Beyond the Core Dividend Holdings

While everyone else is chasing the latest meme stock or trying to time the perfect crypto dip, we're over here building wealth the old-fashioned way, by owning pieces of profitable companies that actually pay us to hold them. Revolutionary concept, I know.

This week, we're shifting gears from our core portfolio discussions to explore the exciting world of satellite positions. Think of these as the seasoning on your investment steak … smaller portions, but they can really make the whole meal sing.

What's Inside Today:

• Why satellite positions deserve a spot in your dividend portfolio

• The art of hunting for temporary weakness (it's not as morbid as it sounds)

• Two compelling opportunities: Canadian National Railways and Prudential

• How dividend yields can be your safety net when prices get wobbly

The Satellite Strategy: Small Positions, Big Potential

Let's discuss why satellite positions are crucial in a core-satellite investment approach. While your core holdings provide the steady foundation (think broad market ETFs, dividend aristocrats, and other set-it-and-forget-it investments), satellite positions are where you can get a bit more adventurous without risking the farm.

The beauty of satellite investing lies in selectivity. We're not building a collection here; we're curating a small portfolio of high-conviction plays. These positions represent maybe 10-20% of your total portfolio, but they're chosen with surgical precision. Each satellite position needs to earn its place through compelling fundamentals and attractive valuation metrics.

The dividend yield requirement isn't arbitrary … it's your insurance policy. When you're buying individual stocks, especially during periods of temporary weakness, the dividend yield serves as a cushion against further price declines. Think of it this way: if you're collecting a 5% dividend yield, you're essentially getting paid 15% over three years just for showing up. Even if the stock price takes another tumble, you're still making money.

This is where the magic happens in value investing. Companies do not maintain ridiculous valuations indefinitely. When a quality company's stock price becomes disconnected from its underlying earnings growth, it creates what we refer to as a "mean reversion opportunity." The rubber band is stretched, and eventually, it snaps back.

The key insight from analyzing hundreds of dividend-paying companies is that stock prices generally follow earnings per share growth over time. There are temporary deviations, sometimes dramatic ones, but gravity eventually wins. This principle forms the backbone of our satellite strategy: identifying quality companies whose prices have temporarily diverged from their underlying earnings reality.

Canadian National Railways (CNI): All Aboard the Opportunity Train

Let's examine our first satellite opportunity: Canadian National Railways (CNI). This isn't just any railroad company; it's essentially an oligopolistic money-printing machine disguised as a transportation business.

The railroad business is beautifully simple to understand, which is exactly what we want in our satellite positions. CNI operates in an oligopolistic market where building new rail infrastructure is practically impossible due to regulatory hurdles and astronomical costs. This creates a natural moat that would make Warren Buffett weep with joy.

The recent pullback has pushed CNI's share price below $100, creating an opportunity that we haven't seen in quite some time. While the dividend yield of 2.8% may not be spectacular compared to some other opportunities, the consistency of the business model more than compensates. Railroads grow with the economy; it's that simple. As goods need to move from point A to point B, CNI collects its toll.

What makes CNI particularly attractive is the dual growth engine at work:

1. The natural economic growth component: As Canada and North America continue to grow economically, more stuff needs to be shipped.

2. You have operational improvements that drive earnings per share growth faster than revenue growth. CNI has consistently improved its operating ratio (lower is better in railroad speak) through technology investments and operational efficiency gains.

3. The dividend growth story here is steady rather than spectacular, but steady wins the race in satellite investing. CNI has been increasing its dividend consistently, and with a payout ratio that leaves plenty of room for future growth, this looks like a position you could hold for decades while collecting an ever-increasing income stream.

It has been a profitable holding over the last 20 years:

Prudential: Eating Your Vegetables Can Be Profitable

Our second opportunity requires a bit more patience and conviction: Prudential Financial. This is what I call an "eating your greens" investment – not the most exciting company in the world, but absolutely essential for a well-balanced portfolio.

[Insert FastGraphs screenshot of Prudential showing the more volatile earnings pattern and current valuation opportunity]

Prudential offers something that CNI doesn't: a higher starting dividend yield of around 5%. This higher yield provides more immediate income and a bigger cushion against potential price declines. When dealing with more cyclical businesses, such as insurance, that extra yield buffer becomes crucial for maintaining your sanity during volatile periods.

The insurance business is inherently more complex than railroads, which explains the more volatile earnings pattern you'll see in the FastGraphs analysis. Insurance companies must contend with interest rate sensitivity, claims volatility, and regulatory changes that can cause earnings to fluctuate more than we'd ideally like. However, this volatility also creates the opportunities we're seeking.

What keeps me interested in Prudential despite the earnings volatility is the fundamental stability of the insurance business model. People and businesses need insurance … it's not optional in modern society. Prudential has been in this business for over 140 years, surviving multiple economic cycles, wars, and financial crises. Companies don't last that long by accident.

The dividend growth rate of 4-5% annually may not be earth-shattering, but it's a real growth that compounds nicely. More importantly, Prudential has maintained its dividend through multiple economic downturns, including the 2008 financial crisis. In the satellite portion of your portfolio, dividend reliability often takes precedence over dividend growth rate.

Ultimately, I view this as a less attractive proposition at this price, and therefore, I have initiated a position in CNI this week and will continue to monitor PRU.

The Long-Term Mindset: Hold or Recycle?

One question that inevitably comes up with satellite investing is whether to hold these positions long-term or practice capital recycling. Both approaches have merit, and your choice depends on your personal investment temperament and tax situation.

The "buy and hold forever" approach works particularly well when you've bought quality companies at attractive valuations. As these positions recover and potentially exceed their fair value, your yield on cost (the dividend yield based on your original purchase price) can become quite attractive. Imagine buying CNI at $95 and holding it as it grows to $120, $140, or beyond. Your dividend yield on the original $95 investment continues to grow as the company increases its dividend.

The capital recycling approach appeals to more active investors who enjoy the process of finding new opportunities. When your satellite position has recovered and reached fair value or beyond, you sell it and redeploy the capital (including your dividends and capital gains) into the next undervalued opportunity. This approach can potentially generate higher returns over time, but it requires more attention and involves transaction costs and tax implications.

Both strategies can work beautifully within the satellite framework. The key is to choose an approach that matches your personality and stick with it consistently, rather than switching strategies based on short-term market movements.

Wrapping Up: Patience Pays Dividends

Satellite investing isn't about hitting home runs or timing the market perfectly. It's about methodically identifying quality companies trading at temporary discounts and having the patience to let mean reversion work its magic. The combination of dividend income and eventual price appreciation can generate the 15-30% annual returns we're targeting, but it requires a multi-year perspective.

Remember, we're not trying to predict exactly when these opportunities will pay off. CNI might recover within six months, or it might take up to two years. Prudential could surprise us with stronger earnings, or it might muddle through for several quarters. The beauty of dividend-paying satellite positions is that we get paid to wait.

Next week, we'll explore how to size these satellite positions appropriately and discuss some position management techniques that can help maximize your risk-adjusted returns.

Want to dive deeper into dividend satellite strategies? Reply to this email with your biggest satellite investing question, and I'll address it in a future newsletter.

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