My dividend portfolio keeps churning out cash

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John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.

The latest Strategy Lab performance numbers are in and today I'm going to share the results with you. I hope you'll agree that they validate the dividend growth approach that I've adopted, both for my Strategy Lab model portfolio and my own investments.

But I'll let you be the judge.

First, let's look at the portfolio's overall performance. Then we'll drill down into the details. My goal here is to illustrate how dividends – combined with two critical ingredients, time and compounding – can produce gratifying returns without requiring a lot of specialized knowledge, frequent trading or excessive risk.

To quickly recap, I launched my Strategy Lab model dividend portfolio on Sept. 13, 2012, with $50,000 in virtual cash. My objective was to build a collection of conservative, blue-chip stocks that would pay me a steady stream of dividends that increase regularly. In keeping with my buy-and-hold philosophy, I've done very little trading since then, having sold just two of my original 12 securities (I replaced McDonald's and Coca-Cola with Johnson & Johnson and Brookfield Infrastructure Partners).

More than 3 1/2 years later, I'm pleased with how the strategy has performed. As of March 31, the portfolio was worth $72,551.10, representing a total return – from capital growth and dividends – of 45.1 per cent. That's equivalent to a total return of 11.1 per cent annually, more than double the S&P/TSX composite index's total annual return – also including dividends – of about 5.4 per cent over the same period.

What went right for my portfolio? Well, steering clear of energy producers was a big help. Dividends from oil and gas companies can look tempting when energy prices are high, but as we've seen over the past year, when crude plunges, those juicy dividends don't last. The falling loonie was also a plus, because it lifted the value of my U.S. stocks in Canadian currency and also boosted the value of my U.S. dividends.

On the whole, there was nothing spectacular about the performance of any of my companies – no doubles or triples, just gradual growth in their share prices and dividends. In isolation, none of the dividends was especially impressive, either, but add them up and you begin to appreciate the power of a dividend-based approach.

Care to guess how many dividends I've received since the portfolio's inception? Answer: 193. Even I had to do a double take when I saw that number. And how much do you suppose those dividends have contributed to my portfolio? More than $8,000.

Those dividends haven't just sat around doing nothing. I put them to work – this is where compounding comes in – by reinvesting the cash in additional shares of the companies I already own. (If you're wondering, none of my stocks are on a dividend reinvestment plan, or DRIP. Instead, I wait until a sufficient amount of cash builds up, then I buy more of whatever looks attractive. That's not meant as a criticism of DRIPs, which can be a great solution.) By reinvesting my dividends, I acquire more shares that produce even more dividends, which I then reinvest to generate still more dividends. We've all heard of people who dig themselves into debt and can't get out because their interest charges keep piling up. Well, reinvesting dividends works on the same compounding principle – except in reverse.

It's actually better than that, though, because the dividends themselves keep growing. Every one of the companies in my Strategy Lab portfolio has raised its dividend at least annually, and a few have increased more frequently than that.

Telus, for example, has raised its dividend seven times since the portfolio's inception, Royal Bank of Canada and Bank of Montreal have announced six increases each, and Fortis and TransCanada have hiked four times. My two U.S. stocks – Procter & Gamble and Johnson & Johnson – typically announce increases in April, so I'm expecting my dividend income to grow again in the next few weeks. P&G and J&J have been raising their dividends annually for more than half a century, and they aren't going to stop now.

Stock markets bounce around, sometimes violently, but my portfolio's dividend income has gone in only one direction: up. When I launched my Strategy Lab portfolio, it was generating projected annual income of $1,875.84 based on dividend rates at the time. Thanks largely to all those dividend increases and dividend reinvestments, the portfolio is now churning out $3,008.26 in cash annually – an increase of 60 per cent.

And that number will only continue to grow.

Is dividend investing the only approach that works? Not at all. As happy as I am with my portfolio's performance, it still trails the Strategy Lab value and growth portfolios (although my dividend portfolio had the best return by a wide margin in the first three months of 2016). The important thing is that my portfolio is doing exactly what it was designed to do: generate a growing stream of income and steady capital gains. I have every reason to believe that will continue.

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The performers

Our four Strategy Lab experts started with a hypothetical $50,000 portfolio on Sept. 13, 2012. They can each hold five to 12 Canadian or U.S. securities and trade as often or as little as they wish. Here are their returns since the battle began, as of March 31, 2016:

• Dividend investor John Heinzl: 45.10 per cent
• Index investor Andrew Hallam: 30.89 per cent
• Value investor Norman Rothery: 67.77 per cent
• Growth investor Chris Umiastowski: 260.69 per cent