Put many investors’ share portfolios under the microscope and they will look somewhat haphazard.
Even those who started with the best intentions can find that life gets in the way and their selection of shares reflects a scattergun approach rather than a well-planned investment strategy.
One answer to this is to buy funds and outsource building a portfolio to a fund manager, or even to take their potential for making mistakes out of the equation and get an index tracker.
Yet, if you do want to build your own share portfolio – or just understand how people do it – how do you go about it?
Building blocks: How do you put together a shares portfolio that can deliver over the long-term
I’ve spent quite a bit of time listening to fund managers over the years and to my mind the best have a simple understandable strategy that they can clearly articulate – and they stick to it.
To understand how private investors can adopt a similar approach, I asked our friends at Stockopedia to build a buy-and-hold DIY investing Isa share portfolio – and explain how it was done.
The criteria was that it would be focussed on not too risky, dividend-paying shares, with a bit of growth chucked in.
The idea was that we wanted a portfolio you don’t need to pay too much attention to, that reinvested and compounded dividends deliver most stock market returns over time, and that a sprinkling of growth often helps.
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On the back of that request Stockopedia’s Thomas Firth build a share screen and explained the rules behind it.
'One of the key goals here is to try and create a stable and safe portfolio - as far as is possible', he said.
'By far the best way to do this is to diversify. If you put all your eggs into the financial services basket, don’t be surprised when 2008 rolls round again and you’re left with severe losses.
'So we should look at the industry groups and avoid excessive concentration in one. We should also look at size and avoid being concentrated in large or mid caps - a mix of both is probably best for the long term.
'Aim for at least 20 stocks but more is preferable if you have sufficient funds to do so.'
This isn’t the only way to build a portfolio, or necessarily the right one for you, but it gives some good insight into the process.
In brief, the rules looked for established and stable companies, so market caps larger than £500million, with a long track record of growing free cashflow, profitability shown by consistent return on capital employed, reliable dividend growth and a decent yield (above 2 per cent) and not too much debt.
They also needed to be not too expensive, so a price-to-earnings ratio of less than 20 was specified.
This screen delivered a list of shares, which Thomas then filtered to make sure it was diversified and not too reliant on one particular type of company.
It's vital to remember that while screening for shares like this can deliver up a good long list of potential investments, you then need to do your own research on those companies.
Dig into the company reports, check the numbers, consider the wider environment, ask yourself if there is something special that this company does.
You may even decide that there are shares of companies included that you just don't want to hold, for reasons of ethics, personal preference or good old-fashioned gut feeling.
Alternatively, if you aren’t left with as many ideas as you’d like then you might decide to stretch the rules a little bit - or try a slightly different approach - just don't stray too far from your initial intention.
One extra caution was sounded by Thomas, however, in that even a long-term buy and hold portfolio needs rebalancing periodically (once a year should do) – companies won’t display the same characteristics forever, some will need culling and others may need to be added.
If you don’t want to bother with that, then a fund manager or tracker fund might be your friend after all.
| Name | Market Cap £m | P/E | Yield % | Industry |
|---|---|---|---|---|
| BT | 43,954 | 13.5 | 3.17 | Telecommunications Services |
| Kingfisher | 8,271 | 16.5 | 2.78 | Specialty Retailers |
| Mondi | 6,361 | 12.5 | 3.11 | Containers & Packaging |
| Persimmon | 6,040 | 11.8 | 5.6 | Homebuilding & Construction Supplies |
| Aberdeen Asset Management | 3,470 | 16.8 | 7.41 | Investment Banking & Investment Services |
| Henderson | 2,740 | 19.7 | 4.25 | Investment Banking & Investment Services |
| HICL Infrastructure | 2,226 | 11.9 | 4.62 | Collective Investments |
| WH Smith | 1,916 | 18.3 | 2.42 | Specialty Retailers |
| Jupiter Fund Management | 1,904 | 14.6 | 3.51 | Investment Banking & Investment Services |
| Jardine Lloyd Thompson | 1,879 | 13.2 | 3.57 | Insurance |
| Dunelm | 1,827 | 17.9 | 2.44 | Specialty Retailers |
| GVC Holdings | 1,586 | 8.5 | 6.06 | Hotels & Entertainment Services |
| Cineworld | 1,403 | 15.9 | 3.31 | Hotels & Entertainment Services |
| Renishaw | 1,358 | 13.9 | 2.49 | Machinery, Equipment & Components |
| Michael Page International | 1,325 | 19.1 | 2.83 | Professional & Commercial Services |
| Go-Ahead | 1,110 | 17.4 | 3.55 | Passenger Transportation Services |
| Greggs | 1,102 | 18.8 | 2.63 | Hotels & Entertainment Services |
| Elementis | 958.8 | 16.5 | 2.79 | Chemicals |
| Rank | 933.7 | 15.2 | 2.43 | Hotels & Entertainment Services |
| Tullett Prebon | 809 | 10.8 | 5.07 | Investment Banking & Investment Services |
| Brewin Dolphin Holdings | 777.9 | 15.7 | 4.37 | Investment Banking & Investment Services |
| Hill & Smith Holdings | 708.4 | 18.9 | 2.29 | Machinery, Equipment & Components |
| PayPoint | 568.9 | 17.8 | 4.82 | Professional & Commercial Services |
| Source: Stockopedia |
How to build a DIY buy-and-hold dividend share portfolio
These are Thomas Firth, of Stockopedia's, notes on building the portfolio screen, to explain the thinking behind it.
Building a screen
The target is to build a screen that looks for high quality and stable companies, which are paying good dividends and are growing.
We can accomplish this with rules something like this:
- We want well established and stable companies, and these are more likely to be a little larger than most. That said, it is much easier for a company with a £500m market cap to double in size than one with a £5bn market cap after all. I have limited my results to companies with market caps larger than £500m.
- We want a long track record of growing their free cash flows (in the long run companies have to turn earnings to cash so FCF is better than earnings). The rule I have chosen is FCF 5y CAGR > 5%.
- We want a company that has consistently been profitable and that uses its capital effectively - ie, companies with a high return on capital employed. The rule I have chosen is ROCE LT Avg > 10%.
- We want companies that have consistently grown their dividends. The rule I have chosen is DPS 5y CAGR > 0%.
- It’s one thing for a company to grow its dividends, but we only want companies with high yields. The rule I have chosen for this is Yield % > 2.
- We want to ensure that we don’t pick risky companies that are exposed to a lot of leverage (debt). These companies are much more likely to face financial difficulty in bad times with negative consequences for shareholders. The rule I have chosen for this is Gearing % < 150.
- Finally, we’ve found some companies with the above rules but price is still an issue. To keep this reality check in, I’ve required that the P/E ratio be under 20. We shouldn’t go too low here - we’re looking for quality merchandise after all and the best goods sell at premium prices, even when marked down.
Constructing the portfolio
One of the key goals here is to try and create a stable and safe portfolio - as far as is possible. By far the best way to do this is to diversify. If you put all your eggs into the financial services basket, don’t be surprised when 2008 rolls round again and you’re left with severe losses.
So we should look at the industry groups and avoid excessive concentration in one. We should also look at size and avoid being concentrated in large or mid caps - a mix of both is probably best for the long term.
Aim for at least 20 stocks but more is preferable if you have sufficient funds to do so.
A look at the results from this screen shows that we’ve come up with quite a few stocks in investment banking & investment services and the hotels & entertainment industry groups, so we should look to ignore some of them.
Try to pick one that goes well with the rest of the portfolio - if you have lots of big stocks so far, take a small one, or if you have mostly dividend paying stocks, try one that is focused more on growth.
It’s also best to exclude investment trusts or similar from this kind of screen - they need to be assessed a little differently so it’s not appropriate to pick them with these rules.
Relaxing the rules
If you aren’t left with as many ideas as you’d like, you can either relax the rules a little or try a slightly different approach.
It could be worth including a few even smaller growth companies (though avoid the very smallest firms). These may be a little riskier individually but are great as part of a diversified portfolio and they offer a good chance for capital appreciation over the long run.
You could find some by removing the dividend criteria (growth companies tend to reinvest their money rather than distribute it to shareholders) from the screen and reversing the size criteria.
It is also worth looking for some big international dividend paying companies such as AstraZeneca, BAE Systems or Land Securities.
These are not fast growing companies, but they should be around for years to come due to their well-developed and powerful business models. They pay good dividends and if you are careful about the price you pay, there is still room for a capital gain. You could do this by removing the growth requirements from the screen and instead increasing the size requirement.
It’s important to note that while these companies can add some security and income to a portfolio, they are not going to deliver the kind of capital appreciation that is available to the mixed portfolio.
Maintaining the portfolio
Remember that the goal is not to be exposed to a certain company, but to certain desirable ‘factors’. These factors are long run growth and profitability, growing and decent dividend payments, low levels of debt and reasonable valuations.
Over time, our portfolio will naturally drift from these factors as companies change in price and performance.
We should therefore check up on things once in a while. For a strategy like this one, once every six months or even annually would suffice, though in theory more frequently is better. Just be wary of the cost of rebalancing - it can be costly so you have to get the balance right between frequency and cost. A larger portfolio can afford to do this a little more often.
The rebalancing process just involves bringing things back in line with the screen - companies should be equally weighted and if they are no longer meeting screen criteria, they should be discarded. That said, we would expect many of these high quality shares to meet the criteria for a long time.
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