Introducing the Death-and-Taxes Portfolio

 | Nov 17, 2011 | 11:00 AM EST  | Comments
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Stock quotes in this article:

mo

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pm

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LQD

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ston

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uvv

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hi

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sci

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stei

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csv

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mcd

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hrb

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intu

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JNK

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HYG

This column originally appears on Real Money Pro on Nov. 16 at 1:30 p.m. EST.

There is nothing certain in life except death and taxes. There is nothing certain about the markets. But what if we combined the two notions? Would they create any certainty? More importantly, could they create a portfolio worthy of your after-tax money for your remaining days?

Just because an idea might seem strange or even a bit silly, that does not necessarily mean it isn't worth merit or at least worth researching. My methodology here was to bring together companies with the theme of death and taxes. Perhaps if it were an ETF, I'd get the ticker REPR, REAP or DEAD, but alas, I am not to that point yet.

I maintained an equal weighting for each equity name and looked at the portfolio as being static from setup. Rebalancing could be used along with a diversification of dividends or even option writing, but for the purposes of just keeping the initial idea simple, I avoided those steps at the beginning. Moving forward, they are normal steps I would consider for any portfolio.

 

Death and Taxes: Risk/Return

 

The most obvious sector to use for this portfolio is personal services, with a focus on funeral services and funeral service products. This group includes Hillenbrand (HI), Service Corp. (SCI), Steward Enterprises (STEI), Stonemore Partners (STON) and Carriage Services (CSV). Hillenbrand is the only one in the group that does not own funeral homes or cemeteries. Its business focuses more on products such as caskets, burial vaults and urns, while the other four are more focused on the burial process and funeral services, with some foray into products. I found it a bit ironic that some of these companies are using the term "death care," possibly to soften the initial thoughts.

Although there may not be a lot of growth in the industry, there is a steady demand. It's a bit dark to think about it that way, but it is also realistic. The companies trade with relatively attractive P/Es, but what I find more attractive are the dividends these firms continue to churn out. It's like a little lifeblood for a portfolio. Stonemore has increased its dividend by 26% since mid-2005, while Steward has increased it by 40% since that time, and Service Corp. has doubled its dividend in the same time frame. Hillenbrand is really the only laggard for increases, but it has remained steady, while Carriage Services poses the greatest risk, since its dividend is less than a year old.

Death doesn't have to be quite so obvious. Two big drivers behind death are cancer and obesity, so why not pull those into the mix? Cigarettes have the nickname "cancer sticks" for a reason, so I chose to add Altria (MO) and Philip Morris (PM) to the mix, along with leaf tobacco merchant Universal Corp. (UVV). There are several cigarette makers an investor could turn to here, so there are options, but I went with the names I had the most familiarity with in terms of trading and holding. Universal is a little outside the normal mix for me, but I really like the chart here, and the payout ratio is acceptable, along with the beta and dividend yield. All three have paid dividends for more than a decade, with a history of constantly increasing those dividends. And it doesn't appear as if smoking will be gone anytime soon.

Many restaurant chains have made a push to offer healthy choices on their menus, but when I think of obesity, I think of fast food. No one does more fast food than McDonalds (MCD). I'm partial to this one for several reasons. First, I think my family keeps the local McDonald's locations in the green. Second, it is a blue-chip name with an international presence. Third, I find the short-term and long-term charts attractive. Finally, McDonald's has been ramping up its dividend aggressively since 2008, and the payout ratio is still under 50%. Tack on a very low beta, and McDonald's makes a nice core to this portfolio. Again, there are other fast-food names an investor could go with, but McDonald's is my choice.

There aren't many pure tax-preparation firms any longer, but H&R Block (HRB) is one obvious choice, and TurboTax and QuickBooks maker Intuit (INTU) is another. The performance of H&R Block has been poor, but it does have an attractive dividend. This one is probably my biggest concern, but the chart looks much better, and I believe H&R Block would do well if the economy begins to recover, especially the financials. It has an outside shot at being bought out, but I wouldn't use that as a reason to buy the name. Intuit isn't very sexy either, but it did just initiate a dividend, and it has a big share buyback in place. Unfortunately, the choices for the taxes part of the portfolio are a bit thin.

This market is tricky though, so I will take some small liberties with the theme and add in some junk bonds to go with the junk food and some corporate bonds that also fail to avoid taxes. My allocation here would be small at only 15% of the portfolio, with 7.5% split between SPDR Barclays Capital High Yield Bond ETF (JNK) and the iShares iBoxx High Yield Corporate Bond Fund (HYG), along with 7.5% in the iShares iBoxx Investment Grade Corporate Bond Fund (LQD). These offer some diversification from the equities, and they provide additional sources of yield.

Overall, the dividend yield on the proposed portfolio runs just above 4% with an anticipated growth rate on the yield from the equities of at least 10%. In other words, I anticipate that the yield based on the purchase price will increase from 4% to 4.4% over the next 12 months. This increase may be a little bumpy at times, with some 12-month periods seeing a lower increase while other periods will see a bigger rise, but overall, this is where I expect the average annual increase to come in over the next five years.

I did back-test the portfolio over the past year and three years, just to satisfy my own morbid curiosity. The results, as shown in these charts, were fairly attractive. Of course, past results do not guarantee the future results, but they at least give us a guide. There is clearly a correlation to the overall market, since the portfolio fell during times of the market decline, but overall, the annual standard deviation in both time frames was significantly less than that of the S&P 500.

 

Death and Taxes, one year
Death and Taxes, three years

 

Furthermore, the returns were nearly twice that of the S&P 500, and that was with taking the dividends in cash. It is an interesting concept, although certainly not the holy grail. Plus, we aren't looking to escape death, so the holy grail would have to be owned, since it would be a hedge against death. The results are at least worth further research, and from the research, I've already added PM, UVV, and SCI to go along with MO, JNK, HYG, LQD and STON, which were names I already held. 

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