In my dividend investing I focus a lot on diversification. Proper diversification means that an investor owns at least 30 individual stocks, representative of as many of the ten Standard and Poors sectors as possible. Proper diversification also means that investors do not simply purchase stocks in order to diversify their risk however.
It means to invest in a diverse number of businesses with favorable economics, which are attractively priced and which also have bright long term prospects. Proper diversification will add an extra layer of protection for an investor’s portfolio when unforeseen events such as financial crises, oil spills and lawsuits affect otherwise stable and profitable dividend paying stocks.
In the world of dividend investing, many claim to be excellent stock pickers, trying to maximize returns by betting on a concentrated portfolio of 10 to 15 stocks. After all, it is easier to find 10 great dividend stocks, than finding 30 or more of them. This sounds like a decent plan if you are already collecting a generous pension and have a decent amount of social security kicking in. Such investors could likely afford to build a concentrated dividend portfolio, and take huge risks in the process.
Even if you do a fantastic research, and know the company and industry inside out, you can still lose money on a stock. In general, all the information you have about a stock is based on past data and assumptions based on it. While companies like Coca-Cola (KO) and McDonald’s (MCD) look like long-term winners for the next 30 years, I could see several scenarios where they could go to zero in the process.
That being said, this does not mean that they will go to zero, but just that investors might have to regularly monitor the positions in their portfolios. I also believe that investors should not only focus on quality regardless at price. Instead, investors should focus on finding quality stocks at a reasonable price.
If I were to decide between purchasing shares of Coca-Cola trading at 22 times earnings or Chevron (CVX) at 9.50 times, I would likely choose Chevron. I will still hold on to Coca-Cola for decades, but for new money, I would choose Chevron. Some attractive companies in other sectors include:
Air Products & Chemicals (APD) is a stock in the materials sector, which has boosted dividends for 31 years in a row. This dividend champion company trades at 16.80 times earnings, and yields 3%. Check my analysis of Air Products & Chemicals.
United Technologies (UTX) is a stock in the industrials sector, which has boosted dividends for 19 years in a row. This dividend achiever company trades at 14.20 times earnings, and yields 2.20%. Check my analysis of United Technologies.
One of my favorite reasons and examples on why dividend investors should hold a diversified portfolio is the Financial Crisis of 2007 – 2009. For several decades before that, investors in stable companies such as Bank of America (BAC) collected higher dividends, while also enjoying above average dividend yields.
The current rage is all about consumer staples. While I enjoy the stable nature of many consumer staples companies such as Procter & Gamble (PG) and Coca-Cola, I do not want to place all of my bets on a single sector. It is true that consumers tend to purchase Gillette razors, shaving cream, Coca-Cola drinks repeatedly and they also tend to stick to the products they use for years.
However, if companies make a few wrong moves such as making the wrong acquisition and taking on too much debt, not investing enough in the business or simply if company’s products are deemed to be unhealthy for the population, they could lose money and cut the dividends.
When analyzing my portfolio, I noted that Consumer Staples accounted for 36% of it, while Energy, Financials and Healthcare accounted for 22%, 12% and 11% respectively.
After that I have exposure to five sectors, which accounts for a whopping 19% of my portfolio. These sectors include Industrials, Consumer Discretionary, Information Technology, Materials and Utilities.
Unlike most other dividend investors, I do not have much exposure to U.S. telecom stocks, since I find their dividend payouts to be too high in general, and thus I do not trust the dividend yields.
In addition, I doubt that long-term dividend growth will be more than 3%/year for the largest players such as Verizon (VZ) and AT&T (T). I do have exposure to Vodafone (VOD) however, which accounts for less than 0.60% of my portfolios.
Just because I am underweight Utilities does not mean that I will load up so that I increase my exposure. The stocks in my portfolio are geared towards paying a decent dividend today, with the potential for growing it over time, while potentially delivering strong total returns in the process. Most utilities pay high current yields, but have limited prospects for increasing earnings and dividends over time. In fact, many utilities are actually prone to cutting distributions to income investors.
Full Disclosure: Long KO, APD, UTX, PG, AFL, VOD, MCD, CVX