A Dividend Portfolio with Upside Potential

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As you may read in many of my posts, I am basically an emerging market bond investor (you can see my bond trades at WarrenTrades); but I am sure equities can offer much better long-term protection against inflation. I chose a portfolio that can generate the income that you would usually get with a fixed-income portfolio plus considerable capital appreciation upside. I consider all these companies to have great management in place, and I think some of them offer great long term potential. Of course, by investing with a four stock portfolio we shall have the added cost of increased volatility; and indeed, this portfolio will have a weighted average Beta of 1.57 against the Beta of 1 that you would achieve by buying the S&P 500 index. 

25% of my portfolio belongs to Eni (NYSE: E), the Italian national oil/gas champion with reserves all over Africa and Asia that just released its 2012-2015 strategic plan. This is one of my favorite stocks, if for no other reason than that the company pays a 4.9% dividend yield that it aims to increase by 4% every year. Eni trades at x5 EV/EBITDA and x8.5 P/E, but operating profits are growing at a fast 13% yearly rate. Its a long term investment with a great dividend.

Arcelor Mittal (NYSE: MT) controls another 25% of my portfolio.  This company is the king of steel, but its European operations and high leverage have been producing some trouble. That said, I like the stock and I think it's oversold. The company has no liquidity issues, and the recent downgrade to sub-investment grade by Moody's has made a rights issue unnecessary. MT is trading at historical lows, and with the de-leverage process in place I think its time to accumulate shares. On valuation MT trades at 2013 x20.6 P/E and x6 EV/EBITDA, but those multiples are poised to decrease rapidly as steel outlook ameliorates. I expect the 2013 dividend to be very low at 1.3% from the current 4.8% in order to focus on reducing debt, but I also expect the dividend to grow rapidly from there.

I've put 25% of my portfolio into British Petroleum (NYSE: BP), the Anglo-American oil giant that is in the final steps of dealing with the consequences of the Macondo disaster. The company has almost finished with its $38 billion asset disposal target and its ready to come back to growth. The 2013 dividend yield is at 5% after BP decided to raise the dividend by 12.5%.  BP is trading at a 17% discount to US peers, with a 2013 expected 7.3% Free Cash Flow yield and a x6.4 P/E multiple. I choose to invest now before every institutional investor on the Street does.

Finally, 25% of my portfolio is in Banco Santander (NYSE: SAN), the leading European banking institution with its headquarters in Madrid. More than 50% of its business comes from Latin America, and it's becoming a growing force in the UK banking arena. After making huge real estate provisions for its Spanish branch during 2012 the company will normalize its earnings in 2013. The now seemingly expensive x18 P/E is expected to go down to x9.6 next year. Yes, you are paying x1.3 tangible book value, but you are also getting the 10.4% dividend yield!

The selected portfolio offers great appreciation potential from MT and BP, a stable growing dividend from E, and high dividends with great management at SAN. The weighted achievable cash yield is 5.4%, and you get great inflation protection plus a free option on the healing of MT and BP. Its difficult to time the market, but its important to have a smart value-oriented strategy. 

martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of ArcelorMittal. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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