Dividend Growth Investing For The Middletons - A New Experiment

I’m a middle-aged finance and investment writer with a solid backstop of intergenerational family wealth behind me, so I decided to use a very small portion of my excess of privilege to run an experiment.

My hypothesis is that it’s nearly impossible to gradually average into a well-diversified, balanced dividend growth portfolio – but to prove or disprove that hypothesis, I’m going to try it to see if it works. Most Americans - and most investors for that matter - are 'middletons' - they do not have high paying jobs, they don't have 8-9 figures of family wealth to fall back on, and they don't have the ability to sock a lot of money away.

Dividend growth investing looks for stocks with a history of growing dividends and the capability to continue growing their dividends in the future. The idea is to build a growing stream of passive investment income to supplement and eventually supplant the income one derives from a salary or wage. It’s become the preferred investing strategy for many in the financial independence movement – once one’s investment income is sufficiently high, the need for a salary or wage is eliminated and financial independence is achieved.

The strategy works great for the wealthy and high earners who have the liquidity to purchase large blocks of dividend-paying securities at attractive prices. I don’t think it should work as well for young, middle-income earners who might only be able to contribute a small amount of their earnings to an investment account and who would have to build their portfolios one share at a time. But I’m not sure about that. Hence my experiment.

The Experimental Structure

I’ve opened a new account on Robinhood, a mobile device-oriented investing service that allows users to purchase stocks without paying a commission. The role I will be playing will be one of a low-to-middle income earner who is entering their career with a heavy debt burden and large short-term financial goals – a 20-to-30 something with student loan payments, perhaps car payments as well, who is saving to buy a house and start a family. My guess is that with income and expense uncertainty, this person would only be able to contribute $20 or less to their accounts each month.

I am adapting my own escalating contribution strategy for this account – so while my first automatic contribution, on Nov. 1, will be for a mere $16 or so, I will try to increase contributions by $1 a month each month, or by $5 a month each quarter depending on how regularly I check my portfolio. When I receive a raise or pay down a debt in my personal life, I may adjust my contributions upward to mirror a young person's career advancement and financial achievements.

I selected Robinhood because it's commission free. If I'm contributing to this portfolio in small amounts, then avoiding commissions greatly reduces my investing costs. I've mirrored this strategy in my personal portfolios, as I keep a handful of accounts with discount brokerages offering large no-transaction-fee ETF platforms, gradually building up long-term savings in low-cost index ETFs. It's worth noting that Robinhood recently became controversial as it sells its brokerage customers' transactions to high frequency traders, which allows it to provide a 'free' trading platform to smaller investors. In my opinion, for the purposes of my experiment (and for middle income, low-net worth young investors) the risk in Robinhood's business model is worth the reward of avoiding commissions to build invested assets and passive income.

Back to my experiment. The goal for this account will be to generate $100,000 worth of investment income annually, which should be sufficient for most young middle-income Americans to retire on in a few decades. My time horizon for growing this portfolio is 35 years (a rough average – most people entering the workforce have 40 years of accumulation ahead of them, while most people starting to invest in equities on their own have 25-35 years ahead of them).

What I want from a stock pick, then, is a decent history of dividend growth (I will not restrict myself to a subset of "Dividend Aristocrats" or "Dividend Champions, Contenders and Challengers"), yield above the S&P 500, relatively low payout ratio (this is a sector- and business model-dependent call that I will expound upon at a later date), with valuation measures under that of the S&P 500 and historically cheap for the company. Thus, this portfolio will follow a hybrid of dividend growth and value strategies but it will not be a true value portfolio, as a real value investor creates some measure of a company's intrinsic (or true) value to compare its price-oriented valuations to.

 My First Move

To get the account started, when the market declined yesterday, Wednesday October 24, I contributed $33 to the account and bought an anchor position – in AT&T.

When brainstorming this experiement, I made an initial 10-stock watchlist for this portfolio:

• PEP
• ITW
• WBA
• XOM
• SBUX
• IFF
• FDX
• D
• DIS
• MO

The idea was that this list was diversified among several different sectors, consisted of well-established and respected dividend growers often available at a discount to their intrinsic value, and would start my research into the portfolio. I added AT&T to the list ($T) because it is already one of my personal holdings, is a proven dividend grower and payer, and recently took a severe hit to its price after an earnings miss and concerns about the company’s debt.

Ticker	Price	PE	Div Yield	Payout Ratio	5y Div Grow	FWD PE	PB
PEP	112.96	32.57	3.28	62.09	8.15	18.3	15.12
ITW	119.83	23.01	3.16	48.73	8.21	15.5	11.21
WBA	72.4	15.24	2.28	25.03	9.16	11.04	2.83
XOM	77.62	16.29	4.11	56.94	7.02	14.09	1.81
SBUX	58.06	18.44	2.45	47.69	23.87	19.51	20.13
IFF	137.35	37.16	2.09	44.09	10.14	21.1	6.32
FDX	209.2	12.35	1.19	12.85	21.49	10.8	3
D	74.19	15.37	4.58	78.21	7.54	17.16	17.16
DIS	111.61	14.84	1.43	22.14	2.93	15.58	3.84
MO	62.31	11.12	5.17	73.81	8.32	14.14	7.39
T	30.36	6.44	6.06	55.51	2.18	9.07	1.31

Yesterday, when I was researching my 10 stocks plus one watch list, T had the lowest valuation metrics – a current price-to-earnings (PE) ratio of 6.44, a forward-looking PE ratio of 9.07 and a price-to-book ratio of 1.31. It also had a relatively high dividend yield – 6.06%, a low dividend payout ratio (a decent measure of how much financial stress a company endures from paying out its dividend) of 55.51%. The only place where AT&T fell behind the other stocks on my list was in its 5-year dividend growth rate, which measured 2.18 percent. AT&T is a great yielder right now, but has fallen behind some of its peers as a dividend grower.

My assumption is that as the company finds synergies with Time Warner, a company it recently purchased, and finally rolls out 5G technology, it will be able to reduce expenses, increase revenues and pay down its debt as well as continue increasing its dividend, likely raising its dividend growth rate over time.

This morning, my order for T executed at $30.66. The stock pays $2 in annual dividends, meaning I bought myself an additional $2 in annual income for just over $30. 50,000 more of these and the portfolio has reached its goal.

My Robinhood account already had one position in it, a free stock that the company offers to new customers as a perk. For the purposes of my experiment, that free stock will not be figured into my calculations or performance measurements - though I am in no hurry to exit the position.

So as of this morning, my Robinhood account has one share of T worth $30.33 in it, and $2.34 in cash. On Nov. 1, my first $16 contribution will land in the account. As I purchased T after its ex-dividend date, I will not receive the $0.50 dividend payout on 11/1 and my first dividend payment will arrive in 2019.

I will revisit this portfolio on a monthly or quarterly basis in posts to report on the dividend, dividend growth, contributions and purchases.