Streetwise

Lauren Rudd

Sunday, December 2, 2012

Keeps You Away From the Eggnog

The period between Thanksgiving and the start of the New Year is an excellent time to work on your portfolio. In doing so, you should strive to create a return that exceeds the sum of what a 30-year treasury bond would pay, along with what you will lose through taxes and inflation with a kicker for risk.

The guideline I give my students is a minimum compounded annual growth rate over 2-3 years of 12 to 15 percent. A prudent stock selection process should enable you to meet that objective and probably even surpass it. On the other hand, some like Warren Buffett believe that future long-term stock market returns can be estimated as nominal GDP growth plus expected dividend yield.

According to that formula an estimated 3 percent nominal GDP growth rate plus a 3 percent dividend yield equals an expected long-term total return of 6 percent. However, to invest in stocks you want a greater reward for the risk entailed, so I use a minimum of 12 percent.

To achieve your returns, you are looking for those companies that have successfully weathered the Great Recession and are now on-track to follow the economic recovery as it unfolds. However, you are going to need an edge. If you want to become a market-trouncing master strategist, your knowledge of a given company must be superior to that of the great unwashed. So where to begin?

For those of you who need little help or motivation to get started, each year at this time I provide you with a dozen possible research candidates. To make it interesting, I then review their performance a year later.

Here are the stocks from last year and their one-year performance. I have provided you with two numbers for each company. The first is the percentage capital gain without taking into account dividends and the second is the dividend yield.

Church & Dwight (CHD, 21.6, 1.8), Coach (COH,-9.2, 2.1), Decker’s Outdoor (DECK, -66.1, 0), Joy Global (JOY, -37.9, 1.2), Kimberly-Clark (KMB, 21.5, 3.4), McDonald's (MCD,-9.9, 3.6), MWI Veterinary Supply (MWIV, 65.2, 0), Annaly Capital (NLY, -9.6, 13.6), Southern Copper (SCCO, 15.2, 10.2), Terra Nitrogen (TNH, 38.6, 7.6), Valspar (VAL, 70.3, 1.3),  VF Corporation (VFC, 11.2, 2.2).

In summary, the 12 stocks produced a one year total return of 10.8 percent. Did every stock perform well? No, but that virtually never happens; it is the overall total return that matters. However, in self-defense, if this had been a managed portfolio, DECK and JOY would have been eliminated early on.

During the same period, the Dow Jones Industrial Average chalked up a total return of 8.07 percent and the S&P 500 index a 13.5 percent total return, according to Morningstar. So even with one stock losing 75 percent of its value and another losing 49 percent, overall the group still produced a return between that of the Dow and the S&P 500. And there is talk on the Street that DECK could be in play soon, meaning it might be acquired by another company at a premium price.

Yet, all this is ancient history. The key question is what 12 stocks can I come up with that might tickle your fancy going forward? Here is my list: I am staying with Southern Copper (SCCO), Terra Nitrogen (TNH), Valspar (VAL), and MWI Veterinary (MWIV). To that group I am going to add Apple (AAPL), American Capital Agency (AGNC), National Retail Properties (NNN), Kinder Morgan Energy (KMP), Gilead Sciences (GILD), Abbott Labs (ABT), Aflac (AFL), and PetSmart (PETM).

In today’s market environment dividends are crucial to your portfolio’s performance, despite any potential tax increases. Therefore, it is important to note that every stock, with the exception of Apple and Gilead, has a multi-year track record of paying and raising dividends.