The previous postings (see links to the full series to date at the end of this article) described a 39-stock dividend growth portfolio. One might think, "That's all she wrote." However, there are still a number of areas where it would be beneficial to have exposure.
In the postings, there was reference to the desirability of having more exposure to the US financial services industry. There was also discussion of why that has been avoided of late. With a little more effort, it may be possible to find an investment opportunity. Anybody reviewing the portfolio also might criticize it for the absence of any electric utilities. Both are industries that I worked with extensively during my career, and, not surprisingly, I formed opinions about which companies were the better investments. Since I wasn't constrained by any conflict of interest, I have, in the past, tried investing in both industries. I was blindsided by a risk that I feel totally incapable of assessing: regulatory risk. I won't rush to add them to this portfolio, but I may try trading them or their derivatives in a separate, smaller trading account.
Further, it would be nice to identify another non-pharmaceutical method of getting exposure to the healthcare industry. So, health insurers and hospital chains are of interest, and there might be other areas of healthcare that have yet to be considered. Finally, there was a time when it seemed like the content providers were going to dominate the entire entertainment industry. Right now, investors seem to be putting more confidence in the ability of certain distributors to dominate the industry. It would, nevertheless, be nice to have some exposure to a strong content provider.
The whole enchilada
The inspiration for this section of this posting owes a major debt to a Seeking Alpha author who goes by the name of RoseNose. The author posted: "My 84 Stock Portfolio - Oh, What To Buy? Evaluation Process." By taking a portfolio of 84 stocks and presenting it as a single portfolio in a cogent manner, it proved that the same could be done with the smaller number of names in this portfolio. It's an analysis I do maybe once a year, but that I had not planned to do for these postings.
Because this portfolio exists in seven different accounts with varying tax implications, there is a tendency to manage it as multiple small portfolios rather than as one portfolio. It certainly made it easier to understand and explain the holdings in any one account. For example, when first asked to provide some insight into what I was doing, it was more productive to present the Widows' and Orphans' Portfolio rather than go into a core dump of all the detail. The important thing is to get started, and the 10-stock portfolio is the essence of what is needed, and it contributes the most to the overall portfolio.
However, as stated previously in this series of postings, what one buys should reflect what one owns. Plus, setting a low dollar value for any single holding required constantly looking for opportunities that fit the existing portfolio. So, there was always an informal practice of viewing everything as one portfolio, but the result was probably less than optimal. The total portfolio looks like this:
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The total portfolio has a dividend yield of 2.94%. One of the portfolio objectives is to keep the portfolio's dividend yield at, or above, 3%. Consequently, there will be some modifications. Further, some of the holdings are so small that they are insignificant from the portfolio's perspective, and they will probably be exited at some point.
Also, it is worth noting that even with 39 stocks in the portfolio, it still tends to be a concentrated one. The 10 stocks that produce the most dividend flow account for almost half of the dividend flow, as well as more than half of the value of the portfolio. That reflects the belief that one has to let the winners have their run. However, it still has to be managed.
It is not unusual for one or two stocks in the portfolio like this to carry the portfolio in any given year. The stock or stocks doing it tend to rotate from year to year. An environment that's beneficial to 3M and Boeing may be less beneficial to Exxon and Verizon, but a change in the environment can totally reverse the relationship. The portfolio is designed to work that way. The phenomena can last through an entire market cycle. For example, after the Internet bust and throughout the market decline and well into the recovery, I would joke that Johnson & Johnson was carrying the entire portfolio. It wasn't entirely, but the point was it would regularly appreciate in value and increase its dividend, while most of the other stocks were struggling.
The portfolio stock weights are all actually slightly less than what is shown in the table. Two mutual funds were mentioned and are still retained. One is a small-cap fund, basically the market minus the S&P 500. The other is an aggressive growth fund, which is the only exposure to certain industries (e.g., biotech), as well as a different style of investing. The mutual funds lower the portfolio weights slightly.
Further, one can write covered calls on stocks and cash-covered puts to diversify the cash flow. However, those techniques are actually the frosting on the cake, and they only made a marginal contribution to the overall portfolio's performance. Both techniques are only appropriate if the investor is willing, or happy, to accept the consequences if the option is exercised.
It should be noted that whole areas of investing were excluded from the discussion by restricting it to dividend growth stocks. When talking about stocks, it's very easy to overlook the fact that most of the economy is composed of nonpublic companies. ESOPs, where an employee automatically receives stock as a part of their compensation, companies that restrict the ability to buy stock to their employees, offerings through the "friends and family exclusion" from the requirements of accreditation, and now, the crowd funding as well as the secondary markets offer ways for many investors to get exposure to nonpublic companies. The Hedge Economist has numerous postings regarding the potential role of such investments. For anyone who is interested, the March 16, 2011, posting entitled "Investing PART 12: Angel Investing" provides references to most of those postings.
What I have concluded
The previous postings talked about buying individual stocks. Nothing was said about how that was done. Early on, that was done by having the broker make the purchase. Later on, many purchases were done by a simple one day limit order at, or close to, the current price.
There are other techniques that have been employed from time to time when the circumstances seemed appropriate. They've included selling cash-covered puts in the hopes that the stock would be put at the price targeted by the put. At other times, it seemed appropriate to enter limit orders as "good till canceled" with the hope that they would be filled within some reasonable amount of time. However, as mentioned, this is intended to be a stock portfolio. Consequently, tying up cash in order to use those techniques was infrequent.
The only principle for using those techniques seems to be that they are appropriate when the investor is willing to, perhaps, miss the opportunity to buy that stock. That would seem most likely if the investor has another potential use of the funds. By definition, with this portfolio, the alternative use would have to be another stock.
One other principle has guided the use of the technique of selling cash-covered puts. The principal was that there was an advantage to accumulating the rather minor proceeds from selling the puts. That could occur if the investor believes that the proceeds would accumulate faster than any upward movement in the price of the stock. Then, the proceeds could be added to the cash received as a result of selling the puts. But, the investor has to be prepared for the possibility that the stock might gap right through the put price and be available at a lower price. Consequently, the approach is best used when initiating a position where the intention is to accumulate a total position over time. When that is the case, if the stock gaps through the put price, the investor can accept the put stock and purchase additional at the lower price.
It's always a good idea to improve one's trading techniques, and they have been discussed in previous postings before this series. In many respects, trading techniques are somewhat more fascinating than just buying and holding a portfolio of dividend growth stocks. My own experience has been that a separate, smaller trading account is a good vehicle for honing trading techniques. However, it's highly unlikely that most investors can out-trade Wall Street professionals. Trying to do so is like betting against the house. The odds are always stacked in the house's favor.
While preparing this series of postings, I noted an unanticipated phenomenon. The only time I remembered the details of the technique used to purchase the stock was when it was described in previous postings. By contrast, there was never any uncertainty about how the company fit into the portfolio or how having the stock in the portfolio affected the behavior of the portfolio over time. The realization was that any gain from the particular technique used was minor compared to the contribution the stock made to the overall performance of the portfolio.
A logical conclusion is that any benefit from refined trading techniques pales by comparison to what can be accomplished by putting the same effort into carefully constructing a portfolio. The one exception is that it is almost always beneficial to build a position with multiple buys rather than one big purchase. The commission costs are minor relative to the amount it reduces timing risk.
There are also of other takeaways from the analysis:
The periods of mismanagement of a good company (strong brands, strong balance sheet, and history of shareholder-friendly behavior) can present buying opportunities. Often, with adequate analysis, those buying opportunities are appropriate for a conviction buy.
When a stock that is of interest is going through a merger, split-up, or spin-off, it deserves special attention. The corporate action creates uncertainty that will depress the price in some cases. That doesn't always occur, but it's worth watching for. At a minimum, one should consider whether it makes more sense to buy before or after the corporate action. Failed merger attempts also should be examined. At a minimum, one should determine whether the failed attempt leaves the company in a stronger or weaker position.
Incongruences between the media's portrayal of a company's situation and the reality of the situation can be a major buying opportunity. One should always keep in mind that the media looks for the sensational, and it will manufacture it if it can't find it. Never forget the media saying: "If it bleeds, it leads." It spends a lot of time looking for, and making up, bad news. Consequently, the media is very easily manipulated by short sellers.
An individual investor should always be cognizant of his or her own unique time preference and the unique opportunities that it can create. In most cases, the investor's time preference will be different from that of "the market." Wall Street keeps score quarter to quarter, while an individual keeps score based upon their own unique objectives (e.g., from when an action is taken until retirement).
Finally, the performance of any individual company is less important than the performance of the total portfolio. At any given time, some securities in the portfolio should be underperforming simply because they were selected in order to benefit from circumstances that don't exist at that particular time or as a hedge against the other investments.
Disclosure: In the interest of full disclosure, I have exposure to nonpublic companies, and I mention them because, along with bonds and a small speculative trading account, they represent diversification away from the concentration on dividend growth stocks. Some dividend growth investors will argue that theirs is the only style of investing that makes any sense. It should be clear from the fact that I have other types of investments that I recognize that there are many different ways to profit from financial markets. I know people who would no sooner consider a buy-and-hold position than cutting off a finger. All of them are successful investors using their own unique approaches. However, their success is based upon their own definition of success and their own personal risk tolerances. They generally have built up tremendous expertise in their own brand of trading. By contrast, I favored dividend growth investing because I believe it can be done successfully by just about anybody, and it is the approach that has consistently proven profitable for me and many other investors over very long periods of time.
It should be obvious to readers that I own all of the stocks mentioned in this and previous postings on this topic. In the disclosures related to individual stocks, I indicated whether I might be buying or selling the stock mentioned.
Links to previous articles in this series:
- Buying Stocks For A Dividend Growth Portfolio: Part 1A Generalizations
- Buying Stocks For A Dividend Growth Portfolio: Part 1b Looking Forward
- Buying Stocks For A Dividend Growth Portfolio: Part 2a Core Examples
- Buying Stocks For A Dividend Growth Portfolio: Part 2b More Examples
- Buying Stocks For A Dividend Growth Portfolio: Part 2c Supplemental Examples