Building An Income Portfolio Based On The Talmud

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Includes: BBY, CA, CHSP, CMI, CSCO, DFT, EDR, HST, IEF, IEI, LHO, NHI, NUS, O, OHI, QCOM, ROIC, SHY, SPG, WDR, WPC
by: Backroom Analyst

Summary

Recently, I wrote how the Talmud outlines a specific strategy to invest based on equities, real estate, and cash.

That piece used mutual funds. Now, I show which specific stocks, REITs, and ETFs can be used to build an income generating portfolio.

Both of the equity and REIT strategies are backtested to prove their worth as stock screens.

Introduction

Recently, I wrote how one can use biblical principles and spiritual guides to provide inspiration for one's investing strategies. One such spiritual guide, the Talmud; "…the body of Jewish civil and ceremonial law and legend comprising the Mishnah and the Gemara," is very specific on how to invest money. From the Tractate Baba Mezi'a folio 42a:

R. Isaac also said: One's money should always be ready to hand, for it is written, and thou shalt bind up the money in thy hand.

R. Isaac also said: One should always divide his wealth into three parts: [investing] a third in land, a third in merchandise, and [keeping] a third ready to hand.

With this, I just developed an income portfolio based on the simple concept of dividing one's money in these thirds; equities, REITs, and Treasury ETFs. To fully test the theory, I developed a portfolio in my Marketocracy account so I can report how it will perform over the next year.

Equities

Since my focus is on income, I screened for equities that had the following criteria, which are roughly based on the Dividend Strength Portfolio from First Trust Portfolios. Please remember that this screening strategy would have yielded 13.23% (±21.02%) annually since January 1999. That far outperforms the S&P 500 at 3.04% (±15.52%):

  • Member of the Russell 3000
  • Debt to Equity < 40%
  • Market Cap > $1 Billion
  • Average Return on Equity > 15%
  • Current Yield > 3%
  • Five-Year Dividend Growth > 5%
  • Consistent Dividend Increases for The Past Five Years
  • Five-Year Payout Ratio < 50%
  • Positive Free Cash Flow

Ticker

Name

Price (12/31/2015)

Yield (%)

BBY

Best Buy Co. Inc.

30.45

3.02

CA

CA Inc

28.56

3.50

CMI

Cummins Inc.

88.01

4.43

CSCO

Cisco Systems Inc

27.16

3.09

NUS

Nu Skin Enterprises Inc.

37.89

3.69

QCOM

QUALCOMM Inc.

49.99

3.84

WDR

Waddell & Reed Financial Inc.

28.66

6.42

Average

4.00

Table 1

If one is looking for income generation with the potential for growth, this is a pretty good start. One would think that a 4% yield with a history of rising dividends would always be a good thing.

REITs

REITs with their tax-advantaged dividends, and mandatory payout ratios are wonderful ways to invest for income. While past firms for which I have worked limited REIT diversification to 4%, Talmudic investing looks for 33 1/3% allocation. Much like the equity search, I want to find real estate investments that have a history of rising dividends, so here is the screen:

  • REITs only
  • Average Daily Dollar Volume > $1 Million
  • Current Yield > 3%
  • Funds from Operations are positive
  • Persistent Rising Dividends for the last five years
  • Five-Year Dividend Growth > 5%

Ticker

Name

Price (12/31/2015)

Yield (%)

CHSP

Chesapeake Lodging Trust

25.16

6.36

DFT

DuPont Fabros Technology Inc

31.79

5.91

EDR

Education Realty Trust Inc

37.88

3.91

HST

Host Hotels & Resorts Inc

15.34

5.22

LHO

LaSalle Hotel Properties

25.16

7.15

NHI

National Health Investors Inc.

60.87

5.59

O

Realty Income Corp.

51.63

4.44

OHI

Omega Healthcare Investors Inc.

34.98

6.40

ROIC

Retail Opportunity Investments Corp

17.90

3.80

SPG

Simon Property Group Inc.

194.44

3.11

WPC

W. P. Carey Inc

59.00

6.54

Average

5.31

Table 2

While I usually backtest for periods beginning in 1999, I only looked at this one for the past five years due to limited technology. This method yielded a 14.20% (±16.64%) annual return since the beginning of 2011. This compares quite favorably with the S&P's 10.20% (±12.78%). That's pretty good considering this is a strategy that is more interested in income generation than capital growth.

Cash

The Talmudic passages are pretty clear about investing in cash. I am assuming, and my expert resources have confirmed this, it is because of the safety cash offers. Given that we are looking for income, though, I wanted to use investments that are as safe as cash, but still provide interest income. That is where Treasury ETFs are useful. For this allocation, I am using iShares ETFs, and allocating as follows:

Ticker

Name

Price (12/31/2015)

Yield (%)

Allocation (%)

Cash

1.00

0.01

3.33

SHY

iShares Barclays 1-3 Year Treasury Bond Fund

84.36

0.51

6.67

IEI

iShares Barclays 3-7 Year Treasury Bond Fund

122.61

1.37

13.33

IEF

iShares Barclays 7-10 Year Treasury Bond Fund

105.59

1.90

10.00

Average

1.22

Table 3

If one notices, the allocation for the cash and Treasuries roughly matches the same allocation one would use if they were to ladder these investments. Given that we are still in a rising interest rate environment, it is best that we keep these investments to short and intermediate time periods.

Review

If one were to use this as an income strategy, it would provide a 3.51% current yield, and the portfolio is based on the belief that interest and dividends will rise over time. The Dividend Strength and REIT strategies have certainly proven themselves over the years. If one is looking for a portfolio where two-thirds of it will grow over time while it provides pay raises, then this is a way to go.

Happy Investing!

Disclosure: I am/we are long SHY, IEI, IEF.

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.