Bunker Dividend Growth Portfolio: Why I Just Doubled Down On Everything (2024)

(Source: imgflip)

Introduction To The Bunker Dividend Growth Portfolio

I'm a huge fan of dividend growth stocks and dream of eventually becoming financially independent as defined by being able to live on 50% of my post-tax annual dividends alone. Being able to live 100% off passive income from a quality dividend growth portfolio is a dream shared by many of my readers.

And it's not hard to see why. Historically, S&P 500 dividends have been 16 times more stable than stock prices, even during recessions and bear markets.

Thus, a well-built dividend growth portfolio can be trusted to provide you safe and even growing passive income no matter what the stock market or economy is doing. That makes it perfect for achieving your dreams of a comfortable retirement.

But wait, it gets better. Dividend growth portfolios aren't just a boring way to earn income at the expense of great total returns.

Historically, dividend growth stocks have outperformed the S&P 500 and non-dividend payers, and all while experiencing 13% less volatility to boot. But as great as dividend growth investing is, it's far from the only proven market-beating or alpha factor strategy.

(Source: Ploutos Research) - note data through February 2019

I personally like to stack alpha factor strategies (like dividend growth, value, and low beta) so as to essentially rig the game so much in my favor that getting rich becomes purely an issue of time, patience, and discipline (to stick to time-tested strategies). After all, Warren Buffett, the greatest investor in history (53 years of 20+% CAGR total returns), famously summarized the two biggest reasons for his success thusly:

"We don't have to be smarter than the rest. We have to be more disciplined than the rest." - Warren Buffett

"The Stock Market is designed to transfer money from the active to the patient." - Warren Buffett

Thus, my model Deep Value Dividend Growth Portfolio or DVDGP (beating the market by 5.8% after 12 weeks) combines the power of dividend growth stocks and valuation, and the focus on mostly low-risk blue-chips is why we also tend to be less volatile during market downturns while keeping up with the market during rallies.

That's a commonality that portfolio shares with the legendary dividend aristocrats, S&P 500 companies that have raised their dividends for 25+ consecutive years.

(Source: Ploutos Research)

The aristocrats have managed to beat the market by 25% annually since 1990 not because they are necessarily super fast-growing companies that soar high and fast, but steadily growing blue-chips that merely keep up during bull markets and fall a lot less during bear markets.

I've had a lot of readers ask me two questions about that portfolio. First, why do I own so many companies (76), and second, why I don't just buy a dividend aristocrat ETF like ProShares S&P 500 Dividend Aristocrats ETF (NOBL).

The answer to the first question is that I'm testing out several investing strategies simultaneously and thus need a lot of data points (I need to know the system itself is market-beating and reproducible since I plan to use it for all future savings).

As to why I don't just buy an ETF and be done with it, the answer is mostly about valuation. ETFs buy stocks blindly and ignore valuation, which is something I can't personally stomach.

A Yale study found that starting valuation can affect your future returns out to 30 years. In other words, overpaying for a company, no matter how great, is not something that patience and time can necessarily overcome.

However, in order to help ultra conservative income investors, like retirees or those close to retirement, harness the proven power of the aristocrats and kings and value investing, I've decided to build a model ultra-low risk portfolio called the Bunker Dividend Growth Portfolio.

It's 100% composed of nothing but aristocrats and kings and built on two modified watchlists from my "best dividend stocks to buy this week" series. As for my valuation approach, I use dividend yield theory or DYT.

(Source: Investment Quality Trends)

That's because asset manager/newsletter publisher Investment Quality Trends has been using a pure valuation approach on nothing but blue-chip dividend stocks (based on six quality criteria) since 1966 and has managed to consistently beat the market by about 10% with 10% lower volatility.

1% annual outperformance for 30 years doesn't sound like much but just 7% of mutual fund managers can even match the S&P 500 over 15 years. Beating the market by 1% over 30 years puts IQT in the elite of professional money managers/analysts.

(Source: S&P Global)

DYT merely compares a stock's yield to its historical yield. If a company is mature and the business model relatively stable, yield will mean revert and return to a long-term average that approximates fair value.

For example, if a dividend aristocrat normally yields 2% and grows cash flow and dividends 10% per year, then buying it at fair value (2%) can get you about 12% long-term total returns (2% yielding + 10% long-term cash flow growth).

That's because stock prices are, in the long term, always a function of cash flow (from which dividends are paid). If that same company is now yielding 3%, yet the fundamentals are intact, then it's 33% undervalued (3% -2%/3%) and has 50% upside back to fair value (3%/2%).

My valuation-adjusted total return model (based on the one Brookfield Asset Management has been using for decades) is based on a return to fair value over five to 10 years.

Our example, aristocrat returning to fair value over five years would deliver total returns of 3% yield + 10% cash flow (stock price) growth + 8.5% valuation boost (return to fair value yield over 5 years) = 21.5%.

Over 10 years, it would be 3% yield + 10% cash flow growth + 4.1% valuation boost = 17.1%.

Historically, the margin of error on this valuation model (the best I've ever come across so far) is 20%. The point is that using dividend yield theory you cannot just invest in ultra-low risk aristocrats and kings but you can also know which are the very best ones to buy at any given time.

So, now that you know the theory behind the Bunker Dividend Growth Portfolio (capable of surviving any economic or market storm), let's take a look at the rules of how I run it.

Rules For The Bunker Dividend Growth Portfolio

The BDGP is very different than my DVDGP. That portfolio is very diversified because it serves as a kind of master watchlist of low-risk dividend growth stocks I consider worth owning with long-term 13+% total return potential.

BDGP is going to be:

• far more concentrated (with no sector caps)
• higher quality (the bluest of blue-chips)
• has no long-term total return target (though it should deliver double-digit returns over time)

Here are the rules for this portfolio:

• I start out buying $1,000 of each (rounded up to the nearest share) of the 5 most undervalued aristocrats and kings.
• Any week where a new one makes the list (companies roll on and off naturally over time), I make a $1,000 starter position buy.
• Once per month, I make a $1,000 cost average buy into any active recommendations (that week's top 5 aristocrats and kings).
• Only sell if the thesis breaks (dividend becomes unsafe, or a company loses its aristocrat or king status, a very rare occurrence).
• Or if a company becomes 25%+ more overvalued (sell 50%) or 50+% overvalued (sell the other half) - also very rare outside of crazy bubbles like 2000.
• Dividends are reinvested via DRIP.

As with DVDGP, should some opportunistic buying opportunity appear (like during earnings season or unexpected bad news), I will move up the next month's buy to that day, using the next month's DCA funds.

This recreates the limited capital constraints most investors have and also helps maintain a more balanced portfolio (avoids buying too many dips and becoming severely overweight in one company). I'll provide a portfolio update any week there is new buying (which means at least once per month).

So, now that you understand why this new model portfolio is so potentially useful and the rules behind it, here are the top 10 most undervalued aristocrats and kings you can buy today.

The Best Dividend Aristocrats And Kings To Buy Right Now

These are the most undervalued dividend aristocrats and kings you can buy right now. I've curated this list myself to exclude companies that I think have a high risk of the thesis breaking (thus, the exclusion of certain companies like BEN). The companies are sorted by most to lease undervalued according to DYT.

Top 5 Dividend Aristocrats To Buy Today

(Sources: Management guidance, GuruFocus, F.A.S.T. Graphs, Simply Safe Dividends, Dividend Yield Theory, Gordon Dividend Growth Model) Note: Margin of error on total return potential is 20%.

Top 5 Dividend Kings To Buy Today

(Sources: Management guidance, GuruFocus, F.A.S.T. Graphs, Simply Safe Dividends, Dividend Yield Theory, Gordon Dividend Growth Model) Note: Margin of error on total return potential is 20%.

Note that the dividend kings trade at such high (but well-earned) premiums that even the most undervalued one in America is only 12% undervalued. Buying these elite dividend growers is an example of Buffett's famous rule that:

It's far better to buy a wonderful company at a fair price, than a fair company at a wonderful price."

New Buys Over The Last Two Weeks

Two weeks ago I bought 22 shares of Coca-Cola at $45.93 when the company broke into the top 5 kings list (jumped to #3).

Last week I made the monthly dollar cost averaging buys of the top 5 aristocrats and kings which included

• 21 shares of Cardinal Healthcare at $48.15
• 16 shares of Walgreens at $63.27
• 13 shares of AbbVie at $80.59
• 19 shares of A.O Smith at $53.32
• 7 shares of Illinois Tool Works at $143.53
• 15 shares of Colgate at $68.54
• 5 shares of 3M at $207.78
• 8 shares of Federal Realty at $137.85
• 22 shares of co*ke at $46.86
• 23 shares of Hormel at $44.76

Now given that I've recently completed recession-proofing my retirement portfolio and have been warning readers about a possible recession coming in 2020, some might ask why I'm still buying anything at all.

After all, according to Lipper Research and Factset, since 1946 there has never been a recession without a bear market, in which stocks fall on average 37% from all-time highs.

However, both history and macroeconomic analysis is probabilistic and provides a rough guide of what's likely to happen, and not what's 100% certain to occur. There are no crystal balls on Wall Street and so the best you can do is make high-probability decisions with high reward/risk ratios with your money.

As you can see, the stock market is historically the best way to grow your wealth over time. While returns over short to medium-term time periods can be highly volatile, over the long-term (15+ years) stocks have never delivered negative total returns.

This is where the famous "time in the market is more important than timing the market" saying come from.

(Source: Bianco Research, Marketwatch)

My decision to eliminate all high-risk stocks and margin from my retirement portfolio was triggered by the 10y-3m yield curve (the best recession predictor in history) inverting on March 22nd. However, I have no plans to sell the rest of my holdings (over $220K in 19 companies representing 91% of my net worth). I wanted to err on the side of caution and would rather be too early than late, and now I'm able to start building dry powder in case we're facing a sharp market drop in the coming year.

That's because, while charts like the one above might be frightening, it's important to understand how to read it. Yes, it's true that since 1969 there has never been a time when the yield curve has been negative for 10 straight days when a recession (and bear market) hasn't followed within 16 months.

BUT the yield curve has one false positive (the mid-60s it inverted and we had very slow growth but no recession) AND 7 data points is not a statistically significant sample size (usually statisticians want at least 40 data points). This means that the best we can say is that if the curve were to stay negative 10 straight days (it closed at +0.4 basis points on Friday, March 29th, resetting the 10-day confirmation clock), a recession in 2020 merely becomes a high-probability event.

The Bunker Dividend Growth Portfolio is NOT designed to be a bond alternative (no dividend stocks are). It's merely meant to create a low-volatility, defensive collection of top-grade dividend growth companies that will outperform the stock market by falling less during a bear market.

(Source: Morningstar)

Here's a good model portfolio from Morningstar showing the importance of proper asset allocation (the mix of stocks/cash/bonds you own) and portfolio construction. Cash (like the ETF MINT) and bonds (like the ETF VGLT) are meant to provide you something to sell that's stable or appreciating in value during a bear market so you don't have to sell undervalued stocks (including aristocrats and kings) at rock bottom valuations.

As "risk-free" assets, in terms of permanent loss of capital possibility, cash (T-bills) and bonds tend to appreciate or stay constant during times when stocks are crashing. That's because falling interest rates and a flight to safety causes investors to pour money into bonds. Future QE from the Fed is also likely to cause long bonds to appreciate.

The average bear market since 1926 has lasted three years (from market peak to fresh all-time high) which is why you want to own enough cash and bonds to cover retirement or unexpected expenses (like unemployment) for several years.

(Source: Moon Capital Management)

Cash is what you use first, and when that runs out your appreciating bonds (the longer the duration the more they rise in a bear market) is what you can sell at a profit to meet expenses. Note that while the average bear market lasts three years (22 month recovery time) the historical range on how long it takes stocks to recover from the bottom can range from three to 69 months.

This is why proper asset allocation is so crucial to long-term investing success. BDGP is meant to simulate the equity portion of your portfolio and fall less during a bear market. But to truly sleep well at night in a recession you need enough cash/bonds to pay the bills without having to sell undervalued dividend paying blue-chips.

If your portfolio is large enough to live off dividends alone then it's OK to be 100% stocks, as long as the portfolio is diversified and low-risk enough (such as a 100% blue-chip focus).

The Bunker Dividend Growth Portfolio Today - 11 Holdings

(Source: Morningstar) - data as of March 29^th

Starting out the portfolio is going to be heavily concentrated because we're working off a watchlist of just 10 companies, with minimal weekly turnover.

Due to the small investing universe we're dealing with, the BDGP will likely top out at 60 holdings after many years of steadily adding aristocrats and kings.

Our Highest Yielding Positions

(Source: Morningstar) -data as of March 29th

Note that stewardship is Morningstar's rating of the quality of management. S = standard (fair to good) and E = exemplary (very good to great). P = poor, but our policy is to avoid such companies (thus why we're not buying AT&T (NYSE:T) anytime soon).

The portfolio isn't "high-yield" by most definitions but is paying about 50% more than the S&P 500. And given the ultra-low risk nature of its income stream and double-digit dividend growth rate, I consider a yield roughly equal to the 30-year US Treasury to be very good.

(Source: Morningstar)

Due to only owning aristocrats and kings, the portfolio is 100% US stocks. But in reality, we have very strong exposure to foreign markets because almost all our holdings are multi-national blue-chips.

Of course, that is likely to hurt us at times, such as periods when a stronger dollar and trade conflicts hurt multi-national earnings. However, that just creates more buying opportunities that will eventually result in superior returns when those temporary headwinds subside.

(Source: Morningstar)

Due to the 100% focus on the safest blue-chips, we're mostly in slower growing companies.

Sector Concentration

(Source: Simply Safe Dividends)

Since we're starting out very concentrated into the most undervalued kings and aristocrats, there is going to naturally be a lot of sector concentration. Over time, this will smooth out, but given the rock-solid dividend safety of every company we own, I'm not worried about being overweight by sector (there are no sector caps). That's especially true since the highly defensive sector concentration (61% staples and healthcare) makes this portfolio ideal for a future recession/bear market.

Income Concentration

(Source: Simply Safe Dividends)

As with any equal weighted and concentrated portfolio, the highest yielding stocks will dominate the income stream. This will balance out in the future as we diversify into more companies.

Annual Dividends

(Source: Simply Safe Dividends)

Any concentrated portfolio is going to have a lot of month to month variation in dividend payments. Eventually, this will spread out as we diversify into a few dozen companies.

The small annual income is due to this portfolio being about $25K in size. Over time adding fresh savings and steady dividend growth will generate impressive and very safe income.

(Source: Simply Safe Dividends)

I'm pleasantly surprised at how fast this portfolio would have grown its dividends in the past one to 10 years. The S&P 500's 20-year median dividend growth rate is 6.4% and these dividend legends have delivered close to double-digits this decade and even better in recent years.

If we could maintain the five-year average rate then in 20 years even this $10,000 portfolio would be generating impressive amounts of super safe income, generating a yield on cost of about 25% (about 13% adjusted for 2% long-term inflation).

(Source: Simply Safe Dividends)

It might not be easy to maintain such growth rates but currently analysts are estimating earnings growth (and thus likely dividend growth) of 10.6% over the next five years.

(Source: Morningstar)

The quality of these stocks can be seen in the far-above-average returns on assets and equity of this portfolio (good proxies for quality long-term management and good corporate cultures). In addition, Morningstar rates many of our companies' management as "exemplary" in terms of long-term capital allocation decisions.

Fundamental Portfolio Stats: (Total Return Potentials Are From Current Levels)

• Yield On Cost: 2.9%
• Yield: 2.9%
• Expected 5-Year Dividend Growth: 10.6%
• Expected 5-Year Total Return (No Valuation Changes): 13.5%
• Portfolio Valuation (Morningstar's DCF models): 7% undervalued
• 5-Year Expected Valuation Boost: 1.6% CAGR (20% margin of error)
• 10-Year Expected Valuation Boost: 0.8% CAGR (20% margin of error)
• Valuation-Adjusted Total Return Potential: 14.3% to 15.1% (market's historical return 9.1%) - note margin of error 20%
• Margin of error adjusted total returns expected: 11.4% to 18.1%
• Portfolio Beta: 0.82 (18% less volatile than S&P 500)

Portfolio Performance

• CAGR Total Return Since Inception (February 25^th, 2018): 0%
• CAGR Total Return S&P 500: 1.6%
• Market Outperformance: -1.6%
• Long-Term Outperformance goal: 1+%

Due to the highly concentrated nature of the portfolio and the timing of when the portfolio is starting (deep into a strong rally), it's not surprising that the initial results after a week are not that impressive.

(Source: Morningstar)

Starting out our heavy concentration in healthcare is badly hurting short-term returns. However, monthly dollar cost averaging buys will reduce the cost bases of our biggest losers helping to boost returns over time when these blue-chip SWANs recover.

Bottom Line: The Low Volatility, Ultra High-Quality Strategy Is Starting To Pay Off

It was a rough start for BDGP with unpopular healthcare stocks dragging us down for the first few weeks. Last week our patience and dedication to opportunistic dollar cost averaging started to pay off and we outperformed the market 2% vs 1.2%. That allowed BDGP to break even.

But the true test of this portfolio is how it will perform during a recession and bear market. The yield curve has managed to claw its way to +0.4 basis points, resetting the 10-day recession confirmation clock. But it's certainly possible that it will tip negative next week if economic data comes in weaker than expected.

If a recession is coming in 2020 then a bear market is also highly likely and I'm confident that BDGP will shine during what's likely to be a rough year for stocks. BDGP will keep on buying steadily over time, simulating the approach that decades of studies say is best for most investors.

But don't forget that outperformance in bear markets doesn't necessarily mean this portfolio will deliver positive returns when Wall Street is running deep red. BDGP (or any of my model portfolios or recommendations) are purely meant to represent the equity portion of your portfolio.

Holding enough cash/bonds to pay the bills during a bear market (average of three years but can last nearly six) is crucial to letting the value/quality dividend growth approach of this portfolio play out.

Even the bluest of blue-chips can decline significantly when panic grips the street, so never forget the importance of proper asset allocation and risk management.

My own retirement portfolio is 9% in VGLT (25-year average duration US Treasury ETF). When the yield curve is positive I sell that to buy deeply undervalued blue-chip dividend stocks (as I did last week with CVS, article coming next week explaining why).

But the reason for owning that bond ETF is so that should a bear market occur next year, I'll have an appreciating asset that not just cushions my overall portfolio, but gives me something to sell when the S&P 500 hits -20% (from all-time high) and Wall Street becomes a target rich opportunity where top quality blue-chips, SWANs, and aristocrats and kings are selling at deep discounts to historical fair value.