Bruce Lee, one of the greatest martial artists of all time, used to believe that the abdominal muscles were the key muscle group to develop, since virtually every movement involved their use. A martial artist with a weak core had no business sparring, he reasoned. Similar to investing, the Core Holdings of a portfolio provide the foundation and structural support needed for victory.
When times are good and the economy is surging, any geek off the street can pick a stock at random and succeed. However, when the going gets rough, that’s when you will thank your lucky stars that you invested in sound companies.
When picking Core Holdings, it can be helpful to analyze past data. Although past performances will not predict future successes, until we find a way to build an anti-causal system, this is the best we can do. In particular, confidence can be gained by specifically analyzing the rough times (depressions, recessions, financial crises, etc), and observing which companies not only survived the storms, but continued to thrive throughout them.
For my own personal criteria, I am most keen on investing in companies that have a proven track record of:
- Continuing to grow the dividend in spite of tough economic times
- Strong balance sheet with minimal debt-to-equity (this is extremely important as free cash flow ensures the dividend can be maintained even if earnings miss from time to time and the payout ratio swells)
- Offer products and services that are always in high demand, regardless of the state of the economy
- Have a strong presence in the global marketplace, not just the local economy
- Are leaders that dominate their respective markets (either due to leading edge technology, strong barriers preventing others from entry, or simply due to strong marketing which has created a household name)
When searching for these stellar companies, a good place to start is to look at the Dividend Aristocrats list. To qualify as an aristocrat, a company must have raised its dividend for a minimum 25 consecutive years.
Here is a link listing the 2012 Dividend Aristocrats:
Choosing the core is not an exact science, but my general rule of thumb is to pick 5 or 6. Each holding should represent between 3% to 10% of the total portfolio’s value.
These are the companies I have qualified to be Core Holdings in my portfolio*:
- Chevron (CVX)
- Johnson and Johnson (JNJ)
- Procter and Gamble (PG)
- Coca Cola (KO)
- McDonald’s (MCD)
*At this time of writing, I have only initiated positions with: CVX, PG, KO
I couldn’t identify a clear consensus pick for the #6 position (KMI?, EPD?), so will go with a Starting 5 for now.
Here is data highlighting the dividend growth starting from January 2, 2002 up to October 1, 2012. We assume an initial investment of $1000 for each holding, for a total of $5000.
For each company, you’ll notice the dividend was not cut, and in fact, increased every year during the Great Recession of 2008-2009.
CVX Data: Dividend Growth Rate (2011) = 9.2%
JNJ Data: Dividend Growth Rate (2011) = 12.3%
PG Data: Dividend Growth Rate (2011) = 11.22%
*Excludes June 2002 special dividend due to Crisco/Jif spin-off
KO Data: Dividend Growth Rate (2011) = 9.96%
MCD Data: Dividend Growth Rate (2011) = 30.22%
The average dividend growth rate for the Core Holdings is 14.57%
The total payout in dividends for each $1000 investment are as follows:
We would have received 42% of our initial $5000 investment back in dividend payouts over the 10 years.
The value of the shares is $10,623.95
The total value is $12,705.45
These type of gains might not seem too impressive, or astronomical to those who like to trade and play with options (especially with volatile tech stocks). However, I’ll gladly take these results and not have to deal with the stress and anxiety associated with trading.
I’ll also take comfort in knowing that I am investing in large-cap industry leaders who have proven that they can consistently increase earnings + dividend payouts. Even better, each one of these companies has proven that they can withstand even the worst economic crashes, and still bounce back stronger than ever. How’s that for peace of mind?
What companies make up your Core? Do you believe in designing around a Core, or do you prefer to have an evenly distributed allocation across all holdings?