(Source: imgflip)

Each week, I make one purchase of a dividend stock for my retirement portfolio that is designed to meet my goal of maximizing safe income over time.

The dream is to be able to live off 40% of my portfolio dividends, meaning 50% of post-tax dividends. The half that would always be reinvested will ensure that my family and I would always see a rising standard of living, no matter how long I live or what the stock market does over time.

Alpha Factor Strategies Total Returns

(Source: Ploutos) – data as of September

I’m a fan of evidence-based investing, and of the seven proven alpha-generating strategies, my favorites are dividend growth, low volatility, quality, and value. Why these four?

  • dividend growth stocks pay you to patiently wait for the thesis to play out (keeps you focused on fundamentals not share price)
  • quality is paramount because you’re buying part of a real business, so you want to own quality income-producing assets run by competent and trustworthy management
  • valuation always matters, the lower the price you pay in terms of earnings, cash flow and dividend valuation the higher your margin of safety and better your long-term total return potential
  • volatility, outperforming by falling less during market declines serves to help you sleep at night and also boosts returns because smaller drawdowns are easier to recover from

I try to target my weekly buys to companies that include several of these strategies, and I’m also diversifying my portfolio by dividend strategy over time.

  • 30% Super SWANs (11/11 quality companies) – based on Dividend King’s Fortress portfolio
  • 30% deep value high-yield- based on Dividend Kings’ Deep Value and High-Yield blue chip portfolio
  • 30% double-digit dividend growth stocks – based on all four of our model portfolios
  • 10% Brookfield Asset Management (NYSE:BAM) – the Berkshire (BRK.B) of global hard asset management and 15% to 20% CAGR long-term return potential

I use the Dividend Kings valuation lists, which now number nine groups of stocks totally 200 companies. This allows me to always know what quality companies are worth buying, what they are worth in any given year, and what realistic long-term returns they can generate.

From the Dividend Kings master list, I select the best buy candidates for my retirement portfolio each week.

1 Of These 4 Blue Chips Is My Next Retirement Portfolio Buy

Company Ticker Quality (11 Point Scale) Yield Current Price Historical Fair Value Price (2019) Discount To Historical Fair Value

5-Year CAGR Total Return Estimate (F.A.S.T Graphs)

Simon Property Group (SPG) 11 (Super SWAN) 5.6% $149 $206 27% 15% to 20%
UnitedHealth Group (UNH) 11 (Super SWAN) 2.0% $215 $214 -1% 10% to 17%
Caterpillar (CAT) 11 (Super SWAN) 3.5% $119 $172 31% 17% to 31%
Broadcom (AVGO) 9 (Blue chip) 3.9% $271 $366 26% 15% to 22%

(Source: F.A.S.T Graphs, Factset Research, analyst consensus, management guidance, Gordon Dividend Growth Model)

It’s a strong group of candidate companies this week. In a world where the S&P 500 yields 1.9% and most dividend growth ETFs about 2%, and “high-yield” ETFs offer 3%, 2% to 5.6% safe yields growing at 4% to 15% over time make for attractive opportunities.

Factor in reasonable to very attractive valuations, and I expect all of these companies to outperform the 5% to 8% CAGR total returns of the S&P 500 that most asset managers expect.

The Pros And Cons Of Each Of These Companies

Why Buying Simon Today Is A Potentially Great Idea

Next year, analysts expect 4% growth from Simon, meaning its fair value is likely to rise from $206 to about $214. That means SPG is currently trading at a roughly 30% discount to next year’s fair value.

For a Super SWAN, 20% or higher discounts are “very strong buys”, and Simon is currently one of the best Super SWAN dividend stocks you can purchase.

  • 5.6% yield is both generous and very safe, even in a recession
  • high margin of safety means very high total return potential from a modestly fast-growing REIT

My cost basis on SPG is $148.52, and it’s now back to that, potentially allowing me to lock in $67 per year in additional safe income with this week’s $1,100 standard buy.

(Source: F.A.S.T. Graphs, FactSet Research)

Simon’s realistic total return potential is based on mean reversion to its historical P/FFO and 4% to 7% long-term growth. The REIT’s $5 billion development pipeline makes that realistic as does the best management team in the industry’s brilliant adaption to the changing retail environment.

  • SPG is investing in e-sports
  • SPG now has its own e-commerce platform partnering with its retailers to integrate online sales with in-store pickup

Using the current 4.8% consensus long-term growth rate, SPG can realistically achieve almost 17% long-term returns over the next five years, two to three times what the broader market is expected to deliver.

What about the “retail apocalypse”? Simon is truly best in breed and having some of the best Malls in the country means that it suffers far less than other mall REITs.

Bankrupt Forever 21 just announced which US stores it would be closing. Most of Simon’s peers are seeing 50+% of these stores close. Simon? Just 1…out of 99 leased to Forever 21. As Julian Lin points out, even if Simon had to offer 30% rent consensus to keep 99% of these stores open, that equates to a 0.4% decline in its overall rent. This is basically a rounding error that means the current pullback in the share price is not justified by its fundamentals, long-term growth prospects, or dividend safety.

Simon has one of the few A credit rated balance sheets in REITdom, can borrow for 30 years at 3.25%, and has $1.5 billion in retained cash flow.

Basically, Simon is big daddy Warbucks in its industry, is swimming in cash, and has $6.8 billion in low-cost borrowing power to ride out any recession, dividend intact.

What I Might Want To Wait

According to the bond market, 12-month recession risk is about 38%, and Simon, whether or not it makes fundamental sense, might suffer from a lot more “retail apocalypse” headlines.

US trade talks with China are scheduled for October 10th, and Moody’s estimates an 85% probability that no major headway will be made. A weakening economy, and 15% tariffs on apparel (which could go to 30% at some point) could be very bad for mall REIT stock prices.

Basically, there is opportunity cost to consider for anyone who has less buying power than I do and can’t afford to buy as frequently as I can.

Why Buying UnitedHealth Today Is A Potentially Great Idea

UnitedHealth is one of my favorite rapidly growing Super SWANs, and it happens to be a great defensive choice too, given its historically low volatility and recession-resistant business model.

10-Year Average Volatility Relative To S&P 500

(Source: YCharts)

The best management team in the industry has consistently kept this 11/11 quality company growing at 10% to 15% over time, and that’s likely to continue. Management says it is pursuing 85 million new potential customers in the coming years, totaling a $1 trillion untapped managed care market.

(Source: F.A.S.T. Graphs, FactSet Research)

UnitedHealth isn’t undervalued at the moment, merely fairly priced for 2019 but about 10% undervalued relative to 2020 fair value.

10% to 17% CAGR total returns are possible over the next five years, with the consensus growth rate of 13.2% resulting in 14% annualized returns that could double your investment by the end of 2024.

What I Might Want To Wait

While UnitedHealth has basically been overvalued since 2014, it’s merely come down to fair value.

UnitedHealth Monthly Pullbacks/Corrections Since 2010

Monthly Pullback/Correction Stock Performance Starting PE Overvaluation
April 2010 -7.1% 9.5 -36%
July 2012 -12.7% 11.7 -21%
April 2014 -8.5% 14.8 -0%
April 2015 -5.8% 20.1 26%
August 2016 -5.0% 19.4 23%
March 2018 -5.1% 21.5 31%
December 2018 -11.5% 22.3 33%
February 2019 -10.4% 20.7 28%
April 2019 -5.7% 18.5 20%
August 2019 -6.0% 17.8 16%
September 2019 -6.7% 16.5 10%

(Source: Portfolio Visualizer, F.A.S.T. Graphs, FactSet Research)

Like any company, it can be highly volatile, suffering numerous 5+% monthly declines since the ACA passed in March 2010.

UnitedHealth Pullback/Corrections Since 2010

Pullback/Correction End Ending PE Total Return

Months To New Record High

June 2010 7.8 -15.7% 3
July 2012 10.1 -13.0% 9
September 2011 10.1 -10.3% 4
March 2018 19.9 -9.3% 1
April 2014 13.5 -8.5% 2
November 2015 17.7 -7.2% 4
October 2013 12.5 -6.0% 1
April 2015 18.7 -5.8% 1
August 2016 18.1 -5.0% 3
Average 14.3 -9.0% 3.1

(Sources: F.A.S.T. Graphs, FactSet Research, Portfolio Visualizer)

Over the past decade, the average pullback/correction low PE was 14.3, but it’s possible that campaign 2020 rhetoric will weight on the stock for the next 12 to 24 months, and possibly take it down lower.

The reality is that there is very little chance that “medicare-for-all” decimates the health insurance industry since it takes 60 Senate votes to overcome a filibuster. But the market often acts on perceived risk and can ignore the fundamentals (15% growth this year).

Buying UnitedHealth now is a reasonable choice and would allow me to build on my position while modestly lowering my cost basis. However, Caterpillar offers me a much better opportunity to lower my cost basis on a rapidly growing Super SWAN, and a dividend aristocrat to boot.

Why Buying Caterpillar Today Is A Potentially Great Idea

In 2020, CAT is expected to grow earnings and cash flow 4%, even with the trade war playing havoc on global manufacturing and industrials. If this fast-growing Super SWAN dividend aristocrat achieves that modest growth, then it’s fair value will rise to about $179 next year, 34% higher than today’s price.

(Source: F.A.S.T. Graphs, FactSet Research)

Such a high discount to fair value creates one of the best low-risk total return potentials on the Dividend Kings’ 200 company master watchlist. The consensus growth rate of 13.2% applied to its historical 17.5 PE could nearly triple your money courtesy of 29% annualized returns. That’s the power of a fast-growing world-class company trading at about half its historical PE.

The realistic total return potential is based on 7% to 15% growth and a 15 to 17.5 PE, which means that Caterpillar can realistically deliver 17% to 31% CAGR total returns. The lower end of the growth range already bakes in a mild US recession in the next few years.

I’ve bought Caterpillar just once for my portfolio, a $1,200 starter position at $133.24. Buying it again this week could significantly reduce my cost basis while locking in about $40 in very safe dividend income. Caterpillar has guided for 7% to 9% dividend growth over the next three years, which its current growth plans support.

If you’re looking for a fast-growing dividend aristocrat offering a generous 3.5% yield, it’s hard to go wrong with Caterpillar today.

Why I Might Want To Wait

Caterpillar is the most volatile company of these four, and there is very little chance that the US economic picture brightens in the next few months. Recession is still a lower probability outcome, but anyone with limited capital to put to work might want to potentially hold off and in case industrials take it on the chin as they did in August.

(Source: YCharts)

I’m fortunate to be able to buy stocks every week, currently at a $1,100 rate. Thus, my opportunity cost is lower than most people, who have a lower savings rate and get paid every two weeks.

Why Buying Broadcom Today Is A Potentially Great Idea

Broadcom is my favorite high-yield tech stock to buy today and my second favorite chip maker behind Super SWAN Texas Instruments (TXN).

TXN follows a low-risk organic growth strategy, paying out 100% of FCF as buybacks and dividends. Broadcom pursues an aggressive M&A growth centered approach that in the hands of CEO Hock Tan has worked out brilliantly so far.

Broadcom Acquisitions Have Been Brilliant

(Source: investor presentation)

Hock Tan is a classic Buffett-style value investor seeking quality sources of stable cash flow for reasonable prices. In recent years, that focus has been on software companies like CA Tech and now, Symantec’s (NASDAQ:SYMC) enterprise business.

The result has been more and more revenue and cash flow coming from monthly recurring enterprise software subscriptions, which now make up 29% of revenue and over 30% of cash flow.

(Source: YCharts)

5+% FCF margins are good by Corporate American standards, and thanks to putting together great strategic deals and executing brilliantly on synergist cost savings, Broadcom’s FCF margin is now at 40% and has been steadily rising over time.

The dividend policy is to payout 50% of FCF and use the rest to pay down debt used to fund its M&A. Based on management’s 2019 guidance, a 10% to 11% dividend hike is likely in December 2019. Based on the analyst’s current consensus for 2020 FCF growth of 12%, a 12% hike is likely next year.

That means anyone buying today at about $270 is looking at a probable 4.9% yield on cost by Christmas of next year.

(Source: F.A.S.T. Graphs, FactSet Research)

Thanks to its low valuation, Broadcom achieving the 12.1% consensus growth (10+% is management guidance) could result in 18% long-term total returns.

The 10% to 15% long-term growth range equates to 15% to 22% long-term return potential.

Why I Might Want To Wait

An escalation in the trade war could send Broadcom much lower. But more fundamentally the big risk with Broadcom is management’s love of debt-funded M&A. No one does smart acquisition better than Hock Tan (at least in this industry). But no management team ever bats 1.000, and leverage is always a double-edged sword.

Moody’s estimates that, once the Symantec deal closes in late 2019/early 2020, Broadcom’s debt/EBITDA will hit 4.3. That’s very high for any corporation, much less one that still gets 70% of revenue from cyclical semiconductors sales.

Moody’s estimates that AVGO’s debt/EBITDA ratio will fall by 0.5 per year but is worried that M&A happy management will not deleverage sufficiently before buying something else.

Before the latest acquisition was announced, Broadcom was a 10/11 SWAN stock, and it has been downgraded to 9/11 Blue chip due to elevated debt.

Moody’s has the company on a review for a possible downgrade to junk bond status, which might explain why the company recently sold nearly $4 billion in convertible debt to repay debt in exchange for guaranteed dilution in 2022.

S&P has not indicated a downgrade to junk status is coming, but if Broadcom were to lose its investment-grade rating (BBB- or equivalent from both Moody’s and S&P), then I’d have to downgrade the company to 8/11- above average quality.

(Source: S&P 2018 Global Default Report)

Mind you, 8/11 is not a low-quality stock, nor is a BB+ credit rating (what S&P would likely downgrade to if it cut) indicative of an unsafe dividend. Over the past 30 years, 22.3% of BB-rated companies have defaulted, and Broadcom’s risk would likely be under 20% (BB range includes BB- to BB+).

A downgrade to junk bond status would merely raise Broadcom’s future cost of borrowing and limit its financial flexibility, including during future recessions and industry downturns.

Level 8 quality companies require a 15% margin of safety for me to consider them “good buys”. Broadcom is not at a significant risk of such a downgrade right now. If a recession were to occur, Broadcom might receive a downgrade from S&P and myself, but the current margin of safety would still make it a good buy.

And we can’t forget that a company growing as rapidly as this, with increasingly stable cash flow, is going to be worth far more in 2020 (about $410). But fair value is NOT a “12-month price target”, and I make no claims about when a company will trade at fair value.

It will happen eventually as long as management executes well and delivers the expected growth. But short-term pessimism and fear can cause high-quality blue chips to languish for many years.

My goal with Broadcom is to steadily build my position whenever I can buy this fast-growing high-yield tech stock at attractive levels, and it remains under my risk cap of 10% of my portfolio.

Bottom Line: It’s Hard To Go Wrong With SPG, UNH, CAT Or AVGO At Current Valuations… As Long As You Have A 5+ Year Time Horizon And Use Proper Risk Management For Your Needs

The highlight of my week is getting to buy a quality dividend stock that meets my long-term objectives.

Watching my safe annual dividends ($18,153) grow each week is how I stay focused on what matters. Those are the fundamentals of my portfolio and my dream of a prosperous retirement that can be funded entirely by 40% of my portfolio’s dividends.

I haven’t checked my portfolio balance in nearly two months and have no interest in such short-term distractions. As legendary value investor Joel Greenblatt said, the key to long-term success is buying “above-average quality companies at below-average valuations”.

It’s a very tough call this week, choosing between four top-quality blue chips, each one offering pros and cons. I’ll let you know what I bought in my next retirement portfolio update, coming out early next week.

If you are using my retirement portfolio articles to make your own investment decisions, remember to always think first of risk management.

Also, don’t forget to leave room under your risk caps to buy more should the market sell-off, and these blue chips fall lower.

As long as you have the right long-term strategy, designed for your personal needs and using the proper risk management and asset allocation, consistently buying companies like these, at valuations like these, is likely to work out very well for you.

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Disclosure: I am/we are long AVGO, SPG, CAT, UNH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-10-07