3 Ways To Build An Armadillo-Armored Portfolio of Blue-Chip Dividend Stocks

In the entire history of the American capital markets, this fact remains true: there has never been a year in which 10% of the companies that have been raising their dividends annually for more than 25 years went on to fail to raise their dividend in the subsequent year. That is to say, in a century that saw the Great Depression, the 1973-1974 bear market, the 9/11 terrorist attacks, and the 2008-2009 financial crisis, there was never a year in which this statement proved false: “I hold nothing but stocks that have been raising their dividends for 25+ consecutive years, and at least 90% of them raised their dividend this year.”

For someone that is starting to build a portfolio, the Exxons, Coca-Colas, 3Ms, Johnson & Johnsons, Colgate-Palmolives, Becton Dickinsons, and Emerson Electrics are where the research should begin. If you are interested in something resembling a bullet-proof portfolio in which your dividend checks come with armadillo-encrusted armor, your starting rule should be this: “I will only purchase stocks that have been raising their dividends for more than 25 years and have been growing their profits at a rate in excess of at least 5% annually over the past decade.” That would be the perfect fertile soil for an investment. Remove the banks from the list if you don’t want to study those companies in-depth and individually, and I can’t think of a better limiter that would ensure super long-term financial success.

There is a stark difference between companies that raise their dividends for 10-24 years and 25+ years. It can be seductive to lump those categories into the same mental grouping of “dividend growth stocks” and stop distinguishing between them. That would be a mistake because the “failure rate” of dividend growth for the 10-24 year dividend raises is much higher; in normal and moderately bad years, the dividend attrition rate for them is between 8% and 15%. That’s not a bad place to be; a little common sense could probably eliminate some of the riskier firms with impending dividend cuts, and even if you did see 15% of your companies fail to raise in a given year, it’s not necessarily that they eliminated their dividend, and the dividend growth from the other 85% of the portfolio would be enough to compensate for this.

I’ll give a quick back-of-the-envelope example, assuming each stock accounts for a similar amount of income in your portfolio: if 85% of your portfolio contributes $8,500 in annual income for you, and that figure grows by 7.5% in a given year, that would take you up to $9,137.50 in annual income the next year. If you were reinvesting your dividends, thus having a 9.5% growth rate, your $8,500 dividend income would grow to $9,307.50 the next year.

Now let’s assume that the 15% of your portfolio which was contributing $1,500 in annual income managed to cut its dividends in half to $750 (I’m using severe cut assumptions to model a realistic bad case scenario). On a year-over-year basis, you would still end up between $9,887.50 and $10,057.50 on the annual income front (relative to the $10,000 in annual income we started out with). In other words, assuming deep dividend cuts in a worst year scenario from the basket of stocks that had been raising their dividends for between 10-24 years, the realistic bad case scenario is that you tread water on the income front for a year.

For companies that have been raising their dividends for more than 25 years, the typical attritution rate is 3-4%. In other words, you are almost guaranteed to see your annual income by at least 6% as the dividend growth from the Exxons and Johnson & Johnsons only have to compensate for an odd stock here and there in a typical year. The moral of the story: if you stick with companies that have been raising their dividends for 10-24 years, you’d be fine in a bad case scenario as your income would roughly stagnate for a year. If you stick exclusively to companies that have been raising their dividends for 25 years or more, then suddenly, the odds get much better: the historical tradition offers the promise that your income will increase in excess of inflation every year as the dividend “failure to raise” rate is only 3-4%.

Of course, most people have blended portfolios, and this is not an either/or proposition. And then again, nothing can replace good ‘ole fashioned thinking. Some companies don’t have much of a dividend growth legacy at all—Dr. Pepper, Philip Morris International, and Hershey aren’t on any lists of companies raising their dividends for decades on end (Hershey froze its dividend during the crisis, Philip Morris International spun off of Altria so it doesn’t have its own record, and Dr. Pepper has been taken private a couple of times in the past century so it doesn’t have a clean, independent record like you’d find with Coca-Cola). Yet, I would rather have each of those companies in a long-term dividend portfolio over a water utility that has been raising its dividend every year for five decades, but has a profit growth and dividend growth rate that is barely limping along, not even covering inflation (I’ll let you look it up yourself so you can cement it in your mind better).

If building a truly defensive portfolio from an income standpoint is something you consider priority #1, here are my advice filters: (1) First, screen for only stocks that have been raising their dividends for more than twenty-five years. (2) Then, screen out the ones that haven’t grown earnings by at least 5% this decade. Given the gravity of the 08-09 crisis, the companies left on your list will be the truly goodies. (3) Then remove banks, tech-oriented companies, and anything subject to product obsolescence (like Kodak film). That’s about as defensive as it gets. There are a lot of opportunities you’d miss by following such stringent rules, but if your aim is “I want 99% success rate with a portfolio of common stocks”, that’s the best prescription I have for how to start your research in a quick and effective manner.