not market timing that matters most.
To be clear, I’m talking about owning great individual businesses bought at sound valuations and held for the long run. With this philosophy, I am rarely concerned about what the general state of the market might be. Instead, I am greatly concerned about the fiscal health and valuation of each of the individual companies I own. Moreover, this is where I spend all of my time, energy and effort. Once I buy a great business I like, at a good price, I continuously monitor and research that business with little concern about the general state of the markets, or the economy for that matter.
A Methodical Approach To Finding Value In This Market
I believe in diversification as a risk minimization tool. However, in the context of this article, I’m going to discuss sensible or prudent diversification within the dividend growth stock asset class. In other words, I’m going to present a logical and methodical approach to creating a diversified portfolio of dividend growth stocks purchased at fair value in our current market environment.
For starters, I believe a dividend growth portfolio can be properly diversified with only 20 to 25 stocks. However, I would add that with this amount of concentration, it’s critical to continuously monitor the fundamentals behind each of the businesses in the portfolio. This is the old adage that if you only put a few things in your basket, then you must watch that basket very closely. But I believe that continuous monitoring is a good practice regardless of how many names in your portfolio. My point being that it is much easier to watch and closely monitor 20 to 25 stocks, than it would be 100 or more.
For those that would be uncomfortable with such high concentration, I would acquiesce that 30 to 50 stocks would also work. With 50 stocks, you would only have a 2% exposure to your overall portfolio in the event that any one of those stocks actually went completely bankrupt. On the other hand, if you’re careful with your selection in the first place, the odds of that occurring are very rare. To repeat, the problem with holding this many companies is the time, complexity and amount of effort required to monitor your portfolio efficiently and effectively.
Regardless of whether you like a concentrated, or are more comfortable with a more broadly diversified portfolio of stocks, what follows is my logical and methodical approach to putting one together today. First of all, I will utilize the screening function of the F.A.S.T. Graphs™,fundamentals analyzer software tool and search each of the 10 major sectors for potential candidates. My initial search is very simple and straightforward. The Global Industry Classification Standard (GICS) was developed by Morgan Stanley Capital International (MSCI) a leading provider of global indices, and Standard & Poor’s (S&P).
There are 10 sectors designated by 2 digit codes as follows:
10 – Energy
15 – Materials
20 – Industrials
25 – Consumer Discretionary
30 – Consumer Staples
35 – Health Care
40 – Financials
45 – Information Tech
50 – Telecommunications
55 – Utilities
Additionally, under each of these major sectors there are several subsectors, anyone interested in seeing all the information on all sectors and subsectors you can follow this link.
Consequently, in searching for dividend growth stocks at fair value within each sector, I utilized the following simple screen. I searched by sector, and then for companies within each broad sector that have a minimum of a 2% dividend yield. Then I reviewed each company that the screen produced and hand-picked only those companies that had reasonably consistent historical earnings growth, and that were plus or minus at fair value. The reason I included stocks that might be slightly overvalued, was because they could quickly become attractive candidates with only a moderate correction.
Summary and Conclusions
Within this article, I provided a sneak peek at the sectors: 45 – Information Tech with my IBM example, 20 – Industrials with Stanley Black & Decker, and finally 25 – Consumer Discretionary with Lowes. In the subsequent articles in this series, I will provide samples of prescreened companies that I believe are currently at fair value or close to it, in each of the 10 broad sectors in the order that they are listed above.
Therefore, the first of my 10 future articles will cover the energy sector. Incidentally, there are numerous companies in the energy sector that are undervalued in comparison to equivalent quality companies within the other sectors. I will provide a portfolio review, covering a hand-selected list of companies in each sector that I feel are currently fairly valued, and worthy of consideration and a more comprehensive due diligence effort. I will also include specific examples that I feel represent two general types of dividend growth opportunities. The first I will categorize as Conservative Growth and Income, and the second I will categorize as Aggressive Growth and Income.
When I started my career in the financial services industry in 1970, it was prior to Modern Portfolio Theory’s coming in to vogue and ubiquity. It was a time that I now refer to when investors practiced “Ancient Portfolio Reality.” In these, what I consider to be more sane and rational times, portfolios were constructed and designed based on the unique and specific goals, objectives, risk tolerances and needs of the individual investor. Instead of asset allocation, and its highly profitable (to the professional providers) policy of continuous rebalancing that generated lots of new commissions each year, portfolios were built to get a specific job done.
Instead of spreading as much mud up on the wall, regardless of whether an asset class made prudent sense or not, the approach was more intelligent, at least in my humble opinion. Investors were given the choice of having their portfolios constructed on investing principles and strategies such as conservative, moderate or aggressive growth. Other choices included conservative, moderate or aggressive growth and income. Accordingly, portfolios were constructed in such a manner that the investor could understand, embrace and sleep well at night with.
Consequently, since this series of articles is focused on dividend income, and the growth thereof, I will provide aggressive and conservative examples covering each of the 10 sectors. What I’ve already learned from this exercise, is that a portfolio of quality blue-chip dividend growth stocks, all trading at fair value, can be properly constructed today, in spite of the market’s recent run-up. There is a lot of value left in quality common stocks, if you’re willing to look, and smart enough to think specifically rather than generally. Regardless of the market, there are always fairly valued, undervalued and overvalued stocks available. As a result, no investor needing income and safety, need ever feel left out.
Disclosure: No positions at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
