Building a Diversified Portfolio With 5 Stocks

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Whether you have been a longtime investor or are just getting started, ushering in a new year is a great time for fresh insight.  Below are five stocks with a balanced potential for capital appreciation and dividend increases combined with reasonable valuations.  The businesses selected represent favorable, durable and competitive characteristics for a long-term buy and hold approach.  The securities represented are in industries with low correlation in an effort to help build a more diversified portfolio.  


Travelers Insurance - (NYSE: TRV)

Property Casualty Insurance

Share Price - $73

Market Cap - $27.8B

PE TTM - 10.4

Forward PE - 10.7

PEG - 0.93

Div Yield - 2.6%

Return on Equity - 11%

Why Buy: Valuation

Property casualty insurance is a stable industry and will be needed for the indefinite future.  Recent quarterly reports show that Travelers has been able to achieve consistent rate increases on its book of business and this has translated into earnings growth.  The insurance market has been hardening since late 2011 and it has a strong chance to continue into 2013.  With a recovering economy, the amount of risk to insure should increase, which allows them to grow. Travelers is a diversified national P&C carrier regarded as one of the stalwarts in the industry and pays a nice dividend.  

Two areas of caution are the company's ability to earn adequate investment income in the current low rate environment and the impact of Hurricane Sandy claims.  A key component of the insurer’s revenue is interest income.  With historically low interest rates, insurers are not able to earn as much investment income from when premiums are paid in to when losses are paid out.  In addition, the company put out an estimate on the total cost of claims from Hurricane Sandy, which analysts have inevitably factored into their models.  If these estimates are off, when the company reports Q4 earnings, we could see significant stock price movement in either direction.  It may be advantageous to hold off buying until they report earnings.

 

Marathon Petroleum Corp - (NYSE: MPC) 

Petroleum Refining and Marketing

Share Price - $64

Market Cap - $21B

P/E TTM - 8.7

Forward PE - 7.2

PEG - 0.53

Div Yield - 2.2%

Return on Equity - 24%

Why Buy: Valuation, Macro-Trend

Since its spin-off, Marathon has been successful unlocking shareholder value.  In the last year, earnings have grown and in response, its share price is up substantially.  Trading at a low PE and with over a 2% dividend yield, this stock has attractive characteristics.  Oil refining will be in demand so long as the US maintains its oil addiction.  As our domestic energy strategy strives for energy independence, domestic refining demand will accelerate.  With new extraction techniques, plenty of US reserves, and growing oil production, the company should continue its momentum. 

Refining has some key risk factors.  Furthermore, as our nation may be poised for a shift to natural gas, it could affect the demand of oil refining.  The EPA has often been a thorn in the side of the industry and carbon restrictions could affect profitability. 

 

Waste Management - (NYSE: WM) 

Garbage Services

Share Price - $34

Market Cap - $16B

PE TTM  - 18

Forward PE - 15

PEG - 2.7

Div Yield - 4.2%

ROE - 14%

Why Buy: Income

The waste management services industry has been around long before we were born and will be around long after we are gone. Waste Management is the major player in the industry and has a stranglehold on disposal sites in the US.  The company has a reasonable valuation and pays a 4% dividend.   

While this business is never going to have blockbuster earnings, it should better weather economic downturns due to the inelastic demand of the business.  Main risk factors include competition from rival waste management companies and fuel costs. 

 

Apple - (NASDAQ: AAPL) 

Technology

Share Price - $549

Market Cap - $516 B

PE TTM - 12.4

Forward PE - 9.6

PEG - 0.53

Div Yield - 2.0%

ROE - 43%

Why Buy: Valuation

Apple has long been a tech innovator with a cult-like following of its products. Its Earnings growth rate has been explosive and it is trading at an extremely low P/E relative to its historical growth rate.  Although it will be difficult to maintain the same rate of EPS growth, I anticipate that the dividend rate is poised for expansion.  With extremely low debt, piles of cash, and a attractive valuation, there are compelling reasons to own Apple.  

If the company ever loses the ability to out-innovate the competition, it could spell their demise.  With products in the pipeline, such as Apple TV, it does not look like they are running out of steam any time soon. 

Whole Foods Markets - (NASDAQ: WFM) 

Grocery Stores

Share Price - $92

Market Cap - $17B

PE TTM - 37

Forward PE - 27

PEG - 1.9

Div Yield - 0.9%

Return on Equity - 14%

Why Buy: Shifting consumer preference, growth potential

Whole Foods will continue to capitalize on shifts in consumer preference towards healthier eating (just look at bankruptcy of Hostess in 2012).  Whole Foods has impressively grown revenues, earnings, number of stores, and same store sales at a consistent rate since the recession.  Going forward, it has ambitious targets to continue the pattern.  The company also maintains one of the higher profit margins among its peers (Kroger and Safeway).  

Whole Foods is a great business and the stock has great potential for the long term, but it would be advantageous to get in at a cheaper price if one presents itself. To paraphrase the words of Warren Buffett, it is far better to buy a wonderful company at a fair price, then a fair company at a wonderful price.   On a fundamental standpoint, I think the may be overvalued on a PE and PEG basis.  Looking at this stock from a Peter Lynch perspective, WFM's 3-year EPS growth rate may justify its high PE.  If the market decides to grant a better entry price, I think there is a strong case to pick up some shares up.  

 


dartzero7 has long positions in Apple, Travelers, and Waste Management. The Motley Fool recommends Apple, Waste Management, Inc., and Whole Foods Market. The Motley Fool owns shares of Apple, Waste Management, Inc., and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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