Build a diversified portfolio of dividend aristocrats

Charles Ellis, author of Winning the Loser’s Game, believes that you should build your portfolio as you would a house. Your house should be suitable to the climate, not last week’s weather. Similarly, your portfolio should be suitable to your long run investment goals, not the latest news flash.

Even so, for speculators and investors in a hurry, we go out on a limb and make short-term predictions four times a year. We make a 180-day forecast for the economy and stocks. Just remember to put little faith into predictions, including ours. Predictions often go awry.

Canada is expected to beat most of its peers

Canada’s GDP is expected to grow by 2.5 per cent in 2014. (GDP, or Gross Domestic Product, is the value of the goods and services an economy produces in a year). Despite a weak first quarter, due to terrible weather, Canada’s GDP growth is expected to exceed that of the G7 (Group of Seven advanced countries) except for Britain. Canada should profit from an economic upswing in some of its trading partners—especially the U.S. and Britain.

The U.S. and Britain are expected to beat the other four G7 nations. In 2014, their GDPs are expected to grow by two and 3.2 per cent, respectively. With three quarters of Canada’s exports going to the U.S., faster growth there is a plus. The same is true with Britain. It’s Canada’s third-largest trading partner.

China is Canada’s second-largest trading partner. In 2014, its GDP is expected to jump by 7.5 per cent. That remains the highest in the world.

An expected trade agreement should raise trade with the EU. But the Euro-zone has slipped again. The European nations that share the euro are expected to grow by 0.9 per cent in 2014. Italy’s economy is not expected to grow at all. France and Holland are expected to grow by only 0.5 per cent. Germany’s solid GDP growth of 1.7 per cent—the best of the Euro-zone—pulled up the region’s average.

The trade agreement with South Korea should raise two-way trade with our eighth-largest trading partner. Even better, South Korea’s GDP is expected to grow by a relatively fast 3.8 per cent in 2014.

The Canadian and American economies could grow faster than expected. That’s because some companies are sitting on piles of what’s known as ‘dead money’. If they invest more vigorously, economic growth would pick up. Business investment is one economic engine that has largely been missing in the recovery. Still, cash-rich companies could reward shareholders like you with dividend increases, one-time special dividends, or share repurchases.

Thankfully, Canadian exports have jumped. That matters because exports account for about a third of the Canadian economy. In July, exports climbed by 1.4 per cent, to a record $45.5 billion. Imports grew by a slower 0.3 per cent. As a result, the net merchandise trade surplus went up to $2.58 billion. This was the highest trade surplus since October, 2008. A lower loonie could further raise exports. It makes Canada’s exports more affordable to foreigners. Meanwhile, a lower loonie makes imports more costly. This leads to what’s known as ‘import substitution’. Rather than buy costly imports, Canadians would buy cheaper domestically-produced goods.

Faster economic growth should raise Canadian companies’ profits. Profits are the main factor setting stock prices in the long run. Benjamin Graham, the father of fundamental stock analysis, said that in the short run, the stock market is a voting machine. But in the long run, it’s a weighing machine. With earnings likely to rise in 2014 and interest rates likely to remain low, we’re cautiously optimistic that stock prices will rise further.

Nothing risked, nothing gained

The stock market is forward looking, assessing future prospects. If the Canadian economy and company earnings do better than expected, stock prices would likely rise. Still, there are also several risks that could hurt Canadian stocks.

One risk for Canadian stock prices is a potential fall in U.S. stock prices. After all, the Canadian market usually follows the U.S. markets. It’s been a while since we’ve had a ‘correction’. This would set back stock prices by 10 to 20 per cent. After the market’s run up, a pullback in U.S. stocks could occur. If so, Canadian stocks would likely get sideswiped. On the other hand, a correction is so widely anticipated that it may not occur in the near future.

A second risk is that some companies’ sales may stagnate. While many earned more in recent years, these profits came mostly from cost cutting—not higher sales. Without a pickup in sales, it’s hard for companies to keep raising their profits quickly.

Unforeseeable risks also exist. What will happen in the Ukraine? Will pipelines link Alberta’s energy to refineries and export terminals? The world is unpredictable. That’s why it pays to diversify.

Besides, if you wait for a risk-free time to invest, then you’ll always be sitting in cash instead of putting that cash to work. Should a risk-free environment appear, it might be time to sell. After all, when things can’t get any better, they can only get worse.

Given these risks, it’s best to focus on ‘dividend aristocrats’ that raise their dividends each year. Most of the stocks that we expect to beat the market are dividend aristocrats. They’re apt to rise. Their growing yields attract income-seeking investors who bid up their prices. Dividends give you cash to take advantage of bargains. And your dividends give you a return even when stock prices go nowhere.

Remember to diversify across the five economic sectors. Also remember to diversify within each economic sector. Within the financial sector, for instance, you might buy one bank, one life insurance company and one mutual fund company.

Invest gradually. That way, when prices are high, fixed purchases buy fewer shares. When prices are low, you buy more shares. Such dollar-cost averaging lets you buy your shares at below-average prices. The long-term outlook for stocks is favorable. Keep buying high-quality, dividend-payers for long-term gains and rising dividends.



The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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