Is Rebalancing A Stock Portfolio A Form Of Value Investing?

by: Dale Roberts


20 months ago I bought 15 of the largest cap Dividend Achievers, without any further evaluation. To date I've let them run.

What will create greater total return? Letting the winners run, or rebalancing to some of the companies that have declined in price?

Does adding exaggerated new monies to the underperformers find greater total returns as one might be able to purchase greater current earnings?

I like to research investment situations and probabilities before I put them into action. I like to research them and research them again. I do not generally invest based on guesswork or individual stock analysis, but on 'investable' trends. The propensity of larger cap companies with a meaningful dividend growth history to outperform the markets with lower volatility would be, for me, an investable trend. Now there's certainly no guarantee that the trend will continue. As they say "past performance does not guarantee future returns." We don't know the future; past trends can be, well, past trends that do not repeat. Past trends might have been the result of certain conditions that do not exist today. But for many, investing on past trends and hoping that the past trend continues is at the core of the investing approach or philosophy.

McDonald's (NYSE:MCD) has made a lot of money in the past and investors hope that McDonald's will continue to earn wonderful profits and increasing profits well into the future. Of course, many large cap investors would not want to put all of the Egg McMuffins in one basket so they will buy a bunch of McDonald's-like companies and hope that enough of them deliver a repeat performance. And we'll diversify across many sectors and regions. And many will hold assets not highly correlated to equities. Of course, more active managers will do extensive research and try to estimate or guess at what companies might do better, and when the companies they hold no longer hold those growth prospects. I would not profess to have the talents of an expert CFA stock analyst, and I think it would be dangerous and counterproductive for me to pretend that I hold such talents. I will have to rely on past events and the metrics that have found past performance that has had the ability to repeat.

As many may know, I trust the divining rod of a meaningful dividend growth history. For my US holdings that means trusting a 10-year or more history of increasing dividends combined with a larger cap bias. That larger cap bias signals that those companies have already risen to the top or near top in their sectors. These are winners. In early 2015, I purchased 15 of the top holdings of the Dividend Achievers Index. Here are those 15 companies. Nike (NYSE:NKE), CVS (NYSE:CVS), Walgreens (NASDAQ:WBA), Microsoft (NASDAQ:MSFT), 3M (NYSE:MMM), Colgate-Palmolive (NYSE:CL), Johnson & Johnson (NYSE:JNJ), Qualcomm (NASDAQ:QCOM), Medtronic (NYSE:MDT), Abbott (NYSE:ABT), PepsiCo (NYSE:PEP), Texas Instruments (NYSE:TXN), Wal-Mart (NYSE:WMT), United Technologies (NYSE:UTX) and Lowe's (NYSE:LOW).

And you can see the 17-month update of the portfolio results in this article here. Interestingly, two of those companies, Qualcomm and Wal-Mart have already been removed from the index due to the 'dividend health' screens. I will continue to hold those companies.

Already the weighting of the individual holdings is out of whack. And that brings up the very important question. Should I let the winners run or rebalance? Or should I do something in between? As a simple test I ran these companies through a few scenarios on the wonderful tools at I ran them with rebalancing and no rebalancing.

From January of 2007 to end of November 2016 here are the returns for the 15 companies without rebalancing.

And here are the returns for the same period with quarterly rebalancing.

We see that rebalancing has boosted returns. And the returns of the individual assets for the period certainly do not have equal contributions to the portfolio total return.

It is certainly telling that one can take money from a company that we know did better over time, but we can create additional returns by confiscating those profits and delivering those monies to the 'losers.' And we can see the allocation drift in this chart.

The event that can boost returns and reduce concentration risks is trimming from a winner (a company the market really likes) and moving those funds to a company that the market is finding out of favour. If we take two of the more non-correlated assets such as Texas Instruments and Wal-Mart we might see that event in play. We can see that in the recession Wal-Mart held up quite well (not surprisingly) while Texas Instruments struggled. The lesser performing asset over time, Wal-Mart was able to feed monies to Texas Instruments, the greater performing asset over time. As they say, this can be classic "buy low and sell high."

If we isolate Texas Instruments and Wal-Mart for the total period of 2007 to November 2016 the quarterly rebalanced returns are greater than the non-balanced returns. We can also see that in 2011 and 2012 Wal-Mart was outperforming and would have been feeding funds to Texas Instruments previous to the company going on a very nice run in 2013. And yes, of course, those Texas Instruments capital gains are trimmed along the way and returned to the typically more stable Wal-Mart. And at times, Texas Instruments' gains would be trimmed to feed a period when Wal-Mart outperformed, such as recently in late 2015 to early 2016 when Wal-Mart outperformed after being under pressure for many months.

Rebalancing is a continuous cycle of winners feeding losers. Of course, enough of the losers have to recover for the rebalancing strategy to deliver on its promise. As we can see a "passive" strategy of rebalancing robotically on a regular schedule is actually very active and entails a lot of buying and selling. Most of us would describe a lot of buying and selling as active management. And it can create a lot of fees as well. One certainly has to be aware of the fees.

Rebalancing is not a guarantee of added returns. There are certainly conditions where rebalancing will lessen your returns. All said, I did investigate many different baskets of companies and found that most often the rebalancing did boost returns. It is something I will consider with regard to my own portfolio management. One can also rebalance 'on the fly' by redirecting portfolio income and any new monies to the companies that are under pressure.

With regard to the Aristocrat 15 portfolio these days, that would mean redirecting monies to companies such as Nike and CVS Caremark. CVS has come under pressure due to a meaningful change in its near-term revenues situation and perhaps regulatory uncertainties. According to, if one purchases CVS at current prices one will be buying a 6% earnings yield; and many will write that the company still has very generous growth potential. Management believes it can grow at 10% annualized. We'll see. The forward rate of return projection is 19.10%, according to gurufocus.

Nike, is well, Nike. Nike's current earnings yield is 4.4% and the forward rate of return projection is 15%. Keep in mind that the projections are based on recent cash flow trends and are backward looking. A stock analyst might be able to take an educated guess as to the probabilities of a company being able to repeat its past success. I personally would not be able to take an educated guess.

One of the big winners, Microsoft would currently offer an earnings yield of 3.53% and a forward rate of return projection of 4.87%. Current earnings and recent cash flow generation suggest that money is 'in a better place' these days with the Nikes and CVSs of the world compared to a Microsoft.

Recently I did purchase some additional shares of CVS. On November 8th, I added shares at the price of $72.51, very near the 2 1/2 year lows. CVS currently trades at $77.62 meaning my earnings yield at the time of that share addition was some 7% greater. The earnings yield at the time was above 6.4%.

Wal-Mart is another company that is an underperformer and of course it was removed from the Dividend Achievers index, but not removed from the Achievers 15 portfolio. The current earnings yield for WMT is 6.5% with a forward rate of return projection of 7.1%. Once again, rebalancing is asking me to add some very decent earnings.

The rebalancing mechanism can direct an investor to greater earnings. That can occur at an individual stock portfolio level or rebalancing between index sectors or index geography - for example, portfolio rebalancing between US and International markets. Rebalancing keeps the risk profile in check and can at times add value.

My approach would be to go at this in robotic, non-emotional, non-individual stock evaluation fashion. I do not know how to analyze individual equities. I am not a CFA. And we know that analysts often get it wrong. They are placing an educated guess based on the company's current earnings and earnings potential and overall business prospects. For me to create some very slight alpha, rebalancing would have to find enough situations when the market has overreacted slightly or modestly to the downside. As we know, a true value investor likes to find great companies that have been thrown out in the trash. A true value investor would have extensive analytical skills and industry expertise. A non-sophisticated investor might be able to find some added value by way of applying a blanket rebalancing rule without the need for any, or much individual stock evaluation.

For now I will be content to direct portfolio income to some of the 'losers' such as CVS, Wal-Mart and Nike. I might eventually consider some very slight rebalancing between some of the losers and winners. My initial intention or thought was to simply let the winners run 'to infinity and beyond.' But I am open to considering that rebalancing option if the research continues to lead me in that direction. I also have to consider the rebalancing between equities and bonds as the run-up of equities has (fortunately) pushed one portfolio to a level of equities above 65%. That will certainly be the subject of a future article. Mr. Graham suggests that most investors should not move beyond 75% equities.

That's all for now. Thanks for reading and please remember to always know and invest within your risk tolerance level and within your skill level.


Disclosure: I am/we are long AAPL, NKE, CVS, WBA, MSFT, MMM, CL, JNJ, QCOM, MDT, BRK.B, ABT, PEP, TXN, WMT, UTX, LOW, BLK.

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.

Additional disclosure: Dale Roberts is an Investment Funds Advisor at Tangerine Investment Funds Limited a subsidiary of Tangerine Bank, wholly owned by Scotia Bank; he is not licensed to provide professional advice on stocks. The opinions expressed herein are Dale Roberts' personal opinions relating to his experience as an investor and are not those of Tangerine Bank or its subsidiaries and/or affiliates. This article is for information purposes only and does not constitute investment advice or an offer or the solicitation of an offer to buy or sell any securities. Past performance is not a guarantee and may not be repeated. Investment strategies are not suitable for everyone and you should always conduct your own research or speak to a financial advisor.