This current series of articles could be summarized as a review of ways to construct and diversify a common stock portfolio. In part 1 found here I discussed various viewpoints on how many stocks a portfolio should hold. In Part 2A found here I presented and discussed Peter Lynch’s 6 general categories of stocks. In this part 2B I will continue reviewing diversification strategies by evaluating the potential benefits of portfolio construction across the 11 sectors.
Therefore, the best place to start is with a review of the 11 major sectors. (Note: REITs used to be included in the financial sector but were recently given their own sector status.) However, in addition to the 11 major sectors, there are numerous subsectors included in each. Consequently, a portfolio can technically be over-weighted in a broad sector while still being more broadly diversified over various subsectors. To provide the full impact of how broadly diversified each major sector is, I offer the following list of the 11 major sectors plus all the subsectors in each:
Energy
Oil & Gas Drilling
Oil & Gas Equipment & Service
Integrated Oil & Gas
Oil & Gas Exploration & Production
Oil & Gas Refining & Marketing
Oil & Gas Storage & Transportation
Coal & Consumable Fuels
Materials
Commodity Chemicals
Diversified Chemicals
Fertilizers & Agriculture
Industrial Gases
Specialty Chemicals
Construction Materials
Metal & Glass Container
Paper Packaging
Aluminum
Diversified Metals & Minerals
Gold
Precious Metals & Minerals
Silver
Steel
Forest Products
Paper Products
Industrials
Aerospace & Defense
Building Products
Construction & Engineering
Electrical Components & Equipment
Heavy Electrical Equipment
Industrial Conglomerates
Construction Machinery & Supply
Agricultural & Farm Machinery
Industrial Machinery
Trading Companies & Distribution
Commercial Printing
Environmental & Facility
Office Services & Supply
Diversified Support Services
Security & Alarm Services
Human Resource & Employment
Research & Consulting Services
Air Freight & Logistics
Airlines
Marine
Railroads
Trucking
Airport Services
Highways & Railtracks
Marine Ports & Services
Consumer Discretionary
Auto Parts & Equipment
Tires & Rubber
Automobile Manufacturers
Motorcycle Manufacturers
Consumer Electronics
Home Furnishings
Homebuilding
Household Appliances
Housewares & Specialties
Leisure Products
Apparel, Accessories & Luxury Goods
Footwear
Textiles
Casinos & Gaming
Hotels, Resorts & Cruise Lines
Leisure Facilities
Restaurants
Education Services
Specialized Consumer Services
Advertising
Broadcasting
Cable & Satellite
Movies & Entertainment
Publishing
Distributors
Catalog Retail
Internet Retail
Department Stores
General Merchandise Store
Apparel Retail
Computer & Electronics
Home Improvement Retail
Specialty Stores
Automotive Retail
Home Furnishing Retail
Consumer Staples
Drug Retail
Food Distributors
Food Retail
Hypermarkets & Super Centers
Brewers
Distillers & Vintners
Soft Drinks
Agricultural Products
Packaged Foods & Meats
Tobacco
Household Products
Personal Products
Healthcare
Healthcare Equipment
Healthcare Supplies
Healthcare Distributors
Healthcare Services
Healthcare Facilities
Managed Healthcare
Healthcare Technology
Biotechnology
Pharmaceuticals
Life Sciences Tools & Services
Financials
Diversified Banks
Regional Banks
Thrifts & Mortgage Finance
Other Diversified Financial Services
Multi-Sector Holdings
Specialized Finance
Consumer Finance
Asset Management & Custody Banks
Investment Banking & Brokerage
Diversified Capital Markets
*Mortgage REITs (*no FFO)
Insurance Brokers
Life & Health Insurance
Multi-line Insurance
Property & Casualty Insurance
Reinsurance
Infotech
Internet Software & Services
IT Consulting & Other Services
Data Processing & Outsourced Services
Application Software
Systems Software
Home Entertainment Software
Communications Equipment
Technology Hardware, Storage & Peripherals
Electronic Equipment & Instruments
Electronic Components
Electronic Manufacturing
Technology Distributors
Semiconductor Equipment
Semiconductors
Telecom Services
Alternative Carriers
Integrated Telecommunications
Wireless Telecommunications
Utilities
Electric Utilities
Gas Utilities
Multi-Utilities
Water Utilities
Independent Power Producers & Energy Traders
Renewable Electricity
REITs
Diversified REITs
Industrial REITs
Hotel & Resort REITs
Office REITs
Healthcare REITs
Residential REITs
Retail REITs
Specialized REITs
*Mortgage REITs (*no FFO) in Financials Sector
*Diversified Real Estate Activities (*no FFO)
*Real Estate Operating Companies (*no FFO)
*Real Estate Development (*no FFO)
*Real Estate Services (*no FFO)
It Is a Market of Stocks Not a Stock Market
One of the most common refrains I share with readers is: “it is a market of stocks not a stock market.” I so adamantly repeat this because I feel that too many investors think of investments in terms that are far too general. My favorite (or more honestly stated my least favorite) example is how often I am asked what I think the market will do? My response is always the same, I have no clue or idea what the market will do in the short run. However, this answer is usually met with consternation at worst and/or confusion at best. I guess people feel that because I am a registered investment advisor, I should have an opinion of what the market will do.
However, from my perspective, the answer to that question has too many variables that would have to be evaluated simultaneously. In other words, the question is too complex. Therefore, I believe it is an impossible question to answer. On the other hand, if you ask me what the individual holdings in my portfolio will do, I feel I possess a reasonable ability to correctly answer that question. However, I would qualify that by stating that I have no idea what the price of my individual holdings might do in the short run. Instead, I feel I have a reasonable idea of how the businesses might perform over the long run. As a result, and from that perspective, I am willing to make an educated guess on what the price of my individual stocks might do over the long run, as well as the prospects for dividend income – if any. For further clarification, my view of what the price of my individual stock might do over the long run will include a consideration of its current valuation relative to my expectations of operating results going forward.
My point is simple, and I hope obvious to the reader. It is far easier to analyze an individual stock based on its past, present and future fundamentals and values than it is to attempt to guess what a fickle stock market might do in the short run. But even more to the point, my opinions are always long run in nature. After more than four decades of analyzing and investing in stocks, I have learned to accept the unpredictable nature and reality of short-term stock price movements in an auction stock market.
Furthermore, and getting back to the subject of diversification, the nature and attributes of the individual stocks that I own or manage are more pertinent to me than a sector or subsector designation they carry. Just like people, common stocks are unique, and therefore, I believe should be judged based on their specific merits. Nevertheless, I can understand and even support the idea of diversifying a stock portfolio across several sectors and/or subsectors. Consequently, and as promised, I recently ran screens looking for high quality (companies rated A- or better) reasonably valued dividend growth stocks in each of the 11 sectors.
This has proven to be a challenge considering how late we are in this long-running bull market. However, I did find 19 high-quality dividend growth stock research candidates that could be considered for constructing a total-return-focused dividend growth portfolio. In addition to high quality, I was also looking for consistent historical operating results, attractive valuations and above-average prospects for future growth.
But, my goal was to include at least one company from each of the 11 major sectors. Although I was able to find companies in 10 of the 11 sectors that met all my criteria, I was unable to find anything in the Materials Sector. Nevertheless, I did include the Dividend Aristocrat Nucor Corporation (NUE) based on its A- rating, aristocrat status and low valuation. However, Nucor Corporation did not meet my criteria for consistent and reliable historical or future growth potential. Consequently, I only included it in the following portfolio review because I feel it supports the concept of a market of stocks.
FAST Graph Analyze Out Loud Video Portfolio Review: 20 A- or Better Rated Dividend Growth Stocks
Summary and Conclusions
In closing, I would like to emphasize that my approach and preference for diversification strategies are always long-term oriented. When I invest in a stock, my preferred objective is to consider it a permanent long-term holding. Consequently, I am rarely concerned about short-term stock price performance. Instead, I tend to focus on the business and I attempt to do it in a very pragmatic way.
For example, from my perspective I only get real information four times a year when companies report their operating results. Moreover, I am not interested if they beat or miss earnings estimates by a few cents and the short-term stock reaction that often occurs. Instead, my more practical approach is to determine whether (or not) the company is more (or less) continuing to grow in line with my expectations and needed results.
In this same vein, when I am diversifying across various sectors, my thinking is once again based on the long-term prospects I see in the actual company under consideration. However, most people tend to be shorter-term oriented with investing or diversification strategies. For example, I received a comment in my most recent article providing a link to a Fidelity Leadership Series published January 2017 titled “The Business Cycle Approach To Equity Sector Investing.”
Although I found the information fascinating and rational as presented, it was a little too short-term oriented for my taste. However, some of you may find it worth the read.
Finally, one of the primary goals of this series has been to illustrate that there are numerous strategies, methodologies and realistic ways to diversify a stock portfolio. As I stated in my first article, there is no one perfect strategy – nor is there a one-size-fits-all. At the end of the day, investors need to build and design their portfolios to their own goals, objectives, risk tolerances and needs. With this segment I focused on a strategy of identifying high-quality dividend growth stocks for a total return objective. In part 3, I will turn my focus to dividend growth stocks with a higher current yield. In other words, building a diversified portfolio of fairly-valued dividend growth stocks for a current and growing dividend income stream.
Disclosure: Long XOM,KMB,AMGN,INTC,SO,SPG.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
