In this episode of The Market Call Show, I discuss a practical strategy for investors seeking a rising income stream, particularly in the face of inflation and increasing retirement expenses. I outline a dividend growth approach that combines consistent income with long-term capital appreciation, making it a core strategy for retirement portfolios.
I explain how to identify and select a "winning universe" of stocks, emphasizing the importance of companies with strong fundamentals, reliable earnings, and a history of steadily increasing dividends. The process includes filtering stocks based on criteria like liquidity, a 10-year track record, and consistent dividend growth. This narrows the focus to high-quality companies that can provide stable and growing returns.
Portfolio construction is another key element. I share how to build and manage a diversified portfolio by limiting sector and industry concentrations, maintaining balanced position sizes, and setting guidelines for rebalancing. I also discuss how to evaluate stocks continuously, using both fundamental and quantitative rankings to guide investment decisions.
This approach is designed for long-term investors aiming for reliability rather than speculative gains. I highlight the benefits of blending this core strategy with other satellite investments, such as bonds or private real estate, to enhance returns and reduce risks. Whether you're retired or planning for the future, this strategy can serve as a foundation for a resilient and income-generating portfolio.
Listen in for actionable insights and tips to build your financial future.
SHOW HIGHLIGHTS
- I discuss the need for a rising income strategy in response to inflation and retirement expenses, emphasizing the importance of long-term capital appreciation alongside growing income.
- I explain the value of dividend growth investing, focusing on selecting companies with a consistent track record of increasing dividends and strong earnings.
- I outline criteria for selecting stocks, such as filtering for liquidity, excluding companies with less than 10 years of performance history, and prioritizing sustainable dividends.
- Portfolio construction is discussed, including limiting sector concentration, balancing position sizes, and maintaining diversification to reduce risk.
- Stock analysis involves both qualitative and quantitative methods, focusing on profitability, analyst coverage, and adaptability to ensure steady growth.
- I highlight the importance of ongoing portfolio management, including regular reconstitution and rebalancing to maintain alignment with investment goals.
- Criteria for selling stocks include dividend cuts, declining fundamentals, and insufficient liquidity, ensuring the portfolio remains strong.
- Strategies for blending dividend-focused portfolios with other investments, like bonds or real estate, are explored to enhance returns and mitigate risks.
- This approach is positioned as suitable for long-term investors, offering stability and income generation, particularly for retirees.
- The episode concludes with a discussion on integrating this strategy with faster-growing investments for a well-rounded portfolio.
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TRANSCRIPT
(AI transcript provided as supporting material and may contain errors)
Louis:Okay, today we're going to be talking about a winning strategy for people who are looking for rising income. What spurred me to want to talk about this was that, frankly, there's a lot of people that are needing rising income. They need rising income because inflation continues to go up. And many people are retiring and they need an income stream that's going to keep up with inflation. So I wanted to talk about a strategy that is very effective, really as a core strategy for people who are needing rising income. Because one of the most common challenges that investors face Is that over the long term, especially, you know, when you're trying to fight inflation, your expenses continually rise and you need a combination of long term capital appreciation and a growing income.
So a dividend growth approach is one of the best strategies to achieve dividend growth. Now, I want to share today a method to accomplish this goal, and I'm going to be very specific because I find that people really feel more comfortable when they understand what's behind the curtain in generating a portfolio that you can really rely on, especially when you're dealing with your core strategies.So, this method can give you some ideas to form a core strategy, and Within a retirement income plan, and it's designed to be, really the bedrock of the portfolio, but it's also a good idea to have satellite strategies to enhance the returns over time for the portfolio. But let's just start off with the first thing that you need to do in order to have a good, rising income approach with stocks.
The first is you need to choose winning a winning group of stocks. You need to choose a winning group of stocks that have a successful dividends track record. So you got to get that universe, right? And that's crucial. So what I like to do is I like to start off with the S&P1500. The S&P1500 includes large companies, mid cap companies, as well as small cap companies, and they're all in the United States. And I like to filter out from that group companies that have excessively high yields because companies that have really high yields, it's generally unsustainable. I want to make sure that the dividends that are there are well supported by earnings as well as the company fundamentals and that they have the ability to provide a competitive advantage. So the numbers are basically showing us that these companies have a strong business and a competitive advantage. So I want to explain a little bit more about, like, establishing the universe, if you will.the other thing I like to look at is, I want to look at the daily dollar volume and eliminate those stocks that are really illiquid.
So the dollar, daily dollar volume just says, Okay, what is the average volume of the stock in the market? And multiply that times its price, and that gives you kind of the dollar value that is traded in a given day. So typically, So I rank order those companies and I want to make sure that they have a that they're generally usually in the top 90%.
So like the bottom 10 percent of illiquid stocks I generally want to ignore them. And then I also have a cutoff, a dollar cutoff to say it needs to be at least x. And that number does change depending on the purpose. So basically get rid of those stocks that are too illiquid. You don't want to have them in your.
In your strategy, because you're really looking for those solid companies. So I also want companies that have a long term track record. So I exclude stocks that have a track record that is less than 10 years. Now, some people say, well, wow, there's a lot of great companies that you're missing out on. Well, that is true, but I like to look at those younger companies for different types of strategies.
For this strategy, this is a strategy that's designed for steady growing income stream. And, long term capital appreciation. So we're not really trying to hit the cover off the ball. We're trying to get steady growth of rising income and also getting rising capital appreciation. So we want to get rid of those companies that have a 10 year, less than a 10 year record.
And now it's for the best part of the universe selection.I want to exclude stocks that are not raising their dividends. So I'm looking for companies that are raising their dividends every year and they haven't cut their dividend in the most recent four quarters. So in the last year, they haven't cut their dividend.
They may have kept them the same, not necessarily raised them. But we're looking for annually, successively, higher dividends. And then we're looking at the quarters and saying, you're not cutting the dividend. This really narrows the universe down. And like, for example, as of right now, that universe is 341 companies.
That I just outlined. So you want to start off with those winning stocks. So now we've got this group, this universe of companies that, you know, you've really shut off a lot of dead weight. You're only including those companies that have a long term track record of rising income, and they have the characteristics that can get you headed in the right direction.
But you don't want to leave right there. You also want to actually move from there and actually look at these companies fundamentally. So, you know, you want to demand from these companies that they have steady rising dividends and strong earnings. So, a critical aspect of this strategy is to focus on companies that have adequate analyst coverage.
So, analyst coverage would be, Is good to have. You want to make sure that you don't want to make it too stringent because there are some smaller companies that you want to have investment in and they may have less analysts following them. So I have found in today's marketplace that the sweet spots right around five analysts.
So five analysts are covering it. You still have a big universe of companies that are in a smaller market caps. As well as the mid cap and the large cap. So why do you care about whether or not Wall Street is looking at these companies? Well, the first thing is there's a lot of value in actually assessing and analyzing the change in what's happening with analyst expectations because stock returns have high correlation to these changes.
So we're looking at. You know, earning surprise. We're looking at, you know, whether the company is beating expectations or whether, analysts are starting to upgrade a stock because that's really indicative showing that the company is actually improving their results. So part of the equation is looking at expectations and another part is actually looking at what is actually printing and what the company is demonstrating with their fundamentals.
So, that's why we want to have at least five analysts covering that. Another thing that we want to do is we want to, you know, like I had mentioned, we want to have rising dividends. So as we narrow that universe down, we're getting to a high quality basket of stocks that can build a reliable income source.
Now the next step is to, I like to connect, kind of think of, building a portfolio like cooking. You know, it's like having a good recipe. So I'm really what I'm outlining for you right now is a recipe. So you want to build a tasty recipe to get better results. And that means you got to build and manage the portfolio.
And select from this list of companies, you can just buy all of them if you wanted to, but if you want to get better results, I recommend, or I like to limit the sectors and the industry weights of companies. And I like to first look at them fundamentally. So. You know, looking at these companies from many different directions, you know, the first would be quality.
How profitable are they? What is the return on capital? We like companies that are capital efficient. are they growing their sales and their earnings? And to what extent are they really printing good numbers there? the other thing I like to look at is, you know, there's just so many different things, but I mentioned the sentiment aspect about what the analysts are viewing, how they're viewing the company, but also we want to actually look at just the profitability, the quality, the valuation.
So once that's been, analyzed, there's another, there's a qualitative thing that I like to look at and, I call it ADP, A as in apple, D as in dog, and P as in profits, . I outlined that in my book actually. the financial freedom blueprint. And you know, I'm really thinking about writing another book because I have a lot more that I want to share with people.
But if you go to my book and you go to page 22,I outlined the ADP criteria and this is how focusing your capital on companies that have a few different characteristics. Number one, are they adaptable to changes in technology and innovation? And number two are, do they have desirable products and services, that are desirable now and likely to be desirable in the future?
So it's not a fickle thing because for this portfolio, we're really looking for long term growth, right? And compounding growth and are they profitable? Is their business model such that they have getting, they're getting good? Returns on capital now and is likely to do so in the future. So it's really an assessment of now actually demonstrating it as well as, you know, when you're looking at the company's business model, is it likely to sustain in the future?
So those three things can really help you. to have better returns than sticking your money under the mattress. And, and also, better returns are more likely than you would get in bonds, by a significant margin. Okay, so once we've done that, you know, we've done the fundamental aspects and looked at all the quantitative methods.
basically, I like to quantify those into ranks. And that really keeps you disciplined so that you can compare companies to each other. So, I, the next step in this is something that's really important because what a lot of people don't understand, is that stock selection or investment selection is very important, but what is equally important and could be sometimes more important is how you blend And how you put the portfolio together.
That's called portfolio construction. So there's some key elements and I'm just going to give you some of the broad strokes here, limiting your sector and your interest, what industry weights is important because you don't want to have too much concentration and you want to make sure that you're not.
You know, 70 percent in tech stocks or, you know, 50 percent in energy stocks, anything like that. You want to have some balance there because that generally will improve your risk adjusted return because when you're retired or when you're generating income from pulling from your portfolio consistently, you need to have some more stability in the portfolio.
So we also want to have individual position sizes. So the amount of capital allocated to each individual stock should also be,limited. So typically the range between one and 5 percent of, initial capital is a good place to go in terms of getting adequate diversification for a portfolio like this, looking at a lot of different ways you could go, really, 50 stock portfolio is a good starting point for a high net worth investor.
You want to own those stocks individually rather than going out and buying some package product. This gives you a lot more ability to home in on exactly what you need. So once you've, you know, invested in these stocks, it's not just set it and forget it, it's an ongoing process. So you want to allow some drift with these stocks.
And typically I like to let stock portfolios or individual stock positions drift about 30 percent from the target. So if we have a target weight of 5%, then it could go up, you know, point, 0. 3 times,0. 05, you know, so 30 percent of your target position could go up or down. Thank you. So you want to give some drift because you don't want to have,you want to give these companies some room and you don't want to rebalance too frequently because this will minimize, this needs to minimize your turnover.
So we want to place those constraints on sectors and industries to ensure Good diversification and their businesses should have non correlated,factors of returns that, that, that generate revenue and expenses for the company. They should be relatively non correlated. Okay. So let's talk about like how much capital that you put in stocks over time.
So my approach is to dynamically adjust the, target weights based on fundamental rankings, basically. And the fundamental ranking is all those factors that I mentioned to you, the quality of the valuation. And there's multiple dimensions, you know, and how you look at those companies, but how are they, are they improving?
Are they not improving relative to the whole basket? And typically, if you look at the whole universe, we're typically focusing capital in the top quartile. of companies in there,in the universe. And if the companies fall out, maybe falling into the bottom quartile, typically they're going to be, removed from the portfolio.
There's let's talk a little bit about selling and how important that is. So this strategy generally, it's a moderate,turnover strategy. So it's not a high turnover strategy, because you're really looking to You're really looking to hold on to those great stocks as long as possible and learn to earn the compounding dividends.
But you also want to make sure these companies are doing well, fundamentally. So, one reason that a company can get pulled out of the portfolio would be if they cut their dividends, because they're no longer in the universe at that time. So if their dividends are getting cut, they'll, they're going to be eliminated from this strategy.
if they are no longer as liquid as they need to be, they'll be eliminated. eliminated. That rarely happens. the other thing is if their fundamental fundamentals deteriorate enough, then we're going to need to pull that stock out of the portfolio because they no longer meet the criteria of strong fundamentals, which is a high,correlation to expected returns in the company.
So, so those are the main reasons why you pull stocks out.this, you know, and you want to just do this continually. So there's really basically two processes. There's what's called reconstitution, which is basically when we say, okay, what does the universe look like? And then what are the rankings right now?
And who's in and who's out. Right. And then there's rebalancing and that's the process of saying, okay, here's our target weights, based on the fundamentals now and the market cap, et cetera. and based on that. how far are we off from that? If it's within range, no problem. If it's out of range, then we need to pull that back.
So let's talk a little bit about that. So we're talking about recognizing when you need to cash out, right? So just to recap, selling criteria is really straightforward. Stocks are removed if they cut their dividend. If they drop in their fundamental ranks, right, typically below the 25th percentile. And again, this approach helps you maintain our portfolio of top performing liquid stocks with a strong track record of dividend growth.
It's a really simple concept that is very effective. So by adhering to these rules, the portfolio remains robust and avoids over concentration in one sector or industry, right? Because we have those constraints and is providing steady, reliable, Income and returns over time relative to more speculative investment strategies.
So we're talking a little bit about the mindset of this strategy of some, you know, having this as a core part of a portfolio for somebody looking for rising income, you really should have a mentality of hold and prosper. I like to think of it that way. You want to hold and prosper because these, you really reap the rewards over time with these stocks as they're building their profits, they're growing, the dividends moving up and it just keeps going up and we're focusing our capital and our attention in those companies.
So it's designed for longterm investors who are seeking that steady growth and income. It's not meant for market timing. It's again, it's meant for that reliable income, and the volatility of this strategy has been lower than the overall market. So one of the things we like to look at a standard deviation.
You probably have heard of that before, but if you look at a simulated result of this It's a standard deviation is 13. 19 percent since February of 2004 and the beta is 0. 72 compared to the S& P 500. So it makes it suitable for a retirement portfolio where stability is important. Right? And historically, this strategy has performed well, too.
It's annualized at 12. 2%. But whenever you're looking on at simulated strategies, it's important to understand as with any investment strategy, past performance doesn't always be an indication of future results, right? It's important to understand that and returns, you know, that I'm talking about here have a provision for transaction costs, but it doesn't include advisory fees.
Okay. So that's just, you know, something to understand. So, The performance has shown to be very competitive and it's generating what we're looking for, a rising stream of income. So you want to choose the best stocks and let go of the rest. That's really the key on this. So historically this, again, this portfolio shows moderate turnover.
It's been around 0. 57 percent annually, 57 percent I should say. And the average holding period over is over years. Typically winners are held on average 646 days. So that's well over a year while losers are held for roughly on average 300 days. So you want to have, you know, we're not trying to generate a lot of short term gains here, right?
We're trying to build longterm capital appreciation. But one of the key aspects is you will, you'll notice is that the days held for losers is a lot lower than the days held for winners. And sometimes you can hold winners for years and years. Like for example, Costco or Microsoft, you know, Apple.
You know, Nvidia has been in there is in there now, so you want to understand that there's going to be some outlier stocks that you hold for a very long period of time and you're, and, but this, these are just average statistics to understand, but this discipline longterm approach helps you balance this risk and return target that you're looking for and gives you that steadier, return.
So just overall, this is a big. bedrock. I consider it a bedrock strategy for people who are retired. it adds for stability. and one of the things you can do with this is you can blend in other portfolios around it as satellite positions. For example, you can have high quality municipal bonds to save on taxes and that could give you a different return stream and more conservative. same with corporate bonds if that makes sense for you and your tax bracket or the type of account that you have. private real estate can be very good. in this, and, you know, that is something to really consider, depending on, which areas look the most attractive there, but that can enhance your income and mitigate risk during market downturns.Because again, this is a stock portfolio, so it's going to fluctuate. It generally has historically fluctuated less than the overall market. Most people the S& P 500 type companies, and those stocks have fluctuated more, which makes sense because these are lower duration stocks that are paying you dividends now,And then, you know, owning around 50 stocks offers diversification across those industries and it can help you counter that inflation and the tax problem that people have over time, over retirees lifetime, which could be 20, 30 years.
So, that's pretty much it, that I had for you today. I hope you've gotten some ideas, insights, maybe on how to incorporate a dividend investing strategy. Thank you. for yourself, even for people who aren't retired. A portion of your portfolio in this type of strategy is a great compliment to more aggressive, fast growing type company strategies.
there's another strategy that I managed called the fundamental trend strategy that is more geared towards fast growing companies. They could be younger companies, more dynamic. Companies like that. it's a great compliment to that type of strategy. When you put those two strategies together, you get a really nice blend.
So, thank you for listening. And, you know, hopefully you get some ideas about, dividend strategies. And if you found this helpful, share it with your colleagues, any friends or family. And, you know, follow me for more and, like and subscribe. Hope you're doing well. And we'll talk to you next time.