A Basic 5 Stock Portfolio for Beginners

Disclaimer:

***I own all 5 stocks mentioned below.  Also, the following is not a stock recommendation.  I don’t know you or your situation.  Stock investing is supposedly not for everyone and involves risk.  If you want to know what a year like 2008 feels like, it’s a lot like having to throw up and having a diarrhea attack at the same time, while only having one bucket to use…what do you do?***

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Graphic!  So with that out of the way, I am always going to be an advocate for stock investing all of my life.  No really, I don’t care if I’m 90 years old, I’ll always be 100% stock all the time.  A few reasons: I can make more from the markets than working a good paying day job without putting up with the BS, at the same time paying lower taxes on my “income”, cash flow from dividends coming in each month to live off of, those cash flows grow every year outpacing inflation, low transaction cost, and liquidity-just a few clicks of my mouse and I can raise some cash if needed.  You can read more about it here if you like and see funny videos and gifs while you’re at it.

So a question I get emailed from time to time, where do I start with stock investing?

I’ve brushed those email off, but figure I’d do a general post.  There’s some psychology BS about Maslow’s Hierarchy of Needs.  It’s about covering your basic needs and moving up some pyramid to achieve self actualized needs.  Self actualized needs sounds to me like reincarnation or achieving nirvana or some crap.  Hell it could just be finding a taco bell to satisfy your munchies for a stoner.  I don’t know.

Here’s the pyramid, to judge it yourself:

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So back to the “where do I start” question for stock investing.

I believe a good foundation for any stock portfolio can be covered by 5 basic stocks.  Yep 5.  Hell, I’m confident you can even just use 5 basic stocks to cover the majority of investment needs that creates a diversified enough portfolio to match or beat the S&P 500 over the long haul.

The 5 Stocks to build your portfolio on: Altria (MO), Johnson & Johnson (JNJ), ExxonMobil (XOM), Procter & Gamble (PG), and 3M (MMM).

For those who don’t know Altria, think Marlboro Cigarettes.  Ding, Ding, Ding… Big Tobacco.

So let’s look at each company individually first, then collectively as a portfolio, and then compare the numbers to the S&P500 over the last 10 years.  I won’t do a comparison going back to 30 years, because it’s just ridiculous.

So, let’s start the sales pitch:

Altria (MO)

One of my absolute favorite companies and currently the largest holding in my portfolio.  MO is the largest player in the world of tobacco.  Go ahead and judge me for investing in them, I’ll dry my tears with the fat dividends I receive.  Also, get over it, obesity has long been the biggest cause of death in the States for a while now, so turn your hate towards the fast food and sugary beverage world, or just our populations lack of exercise.  Rant over.  Altria is best know for it’s Marlboro brand of cigarettes (among others), but is also in the cigar world, smokeless tobacco products, owns some of the largest wineries, and also a large ownership stake in SAB Miller.

I don’t say this about many companies (especially the last place I worked), but this company has the smartest team of managers and lawyers out there.  Why would I say that.  Well, did you know that Kraft Foods was once under the umbrella of Altria.  Yep, back in the day you socially responsible investors were once supporting Big Tobacco by purchasing mac n’ cheese for your kids.  Fun little ironic fact.  They have also spun off Philip Morris (PM) into it’s own international maker of Marlboro brand cigarettes.

Now why would a company spin off 2 companies from itself?  While overall I’m not a fan of spin offs, because they can sometimes screw shareholders into owning 1 good company and 1 crap company (I’m looking at your DuPont), they can sometimes work out (I’m looking at you Abbot Labs and Abbvie).  I would be crazy to doubt the reasons MO decides to do a spin off.  Think about it?  What the biggest risk to investing in a tobacco company?  Litigation.  Yes, law suits.  A way they diversified assets away from litigation is to spin off the company into it own entity.  Take Kraft out of the equation from lawsuits over tobacco products.  Same for spinning off PM.  Instead of being a target to worldwide lawsuits from governments, spin off a branch into the international arm of your cigarettes.  They effectively have diversified their company from lawsuits against them.  Also the PM spin off provided a hedge from exchanges rates, MO did not get affected from the strong dollar impacting international sales at all, PM did, genius.  So, yes I think Altria has some of the best management talent out there.

Some fun stats on MO: Market Cap $135Billion, Currently trading at near all time highs, current dividend yield of 3.27% (at the lower end historically because the stock price has been going gangbusters for years), profit margin of 28%, managements goal is to return 80% of earnings to shareholders as dividends, P/E of 24, 46 years of growing their dividend, 10 year dividend growth rate of 11.6%, beta of 0.66

Risk involved: Law suits, declining number of smokers in the US although smokeless use is growing

Johnson & Johnson (JNJ)

One of the ultimate grandma stocks that kicks ass.  I really don’t know what to say about this company that hasn’t already been said.  I mean Warren Buffet loves this company, why wouldn’t you.  They make band-aids, baby shampoo and powders, and products for consumer health care, all the way up to expensive medical devices.  Your bathroom is probably full of their products, Tylenol, Listerene, and Visine to name a few, and you probably didn’t realize it.  So I really, don’t have anything to add, except you probably use a lot of their shit.

Some fun facts on JNJ: Market Cap $344Billion, Currently trading at near all time highs, current yield of 2.56% (a little lower than historically, because of the stock price appreciation, profit margin of 21.92%, P/E of 23, 54 years of growing their dividend, 10 year dividend growth rate of 8.8%, beta of 0.80

Risk involved: I guess the occasional Tylenol recall, to a degree: general macro economic risk, exchange rates

ExxonMobil (XOM)

The world’s largest oil and natural gas producer and explorer.  They have the most conservative balance sheet in their industry and are atop the food chain in the world of oil.  That conservative balance sheet allowed them to increase their dividend the last 2 years, while most of the competition has either maintained or worse SLASHED their dividend. The conservative balance sheet also helped the stock price take less of a hit compared to the competition.  The stock is around 15% off its all time highs and we have yet to see a real rebound in the price of oil.  I expect great things to happen when (not if) oil goes back around the $100 barrel level.  I’ve already written extensively on some of the math behind XOM comparing it against the S&P500 about a year ago, check it out if you like.

While electric cars will continue to increase in popularity among consumers, I don’t think it will reach critical mass to dent the need for oil.  Also when looking at how goods are transported around this country, battery capacity is just not even close to being able to replace an 18 wheelers need for gas.  I also think it would be naïve to think another war would not break out in the Middle East, leading to a rise in crude.  Also, the Middle East, Russia, and South America hate light sweet and brent at the current levels.  OPEC is bound to agree to cut output levels to help their economies.  Any spike in oil prices is goes for XOM’s upstream business.  Don’t forget China, as their middle class grows, they’ll eventually desire to have cars instead of mopeds to get around.  That’s a lot of potential oil to be burned.

Some fun facts on XOM: Current market cap of $389Billion (formerly largest company in the world), in the past at high oil prices was consistently post quarterly profits of +$10Billion, currently trading about 15% off all time highs, current yield of 3.19% (about par for the course), profit margin of 5.92% (oil prices are low), P/E of 30 (way higher than normal-which is the 11 range), 34 years of growing their dividend, 10 year dividend growth rate of 9.7%, beta of 0.90

Risk involved: Oil leaks, refinery fires, foreign governments taking over plants, push towards energy independence, consumer demand during recessions

Proctor & Gamble (PG)

PG makes a bunch of consumer staples products that you pick up at the grocery store.  While there are some competing products with JNJ, the vast majority of their product lines differ.  PG is one of the dozen companies that controls the grocery store aisles.  While the company as of late has struggled with growing their bottom line, management is trying to divest some of the lower revenue growth brands to bring the focus back to growing EPS.

Some fun facts on PG: Current market cap of $227Billion, trading about $10 off all time high, current yield of 3.14%, profit margin of 12.74%, P/E of 28, 60 years of growing their dividend, 10 year dividend growth rate of 9.2%, beta of 0.65

Risk involved: Exchange rates, consumers using generic brands, general macro economic environment

3M (MMM)

MMM is a giant industrial company making a ton of products for both consumer and business use.  Everything from the all mighty Post It note to automotive adhesives and abrasives to name a few.  Their product line up and broad industry exposure is mind boggling.

Some fun facts on MMM: Market cap of $110Billion, trading near all time high, current yield of 2.45%, profit margin of 16.31%, P/E of 23, 58 years of growing their dividend, 10 year dividend growth rate of 9.3%, beta 1.05

Risk involved: Exchange Rates, general macro economic environment

So How Do These Companies Look as a Portfolio

For simplicity sake, I’ll just assume an equal weighting across the 5 stocks.  In other words, 20% allocation across the 5 stocks.

So on the above table, you can see what the average returns, portfolio dividend yield, 10 year dividend growth rate, and beta for the 5 stock portfolio.  All figures based on the 7/20/2016 closing values.  This leads us to:

Comparing the 5 Stock Portfolio vs the S&P500

Now lets compare the snoozer portfolio created above to the S&P500 index:

This is where it gets interesting.  You’ve seen me write “boring is beautiful” on my site multiple times (even my layout is generic, it’s like the craigslist of personal finance sites, right?). Comparing my boring 5 stock portfolio (buy and hold) vs the S&P500 you see a difference over a 10 year period of 4.396% PER YEAR.  Those return figures don’t even include the dividend.  Looking at the difference in the dividend yield, the boring 5 stocks nets you almost 1% more in yield (0.902).  Oh let’s not forget beta (a risk measure).  The beta on the 5 stock portfolio is actually lower.  So lower risk, higher return.  I think that’s something actively managed funds try for, but fail to actually do most of the time and charge high fees on customers.

Conclusion

So there you have it, a basic 5 stock portfolio you can easily build, sit on it for life, receive income from, let that income grow, and not really put any effort into it.   Before leaving, are you curious what that 4.396% difference translates into dollar wise?  Over a 10 year period (time frame we’re looking at), based on $100,000 (an amount anyone should be able to muster  up), that 4.396% difference equates to a difference of $53,758.30 in your pocket.  For someone with a sweet million, the difference is $537,583.06.  It makes a huge difference anyway you look at it.

Not bad for being lazy and boring (and again, we’re not factoring in dividends).

Lets also look at the dividend income and what is happening there.  We see the yield of the 5 stock portfolio is currently at 2.922%.  On a million dollar portfolio, that is generating $29,220 in dividends a year.  Not bad, especially for those looking to do the 4% withdrawal rate.  Just like any good infomercial, but wait there’s more.  Let’s assume we do get that same dividend growth rate over the next 10 years for fun (9.72%).  Over the next 10 years, the cash coming in the door from dividends on that million balance is $73,881.92.  An increase in your dividend income of 152.84% over 10 years.  Also notice the rate at which your passive dividend income has grown (9.72% per year), that far outpaces the current and recent past levels of inflation by quite a bit.  Not a bad inflation hedge and where else do you get pay raises of almost 10% a year, not at your job.

I’ll say it again: boring is beautiful.

This discussion comes from emails I’ve received, but also friends, and former co-workers asking about this stuff (wait investment advisors asking for help with investing…take you money elsewhere. RUN!).  Where do I start stock investing and is early retirement really possible are the 2 most frequently asked questions I get.  You can try getting cute with stuff sometimes, but really it’s not necessary.

 

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Readers Comments (5)

  1. Impressive data and results. All are solid companies that I own (or have been on my radar). But I’ve never looked at them as a group or compared with the S&P500. A lot to consider.

    • I stopped at the 10 year, because if you go further there’s an even bigger disparity in the comparison.

  2. Five stocks is super simple and saves you on the trading costs. I personally want to switch out Exxon for WW Grainger, and Altria for Archer Daniels Midland. I like Grainger, because things will always need to be repaired and I like ADM because farms will always exist.

    • I actually go back and forth on PG with Clorox (CLX) or Kimberly Clarke (KMB) as an alternative. I own all 3, but figure PG is more broadly diverse for someone starting out.

  3. Most what i read online is trash and copy paste but i feel you offer something different. Maintain it like this.

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