Wednesday, May 2, 2018

Starter Portfolio of 5 percenters

I write for the individual, ordinary investor who wants to manage or monitor their own income stocks.  In this post I am looking at stocks that I call my "5 percenters."   These stocks are intended for retirement accounts.  Therefore, the universe of stocks does not include master limited partnerships due to their complicated tax implications.

  • Three percent is not enough
  • A pristine balance sheet is critical
  • Value is important
  • Dividend increases are desirable

Three Percent is not enough


When you can buy a totally safe instrument such as U.S. Treasury bonds that pay you 3%, why would you risk exposure to a stock?   Reasons are: (1) you either don't really need more than 3 % to live or (2) you think there is stock appreciation potential which you will tap for income by selling some shares. 

I have never been comfortable with the idea that I have to sell some shares to meet my income needs. Perhaps I have been in this business too long and know what can happen to stock prices in what seems like an instant.   1987, 1992, 1994, 2001 and of course the 2007 - 2009 debacle are fresh in my mind.

Another reason is my very low risk tolerance, especially in retirement account investments.   Once you retire, you cannot re-fill the coffers should you suffer a loss.  Moreover, so many people end up selling during a rout instead of waiting it out.   

You can wait it out better if you know your income will continue during times of turmoil.  If you don't look at the stock prices and only look at deposits from dividends and interest, you can make it through these difficult times.

I am not suggesting the stocks in my "5 percenters" portfolio will not suffer price declines.  I am suggesting, they will pay you an average of five percent and may even increase your income over time.

Selection criteria


I found five stocks that would make a good starter portfolio for retirees like me who need five percent.  I did not include any MLP's (master limited partnerships) that can deliver really high yields but also have complicated tax implications.

The average yield of these five stocks is 5.22%.  The range is 4.26% - 6.1%.  

Several stocks did not make the cut due to balance sheet issues.  I want a really solid balance sheet as measured by D/E ratio (debt to equity.)   General guidelines suggest a D/E of one or less or within industry standard is a desirable hurdle.  

The average D/E ratio of these five stocks is .59.  The range is .11 - .89.  All are within industry standard.

Earnings always have to exceed dividend paid out and some dividend growth is desirable.  

Value


Let's assume, the investor reading this post has just received their corporate retirement payment.  Now they have to invest it.  You don't want to start by buying high.  Nothing can make a new retiree more uncomfortable than seeing the value of their holdings go down and that can happen in the best managed portfolios.

I am using P/E ratio (price earnings ratio) to measure value.   Current common wisdom suggests many good stocks are over valued.   Stocks are considered cheap when their P/E ratio is under 15 and expensive when their P/E ratio is over 20.   

Growth stocks almost always carry a high P/E ratio.  If you are going to live a full and long retirement, you will need some growth but this post highlights five stocks to consider not for growth but for five percent income.  

The average P/E ratio of these five stocks is 12.20.  The range is 6.61 - 17.64.

My Five 5 Percenters


Years ago when I would advise a client on a starter portfolio it almost always included names like Johnson and Johnson (JNJ).   Today stocks like JNJ pay too small a dividend.  JNJ's yield is not even 3%.   And, JNJ has had some earnings issues making their current P/E quite high although, JNJ will improve that metric in 2018.  

The five stocks I have selected are quite diversified and I am pleased to see that result.  I did not go into this study trying to find diversification, but I did hope to end up with a diversified portfolio.

All data is on the five percenters is presented below.

DIVIDENDS


In the table below, I bought $40,000 worth of each of the five stocks.  You can see the dividend income and yield.




Investors who want to live off of their dividends and interest payments, need to look carefully at this chart.  This chart presents very realistic expectations of income from dividend stocks.

BALANCE SHEET, DIVIDEND INCREASES & VALUE


In the table below, you can see the EPS (earnings per share) as compared with dividends paid out.  Also note  D/E ratios of these five stocks.  Finally P/E ratios are displayed.  P/E ratios are based on previous earnings rather than future earnings.  However, when I look at projected earnings the P/E ratios change only a bit.  T's P/E is projected to increase from 6.61 to 9.60 and NHI's P/E is projected to decrease from 17.64 to 12.41. 

Also presented are the dividend increases over the past four quarters.  To calculate dividend increase %, I summed the most recent four quarter dividends, and compared them with the prior four quarters to create the dividend increase %.



Everyone of these stocks has some trouble.  That is why they are considered cheap.  Yet I believe their fundamentals are strong enough that I am using them in my personal portfolio to create 5% income.




M* MoneyMadam
Disclosure:  Long all stocks discussed