In the past month, I published the list of dividend holdings I own to my subscribers. Many subscribers were amazed at the number of companies I own. I have always mentioned that having at least 30 – 40 individual positions is great for diversification purposes. This ensures that I am not overly reliant on a single company for my dividend income, in case it cuts or suspends distributions.
However, there is the other side of the coin, where owning too many securities is too much. It could mean that effective monitoring a portfolio might be more difficult with more than a certain number of positions in it.
The first reason behind the excessive number of companies in my portfolio is corporate actions. For example, several of the companies I own stock in have tended to split in two separate entities. Examples of that include when legacy Abbott Laboratories divided itself into Abbvie (ABBV) and Abbott Laboratories (ABT) in 2013. Another example includes when Kraft Foods split into Kraft (KRFT) and Mondelez International (MDLZ). Currently, my small position in Vodafone (VOD) will result in yet another addition to my portfolios after it distributes Verizon Wireless (VZ) stock to me in 2014.
The second reason behind the excessive number of companies in my portfolio is valuation. When I identify a quality company at a reasonable price, I tend to start nibbling at it one lot or half lot at a time. Because I have a limited amount of capital relative to the number of investment ideas I have, I might end up making an investment in a new idea once or twice per year. For example, if it was cost efficient to purchase stock in $1000 increments and I had the ability to put only $12,000/year, I can only make 12 purchases in my portfolios. Therefore, if I had 12 ideas, I might not be able to make another investment in any of those ideas for a whole year. By that time, the stock could have become overvalued or there might be a better value in a whole new enterprise. The company would still be a good long-term hold, which is why selling it would violate common sense. This is why I am considering dividing my monthly contributions into all my ideas, using Sharebuilder. I just need to make sure I can find $2,400 every month, in order to make this exercise cost effective at a $12 monthly fee for 12 trades.
The third reason behind the large number of securities I own is because I have been investing in dividend paying stocks for several years. When I first started investing in dividend stocks, I did not pay any commissions and could only put a small amount of funds to invest. Therefore, I usually put about $100 - $200 per position. Over time, I have increased my lot size from there. Unfortunately, some of those companies stopped being attractively valued, which is why I ended up stuck with them. Since I am now paying commissions to sell those legacy securities, I have calculated I am better off sitting on them. For example, I try to maintain my trade costs below 0.50%. Therefore if I paid a $5 commission to buy or sell stocks, it would not make economic sense to sell a position whose value is less than $1,000. Investment costs can add up pretty quickly, which is why I try to run a tight operation. It also does not make sense to sell stock in a company that is delivering earnings and dividend growth, and its only sin is being overvalued.
Reasons number two and three have contributed to a number of great companies, where I have pretty low position amounts in plenty of companies.
The fourth reason I own so many companies includes some points from reasons two and three. I essentially have managed to find attractively valued stocks at every single point since 2007 – 2008. Unfortunately, the list of attractive candidates for my money has changed over time pretty significantly. For example, for several years I had companies like Colgate – Palmolive (CL) or Clorox (CLX) or Procter & Gamble (PG) on my shopping list whenever I had cash to put to work. Unfortunately, these companies have been selling at prices that exceeded what I was willing to pay for them in 2013. In addition, since I constantly search for unconventional ideas, I might end up finding better values. This is how I ended up with so much in Phillip Morris International (PM) or Kinder Morgan Inc (KMI) for example.
The fifth reason behind this large number of portfolio holdings is some actions I took over the past year. I sold my shares in a position I believed to be overvalued and having poor future, and then divided the money into several ideas. For example, I also did some selling of a few overvalued REITs such as National Retail Properties (NNN) or Universal Health Realty Income Trust (UHT). I then put the money to work in three new REITs and added to positions in an existing REIT (O). These reits included American Realty Capital (ARCP), Digital Realty Trust (DLR) and Omega Healthcare Investors (OHI). Another example includes the sale of Cincinatti Financial (CINF), and using the money to buy stock in the five leading Canadian Banks – Toronto Dominion Bank (TD), Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Royal Bank of Canada (RY) and the Canadian Imperial Bank of Commerce (CM).
The good part of owning so many companies is that I can still monitor these positions regularly. I am reminded I own these companies anytime I receive an annual report in the mail. I also monitor the conditions of companies I have sold previously. That way, I am able to keep up with and learn about business ,which should hopefully pay dividends for a long period of time. Although I do not have the time to read 500 pages/day like Warren Buffett, I try to find the time to search for knowledge on a daily basis. I have quite a few “starter” positions in companies that were attractive at some point, but later on were not or there were better values out there. I do monitor them however, and could add to them if I saw the right opportunity. For example, in 2013 I added to Family Dollar (FDO) and Yum Brands (YUM), when there were weaknesses in the stocks, which were not warranted.
I believe that investors should follow as many companies as possible, in order to learn as much as they can about business. Even if you only own 20 companies in your portfolio, if all you do is keep up with those 20, you might be doing yourself a disservice.
Overall, I do realize I have too many companies in my portfolio. However, I am never going to let this stop me from looking for new opportunities. For example, I like General Mills (GIS) stock at current levels. I find it a much better value than competitors than existing peers I already hold in my portfolio. I recently initiated a position in the stock. I could theoretically buy shares in PepsiCo (PEP) or Nestle (NSRGY) or Kellogg (K) instead, in order to keep the number of positions in my portfolio static. From a capital allocation point however, it seems pretty dumb not to focus on the best value you find when you have new money to put to work.
I find that investors who focus on absolute number of stocks in a portfolio, miss this important nugget of gold. There is no limit to the amount of companies in your dividend portfolio. It should only be limited by the number of good ideas you have. You should also build your portfolio slowly, one position at a time, and several buys per each position. The worst piece of advise I hear is from those who paraphrase Warren Buffett and his supposedly concentrated approach. The saying goes that your 25th idea is not as good as your first idea.
I have news for you - you are not Warren Buffett. I am highly skeptical that investors know in advance which ideas are their best ideas. From my experience, my best ideas were way past portfolio components number 25 or 30. At the time of purchase, you do not know which company will keep raising dividends, and which would cut them and burn to the ground. With income investing, you are dealing with a lot of bits and pieces of imperfect information, which is why it is impossible to know which company will perform great. In addition, while Warren Buffett was not very diversified during the days of the Buffett Partnership, he has diversified extensively since the early 1970s. I have read his annual reports, and he has never once said that Berkshire Hathaway has too many subsidiaries or stock holdings.
I do not believe that holding so many stocks is probably not perfect if I wanted to outperform all other investors. You can see that despite the large number of holdings, the top 30 positions account for almost 80% of the portfolio. The top 40 positions account for 90% of the portfolio. Some of the remaining ideas have the chance to grow if they became attractively valued. For example, Peter Lynch from the Fidelity Magellan Fund managed an outstanding performance over a 13 year period, while holding hundreds of individual stocks in his portfolio. This did not hurt his performance at all. While I am not a super investor, I believe that the notion of finding a good idea and testing it with real money, before adding a significant amount of change to it has some merits.
I believe the real reason behind my comfort level with so many individual holdings, is because of my intense focus on reducing risk. I believe that you only need to get rich once in life. I would hate to spend years of my adult life accumulating a nest egg, only to lose it due to a few concentrated stupid investments. I would much rather end up with $1 million but with lower risk, than shoot for the stars and end up with somewhere between $10 million or zero dollars. If all I need to be retired is the $1 million, then why shoot for the stars and potentially risk it all?
Full Disclosure: Long everything mentioned above except for NNN, UHT, VZ and CINF
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