Diversified Stock Income Plan ... - Wells Fargo Advisors

January 14, 2022 Joseph E. Buffa, Equity Sector Analyst Jack Russo, CFA, Equity Sector Analyst

Global Securities Research

Diversified Stock Income Plan

Quarterly Review ? Fourth Quarter and Full-year 2021

DSIP List Overview

The Diversified Stock Income Plan (DSIP) List focuses on companies that we believe will provide consistent annual dividend growth over a long-term investment horizon. Our objective is to provide a broad list of high-quality, industry-leading companies from which an investor can assemble a well-diversified portfolio. Through consistent dividend growth, our goal is to help investors stay ahead of the wealth eroding effects of inflation.

A big end to another big year

? The DSIP List closed 2021 with a +12.5% fourth quarter return, bringing the full year to +22.4%. That +12.5% return ranks among the top ten quarterly returns in the List's 28-year history.

? Notably, 2021 marked three consecutive years of positive double-digit returns for a cumulative +83% or +22% on an annualized basis.

? Each of the 77 companies on the DSIP List for the entirety of 2021 announced dividend increases compared to 2020. The average increase announced during the year was +8.9%, outpacing an outsized year for inflation.

Source: Wells Fargo Advisors, FactSet. Data as of 12/31/2021. Past performance is no guarantee of future results. An index is unmanaged and not available for direct investment.

Please see pages 10-12 of this report for Important Disclosures, Disclaimers and Analyst Certification

Investment and Insurance Products: NOT FDIC Insured NO Bank Guarantee MAY Lose Value

Diversified Stock Income Plan ? Quarterly Review

January 14, 2022

Annual and Quarterly Commentary

The S&P 500 bounced back from its third quarter slowdown to finish 2021 with a double-digit gain, thus bringing the full year to a robust +28.7% return. After trailing in each of the first three quarters by 200-300 basis points ((bps)100 basis points equals 1%), the DSIP List outpaced the index in the final frame but the strong ending wasn't enough to completely close the gap, finishing with a respectable +22.4%.

Looking simply at the annual return, an investor might assume the market was smooth sailing in 2021 but that was hardly the case. Leadership and sentiment shifts among cyclical value, reopening, rising rate plays and cyclical growth seemed commonplace as COVID variants, interest rates, inflation and Federal Reserve policy made their way through the news cycle and each contributed its own dose of volatility. The lone constant throughout the year seemed to be the general lack of interest in defensive stocks and sectors which, unfortunately in this case, are the DSIP List's hallmark.

Nonetheless, the scoreboard sums up the game and 2021 capped off a robust three-year stretch of double-digit returns for both the S&P 500 and the DSIP List which is astonishing considering what has occurred over that timeframe. From 2019 to 2021, the S&P 500 doubled on a total return basis which is +26.1% compounded annually. All with a nearly -20% COVID-induced pullback in the first quarter of 2020. The DSIP List also generated robust, if not quite as spectacular, numbers at +82.8% cumulative and +22.3% annualized. For DSIP List history buffs and those simply wondering if this type of market action is normal, consider that in the nearly 30-year history of the DSIP List, there were only two other threeyear periods with double digit returns in each year, one starting in 1995 and the other in 2012.

In 2021, nine of 11 DSIP List sectors generated double-digit returns. The largest in absolute terms was Real Estate at +40.5%. Retail property owner Federal Realty Investment Trust bounced back from a difficult 2020 with a +65.9% return, tops on the List. Information Technology and Financials sectors were the next largest contributors to return at +33% each and these two were also the largest contributors to overall return when factoring in sector weights. Info Tech strength was broad-based with all but three of our 11 recommendations up greater than +20%. Our Financials names also generated robust returns across the board. Communication Services was the List's only sector to decline for the year, -4.2%, with both of our recommendations, Verizon Communications and Comcast, declining. Overall, it was a year in which most DSIP List recommendations performed well.

Pinpointing drivers of relative performance for the year is fairly easy given the commentary above on defensive performance. The two biggest negative contributors to the DSIP List's relative performance compared to the benchmark were Consumer Staples and Utilities, two DSIP List stalwarts past, present and future. These two sectors accounted for nearly half of the 630 bps of underperformance (DSIP List return +22.4% and the S&P 500 +28.7%, the difference being 6.3% or 630bps). This was largely a function of our overweight positioning in these sectors, a stance we are comfortable maintaining going forward. Recall that one of the DSIP List's top priorities is delivering a reliable, growing stream of income to investors. We believe Consumer Staples and Utilities companies can fulfill that requirement with an attractive balance between reliability and growth.

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Diversified Stock Income Plan ? Quarterly Review

January 14, 2022

The fourth quarter proved to be the DSIP List's strongest of the year at +12.5%. Notably, this ranks fourth quarter 2021 as the eighth largest quarterly return in the List's history. That's #8 out of 112. It was a good quarter all around, as seven of 11 sectors produced double-digit returns and only one, Communication Services, finished in negative territory. The Materials, Real Estate and Consumer Staples sectors generated the highest absolute returns at +19.5%, +16.0% and +15.3%, respectively. Our five Materials recommendations were each up double-digits, led by coatings companies Sherwin-Williams (+26%) and PPG Industries (+21%) while industrial gas names Linde and Air Products and Chemicals were both up about +19%. Crown Castle, a provider of communication infrastructure, paced the Real Estate sector with a +21% return with the sector's three other recommendations up double digits, too. Consumer Staples strength was also broadbased with two outliers on the low side ? Walmart and Clorox, up +4% and +6%, respectively. Our other nine staples recommendations were up double-digits. On the negative side, Communication Services declined -6.2% for the quarter with both recommendations declining ? Verizon -2.7%, Comcast -9.6%. When considering sectors weights, the largest contributors to the List's return were Consumer Staples (+207 bps), Information Technology (+202 bps) and Financials (+157 bps), offset slightly by Communication Services (-16 bps).

Relative to its benchmark, the DSIP List outperformed in the quarter by about 150 bps, +12.5% compared to +11.0%. The largest sector contributors were Financials and Communication Services. In Financials, the biggest relative contributions came from what we do not recommend, namely banks. Those following the DSIP strategy for a while may recall that we have not recommended many banks for over a decade now. Following the financial crisis in 2008-2009, large bank's capital allocation decisions have been heavily influenced, or in fact limited at times, by the Federal Reserve. This undoubtedly increases the safety of the financial system but we prefer to not have an outside entity dictating dividend policy. Our Capital Markets recommendations, FactSet Research Systems and Intercontinental Exchange in particular, were notable positive contributors. Insurance broker Brown & Brown was also a standout, providing the largest positive contribution across the sector. Communication Services was another case of avoiding underperforming industries and stocks. Entertainment and Interactive Media & Services, two industries that house some of the biggest names in the sector and index, posted sub-par returns which benefitted DSIP List relative performance. To avoid any confusion, many of the stocks in these industries do not pay dividends, thus eliminating them from consideration for the DSIP List. Overall, we're happy with both absolute and relative fourth quarter performance.

Outlook

Our colleagues in the Wells Fargo Investment Institute (WFII) believe the market is likely past peak growth but that this cycle still has plenty of room to run. We tend to agree. WFII strategists expect 2022 U.S. gross domestic product growth to slow slightly to a still robust +4.5%, CPI inflation to step down dramatically to +4.0% (still above average), and unemployment to decline to 3.6%. Against that economic backdrop, WFII set its S&P 500 target about +11% higher than recent levels on +12% earnings growth, implying a relatively static multiple. As the cycle matures, WFII favors, in their terms, the highest-quality and least-cyclical equity asset class, U.S. large-caps, followed by U.S. mid-caps with an eye to balance cyclical and growth sectors. In short, defensives stay out of favor. In our view, this does not mean a year of negative performance for a defensive strategy such as DSIP but perhaps something similar on a relative basis to 2021 ? i.e. a nice gain but underperformance relative to the market. As a reminder, we do not try to invest around cycles but through them.

Dividends

Over the course of 2021, 77 DSIP List companies announced 85 dividend increases with each company that was on the List for the entirety of the year providing at least one increase. The average was +8.9%, a nice rebound from +3.4% in 2020. Interesting, in our view, is the relatively pedestrian increase from the benchmark at +3.5% given the index's payout ratio will likely be below average at around 32% for the year.

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Diversified Stock Income Plan ? Quarterly Review

January 14, 2022

In the final quarter, 20 DSIP List companies announced increases, four of which were repeats for the year ? Realty Income increased twice in the quarter for five times total in 2021, Union Pacific increased for the second time, and American Tower for the fourth. Notable increases during the quarter: Emerson Electric increased its dividend for the 65th consecutive year, among the elites in dividend growth history. Two companies, Becton, Dickinson and Abbott Laboratories both joined the five decade club while V.F. Corporation moved a step closer at 49.

The average annual dividend increase for DSIP since its first full year in 1994 is nearly 10%, ahead of the corresponding number for the S&P 500 of 6% and annual inflation of about 2% as measured by changes in the Consumer Price Index (see the figure below). Although future results should not be assumed to equal historical performance, we believe that holding a diversified portfolio of DSIP stocks has proven to be and should continue to be a viable strategy to help investors generate income and stay ahead of the rising cost of living.

Source: Federal Reserve Bank of St. Louis, S&P, Wells Fargo Advisors. Inflation represented by the Consumer Price Index. Data through year-end 2021 except for inflation which is through November 2021. The Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services. Past performance is not a guarantee of future results. An index is unmanaged and not available for direct investment.

List Changes

There were no changes during the fourth quarter and one in 2021. We added Target in the waning days of the third quarter. Target is a leading omni-channel retailer and a repeat DSIP List name. We're attracted to the company's positioning in retail, both physical in-store retail and e-commerce. In our view, Target's growth profile and payout ratio should support our +8% dividend per share growth estimate going forward.

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Diversified Stock Income Plan ? Quarterly Review

January 14, 2022

Appendix A ? 2021 Diversified Stock Income Plan Dividend Increases

Company First Quarter Aflac Incorporated BlackRock, Inc. CMS Energy Corporation WEC Energy Group Inc. Linde plc S&P Global, Inc. Comcast Corporation Class A Air Products and Chemicals, Inc. L3Harris Technologies Inc. Church & Dwight Co., Inc. 3M Company Intercontinental Exchange, Inc. Commerce Bancshares, Inc. T. Rowe Price Group Xylem Inc. Cisco Systems, Inc. Eversource Energy United Parcel Service, Inc. Class B NextEra Energy, Inc. Jack Henry & Associates, Inc. Analog Devices, Inc. Sherwin-Williams Company Xcel Energy Inc. Walmart Inc. Home Depot, Inc. Chubb Limited General Dynamics Corporation American Tower Corporation1 Colgate-Palmolive Company Realty Income Corporation2

New Annual

Dividend

Symbol

Rate

AFL BLK CMS WEC LIN SPGI CMCSA APD LHX CHD MMM ICE CBSH TROW XYL CSCO ES UPS NEE JKHY ADI SHW XEL WMT HD CB GD

AMT CL

O

$1.32 $16.52 $1.74 $2.71 $4.24 $3.08 $1.00 $6.00 $4.08 $1.01 $5.92 $1.32 $1.05 $4.32 $1.12 $1.48 $2.41 $4.08 $1.54 $1.84 $2.76 $6.60 $1.83 $2.20 $6.60 $3.20 $4.76

$4.96 $1.80

$2.82

Year Earlier Annual Dividend Rate

$1.12 $14.52 $1.63 $2.53 $3.85 $2.68 $0.92 $5.36 $3.40 $0.96 $5.88 $1.20 $1.03 $3.60 $1.04 $1.44 $2.27 $4.04 $1.40 $1.72 $2.48 $5.36 $1.72 $2.16 $6.00 $3.12 $4.40 $4.32 $1.76 $2.80

Annualized Increase 8.8% 17.9% 13.8% 6.7% 7.1% 10.1% 14.9% 8.7% 11.9% 20.0% 5.2% 0.7% 10.0% 2.1% 20.0% 7.7% 2.8% 6.2% 1.0% 10.0% 7.0% 11.3% 23.1% 6.4% 1.9% 10.0% 2.6% 8.2%

14.8% 2.3%

0.9%

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