As a follow up to my Constructing a Dividend Portfolio post I thought I would touch upon my position as it relates to the basics of investing. What I share below are observations and findings based on my personal experiences over the course of many years as an investor in individual companies.
A well diversified mid-7 figure portfolio probably doesn’t really need shares in anything more than roughly 45 companies. As such, a well balanced portfolio does not mean having a low 6 figure portfolio consisting of shares in 100+ companies (I am not exaggerating when I say I have seen this). There is a fine line between insufficient diversification and too much diversification.
There are 500 companies which make up the S&P 500 and 60 companies which make up the TSX 60. The vast majority of investors creating and managing their own portfolio of individual stocks probably do not really need to venture beyond these two pools of companies to create a decent portfolio.
Some of the largest companies found within the S&P500 and the TSX60 have substantial international operations. By investing in these companies there probably is little reason for the average investor to invest in companies headquartered in lesser developed parts of the world in order to get international exposure.
Be careful of the companies in which you invest otherwise the time you spend managing and monitoring your portfolio could become overwhelming. Looking at stock prices and stock charts every day can be a huge waste of time (unless this is something you definitely want to do).
Pay heed to the following advice from Warren Buffett:
- “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
- “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes”
- “You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.”
Avoid mutual funds. Most mutual fund managers underperform the benchmark and charge high fees which negatively impact your investment returns. The alternative, if you do not feel comfortable creating and monitoring your own portfolio of stocks, is to invest in a low cost diversified Exchange Traded Fund (ETF).
A company with an abnormally high dividend yield should be a “red flag”. The risks with high dividend yield stocks are:
- The company may not be able to sustain the high dividend yield from profits and free cash flow generated through normal business operations and there is a strong probability of a dividend cut.
- A dividend should be a return ON capital. Several companies with abnormally high dividend yields are also returning a portion OF capital.
- They attract investors who require income to sustain their standard of living or unsophisticated investors who are unaware that the company’s earnings are so low or so volatile that the shares are totally unsuitable investments for their investor profile.
The importance of dividend growth is far greater than dividend yield. By way of example, let’s use the metrics for AT&T (NYSE: T) and Broadridge Financial Solutions (NYSE: BR) as at September 9, 2017.
AT&T closed at $35.60, has an annual dividend of $1.96 (5.51% dividend yield), and the dividend has a historical growth rate of 2.20%/year. Broadridge, on the other hand, closed at $79.08, has an annual dividend of $1.46 (1.85% dividend yield), and the dividend has a historical growth rate of 11.0%/year. If these metrics remain in place for the next 5 years, Broadridge’s annual dividend will surpass that of AT&T.
Most investment newsletters aren’t worth the price. If most mutual fund managers can’t beat the benchmark, what makes you think investment newsletters are any better?
Beware of companies that continually issue new shares thus diluting existing shareholders’ ownership. The issuance of new shares, however, is acceptable if for sound business reasons such as a major acquisition. Typically, I look for a reduction in share count especially if the repurchased shares are at attractive prices.
Invest in companies that have a track record of consistently growing their earnings. This is why I avoid investing in companies which operate in cyclical industries (eg. mining, automotive) or which sell a commodity since there is nothing that differentiates the company from the competition (unless you are the lowest cost producer).
Do not confuse investing with gambling. Avoid:
- Marijuana stocks
- Lithium batteries
- Bitcoin, Cryptocurrency
- Junior mining companies
- Initial public offerings (IPOs)
- Stocks traded on junior North American stock exchanges or Pink Sheets
- Junior biotech companies
If your friends are talking about company XYZ then it is highly probable XYZ is not a company in which you should invest. If you buy what is popular there is a strong likelihood you will not do well. The time to become interested in buying something is when nobody else is interested.
Find companies with competitive advantages. Examples of competitive advantages include but are not restricted to:
- brand loyalty
- market share
- cost competitiveness
- superior product
- superior service
Invest in companies you understand. Having said this, if you have a deep understanding of the automotive industry AND are employed in the automotive industry it is not a good idea to invest heavily in the automotive sector. Holding investments in companies in the same industry as that from which you generate your income is tantamount to having “all your eggs in one basket”.
There is nothing wrong if you know you don’t know anything about investing. The investors who get into trouble are those who don’t know that they don’t know.
Some industries are known for companies which make significant use of leverage. The banking sector is an example where industry participants have a significant amount of leverage. Rather than suggest you avoid companies with high debt levels, I suggest you avoid companies that are much more highly leveraged than their peers.
Insider selling is not as good an indicator as insider buying. Selling can be for various reasons. Insider buying, however, is only done when senior management view the shares as undervalued.
A recent example of an insider purchase that is a favorable indicator is Richard K Smucker (Executive Chairman) bought 10,000 J M Smucker (NYSE: SJM) shares @ $105.40 on the open market on August 29, 2017 thereby bringing the total number of shares he directly owns to 652,168 (Source: INK Research report) .
Check the company’s most recent Annual Proxy Statement to see the extent to which senior management owns shares in the company. For example, on page 83 of 91 in SJM’s 2017 Annual Proxy Statement dated June 30, 2017 I see that Richard K Smucker directly or indirectly owned over 2.5 million SJM shares. Another Smucker family member directly or indirectly owned in excess of 1.9 million shares.
Investing does not mean continually buying and selling. Well run companies with competitive advantages will make you money if you give them time. Invest in good solid companies and then get out of the way.
Sometimes your investment thesis will not pan out or the company in which you have invested has changed dramatically to its detriment. In this case your best bet might be to just cut your losses and to move on.
I think the following two quotes from Warren Buffett sum up the basics of investing very nicely.
“You only have to do a very few things right in your life so long as you don’t do too many things wrong.”
“It is not necessary to do extraordinary things to get extraordinary results.”
Note: I sincerely appreciate the time you took to read this post. As always, please leave any feedback and questions you may have in the “Contact Me Here” section to the right.
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long SJM, T, and BR.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.