The concept of diversification has always been quite clear: The goal is to invest in a number of sectors, markets, and types of investments to be better protected from volatility and to perform better over the course of many years. Most people believe that you need a balanced presence of REITs, bonds, ETFs, etc. in order to be diversified. While these investments work for many, and have paid dividends, it's not my preference and I believe better returns can be achieved with equity investments in the stock market with a number of new age strategies.
There's a reason that I don't like the idea of a balanced portfolio with the use of bonds: I consider it a mindless investment strategy that has become more of a rule on Wall Street versus a sensible approach to investing. Personally, I want to invest in something that makes money, that reports earnings, and that produces a product or offers a service that I can see, touch, and utilize. Therefore, I don't like investments in commodities, as I don't like any investment that is only controlled by fear and greed (i.e. gold). My investment goal is to buy low and sell high, as is everyone else's goal. But if interest rates are at zero, then there is nowhere to go but up over a period of time for bonds. Hence, bonds have reached a peak, and when interest rates begin to rise, bonds will fall, meaning it's no longer a "buy low sell high" investment.
Now there is no denying that investments such as bonds have been good for many years. But after more than a decade of flat trading, it now looks as though equity markets are preparing for a breakout higher, or to at least find some stable ground. Either way, regardless of market direction, there are numerous companies that pay high dividends that can return nice gains for an investor in any stage of their life. In this article I am looking at one specific group of investors, those with a med-high risk tolerance, who wish to earn higher returns with slightly more risk while still be protected for the long-term. The good thing about a high-yield dividend investment strategy is that risk is naturally lower as investors and institutions hold the investments longer. Therefore, I am going to show you how to diversify a $50,000 portfolio in equities alone with a med-high risk approach.
It's important to include secular investments in any portfolio because these are the companies with growth and performance that remains consistent regardless of the economy. These are often called "recession proof" investments. In this particular portfolio, $15,000 is set aside for this portion of your portfolio. The good thing about these investments is that a secular company's success is often tied to population, because it provides products or services that we can not live without. Therefore, over time, these stocks should also trade higher while also paying good dividends.
I've never been a big fan of the "one-size fits all" investment approach. The reason I am using a $50,000 portfolio is because a person with this portfolio will invest differently than a person with a $50,000,000 portfolio. When you have $50,000,000 you are trying to protect first then grow second, but with $50,000 you want to make money and reach a point where you can retire comfortably. Therefore, despite this being a safety portion of your portfolio, you want to ensure that certain measures are taken to get the most from the investment, purchasing three good stocks that could outperform the market. As a result, you want growth potential, high institutional ownership as a security blanket, large dividend yield, and a history of increasing the dividend. Here are three secular investments that would fit nicely into this portfolio.
5 Yr. Dividend Growth
The Southern Company
The three stocks above show how I would diversify a $50,000 portfolio with companies that will perform regardless of the economy. Some might think that companies such as Exxon Mobil (NYSE:XOM) or Procter & Gamble (NYSE:PG) fit better as secular investments; however these three pay better dividends, have performed better, and have just as stable of businesses. The Southern Company as a utility company is self-explanatory, but with McDonald's we have seen that as economic problems exist that consumers flock to the restaurant because it's cheap food. There is probably no company in the world that has endured more regulation, criticism, and hate than Phillip Morris yet it continues to trade higher and improve fundamentally. Therefore, my $15,000 gets split into these three investments.
The same rules apply for a cyclical stock, which is a company that grows with a strong economy, which we use for secular investments. It needs to pay a good yield, have strong ownership, and performance. Furthermore, we are investing in these companies as value investments, those that are cheap compared to growth and outlook. Once again, three investments split into the balance allowed, which is $25,000. The reason that this would be the largest category is because it presents the greatest likelihood for strong performance while also paying a dividend, as cyclical stocks tend to trade with greater beta.
If the idea is to buy low and sell high then a bank is the perfect cyclical investment. Personally, I prefer regional banks that will grow with strong regional performance, yet larger banks work just as well. The reason that banks might be a good investment choice is due to recent improvements in housing and because compared to book value the space is among the cheapest in the market. My favorite is JPMorgan Chase (NYSE:JPM). While other banking stocks have lost significant value over the last five years it has traded evenly and has a dividend yield of 2.47%. The company has a massive presence and institutional ownership of 73% and is currently trading at new 52-week highs. If you believe that housing will recover at some point then you might want to look at a company such as JPMorgan, a stock with limited downside but great global upside.
Ford Motor Co. (NYSE:F) might be the perfect value stock. The auto industry has been the strength of the economy for the last two years with sales at multi-year highs. The stock is trading at about 0.40 times sales with a forward P/E ratio of 7.86. In addition, the ultimate sign of value might be the fact that sales in the U.S. are expected to rise and the crippling region of Europe has found a bottom according to the auto giant's recent earnings. Yet if you need more signs of confidence from Ford, the company recently increased its dividend by 100%, and now pays a yield of 3.10%. Therefore, I say this is a great undervalued investment in a growing company that is returning larger amounts of capital to its shareholders.
My final investment is Seagate Technologies (NASDAQ:STX), a stock that has been priced for a worst case scenario for the last six months. The company is one of the most shareholder friendly companies in the entire market; a company that returned 95% of its operating cash flow in the form of redemptions and dividends in the last quarter alone. The company increased its dividend by 19% and is now paying a dividend of 4.50% in 2013. Yet despite these facts, the stock remains cheap with a P/E ratio of 4.50 and a price/sales of 0.75. The reason is because of the shift to tablets and smartphones by consumers, and Seagate is a company that makes hard disk drives that are widely used in computers and laptops. However, people forget that hard disk drives are used in various devices and equipment such as DVRs, gaming consoles, supercomputers, and are even used to store information through the cloud. Therefore, this is a company that I'd definitely want to own in my portfolio.
While investors who prefer long-term performance must have a balanced dividend approach it's still always good to have a little speculation in your portfolio. These are stocks that don't return yield but are undervalued with good growth prospects. In a $50,000 portfolio this particular segment would account for anywhere between $10,000 and $15,000. In this particular chart it accounts for $10,000, and should be split into two or three different investments. Despite the fact that you are taking on a med-high risk, you never want to place too many eggs in one basket when dealing with a speculative investment.
So in this category we look for three things: 1) Unrealized value in the market, 2) solid growth potential, and 3) an unmeasured fundamental of some sorts that could become a high return catalyst. My top three in this category are as followed: XPO Logistics (NYSE:XPO), Spectrum Pharmaceuticals (SPPI), and Alcatel-Lucent (NYSE:ALU). XPO Logistics is a company trading at about 0.50 times this year's sales yet is set to grow by more than 150% year-over-year due to acquisitions; Alcatel-Lucent trades at just 0.21 times sales despite competitors in the market trading at 1.0-2.0 time's sales; and Spectrum trades at less than three times sales in a biotechnology space that warrants high valuations compared to sales.
When deciding on a long-term investment I have always preferred sales over income because a company can always cut costs to improve its bottom line, but creating revenue is a different story. A company with higher revenue can make more significant cuts to earn larger bottom line growth, while a company such as The Home Depot (NYSE:HD) can only cut its costs so much before margins peak and sales have to grow. Furthermore, larger revenue usually means more assets or that the company could be broken down and sold for more than its valuation. Such is the case for Alcatel-Lucent, which is its unmeasured fundamental that could push the stock higher over a course of several years.
XPO Logistics CEO Bradley Jacobs is attempting to build his fifth billion dollar company, all of which were started from scratch, therefore history tells us not to bet against this guy. And Spectrum has operated to perfection over the last five years, has three approved drugs, and 10 in its pipeline. Therefore, with these three companies we have unmeasured fundamental/catalyst, value, and different growth drivers for each: XPO growing through acquisitions and cold starts; Alcatel restructuring and focusing on its profitable and growing businesses; and Spectrum with its pipeline and history of clinical perfection.
The first thing that diversification purists are going to say to me is that you can't have a diversified long-term portfolio without diversification into all sectors/industries. Actually, this stance might be the second argument behind those screaming about owning bonds and fixed income investments. However, this is one of countless strategies/theories that I have discussed in my new book on many different levels, both fundamental and psychological, that I call an unconventional new age method of diversification. Because although I am not equally diversifying my portfolio with every industry with the exact same percentage to be "fully protected", I have indirectly built a very diversified portfolio based on investing in companies that serve a purpose in my portfolio.
I have cyclical stocks that will grow in a booming economy, then I am hedging that position with secular stocks that should perform well regardless of the market, and finally I have a speculative undervalued portion that will hopefully appreciate over time. All the while, five of the companies in my portfolio have a global presence which gives me more than 50% of my portfolio exposed to global growth. Yet despite this fact, there will still be some who will say that this portfolio is not diversified, but the truth is that it's greatly diversified. I simply invested in companies to serve an actual purpose in my portfolio rather than buying an index fund, a bond, or a mutual fund just to ensure that I held many holdings. This portfolio has biotechnology, transportation, communications, tobacco, restaurant, utilities, auto, bank, and a technology holding. Therefore, I am greatly diversified and am well-positioned with undervalued companies that have growth and have allocated capital based on my risk assessment. With that being said, I will conclude with one last look at my model for an undervalued $50,000 portfolio with a med-high risk tolerance.
The Southern Company
Disclosure: I am long ALU, XPO, SPPI, F, STX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.