Two Steps to a Solid and Profitable Portfolio

Solid and Profitable PortfolioWhen it comes specifically to dealing with stocks, creating a portfolio does not need to be complicated.

Depending on your goals, any equity market portfolio is well served by a handful of anchor positions. These are stocks representing underlying businesses with long track records of wealth creation. Preferably, they pay dividends, and those dividends can be reinvested into new shares if the income is not required.

All stocks are volatile and inherently risky securities (The Procter & Gamble Company [PG] had an earnings miss in 2000 and took six full years to recover).

While buying and selling stocks are business decisions, the stock market is an emotionally driven secondary market of corporate ownership. Within it, however, investment risk can be managed through diversification and the quality of the underlying businesses themselves.

Choosing five core anchor positions is a good way to start. I’m a huge believer in dividend income; and if that income isn’t required, dividend reinvestment compounds your returns and is a solid path to genuine wealth creation from the equity market.

The following are five examples of stocks that may be considered as core positions.

1. Johnson & Johnson (JNJ): With more than 50 years of consecutive dividend increases, Johnson & Johnson is a dividend-paying blue chip with three main business lines, including consumer products, pharmaceuticals, and medical devices. The company typically announces a quarterly dividend increase in the second quarter of the year.

2. Colgate-Palmolive Company (CL): A well-known producer of toothpaste, soap, deodorant, and dog food, Colgate-Palmolive is a consistent grower of diluted earnings per share and dividends, and a consumer products favorite.

4. 3M Company (MMM): A top conglomerate in industrial, safety, healthcare, consumer products, electronics, and energy, in 2013, 3M paid $1.7 billion in cash dividends and bought back $5.2 billion of its own shares. The company has increased its annual dividend to shareholders for 55 consecutive years.

5. NIKE, Inc. (NKE): Specializing in footwear and apparel, NIKE has offered an annual dividend increase for the last 11 years. In its fiscal second quarter (ended November 20, 2013), NIKE saw an eight-percent gain in sales from continuing operations and a 12% increase in global future orders.

6. Kinder Morgan Energy Partners, L.P. (KMP): One of the largest master limited partnerships and the largest natural gas pipeline and storage operator in the U.S., Kinder Morgan provides oil and gas transmission and storage. The company’s fee-generating assets produce stable cash flows, and its current yield is 6.6%.

Core positions can be accumulated over time and dividend reinvestment is an excellent way to increase your holdings in a cost-effective manner. Positions can be reviewed quarterly.

Now, hopefully there’s room in your portfolio for a handful of more aggressive stocks. These are the speculative positions for capital gains.

Restaurant stocks can be good moneymakers as new chains continually come to market. Large-cap biotechnology stocks always offer lots of action, too.

Pure-play technology is attractive, but not products that are easily commoditized. (See “A Must-Read for Long-Term Equity Investors.”) Likewise, cloud-based software and data optimization companies are quickly growing.

Finally, resource stocks can make money, but they are highly cyclical and always tied to underlying spot prices. Turnaround or penny stocks are time-consuming and not really worthwhile when broader market action is good. But there are always exceptions.

Overall, risk control is more important than potential return, which is why a portfolio of conservative, core positions can easily handle a few high-flyers. At the end of the day, valuations and expectations are all relative. Anything can happen to any stock, so some diversification is useful.