Warren Buffett recommended investing only in what you know. I have a two-year-old niece. I decided to look at investing based on my niece's view of her world. What would her portfolio contain if she invested in what she knows?
In the technology category, it would definitely include Apple (AAPL). She asks to use the iPad. She knows how to recognize icons, scroll with finger movements, and look for the "X" to close apps. Apple products are already a mainstay in her life.
Talking staples, whether she realizes it or not, Pampers has been a significant contributor to her well-being. Procter & Gamble (PG) makes the list for that reason alone, though it provides a long product list of other reasons.
For discretionary purchases, it could contain Disney (DIS). She's recognized Mickey Mouse and Little Einsteins for over a year. Just recently, classic Disney movies are sparking wonder in her mind. After watching Cinderella recently, she would only eat "Relly" soup (Campbell's (CPB) features the Disney princesses on a soup can - maybe Campbell's should also be added to the portfolio?) Or, with a roomful (okay two roomfuls) of Fisher Price, Little People, Barbie and American Girl products, perhaps Mattel (MAT) is a better candidate.
Next, being a girlie girl, she already loves clothes. The Kohl's (KSS) Jumping Beans children's line has provided a substantial amount of her wardrobe her first two years. Yet, Wal-Mart (WMT) is the convenient, cost-effective choice for all sorts of purchases - food, house wares, personal care products and on and on. It just simply is where her family "runs to" or "runs into".
The fate of Apple has been debated ad nauseum. For the believer, Apple's recent share price presents a reasonable entry point. The cash-adjusted forward P/E is just over 9. Analysts are still projecting 20% five-year (per annum) EPS growth. Apple now pays a 2% dividend. To the naysayer, it may no longer qualify as an "aggressive" grower. So what?
Procter & Gamble has prominent brands that are global leaders in its differing categories. P&G is a dividend-paying workhorse at 3.4%. More importantly, P&G has increased its dividend for 56 consecutive years. Though her Pampers usage will definitely be eliminated, odds are, with over 250 brands, it'll retain her family as consumers.
Disney has been flirting with its all-time high for months now. It just raised its dividend by 25% in November and is now paying 1.5%. Five-year (per annum) EPS growth is projected at over 11%. Star Wars and Lucasfilms, ESPN, theme parks and cruises, an increasing global footprint - the mouse isn't retiring any time soon. Even though J.C. Penney (JCP) is in its own whirlwind, the branded shop concept JCP is testing in stores could further imprint the Disney brand into the minds of consumers.
On the other hand, Mattel pays a much better dividend at 3.4%. But, Mattel trails Disney on other fundamentals. EPS growth for Mattel over the next five years is projected at 9%, 2% less than Disney. The long-term debt to equity ratio is 56 compared to Disney's 34. And, the insider ownership at Mattel is barely detectable at 1/3 of 1%.
Disney gets the nod over Mattel for fundamental reasons and in honor of its much broader diversification.
Kohl's has traveled its own rickety bridge to retail stewardship in a stagnant, mature market. It has differentiated itself by focusing on exclusive brands. The sales of these brands has grown from 25% of total revenue five years ago to 50%+ of total revenue now. It trades at a forward P/E below its historical average. It pays a 3% dividend and has not hesitated to reward shareholders with increases. Kohl's has figured out its inventory strategy and a reasonably-paced growth strategy.
Then there is Wal-Mart with its reams of negative press surrounding fair wages and fair working conditions. The shelf-stocking missteps where Wal-Mart curtailed inventory choices hurt its sales for quarter after quarter. Still, it is Wal-Mart whose very name is synonymous with low prices. And, because of sheer purchasing volume as well as product and geographic diversification, that definition is not likely to change. Plenty of opportunity still exists for international expansion. Wal-Mart's dividend at 2.3% does trail Kohl's. Wal-Mart has outperformed the S&P the past five years while Kohl's has not.
History would be on Wal-Mart's side regarding where to invest. However, I allowed two factors to push the decision to invest in Kohl's. With the ever-increasing negative press, the assumption is Wal-Mart will adjust something to address the issues which may naturally and negatively impact share price. Second, comparing each company's recent stock price to its YPEG formulas and comparing current P/E ratios to industry averages, Kohl's is more attractive than Wal-Mart. Therefore Kohl's share price may have more room to run.
So, the portfolio shall consist of Apple, Procter & Gamble, Disney and Kohl's. While such a portfolio may not be adequately diversified across sectors, it is diversified by other standards. There's a fast-growth stock in Apple, a dividend payer in P&G, well-diversified exposure in Disney and a semblance of a long shot in Kohl's. Three of the four have international exposure. All four pay dividends with three of the four offering a DRIP (dividend reinvestment plan). Considering it was determined by a two-year-old girl, it is a wily mix of industry stalwarts. Buffett doesn't even endorse diversification anyway.
Investing like a two year old may just make sense. And, it should prove profitable.
Additional disclosure: The investment club to which I belong is long Apple, Disney and P&G.