Lemon_tm
Quality Stocks
June market woes were quickly forgotten as broad equity indices rose sharply last month. The SPDR S&P 500 Trust ETF (SPY) gained 9.21% last month brining its year-to-date return to -12.61%. My watchlist for July performed slightly worse, finishing the month with a gain of 8.34%, this brought the year-to-date return to -8.37%. Vanguard Dividend Appreciation ETF (VIG) finished July with a gain of 6.8%, underperforming SPY and my watchlist. Since inception, September 2020, my watchlist is generating 3.96% of alpha over VIG and 4.01% alpha over SPY, on an annualized basis. The annualized return for my watchlist moves back ahead of my target rate of return of 12%.
The main focus of this watchlist is to find the best combination of quality companies trading for attractive prices. I believe this is the optimal long-term strategy to building wealth.
The top 15 dividend growth stocks for August offer an average dividend yield of 2.48%. Collectively they have increased dividend payments at a rate of 32.56% during the last 5 years. Based on dividend yield theory these 15 stocks are about 37% undervalued right now, and I think they are poised to offer strong long-term returns. Even though July was a very strong month for many of the selected stocks they are all still potentially undervalued.
I would recommend two approaches to dividend investing. The first is to dollar cost average into at least 10-20 or more quality dividend-paying stocks across multiple sectors and industries. By dollar cost averaging, you eliminate the risk of trying to value a stock and over a long enough period, theoretically, you will buy shares at market highs, lows, and in-between resulting in an average cost basis somewhere in the middle. The second method carries a little more risk. Invest in undervalued stocks also dollar cost averaging into at least 10-20 unique quality companies across multiple sectors and industries. The additional risk with this approach comes from the chance that your valuation method proves to be incorrect. However, by investing in multiple unique stocks, the odds that you accurately identify at least a few undervalued stocks increases. The resulting upside from a few correct picks may more than offset the underperformance from the bad ones.
Watchlist Criteria
The criteria used to determine which stocks are included in my high-growth dividend stock watchlist remains unchanged for August 2022. It is made up of the 8 factors listed below that have historically outperformed the broad universe of dividend-paying stocks when analyzed collectively.
- Market Cap of at least $10 billion
- Payout Ratio no greater than 70%
- 5-year Dividend Growth rate of at least 5%
- 5-year Revenue Growth rate of at least 2%
- 5-year EPS Growth rate of at least 2%
- S&P Earnings and Dividend Rating of B+ or better
- Wide or Narrow Moat (Morningstar)
- Exemplary or Standard Management Team (Morningstar)
The rules identified 114 stocks for the month of August that were all ranked based on the above-mentioned metrics with the exclusion of market cap. I then computed the current valuation for each stock using dividend yield theory. All stocks were ranked for both quality and valuation and sorted by the best combination of both. Next, I computed a forecasted rate of return for the next 5-year period for each of the stocks. This return is based on forecasted earnings growth, a return to fair value and the dividend yield.
The highest ranked 15 stocks with a forecasted return greater than or equal to 12% were chosen for the July watchlist. The long-term hypothesis for this watchlist is that it will outperform a broad quality dividend fund such as Vanguard’s Dividend Appreciation ETF, VIG.
Watchlist For August 2022
Created by Author
Above are the 15 stocks I am considering for further evaluation during the month. They are sorted in descending order by their rank and 5-year dividend growth rate.
The “O/U” column represents potential undervalue; this is a comparison of the current dividend yield to the historical dividend yield as a function of share price. Collectively these 15 stocks offer a dividend yield of 2.48%.
The expected return in the table above was computed using a discounted 5-year EPS forecast, a return to fair value and the current dividend yield. There is also a margin of safety built into the forecasted return. These figures are just assumptions based on the available data and there is no guarantee these returns will be attained.
The large potential undervaluations for Cigna (CI) and Advance Auto Parts (AAP) are overstated due to very fast recent dividend growth by both companies. Dividend yield theory works best for companies with stable and consistent dividend growth.
Past Performance
July was a great month for the watchlist as it posted its 3rd best monthly return since September 2020. The watchlist outperformed VIG but not SPY, however, it remains ahead of both benchmarks on a year-to-date and since inception basis. The annualized return since inception for the watchlist moves up from 10.46% after June to 14.68% after July. It’s nice to see the long term return climb back above my long-term target of 12%.
|
Month |
Watchlist |
All |
VIG |
SPY |
|
1 Month |
8.34% |
9.12% |
6.80% |
9.21% |
|
3 Month |
4.70% |
3.88% |
0.08% |
0.43% |
|
6 Month |
-4.55% |
-5.92% |
-4.92% |
-7.75% |
|
1 Year |
2.06% |
-3.91% |
-2.30% |
-4.69% |
|
2020 |
6.27% |
6.15% |
9.09% |
7.94% |
|
2021 |
33.53% |
31.55% |
23.75% |
28.76% |
|
2022 |
-8.37% |
-12.49% |
-9.96% |
-12.61% |
|
Since Inception |
30.02% |
22.21% |
21.56% |
21.45% |
|
Annualized |
14.68% |
11.03% |
10.72% |
10.67% |
Top 5 past and present watchlist stocks in July 2022:
- Monolithic Power Systems (MPWR) +21.01% (past)
- KLA Corporation (KLAC) +20.20% (past)
- NVIDIA (NVDA) +19.82% (past)
- Amphenol (APH) +19.80% (past)
- Intuit (INTU) +18.55% (past)
None of the top 5 best performing past and present watchlist stocks in July were part of my watchlist. The best stock on last month’s watchlist was Best Buy (BBY) that gained 18.1% and had the 6th best overall return. In total there have been 65 unique dividend stocks selected by this watchlist since September of 2020.
Top 5 Stocks by Total Return since joining the watchlist:
- Automatic Data Processing (ADP) +80.56% (23 months)
- UnitedHealth Group (UNH) +65.97% (18 months)
- Costco (COST) +47.32% (23 months) NEW
- Northrop Grumman (NOC) +43.43% (23 months)
- CDW (CDW) +40.02% (18 months) NEW
- Tractor Supply (TSCO) 37.87% (18 months)
- Progressive (PGR) +34.70% (18 months)
ADP remains the best watchlist stock after adding a gain of 14.8% in July. UNH had a return of only 5.59% last month but retains the 2nd position. COST jumps onto the top 5 list after adding 13.13% in July. NOC drops from 3rd to 4th place after a very modest gain of 0.07% in July. CDW climbs onto the list rounding out the top 5, the stock gained 15.21% last month. TSCO falls out of the top 5 after losing 1.22% last month. PGR also fell off after losing 0.96% in July.
Since not all stocks have been on the watchlist for the full 23 months of its existence, comparing a monthly average return can help normalize the results. Here are the top 5 stocks with the highest average monthly return since joining the watchlist.
- Best Buy (BBY) +18.10% (1 month)
- Advance Auto Parts (AAP) +11.86% (1 month)
- Cigna (CI) +3.17% (5 months)
- UnitedHealth Group (UNH) +2.85% (18 months)
- Rollins (ROL) +3.90% (6 months)
- Automatic Data Processing (ADP) +2.60% (23 months)
- Tractor Supply (TSCO) +1.80% (18 months)
Two newcomers to the watchlist start off with a bang. BBY returned an excellent 18.1% last month, while AAP posted a gain of 11.86%. ROL surpasses CI after posting a gain of 10.45% last month and seeing its average monthly return climb to 3.9% over 6 months. CI had a return of 4.49% in July and did see its average monthly return improve to 3.17% over a 5-month period. UNH rounds out the top 5 list after a gain of 5.59% in July.
Drivers Of Alpha
The watchlist outperformed VIG in July. 9 watchlist stocks outpaced the ETF last month.
- (BBY) +18.10%
- (SWKS) +17.53%
- (MA) +12.31%
- (MS) +11.87%
- (LOW) +10.26%
- (AAP) +11.86%
- (HD) +9.72%
- (TROW) +8.68%
- (ICE) +8.45%
The remaining 6 stocks underperformed VIG.
Buy-And-Hold Portfolios
The best way to utilize the ideas presented by this watchlist is with a long term buy-and-hold investing approach. I started tracking how such a portfolio would have worked out with one portfolio started at the beginning of 2021 and the other at the beginning of 2022. Each portfolio assumes you invest equally amongst the chosen 15 stocks for the given month and never liquidate these positions.
The 2021 B&H portfolio performed well in July, gaining 7.90% and slightly outperforming VIG. The cumulative return since January 2021 for the portfolio is 15.63% compared to 11.43% for VIG and 12.52% for SPY. On an annualized basis the portfolio has a 9.61% return compared to 7.07% for VIG and 7.74% for SPY. The portfolio holds 53 unique positions with the largest position being:
Here are the 5 best performing positions:
The 2022 B&H portfolio performed slightly better in July, returning 8.25%. The year-to-date return is -12.58% compared to -9.96% for VIG and -12.61% for SPY. The portfolio is not off to a great start but did trim its loss to VIG last month. There are a total of 37 unique positions in the portfolio due to a high turnover rate on the watchlist because of all the market volatility.
Here are the 5 largest positions:
Here are the 5 best performing positions:
My expectations are for this watchlist to produce a long term 12% annualized rate of return. I use this watchlist along with my high yield watchlist to identify investing opportunities that I act on in my personal portfolio.
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