Three Steps To A Diversified Income Porfolio

8/25/2014


Plenty of subscribers have asked questions like this one: "How can I collect more income from my stock portfolio?"

It's an understandable question, but not the right question, and I don't have a good answer for it. "Stick with high-yield stocks," is the most obvious answer, though not a particularly wise one.

Investors who load up on high-yield stocks can easily end up with most of their money in small slivers of the market, taking on more risk than they intend. Bonds pay higher yields and provide less-volatile returns than stocks, but also tend to underperform stocks over long periods.

Most investors should own a mix of equities and fixed-income securities. For many investors, the greater their cash-income requirements, the larger the role fixed-income plays in their portfolios. However, it can make just as much sense — and provide higher total-return potential — to maintain a higher stock allocation and periodically sell stocks to augment the cash generated by fixed-income holdings. For the equity portfolio of your portfolio, as a rule the Forecasts advises income-oriented readers to stick with the best available stocks rather than the highest-yielding. Which leads to a better question: "How can I make the most of my dividend-stock portfolio?"

That question, I can answer with confidence.

1) Stick with strong Quadrix® scorers. Our research suggests that portfolios containing stocks with high Overall scores not only outperform but also provide greater diversification benefits. In other words, you can achieve optimal diversification with a smaller number of stocks.

2) Spread your money around different sectors. Both logic and reams of research tell us portfolios containing stocks from a variety of sectors should take less of a hit when one or more sectors behave badly. Just as importantly, if one sector roars ahead while the others lag, you'll do better if you own a piece of that leading group before its big move.

3) Don't just go big. Big stocks are more likely to pay dividends, and many income-hungry investors limit themselves to large-caps. But as the tables above and on page 2 show, plenty of smaller stocks can also warm an income investors' heart. While small stocks are less likely to pay dividends, those that do average higher yields.

IN QUEST FOR INCOME, DON'T FORGET SMALL STOCKS
Larger stocks are more likely to pay dividends, with 83% of stocks with market capitalizations of $10 billion or higher paying out, versus just 31% of stocks with market caps below $1 billion. However, dividend-paying stocks in the microcap group average yields of 3.7%, dwarfing the largest stocks' 2.7%.
------ Average Yield ------
Number
Of Stocks
Number Of
Dividend
Payers
% Of Stocks
Paying
Dividends
All Stocks
In Group
(%)
Dividend
Payers
(%)
Less than $1 billion
2,675
830
31
1.2
3.7
$1 billion to $3 billion
881
478
54
1.8
3.3
$3 billion to $10 billion
739
468
63
1.7
2.7
$10 billion or higher
629
524
83
2.2
2.7

Diversification serves more than one purpose. By broadening the mix of investments, it can reduce risk. But by adding higher-return investments (such as small-cap stocks) to a portfolio of securities with lower expected returns, you can potentially diversify your way to superior long-run performance.

The portfolio presented in the table below consists of 20 stocks with yields of at least 1%, drawn from four different size segments of the market and representing nine of the 10 market sectors. No single sector makes up more than 20% of this diversified income portfolio.

DIVERSIFIED INCOME STOCKS
Each of the 20 stocks below yields at least 1%. The portfolio features stocks of all sizes and contains names from nine of the 10 market sectors, with no sector accounting for more than 20% of the portfolio. Stocks in green are Forecasts recommendations, those in bold are from our Upside small-cap newsletter, and the rest are components of our Top 15 Utilities portfolio.
Stock-
Market
Value
($Mil.)
Ann. Div.
- Growth -
---- Quadrix Scores ----
Company (Price; Ticker)
Div.
($)
Yield
(%)
3
Yrs.
(%)
10
Yrs.
(%)
Sector
Momen-
tum
Value
Overall
Less than $1 billion market cap
AMERISAFE
($38; AMSF)
0.48
1.3
716
NM
NM
Financials
96
87
96
Bel Fuse ($23; BELFb)
0.24
1.1
261
0
11
Technology
54
99
93
Midsouth Banc.
($19; MSL)
0.36
1.9
224
5
10
Financials
72
92
97
$1 billion to $3 billion
Avista ($32; AVA)
1.27
4.0
1,935
6
17
Utilities
47
79
69
Otter Tail ($29; OTTR)
1.21
4.2
1,049
0
8
Utilities
68
85
80
Finish Line
($29; FINL)
0.32
1.1
1,398
19
NM
Discretion.
94
79
95
GATX ($66; GMT)
1.32
2.0
2,985
4
12
Industrials
84
74
88
Methode Elect.
($33; MEI)
0.36
1.1
1,289
(9)
16
Technology
98
75
97
$3 billion to $10 billion
AmeriGas ($45; APU)
3.52
7.8
4,199
6
7
Utilities
51
85
63
Gentex ($29; GNTX)
0.64
2.2
4,282
8
14
Discretion.
97
86
99
Manpower
($79; MAN)
0.98
1.2
6,410
7
25
Industrials
94
87
96
Och-Ziff ($13; OZM)  
0.68
5.2
6,272
18
NM
Financials
56
79
75
Packaging Corp.
($66; PKG)
1.60
2.4
6,402
35
18
Materials
86
90
95
UGI ($51; UGI)
1.31
2.5
6,023
4
10
Utilities
90
78
88
$10 billion or larger
Aetna ($79; AET)
0.90
1.1
28,507
65
NM
Health care
74
88
95
CVS Caremark
($80; CVS)
1.10
1.4
93,368
33
31
Staples
76
60
88
Dow Chemical
($53; DOW)
1.48
2.8
63,441
30
7
Materials
56
55
69
Helm. & Payne
($99; HP)
2.75
2.8
10,850
111
34
Energy
55
60
82
Kroger ($50; KR)
0.66
1.3
25,553
16
NM
Staples
54
69
86
Schlumberger
($109; SLB)
1.60
1.5
143,887
15
22
Energy
78
61
92
Portfolio average
2.4
20
16
74
78
87
Note: Quadrix scores are percentile ranks, with 100 the best.  †  Och-Ziff is a master limited partnership with a variable dividend.  NM Not meaningful because company didn't pay a dividend in the historical period.

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