Wednesday, June 22, 2011

Is your dividend income riskier than expected?

I try to maintain a conservative portfolio of dividend growth stocks, where I maintain proper asset allocation, position sizing and have exposure to asset classes and markets outside of the US. You could see my portfolio here.

Since my investments are spread out in several brokerages, it makes sense to keep track of them in one place using spreadsheet software. This makes it easy to compare the overall position size of each stock that I own in relation to my total portfolio overall. In an ideal world, In a dividend portfolio consisting of 40 stocks, one would expect to have a 2.50% allocation to each one of them. In reality however, building a dividend portfolio takes time. The companies which might have been great buys in 2008, might not fit in my entry criteria today. Since I only sell after a dividend cut, I hold on to companies which are overvalued today but either keep or increase their distributions. As a result the allocation to these companies decreases over time, since I constantly add new money to the accounts and reinvest dividends selectively.

As a result, of all the 40 or so stocks I own, almost half of them have a below average weight in my total portfolio. These stocks account for 24% of my portfolio value and 18% of my total dividend income. One quarter of all the stocks I own have an allocation of one percent or less in each company. These stocks account for 6% of my portfolio value but only for 4.5% of the income.

This means that almost half of the names in my portfolio account for 76% of the total portfolio value and 82% of the total dividend income I generate per year.

I was particularly worried when I noted that three stocks were responsible for generating 21.50 % of my total dividend income. These three stocks had a total weighting of 12.50% in my portfolio. These are three high yield dividend stocks which so far have rewarded me with generous distributions coupled with decent increases along the way. The companies include:

Kinder Morgan Energy Partners, L.P. (KMP) owns and manages energy transportation and storage assets. 10 year dividend growth rate: 10.90% Yield: 6.40% (analysis)

Enbridge Energy Partners, L.P. (EEP) owns and operates crude oil and liquid petroleum transportation and storage assets, as well as natural gas gathering, treating, processing, transmission, and marketing assets in the United States. Yield: 6.90%

Universal Health Realty Income Trust (UHT) operates as a real estate investment trust (REIT) in the United States. 10 year dividend growth rate: 2.80% Yield: 6.10% (analysis)

As a result of this analysis, I would probably stop adding money to these positions until my dividend income and stock weights decrease to more manageable levels. On a side note, my investments in Kinder Morgan and Enbridge Energy Partners are primarily in the form of i-shares such as KMR and EEQ. As a result I receive distributions in the form of fractional units, which does not trigger a taxable event. If I were to sell those fractional units however, I would be generating a short-term capital gain.

Two stocks which have a lower weight in my portfolio than average include Air Products and Chemicals and Wal-Mart Stores.

Air Products and Chemicals, Inc. (APD) provides atmospheric gases, process and specialty gases, performance materials, equipment, and services worldwide. 10 year dividend growth rate: 10% Yield: 2.60% (analysis)

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. 10 year dividend growth rate: 17.80% Yield: 2.80% (analysis)

I would look forward to increase my positions to these stocks more aggressively over the next few months given their strong fundamentals as well.

Full Disclosure: Long all shares listed above

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