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Investment Thesis
In a previous analysis, I discussed ‘How To Build A Portfolio That Combines An Attractive Dividend Yield With Dividend Growth’. In that article, I briefly mentioned some of the advantages of selecting stocks individually over investing in exchange-traded funds (“ETFs”).
In today’s article, I would like to dive deeper into this topic and write in more detail about the advantages of selecting stocks individually over investing only in an ETF. As examples, I will use 10 companies that pay a dividend in order to show you these advantages.
However, it is true that ETFs do have advantages over the individual selection of stocks; especially if you don’t have time to gain enough information to make well-founded investment decisions. In addition to that, they also offer a broad risk diversification due to the fact that they, depending on the composition, may consist of companies from different sectors, industries and countries.
But there are also various advantages to selecting stocks individually. Below, I have listed some of these advantages. Throughout the article I will go into more detail on in each example.
The advantages of selecting companies individually over investing in an ETF
- Building a personal investment portfolio that consists of a selection of individual stocks gives you more flexibility – The example of Unilever (NYSE:UL)(OTCPK:UNLYF)
- An individual investment portfolio gives you more individuality to achieve your personal investment goals – The example of AT&T (NYSE:T)
- Through the acquisition of companies with a low Beta Factor, you can protect your investment portfolio against the next stock market crash – The example of Coca-Cola (NYSE:KO)
- You can build your portfolio with the goal of receiving monthly dividend payments instead of quarterly – The example of Realty Income (NYSE:O)
- When you build your investment portfolio individually, you can achieve a higher Average Dividend Yield than when investing only in an ETF – The example of Altria (NYSE:MO)
- Through the individual selection of stocks, you can reach a higher Average Dividend Growth Rate than when only investing in an ETF – The example of Microsoft (NASDAQ:MSFT)
- You can focus on buying the best companies from each industry or ones with a strong brand value that are able to raise prices in times of high inflation – The example of Starbucks (NASDAQ:SBUX)
- You can overweight sectors and industries you are more familiar with – The example of Nike (NYSE:NKE)
- You can overweight the stocks that you expect could beat the market – The example of Apple (NASDAQ:AAPL)
- You can avoid sectors you do not want to invest in – The example of Philip Morris (NYSE:PM)
Building a personal investment portfolio that consists of a selection of individual stocks gives you more flexibility – The example of Unilever
When you decide to make a new acquisition for your investment portfolio, you can focus on companies that are undervalued as this provides you with the chance to buy the company for a price that is lower than its intrinsic value.
A company that I consider to be currently undervalued is Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL). With a P/E [FWD] Ratio of 18.83, the company’s P/E Ratio is 30.58% below its Average P/E Ratio of the last 5 Years, providing us with a strong indicator that Alphabet is currently undervalued.
In addition to that, the individual selection of stocks provides you with more flexibility when you need to sell some in order to get more cash. Here is an example to illustrate this further:
Let us assume that investor A has only invested in one ETF. Investor B, on the other hand, has managed to build an individual investment portfolio consisting of 25 different stocks. Let us imagine that both were forced to sell a part of their stocks/ETFs due to an unforeseen situation in their lives shortly after a worldwide stock market crash occurred, which has caused the overall market (the ETF) to decrease by 20%.
Investor B, who has managed to build an individual investment portfolio consisting of 25 picks, would have an advantage as they could sell the companies that have decreased by less than 20% of the overall stock market. In particular these are companies with a low Beta, that tend to decrease less than the broader stock market when a stock market crash occurs.
Unilever is one of these companies with a low Beta Factor. It’s an attractive choice from the Consumer Staples Sector and Personal Products Industry with strong financials (A1 credit rating by Moody’s) and a low 24M Beta Factor of 0.12 and 60M Beta Factor of 0.14.
An individual investment portfolio gives you more individuality to achieve your personal investment goals – The example of AT&T
When selecting stocks individually, you are able to put your focus more towards your individual investment goals: a person that aims to investment with a long investment-horizon, for example, can overweight companies that show significant Dividend Growth. A person that aims to invest with a shorter investment horizon to achieve a higher Dividend Income can overweight companies with a high Dividend Yield.
An example of a company that offers a relatively high Dividend Yield is AT&T. The company currently provides its shareholders a Dividend Yield [FWD] of 5.92% while it has a Payout Ratio of only 46.96%, making it an attractive pick for those seeking Dividend Income.
Through the acquisition of companies with a low Beta Factor, you can protect your investment portfolio against the next stock market crash – The example of Coca-Cola
You can prepare your investment portfolio for the next stock market crash by adding companies with a low Beta Factor.
An example of a company with a relatively low Beta Factor is Coca-Cola. The company has a 24M Beta of 0.61 and 60M Beta of 0.59. Its low Beta would contribute that your portfolio could decrease less than the broader stock market during a stock market crash.
You can build your portfolio with the goal of receiving monthly dividend payments instead of quarterly dividend payments – The example of Realty Income
When individually selecting companies for your investment portfolio, you can pick ones that pay you monthly dividends. An example of a company that pays its shareholders a monthly dividend is Realty Income.
Furthermore, the company pays an attractive Dividend Yield [FWD] of 4.70%. In addition to that, it has shown 26 Consecutive Years of Dividend Growth, implying that it’s an attractive pick for dividend income and dividend growth investors.
However, you do not necessarily need to pick stocks that pay a monthly dividend in order to receive an additional income every month of the year: you could also build your investment portfolio in a way that at least one of the selected companies pays a Dividend in one month of the year. This would provide you with an advantage over only investing in an ETF. Most ETFs, such as the Vanguard S&P 500 ETF (NYSEARCA:VOO), only pay a Dividend quarterly.
When you build your investment portfolio individually, you can achieve a higher Average Dividend Yield than when investing only in an ETF – The example of Altria
The iShares MSCI World ETF (NYSEARCA:URTH) provides its shareholders with a Dividend Yield [TTM] of 1.68%. The Median of all ETFs is 2.08% (below you can find the Seeking Alpha Dividend Grades for the iShares MSCI World ETF).
When selecting stocks for your investment portfolio individually, you can reach a higher Dividend Yield than when compared to the iShares MSCI World ETF or the Median of all ETFs. You could do so by adding companies that pay a relatively high Dividend Yield to your portfolio. Companies from the Tobacco Industry, such as Altria, for example, tend to pay its shareholders a relatively high Dividend Yield.
At this moment, Altria provides its shareholders with a Dividend Yield [FWD] of 8.23%. The Dividend Yield is attractive, particularly when taking into account the company’s 5 Year Average Dividend Growth Rate of 7.70% and considering that it has shown 53 Consecutive Years of Dividend Growth.
Another example of a company with a high Dividend Yield [FWD] is Verizon (NYSE:VZ). The company currently shows a Dividend Yield [FWD] of 6.62%. Due to its relatively low Payout Ratio of 48.63%, I expect Verizon to continue raising its dividend in the coming years, making it an excellent choice for those seeking Dividend Income.
Through the individual selection of stocks, you can reach a higher Average Dividend Growth Rate than when only investing in an ETF – The example of Microsoft
The iShares MSCI World ETF has shown a Dividend Growth Rate [CAGR] of 2.06% over the past 5 years. In the case where you individually select companies for your investment portfolio, you could be able to achieve a higher Average Dividend Growth Rate than this or through other ETFs.
In order to achieve a higher Average Dividend Growth Rate, I would recommend taking a deeper look into the IT sector in particular: I especially consider companies that have strong competitive advantages, strong financials, a relatively low Payout Ratio, and, in addition to that, have managed to increase their Dividend significantly in recent years to be appealing.
An example of a company that fulfills all of these characteristics is Microsoft. The company has strong financials (Aaa credit rating by Moody’s), a Payout Ratio of only 27.37% and has shown an Average Dividend Growth Rate of 9.82% over the past 5 years. This makes Microsoft an attractive pick to raise the Average Dividend Growth Rate of your investment portfolio.
Selecting companies such as Microsoft for your individual investment portfolio, can help you reach a higher Average Dividend Growth Rate than most ETFs can provide.
The Seeking Alpha Dividend Grades, which you can find below, strengthen my theory that Microsoft is a great pick for investors seeking dividend growth.
You can focus on buying the best companies from each industry or ones with a strong brand value that are able to raise prices in times of high inflation – The example of Starbucks
When investing in an ETF you acquire all types of companies, this includes ones with marginal competitive advantages and weak financials.
When selecting stocks individually, you can put your focus on only investing in the best companies from each industry. This might help you outperform the market over the long term.
You could also focus on investing in companies with a strong brand value. These companies such as Apple, Nike or Starbucks, are more likely to raise their prices in times of high inflation than companies with less brand strength. This strategy can help you to protect your money against inflation.
The Seeking Alpha Quant Ranking confirms that Starbucks is one of the leading companies out of its Industry and Sector: it is ranked 11th out of 42 within the Restaurants Industry and 131st out of 549 within the Consumer Discretionary Sector.
Source: Seeking Alpha
You can overweight sectors and industries you are more familiar with – The example of Nike
Furthermore, when selecting stocks individually you can overweight the companies you are more familiar with and can therefore better identify their competitive advantages.
A professional sports athlete, for example, that aims to invest, might have a stronger ability to identify the competitive advantages of companies from the Sporting Goods Industry, such as Nike or adidas (OTCQX:ADDYY) and might prefer to overweight these companies in an investment portfolio.
A person that has worked for a long time within the Digital Payment Industry might feel more comfortable to overweight companies such as Visa (NYSE:V) or Mastercard (NYSE:MA).
You can overweight the stocks that you expect could beat the market – The example of Apple
When selecting stocks individually for your personal investment portfolio, you could pick companies that you think might be able to outperform the broader stock market.
An example of a company that has managed to do this over the last decade and which I expect could do the same in the coming years is Apple: the company has outperformed the S&P 500 in the last 3 years (showing a Total Return of 72.03% while the S&P 500 has shown 24.44% over the same period), as well as the last 5 years (204.17% vs. 53.70%) and even the last 10 years (672.99% vs. 215.68%).
Another example of a company that has proven to be capable of outperforming the broader stock market over the long term is Nike. The world’s leading sporting goods manufacturer has shown a Total Return of 96.19% over the past 5 years while the S&P 500 has shown a Total Return of 53.70%. Furthermore, Nike has shown 398.64% over the past 10 years (compared to 215.68% by the S&P 500).
Due to Apple’s and Nike’s strong competitive advantages, I believe that both can continue to outperform the broader stock market over the next decade.
You can avoid sectors that you don’t want to invest in – The example of Philip Morris
When you choose to invest in an ETF, you generally invest in all kinds of sectors and industries (as long as it’s not an Industry ETF). However, you might not want to invest your money across all of the different sectors and industries.
For example, you might be unwilling to invest in companies from the Defense Industry, such as Lockheed Martin (NYSE:LMT) or for health reasons, companies from the Tobacco Industry, such as Philip Morris.
Through the individual selection of stocks, you can avoid certain sectors and industries that you’re not willing to invest in.
Conclusion
Even though it’s true that ETFs also provide you with advantages over individual stocks due to their broader risk diversification, there are still a lot of advantages when selecting stocks individually as compared to investing in an ETF.
In this article I have used 10 companies to show you the advantages of selecting stocks individually instead of investing in an ETF.
In particular, I see the advantage of individual stocks being that they provide you with more individuality to achieve your personal investment goals and also more flexibility.
In the case where you are in a situation in which you are forced to sell some of the companies of your investment portfolio, stocks with a low Beta Factor could be a good choice: they may help you to protect your investment portfolio and can contribute to the fact that your portfolio decreases less than the broader stock market (or an ETF) in times of a worldwide stock market crash.
In addition to the above, I especially like the fact that you can achieve a higher Dividend Yield and a higher Dividend Growth Rate through individual stock picking when compared to only investing in an ETF.
Authors note: I would be glad to hear your opinion on this topic! Thank you very much!
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.