4 Factor Dividend Growth Portfolio – A Strong Finish To Quarter 1

4-Factor Dividend Growth Portfolio

The 4-factor dividend growth portfolio was launched on November 1st, 2022. You can read about the strategy, stock selection process, and portfolio construction in this 4-Factor Dividend Growth Portfolio article. 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 US Dividend 100 Index (DJUSDIV), with a few minor modifications.

The first major difference is the starting universe of stocks, I chose to create my own investable universe focused on high-quality companies that have a history of above-average dividend growth.

The second major difference is the modification to the ranking criteria, instead of using the return on equity, as the DJUSDIV, I chose to replace it with the return on capital. I personally believe that return on capital is a superior metric to return on equity.

On November 1, 2023, I rebalanced this portfolio with 25 newly selected stocks using the 4-factor stock selection process laid out in the original article.

These stocks will be held for a duration of 12 months and the portfolio will be rebalanced back to equal weight (4% per stock) at the end of each month. The portfolio is held in a traditional IRA and therefore has no tax drag from being rebalanced frequently.

Here is a snapshot of the actual portfolio as of March 31, 2024, including each position, the number of shares, current market value, estimated annual dividend, current allocation, and target allocation.

On April 1st, the portfolio will be re-balanced to bring it back to equal weight. If you continue reading you’ll learn that the monthly re-balancing has not proved to be the optimal strategy and will likely be eliminated in fiscal year 3.

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March 2024 Results

The portfolio continued its strong run from February into March. The S&P 500 returned 3.22% last month, SCHD returned a more impressive 4.65%, and my portfolio posted a gain of 3.66%. Year-to-date the portfolio is still trailing the S&P 500 (+10.56% vs. +8.68%) but continues to remain ahead of SCHD (+8.68% vs. +6.72%). For fiscal year 2 (Nov 2023 – Oct 2024), my portfolio maintains a healthy level of alpha over both the S&P 500 (+6.47%) and SCHD (+12.00%). Since its inception, on November 1, 2022, the portfolio has a CAGR of 31.29% and is outperforming the S&P 500 by 5.16% and SCHD by 20.80%.

Beating the S&P 500 or SCHD is not a primary objective, but it is useful to see how the portfolio fares compared to alternative options. The goal is for this portfolio to deliver a long-term (5+ years) CAGR of at least 12%. Thus far, 17 months in, the portfolio is sitting comfortably ahead of this goal. Outperforming the S&P 500 and SCHD is just icing on the cake.

The average gain for all 25 holdings in March was 3.53%. The reason for the slight difference in return between the portfolio and the average return for all holdings is that it is very difficult to bring this portfolio back to equal weight. The rebalancing happens while the market is open and also causes some fluctuations in the final monthly return measured against the benchmark.

Individual Returns and Variations

Here are the individual returns for March for each holding. In the table below you can see the ticker symbol for each holding, the target allocation weight, the total return in March, and the respective allocation return in the portfolio.

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20 out of the 25 stocks had a positive return last month, and 2 of them posted double-digit gains.

Here are the best performers:

1. WSM +34.82%
2. EOG +11.69%
3. WSO +9.60%
4. MCHP +6.62%
5. LOW +5.84%

The average cumulative return for all 25 stocks for the period November 2023 to March 2024 is 32.41%, slightly lower than the actual portfolio return (+32.60%). 20 out of the 25 chosen stocks have double-digit returns, with only no stocks currently sitting in the red.

Here are the top 5 performers in fiscal year 2:

1. WSM +112.28%
2. LRCX +65.97%
3. ASML +62.75%
4. AVGO +58.92%
5. MPWR +53.90%

Breaking down the returns by the original ranking of the top 25 holdings chosen for inclusion in the portfolio, we can see that it’s the mid-ranked stocks (6-20) that continue to generate the highest returns. Prior to March, the top 5 ranked stocks were performing pretty poorly, this flipped last month with the top 5 stocks delivering a very strong return. What’s interesting though is that the 2 highest-ranked stocks are the two worst performing stocks thus far.

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In fiscal year one, there was a clear correlation that higher-ranked stocks performed better than their lower-ranked counterparts. Thus far, this trend has not held true in fiscal year 2.

Since there are 25 stocks included in the portfolio, there is no easy way to divide it into two equal halves. If I eliminate the middle stock, the 13th best-ranked stock, the top 12 stocks have an average return of 31.23% thus far, while the bottom 12 stocks have an average return of 34.90%. The bottom 12 stocks performed better in March relative to the top 12 stocks, this breaks the 2-month streak of the top 12 stocks outperformance.

Long-Term Performance

The portfolio achieved a 10.90% return in fiscal year one, outperforming the S&P 500 by 0.75%. The return for fiscal year two (Nov. 1, 2023 – Mar. 31, 2024) is 32.60% and puts the portfolio 6.47% ahead of the S&P 500. Since inception, Nov. 2022, on an annualized basis the portfolio has a return of 31.29% versus 26.12% for the S&P 500, resulting in 5.16% of annualized alpha over the index.

Given that the inspiration for this strategy and portfolio was SCHD, it’s only fair that I compare the returns the portfolio attains to those of SCHD. SCHD did not perform well in 2023, with the exception of the last two months. The return for SCHD during fiscal year one (Nov. 2022 to Oct. 2023) was -4.51%, my portfolio outperformed SCHD by 15.41%. SCHD’s return for the period November to March 2024 is 20.61%, and my portfolio is outperforming the fund by 12.00%. Since its inception, my portfolio has been beating SCHD by 20.80% on an annualized basis.

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. Fiscal year one came up a little short of this threshold, but things are back on track in fiscal year two.

Dividend Review

Currently, the portfolio has a forward dividend yield of 2.06%, which is down from the 2.10% dividend yield a month ago. This is primarily driven by the positive gains last month. The portfolio generated $5.32 in dividend income during the month of March, the dividends were reinvested in a way to reduce the allocation drift. March 2024 dividend income was 48.19% higher than March 2023 dividend income. The total dividend income generated in 2022 was $6.08, and $49.08 in 2023. Dividend income in fiscal year one was $42.21, fiscal year two should be significantly higher. Five months in and the dividend income for fiscal year 2, $25.33, is already more than 60% of fiscal year 1’s total dividend income.

The projected dividend income for the next 12 months is $59.43; this figure has increased from $58.71 a month ago as a result of the recent rebalancing. I’ll be curious to see what impact the monthly rebalancing will have on potentially missed dividend income. 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.

At portfolio launch on November 1, 2022, the projected dividend income for the next 12 months was $46.79. The current projection of $59.43 is 27.01% higher, that equates to an 18.39% CAGR.

New 4 Factor List

Since June 2023, 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.

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.

Thus far, starting this strategy during any month between June 2023 and March 2024 would have led to a better return than SCHD and SPY all but one time. Here’s a breakdown of the total returns.

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The returns in the table above are through 3/31/24. The January 2024 top 20 list is thus far trailing SPY and the March 2024 top 20 list is trailing SCHD. Both lists haven’t been around for long and still have room to deliver stronger returns.

Here are the criteria for the initial stock screener:

1. Payout Ratio of 80% or less.
2. 3 & 5-year Dividend Growth Rate of at least 5%.
3. 5-year Revenue and EPS Growth Rate of at least 5%.
4. Stock must trade on the NYSE or NASDAQ.
5. Wide or Narrow Economic Moat.
6. Exemplary or Standard Stewardship Rating.

I ran this screener on March 29 and 111 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 25 ideas. The list is presented below, with data shown as of March 31, 2024.

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