The US into stock market divides into 10 broad sectors:
- Consumer Discretionary
- Consumer Staples
- Health Care
Diversifying across sectors reduces your exposure to risk factors in any one industry. For example, if legislation is passed that greatly affects health care, it is unlikely that a consumer staples business will be effected. Investing in high quality businesses spread across industries is an excellent way to reduce overall portfolio risk by minimizing your exposure to any one industry.
Dividend Aristocrats & Sectors
The Dividend Aristocrat Index is heavily weighted toward consumer staples businesses. Weighting the Dividend Aristocrat index so that each of the 10 sectors are represented equally reduces risk by limiting exposure to any one industry.
At the same time, investing in mediocre businesses or overpriced businesses is very likely to reduce returns over long-time periods.
Investing in the highest ranked business based on the 5 Buy Rules from the 8 Rules of Dividend Investing in each sector will create a portfolio constructed of high quality businesses with limited exposure to any one industry.
The 8 Rules of Dividend Investing rank stocks with 25+ years of Dividend Payments without a reduction based on several quantitative factors including dividend yield, payout ratio, volatility, and growth rate. The core goal of the 8 Rules of Dividend Investing is to find high quality stocks suitable for long-term holding. A diversified portfolio of high quality dividend growth stocks limits specific firm and industry risk through diversification while still investing in businesses that have a high probability of performing well for shareholders.
The top ranked Dividend Aristocrat for each industry is listed below:
- Materials - Ecolab (NYSE:ECL)
- Consumer Discretionary - McDonald's (NYSE:MCD)
- Consumer Staples - Walmart (NYSE:WMT)
- Energy - Exxon (NYSE:XOM)
- Financials - Chubb (NYSE:CB)
- Technology - Automatic Data Processing (NASDAQ:ADP)
- Health Care - Abbott Laboratories (NYSE:ABT)
- Industrials - Grainger W.W. (NYSE:GWW)
- Telecom - AT&T (NYSE:T)
- Utilities - Consolidated Edison (NYSE:ED)
A portfolio of these 10 businesses has a dividend yield of 2.75%, a P/E ratio of 18.63, and a 10 year revenue per share growth rate of 6.57%. Further, the portfolio is equally weighed toward each sector of the US economy. Several of these businesses are examined below to give you an idea of why they are highly ranked.
McDonald's operates 6,719 restaurants and licenses 28,774 more restaurants in over 120 countries throughout the world. McDonald's international expansion has gone very well. The company generates more revenue in Europe than it does in the United States.
Source: 2014 First Quarter Report
McDonald's constant currency revenues increased 3% for the first quarter 2014. McDonald's expects to add between 1,000 and 1,100 restaurants in 2014, which is a total store count increase of about 3%. The company plans to modernize about 1,000 stores in 2014 as well, boosting sales in another 3% of stores.
Shareholders of McDonald's can expect long-term growth of around 3% due to McDonald's increasing store count assuming same store growth does not increase. This is unlikely, as McDonald's has historically been able to increase same store sales through innovative new product offerings such as breakfast, coffee, and healthy menu items.
McDonald's most rapid growth opportunity lies with emerging markets. Emerging markets are quickly growing middle class consumers. Currently, the company is generating about 24% of its sales from the APMEA division. Comparable store sales in APMEA increased 2.9% compared to last year in April. Total constant-currency adjusted APMEA sales increased 7.5% for the same period. This strong level of emerging market growth bodes well for McDonald's future prospects.
Wal-Mart is the largest retailer in the world by market cap. As Wal-Mart grows, it gains pricing power over its smaller suppliers, allowing the company to cut prices, which in turn drives more customers to Wal-Mart, growing the business. This virtuous cycle is what has grown Wal-Mart's earnings to over $15 billion per year. The company has 10,700 retail units in 27 countries with 245 million customers served weekly.
Source: Wal-Mart 2013 Annual Report
Wal-Mart grew constant currency adjusted revenues 2.1% for the first quarter of 2014 compared to the first quarter of 2013. Same-store sales in the US were down 0.1%, due to a -1.4% decrease in comparable traffic, which was offset by a 1.3% increase in comparable tickets.
Source: Wal-Mart 1st Quarter Results
International constant currency revenue grew 3.4% versus the first quarter of 2013. In addition, operating income increased 5.3% in the International segment. Wal-Mart's strong international results is a positive sign for shareholders of the company. Wal-Mart's future growth will be driven by the company's ability to expand internationally, and through the company's implementation of e-commerce sales.
Chubb Corporation sells home, car, business, & supplemental health insurance. The company sells its insurance through independent agents and brokers throughout the world. The bulk of Chubb's revenue (75%) is generated in the US.
The Chubb Group posted solid results in 2013. The company's combined loss and expense ratio was only 86.1%, the lowest since 2009. The company has not had a loss and expense ratio over 100% since 2002. The disciplined underwriting of Chubb Group allows the company to remain profitable in both strong and weak insurance markets. Disciplined underwriting in the insurance industry is a competitive advantage as it allows an insurance business to avoid costly policies.
Source: 2013 Annual Report
Chubb's future growth will come from the expansion of the company's insurance business in profitable niche markets. Chubb is also focused on increasing profitability through using predictive analytics to improve underwriting and prevent fraud. The company will likely continue to grow slowly in the competitive US insurance industry.
Sectors & Correlation
Investing in different sectors provides diversification between large swaths of the US economy. Each individual business is unique, even if it operates in the same sector. Using sectors as a way to diversify your portfolio is a "quick and dirty" approach to diversification.
Minimizing correlation between stocks is a more effective way to diversify your portfolio as compared to investing equally in different sectors. With that said, sector investing is a simple way to diversification benefits.
The Low Correlation Dividend Aristocrat series of articles will continue with a more in depth look at the stocks mentioned in this article, along with a deeper dive into the relationships between sectors, industries, correlation, and diversification.
Disclosure: The author is long WMT, MCD, ABT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.