I recently heard from a reader who mentioned that his wife had over 2,700 shares of AT&T stock sitting in an individual retirement account (IRA), and was seeking my input on whether such a heavy concentration in one stock was wise (this constituted almost the entirety of the IRA assets, in addition to a plain old bond index fund).
I posed the same question to him to rely on to his spouse that I pose to everyone wondering about proper portfolio risk management, “If something super weird happened and this stock went bankrupt, could you deal with it? Would it wreck your life? Would it set back your standard of living substantially?” If your answer is, “Yeah, it would cause me a whole lot of harm”, then there is no reason why you should stay super concentrated. You can reduce the risk substantially by dividing that money into Coca-Cola, Procter & Gamble, Johnson & Johnson, Disney, Nestle, Exxon Mobil, Chevron, PepsiCo, Colgate-Palmolive, McDonald’s, and Wells Fargo. The only sacrifice would be a reduction in income, but the diversification acquired by such a maneuver would be substantial.
Lately, I’ve been studying the opportunities that showed up during the 2008-2009 financial crisis to get clues about what would be the most intelligent behavior during the next time the once-in-a-generation financial crisis arrives.
Although it seems very counterintuitive, the long-term wealth maximization decision is not necessarily buying the high-quality blue chips that I frequently discuss here: Yes, they get cheap and provide a platform for 12-15% annual returns even when you are dealing with high-caliber businesses that will only be growing at 10% because you were able to lock in prices at such a cheap rate. Perhaps if you invest $40,000 over the course of a recession, blue-chips should occupy $30,000 of that investable capital.
If you are a close follower of IBM’s stock, you know what has been the general story for the company over the past several years: IBM has been having trouble transitioning to the cloud and growing revenues because operations are so immense, but because the dividend only accounts for a little more than a fifth of profits, IBM is able to retire significant blocks of stock and increase earnings per share due to buybacks with only a soft reliance on what we would consider old-fashioned growth, at this point in time.
I don’t think people realize how difficult it is to deliver annual returns in the 10% range once you reach a certain size. In the case of Wal-Mart, it is almost incomprehensible how huge this company is. In terms of revenue, it generates about $487 billion per year. They sell about $1.3 billion worth of goods every single day. It wouldn’t surprise me if, within the next fifteen years, Wal-Mart comes closing to moving $1 trillion worth of merchandise in a given year. In terms of profits, Wal-Mart makes about $16 billion in a year. That’s a little bit less than in 2012 when Wal-Mart made just shy of $17 billion per year.
The best argument in favor of the reinvestment of dividends—particularly pertaining to companies that you know will be bigger and stronger ten years from now—is that your money immediately is put to productive use. If you choose to pool dividends together for a separate investment at a later date while sitting on cash, you miss out on the dividends (and price appreciation, if any) that occur before you get a chance to put your cash to use.
The classic Benjamin Graham quote on this topic is this:
In 2002, Otter Tail made $1.79 per share in profits on behalf of its owners. For those of you unfamiliar with the company, it is a small, $1 billion-sized northern electric company with 2,300 employees. It has 130,000 costumers, and provides power to half of Minnesota and a little less than half of North Dakota. It has a small footprint in South Dakota as well. The earnings don’t grow all that much, as the company spends about 13% of its revenues on fuel costs alone. Plus, it has an extensive dividend commitment that prevents the company from retaining profits and growing significantly over the long term.
Colgate-Palmolive is probably one of my favorite businesses—if someone said I had to make a decision today to only own eight stocks for the rest of my life, and the list could never be changed, it would occupy one of the eight slots (with Nestle, Coca-Cola, PepsiCo, General Electric, Johnson & Johnson, Procter & Gamble, and ExxonMobil occupying the others).
You’re already familiar with its product line—Colgate toothpaste, Hill’s petfood, Irish Spring soap—and the fact that the company has been growing dividends for 50+ years (and, like Procter & Gamble, has been paying dividends in uninterrupted quarters dating back to the 1890s). Not only is it a blue-chip with a long history, but its recent growth has been good as well: In the past ten years, revenues have grown by 7.5% annually and dividends have grown by 12.5% annually. That means the company has meaningful top-line growth, and not only do you get the safety inherent in a durable business model with a very long track record, but you are receiving growth in your income at a substantial rate as well.
Yum Brands. Diageo. Nestle. Wal-Mart. Coca-Cola. If you ever develop the urge to invest in Africa, look to buy stock in those five companies which are currently investing throughout the continent to mixed results, although Nestle is once again proving that it has the business model to make money anywhere.
I was reading through the T. Rowe Price Africa & Middle East Fund (ticker symbol TRAMX), and I was reminded of the statistic that there has never been an African-focused fund open to American retail investors that has beaten the S&P 500 because it is extraordinarily difficult to successfully predict African firms that would serve as suitable long-term investments.
Warren Buffett’s largest stock holdings at Berkshire Hathaway might change more often than you think they do. If you pull up an annual report of Berkshire from 2005, you will see the largest stock investments listed as follows: American Express, Ameriprise Financial, Anheuser-Busch, Coca-Cola, M&T Bank Corporation, Moody’s, Petrochina “H Shares”, Procter & Gamble, Wal-Mart, The Washington Post Company, Wells Fargo & Company, and White Mountain Insurance.
By the time 2013 came around, the reported list of stock holdings contained some familiar faces, but some changes as well: American Express, Coca-Cola, DirecTV, Exxon-Mobil, Goldman Sachs, IBM, Moody’s, Munich Re, Phillips 66, Procter & Gamble, Sanofi, Tesco, U.S. Bancorp, Wal-Mart, and Wells Fargo & Company. I put in bold the names that remained consistent between the 2005 and 2013 list.