The 3 rules of investment quality — profits, dividends and diversity
In good markets and bad, investment quality wins out, says this Canadian advisory, which shows how to choose the stocks that have it.
Once upon a time, “the quality” was the upper crust in society, those who possessed elegant mansions, carriages and the like.
Just having money wasn’t enough to earn you this designation. You had to know how to spend it.
And when financial advisers talk about “investment quality,” they mean exactly the same thing — how you spend your money. It’s very easy to get the least out of your money if you’re not careful.
And in today’s endlessly changeable markets, investment quality would appear to be the minimum requirement for survival, let alone success.
One of Canada’s oldest investment advisories, The Investment Reporter, has very clear ideas on the subject.
Quality in your portfolio gets down to three things — profits, dividends and diversification.
The advisory examines the three rules of quality and shows how to separate the stocks that have it from the ones that don’t.
Clean out the junk
“Some investors do poorly even in strong markets,” this advisory says. Too many investors are stuck with portfolios that simply won’t deliver the goods — and are liable to flirt with disaster when the markets correct.
To raise the investment quality of your portfolio, the advisory says, start by cleaning out the junk. Get rid of the promotional stocks and the concept stocks (those with an idea but no sales — like the dot-coms of a decade ago).
But above all, make sure your stocks are profitable. If they aren’t making money steadily, neither will you. Energy fuel cell maker Ballard Power Systems (TSX-BLD) would seem to have a bright future, but it loses money consistently and the share price ($1.81 at the moment) never really seems to get off the ground.
The share price for ACE Holdings (TSX-ACE.A) did get off the ground somewhat in the past year (it’s at $8.07). But this company recently announced another money-losing quarter. And it is the successor of Air Canada, which famously went bankrupt.
And there’s one very important thing missing. Neither of these companies pays a dividend. You have no compensation while you’re waiting for the shares to blossom. Instant gratification may have a bad reputation these days, but there’s a lot to be said for it in investing.
Going up
The Investment Reporter can’t make the point too vigorously. Buy stocks that pay dividends.
Better still — buys stocks that raise their dividends regularly. “You can profit even if the stock goes nowhere,” points out the advisory.
But stocks that raise their dividends usually do go somewhere — up. For one thing, they attract income investors looking for nice yields.
“What’s more, these dividends usually rise faster than inflation,” adds the advisory. Inflation may be low at the moment, but it few would be willing to assume that it will remain that way.
Dividend-paying stocks are, almost by definition, wealthy stocks. They do not buckle in bad times. In fact, says the advisory, they can “use their financial strength to buy small competitors cheaply or take away their business.”
But do not pick all of your profitable, dividend-paying stocks from the same basket.
Not too much of a good thing
Diversify, says this advisory. Keep at least 10 per cent and no more than 30 per cent of your stocks in one of the five broad economic sectors.
Finances, utilities, retail, manufacturing and resources — balance your investments among them and don’t let them get out of whack.
In the market rally that began in March 2009, for instance, resources soared while utilities rose modestly. So what was once a well-balanced portfolio might now be well over 30 per cent in resources and under 10 in utilities. That might not be the best arrangement when the market corrects.
And diversify within those groups, adds The Investment Reporter. It uses utilities as an example. First, you should own an electricity company like Emera Inc. (TSX-EMA) or Fortis Inc. (TSX-FTS).
Emera trades today at $24.84 and yields 4.5 per cent on its dividend of $1.13. Fortis is at $27.27 and yields 4 per cent on its $1.12 dividend — a dividend it has raised every year for over three decades, by the way.
But don’t stop there. Own a pipeline as well. The advisory likes Enbridge Inc. (TSX-ENB) and TransCanada Corp. (TSX-TRP). Enbridge is trading at $49.13 and yielding 3.4 per cent on a dividend of $1.70. TransCanada is at $36.76 and yields 4.3 per cent on its $1.60 dividend.
Then add a phone company. BCE Inc. (TSX-BCE) and Telus Corp. (TSX-T) are the suggestions here. BCE trades at $31.09 and yields 5.5 per cent on the $1.74 dividend. Telus is trading at $40.63 with a yield of almost 5 per cent on its $2.00 dividend.
But don’t overdo it with too many stocks. The advisory quotes Mae West’s famous quip, “Too much of a good thing can be wonderful.” But it can take all the pleasure out of your portfolio.
Not only is it hard to keep track of a great mob of stocks, it “also reduces the impact of your winners.” For most investors, 20 to 25 stocks with a weight of four to five per cent each will be just about right.
It all gets down to this, in the advisory’s opinion. You can only build well on a firm foundation.
So if you want to ride with “the quality,” you have to know exactly what you are getting for every investment dollar you spend.
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