't a core industrial position for me. I don't feel compelled to own an elevator company (even if it's the world's best). And in a way, Otis is a play on the real estate market and therefore, although there isn't going to be an elevator in my new home, I was happy to take the gains and use the OTIS sale to reduce my exposure to the real estate sector while also dropping the company count within my portfolio.

Nicholas Ward's Dividend Growth Portfolio

Conclusion

TLDR; I bought a house and had to sell some stock to pay for it. Moving forward, I hope to become more concentrated on my highest-quality ideas. It's a bummer that this financial decision will hurt my passive income stream, but quality of life is important and my wife and I can't wait to move our family into a new home.

Whenever I have cash available to invest, I will continue to focus those funds on my favorite perpetual compounders. However, most of my savings will be directed towards my upcoming mortgage, unless rates fall significantly between now and June.

Because of this, when I see an opportunity in the market, I will need to sell an existing position to capitalize on any new deals that arise. Therefore, I may be more active with my trading during the coming quarters.

On the other hand, if the market's recent rally continues then I'm more than happy to sit back, watch my existing positions rise, and build cash yielding ~5% in money market accounts.

Either way, I will continue to selectively reinvest my monthly dividends into my highest conviction long-term ideas.

Happy holidays, everyone!

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