Completing The Ultimate Dividend Growth Portfolio

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

When you're building a dividend growth portfolio it's a good idea to hold a relatively diverse set of stocks. You don't need to get too crazy with diversification, but having half of your portfolio in oil stocks is probably not a great idea. As I've built my Ultimate Dividend Growth Portfolio I've attempted to spread out investments across the different sectors, and today I'll use the remaining cash to add three final positions. I've already got three banks, two oil stocks, a cigarette stock, a bunch of tech, some food-related stocks, and a drug store, so I'll try to avoid these areas with the new additions. 

Leading brands and a leading dividend

Clorox (NYSE: CLX) may be best known for its namesake bleach, but the company owns a handful of other popular brands as well. Glad trash bags, Brita water-filtration products, Kingsford charcoal, Fresh Step cat litter, and Burt's Bees are just a few. And according to the company's website nearly 90% of its brands holds the number 1 or number 2 market share positions in their categories. This focus on a small number of leading brands instead of a smorgasbord of mediocre brands is what makes Clorox special.

Clorox currently pays a dividend yielding 2.98%. Since 2003 the dividend has grown at an annualized rate of 11.8%, although this has slowed down a bit in recent years. The last dividend hike, which occurred in the middle of last year, was only an increase of 6.67%.

In addition to this dividend Clorox has spent quite a bit of cash on share buybacks over the past decade. The share count has decreased by 40% since 2003, and this is largely the reason that EPS has nearly doubled in that time. Share buybacks allow the dividend to be raised without increasing the payout ratio, since the number of shares declines. So if the company buys back 5% of the outstanding shares then the dividend could be raised by 5% while keeping the payout ratio the same.

Clorox has maintained a very consistent free cash flow over the years, which will allow the company to continue buying back shares and raising the dividend. In fiscal 2012 the payout ratio with respect to net income was 58.7%, historically high for the company. This could lead to slower dividend growth in the near-term, but long term I think that the dividend growth prospects look good.

Based of the current share price I'll add 58 shares of Clorox to The Ultimate Dividend Growth Portfolio for a total cost basis of $4,985.68. This position will generate a projected annual dividend of $148.48.

A toy giant with a giant dividend

Mattel (NASDAQ: MAT) is the largest company in the toy industry, with revenue of about $6.4 billion in 2012. Some of the best known toy brands like Matchbox, Hot Wheels, and Barbie are under the Mattel umbrella, and the company's margins are exceptional. With an operating margin of 16% in 2012 the company outpaces competitor Hasbro by about 2.5 percentage points.

Mattel pays a dividend yielding 3.11%. The dividend has more than tripled since 2003, growing at an annualized rate of 13.4%. The most recent dividend increase occured earlier this year when the payout was hiked by 16.1%. If this kind of growth can continue then Mattel looks like an ideal dividend growth stock.

The payout ratio did jump a bit to 55.9% in 2012, and the increase earlier this year puts it even higher. The company recorded higher net income in the first quarter of this year compared to last year as well as a 7.3% jump in revenue, so if the net income grows considerably this year then the payout ratio will be kept in check. And with analysts expected annual earnings growth of 11% over the next five years the dividend should be able to be boosted by roughly that amount.

Mattel should see considerable growth from emerging markets as more and more people have disposable income to spend on their children. This will be the main driver of earnings growth and therefore dividend growth in the years ahead.

Based on the current share price I'll add 108 shares of Mattel to The Ultimate Dividend Growth Portfolio for a total cost basis of $4,996.08. This position will generate a projected annual dividend of $155.52.

High yield, high uncertainty

Adding a defense company seems risky due to the expectation of lower government spending in the coming years, but Lockheed Martin (NYSE: LMT) looks like a compelling choice. The dividend yield is currently 4.52%, meaning that dividend growth does not need to be all that fast.

Historically Lockheed has grown the dividend rather quickly. Since 2003 the dividend has grown at an annualized rate of 24.4%, and the most recent dividend hike was an impressive 15%. But with the payout ratio right around 50% and the likelihood of earnings declines very real it seems like this kind of growth can't continue.

The good news is that the company has been buying back shares and could retire around 5% of its share count annually even after paying the dividend. This allows the dividend to be increased by about that much each year without raising the payout ratio, so even if earnings growth stops the dividend could still be raised.

The high yield is the savior of this stock. Since dividend growth will likely be slow the 4.5% yield is critical. It's still unclear exactly how Lockheed will be affected by the spending cuts, and it could turn out far better for the company than some people think. Analysts are still expecting earnings growth in the coming years, and if that's the case the dividend should be able to grow much faster.

Based on the current share price I'll add 49 shares of Lockheed Martin to The Ultimate Dividend Growth Portfolio for a total cost basis of $4,988.20. This position will generate a projected annual dividend of $225.40.

Complete...for now

Adding these three positions uses up the rest of the cash in the portfolio, so I won't be adding more stocks any time soon. As the dividends begin rolling in I'll reinvest that money in either stocks already in the portfolio or new dividend growth stocks which look appealing.

The portfolio is up about 4% in just about a month, impressive since it wasn't fully invested until now. Big gains from Corning, Microsoft, and Intel, as well as Apple's recovery, have led the portfolio higher. The yield on cost of the portfolio is 3.39%, and the goal is to grow that number as fast as possible.

The portfolio can be tracked at any time by going here. Until next time, here's what the portfolio looks like today.

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Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Mattel. The Motley Fool owns shares of Lockheed Martin. 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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