What Your Portfolio and Veal Parmesan Have in Common
Timing the stock market is a losing proposition even for those who moonlight at the Psychic Network. A much easier and proven way to make money in the market is as easy as cooking your favorite meal. By following a simple recipe you can create not only a tasty dish, but also a well-performing portfolio.
Dishing up a balanced portfolio
Studies show that 90% of variability in portfolio returns is derived from asset allocation, not market timing or stock selection. So while stock selection can make a difference over the long haul, higher-level portfolio decisions overwhelming dictate your results.
Benchmarks offer us guidance in structuring our portfolio, keeping risk in check, and evaluating our performance over time. Benchmarking helps us make strategic decisions on sectors, while maintaining diversification, so we can manage risk appropriately. A properly benchmarked portfolio helps us mitigate uncertain market conditions since sectors perform differently over bull, bear, and flat markets.
Think of a benchmark as a set of instructions, like a recipe for cooking a meal. If you're preparing veal parmesan, you know that veal, cheese, bread crumbs, eggs, herbs, olive oil, and tomato sauce are required ingredients. The recipe spells out the ingredient list and the quantity of each necessary for crafting a palatable dish.
We'll use the MSCI World Index as an approximate benchmark for determining how much of each sector -- or ingredient -- you'll want to consider for your portfolio.
Source: Industry weightings adapted from MSCI World Index.
The industry weightings provide you with a starting point for making decisions. If your stock portfolio carries the same weightings as the index, then you are neutral from an industry standpoint; you'll prepare your veal parm as the recipe dictates. If you feel strongly about a particular industry and buy stocks only in that industry -- effectively overloading your dish with fistfuls of parsley and basil -- then you take on more risk. The flavors won't marry, and your meal will taste like an herb garden.
Grab your apron or order out
Once you've determined your strategy, execute on it. One method is buying broadly diversified mutual funds or exchange-traded funds (ETFs), effectively procuring premade veal parm. For those who prefer take-out, broadly diversified ETFs like Vanguard S&P 500 ETF and SPDR S&P 500 ETF do the trick.
Or get in the kitchen and roll up your sleeves. You can screen for stocks based on predefined criteria, like valuation, or look for companies with sustainable competitive advantages. Let's take a look at some stocks to consider for five of the sectors -- or ingredients -- mentioned above.
3M (NYS: MMM) , the company that brought us Post-It Notes and Scotchgard, makes its mark nearly everywhere in our daily lives -- hospitals, highways, offices, and homes. Known for its product innovation, 3M consistently spends between 5% and 6% of annual revenue on research and development. The company boasts a solid balance sheet that typically contains $2 billion of cash and $4 billion of annual cash flow. 3M has paid a dividend since 1916 and has raised it for 54 consecutive years.
Chip giant Intel (NAS: INTC) claims 80% of the total microprocessor market share. Intel transforms our computers and mobile devices from dumb hunks of plastic and metal to smart, lightning-speed research and communication tools. Its huge size provides tremendous scale advantage over smaller rivals. Intel has a strong balance sheet with low debt levels and generates substantial free cash flow.
MasterCard (NYS: MA) , the experienced payment processor second in the U.S. only to Visa, is one financial stock worth a serious look. The company ranks among America's best free cash flow generators. It boasts high margins versus the industry and its competitors, lots of cash on the balance sheet, and no long-term debt.
Chevron (NYS: CVX) operates the gamut from oil exploration to gas pumps and everything in between. Its reserve replacement ratio is over 100%, meaning it replenishes more oil than it sells. Chevron's deepwater drilling expertise will likely mean more joint ventures and, quite possibly, more money for shareholders. Meanwhile, it pays a slick 3.5% dividend yield.
Considered the McDonald's of Latin America, Arcos Dorados (NYS: ARCO) is the world's largest McDonald's franchisee with enormous growth potential. There are only 1,840 Mickey D's restaurants spanning Latin America's 570 million people, compared to 14,000 locations feeding the U.S.' 312 million. Earnings are expected to grow 24% annually during the next five years. One Foolish team of analysts feels so strongly about its growth prospects and attractive valuation they recently loaded up on more shares for their real-money portfolio.
Foolish bottom line
Now that you're equipped with a recipe and know the type and quantity of ingredients needed, you can better evaluate stock ideas that come your way. Take a look at your stock portfolio and see how it stacks up. Then focus on finding great stocks in sectors in which you are underweight.
We've done some of the homework for you and found one under-the-radar tech company whose clients include blue-chip bellwether Coca-Cola. Our analysts highlight the stock in a free report that's now available. It won't be around forever, so get your copy today.
The article What Your Portfolio and Veal Parmesan Have in Common originally appeared on Fool.com.Fool contributor Nicole Seghetti owns shares of 3M and Intel. Follow Nicole on Twitter @NicoleSeghetti. The Motley Fool owns shares of Arcos Dorados, MasterCard, Coca-Cola, and Intel. Motley Fool newsletter services have recommended buying shares of Intel, Chevron, Coca-Cola, McDonald's, and 3M. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.