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In the summertime, many of us would rather enjoy the outdoors or travel than be chained to our computers watching our stocks.
With that in mind, a little more than a year ago I came up with a low-maintenance portfolio, a group of 12 stocks that didn't require a lot of baby-sitting.
I built the portfolio by screening for profitable companies that pay relatively high dividends. From that list, I zeroed in on the few stocks in the group with two qualities that you don't often find in the same stock: low risk and strong price-appreciation potential.
I'm telling you about this because a week or so ago, I checked up on how my portfolio had fared.
Since May 8, 2006, when I ran the screen, my 12 low-maintenance stocks had averaged a 41% return. The overall market, at least as measured by the Standard & Poor's 500 Index ($INX), had returned about 16% during the same time frame.
Even better, unlike so many instances when strong portfolio results are driven by one or two outperformers, only one of my stocks dropped, and that was by only 5%.
Encouraged by those results, I used the same screen, with just one small modification, to create a new low-maintenance portfolio. Here are the details:
Real profits
Profitability means more than reporting positive earnings at the end of the quarter. You also have to consider how much a firm's shareholders had to invest to generate the earnings.For instance, say two companies both reported earnings of $1 million last year. But Company A's shareholders invested $10 million to get that return while shareholders had to sink $100 million into Company B to turn the same profit.
In that example, Company A's shareholders are getting a 10% return on their invested capital compared with only 1% for Company B.
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There are three widely used profitability measures: return on equity, return on assets and return on invested capital (ROIC). For this screen, I used ROIC, which compares net income with the total of shareholders' equity (book value) plus long-term debt. Values can range from negative numbers for unprofitable companies to 25% and sometimes higher.
I require a minimum 10% ROIC. Here's why: Corporate bond rates are running at about 6%. If a 10% ROIC firm borrows funds at 6% interest, it would net 4% after servicing its debt, a significant profit. By contrast, a lower-profitability firm, say with 5% ROIC, could not profitably borrow to fund expansion.
Try moving the minimum down to 9% if you want to see more stocks.
Screening parameter: Return on invested capital >= 10
Dividends make it work
High-dividend yields help to reduce risk.Dividend yield is the expected dividend for the next year divided by the current share price. For instance, the yield would be 5% for a stock trading at $20 per share that is expected to pay out $1 per share over the next year ($1 divided by $20).
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If investors see the dividend as secure, a high yield will temper share-price downdrafts when things go wrong. For instance, say the $20 stock I just mentioned drops to $15 but that it is still expected to pay out $1 per share in dividends over the next year. Its yield to new investors jumps to 6.7% ($1 divided by $15), a figure high enough to attract more buyers.
What's a high enough yield? I arbitrarily set my minimum at 4.5% because yields above that figure seem to attract investors' attention. You could increase that figure up to 5% or so, but don't reduce it.
Screening parameter: Current dividend yield >= 4.5
When I checked, 145 stocks met my profitability and dividend-yield requirements. Next, I pinpointed the lowest-risk stocks in that group.
Yes, it matters
Small companies are inherently riskier than larger ones. They typically don't have the product diversification, financial stability or experience to ward off new competition or economic downturns that bigger companies do.Market capitalization, which is the number of shares outstanding multiplied by the current share price, is the way most investors measure company size. It's how much you'd have to shell out to buy all of a company's shares.
Definitions vary, but market caps below $1 billion or $2 billion usually define small-cap stocks, which are the riskiest bets.
Last year, I set up my screen to rule out stocks with market caps below $1 billion. This time, I'm getting a little more conservative and raising my minimum acceptable market cap to $2 billion. Try lowering that figure to $1 billion if you want to see more stocks.
Screening parameter: Market capitalization >= $2 billion (entered as 2,000,000,000)
Continued: Listen to the analysts
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