How Do You Build A Quality Portfolio? - Tastes Like Retirement

There is a beauty of starting from nothing, having a blank canvas by which to create something that is uniquely yours. This is something I taught my daughters when they were building their resumes. They started with nothing and everything they did either built a stronger resume or it didn’t. If done right and with focus, it can look like you really have your act together. If done poorly or haphazardly, then you’ll end up serving customers at the neighborhood drive-thru window.

Building a stock portfolio is the same way. I was starting from scratch – there was about $10,000 in my Vanguard Taxable account and I was ready to start funding it with regular contributions. Of course, I could easily have gone the index mutual fund or ETF route but I didn’t.

And so far, it’s been working. Through May 2022, my 1-year total return in my taxable stock portfolio is 23.1% compared to the S&P 500 index return of -1.7%. And as you’ll see, that’s with a beta (risk) that is much lower than the market. My portfolio is built for downside protection in times like these. Why? Because they are quality, industry leading companies with good balance sheets.

When I first started building the portfolio I made some errors and the strategy has constantly evolved. In the beginning, I had to answer many questions so I wrote some articles to help me work through the issues. Below, I chose the Top 10 articles (plus one bonus article) that I answered to help me build my plan. I highly recommend you read them so that you can make your own decisions and plan.

Personally, I think once you determine which sectors will have an overweight in your portfolio, the easy part is picking the stocks. Why? Because characteristics like being an industry leader, strong balance sheet, dividends that can survive in bad times, and products that you understand make it easy. We make things too complicated and it really doesn’t need to be that way.

Create Your Master Stock List

Before you do anything, you have to determine what kind of investor you want to be. What are your objectives and what are you trying to achieve by investing in the stock market? Once you’ve figured that out you need to determine how to execute on your plan. I use Vanguard to execute my plan but you could do this at Charles Schwab or any number of brokerage firms.

Before you buy your first stock, narrow the list down to a manageable number. There are stock screeners that can help define those parameters but I like to also use a more wholistic approach too. My stocks should be well known to the average investor. If I can’t understand the stock then it’s probably something I shouldn’t be buying. I can understand drinking a Coke, eating a Hershey chocolate bar, or getting jabbed with a Pfizer Covid shot.

“In Peter Lynch’s book “Beating the Street,” he often talks about roaming the mall, watching people, and buying things you are already familiar with.”
Mr. TLR – 11/12/19 article “Building Wealth Through Individual Stocks”

There are thousands of stocks to choose from, so creating a list that meets whatever parameters you set is important. This list will keep you focused and away from all the noise of cable or internet news. This will evolve as you better understand what you really need. My list has probably had 25% of the original stocks changed. And I’m constantly reevaluating the strength of the companies to determine how much I should invest or if they should be on the list at all.

My list is far from perfect but it’s my list that was developed to meet my goals. In most cases, I just wait for a stock on my list to get within my fair value buy range. It’s really that easy. But waiting is hard. For example, I’ve wanted to buy Proctor and Gamble for years and I still don’t own it. It’s either been too expensive or I’ve not had cash available to buy it when it was within range. Making choices with you hard earned dollars is difficult and sometimes it means not owning a stock you’ve always wanted. However, it’s that kind of disciple that will generate the best risk-adjusted total returns over the long haul.

My 15 Dividend Stocks

Since I’m retiring at 62-years old, I’m looking to build a portfolio that can last at least 30-years. This means, my companies need to survive and the dividends need to continue. I’m fine if a company temporarily pauses/maintains (not cuts) their dividend at times for the right reason. For example, CVS Health stopped growing/raising their dividend for a few years while they took on some debt to buy a Aetna Insurance. Once that debt was back down to appropriate levels then started growing their dividend again. To me, that is good business and I’m fine with that.

But those are the basics … the company must survive and so must the dividend. Sounds simple but finding those companies is the challenge. I’m not Nostradamus and I don’t proclaim to be a seer into the future. It’s possible that something(s) could happen to some of these stocks in year 10 or year 25. My focus is capital preservation, growing income, and price appreciation. In other words, risk-adjusted total returns that can occasionally beat the market.

Looking at the names and you’ll see some very familiar brands. And make no mistake, there is risk in the portfolio but that just can’t be avoided. I’ve got three tobacco companies and a large oil company. A couple of those companies have major litigation issues to deal with (J&J and 3M).

The above list is not perfect but it works for me at the time. Will some of these stocks end up being losers some day? Absolutely. But the dividends will cushion the downside.

Consider some of these numbers that a guy named Meb Faber uncovered in a study he did that tracked over 8,000 stocks from 1983-2006.

39% of stocks lost money over the 24-year period
19% of stocks lost more than 75% of their value
64% of the stocks underperformed the index (meaning they got beat by the market)
36% of stocks outperformed the index (meaning they beat the market)
18% of stocks outperformed the index by 100% or more
6% of stocks outperformed the index by 500% or more

Here’s something to consider with these numbers. For #1 and #2, buying quality stocks at good prices should keep you away from losing money. I consider #3 a tough one because underperforming the index is possible but some stocks aren’t in your portfolio to beat the index. Most people will never achieved #5 or #6 because they aren’t buy/hold investors … they would sell the stocks before a 100% or 500% total return was achieved. Our goal is to have our portfolio achieve #4. Some stocks in your portfolio aren’t built to beat the index … every stock in your portfolio serves a purpose. I care about the portfolio above all.

Sectors Matter

In March 2020, I did some research and concluded that I wanted some upside in my stock portfolio but downside protection was important. I found that the Consumer Staples (e.g. Consumer Defensive) and Health Care sectors had exactly what I needed to overload my portfolio.

As you can see, mission accomplish so far. These two sectors account for 71% of my positions. With my focus on getting these stocks at a decent price (meaning I don’t like to overpay), my returns have beat the markets pretty easily. This is working for me and it’s my plan.

Now, I’m no Warren Buffett but he has 87% of his entire portfolio in three sectors: Technology, Consumer Defensive, and Financials. Two of those three are sectors have a very low presence in my portfolio because it’s what I need. I don’t want the volatility that Buffett gets with his Technology and Financial stocks.

Some like to balance their sectors or match the S&P 500 Index but not me. If I wanted that then I’d just buy an index fund. But I think I can do better and so far that’s working well for me. Sure, I’m not a Tesla millionaire but my plan is working for me. And for the record, Tesla is currently down about 50% from its peak in just 7 months time. All those Tesla millionaires have just disappeared. I will guarantee that some poor soul bought at the peak and probably sold for a 50% loss. Some probably retired only to see their portfolio get cut in half. That is doing it all wrong.

My Five “Must Have” Dividend Stocks

As much as I love my current portfolio, there are still five stocks I want to buy. And like I said in the first paragraph of this article, I know what those stocks are and I’m waiting to add the to my portfolio. But like all of these stocks, they must be bought at the right price. That’s part of the issue when you start from scratch. You can’t buy all the stocks exactly when you want them. You have to slowly contribute the cash to your account and then dollar cost average to build a position. I’ve probably bought Coca-Cola 4-5 times already.

**My Short List of “*Must Have*” Stocks**

After seeing my love for Consumer Defensive and Healthcare related stocks, it should come as no surprise that 3 of these 5 are Consumer Defensive. Again, it just gets back to buying real things that people want/need to buy with companies that make money. It’s that simple. And, of course, buying all of these at fair value or much less.

And though I love Home Depot, I’d easily swap in Lowe’s (LOW) if it was within striking distance. I don’t need to own both but I’ll take either. The same goes for Lockheed Martin, which I’d be just as happy to own General Dynamics too. Home Depot/Lockheed Martin are quality stocks but so are Lowe’s/General Dynamic too.

That can’t be said for Procter & Gamble, Colgate-Palmolive, or Hershey. These can’t be easily exchanged with just another company.

Summary

Like I’ve said many times, my two rules are fairly simple: (1) my companies must survive and (2) so must their dividends. Personally, you already know which companies should be on your master stock list. Just do a little further research to finalize the process. It surprises most people that Disney, Clorox, Starbucks and many others aren’t on my list. I’ve got my reasons but you need to come up with your own reasons.

And let’s not forget, I’ll be very light with financials and technology companies too. They are just too volatile for my retirement needs but Warren Buffett sure loves them. Sure, I own a little Google (I mean Alphabet) and Facebook (I mean Meta) but I bought those at cheaper prices and not the 100 P/E that most people bought them.

As famous fund manager Donald Yacktman has said, “You buy above average businesses at below average prices and everything will, on average, work out.” If you focus on a narrow universe of companies that meet your criteria then all you are doing is waiting for them to come within your price range. Does it get much easier than that? No! Does it take a genius to buy Pepsi, Coke, Johnson & Johnson or Nestle? No! Does it take a genius to be patient and buy those companies at below average prices? No!

Then why doesn’t everyone do this?

Thanks for reading!

Mr. TLR