2023-09-07 15:20:30 ET
Summary
- The 4-factor dividend growth portfolio is a strategy that leverages the stock selection process of Schwab U.S. Dividend Equity ETF, with a few minor twists.
- The portfolio fell by 0.57% in August, outperforming the S&P 500 by 1.02%. Year-to-date, the portfolio is up 14.07%.
- Since inception, the portfolio is generating 3.95% of alpha over the S&P 500.
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 4 Factor Dividend Growth Portfolio . In a nutshell, the strategy leverages the stock selection process of Schwab U.S. Dividend Equity ETF™ (SCHD), or rather its underlying index, the Dow Jones 100 Dividend Index (DJUSDIV), 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 September 6th, 2023, including each position, the number of shares, current market value, estimated annual dividend, current allocation and target allocation.
Ticker | Shares | Market Value | Annual Dividend | Allocation | Target |
ABBV | 0.912160 | 133.27 | 5.40 | 6.03% | 6.67% |
ACN | 0.445310 | 145.24 | 1.99 | 6.57% | 6.35% |
ADP | 0.291340 | 73.67 | 1.46 | 3.33% | 3.56% |
AMAT | 0.489580 | 75.20 | 0.63 | 3.40% | 2.69% |
ASML | 0.223530 | 148.33 | 1.72 | 6.71% | 6.67% |
BBY | 0.151950 | 11.24 | 0.56 | 0.51% | 0.49% |
BLK | 0.087470 | 60.87 | 1.75 | 2.76% | 3.24% |
CSCO | 2.859880 | 163.76 | 4.46 | 7.41% | 6.61% |
EXPD | 0.125700 | 14.53 | 0.17 | 0.66% | 0.57% |
FAST | 0.364810 | 20.46 | 0.51 | 0.93% | 0.98% |
FERG | 0.108560 | 17.09 | 0.45 | 0.77% | 0.76% |
GRMN | 0.073540 | 7.72 | 0.21 | 0.35% | 0.40% |
HD | 0.433760 | 142.18 | 3.63 | 6.43% | 6.67% |
INFY | 2.713840 | 48.22 | 1.09 | 2.18% | 2.45% |
KLAC | 0.086540 | 44.36 | 0.45 | 2.01% | 1.59% |
LMT | 0.161960 | 72.10 | 1.94 | 3.26% | 3.86% |
LOW | 0.406170 | 93.59 | 1.79 | 4.24% | 4.30% |
LRCX | 0.080980 | 56.75 | 0.65 | 2.57% | 1.96% |
MA | 0.380820 | 156.71 | 0.87 | 7.09% | 6.67% |
MPWR | 0.030340 | 16.04 | 0.12 | 0.73% | 0.54% |
MRK | 1.298850 | 139.64 | 3.79 | 6.32% | 6.67% |
PAYX | 0.216150 | 26.23 | 0.73 | 1.19% | 1.35% |
ROL | 0.142100 | 5.40 | 0.07 | 0.24% | 0.37% |
SNA | 0.028600 | 7.53 | 0.19 | 0.34% | 0.41% |
SWKS | 0.115810 | 12.64 | 0.32 | 0.57% | 0.49% |
TROW | 0.143730 | 16.07 | 0.70 | 0.73% | 0.83% |
TSM | 1.764350 | 166.91 | 3.26 | 7.55% | 6.67% |
TXN | 0.599890 | 101.83 | 2.98 | 4.61% | 5.17% |
UPS | 0.479990 | 78.70 | 3.11 | 3.56% | 4.34% |
V | 0.624460 | 153.21 | 1.12 | 6.93% | 6.67% |
August 2023 Results
Despite seeing a negative return in August the portfolio outpaced the SPDR S&P 500 Trust ETF ( SPY ) last month. The portfolio finished the prior month with a loss of 0.57% while SPY dropped by 1.59%, in turn adding 1.02% to the long-term alpha. The 10-month return for the portfolio, through August 2023, is a very nice 22.10% compared to a return of 18.14% for SPY over the same time period. Beating the S&P 500 is not a primary objective but it is useful to see how the portfolio fairs compared to the broad U.S. Equity Market.
Year-to-date the portfolio is up 14.07% and trailing the S&P 500 by 4.66%. The entirety of the alpha generated by this strategy came in the last two months of 2022 as the portfolio outpaced the index by 7.53%.
The key drivers that attributed to a lower than average loss for this strategy compared to SPY were 5 individual holdings. Cisco (CSCO) posted a gain of 10.2% in August, Mastercard ( MA ) was up 4.66%, Visa (V) was up 3.54%, Accenture (ACN) was up 2.35% and Merck (MRK) was up 2.18%. Collectively these 5 holdings account for nearly 33% of the portfolio weight and they helped offset some of the worse performing components last month.
The average loss in August for all 30 holdings was 1.77%, and the strategic asset allocation led to a positive overall outcome since the portfolio finished the month with a loss of just 0.57%.
Since inception the actual allocation has drifted away from the target allocation, at the moment the absolute drift is 9.56%. Once again we observe the absolute drift increase compared to the prior month when the absolute drift was 8.76%. 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 August for each holding. In the table below you can see the ticker symbol for each holding, the target allocation weight, the total return for August and the respective allocation return in the portfolio.
Symbol | Target Allocation | Aug 23 | Alloc Return |
ASML | 6.67% | -7.59% | -0.51% |
ABBV | 6.67% | -1.75% | -0.12% |
TSM | 6.67% | -5.63% | -0.38% |
HD | 6.67% | -0.43% | -0.03% |
MA | 6.67% | 4.66% | 0.31% |
V | 6.67% | 3.54% | 0.24% |
MRK | 6.67% | 2.18% | 0.15% |
CSCO | 6.61% | 10.20% | 0.67% |
ACN | 6.35% | 2.35% | 0.15% |
TXN | 5.17% | -6.63% | -0.34% |
UPS | 4.34% | -8.64% | -0.38% |
LOW | 4.30% | -1.62% | -0.07% |
LMT | 3.86% | 1.12% | 0.04% |
ADP | 3.56% | 2.97% | 0.11% |
BLK | 3.24% | -5.19% | -0.17% |
AMAT | 2.69% | 0.99% | 0.03% |
INFY | 2.45% | 4.26% | 0.10% |
LRCX | 1.96% | -2.24% | -0.04% |
KLAC | 1.59% | -2.09% | -0.03% |
PAYX | 1.35% | -1.88% | -0.03% |
FAST | 0.98% | -1.76% | -0.02% |
TROW | 0.83% | -8.95% | -0.07% |
FERG | 0.76% | -0.04% | -0.00% |
EXPD | 0.57% | -8.32% | -0.05% |
MPWR | 0.54% | -6.84% | -0.04% |
BBY | 0.49% | -7.95% | -0.04% |
SWKS | 0.49% | -4.31% | -0.02% |
SNA | 0.41% | -0.81% | -0.00% |
GRMN | 0.40% | 0.12% | 0.00% |
ROL | 0.37% | -2.78% | -0.01% |
-1.77% | -0.54% |
It was positions 5 through 9 that drove the outperformance last month. Additional contributors to the return last month were: Lockheed Martin ( LMT ), ADP ( ADP ), Applied Materials ( AMAT ), Infosys ( INFY ) and Garmin ( GRMN ) that all posted a positive gain as well.
20 out of the 30 stocks in this portfolio saw a negative return last month but still only 3 stocks remain in the red since inception.
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.
Breakdown | % of Portfolio | Average Return | Portfolio Return | % of Portfolio Return |
Top 7 | 46.69% | -0.72% | -0.33% | 62.17% |
Top 10 | 64.82% | 0.09% | 0.15% | -26.99% |
Top 15 | 84.12% | -0.70% | -0.32% | 59.14% |
Top 20 | 94.16% | -0.57% | -0.29% | 53.82% |
Bottom 10 | 5.83% | -4.16% | -0.25% | 46.18% |
This data is based on the target weight and not the actual portfolio weights, however, the margin of difference is not significant.
Here are the combined returns for each holding since November 2022.
Symbol | Target Allocation | Combined |
ASML | 6.67% | 41.29% |
ABBV | 6.67% | 3.42% |
TSM | 6.67% | 54.35% |
HD | 6.67% | 14.56% |
MA | 6.67% | 26.32% |
V | 6.67% | 19.57% |
MRK | 6.67% | 9.85% |
CSCO | 6.61% | 29.18% |
ACN | 6.35% | 15.36% |
TXN | 5.17% | 6.90% |
UPS | 4.34% | 4.71% |
LOW | 4.30% | 20.01% |
LMT | 3.86% | -5.45% |
ADP | 3.56% | 7.08% |
BLK | 3.24% | 10.80% |
AMAT | 2.69% | 74.69% |
INFY | 2.45% | -6.01% |
LRCX | 1.96% | 75.24% |
KLAC | 1.59% | 60.65% |
PAYX | 1.35% | 6.35% |
FAST | 0.98% | 21.49% |
TROW | 0.83% | 9.25% |
FERG | 0.76% | 50.35% |
EXPD | 0.57% | 20.71% |
MPWR | 0.54% | 54.46% |
BBY | 0.49% | 15.69% |
SWKS | 0.49% | 29.56% |
SNA | 0.41% | 24.11% |
GRMN | 0.40% | 23.08% |
ROL | 0.37% | -4.71% |
After some more volatility last month, we now have only 20 out of the 30 stocks seeing double-digit total returns. That's 3 fewer than a month ago. This is still pretty exceptional given that we are 10 months into the first year for this strategy. Here are the best performers:
- LRCX +75.24%.
- AMAT +74.69%.
- KLAC +60.65%.
- MPWR +54.46%.
- TSM +54.35%.
The average return of the top 7 holdings is 24.19% compared to an average return of 23.76% for all 30 positions. After briefly flipping last month, the top 7 holdings regain their lead over the portfolio as a whole. Once again suggesting there may be some merit to the strategic asset allocation that was used.
3 holdings have thus far generated an overall loss for the portfolio, the list remains unchanged from a month ago. The losers are:
- INFY -6.01%.
- LMT -5.45%.
- ROL -4.71%.
The target allocation for these 3 positions is 6.69%, and their inclusion is costing the portfolio approximately 0.38% in total return. Definitely not a major setback.
Long-Term Performance
The portfolio trailed the S&P 500 by 0.19% in Quarter 1 (7.31% to 7.50%). Quarter 2 was even worse; the portfolio finished the quarter 4.38% behind the S&P 500 (4.36% to 8.74%).
Quarter 3 got off to the same poor start, but fortune has tipped in the portfolios favor in August. After 2 months the portfolio is outpacing the S&P 500 in the current quarter by 0.28% (1.85% to 1.57%). While this lead is narrow and can be lost in September it is good to see strong results from the strategy as we near the end of the first full year. What I would like to see from this strategy is a strong total return (12% CAGR) over a long period of time, say 5 to 10 years.
Since inception, the portfolio has been generating alpha over the S&P 500. After August the alpha increased to 3.95% from 2.70% a month ago. I think that is still a comfortable cushion going into the final 2 months of fiscal year number 1. Since inception the portfolio is up 22.10% (through month-end August) which for me is an excellent return.
My hypothesis for the 4 factor stock selection strategy is that it can produce an annualized total return of at least 12% and generate a growing passive dividend stream along the way.
Dividend Review
Currently, the portfolio has a forward dividend yield of 2.09%, which is up slightly from the 2.08% dividend yield a month ago. This is primarily driven by the negative return observed during August. The portfolio generated $4.69 in dividend income during the month of August, these dividends were reinvested in a way to reduce the allocation drift. The total dividend income generated in 2022 was $6.08, and $30.34 in 2023 through month end August.
The projected dividend income for the next 12 months is $46.12; this figure has increased from $45.71 a month ago as a result of changes in dividend rates and dividend reinvestment. The portfolio has exposure to a few foreign positions whose dividend stream is subject to currency fluctuations. 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 dividend growth and dividend reinvestment.
The average dividend increase in the portfolio has been 12.12%, or 6.49% at the portfolio level factoring in individual stock weights and 0% increases for the stocks that have not raised their dividend yet. This figure is highly likely to increase over the next 2 months and it'll be interesting to see where we finish at the end of the first fiscal year.
Observations Made During First 9 Months
I updated my long-term return figures for all 30 chosen stocks through August, extending the amount of data to 10 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 3.36% to 1.89%.
If you happened to read my past updates, you may recall that the first insight I made about this strategy was that stocks that ranked better in the 4 factor test have been generating higher returns compared to lower ranked stocks. And perhaps adopting the allocation methodology of SCHD was not the optimal route to take.
Between November 2022 and August 2023 the average total return for the 15 highest ranked stocks using the 4 factor stock selection process was 27.68%. Whereas the next 15 stocks (positions 16-30) had an average return of just 19.84%. If we break these average returns down further, the top 5 ranked stocks had an average gain of 25.18%, stocks ranked 6 through 10 had an average gain of 13.56% and stocks ranked 11 through 15 had an average gain of 44.45%.
The average return of the top 20 ranked stocks during the last 10 months was 26.90% which is nearly 5% higher than the return of the actual portfolio. Not only would investing in 20 stocks be easier, adopting an equal weight allocation would also be simpler.
The next re-constitution for this strategy is coming up pretty quickly, at the end of October I will run the 4 factor stock screener again to see which stocks will be part of next year's portfolio. I have decided to make the following changes to the structure of the portfolio for fiscal year 2. Instead of selecting the top 30 stocks I will trim the list to just the top 20 stocks. Additionally I will no longer use the capped float adjusted market capitalization to set the initial asset allocation. Instead I will use an equal weight approach with each stock representing a 5% allocation in the portfolio. I am also debating about rebalancing the portfolio on a monthly basis. Seeing how the actual portfolio is held in a Roth IRA account, there would be no tax consequences from such a rebalancing schedule.
New 4 Factor List
Since month-end May, I have been running the 4 factor stock screener on a monthly basis and tracking the list of top ranking stocks. I want to accumulate this data to run additional tests on more frequent rebalancing and to document how much the list changes from month to month.
The top 20 ranked stocks at the end of May had an average return of 9.40% in June, 5.24% in July and -2.60% in August. This was better than the S&P 500 that posted a return of 6.61% in June, 3.21% in July and -2.53% in August. The cumulative return for the top 20 stocks from May is 12.11% compared to just 7.23% for the S&P 500, that's an outperformance of 4.88%.
The top 20 ranked stocks at the end of June also would have gotten off to a better start than the S&P 500, with a return of 5.24% in July and a loss of 2.26% in August. Both months clocked in better than the S&P 500 that gained 3.20% in July and fell by 2.53% in August. The cumulative return for the June top 20 stocks is 2.91% compared to a gain of 0.59% for the S&P 500, that's an outperformance of 2.32%.
The top 20 ranked stocks from the prior month finished August with a loss of 2.03% which was 0.5% better than the S&P 500.
It'll be interesting to see if this pattern continues and if a more frequent rebalancing can achieve even better long-term results.
Compiling the list is a 2 step process; the first part is generating a shortlist of dividend growth stocks; the second step is ranking them based on the 4 factors.
Here are the criteria for the initial stock screener:
- Payout Ratio of 80% or less.
- 3 & 5-year Dividend Growth Rate of at least 5%.
- 5-Year Revenue and EPS Growth Rate of at least 5%.
- Stock must trade on the NYSE or NASDAQ.
- Wide or Narrow Economic Moat.
- Exemplary or Standard Stewardship Rating.
I ran this screener on August 31st and 136 unique dividend growth stocks were selected for further analysis. I then applied the 4 factor stock selection process and narrowed the list down to just the top 20 ideas. The list is presented below with data shown as of August 31, 2023.
Rank | Symbol | FCF/Debt | 5Y DGR | ROC | FWD Yield | Prior Month | Rank | Change |
1 | SQM | 75.52% | 39.54% | 43.10% | 4.95% | 1 | 1 | 0 |
2 | EOG | 331.38% | 35.54% | 23.82% | 2.58% | 2 | 2 | 0 |
3 | WSM | 99.56% | 15.42% | 29.45% | 2.53% | 3 | 3 | 0 |
4 | INFY | 281.04% | 14.08% | 24.00% | 2.43% | 4 | 4 | 0 |
5 | ADP | 118.83% | 13.71% | 41.10% | 1.96% | 6 | 5 | 1 |
6 | TXN | 65.67% | 14.87% | 22.16% | 2.93% | 8 | 6 | 2 |
7 | FAST | 202.20% | 13.25% | 23.61% | 2.42% | 7 | 7 | 0 |
8 | RHI | 333.66% | 11.60% | 23.39% | 2.54% | 9 | 8 | 1 |
9 | PAYX | 191.81% | 9.65% | 30.36% | 2.91% | 10 | 9 | 1 |
10 | HD | 39.68% | 15.47% | 29.10% | 2.53% | 13 | 10 | 3 |
11 | ODFL | 1974.16% | 35.49% | 28.10% | 0.37% | 12 | 11 | 1 |
12 | MPWR | 5212.13% | 28.47% | 20.36% | 0.78% | 11 | 12 | -1 |
13 | LRCX | 98.66% | 22.03% | 26.52% | 1.17% | 16 | 13 | 3 |
14 | ASML | 138.02% | 29.95% | 33.73% | 0.48% | 17 | 14 | 3 |
15 | MAS | 33.99% | 22.00% | 25.40% | 1.94% | 15 | 15 | 0 |
16 | LSTR | 420.86% | 16.83% | 24.91% | 0.69% | 18 | 16 | 2 |
17 | AVGO | 44.50% | 23.34% | 16.28% | 2.06% | 19 | 17 | 2 |
18 | CNS | 129.07% | 7.83% | 22.51% | 3.51% | 5 | 18 | -13 |
19 | MCHP | 62.25% | 15.28% | 15.74% | 2.00% | 38 | 19 | 19 |
20 | UPS | 45.40% | 12.38% | 17.39% | 3.77% | 21 | 20 | 1 |
For further details see:
4 Factor Dividend Growth Portfolio - Closing In On A Historic First Year