August was a fairly interesting month in the markets. The yield curve inverted, which sparked fears of impending recession. We continued to see volatility due to the trade war (which doesn’t appear any closer to being resolved with threats of more tariffs being laid on the bargaining table). The situation in Hong Kong got worse, causing some to question whether or not this could be the “black swan” event that could really put negative pressure on global growth. The Amazon rainforest is burning down. The G-7 meeting came and went with relatively little impact to the markets. And, on a bright note, football season began.

Yet, with all of this seemingly fearful news, August wasn’t a terrible month for the major averages. The S&P 500 opened the month trading at $297 and ended the month trading at $292. There were ups and downs, but ultimately, the market has continued to shrug off fears of potential headwinds and only ended up slightly negative. For years, we’ve heard analysts talk about this being a skeptical bull market. Long-term bull runs like this are typically the ones that climb wall after wall of worry because it’s generally irrational enthusiasm and rampant exuberance that causes the bubbles to form that eventually pop and let the bear out of its cage.

With so many cynical investors, it’s been difficult for such a bubble to form. I think we saw a bit of a bubble form in early 2018 due to the hype surrounding cryptocurrencies, but that didn’t last long with the steep sell-off we witnessed in late February of 2018. And later that year, we experienced another strong sell-off related to central bank policy which once again put a damper on the enthusiastic bulls’ parade. The fear that this sell-off created served as fuel for the rally that we’ve experienced thus far in 2019. It will be interesting to see how the rest of the year plays out as domestic political headlines begin to dominate the news cycle heading into the 2020 Presidential election.

But, regardless of what sort of noise surrounds the market, my outlook isn’t likely to change much. For a while now, I’ve been growing more and more conservative with my market outlook. This isn’t necessarily because of fears of a crash or recession, but instead, because of the fact that Tweets are moving the market more than the actual underlying fundamentals.

To me, this is a difficult market environment to invest in as a rational investor. So, to avoid some of the short-term risks that come along with this sensationalist behavior, I’ve been content to sit back and be patient. I’m only making purchases when I see significantly wide margins of safety and I’m inclined to raise funds from my portfolio to pay for those new shares rather than to dip into my cash position.

Being that ~93% of my portfolio is invested in equities, I’m not keen on dipping into my cash reserves. Although we’ve experienced negative headlines and volatility as of late, the market is still relatively close to all-time highs. To me, cash is still a valuable asset, and since I’m so fully invested, I think it’s prudent to build up my supply of dry powder for a rainy day in the future.

I’ve always said that the stock market should be viewed as a market of individual stocks, and therefore, it’s more important to pay attention to the value that individual names present rather than rely on the broader market averages for buy or sell signals. Yet, I also acknowledge that in this digital day and age where most of the trades in the market are being made by algorithms, stocks rise and fall as one. This leads to outsized volatility that I want to be able to take advantage of. Babies are thrown out with the bathwater more often today than ever before with computers driving the trading volumes. So, while I’m certainly willing to step into the market at all-time highs and make purchases of irrationally beaten names, I don’t feel compelled to unless it’s a high conviction pick and/or the margin of safety is simply too wide to ignore.

August Trades

So, with that in mind, let’s review the only two trades that I made last month.

I made 1 purchase and 1 sale to fund the purchase.

On 8/15/19, I added to my Cisco (CSCO) position, buying shares at $46.91. This was the first time that I’d bought CSCO in years, having originally built my position back in 2013/2014. Prior to my recent trade, my CSCO cost basis was $23.80. Now, it’s $30.20. I have to admit that I was a bit hesitant to add to the position because of my low cost basis. It was fun to be able to throw out that cost basis as a bit of a humble brag during conversations about CSCO. However, it didn’t take long for me to realize that my ego was doing the talking and you know what’s even more fun than having a super-low cost basis? Augmenting my passive income stream.

At ~$47/share, CSCO was yielding nearly 3%. I expect the company to continue to post high single-digit dividend growth, so regardless of the cost, I knew I was adding a high quality dividend growth stock to my portfolio. And furthermore, at ~15x TTM earnings (and ~13x forward earnings), CSCO had relinquished much of the premium valuation that it had been trading with in recent years, and ultimately, I was quite happy to take advantage of the recent double-digit sell-off and add to my position. I wrote a focus ticker article about my CSCO purchase, so if you’re interested in a more in-depth analysis, here’s the link.

To fund that CSCO purchase, I went ahead and trimmed a bit of my Starbucks (SBUX) position.

Starbucks is a great DGI company for sure and I’m certain that many readers will question my decision to sell some shares, yet SBUX has had an amazing rally year-to-date, and when I look at the stock’s ~34x TTM P/E ratio, I can’t help but think shares have gotten way ahead of themselves. To me, SBUX’s fair value lies somewhere in the 22x earnings range. Using the ~$2.80/share EPS estimate for 2019, we arrive at a ~$62 fair value estimate. In other words, at the ~$94 price point at which I trimmed, shares were ~50% overvalued.

Being that SBUX was an overweight position, I felt comfortable taking some of my strong gains off of the table (I locked in 64% gains on the shares I sold) and re-allocating those funds to CSCO that was trading for only ~15x earnings.

SBUX has better dividend growth prospects than CSCO, though it’s also worth noting that because of the massive run that SBUX was been on lately, shares are only yielding about 1.5% in the present. CSCO’s yield was twice as high and assuming that CSCO’s long-term dividend growth rate is in the 7-10% range and SBUX’s is in the 8-12% range, it would take a very long time for the compounding that SBUX’s higher growth needs to produce to overcome the income that CSCO should generate moving forward. This deal increases my income significantly in the short term and I like the flexibility that this gives me in terms of either increased purchasing power when selectively re-investing dividends in the present and/or building up my cash position via larger dividend payments.

Even after trimming my position a bit, SBUX is still a top-5 position for me (right now, SBUX represents ~3.4% of my overall portfolio). I remain very bullish long term and I suspect that the dividends that SBUX produces over the years will play a large role in my eventual financial freedom. This is why I wasn’t interested in selling a large percentage of my SBUX position. But, even the highest quality stocks can become irrationally overvalued, and because of this, I was happy to reduce my SBUX exposure in the short term because of the high risk associated with such lofty valuations. The shares that I sold amounted to roughly 15% of my SBUX stake. Should SBUX shares sell-off and trade back down at levels that I deem more appropriate, I will be more than happy to add to my position once again.

Dividend Income

Speaking of higher dividend income in the present, my passive income stream produced y/y growth of 8.4% in August. This is a bit of a slowdown compared to recent months, though I don’t expect huge dividend growth numbers during the February/May/August/November quarterly cycle because these months include payments from some of my large positions in slower dividend growth names such as Apple (AAPL) (which is usually not considered to be a slower dividend grower, but this year only gave investors a ~5% increase), AT&T (T), Verizon (VZ), and Bristol-Myers Squibb (BMY), for example.

Year-to-date, my dividend income stream is up 16.96% over the first 8 months of 2018. I’m still on track to produce 18-20% dividend growth for the full year, which will be a great achievement being that I haven’t added new capital to the portfolio in over 2 years at this point, so all of the dividend growth that is being produced is organic, via either dividend increases, re-investment, and/or active management.

Oh, and every time I write one of these pieces readers ask about my total return/performance relative to the markets, so I’ll touch on that as well. During August, my portfolio posted gains of 0.71%. This outperformed the broader markets, which were down slightly. And, on the year, my portfolio is up ~18.4% versus the broader market, which is up nearly 17%.

All in all, I’m extremely pleased with the progress that the portfolio, and more importantly, my passive income stream, has made in 2019. I feel like I’ve been discussing market volatility a lot of as late, though it gives me solace to write these types of articles because they prove that regardless of what the broader markets are doing in the short term, my income stream can be not only reliable but also predictable, and this is why I’ve decided to pursue the dividend growth route when it comes to achieving financial freedom. August was but another step in the right direction and I look forward to writing this piece next month, and next August, and the one after that, and so on, because there are fewer things that give me such joy in the markets as tallying up my monthly dividends and seeing the tangible progress that I’m making toward my financial goals.

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Disclosure: I am/we are long CSCO, SBUX, AAPL, T, VZ, BMY. 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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