Sunday, October 5

Week 170 - Growing Perpetuity Index (UPDATED)

Situation: Our blog (Invest Tune Retire) grew from the idea that owning “buy-and-hold” stocks only makes sense if you a) plan on using dividends from those stocks to supplement your retirement income, and b) pick the right stocks. The goal is to receive dividend checks during retirement that grow faster than inflation (see Column H in our Table). We began writing our blog using an unchanging index of a dozen stocks that would bring this idea into focus. To have a catchy name for that index, we borrowed a finance term that is used to describe a rare type of bond that pays out more interest year after year, called a growing perpetuity.

To pick stocks for our Growing Perpetuity Index (see Week 4), we turned to the Dow Jones Composite Index of 65 stocks, which includes the 30-stock Dow Jones Industrial Average (DJIA), the 20-stock Dow Jones Transportation Average and the 15-stock Dow Jones Utility Average. To qualify, stocks were required to: 

1) have a dividend yield no less than that for the exchange-traded fund (ETF) that mimics the S&P 500 Index (SPY);
2) be an S&P “Dividend Achiever” with 10+ years of annual dividend increases;
3) have an S&P stock rating of A- or better;
4) have an S&P bond rating of BBB+ or better.

We turned up 14 stocks but chose to limit our list to 12. Two utilities qualified, NextEra Energy (NEE) and Southern Company (SO), but we decided to include only one. We kept NEE because it is the dominant player in renewable energy (wind and solar). One transportation stock qualified, Norfolk Southern (NSC). There were 11 that qualified from the DJIA, so we needed to exclude one. Caterpillar (CAT) was excluded because the company had not raised the dividend for 24 months during the Great Recession, even though S&P still granted it Dividend Achiever status. After more than 3 yrs, the same 14 are the only companies that continue to qualify. Red highlights in the Table denote underperformance relative to our benchmark, Vanguard Balanced Index Fund (VBINX). For comparison purposes, the Table includes a section for stocks in the Barron’s 500 List that meet our criteria but aren’t in the Growing Perpetuity Index.

Bottom Line: It is not easy to identify high quality, buy-and-hold stocks that pay good and growing dividends. The 65-stock Dow Jones Composite Index has 14 such stocks by our criteria, the same number as in July of 2011 (see Week 4). We use 12 of those stocks to make up our Growing Perpetuity Index (see Table) but there are 28 more in the Barron’s 500 List that meet our criteria, including Microsoft which becomes a Dividend Achiever later this year. In both the list of 12 Growing Perpetuity Index stocks and the list of 28 similar stocks, the majority are S&P Dividend Aristocrats (see Column P in the Table), meaning that there has been a dividend increase approximately every year for at least the past 25 yrs. That’s the best sign that you’ve picked the right stock for your retirement portfolio (see Week 146).

Risk Rating for the Growing Perpetuity Index: 4

Full Disclosure: I dollar-average into XOM, WMT, JNJ, MSFT, ABT, PG, and NEE.

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