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Quality Stocks
So much for the rally at the end of May, in June equities dropped across the board with the SPDR S&P 500 Trust ETF (SPY) losing 8.25% during the month. The popular ETF is down 19.98% through the first six months of the year. My watchlist for June performed better, albeit not great, losing only 6.45% in June. It is down 15.43% this year, offering 4.55% of alpha over SPY. Vanguard Dividend Appreciation ETF (VIG) finished June with a loss of 6.23%, outpacing my watchlist by 22 bps. However, on a year-to-date basis it is down 15.69%, and trails my watchlist by 26 bps. My watchlist, VIG and SPY are all now below my target 12% rate of return on an annualized basis after 22 months.
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 July offer an average dividend yield of 2.35%, that is much better than last month’s yield of 1.51%. Collectively they have increased dividend payments at a rate of 31.61% during the last 5 years. Based on dividend yield theory these 15 stocks are about 42% undervalued right now, and I think they are poised to offer strong long term returns. After the poor results we observed in June, all of the chosen stock for July appear to be potentially undervalued based on dividend yield theory.
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 July 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 118 stocks for the month of July 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 July 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 2.35%.
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
June was a decent month for the watchlist as it extends its streak of beating SPY to 3 months now. The watchlist did not outperform VIG, however it remains ahead of the ETF on a year-to-date and since inception basis. The annualized return for the watchlist since inception is 10.46%, compared to 7.32% for VIG and 5.88% for SPY. The watchlist has thus far generated annualized alpha over VIG of 3.14% and 4.58% over SPY.
|
Month |
Watchlist |
All |
VIG |
SPY |
|
1 Month |
-6.45% |
-7.51% |
-6.23% |
-8.25% |
|
3 Month |
-8.98% |
-13.52% |
-11.09% |
-16.11% |
|
6 Month |
-15.43% |
-19.80% |
-15.69% |
-19.98% |
|
1 Year |
-3.90% |
-9.12% |
-5.61% |
-10.60% |
|
2020 |
6.27% |
6.15% |
9.09% |
7.94% |
|
2021 |
33.52% |
32.60% |
23.75% |
28.56% |
|
2022 |
-15.43% |
-19.80% |
-15.69% |
-19.98% |
|
Since Inception |
20.00% |
12.89% |
13.82% |
11.04% |
|
Annualized |
10.46% |
6.84% |
7.32% |
5.88% |
Top 5 past and present watchlist stocks in June 2022:
- Domino’s Pizza (DPZ) +7.62% (present)
- UnitedHealth (UNH) +3.77% (past)
- Tractor Supply (TSCO) +3.46% (present)
- Humana (HUM) +3.22% (past)
- Costco (COST) +2.80% (past)
Two out of the 5 best performing past and present watchlist stocks in June were part of the June watchlist, DPZ and TSCO. In total there have been 63 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) +57.28% (22 months)
- UnitedHealth Group (UNH) +57.19% (17 months)
- Northrop Grumman (NOC) +43.33% (22 months)
- Tractor Supply (TSCO) 39.57% (17 months) NEW
- Progressive (PGR) +36.01% (17 months) NEW
Even after a loss of 5.33% in June, ADP hold onto the top spot in terms of long term watchlist return. UNH added 3.77% in June and is now in a very close second place, trailing by only 9 bps. NTRS and USB, the 3rd and 4th best stocks last month, both fall out of the top 5 list after posting double digit losses in June. NOC added 2.27% in June and climbs up into the 3rd best overall spot. TSCO added 3.46% in June and pops onto the top 5 list sliding into 4th best place. PGR posted a 2.61% loss in June but joins the top 5 list in 5th place following a very poor month for many past watchlist names.
Since not all stocks have been on the watchlist for the full 22 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.
- Cigna (CI) +2.84%
- UnitedHealth Group (UNH) +2.70%
- Rollins (ROL) +2.64%
- Automatic Data Processing (ADP) +2.08%
- Tractor Supply (TSCO) +1.98%
CI holds onto first place but sees its average gain fall to 2.84% after 4 months. UNH moves up to second place as its average gain improves to 2.7%. ROL drops to 3rd place after a modes 1.52% loss in June sees its average gain drop to 2.64%. ADP holds onto 4th place and NVDA drops out of the top 5 list following an 18.6% loss in June. The new addition to the top 5 list in terms of average monthly gain is Tractor Supply that improves its return to 1.98% per month.
Drivers Of Alpha
The watchlist slightly underperformed VIG in June. 5 watchlist stocks outpaced the ETF last month.
The remaining 10 stocks underperformed VIG.
- (V) -7.20%
- (CDW) -7.24%
- (HD) -8.83%
- (APH) -8.86%
- (SSNC) -9.25%
- (SCHW) -9.87%
- (LOW) -10.56%
- (MA) -11.85%
- (FMC) -12.27%
- (SWKS) -14.91%
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 average in June, losing 6.23% exactly the same percentage as VIG. The cumulative return since January 2021 for the portfolio is 7.17% compared to 4.33% for VIG and 3.03% for SPY. On an annualized basis the portfolio has a 4.73% return compared to 2.87% for VIG and 2.01% for SPY. The portfolio holds 51 unique positions with the largest position being:
Here are the 5 best performing positions:
The 2022 B&H portfolio performed slightly worse in June, losing 6.94%. The year-to-date return is -19.25% compared to -15.69% for VIG and -19.98% for SPY. The portfolio is not off to a great start and saw its loss to VIG extend a bit more in June. There are a total of 32 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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