The period between Thanksgiving and the start of a 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 along with an equity kicker for risk.
The guideline I give my students is a minimum annual return of 12 to 15 percent. A prudent stock selection process should enable you to meet that objective. On the other hand, investors 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, next year's estimated 2.8 percent nominal GDP growth rate plus an average 3 percent dividend yield equals an expected return of 5.8 percent. Many believe an additional 3 percent should be added for the risk you underwrite by investing in stocks, bringing the minimum expected return to 8.8 percent. However, as mentioned above, I believe in a minimum total return of about 12 percent.
To achieve that goal, you will need to become a market-trouncing master strategist. Your knowledge of a given company must be superior to that of others. To help in your search, each year at this time I offer up 12 possible research candidates, whose performance I review a year later. (Note: Abbott spun off AbbVie, resulting in 13 companies this year.)
Here are the stocks from last year and their percentage gain or loss: Looking at the equities, Apple (AAPL) down 3.4 percent, AbbVie (ABBV) up 43.3 percent, Abbott (ABT) up 23.1 percent, Aflac (AFL) up 24.2 percent, Gilead (GILD) up 95.9 percent, MWI Veterinary Supply (MWIV) up 55.5 percent, PetSmart (PETM) up 4.6 percent, and Valspar (VAL) up 14.5 percent.
The capital appreciation for this group was 21.78 percent with a dividend yield of 2.01 percent for a total return of 23.79 percent versus about 29 percent for the S&P 500.
To offset the aforementioned low dividend yield, the other five issues were split between master limited partnerships and real estate investment trusts, both of which pay out about 90 percent of their earnings to avoid federal income tax. Therefore, they generate a high dividend yield that is directly proportional to earnings.
Unfortunately, rising short-term interest rates put a lot of pressure on these two sectors. In addition, actions by China further damaged the share prices of Terra Nitrogen and Southern Copper. Both companies are major players in their respective markets but were forced to deal with exogenous issues beyond their control.
Here are the performances: American Capital Agency (AGNC) down 34.5 percent, Kinder Morgan Energy Partners (KMP) up 1.5 percent, National Retail Properties (NNN) up 2.1 percent, Southern Copper (SCCO) down 31.4 percent and Terra Nitrogen (TNH) down 23.2 percent. The capital appreciation for this group was a negative 13.4 percent but with a dividend yield of 8.5 percent.
For the full group of 13 securities, the overall dividend yield was 3.82 percent with an overall capital appreciation of 12.06 percent for a total gain of 15.88 percent, which is in line with the previously stated goal of 12 to 15 percent despite the agonizing returns from the MLPs and REITs.
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? In today's market environment, dividends are increasing crucial to your portfolio's performance. Therefore, I will concentrate on companies that have a multiyear track record of not only paying but also raising dividends.
Next week I will give you my suggestions for the upcoming year and provide a little background as to why they were selected. Please keep in mind that these lists are not intended to be an instant portfolio where you simply add water and stir. Rather, they are designed to be a catalyst to stimulate ideas and thinking on your part about possible sectors and companies you might want to investigate. And hopefully doing all that research keeps you away from the eggnog.
Lauren Rudd is a financial writer and columnist. Write to him at LVERudd@aol.com.