Mixed Approach For A Diversified Portfolio

by: Tradevestor

Before I get into the meat of this article, I want to say that I do intend to continue my series of "Stock A vs. Stock B" articles. But in the meantime, I wanted to write my thoughts on one of the hottest (and at times unfriendly) topics/discussions on Seeking Alpha.

Which investing approach is the best? Some prefer DGI (Dividend Growth Investing); some pick "current" high yielders; some prefer pure growth stocks, while some say ETFs and bonds are the way to go. The really gutsy (or crazy) ones place many small bets on numerous penny stocks, hoping just one of them turns out to be the next Apple (NASDAQ:AAPL) or Google (NASDAQ:GOOG). I personally am not into bonds and ETFs, while penny stocks picking is like playing the lottery. Yes, one person will hit the jackpot but the odds are miserable to say the least. Hence, this article would focus just on individual common stocks. Which of these approaches is the best when it comes to investing in common stocks? The popular answer is "It depends". Though I agree with that answer on a larger premise, how about "pick the best of each" as another strategy? Sound easy, right?

The "pick the best of each" approach may be suitable for those who look for diversification in not just the stock's industry/sector but in the stock's "nature" as well. This might also favor investors who believe they have a long investing time frame -as I believe this is might be seen as a high risk-high reward approach. I will present the different categories of stocks that I could think of, the reason I hold a few in each of those categories, and what percentage of my portfolio each category takes.

1. Current High Yielders: While everyone loves to own the high yielders, they do possess higher risk. These stocks offer high current yield but do not enjoy the "dividend champion" status. Real Estate Investment Trusts (REITs) like Annaly Capital Management (NYSE:NLY) and American Capital Agency Corp (NASDAQ:AGNC) fall into this category. High yielding and slightly volatile stock like Southern Copper (NYSE:SCCO) is an example as well.

Why? Longer time horizon: REITs performance is dependent on the interest rate. Historically, the rates have fluctuated up and down. This cyclical high yielding business can be taken advantage of by investors who can afford to commit their capital for a longer period of time and accumulate more shares, which would reward them when the economy favors these businesses. The same applies to the cyclical material industry that SCCO is a part of. Some of the yields here are so high that even if the dividend is reduced by half, these stocks could still prove to long term winners, providing you pick the right stocks which have the tendency to bounce back.

How much? My personal allocation into these high yielders is 25%.

2. Growth at Reasonable Price (GARP) Stocks: Investing in growth stocks, usually high tech stocks that do not pay a dividend is favored by those who like "momentum/growth". One of my favorite techniques to hunt for these types of stocks is using the PEG ratio, advocated by Peter Lynch. PEG is calculated as Price/Earnings (NYSE:PE) divided by the growth rate. The lower the PEG ratio, the more attractive the company is. While I do not chase momentum and unreasonably priced stocks like Salesforce.com (NYSE:CRM) that has a PE of 7634 and a PEG of 21, I like to own reasonably priced growth stocks with strong fundamentals. Apple is the major name I own in this category. With a PEG ratio of .54, PE of about 15 and tremendous growth potential still left, I believe this growth stock is as reasonable as it gets using GARP approach.

Why? To catch potential double and triple baggers: Growth stocks usually have very powerful returns during bull markets and also when the company is continuously providing innovative products/services that the general public just cannot get enough of. A point to be noted is that people might actually be better of investing in the original Apple and Google instead of trying to find the next Apple and Google. Imitations rarely work in the long term in the business world as well as in investing.

How much? I've got 30% allocated to this category.

3. Gamble: While I hate to risk my money, at times I like to place small bets (no more than 3 to 5% of my portfolio) on high risk high reward stocks. I am not talking about penny stocks here but companies that once had the momentum but fell out of commission due to a few mishaps. Examples that come to my mind are Travelzoo (NASDAQ:TZOO) and Netflix (NASDAQ:NFLX). You may even pick Salesforce.com in this category. These are stocks that I consider "trades" for a quick gain because of their volatility.

Why? The thrill of it: Investing can get dull and boring at times, especially for the younger crowd. I personally think I "need" a thrill element attached to anything I do in life, be it my work, travel, or investing. While, I go on all rides possible at places like Sea World while on vacation, I do not drive my car at 100 miles per hour without a seat belt. The point is, I like to take a risk alright but not those that are reckless. As a side note, if the gamble pays off, I usually move to point #4

How much? Obviously, the lowest of all at 5%

4. Dividend Champions: And finally, onto the dividend champions. These are companies like The Coca-Cola Company (NYSE:KO), Altria (NYSE:MO), and Philip Morris (NYSE:PM). I am not suggesting that these companies do not grow at all but these stocks are more prominent for fair valuation and dividend history.

Why? To build wealth slowly but surely: To continue my analogy, I sure love to spend the occasional day on roller coasters and enjoy the thrill that comes with it. But will I enjoy being on it 24x7? Definitely not. And that is where the dividend champions come in, to lend that stability to my portfolio during good times and bad. (And let me sleep at night)

How much? 40%

Disclosure: I am not suggesting this approach is suited for everybody or that this is perhaps the best approach. It's merely my personal strategy, which has been successful so far for a tiny period of time and I wanted to share it out here to develop a healthy discussion.

Disclosure: I am long AAPL, KO, TZOO, NLY, SCCO, PM.