How To

Should you Use Profit Protection Measures?

Profit protection measures are ways in which investors sell their shares to safeguard existing profits, or to limit potential losses. How do investors do that? While protecting profits and limiting losses sounds like a wise thing to do, is it?

Profit protection is also known as profit preservation or risk management. Two ways of implementing profit protection are to set a profit cap at which you sell holdings and to use stop-sell orders.

Protect your retirement by making your portfolio recession-proof. Learn how in our free workbook. Download it now!

Profit cap rule

Some investors adopt rules for selling shares. For example, if they’re up 50% on a stock, they sell it. They are putting a cap on their profits, perhaps sometimes thinking that they got lucky and just want to run with a bag of money.

If you’re an active trader and you keep on buying and selling all the time, maybe this type of rule can be part of your strategy.

I prefer to let my winners run so I don’t set rules like this to protect my profit. Over the past 20 years, I found that it’s worth holding on to your great picks—those companies that you were so right about buying. Letting them run 5, 10, 15 years, can create so much profit…300%, 400% sometimes even over 1000%!

Since my focus is on dividend growth, I have 90-95% of my portfolio invested in dividend-growing companies, which I plan on holding for a long time.

Stop-sell orders

Another mechanism investors use for profit protection is to set up stop-sell orders. Imagine you bought shares at $50, and they are now trading at $100. Perhaps you’re thinking “Wow! I’m making a 100% return on this one. That’s crazy. But I don’t want to sell it because, well, what if it keeps going up? On the other hand, if it starts falling, I don’t want to lose all that profit.”

You could put in a stop-sell order that is triggered at $75.00; if the stock goes down to this price, your order becomes active or open, shares are sold, and you cashed in on some of the profit.

My use of profit protection

I don’t adopt profit protection measures very often. As I said earlier, 90-95% of my portfolio are dividend growers that I want to hold for a long time without capping my profit. I believe that if my portfolio’s sector allocation is in good shape, that my holdings are well diversified across industries, that I picked the best of class, and I monitor their results and trends every quarter, I am protected.

However, for the remaining 5-10% of my portfolio, I like the occasional speculative plays, especially when there’s a lot of volatility in the market like in 2020 for example, where I could see opportunities. I never exceed 10% of my portfolio in speculative plays and limit them to three or four positions. With these speculative plays, I do sometimes use stop-sell orders to protect my profit.

Something else that I do that relates to profit protection is to trim winning positions that are weighing too much in my portfolio.

My limit for any single position in my portfolio is 10%; that’s an arbitrary limit. Yes, I like to let my winners run, but I don’t want to wake up one day having 25% of all my investments in a single stock, even if it is a winner. After all, you can never be 100% about any stock, and certainly not about any company being able to thrive forever; competition changes, the economy changes, and consumer behavior changes.

For these reasons, I decided that I didn’t want to lose more than that 10% exposure on a specific stock and that whenever that 10% was exceeded, I would sell part of it automatically to bring the position back below or at my limit.

Protect your portfolio, make it recession-proof. Learn how in our free workbook. Download it now!

Is profit protection worth doing?

I think the value of profit protection has a lot to do with your strategy. If you’re an active trader or an investor who makes a lot of speculative plays, then yes, profit protection can play a role in your strategy.

While I do occasionally use stop-sell orders for my limited speculative plays, I don’t systematically implement profit protection measures. I prefer to protect my portfolio by trimming overweight positions rather than cashing in all my profit.

In the end, though, it still comes down to selling at a profit to protect against the impact of a potential loss by limiting a portion of the profit you make on a winning stock.

Quarterly Review of Your Stocks Made Easy

Quarterly review of your stocks made easy! That’s what I aim to do in this post. Reviewing your holdings’ quarterly results and your reasons for holding each stock to begin with are essential. It makes you confident that you have a resilient portfolio that suits your needs and that protects your retirement.

Finding the information

You’ll find most of the information you need in the companies’ quarterly results press releases. You can also look at their quarterly reports, management discussion and analysis (MD&A), and filing documents. Go to each company’s website, in the Investor Relations section. Dividend Stocks Rock members get links to the press releases in their quarterly reports and see trends for many metrics on stock cards.

Create a recession-proof portfolio and secure your retirement. Download our free workbook!

Trends and anomalies

Graphs showing an emerging trend of growth for revenue and EPS. — The trend is your friend

Reviewing results isn’t simply checking that sales and profits grew compared to last year. You must also look at the trends, i.e. the evolution of revenue, profit, dividend, etc., over time to see whether the company consistently succeeds. The trend is your friend. Also, when results show something unusual, going against the trend, investigate.

For example, you see a sharp drop in sales for a company that has increased its sales every quarter over five years. Do you panic and sell the stock? No, you investigate to see if it’s a temporary setback. Maybe the company had to shut down production when a storm damaged its facility or a ship stuck in the Suez Canal led to a shortage of raw materials.

Revenue growth

In the most recent quarterly results, look for the company’s revenue or sales. Revenue includes money made from sales and other sources, such as investment income.

1 – Compare the revenue number with the comparable period, also called the year-ago period. This is the same period of the year but a year ago. If you’re looking at Q2 revenue, compare it with Q2 revenue from a year ago.

2 – Has the revenue grown, is it flat with last year’s, or has it decreased? By how much in percentage?

Generally, 1% isn’t much, single-digit growth or decline is moderate, while double-digit growth (10% and more) is solid. Of course, that varies across industries and companies; 10% growth in a quarter for a company will disappoint if it had been growing its sales by 20% every quarter for two years.

3 – Look at the company’s quarterly revenue trend over five years. Does the trend show growth over five years? It is steady growth or accelerating? Is the trend showing a decline?

Is the most recent revenue figure within the trend or is it unusually good or bad? If it’s unusual, investigate the cause. The press release often explains exceptional conditions or one-time events that caused an anomaly.

Profit Growth

You also compare the company’s profit with that of the prior-year period. The profit is called net income or net earnings. The easiest metric to use for profits is the Earnings per Share (EPS) metric. EPS is a metric that divides the company profits by the number of shares.

One-time or unusually large expenses, for example, a lawsuit settlement or a product recall, affect EPS. Companies often provide another metric called the Adjusted EPS (or normalized) that excludes such unusual items to provide a value that is more comparable to that from the prior-year period.

1 – Observe whether the EPS (or Adjusted EPS) has grown, is flat, or has decreased, and by how much in percentage.

2 – Look at the EPS trend over five years. Is the company growing its profits, is it stagnating, or in decline? Is EPS growth or decline steady or accelerating?

Accelerating growth hints at a thriving company that executes well while an accelerating decline is a problem.

3 – Are the most recent EPS within the trend or unusual? For unusual EPS, investigate.

If there was a sharp sales drop, EPS falling is not surprising. If EPS falls more than sales or falls while sales increase, perhaps the company costs have risen due to inflation, shortages, etc. Maybe the company lowered its prices to customers to drive up sales, reducing profit margins at the same time.

For some industries with large amounts of depreciation, such as utilities and REITs, EPS can be misleading. Other metrics such as distributable cash flow (DCF) per share or funds from operations (FFO) per share are more appropriate.

Dividend Growth and Safety

Compare the most recent dividend amount paid or announced with the dividend paid in the previous sequential quarter, i.e., when looking at the Q3 dividend, compare it to Q2 rather than Q3 of the previous year.

1 – Has the dividend increased? Is it the same? Was it cut? I usually don’t hold on to companies that cut their dividends.

2 – If there wasn’t a dividend increase, look at the dividends paid over the last 12 months; was there an increase in the last year? A yearly dividend is a minimum for a dividend growth investor.

3 – How much was the dividend increase in percentage? Does it at least match inflation? Companies that don’t consistently match or exceed inflation don’t protect your income in the future.

4 – Look at the dividend trend over five years. Is there yearly growth? Is growth accelerating, steady, or slowing down? Often, dividend growth that slows down is the first sign of a dividend cut in the future.

5 – Look at the company’s payout ratio. This ratio identifies how much of the profits the company pays out in dividends. We all want generous dividends, but if a company pays more than it earns, that’s not sustainable. Compare the latest payout ratio with the payout ratio trend over five years to see whether it is normal for this company, higher or lower. You might also want to look at the cash payout ratio; for some industries, you should look at other payout ratios that are more appropriate.

6 – Look at the company’s cash from operations amount and see the five-year trend. Companies that generate increasing amounts of cash from operations are in a good position to keep paying and increasing their dividends.

We’re here to help! Download our free recession-proof portfolio workbook!

Company’s future

Now that you know how a company performed and how it’s evolving, look at what’s in store for that company in the future. Will it be able to keep growing for years to come? Are there risks heading its way? Some things to look for include:

Mergers and acquisitions that bring challenges but also growth opportunities.
Company getting rid of non-productive assets or brands to improve their future results.
Announcements about new products, expansion in new markets or business areas.
Capital expenditures (CAPEX) invested in infrastructure; is it likely to bring revenue growth?
The company’s outlook for the full year, or the new year.

Interpreting a Weak Dividend Triangle – Part 2

Worried about holdings that show a weak dividend triangle? Revenue and EPS are falling, dividend growth is slowing down, or worse absent. What do you do? Last week we explored how to analyze falling revenue in a weak dividend triangle. Now we look at interpreting weak EPS and dividend growth.

In last week’s article, we explained the importance of putting metrics fluctuations in context and that the trend is your friend, meaning you must look at the evolution of metrics over time to understand what’s going on. Missed it? Read it here.

When earnings per share (EPS) are down

Earnings going down means the company is making less profit, not something that you like to see. Again, however, you must put that in context.

First, understand where that number comes from. EPS is based on accounting principles. Consequently, major events like impairments, one-time charges for an expansion and acquisition, and amortization impact the EPS even though these events aren’t necessarily bad things. Seeing the EPS go down raises a flag regardless, and it must be investigated. Reviewing the trend in Adjusted EPS (also called non-GAAP) can help here because one-time charges and amortization are not included.

Companies that make a lot of investments in assets or infrastructure have a lot of amortizations, and their EPS fluctuation often causes confusion.

Example: Brookfield Corporation (BN.TO / BN)

Recently, at the same time Brookfield Corporation (BN)’s EPS was going down, it announced a generous dividend increase. A business whose profit is plummeting is raising its dividend. “I’m losing my job I think I’ll buy a car.” It doesn’t make sense.

Since BN makes a lot of investments, it’s better off to look at funds from operation (FFO) and FFO/share rather than EPS. The FFO/share is at homemade metric and is not always easy to find. Financial websites show the adjusted EPS or EPS; digging into the quarterly statements and investor presentations will give you the correct picture. For Brookfield, they showed a company that’s growing and thriving, but EPS isn’t showing that profit yet.

Find stocks with a strong dividend triangle from our Rock Stars list, updated monthly!

Example: TD Bank (TD.TO /TD)

Another example from last year was TD Bank which had lots of one-time fees in its financial statements.

Fees for TD’s decision to abort the acquisition of First Horizon, a prudent move in light of many U.S. regional banks having problems with their balance sheets, and some of them going bankrupt in 2023.
The FDIC, which ensures deposits in the US, requested a special assessment of all banks in the U.S. As TD does a lot of business there, it spent $100M for FDIC assessment, passing the stress test and proving it’s well capitalized and has a robust balance sheet
Due to the economy, all banks had to raise their provisions for credit losses.

Combining these three unrelated factors hurt the EPS, whose trend doesn’t look sharp right now.

Graph of TD's dividend triangle that shows weakening EPS but steady dividend growth — TD EPS fell, but dividend growth is still there

Yet TD kept increasing its dividend last year and will continue in 2024 why? While the one-time events hurt the business, going forward, we’ll forget all about those as the business will thrive.

What about dividend growth slowing down?

Slowing dividend growth is usually the result of the rest of the dividend triangle; it’s rare to see a company with a high single-digit to double-digit growth for revenue and earnings whose dividend growth is slowing down.

If you see a dividend increase slowing to 3% and then 1% after being at 6% over 3-4 years, chances are both revenue and earnings were slowing down before that. It is prudent management to slow dividend growth rather than bleeding a balance sheet to death just to pay shareholders, but it’s also a red flag.

Find stocks with a strong dividend triangle from our Rock Stars list, updated monthly!

Can the payout ratio help to assess dividend growth health?

Yes, definitely. When the dividend triangle is weakening and the dividend growth is slowing down, the payout ratio is probably rising. Now we’re looking at the Sell button on our dashboard. However, it’s important to look at the appropriate payout ratio. There’s the classic payout ratio based on earnings. As I said earlier, earnings are based on accounting principles, not on cash flow. You should be mindful of that.

The cash payout ratio is an interesting metric. It’s based on free cash flow, so it does not consider the company taking on more debt to finance capital expenditures. For a capital-intensive business, the cash payout ratio is not perfect either. Instead, use the funds from operation FFO payout ratio. You could also simply compare the company’s dividend per share with the amount of Distributable Cash Flow (DCF) per share to see if there is room there for future dividend growth. See The Different Payout Ratios – A Quick Tour for more details about them.

Again, context is essential. That said, a weak dividend triangle and a payout ratio getting higher starts to scare me a bit more and bring me closer to selling, but I’ll do more research.

What other metrics can help understand a weak triangle?

When I’ve established that I’m concerned about a stock’s triangle, I start by looking at the cash from operations metric, because cash is closely linked to the ability to pay a dividend.

I also look at the long-term debt trend. If the debt keeps rising, and the payout ratio is above 100%, the company is leveraging its future; it better succeed in bringing profit and cash flow to the table and later because if not, it’s literally financing its dividend.

Growing debt can be understandable when there are large projects to fuel growth; the company is financing its projects and using its cash from operations to pay dividends. However, this situation cannot be sustained for a long time. It can last for a few years, but at some point, the company must stop adding debt and pay some of it down.

What’s next?

If after looking at these two sets of metrics (the three dividend triangle metrics, and the payout ratio and debt), I feel it might be fine to keep the stock, I do more qualitative research. The goal is to understand more about what’s wrong with the business model. Is it the economy hurting the business? Competitors? Can management resolve the problem? Has management said it was addressing the problem during the earnings conference call? If they just ignore the problem, that’s another source of concern.

For how many quarters should we tolerate a downtrend?

It’s not so much about a set number of quarters, but rather the reason why the metrics are slowing down. If it’s due to an economic cycle, like a recession that causes many companies in the consumer discretionary to have even two years of bad results or poor growth. Knowing that it’s normal in a recession, I would not sell after one year. However, if it’s because the business is losing market share and not finding ways to improve over several quarters, then it would be getting close to my sell list.

Interpreting a Weak Dividend Triangle – Part 1

Do you have holdings showing a weak dividend triangle? Revenue or EPS is stagnating or falling, dividend growth is slowing down, or worse there is no dividend growth. Do you sell right away? Not so fast. First, interpret the weak dividend triangle to know what’s really happening and make the correct decision.

What’s the dividend triangle again?

The dividend triangle is a tool I’ve been working with for over ten years, successfully and it forms the basis of my investment process. The dividend triangle includes three metrics: revenue, earnings per share (EPS), and dividend.

The key to my investment strategy is to find companies that are capable of growing their revenue, either organically or by acquisition, but that constantly find ways to grow their sales. As investors, we want to invest in thriving companies. A company that found a way to grow its sales year after year is the first thing I look for.
Next on my list that, as an investor, I want to see in a company is more and more profit. Earnings per share track that. Every year, I want to see a company with more sales and higher earnings per share.
After finding this magical Unicorn—well, truthfully, many companies show strong revenue and earnings growth—the next factor I want is for the company to reward its shareholders with yearly dividend increases.

Get great stock ideas from our Rock Stars list, updated monthly!

Why these three metrics?

Since I focus mostly on dividend growers, I want to see constant and often increasing dividend growth. Good and constant revenue and EPS growth are preconditions to a growing and sustainable dividend. The combination of these three metrics often leads to companies that have positive cash flow, repetitive and predictable income, a robust balance sheet, and a business model that has plenty of growth vectors.

A company with a strong dividend triangle also comes with another bunch of great metrics. As an investor, that’s the type of business you want; a thriving business able to go through a recession without too many worries and that’ll honor its promise to increase its dividend year after year.

Learn more about the dividend triangle here.

What does a weak dividend triangle mean?

Look at Equinix’s dividend triangle. It’s easy to understand a positive dividend triangle, right? Revenue keeps growing as does the earnings per share. The dividend growth is steady and even increasing.

Three line graphs highlighting the strong dividend triangle for Equinix: trends of revenue growth, EPS growth, and dividend growth — Equinix (EQIX): a strong dividend triangle

How do we explain a weak one? What do we do when a good company’s dividend triangle is weakening? What if one metric goes down? After a bad quarter or even a few bad quarters, don’t instinctively click the Sell button. Just like our energy level and our weight, numbers fluctuate, it’s normal.

It’s all about interpreting these deteriorating numbers to see what’s happening and whether things will get better soon. As I like to say, the trend is your friend. You must look at the triangle metrics over time, 5 years is a good duration, to see whether the poor results are a hiccup or part of a downward trend over a long time.

Along with the trend, it’s important to put the results in context, i.e., understand what is going on with the company, or around the company, that is making one metric, or the entire triangle go down, or up for that matter. Monitoring your stocks every quarter will help you to quickly spot trends and put results in context.

Get great stock ideas from our Rock Stars list, updated monthly!

When revenue is going down

Whether revenue is fluctuating down or up, you can often find the context for the change in the quarterly results press release or the investors’ presentation. They usually explain the factors that affected the revenue positively and negatively. Revenue could be down for a pretty good reason in which case you shouldn’t worry too much. Here are some examples:

Currency fluctuation. Take Coca-Cola; it makes many sales outside of the U.S. and generates a lot of revenue in other currencies. Revenue reported in U.S. currency is affected by the exchange rate. A U.S. dollar getting stronger will affect its revenue downward. To see if there was revenue growth or not, it’s important to also look at the numbers on a currency-neutral basis, which is stated in the press release.
Cycle of innovation or product cycle. Look at Apple’s dividend triangle below. There’s no frenzy around iPhones, nor is the company launching many products. As a result, over the last five or six quarters, sales and earnings haven’t grown as fast as they used to. This is normal if you look at Apple’s history. It goes through product innovation cycles and occasionally there’s a pause in growth before starting another upcycle.

Three line graphs showing Apple's dividend triangle. Sales and EPS at a plateau for the last 2 years as per its innovation cycle — Apple’s sales and EPS reaching a plateau due to the company’s innovation cycle

Industry-wide cycle. We can think about basic materials and the energy sector for example. If you look at the 2015-2020 period versus 2021-2026, when we get there, we’ll have a completely different picture of the energy sector; the whole sector goes through cycles.
Sometimes it’s just the economy. Recent reports from Home Depot, Canadian Tire, and railroad companies reveal there are slowdowns. We cannot expect huge revenue or earnings per share growth for 2024, and possibly 2025. This isn’t limited to a specific company, but entire cyclical industries getting hit by consumers spending less.

Putting the revenue slowdown in context helps you to differentiate between a temporary cause, such as a cycle fluctuation or a negative currency impact, or a permanent situation. By permanent situation, I mean things that are specific to the company and not resolved by time alone, if at all. This could be a company losing market share as it cannot adapt to increased competition (think Blackberry), or a business that isn’t relevant anymore because it’s in a dying industry and fails to innovate or diversify; remember printed media and video stores?

What about falling EPS and slowing dividend growth?

Yes, the triangle isn’t just about revenue. EPS and dividends are also key metrics that can show signs of weakness. We’ll explore that in next week’s article, along with a few other metrics.

In the meantime, it’s important to understand that you must look at more than one metric to assess the state of a company’s performance, good or bad. Also, remember that putting things in context is a must and the trend is your friend!

Common Investing Mistakes: Waiting for Market Pullback & More

Among common investing mistakes is waiting for market pullback hoping to buy stocks at a cheap price. Another is holding on to loser stocks hoping their price goes back up. These mistakes put your retirement at risk and keep you from sleeping well at night. Learn what you can do about it.

Learn about the other three frequent mistakes investors make here.

Download our Recession-Proof Portfolio Workbook to learn more about building a resilient portfolio.

Waiting for a Pullback

Buy low, sell high, basic and sound investing advice for anyone starting their investing journey. So, what do you do when the stock market keeps climbing higher? You’re not going to buy high, are you? When the market’s trading close to an all-time high, it’s very tempting to wait for the next crash before investing

Why you do this

History is full of investing horror stories. Over the last 25 years alone, we’ve seen the tech bubble, the Twin Towers terrorist attack, the 2008 financial crisis, the oil bust in 2015, the 2018 quick bear market, and the 2020 pandemic crash. Inexplicably, many investors think of the events of went up 145% while the U.S. market tripled!

Hoarding cash until the next crash seemingly makes sense; you’ll buy shares at an incredibly low price and enjoy strong returns when they go back up. Why buy now if you can get it cheaper later? And, while you wait, you won’t lose any money on the chunk you hold in cash. A win-win situation; earn interest on your cash now and bargains in the market later. Wrong!

How it hurts your portfolio

It’s true that investors who invested in 2009 show impressive results today. If the events of 2009 occurred every 5 or even every 10 years, waiting for a major pullback would be a defendable strategy. The opportunity to invest after a major stock market correction is quite rare. Since 1970, there have only been three pullbacks that would’ve been worth the wait (1973-74, 2000-01-02 and 2008-09).

Bar chart showing yearly market variation since the 1928. Only three major market crashes since 1970. — A long wait – Only three major market crashes since 1970

Most often, you’d wait nine years for the next major crash. Who can afford to wait a decade to invest? An insidious effect of waiting is that it makes you doubt your investing plan. Case in point: on December 26^th, 2018, both markets had just decreased double-digit from their peak levels. Did you invest all your available money then? This was a major pullback. You probably didn’t invest more money in December 2018 because you were thinking about the possibility of another 2008 or 2000-2002. None of us knew it was the start of yet another bullish segment. Nobody waives a flag to tell us it’s time to buy.

Fixing it

In 2013-2014, most financial analysts and the media said the market was overvalued, be it Forbes, Goldman Sachs, or Motley fool. Everybody agreed the market was way overvalued again in 2017, and again in 2022.

Stock Buying Process: child following instructions to assemble Legos — Build according to plan

In 2017, I didn’t care where the market was from a valuation standpoint. Selecting from the finest dividend growers at that time, I built my portfolio. Even if a pullback happened 3 months after I invested, I knew my dividend payments would continue to increase during the correction. Sooner or later, share values would go back up… because this is what happens, repeatedly.

Despite 2018, a terrible year, I was better off fully invested during that time than if I had kept 30% to 50% of my portfolio in cash to invest on boxing day. The capital appreciation from early fall 2017 to summer of 2018 combined with the dividends paid exceeded temporary losses incurred during the rest of 2018. None of the calculations I made showed that waiting would have been better.

So, when you think you shouldn’t invest money, focus on your dividend growth plan instead of the stock value. To add in some protection, you can plan to invest at intervals over a 6- to 9- month period. See How to invest a lump sum.

Investing with confidence prevents waiting for a pullback. Our DSR portfolio returns show that even during the market correction of 2018, the focus on dividend growing stocks minimized losses. The best protection against a market crash is a solid portfolio, holding robust dividend growth.

Download our Recession-Proof Portfolio Workbook to learn more about building a resilient portfolio.

Thinking it’ll Bounce Back

Many people invest in the wrong companies. Making poor investment decisions happens to all of us. My positions in Lassonde (LAS.A.TO) and Andrew Peller (ADW.A.TO) were in the red, about 30 months after I bought them. For a while, I waited, but eventually sold my shares of both as they didn’t fit my investment thesis.

Why you do this

None of us want to buy high and sell low. We’ll justify the first 10-20% loss as a temporary setback, the market doesn’t get it, or investors will realize it’s a good company. It’s hard to admit mistakes. It hurts our ego, and our brain does all it can to protect that ego. So, we patiently wait for our losers to come back on track and prove us right.

We also tell ourselves that selling at a loss is acting on fear, and we don’t let our emotions drive our transactions. It’s good reflex to have, but we must analyze our losers to decide to keep or sell them.

How it hurts your portfolio

Investors keep their losers because they focus on the money lost. After making a bad investment that’s trading 40% lower than what you paid, not much else can go wrong. How can you possibly lose more? So, you keep your shares thinking one day it’ll bounce back, and you could recover your money.

In doing so, you leave a lot on the table; there’s an opportunity cost when keeping your money invested in a bad place. What if you cut your losses and bought shares of a strong dividend grower instead? Worried you’ll make another mistake? It could happen, but since you already made one, you learned from it and will make better choices.

Some years ago, I held shares of Black Diamond Group (BDI.TO). The company faced challenges after the oil bust of 2014-2016 and cut its dividend. Sticking with my investing principles, I sold my shares right away and took the loss. I wasn’t happy to lose money and felt a bit dumb for having bought it in the first place. I was wrong with my investment thesis, and I wasn’t fast enough to see the dividend cut coming. Instead of whining about my bad investment, I moved on. With the proceeds, I bought shares of Canadian National Railway (CNR.TO / CNI). The rest is history:

Had I waited for better days with Black Diamond, I’d have suffered a second dividend cut and lost even more money. Meanwhile, my new shares of CNR appreciated in value substantially and the dividend kept increasing.

Fixing it

Investigate why your loser stocks are losers; perhaps they suffered a one-time event or temporary setback? Or perhaps metrics over 5 years show more serious problems with the company, like lack of growth, absence of dividend increase, a dividend cut, ballooning debt, etc. To avoid future mistakes, find where you went wrong; were you blinded by the company narrative, seduced by a high yield, in denial about the risks the company faced? See 7 Reasons we end up With Loser Stocks, What to do About it.

Build a list of replacement stocks; those you’ve researched and would like to own. The best way to get over selling a loser at a loss is to get a shiny new thing!

Building an Income Portfolio – Made Easy

Building an income portfolio made easy. Really? Yes! While there are mountains of books on portfolio building, it’s easy to go down the rabbit hole and get lost in tons of theory.

Here is a simple approach to building a portfolio that holds a good mix of dividend growers, which is what I believe to be the best way to create dividend income for life.

Most of your portfolio return is explained by your asset allocation and your sector allocation. If you’re mostly invested in fixed income products during a stock market crash, you will do well. If you moved your money into the energy sector at the end of 2020, you look like a genius today. In both cases, the allocation was the key to the success.

Get more in-depth information. Download our guide.

Since I’m a passionate dividend growth investor, I’ll leave the asset allocation discussion for another day, to focus on sector allocation. In short, there are 11 sectors that we can sort into three categories:

Income/stability: Sectors where you find many mature businesses that are recession- resistant.
Growth: Sectors where you find companies with multiple growth vectors, able to surge during economic booms.
Both: Sectors where you find companies showing a balance between growth and stability.

Income/Stability Sectors	Growth Sectors	Sectors Balancing Both
Consumer Staples	Consumer Discretionary	Financials
REITs	Information Technology	Communication Services
Healthcare	Energy	Industrials
Utilities	Materials

To explore each sector thoroughly and learn each’s strength and weaknesses, I invite all DSR members to review our DSR fundamental newsletters about sectors and how to get the best of each one. If you’re not a member, you just found another great reason to subscribe 😉😉. In the meantime, here are answers to questions you might have about sector allocation.

Get more in-depth information. Download our guide.

Do I need to invest in all 11 sectors?

Not at all. You must invest in sectors that fit with your goals, i.e., stability vs growth, and that you understand. There’s no point in investing in tech stocks if you have no clue how the semiconductor industry cycles work. When investments are down, you won’t be happy, but if you understand the industry’s characteristics, you won’t panic.

How much to put in each sector?

Again, there are no hard rules here. I like to have a maximum 20% invested in my favorite sectors and around 10% in others. However, it happens that I go above 20% due to the great performance of a few companies. I make sure that I invest in various industries within the same sector to avoid getting wacked by a single market event.

For example, there is a big difference between having 25% invested in financial services that is spread across five Canadian Banks with 5% in each one, and having 5% in each of the following: Royal Bank (Canadian bank), BlackRock (asset management), Visa (payment processor), Great-West Life (life insurance) and Brookfield Corp (alternative asset management).

Which sectors are best?

There are no best or worst sectors, but rather good timing for specific sectors. Investing in the energy sector in 2015 or at the end of 2020 would have created two completely different outcomes. Again, the best sectors are the ones for which you understand how the companies run their businesses.

Get more in-depth information. Download our guide.

Number of stocks per sector?

That depends on how many stocks you want to hold in total and how many sectors you want to invest in.

You can select the best 2, 3, or 4 companies in each sector you want exposure to. That would likely lead to a 20-40 stocks portfolio. Purely by chance, that’s very close to what I think is the ideal number of stocks.

Number of stocks in my portfolio?

Holding fewer than 20 stocks means the room for error is thin. This strategy could be great for high-conviction investors, but I prefer securing a little bit more diversification.

On the other end, if you go above 40, you’re getting closer to building your own ETF. Monitoring 70 companies quarterly will prove daunting and you’ll eventually miss information. Also, if a stock represents 0.32% of your portfolio, even if it doubles in value or crashes by 80%, you will never feel it.

To help you select stocks see also Stock Buying Process – Here’s What I Do.

How to select one stock over another in a sector

As you dig into a sector you might find more than one company that looks interesting. But buying four railroad companies or five Canadian banks won’t improve your diversification. You must find a way to compare more than one industry in the same sector.

The first step is to understand each business model and identify their differences. For example:

Pepsi Vs Coca-Cola: PEP is 50% snacks, 50% beverage while KO is all about beverages.
TD Bank vs Scotiabank: TD is 2/3 in Canada, 1/3 in the U.S. while BNS is concentrated in Canada and expanded its business in Central and South America.

If you don’t find a business model more appealing than the others, compare numbers. I usually go with the companies with the strongest dividend triangle (5 years of revenue, EPS, and dividend growth). At DSR PRO, we’ve created a stock comparison tool that does the hard work for you:

You can add as many companies as you want to look at a sector or an industry. It’s usually easier to use hard data to make a choice.

Now that you know how to create an income portfolio, learn how you can create your own dividend from that portfolio, in Create Your Own Paycheck in Retirement.