Thinking ahead - planning your investment game

The last time I wrote, it seemed like the global economy generally, and the American economy in particular, was in for a serious bout of greacession.

However, the coordinated global attack on the economic slowdown and banking sector crisis appears to have had some effect with, most importantly of all, confidence being restored. That's not to say there won't be some washouts in the road ahead, but most commentators seem to agree that "The Great Depression, Redux" just won't happen at this time. Opinions on the severity and remaining length of the recession in front of us, and the inflation to follow (or not!) now seems to be the subject of debate, rather than the collapse of the economic system itself.

With all that in mind (or not) and remembering that the most important aspect of investment is the right temperament, here is an investment clock that can suggest various investment timing to be had in the cycle in front of us. Whereas it can often be quite difficult to tell exactly where in the cycle we are, at this time it is unusually clear, at least to the extent of knowing that we aren't in the boom phase, nor have we really reached recovery yet. We appear to be, undeniably, in the recession phase at this time.

Therefore, if you like sector rotation and feel you can use it to your advantage, then this Merrill Lynch clock should be very handy at this time.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!


JW

The Confused Capitalist

Stock Market Investment Planning

The following provides links to the Market Tremors series, which is an examination of the factors you should consider when preparing a plan to invest in stocks.

It was written in September 2008, a period of extraordinary volatility, as the credit crisis unfolded as Congress considered whether to grant Treasury`s request for $700 Billion in authority to purchase distressed loans from the banking sector.

1. Background
2. Process
3. Rationale
4. Emotions
5. Holdings
6. Market Exposure

I will provide this as a permanent link on the right hand side of my blog, under the heading of `Learn-Useful Stuff`.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!

I hope you enjoyed the series and it proves useful in your investing.

JW

The Confused Capitalist

Market Tremors Series - Market Exposure

Market Exposure

This is the final installment, #6, in the Market Tremors series.

In prior postings, I stated that few retail investors ask and answer the right questions before portfolio construction, with the result that they panic during both bear and bull markets. This panic, whether due to significant market decline or portfolio lag, is the cause of most market underperformance. That is primarily because the investor panics and begins chasing the wrong asset class, at the wrong time.

I suggest that all investors need to deal with these five questions, in order to have a good chance to outperform the market:

1. Process;
2. Rationale;
3. Emotions;
4. Holdings;
5. Market Exposure

Today, we are looking at Market Exposure, through the lens of my own recent portfolio reconstitution. Here’s how I define Market Exposure:

Am I comfortable with the levels of equities I hold?

This is one of those questions that many investors spend a great deal of time on, as the market is cresting or crashing, with the idea of then repositioning the portfolio to better take advantage of whatever has already occured and is now in the rear view mirror.

There are basically only two types of investments: debt and equity. There are many sectors against which your debt or equity might be backstopped, but really, you only have two real underlying investment choices. It’s worthwhile thinking about that.

Equity is always the most volatile portion of any asset holding. As Warren Buffett once said “the company’s assets were questionable, but its liabilities were rock solid”.

So, with this in mind, you can be an owner, or a loaner.

Owners often borrow money, are subject to business and financial risk, strategy failure, management miscues, and so forth.

Loaners try to protect themselves against these risk factors by securing against assets valued at more than the debt. The price of debt (the interest rate, generally) is very clear. It’s relatively easy to make a decision on whether or not it appears attractive to you, relative to its risk profile.

Ownership, on the other hand, whether complete or partial (as in stock ownership) is more complicated. In addition to all those aforementioned factors, one has to judge whether the offering is at an attractive price. While there are lots of objective criteria upon which a purchase can be judged, the subjective portion is, and will always remain, large. Dr. W. Edwards Deming, the statistical expert who is perceived to be the father of the Japanese quality miracle, stated that “The most important things are unknown or unknowable” and “The most important things cannot be measured”– and he was talking to the insiders who could both measure and effect corporate change!

Given all these attributes that equities have, it’s not surprising that their pricing is volatile. During buoyant markets, the subjective portion will be perceived favourably, and priced accordingly. During bear markets, all those subjectives take on a negative hue, and are thus “properly” discounted off the price.

Its also worthwhile thinking about debt too – over the long term, it just barely matches inflation. If you are an extraordinarily strong saver, with a very low risk tolerance, then this might be a good match for you.

On the other hand, if that isn’t you, then you’ll likely want some equities exposure. However, you have to be mentally and emotionally prepared for market declines, and how much of your portfolio you will accept as being subject to those types of risk. For instance, as Barry Ritholtz has pointed out, the market had numerous large downward moves during the period between 1966 and 1982 – three times of around -25%, and twice between -36% and -45%. These types of moves are always possible in a weakened business and consumer environment.

While it’s always attractive to believe you can get rid of the downside risk, the reality is that you usually will miss having some real portfolio growth if you try to eliminate it all.

Where you stand on the amount of market exposure you are willing to accept depends upon many things: your risk tolerance in general, your emotional readiness to handle market and portfolio declines, the amount of time you can realistically be in the market (i.e. are you 25 or 75?) and your willingness to see your portfolio lag your friends during nice bull markets.

Nevertheless, its useful to model a couple of different equity exposures and think about how that might support your portfolio during bear markets, but possibly hold it back during bulls. There are no pat answers, and formulaic answers fail to account for investment strategies and investor differences. It is something you have to think about and model in your head at a minimum.

Finally, it’s unusually beneficial to think about these things well before the cresting of the bull market when greed is in full force, and before the nasty bear is clawing at your portfolio.

This concludes the Market Tremors series – I hope you enjoyed it, and I welcome any feedback you’d like to give.

Disclosure: Significantly invested, long, equities.


JW

The Confused Capitalist

Market Tremors Series - Holdings

Holdings

This is #5 in the Market Tremors series.

In prior postings, I stated that few retail investors ask and answer the right questions before portfolio construction, with the result that they panic during both bear and bull markets. This panic, whether due to significant market decline or portfolio lag, is the cause of most market underperformance. That is primarily because the investor panics and begins chasing the wrong asset class, at the wrong time.

I suggest that all investors need to deal with these five questions, in order to have a good chance to outperform the market:

1. Process;
2. Rationale;
3. Emotions;
4. Holdings;
5. Market Exposure

Today, we are looking at Holdings, through the lens of my own recent portfolio reconstitution. Here’s how I define Holdings:

What are my specific holdings – what is their orientation, what is their risk profile? How much am I counting on “the future” (potential growth of earnings etc.), rather than “the past” (historical earnings, etc.)?

This is one portion of these questions that many investors spend a great deal of time on, as the market is cresting or crashing, with the idea of then repositioning the portfolio. However, if you have properly considered these prior three questions, then the actual holdings become much simpler to select, and to hold onto during active market phases.

As I have mentioned, I have a concentrated portfolio, something I have always done, and feel comfortable with. In fact, just five stocks account for 50% of my equities. The other 50% of equities is held by five ETFs, with significant thematic overlap on two of those positions.

While just ten positions (5 stocks, 5 ETFs) sounds like relatively few, research has shown that diversification benefits begin dropping dramatically after just five holdings. That’s not to say that risk doesn’t continue to decline relative to market averages, just that the risk decline quickly tapers down.

According to Morningstar, three of my stock holdings have a wide moat, and two a narrow moat. Just 10% of Morningstar’s ranked stocks get “wide” moat status, and 45% get narrow moat (the remaining 45% have no moat). Moreover, these selections were recently selling at an average of just 69% of Morningstar’s Fair Value estimate. The average dividend yield is greater than 5%, and all of the stocks have had recent dividend growth. Additionally, all have had sufficiently long periods of decent or good earnings growth and good to very good returns on equity and capital. Furthermore, all except for one had a four or five star Morningstar ranking.

One note worth thinking about: several of my holdings were former “superstar” stocks or in superstar sectors – ones that never disappointed the markets, and became extremely pricey. In most cases, while the revenues and net income continued to grow at solid rates, it was at rates that the market eventually came to be disappointed with. As I write this, the market (S&P 500) has dropped by 19% against its high over the past five years, while three of my stocks declined between 40-70%, and one by 22% within that time period.

It’s worth considering in terms of your own holdings that I don’t believe for a minute they are attractive BECAUSE they’ve fallen (a trap many investors fall into), only that high PE ratios HAVE finally fallen back to earth. This has provided me attractive entry points relative to their existing earnings, dividends payments, and future potential. If you held one of these superstars through a decline, you must contextualize your thinking to see if it holds good value, AS OF TODAY. The fact you’ve suffered through the decline – too bad, so sad - but don’t bail now just because of that. It might just be your most attractive holding today. Really think about that.

As previously mentioned, my stocks were selected by screening for above average attributes (in fact, far above average) and generally in areas/sectors that are attractive for business on a long-term basis. Overall, I have achieved relative diversification here – none of the selections look like the others, as I have one industrial conglomerate, one bank (a UK bank), a teleco, a spirits (liquor) maker and distributor, as well as a hard asset owner/manager. There is very little or no thematic overlap.

In terms of the ETFs, I have oriented to growth possibilities. Here, my five ETF holdings consist of two emerging market selections (large/mid cap & a small cap; both with a dividend selection orientation), two alt/clean energy holdings (again, one that focuses mainly on large companies, while the other has a mid/small cap orientation), an agricultural ETF.

Each of these three ETF themes account for between 14% and 20% of my total portfolio. I’ve considered the relative valuation measures, and believe they are attractive for the emerging markets (PE ratios of below 11 in both of these ETFs). Furthermore, I have a stabilizing and relatively high dividend yield (5-7%) to go along with my two selections there. While many people would consider this a growth position, I also hold the opinion that it’s really a value position as well (although a volatile one currently).

The alt/clean energy ETF valuations, while not crazy, are definitely on what I consider to be the high side (PE ratios of 30 on average). Nevertheless, its worth considering that the ratio is elevated by the fact that some of the underlying companies aren’t yet profitable in this sector (making the “E” understated in “PE), something I expect will change as societal demand increases for this energy source.

Finally, agriculture is being affected by many of the trends that have previously affected oil prices: emerging economy changes (diet preferences in this instance), and a limited amount of the resource (arable land in this case). Add to this mix 70 million new babies every year and climate change, and it’s not difficult to think that this business sector will be larger ten years out as agriculture becomes more intensive.

In the case of all of these ETFs, I simply close my eyes and try and envision the future, ten years out. I simply cannot imagine that these market sectors are not much more significant than they exist today.

These emerging market economies will be much larger is a given I feel. I consider alt/clean energy to be a global imperative that is becoming more and more recognized. In terms of agriculture, there are numerous value drivers as mentioned.

So I believe am paying a reasonable price for most of these themes, although perhaps on the pricier side for the alt/clean energy. That is likely to be a more volatile holding than many of my other holdings.

In summary, in relation to my holdings, I personally feel more comfortable worrying about those ten holdings – which I think have above average characteristics – than I would be worrying about the whole market. Other investors – perhaps such as you - would of course having different comfort levels about this type and style of holdings.

Having said that, there’s also some tie in between emotions and holdings. It’s much easier to hold junk during market escalations, than during declines. For instance, during the NASDAQ go-go days, I personally owned a lot of junky stocks – no earnings, but lots of “prospects”. It ended up around the top (March 2000 or so) that I owned enough of this crap that I couldn’t sleep well at night. I eventually liquidated my holdings, which was luckily before the taking the 80% beating as the NASDAQ eventually tanked to. Still, the sting hurt, but it did teach me a valuable lesson about both quality, earnings, and value.

Finally, there’s one other thing to think about. As Geoff Gannon once wrote, there’s no reason that cheap stocks can’t get cheaper, and this could happen with each and every one of my picks or to the market in general.

As an example, South Korean stocks declined to a PE ratio of just two (as I recall reading it) following the 1998 Asian contagion. So the question to ask yourself is, “Would I be a buyer or seller at those prices?” and “How solid are my holdings, relative to market averages?”

While it’s seductive to think that you’d hang on to your positions in the face of such a deluge, obviously a great many investors weren’t or that pricing would never have arrived.

If you can come to terms with those questions in relation to being satisfied with your holdings over an entire market cycle, then you probably have a better than average chance at outperformance.

The final installment in this series will be “Market Exposure”, which will be published on Monday.



JW

The Confused Capitalist

Market Tremors Series - Emotions

Emotions

This is #4 in the Market Tremors series.

Previously, I stated that few retail investors ask and answer the right questions before portfolio construction, with the result that they panic during both bear and bull markets. This panic, whether due to significant market decline or portfolio lag, is the cause of most market underperformance.

I suggest that all investors need to ask and answer these five questions, in order to outperform the market:

1. Process;
2. Rationale;
3. Emotions;
4. Holdings;
5. Market Exposure

Today, we are looking at Emotions, through the lens of my own recent portfolio reconstitution. Here’s how I define Emotions:

What is my emotional readiness to handle declines or lags in my portfolio, without changing strategies?

Of all the questions, this is the one that is most problematic for retail investors in particular, especially self-directed ones. That’s because there are so many sources for emotions to arise from, and everyone has a different risk tolerance and also because so few people work through questions like these. With rationale thought, chosen at a time of low stress, comes a better ability to handle the inevitable marketplace ups and downs.

Having said that, there are some sources of emotional distress that you can actively “turn off”. Firstly, we are bombarded today by news – including business news. The anchors and talking heads act as if its’ all meaningful to your portfolio.

Most of it isn’t. It’s mental plaque that’s tough to get rid of. Here are a few suggestions for doing so:

Unless you are actively seeking to reposition your portfolio, shut off or restrict your business news intake. You have to view it like an addition – one that’s likely harming your financial health. If you are repositioning your portfolio, fine, intake that news, collect information for awhile, then shut if off again, and STUDY and THINK about what this means.

As a corollary to that, you also need to stop checking your portfolio every day, or even every week. Generations ago, the saying was “A watched pot never boils” and this still speaks to the impatience of people, when their expectation of the speed of the anticipated change is unreasonable. Just like in the movie “Hitch”, your equities portfolio needs time to percolate.

“Hang on”, you say – “How will I know what’s going on with my stocks/portfolio?”

That’s the point – you won’t – AND you’ll stop thinking that each day or week is meaningful in the life cycle of a business or the stock market. It’s not.

If you’re worried you’ll miss some opportunities to buy, sell or reposition your portfolio, then do this instead: set up email “alerts” when your current or desired stock or ETF hits a certain price (buy or sell signals), and/or for earnings announcements. You really don’t need to be more in the loop than that.

If you don’t believe that, then think about this: with all the changes and gyrations in the Dow Jones Industrial Index in the past 50 years, an investor would have been better off to simply have held those stocks in the Dow of 50 years ago, including all spin-offs and buy-outs, than to have followed the Dow in its reconstituted form. And if that’s the case for a relatively slow changing index, then what do you think the odds are that you can outperform the market with all your shifty moves and break-dances?

In order to break the “watched pot” habit, buy yourself some sort of treat as a reward if you limit yourself to checking your portfolio and stocks just once a month, or better yet, just once a quarter. I can almost guarantee you that treat will easily pay for itself, and the addiction will have been broken!

One other antidote to emotions is to think about how much time you’ll be actively “in the market”. If you perceive that as less than ten years, it’s understandable you worry with every belch and burp of the market. Maybe you shouldn’t be in market at all. You need to consider this.

However, if your time frame is more reasonable, like 10 to 20 years, then print yourself up one of those long-term stock charts and eyeball it every time you’re tempted to trade because the markets’ aren’t moving your way.

The other thing you need to consider is the rationale and holdings within your portfolio; how those stylist leanings might affect your returns in a bear and bull market. For instance, if you invest exclusively in micro-cap stocks, and portfolio is down 45% when the market is “only” down 27% (and all your friends are complaining about that), how will you react? Can you really be at peace with this? Are you prepared to hold those positions (or similar) long enough to capture the returns available as an asset class over the business cycle? Or will you bail at the bottom?

Similarly, whenever the next bull starts, there’ll inevitably be one sector or stylist leaning that’ll crush returns in other asset styles. If you see yourself as a value investor, will you long to be part of that crowd, and inevitably give in, just as the sector is screaming towards its pinnacle? You really need to truly face your mental and emotional aptitude to handle a particular portfolio style. You must adapt that style if necessary to reflect something you can handle over an entire business and market cycle.

Finally, going through a process like this (all five steps), including providing a clear and cogent synopsis of your rationale and the key attributes of your holdings anywhere near your computer, should help stop you from trading indiscriminately. In other words, it will help you to control your emotions at tough times in the market – when the market is falling, or when your portfolio is lagging market averages.

The next installment in this series will be “Holdings”, which will be published on Thursday.


JW

The Confused Capitalist

Market Tremors Series - Rationale

Rationale

This is #3 in the Market Tremors series.

I previously stated that few retail investors ask and answer the right questions before portfolio construction, with the result that they panic during both bear and bull markets. This panic, whether due to significant market decline or portfolio lag, is the cause of most market underperformance.

I suggest that all investors need to ask and answer these five questions, in order to outperform the market:

1. Process;
2. Rationale;
3. Emotions;
4. Holdings;
5. Market Exposure

Today, we are looking at Rationale, through the lens of my own recent portfolio reconstitution. Here’s how I define Rationale:

What was my thought process for assembling this particular portfolio, and how well will this rationale hold up if market conditions are reversed?

In terms of my own portfolio, my first item to mention is holdings concentration amongst my equities. I hold a concentrated portfolio, with relatively few positions. It’s my belief that concentrating your holdings concentrates your mind, and you become willing to take larger positions, as your margin of safety grows. Many studies have shown that equity managers who run concentrated portfolios do better than those who have more traditional numbers of holdings. My rationale is that if I’m looking to outperform the market, if I’ve found something cheap enough with the growth I like, then I’m willing to concentrate my holdings.

In fact, five stocks account for 50% of my equities. The other 50% of equities is held by five ETFs, with significant thematic overlap on two of those positions.

While just ten positions (5 stocks, 5 ETFs) sounds like relatively few, research has shown that diversification benefits begin dropping dramatically after just five holdings. That’s not to say that risk doesn’t continue to decline relative to market averages, just that the risk decline quickly tapers down.

I demand numerous margins of safety with my stock purchases. First, a “moat” (barriers to competition). Second, a stock price at purchase that reflects a healthy discount to fair value. Third, a decent dividend yield (with recent dividend growth) – this indicates the possibility that the market is currently mispricing the stock. Fourth, decent earnings growth over a period of time (although I’ll accept “stalled” earnings growth for a short period, in order to buy a good stock at an attractive price).

A major rationale with my portfolio construction is that I’m seeking at least a moderate level of diversification – none of the selections look like the others. For instance, I have one industrial conglomerate, one bank (a UK bank), a teleco, a spirits (liquor) maker and distributor, as well as a hard asset owner/manager. There is very little or no thematic overlap. This contrasts with the way I used to construct my portfolio, with extremely heavy weightings in just two or three areas.

In terms of the ETFs, I have concentrated my holdings thematically. Some investors use ETFs as a “portfolio gyroscope” providing leanings and risk profiles towards market averages (i.e. SPY or VT as examples). On the other hand, I use mine to provide a ten year growth tilt. If juicy dividends and low PE ratios are available, then so much the better, these but not totally necessary, as I want a moderate to high growth profile.

Accordingly, I think about where the world will be in ten years, what the demand cycle might look like, and try to buy specialty ETFs that capitalize on those long term opportunities. Just like you couldn’t give away oil and mining stocks in 1998, and yet investors have been crazy for them in the last five years, I’m trying to envision the longer-term.

Overall, I have a clear preference to value positions, yet even then I seek growth profiles within those positions. In my portfolio, value accounts for about 65% of the portfolio, with a clear growth tilt to the balance. However, even on the individual stock purchases (which are generally the value orientations), three of them have clear exposure to emerging markets, so despite their conservative valuations, they are also growth profile selections. I have further underpinned, I believe, the safety of this portfolio with a predominant dividend selection process – affecting some 65% of the portfolio.

In summary, I believe that the intrinsic value of the portfolio is much more stable than the market average, given all the attributes I have attempted to capture.

However, I also recognize that market gyrations on the ETFs may be above market averages, but that, in my opinion, these wouldn’t represent permanent impairments of capital. Overall, given the relative valuation measures on both the stocks and ETFs, it also appears there’s considerable opportunity for price growth, should recent market conditions begin reversing in the few years. If not, I get to collect a fat dividend cheque on much of my portfolio, while I await that turnaround.

Finally, it’s my long-stated belief that the US will continue its currency decline over the longer haul (next five to ten years), and I have therefore limited my purchases to reflect that belief. That’s not to say that I don’t have exposure, just that it’s considerably less than the 44% world-stock-market-capitalization held by US companies.

So, summarizing my own rationale, bullet-style, might look like this:

- Titled to diversification – eight different sectors, many different markets.
- Titled to value on most of the portfolio – many relatively low PE selections
- Titled to growth on significant portions of the portfolio
- Titled to dividend downside protection
- Titled away from revenues that are primarily received in US currency
- Overall rationale is “If I left this portfolio untouched for 10 years, would it still be successful?”

In the final analysis, the only thing you can control on your portfolio is your risk profile – the market determines the returns. In my case, I feel that no matter the markets short-term orientation, I have built a portfolio inclined towards relative long-term safety and yet with growth opportunity.

The next installment in this series will be “Emotions”, which will be published on Monday.


JW

The Confused Capitalist

Market Tremors Series - Process

1. Process
   
   This is #2 in the Market Tremors series.
   
   In the last posting, I stated that few retail investors ask and answer the right questions before portfolio construction, with the result that they panic during both bear and bull markets. This panic, whether due to significant market decline or portfolio lag, is the cause of most market underperformance. That is primarily because the investor panics and begins chasing the wrong asset class, at the wrong time.
   
   I suggest that all investors need to deal with these five questions, in order to have a good chance to outperform the market:
   
   1. Process;
   2. Rationale;
   3. Emotions;
   4. Holdings;
   5. Market Exposure
   
   Today, we are looking at Process, through the lens of my own recent portfolio reconstitution. Here’s how I define Process:
   
   What process and tools did I use to construct this portfolio?
   Have I given myself an edge in some way?
   
   Firstly, it’s rare that any long term market outperformance is possible without a decent process. If you’ve been outperforming the market without a specific process, then you better chalk it up to luck – and just like in the casino, it’s not likely to last. If you’ve luckily lurched from stock tip and suggestion and back to the same, better quit now and put your winnings in your pocket. Stop now, build and define your process.
   
   While I don’t suggest my process will fit everyone, it fits me. Here’s mine.
   
   First, I admit with my time constraints, I just don’t have the time to delve deep into the annual report of every corporation in the areas I have chosen. I used to do that when I bought just small and micro cap stocks, but have neither the time nor the desire to orient my portfolio that way anymore.
   
   Instead, I use quality “buy side” analysts who have my interests at heart (unlike the conflicted investment banks and their ADHD analysts). Therefore, I extensively use the Morningstar database to find stocks that might interest me.
   
   Using their database, I screen for stocks based on both “moat” (barriers to competition) and largest discount to fair market value.
   
   Second, I require all of the stocks I select to have a moat, and preferably a wide moat. I want that implicit margin of safety. I also require that all of the stocks I buy to have some margin of safety in terms of the pricing – the lower the stock price relative to their fair value estimate, the better. Also, I generally want to buy a four or five star rated equity, which, according to Morningstar’s data, have on average significantly outperformed the market over a relatively long period.
   
   I also check this rating with the S&P report (another buy side rating agency), to see if it’s roughly similar. Again, they report that their four and five star rated equities have significantly outperformed the market on average.
   
   Third, I also require that the equity be paying a dividend. I am looking for both an above average dividend yield, and recent history of dividend growth (or the possibility that is about to occur). Given the long-term outperformance of dividend-paying stocks, as further boosted by those providing dividend growth, I consider this one of the edges I use in the market.
   
   Fourth, when looking at the truncated financials, I look for above market average returns on equity and capital (assets), as both are long term drivers of stock price growth. I look for decent earnings per share growth. I also look at overall financial health of the company, accepting a “C” Morningstar rating at the lowest, but looking for better if possible. I also look at the PE ratio to see if that is a relative bargain.
   
   In terms of my ETF selection, I use a much more “gestalt” process – I usually pick specialty ETFs in areas I think there’ll be considerable growth into the future. Here, I use my general reading, and just plain thinking about the future, to orient towards those ETF buys. I also try to envision those ETF buys ten years out, because that’s my projected holding period in that instance. I look at the valuation ratios but, given I perceive these as the growth portion of my portfolio, are somewhat less concerning than in the stock selection (which I perceive as the value oriented portion of my portfolio). However, I also check relative value measures, like the PE ratio, to ensure I’m not buying the NASDAQ index circa 1999, with a PE of 100.
   
   Now, the final piece of the process is to print up all these materials I’ve compiled, together with any handwritten notes on the reports. I then do a very brief summary on the equities selection, such as dividend yield, Morningstar ratings and percentage of fair market value the equity is selling at, and a brief narrative overview, including PE ratios, value drivers, exposure to the US market, and/or other odds and sods. I do the same for my ETFs.
   
   Next we’ll look at “Rationale”, which will be published on Thursday.
   

JW

The Confused Capitalist

Market Tremors

Image: Portland Oregon skyline, Mt Hood in background.

In my family of origin, reading something you thought interesting to a sibling, parent or child was a sign of love and affection, as well as a way to stay connected and to expand your world. Receiving one of those readings was taken similarly.

So, on a recent multiple-family shopping expedition to Portland, I asked my wife to read to me, as I ground it out for the fifth hour on the freeway on our way there.

“Read what?”, she asked.

“Globe & Mail – business pages, please.”, I replied.

But then I glanced down at the paper and saw the front page headline – “Markets Pounded – TSX/S&P drops 7% over past three days”. Knowing my wife’s market nervousness, I told her to skip the reading. Instead of it being an enjoyable pastime for us both, I know she’d be pounding me with questions about our holdings, feeling sick if we lost anywhere near the average and dismal if it was more.

Which brings me to the point of this exercise: she reacted just like many people do. At a sign of market decline, they seriously question the market in general, and their holdings in particular.

Unfortunately, it is usually only at times of market extremes like these that people begin ask these questions, and it is usually in this order:

1. Market Exposure – Am I comfortable with the levels of equities I hold?

2. Holdings – What are my specific holdings – what is their orientation, what is their risk profile? How much am I counting on “the future” (potential growth of earnings etc.), rather than “the past” (historical earnings, etc.)?

3. Emotions – What is my emotional readiness to handle declines or lags in my portfolio, without changing strategies?

4. Rationale – What was my thought process for assembling this particular portfolio, and how well will this rationale hold up if market conditions are reversed?

5. Process – What process and tools did I use to construct this portfolio? Have I given myself an edge in some way?

In a bear market, the predictable answers to #1 and #2 are “I have too much equities – I need to lighten up”, and “I have too risky holdings, I need to sell”. In a bull market the answers are of course reversed. Typically, whether in a bull or bear market, few bother to get around to questions #3, #4, and #5.


If you want to outperform the market, aside from being willing to assemble a portfolio that looks unlike the market – and all the perceived and real risk that can entail - you need to spend considerable time on questions #3, #4 and #5.

In fact, I believe you need to reverse the order of asking these questions. That’s because they form the long-term framework for sticking with your ideas. And retail investors are notorious for dumping both their strategies and equities, just as market conditions begin to favor those very equities and strategies.

So, over the course of the next few postings, we’ll look more deeply at all these questions, in what I regard as the proper order (1. Process; 2. Rationale; 3. Emotions; 4. Holdings; 5. Market Exposure), through the lens of my own recent portfolio reconstitution.

(This series will be published every Monday and Thursday until complete)



JW

The Confused Capitalist

Best of the Rest? Dow Jones Industrial Average

A few days ago, I profiled an eight stock selection of the Dow Jones Industrial Average (DJIA) that I felt would outperform the DJIA over the next couple of years.

The selection was based on using a strategy similar to the Dogs of the Dow, wherein I used high yields to favourably indicate the potential for mispriced stocks in the Dow. I chose eight out of the 16 highest yielding stocks, names that included drug and health care companies, telecommunicators, as well as Coca-Cola, Procter & Gamble, and General Electric. I felt these stocks in the aggregate, would produce a total return greater than the DJIA over the next few years.

Generally, drug companies (Pfizer, Merck) selected have had a long cold winter in relation to any positive changes in share prices, despite numerous predictions and suggestions that these offered good value, relative to their moat and prices. Also, payouts are generally at the high end of the earnings range, indicating limited ability for further upward payouts, itself a negative signalling factor about the intermediate future prospects of earnings growth. While Johnson & Johnson doesn't strictly fit into the same criteria, it's greatest revenues are from it's pharmaceutical division, and therefore the share price growth might be stifled by association.

To some extent, the telecommunications companies have had limited payout increases over the past few years, and this can indicate that their earnings growth isn't as robust as it once was.

This leaves, in my mind, three candidates as offering the best combination of safety, dividend yield and potential growth, and potential share price appreciation.

Procter & Gamble has the lowest dividend yield of the remainders (and in fact was in the bottom half of the Dow 30), and also one of the highest PE's of this group. Therefore, it is felt to be more susceptible to share price pull-backs than some others in the group.

This leaves Coca-Cola (KO), and General Electric GE).

Over the past twenty years, Coke (KO) has been one of the most attractive businesses on the planet. It has proven its long-term sustainable competitive advantage, has enormous brand recognition, and achieved very, very, high returns on equity (30-33% over the past five years) over very long periods of time, with minimal use of leverage. Further, earnings growth, while rarely dramatic, is highly visible going forward.

It currently provides a yield in the upper end of the Dow with, in my opinion, far, far, lower than DJIA average business risk. Wall Street consensus estimates suggest that the earnings in 2009 will be $3.36, versus $2.57 in 2007. The business derives 27% of its net income from the US, with 26% from investments in bottling operations likely adding to that figure marginally - suggesting that somewhere in the order of 2/3 of net income is derived from elsewhere on the planet - a nice hedge if you are concerned about the long term stability of the USD.

The dividend payout ratio has varied over the past five years between 50-57%, with 2007 clocking in at 53%.

All-in-all, Coca-Cola has fallen (earnings risen) to become a relative value proposition, and a potential cornerstone building block for a portfolio.

At a different end of the investment spectrum, we have General Electric (GE). It has been priced by the market as if it is a regional bank employing bank-style leverage and with all the attendant troubled homeowner loans. One only needs to look at the current/forward PE ratio at around 13 in either instance, and the yield of 4.5%, to suggest that the market is pricing it like a bank. I suggest that this diversified giant has been egregiously mispriced by the market.

While the company does have a finance division, the retail finance portion (mortgages, credit cards, etc) comprised only 15% of revenue/net income in 2007, and there is a commercial finance division accounting for 20% of revenue/net income in 2007. In total, only 35% of the company looks like or smells like a bank of any sort and certainly the commercial division can't be considered like a retail bank.

Of the remaining revenues and net income, some 35% of the revenue/net income of GE comes from its infrastructure division - hello market, I thought the world infrastructure market still has a "long-tail" of growth?!

Ten percent of revenues relates to health care, also a growth industry, considering the rapid aging of the Western World in particular, but really, now much more of the world since population growth rates are decelerating world-wide.

Finally, the Industrial division (appliances, industrial equipment) at 10% of revenues, and NBC Universal (10%) make up the balance.

Furthermore, 50% of its revenues are derived outside of the United States.

Sorry, tell me again why this is priced and is yielding like a regional bank?

In seriousness though, earnings have continued to rise nicely over the past five years, from $1.55 per share to $2.20 in 2007, with 2008 consensus estimates at $2.21 and $2.34 for 2009.

Dividend payout ratios have ranged tightly from 50-53% in the past five years and, when measured against cash-flow, even tighter from 34.3% to 35.9%. Dividends have risen nicely over that five year period, with substantial raises every year; five years ago they were $0.77 and in 2007, $1.15. Today, they're at $1.24. Returns on equity are very good, ranging between 17-22% over the past five years.

Overall, this isn't a bank, and it's not a highly cyclical stock warranting a low PE. Two different CEO's have proven it's a pretty good business over the past couple of decades.

In summary, I believe that the GE stock is the most obviously undervalued of the two, but that the business dynamics of Coke provide exceptional long-term peace of mind.

In either case, a dealer's choice of outperformance for the next few years, I believe.

Disclosure: Long GE.

JW

The Confused Capitalist

Agricultural, it's all about the diet ...

Agricultural-related investments remains one of the big, visible, themes going forward over the next ten years. While there's been some mainstream acknowledgement of these major food issues going forward, for the most part, the media has been relatively quiet about the food inflation.

Maybe that's because many countries focus on "core" inflation, which ignores volatile changes in energy and food. These, especially food pricing, are likely to continue to ramp upwards over the next five to ten years.

Feeding the world continues to develop into one of the biggest stories of this century. The supply and demand curves for food, especially due to changing diets in the Far East to have more dairy and meat, continues to favour higher prices for these commodities. Other drivers of agricultural prices are:

- Strong population growth, expected to reach 7 billion by 2013;

- Rising income in developed markets and increased demand for soft commodities in developing markets;

- Climate changes challenging agricultural production processes and product quality;

- Arable land per person is decreasing;

- Demand for agricultural products from Bio-energy (sustainable energy resources) market adds an important and competitive new demand source. Agricultural commodities are getting
more and more important for energy generation.

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This is something I have written about here (provides some specific suggestions, which I continue to support) and here. I re-iterate those calls to make agriculture-related an important part of your portfolio. In Canada, you can now also consider a recent Claymore Investments ETF product, COW, which invests in agricultural companies.

Despite recent run-ups in prices of companies serving the agricultural sector, and the underlying commodities themselves, I consider that this investment theme is still just early in the third inning of a ballgame; a ballgame that itself may even go into lengthy overtime.


JW

The Confused Capitalist

7.1%? Are you kidding me!!?

Picture: Kruschev (famous table pounder at the UN)

Well, 2006 seemed like the year I pounded the table for emerging markets. If you'd listened to me - heck, if I'd taken my advice more seriously - my portfolio and yours would be turning into serious dough by now.

I have a feeling that this year I'll be pounding the table about the banks.

Less than two weeks ago, I wrote about an eight stock portfolio containing three banks - stocks that Warren Buffett had recently added to his position in. Since then, two of the three stocks have fallen in price and the dividend yield has correspondingly increased. These three stocks, recent prices and yields are:

Wells Fargo (Bank) - WFC -$26 - 4.8% dividend yield

US Bancorp (Bank) - USB - $30 - 5.6% dividend yield

Bank of America (Bank) - BAC - $36 - 7.1% dividend yield

I can get a 7.1% yield on a bank stock - the largest bank in America by market capitalization -that's just announced a buyout of a troubled financial institution. 7.1%? Are you kidding me!? I say these banks offer fantastic value at these prices.

Do you really think the banking team would have even considered this buyout if they thought there was any potential they'd have to cut the dividend? Because that's what a 7.1% dividend for a major business institution implies: that a dividend cut, a la Citigroup, is in the works.

Unlike Citigroup, however, Bank of America is still buying. Does that sound like a troubled institution to you? 7.1%? You must be kidding.

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By comparison, the ETF "SPY" (S&P500) was trading at $132, and a 2.1% yield.


JW

The Confused Capitalist

Credit Crunch: Canadian Banks On Sale

Pictured: A different kind of crunch.

The global credit crunch seems to be affecting a lot of bank share prices, including many Canadian banks who have relatively little exposure to the sub-prime slime (CIBC excepted).

One analyst recently pointed out that 10 year Government of Canada bonds were yielding around 3.8%, and that the average weighted dividend yield of the six big banks was around 4.5%. The analyst pointed out that this was as large a spread as he could ever recall.

I too think that the banks offer tremendous value at current prices and yields. I look at it this way, if the credit crunch turns really bad, it's not just the banks that will suffer. There will really be no hiding out anywhere if things turn nasty. Having said that, I don't expect it, and therefore suggest that the current environment is great for buying banks stocks.

Of the Canadian ones, I like four of the six that have avoided most of the sub-prime problems and have dividend payout ratios around 40%.

These include the Royal Bank ($47, DivYield 4.2%, 42% Payout Ratio); my personal favourite, the Bank of Nova Scotia ($45, 4.1%, 40%); the TD ($64, 3.6%, 36%); and, to a lessor extent, the National Bank ($47, 5.3%, 39%). I think that buying a basket of these shares now, will look very good in two to five years. Odds are that the dividends will have been raised nicely over the period, and the shares are quite likely to have been repriced higher as well.

By comparison, the XIU ETF (broad Canadian market) is trading at $74 with a 2.1% dividend yield.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!


JW

The Confused Capitalist

Would Morningstar like this portfolio?

Recently, I profiled a portfolio that looks like it could do well to help fund a financially secure retirement, based on borrowing against your home, and using dividends to make the payment.

Today I joined Morningstar, and looked up the rankings for all of those stocks. Some of their key rankings involve their assessment of overall business risk, the moat of the company, the overall rating (out of five stars), and their estimate of fair value. Now, due to their business model, I consider Morningstar ratings to be of higher quality than that churned out by the average investment house.

Of the eight stocks in the portfolio, only three of them have an overall "three star" (average) rating (Progress, Reynolds and Verizon), with GE having a four, and the rest at five stars. This suggests an above-average portfolio, overall.

The average ratio of current stock price to their indicated fair value is just 80%, with only Verizon over 100% (109%), and all the rest are at 92% or below. This suggests that, as a group, there is room for significant capital growth going forward. The best buy of the group on this ranking is Bank of America, which they estimate is trading at just 55% of their fair value estimate.

All of the businesses exhibit "average" business risk, except for Reynolds (above average) and US Bancorp (below average).

Five of the businesses are defined as having a "wide" moat, while the same three stocks that got an overall three star (average) rating had their moat defined as "narrow". According to information Morningstar publishes, only about 10% of their coverage universe achieves a "wide moat" definition, with about 45% achieving the next highest "narrow moat" ranking, and the balance defined as "no moat". This suggests that this portfolio is far more secure than average in this criteria.

In summary, I'd say that the portfolio is above-average quality in three of these four important categories, while still no lower than average in any category (average in overall business risk).

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!


JW

The Confused Capitalist

Buying a Dividend Machine

Photograph: Cash-Flow Machine.

It's easy to say, but often tough to do: buy something popular, before it's popular. As Yogi Berra was once reputed to have said, "It's easy to make money in stocks; just figure out which ones aren't going to go up, and don't buy them"

However, research has repeatedly shown that buying stocks that return money to shareholders, through dividends and/or share buybacks, consistently outperform the market, usually by a wide margin (2% or more).

The best buys however, are usually those whose cash returns to shareholders are just beginning to turn upwards, and those that operate in a protected or oligopolistic environment.

Cable and cell companies fit the bill in terms of limited competitors, and two stocks whose fortunes appear to be ascendancy are Rogers Communications, and Shaw Communications.

Both trade both in Canada on the TSX (RCI.B and SJR.B) and also on the US exchanges (RCI and SJR) respectively.

After a several decades of infrastructure build-out and crushing debt, Rogers is emerging as a cash-flow machine. According to a survey of analysts, as reported here, Rogers is predicted to increase dividends from $1.00 annually to $1.60 later this year, to $2.40 is 2009 and $3.20 in 2010. Morningstar provides some further information, here (note, however, that the dividend information is out of date, as it has been recently raised).

What is also interesting here, is that if the consensus dividend projections are correct, it suggests that the stock may well also be revalued significantly higher by 2010. Compared to its recent price at around $41 (Canadian) with a 2.4% dividend yield, very few quality stocks in Canada yield much over 4.5%. Assuming that the $3.20 in dividends by 2010 is correct, this suggests that the stock may well be valued by the market in the low $70 range at that time, with the distinct possibility of something higher.

Similarly , according to a story here, Shaw Communications, a cable and telephone provider expects to be able to continue churning out the dividend increases. Morningstar provides some further information, here (note, however, that the dividend information is out of date, as it has been recently raised). Shaw's recent price of $23 (Canadian) is producing a 3.2% yield, and it also appears that there may be room for significant upward appreciation of the stock price if the dividends keep getting raised.

In another story, Shaw was picked by analyst Peter Gibson at Desjardins Securities in his outperforming focus portfolio, as one of eight Canadian stocks with the potential to outperform the market. He also picked Rogers in that same portfolio.

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I expect both of these stocks to outperform the broader market over the next five years, and the current dividends (and expectation of future increases) make that prospect just the more tantalizing.


JW

The Confused Capitalist

EFT Benchmark: Broad Canadian Market "XIU" (on the TSX) - $80.40 (Canadian)

Thinking Ahead: Ten Years Out

One of the themes I've tried to engage readers in here, is that by playing some fairly obvious trends, and coupling those with reasonable valuations, is a relatively easy way to outperform the market.

One theme I've pounded on over the past one-and-a-half years is the emerging market theme. It doesn't take too much heavy lifting in the thinking department to realize that with soaring GDP growth rates of 8-12% annually in some of these countries, expecting their stock valuations to follow isn't much too much of a mental stretch, even for weak thinkers like me.

So, thinking ahead, and about 10 years out is a good target, it becomes much easier to think that an overweighted emerging markets position is likely to be both prudent, and very profitable. Now, the graphic above showing firestroms in California (currently displacing one million people) obviously suggests that this posting isn't about emerging markets.

That's correct - this is about alternative energy production. While climate change and global warming have been warned about and was easily readable in the popular media 20 years ago(Time Magazine, for instance, awarded Planet Earth as "Man of the Year" in 1989, due primarily to concerns about global warming), it's only recently that most people are finally waking up to the severity of the problem.

As the problem continues to grow in the public mind, so too will the demand for solutions. These will be invoked on a political and individual basis. As the negative consequences of inaction become more and more and more visible and the predictions more dire, many will begin making personal change AND demanding societal change. This is inevitable.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!)

What is also inevitable is major changes to our type of energy consumption and to the pattern of use. For instance, emerging economies will begin to use far more energy than in the past. This is good for them, but not good for the planet. The energy hogs of the planet - that's us in the western world - will finally begin to reduce consumption outright - not just on GDP weighted basis. Since we were "first in" to this pattern of inefficient energy use, it also is right that we strive to be "first out" of the pattern.

This brings us to our investment opportunity. Looking ten years, does anyone see a world in which the general populace isn't pressuring the politicians to fund alternative energy, to create incentives/disincentives to change energy use, and possibly even to restrict certain types of energy use? Perhaps rationing, a popular method for "spreading the pain" and acknowledging that we're all in this together, will become popular.

In any case, I personally cannot envision a world in 10 years where alternative energy isn't a significantly larger economic sector than it is today.

Of course, my much beloved ETFs provide a way to play this trend while avoiding single company risk. The recent launch of three ETFs targeting this sector might lead some to utter the usual cliques and say that this is a clear sign that this market segment has "topped". Yet the reasonable valuations, societal trends, and my common sense, tell me "no", that is not the case at all. And that is why I am willing to significantly overweight my portfolio to this segment.

While I do not pretend this is a comprehensive list, here are three ETF names in this sector:

Market Vectors Global Alternative Energy ETF (GEX) started trading on the New York Stock exchange. The fund, tracks the Ardour Global index (Extra Liquid), which is comprised of stocks in 30 publicly traded companies engaged in alternative energy production. These stocks are selected from a stable of 250 companies in this space. At least 30% of the names are not US-domiciled companies, and may therefore be attractive to those wishing some diversification out of the US currency. It is however, a relatively concentrated ETF, with 60% of the value being held in the top ten positions. Yahoo Finance shows the current PE as ~30.

Power Shares Global Clean Energy Fund (PBD) is based on the WilderHill New Energy Global Innovation Index. The Index seeks to deliver capital appreciation and is composed of companies that focus on greener and generally renewable sources of energy and technologies facilitating cleaner energy. The modified equal weighted portfolio is rebalanced and reconstituted quarterly. It currently holds 84 positions. It also has limited exposure to US companies, with only 26% of the ETF having US domiciled companies. Yahoo Finance shows the current PE as ~26, while information from PowerShares says the PE is ~42.

Finally, an all US domiciled companies is the First Trust NASDAQ Clean Edge ETF (QCLN)which started trading in February, covers five sub-sectors of the alternative energy industry: renewable power generation, renewable fuels, energy storage and conversion, energy intelligence, and advanced energy-related materials. The investment has above average concentration, with the top ten positions holding 55% of the value. It seeks to track the NASDAQ Clean Edge U.S. Liquid Series Index. Yahoo Finance reports the PE as ~25.

One caution with all of these ETFs is that they are presently quite small, none having assets of more than $100 million. But I predict that will change dramatically by the time 2017 has rolled around. Clean energy - a future whose time is now for the investor.



JW

The Confused Capitalist

I love you, I really, really, do

Are investors too much in love with stocks these days?

The reason I ask this question is obvious, given the recent Dow Jones records, but my interest was piqued by accidentally tapping a link that took me to the msn money web-site.

The so-called "Stock Scouter" on the site purports to show that in three categories of a) sector type, b) investing styles, and c) market capitalization ranges which is "in favor", "neutral", or "out-of-favor". Guess what?!

In all three categories (sectors, styles and capitalization ranges), there isn't a single thing that is "out of favor". Is this one of those contra-indicators, suggesting that the market is priced to perfection, with nowhere to go but down?


JW

The Confused Capitalist

Portfolio Management - Know what you own

I'm reading a very interesting book relating to risk management, Upside Downside: Simple Rules of Risk Management for the Smart Investor. As reported on another aspect of the book, over here, it's a light read and a rather small book - nevertheless, it has some good ideas.

This section of the book is pretty straightforward, simply telling investors that they should "know what they own". Advisors have often found that investors don't really "know what they own" - that is, they rarely deconstruct their portfolios to find out the overall composition. What this means is that you look at all the mutual funds/ETfs you own, you go to their web-sites and write down the 10 largest positions and also the sector orientations.

Do this for all your positions - begin to place them in a setting, the same way that you often see; Growth, Value, Small Cap, Large Cap and so on. Consider the weightings of your sector investments, and finally, consider the individual companies that are hidden within your funds, and also those as individual purchases.

In this way, you can begin to get some sense of how your portfolio might be exposed to the market, and you can consider scenario thinking, in analyzing its overall risk profile, so you can make sure you're happy with it.

Although it sounds simple, you might be surprised at the weightings or sector profile that your portfolio has "morphed" to, over time.



JW

The Confused Capitalist

Portfolio Construction - As easy as 1,2,3 - A,B,C

The other day I talked about portfolio outperformance, suggesting one method to outperform the broader market. This method, a "focused portfolio", has plenty of academic support for its effectiveness and rationale. Yet, it doesn't suit every investor. It's time intensive and requires at least average investing skills (i.e. the ability to read a balance sheet, earnings and cash-flow statements). So it's definitely not for everyone.

But the great thing about investing is that there is more than one way to "skin a cat", as the saying goes. That means you can outperform the broader market (which I define as the S&P 500), by doing other things well. One way is through asset allocation and the use of low-cost ETFs to build a portfolio.

A way to enhance these returns is by investing with history on your side - in other words, finding the type of investments that have historically produced above average returns. Of course, also investing with an eye to what the world might be like in ten to twenty years, is another way to boost your returns.

So, having said that, what are some practical ways to build a low-maintenance outperforming stock-market based ETF portfolio for the next ten to twenty years?

Firstly, to acknowledge that so-called "value" stocks and "value indices" produce better market returns - on average - than so called "growth" stocks and "growth indices".

Secondly, to consider that small company stocks traditionally produce better returns than large company stocks.

Thirdly, to see the rapid rise of the emerging markets, and to acknowledge they are likely to be far larger in twenty years than today (they are producing about 20% of global goods today, yet their stock markets only hold about 5% of the capitalized value of stocks in the global economy).

Fourthly, that these advantages should also be stabilized with some large company stocks and broad-based market exposure, that will produce relatively reliable returns over a longer period.

Fifthly, to consider that the US trade and fiscal deficits are likely to continue impairing the currency for a while longer, and therefore willingly have greater than average exposure to other markets.

Finally, to consider your particular own thoughts and ideas, and to add these into the mix somewhat. This might be the idea that health-care stocks will prosper into the future, or perhaps that technology stocks now appear reasonably priced, or that commodities appear to have a bright future for the next five to ten years. Whatever - the point is is to add one or two of those themes into your overall investing mix, if you feel comfortable doing that.

Now, here is a sample portfolio I've constructed that I think would be suitable for an investor with a twenty year horizon (this is the all-stock market portion of the portfolio), and with a willingness to overload promising positions, as discussed recently. For the twenty year investor, this is the type of portfolio that probably needs only to be re-visited and re-balanced every five years or so. So remembering our themes of:

1. Value orientation;
   
2. Small companies orientation;
3. Emerging Markets exposure;
4. Some Broad-based;
   
5. Consideration of currency implications (ie more exposure to international);
   
6. Your own ideas (in this case, mine);

here's the low-maintenance ETF portfolio I'd construct with an eye to the next twenty years:

1. 20% Broad-based international - EFV - $64.91 - ishares product tracks the MSCI EAFE Value Index, which tracks European, Australian, and Far Eastern markets. This index has outperformed the broader (non-value) index MSCI EAFE index by about 2% annually over the past five year. Five year return on the index is 11.7% annually.
2. 20% Small company - IWN - $74.99 - ishares product tracks the Russell 2000 Value Index (US small cap). It has outperformed the broader (non-value) Russell 2000 Index by about 3.4% annually over the past five years. Five year return on the index is 16.2% annually.
   
3. 25% Emerging markets - EEM - $105.45 - a broadly-based (for emerging markets) ishares product tracks the MSCI Emerging Markets Index. Five year return on the index is 23.2% annually.
4. 20% S&P 500 - IVE - $70.62 - an ishares product tracking the value portion of the S&P500. Produced a 5.0% annual return over the past five years, beating the broader based S&P500 by 1.0% annually.
5. 15% Own Ideas (in this case, my belief that commodity-oriented countries will do well for the next five to ten years). I'd equally weight a Canadian ETF (EWC) - $24.86 - and a Brazilian ETF (EWZ) - $44.25 - or Australian ETF (EWA) - $21.94. Five year returns on these indices have ranged from a low of 18.2% to 27.9% annually.
   

Now, you lose a little bit due to the management expense ratios but, over a decade or so, this looks to me like a portfolio that should significantly outperform the S&P500. By comparison, SPY is trading at $131.47.

Of course, you can always tinker with this, but this is a simple, pretty well-balanced stock portfolio, constructed with the aforementioned moderately overweighting themes in mind. I personally would sleep very easy with this portfolio. We'll check back in with this model portfolio in six months to a year.



JW

The Confused Capitalist

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