If I learned anything from last year, it is that a well diversified portfolio is a must. Although the Dow and S&P are steadily making new highs, it would be a mistake for investors to suddenly get comfortable and forget the importance of managing risk.
A well diversified portfolio has long been one of the best safety nets for even the most seasoned investors. However, though, not everyone understands what true portfolio diversification is or how one is constructed. Having multiple names within a sector and thinking it is diversified is a myth, since stock within a sector tend to trade in tandem.
To that end, I have outlined the five leaders (arguably) in each category. You may disagree. But even if their respective sectors were to underperform, the margin of safety in the individual names selected have proven over time to be heavily resistant to macro pressure. It also helps that these names offer some of the best dividend yields on the market. Let's see if you agree.
Consumer - Wal-Mart (WMT)
I'm going to lead off with retail giant Wal-Mart. Last week, I suggested that the company should pick-off J.C. Penney (JCP). While I felt my argument was solid, readers disagreed. Nevertheless, Wal-Mart remains one of the most interesting stocks on the market. Speaking of diversification, it's hard to get a better diversified stock like Wal-Mart, which is often considered an ETF or a mutual fund of its own, given that its stores carry the brands of so many large publicly traded companies.
While Wal-Mart will never regain its lofty growth levels of years past, the company has always been a safe stock for any portfolio. Still, in the most recent quarter, the company showed that it is still a dominant name. Earnings arrived better than expected at $1.67 per share, up 11% year over year -- helped by a favorable tax rate. Likewise, comps grew 1%. This is the metric that tracks the sales performance of stores opened at least one year.
It's not a robust number, but it bested Target's (TGT) 0.4% comps, which declined from 2.2% a year ago. Plus the company is still showing that it can get customers to spend - given that there was a 1.1% increase in average transactions. However, and perhaps very interesting, the company said that the 1% comp growth in the U.S. helped the company gain market share in several categories, including food, health and wellness/OTC, entertainment and toys.
The company is still a thorn in the side of many rivals. What's more, despite the recent run in the shares, the stock's still cheap. Plus, improved consumer spending is going to be a strong driver over the next couple of quarters. And even just modest improvements will benefit comp growth. Meanwhile, aside from offering one of the best yields on the market, the company continues to generate plenty of free cash flow, much of which will benefit shareholders.
Energy - Exxon Mobil (XOM)
I'm mentioning Exxon here for a couple of reasons. First and foremost, in addition to producing the key energy driver that is oil and gas, the company is a cash producing behemoth. But with respect to building this well diversified portfolio, it has to be anchored with the largest company in the world according to market cap. (Sorry Apple)
Though Exxon Mobil often gets overlooked for what appears to be routine success, there is a lot to like here. The company has huge reserves and an impressive operating cash flow of $56 billion, which is the size of many prominent companies on the market. While the company is coming off a fourth-quarter result that was not up to its usual standards, with revenue dropping 5%, investors overlook the fact that production had gone down as the company had re-prioritized oil and liquids.
That said, the refining and chemical business arrived strong - growing 316% and 76%, respectively. The company is still in the mix of all phases of upstream and downstream operations, and its portfolio of exploration and production projects should help this oil giant remain one of the best stocks on the market for years to come.
Technology - Apple (AAPL)
If I'm going to go with Exxon Mobil as the anchor of the portfolio, it makes sense to flank our position with the second largest company in the world according to market cap. No matter how you slice it or peel it, it's hard to not see how cheap Apple is. But here's the problem, the company is battling poor market sentiment. The market has become disenchanted with Apple because the competition is catching up.
However, there are two frames of thought here; what management sees and what the Street wants. They have not been in alignment. But does Apple have to get worse before it gets better? Some seem to think so. With Apple due to report earnings in less than two weeks, analyst Gene Munster cut his revenue estimates to $41.3 billion, which is the low end of management's guidance, and below Street estimates of $42.8 billion.
Essentially, Apple has not resorted to 9% growth, which would be a 50% sequential decline from the 18% posted in the first quarter. What's more, given that Apple grew Q2 revenue at 60% in 2012, Munster's revenue projections of $41.3 billion would mean that Apple would have only grown this quarter by 5% year over year. Is this acceptable? This means that the Street is beginning to realize those in management are not magicians.
Meanwhile, Apple has begun to rededicate itself to software and other means of revenue - some have hinted at TV, iWatch and most recently, a streaming radio platform to rival Pandora. For now, at $434 with a P/E ratio of 9, things can't get much worse. What's more, with $137 billion in cash, there is relatively little risk to taking a position here. In fact, I would argue that the bigger risk is ignoring this profit opportunity. The stock has already bottomed and investors should expect Apple to regain its $500 price in short order - making this the easiest/safest 20% gain on the market.
Healthcare - Johnson & Johnson (JNJ)
Shares of Johnson & Johnson are sitting at a 52-week high and I'm still trying to reconcile why I let this company slip away last summer when it was trading in the $60s. I placed too much emphasis on the company's size, while ignoring its excellent management team. Interestingly, it has been an acquisition that has propelled the stock higher from the summer lows.
Shares are up more than 17% so far this year, and investors are wondering how far the stock can go. Although JNJ appears rejuvenated, some still question whether management can hold its momentum, especially since it appeared that JNJ's organic growth has slowed. Nevertheless, the company deserves credit for seeing an opportunity in Synthes that is now contributing to its bottom line.
Fourth-quarter operating earnings grew 8% as reported. Likewise, net income arrived at $2.6 billion, or $0.91 per share. While earnings arrived significantly above the $218 million JNJ earned last year, as noted, the Q4 2012 results included a $3 billion charge. However, when removing special items fourth-quarter earnings arrived at $1.19 per share - topping Street estimates of $1.17. Plus there are many more growth catalysts on the way.
What's more, JNJ's new cancer drug, Zytiga, which posted 74% revenue growth in the fourth-quarter, continues to gain incredible traction. While the stock is not cheap at a P/E of 21, shares should continue to rise as long as management continues to improve margins and the medical devices business. Meanwhile, the company also offers one of the best yields on the market at 3%.
Telecom - AT &T (T)
The biggest news out of AT&T recently has been the company's massive 4G LTE network build across several major U.S. cities. The company's recent investments have resulted in the nation's largest 4G network, which covers almost 300 million network users. However, the company has consistently been one of the best markets performers for several years.
Consolidated revenues continue to grow at an impressive rate each quarter. Despite strong competition from Verizon, AT&T's management has done an excellent job of focusing on adding shareholder value. New phone models from Apple and Samsung along with continual network expansion have proven to be the game-changer that AT&T needed to propel the stock going forward.
The company is coming off an excellent fourth quarter, during which revenue arrived up 3%. This is despite adversities related to Hurricane Sandy. Margins continue to head in the right direction - growing even with record smartphone sales. Adjusted earnings per share arrived at 8.5% for the year and the company had its strongest ever annual cash flow growth - reaching almost $20 billion.
The company will look to build on this momentum when it reports first quarter earnings on April 23. What's more, when you add to the fact that the company has one of the best dividend yields on the market at 4.7%, it makes it hard to imagine a safer investment.
Here's making sense
While I use to go by the notion that portfolio diversification was overrated, I realized that my error in judgment was not appreciating what true diversification was. And I think this is also the mistake that several other investors continue to make.
In this portfolio, I have covered stocks from 5 separate sectors to help minimize the risks on money outflows during strong bull and bear markets. What's more, each of these companies are strong dividend payers. However, these are not flawless companies and can be impacted by various factors.
Wal-Mart has recently complained about the increase of payroll tax and its potential impact on consumers. While I don't believe the company will be significantly impacted, some retailers have already see lower foot traffic.
While Exxon Mobil is indeed a dominant performer, the oil industry hasn't suffered from weak shale demand. And the environmental concerns about drilling and fracking can weigh on production. Meanwhile, Apple has seen its stock plummet from a high of $705 due to mounting competitive pressure.
Can Apple roar back with better innovation? Will it increase the dividend or buy back shares? Johnson & Johnson has not posted strong margins recently. With the rise of competition from Abbott Labs, JNJ's medical devices business is no longer the only game in town.
As for AT&T, the company's massive international network build is a massive endeavor, which will be very expensive. Although it's a worthwhile investment, it is not yet clear how much return the company will realize in the long term. Verizon is still seen as having the best mobile network.
Suffice it to say, while these are indeed solid companies, there are still challenges to overcome. But as noted, their solid dividend makes waiting extremely easy. We will monitor their performance and issue an update by the next quarter.