An Investing Chart Placed In The Home Of A Wealthy Family

I received an e-mail from a reader who brought to my attention the fact that different sectors of the U.S. economy have very, very different records of building wealth for the shareowners, and he shared with me a story of how his father handed him a chart of each sector’s performance as an aid for him as he began making substantial investment decisions in his own life (he disclosed to me that he invested a bit here and there, and then upon seeing his salary go up big time, he was able to start investing $2,500 per month and began to take things more seriously).

The data he was referring to is this: The S&P 500 consists of ten different sector segments (Materials, Energy, Telecommunication Services, Utilities, Industrials, Financials, Consumer Discretionary, Information Technology, Consumer Staples, and Health Care). Over the past fifty years, the average returns by segment has been: Materials 8.1%, Financials 8.5%, Telecommunication Services 9.5%, Industrials 9.5%, Utilities 9.6%, Consumer Discretionary 10.4%, Information Technology 10.6%, Energy 11.6%, Consumer Staples 12.7%, and Health Care 13.0%. In this investor’s case, the knowledge that health care stocks have the strongest long-term performance in the S&P 500 led him to make Johnson & Johnson and Abbott Labs the foundational blocks of his portfolio as he began to build.

Now, the data isn’t perfect—it is limited to companies that were actually members of the S&P 500, so worthwhile companies that got booted out for questionable reasons have a skewing effect on the data. For instance, Royal Dutch Shell was one of the original components of the S&P 500 Index, but got kicked out because the trustees at Standard & Poor’s decided to Americanize the list of leading companies and kicked Royal Dutch Shell out for being a Dutch-English firm. Royal Dutch Shell had an outsized weighting on the index when it was a component, and delivered 14.5% annual returns after its removal. If it had stayed a part of the index, the long-term returns for energy will still trail consumer staples and health care, but would be above the 12% annual mark.

Despite imperfect data, I do think there is a lot to learn from the chart of where the S&P 500 Index of wealth creation comes from. There are very few materials stocks that interest me. With utilities and telecoms, it is often best to regard those areas of the market as a place to inventory wealth and achieve moderate growth—they’re not typically the place to look for the highest risk-adjusted returns over the long haul. Tech, despite the high returns, is difficult to get the companies right because the industry involves a lot of creative destruction. To me, if I were beginning a long-term, passively managed dividend portfolio, I would spend my time focusing on the energy giants, consumer staples, and the largest healthcare firms.

If you are in the beginning stages of building a portfolio that will consist of stocks you have no intention of selling in the coming decades, I would think of the initial selection process as something like this.

First, I’d gather the list of the 54 Dividend Aristocrats. These are the companies that have business models so exceptional that the dividends have been growing every single year since the 1980s, and are as follows:

The full list of 54 companies follows: 3M, Aflac, Abbvie, Abbott Laboratories, Air Products & Chemicals, Archer Daniels Midland, A&T, Automatic Data Processing, Bard, Becton Dickinson, Bemis, Brown Forman, Cardinal Health, Chubb Corp, Chevron, Cincinnati Financial, Cintas, Clorox, Coca-Cola, Colgate-Palmolive, Consolidated Edison, Dover, Ecolab, Emerson Electric, Exxon Mobil, Family Dollar Stores, Franklin Resources (my favorite), Genuine Parts, Grainger W.W., HCP, Hormel Foods, Illinois Tool Works, Johnson & Johnson, Kimberly-Clark, Leggett & Platt, Lowe’s Cos, McCormick & Co, McDonald’s, McGraw-Hill, Medtronic, Nucor, PP&G Industries, PepsiCo, Pentair Ltd, Procter & Gamble, Sherwin-Williams, Sigma-Aldrich, Stanley Black & Decker, Sysco, T Rowe Price, Target, VF Corp, Wal-Mart, and Walgreen.

That’s it. That’s the list of fertile soil for investments. Sure, there are other companies like Disney, Hershey, Kellogg, Dr. Pepper, and Visa that would be excellent investments but aren’t on the list, but you could put together an excellent investing life for yourself by sticking to the companies mentioned on this list. When other investors deal with income cuts during those precise moments when assets become cheap, these companies *raise* the amount of money that they give you so that you can reinvest automatically into cheaper shares or take the dividend and buy something altogether different that had become quite cheap.

The next step in the starting process would be this: I’d look to the consumer staples, energy companies, and healthcare stocks when looking to build the mightiest blocks of a portfolio that have a certain hardiness for enduring through tough times. That means Exxon, Chevron, Coca-Cola, PepsiCo, Brown-Forman, Hormel Foods, Colgate-Palmolive, Brown Forman, Abbott Labs, Medtronic, and Johnson & Johnson.

People like to think of the stock market as this place where everything has its day, and each sector will come into and out of fashion over time. There is some truth to that, but it can also mask the fact that certain sectors have a much better record of delivering long-term wealth than others. I’d rather own a healthcare stock that had been raising its dividends for 25 years than a materials stock that had been raising its dividend for 25 years, absent some specific facts that should give cause for me to abandon that presumption.

If I were looking for some kind of formula for building a long-term dividend portfolio brick by brick, you could do quite well buying the best two healthcare firms (Johnson & Johnson and Abbott Labs), then buying the best two consumer staples (PepsiCo and Coca-Cola), then buying the best two energy companies (Chevron and Exxon) as you work your way down the list to a diversified portfolio. Of course, it is entirely possible that tertiary players in the primary drivers of wealth (think Conoco in energy or Gilead Sciences in healthcare) would deliver better long-term total returns than the best industrials and utilities, but it is up to you to determine whether you are willing to sacrifice some long-term returns in the pursuit of intelligent diversification or maximize potential gains by sticking to the industries that are the best at creating long-term wealth.