April 26, 2015

I Had to Put Together a Retirement Portfolio for a Family Member Over My Morning Cup of Coffee

This morning, I had to put together a retirement account for a relative.  The mandate was:

  1. Broad diversification
  2. Individual stocks, no funds of any kind
  3. Only high quality companies with very strong balance sheets
  4. A history of dividend increases that exceed the rate of inflation
  5. Good current valuation
  6. No buy or sell changes for at least 10 years
  7. The account won’t be accessible for 35 to 40 years
  8. Large companies that everyone would recognize and are likely to be around a long time; no small start-ups or midcaps.
  9. Some positions are legacy, though I could sell small amounts if necessary (e.g., Wal-Mart and Berkshire Hathaway)
  10. Dividends are to be automatically reinvested at no cost, plowed back into the company that paid them
  11. The initial funds in the plan are to split into fewer than 15 stocks.
  12. A list of “permanent” companies is to be made for future reference; every year, when more money is added to the plan, the cheapest stocks relative to intrinsic value on the list I created wil be added as new positions with the fresh funds until the portfolio has a total of 40-50 companies.

The problem I ran into is so many of the businesses I’d like to be buying right now are fully or overvalued.  Hershey is a classic example – it’s a brilliant business, with unmatched economics and a strong controlling shareholder.  Yet, it’s trading at a forward valuation multiple of 22.  I do not think earnings will be growing by 15% per share for the foreseeable future, meaning it cannot be justified if I want to end up toward the upper end of the historical returns earned by equity ownership of this class of assets.

This meant a list of 50 to 100 companies I prepared got whittled down to only a handful of stocks, including the legacy positions.  On top of this, I had to choose at least one stock from certain industries (e.g., at least one pharmaceutical) to meet the mandate.  I couldn’t just put 20% of the assets in Wells Fargo, which is clearly still a great deal right now for a long-term owner, even though it is a better deal than PepsiCo, which is also a fantastic long-term holding, just more expensively priced.  This put me in the odd position of actually buying some of the very companies that I, myself, sold only three or four months ago, because the portfolio owner had a different set of objectives; this was to be a “my grandchildren will inherit this and I don’t want to think about it between now and then so I’ll accept slightly lower returns” portfolio, not a “make me the most money possible by being what Ben Graham would call an enterprising investor” portfolio.

In the end, the portfolio ended up with an earnings yield of 6.71% and a cash dividend yield of 2.83%.  I’m more than satisfied given the parameters.  

The valuation multiple and the growth rates are lower than S&P 500, but the dividend yield is twice as high.  With all of the money being reinvested tax-free with no brokerage costs, it’s slightly deceptive as the two figures are closer than one would imagine.  Basically, I mirrored the long-term return potential of the index over very long periods of time, while avoiding companies that are likely to change substantially.

It has:

  • 2 conglomerates
  • 2 oil & natural gas giants
  • 1 mining, metals, and minerals group
  • 2 consumer staples powerhouses
  • 1 restaurant
  • 1 foodservice logistics company
  • 2 soft drink & snack companies
  • 1 discount retailer
  • 1 bank
  • 1 pharmaceutical

The actual holdings, including legacy positions bought several years ago, are:

  • Berkshire Hathaway
  • BHP Billiton
  • Chevron
  • Clorox
  • Dr. Pepper Snapple Group
  • Exxon Mobil
  • General Electric
  • GlaxoSmithKline
  • McDonald’s
  • PepsiCo
  • Procter & Gamble
  • Sysco
  • Wal-Mart Stores
  • Wells Fargo & Company

As for weighting, the largest position is 9.75% of assets, the smallest 6.00%.  I’ll be glad to see that fall to 3% to 5% once the other positions are added in coming years because I turned over a sheet of 26 company names that would serve as a shopping list for future years until the portfolio reaches its target of 40-50 holdings.  The money will compound tax-free for more than a generation, and even if a handful of the businesses go bankrupt, it should still result in a large increase in wealth despite the 30% to 50%+ drops that unquestionably will occur from time to time; that is the nature of the public securities markets, which can be volatile in the short-term.

The names on that list included many of the firms I, myself, would like to own at the right price – Brown Forman, Diageo, General Mills, McCormick, American Express, Johnson & Johnson, Colgate-Palmolive, Deere & Co., United Technologies, Kellogg’s, Unilever, Coca-Cola, Tiffany & Company, Hormel, J.M. Smucker’s, etc.  There were a disproportionate number of food, beverage, and consumer staples companies because the nature of the mandate; I have no idea if Google will still be around in 50 years but I am near certain that most of the jam and jelly in the nation will come from Smucker’s orchards.  

Even the returns end up being just average, which is perfectly satisfactory, the risk relative to other portfolios I’ve seen is so much lower, I can’t imagine an informed, rational investor losing any sleep, especially once the number of holdings has increased to the target range, which will take several years.  The portfolio is already self-funding so that, in the coming years, tens of thousands of dollars in fresh, new money will get plowed back into the firms that distributed the cash to owners, increasing the equity stake held in the plan.  Short of a Great Depression, it is all but assured based on a conservative projection of compounding, that as long as the contributions keep up with the projections, the account will be worth many million, perhaps even tens of millions, dollars by the time it can be tapped.  That’s what happens when you are talking about a near 40-year timeframe; the numbers start getting crazy once you pass 25 years.

The annual expenses on the portfolio are zero.  As in $0.00.  It’s a large enough account the broker doesn’t charge anything for dividend reinvestment and the commission for the initial purchase is less than $9 per position.  Unless you are getting free trades as part of a bank (e.g., someone living in California might get free equity trades at Wells Fargo’s brokerage division because they have their mortgage at the bank), it’s impossible to get any more efficient.  By retirement, total costs will likely have ended up being, at most, 1/10,00th of 1%.  It will result in many hundreds of thousands of extra dollars in the end that would have gone to financial institutions.

The trades are all executed, and I prepared a group of spreadsheets for the account owner to track their share of the net earnings and cash dividends by position, industry, and total, which they can access from a secure link any time they feel like it.  

It was a lot of fun to do over my morning cup of coffee, before I jumped into my own agenda list for the day.  Still, I’ll be much more satisfied when the roster includes at least a dozen or two dozen more names, which will come with time.

  • Jason

    If you could, can you explain why you think GIS, DE, and KO are overvalued? They seem attractively priced based upon their size and earnings.

    • http://www.joshuakennon.com/ Joshua Kennon

      I don’t think those three, in particular, are overvalued.

      By my calculations, General Mills is slightly overvalued (but not enough to matter in the long-run; it’s a rounding error, I’d still buy it for a long-term portfolio given the unparalleled strength of its brands and capital allocation policies), while Coca-Cola and Deere are slightly undervalued. If they handed me more cash tomorrow to start filling out positions, those three would be near the top of my list for the next ones added to the roster. It was a coin toss on those.

      The reason I didn’t pick Coke was because the valuations are roughly the same as its competitors, this particular person prefers Pepsi by a wide margin over Coke, I already have some of my other relatives heavily invested in Coca-Cola, and Pepsi is more diversified with its large packaged foods and snack business, which was appealing since I could only have 14-15 positions in the first round. Plus, with Dr. Pepper Snapple also on the list, I couldn’t give up another spot. That would have made 3 of 14 positions soft drink giants, though I think you could do very well over time doing that.

      Deere had more to do with the cyclical nature; if undervaluations are equal, I’d prefer the business that doesn’t depend too much on the broader economic cycle and can keep pumping out money constantly. Deere is a great company, but it’s not as good, inherently, as a Clorox. But I’d like to add some of it to the KRIP for my own accounts, it just keeps falling right below the list when I’m doing my shopping. One of these days, I’m sure it will get there. I came very close to buying some last month but ended up using the cash to pick up some more DPS when it dipped to my intrinsic value calculation. That dairy farmer I wrote about years ago actually made a lot of money in Deere. It’s a nice company.

      Frankly, you could have subbed in those three firms with three comparable ones on the list and I don’t think it would have made much of a difference. For a portfolio like this, you are really acting like an insurance underwriting, putting together a book of securities that have balanced characteristics, strong financials, reasonable valuations, and aren’t too highly correlated, so that overall, the result is satisfactory, even if there were a few disasters along the way.

      (I would have preferred Royal Dutch Shell to Chevron, but there were some problems in that the broker wouldn’t reinvest the RDS ADR dividends for free, which changed the calculation. It was just too difficult to deal with so I opted for Chevron, which is a great company on its own. It’s long-term dividend record is a sight to behold; I just think Royal Dutch Shell is considerably cheaper relative to intrinsic value.)

      These are just my personal thoughts; take them for what you will.

      • Matt

        Why are the prices for BHP so different on the Australian and London exchanges? As far as I understand, BHP is the merger of a British and an Australian mining company, but if they are now one company, shouldn’t their share prices be somewhat more in sync?

        • http://www.joshuakennon.com/ Joshua Kennon

          You’re asking the right question =)

          BHP Billton Limited and BHP Billton PLC shares are theoretically supposed to be identical. They have the same percentage equity ownership rights and the same voting rights. Yet, for the past five years, the London shares have traded at a considerable discount to the Australian shares. However, you cannot swap one share type for the other, so there is no arbitrage play, meaning that the dislocation is allowed to persist. No one has an incentive to fix it. Long-term investors can take advantage of it, though.

          The London shares are much cheaper and offer a much fatter dividend yield. The difference is material. It’s a quirk in the liquidity and supply/demand situation. For a long-term owner who just wants to get cash dividend checks from his share of the diamond mines, copper mines, gold mines, silver mines, uranium mines, etc., it’s highly favorable.

  • Rob


    This is more of a technical question, but how do you create an automatically updating spreadsheet for the account owner to link to in order to track their share count and value? I’ve been trying to do that for a day or two now but not finding any great information.


    • SamMichigan

      Might very well be a Google Docs spreadsheet. I use one of those to track our dividend portfolios as far as current value, weighting within the portfolio, annual div income, current yield, yield on cost, etc. It allows my wife to look at it when she wants to. She doesn’t have much interest in investing, but she does like to see how things are going.

      • Rob

        Great. Thank you for the help

  • Andrew

    Isn’t Pfizer a much better value than GSK? Only 2.4 price/book vs 11.31, and with a 43% payout ratio vs 88% – PFE has a lot more room to grow dividends too? (I’m learning here)

    • http://www.joshuakennon.com/ Joshua Kennon

      Normally, I hate forward p/e ratios, but this will make more sense to you as a beginner.

      In the case of GlaxoSmithKline, it is trading at 11.7x forward earnings with earnings expected to grow at 11.5%. You are paid a 4.4% dividend yield while you wait.

      In the case of Pfizer, it is trading at 11.89x forward earnings with earnings expected to grow at 9%. You are paid a 3.4% dividend yield while you wait.

      When a company uses a lot of money to buy back stock, book value multiples become effectively useless. Over 15 years, for example, AutoZone has gone from $25 per share to $424 per share, yet now has a book value of negative $43. It has to do with the accounting transaction that involves stock buy backs.

      Glaxo’s payout ratio is not 88%. It suffered a one-time hit to earnings as a result of a settlement that is not going to be repeated in the future. The payout ratio for normalized earnings is much lower.

      There are also some quirks in pharmaceutical accounting that make it hard to do apples-to-apples comparison, though (unfortunately for value investors) many have been fixed in recent years. It used to be that drug companies were always perpetually understating their profits, meaning that they were even cheaper than they appeared, leading to some really crazy returns for a generation or two as cash generation exceeded reported earnings, which added up over time.

      I’m of the school that pharmaceuticals should normally be bought in a basket, not as individual companies. I would very much like to add a few others but the problem I’m running into is that right now, the entire industry looks like a mess. Pfizer looks okay, I wouldn’t mind owning it, and so does AbbVie, though I need to look into it further to make a final determination. Novartis would be great to own as it seems reasonably valued and is a fantastic company, but it is based in Switzerland, meaning there would be a dividend withholding tax that this particularly portfolio could not recapture since it is in a tax shelter, lowering the return considerably (had it been a fully taxable account, Novartis might have gotten bought above GlaxoSmithKline, or right alongside it). Sanofi finally looks to be in the clear with its patent expiration but I’m not as familiar with it these days so I needed to delve back into the books and haven’t yet had a chance. (They have a subsidiary, Aventis, that makes a brand of contact lenses that are the best and most comfortable I’ve ever experienced in my life.)

      • Andrew

        Thank you for the wonderful reply! Are you avoiding telecoms for any particular reason, or just overpriced?

  • Alexander Davis

    Very cool to see XOM and CVX on here. I have been telling my friends who ask for stock tips that these companies are showing great earnings per share with strong cash flow and balance sheets and they are so easy to pick up. I have insider trading restrictions so I prefer to index in case my firm gets a company as a client, I am forced to leave positions. However, I love living vicariously through your value investing decisions!

    • http://www.joshuakennon.com/ Joshua Kennon

      I’m amazed at how cheap the oil and natural gas giants are, just sitting there in plain site. I imagine that 25+ years from now, they will have produced a lot of dividend income for a long-term owner, especially one who held the shares in some sort of tax shelter and used the money to fund other, new investments.

  • ZaVodou

    Hello Joshua,

    why didn’t you pick Royal Dutch Shell as an oil pick?
    I would prefer RDS before XOM at the moment.

    At the moment I think IBM and China Mobile are priced attractivly.
    Why didn’t you choose these companies?


    • http://www.joshuakennon.com/ Joshua Kennon

      I mentioned it elsewhere in the comments thread on this post: I would have much rather owned Royal Dutch Shell than any of the other oil companies but the brokerage firm at which these assets were held would not reinvest the dividends on the ADRs free of charge, meaning they would not fit with the mandate.

      I haven’t looked at China Mobile. I didn’t consider IBM because I was avoiding technology as the foundation of the portfolio was laid, though I’d be open to adding it later.

      • Bill

        Joshua – I own shares of CVX through my IRA, and I’d love to get some shares of Shell. Signing up for FOREX with my IRA would create additional fees that’d really bite into any earnings for a small-time buyer like myself. In your opinion, what would be the best way/method/platform for an individual investor to pick up shares of Shell? Not to mention Unilever, etc… Thanks!

        • Bill

          Oops, seems I was misunderstanding what forex was. My bad lol.

        • http://www.joshuakennon.com/ Joshua Kennon

          Yes, you definitely would not need to sign up with Forex for an IRA. That would terrify me if you didn’t know what you were doing … it’s one of the few places other than Vegas where you can lose everything very quickly.

          As for Royal Dutch Shell? I just put a post up about some changes I made in the KRIP this morning, including picking up some shares of Royal Dutch Shell. For plain vanilla IRAs, SEPs, Simple IRAs, and most other retirement plans, I am partial to the Class B ADS that trade in New York under ticker symbol RDS.B or RDS-B depending on the broker. The reason is they take care of all the currency conversion for you, constantly quoting in U.S. dollars, don’t withhold any dutch dividend taxes, and each ADS represents 2 shares of the underlying British stock. You can’t do an automatic dividend reinvest at most brokers with it, but I pool my dividends together in the bottom of the accounts, combine it with fresh money, then redeploy it so that’s perfectly fine with me.

          If you go that route, you’ll quickly note the cultural differences. In the United States, companies work very hard to have this ever-increasing, smooth upward line of dividends. Not the Dutch or the British. They calculate the results and pay a dividend based on that year, so you get these wild variations in payouts that resemble more of a private business, just as if you owned the town bar or car wash.

          Did that make sense?

        • Bill

          Perfect sense, yes, thank you! I have no interest in putting any of my money into something I don’t understand or enjoy learning/dealing with, so I took a quick step back when I realized it wasn’t what I was thinking it was.

          Thanks for the reply, Joshua!

  • Ahmad

    Hey Josh,

    Can you do me a favor and hit us with a quick review on the book “Financial Shenanigans” by Howard M.Schilit if you read it before.


  • joe pierson

    IMHO. For 40 years, I would omit the oil and natural gas. They will be selling Hershey kisses 40 years from now, but oil? In some quantities for sure, aircraft will still need it to get off the ground but everything else, maybe, maybe not. Transition could be quick when it happens, like when CD’s replaced LP’s. And historically even large companies with huge resources cannot adapt, not due to lack of technology, but more because the company grey beards won’t have it, they cannot deal with being experts in their field one day to idiots the next day in another field, so they keep resisting while the startups pass them by. Imagine attending a meeting with a hundred BP chief engineers with 30 years each experience in drilling and asking them to develop a battery. I have been in those meetings, it’s not pretty.

    • Joel

      Good point, but as you said, that is just your opinion. It would be nice to think that we would no longer need fossil fuels but as it stands now, nothing delivers their amount of energy for a the same buck in as many uses. It isn’t like people haven’t been search for alternatives for at least 40 years already. Another analogy in your favor is the digital camera technology which crushed Kodak. Joshua has written on that. But there is still a decade or two of transition. CDs invented late 70s, used for music in early 80s, not standard in cars until 2000s.

    • Alexis C

      I guess you can look into the management of the company. Something to bear in mind is some of these are drilling companies and some of them are energy companies and conglomerates. So if a new alternative technology takes off, they’ll just buy the leading company or companies in that field and you’ll get ownership that way. This isn’t my idea, it’s something Joshua mentioned in one of the case studies.

  • AJ

    Thank you for the wonderful articles you are posting on this site. It is a great educational opporchunity for people with less financial knowledge.

    Another user (jss027) had asked a question on “passing fortunes along to children and grandchildren” in your article “How Quincy, Florida Became a Town of Secret Coca-Cola Millionaires”. Have you replied to that? If I have missed that, can you please point me to that? Thank you again.

    • jss027


      ….I am also interested in Joshua’s thoughts on that scenario.

    • http://www.joshuakennon.com/ Joshua Kennon

      I have published a response to this question, which you can read here.

  • Adam Yates

    Joshua; Do you have any thoughts about using direct investment plans with the individual companies for purchasing their stock on a regular basis vs. using a broker? I’m thinking about using a direct purchase plan- some companies offer X% discount as well as no fees for purchasing or reinvesting dividends. I apologize in advance if you’ve already covered this on your site. Thanks!

  • APatel

    I would like to hear your thoughts on NKE being considered as a stock to own for a 30 year plan. As an aside, I believe the current valuation of Nike is rich. BUT, when it eventually isn’t, it strikes me as a company that has the quaities (durable competitive advantage and demographic trends) that allow for passive compunding of retained earnings by a management that repects the sharholder. Thanks in advance.