The simple stock-picking strategy that beats the TSX long term by playing good defence

The simple stock-picking strategy that beats the TSX long term by playing good defence

The Two-Minute Portfolio was in fine form in 2020, even as it got spanked by the S&P/TSX composite.

The 2MP is a simple stock-picking strategy that has a proven record of winning over the long term by containing losses in down markets rather than by beating the index in bull markets. The past year was a vintage performance.

While the S&P/TSX composite index lost 20.9 per cent on a total return basis (share price changes plus dividends) in the first quarter of the year, the 2MP’s decline was held to 13.7 per cent. But, as ever, the 2MP could not keep up when the index took off like a rocket in late March. The index ended up with a gain of 5.6 per cent for the year, compared to 3.4 per cent for the 2MP.

The 2MP is a strategy for people who want to own individual dividend stocks, but don’t want to put a lot of work into picking specific companies. With the 2MP, you invest equal amounts in the two largest dividend-paying stocks in each of the 11 TSX subgroups. Adjustments are required every January to make sure you hold the updated roster of 2MP stocks, but there’s not much to do other than that on an ongoing basis.

Changes for 2021 are typical of what 2MP investors will encounter year by year. Rogers Communications Inc. exits the portfolio and is replaced with Telus Corp., Suncor Energy Inc. is replaced with TC Energy Corp. and Canadian Pacific Railway Ltd replaces Thomson Reuters Corp.

Suncor was the 2MP’s biggest decliner in 2020, falling 47.3 per cent. Other drags on the portfolio came from health care, represented by a pair of retirement home stocks that posted double-digit losses. The big winners included Newmont Corp. and Constellation Software Inc., up 37.4 per cent and 31.5 per cent, respectively.

When it debuted in this column in 1999, the 2MP focused on the two largest stocks in each TSX subgroup as measured by market capitalization, which means outstanding shares multiplied by share price. The strategy was later refined to include the largest two dividend-paying stocks in each of the 11 subgroups.

Data for the 2MP is managed by Morningstar CPMS, which has done back-testing that sets Dec. 31, 1985, as the start date. The annualized average total return since inception is 9.97 per cent, compared to 8.1 per cent for the S&P/TSX composite index.

This long-term outperformance has occurred despite a multitude of years where the 2MP was beaten by the index. In fact, 2020 was the second straight year of underperformance. In 2019, the index made 22.9 per cent and the 2MP 19.4 per cent; in 2016, the index soared 21.1 per cent and the 2MP gained just 7.5 per cent.

Some good recent years for the index help explain why it made an average annual 9.3 per cent for the five years to Dec. 31, 2020, while the 2MP made 7.4 per cent. This gap reminds us that the 2MP is about playing the long game as an investor. Over the past 10 years, the 2MP beat the index 8.9 to 5.8 per cent; over the past 15, the 2MP made 7.4 per cent and the index 6 per cent.

This long-term outperformance was built on limiting the damage when stocks fall, just as the 2MP did in the first quarter of 2020. The index had a sour year in 2018 – it lost 8.9 per cent while the 2MP fell just 1.7 per cent. In 2015, the index fell 8.3 per cent and the 2MP eked out a gain of 0.3 per cent. The worst-ever peak to trough drop for the 2MP was 31.5 per cent, compared to 43.4 per cent for the index.

The 2MP’s clear pattern of lagging in hot markets can be seen from April to December last year. In the fourth quarter, for example, the index surged 8.97 per cent and the 2MP galumphed along with a 3.8 per cent gain. In the surging markets of 2020, the 2MP was decidedly out of its element.

A 2MP reality check must also include these factors:

• Rookie investors would be better off with a low-cost exchange-traded fund tracking the Canadian market; consult the latest Globe and Mail ETF Buyer’s Guide (note: the 2021 guide will start appearing on Feb. 12).
• The 2MP is for the Canadian market, so don’t neglect U.S. and international stock market exposure; a test of the 2MP strategy in the U.S. market flopped a few years ago.
• Your returns will be reduced by the cost of stock trades, which can run as high as $9.99 per trade; you’ll need to buy and sell shares to reflect annual changes in the 2MP, and rebalance the portfolio to keep the 22 holdings in more or less equal proportion.
• Outside of my annual 2MP update, finding the market cap leaders in the TSX subgroups can be a challenge.

Dividend investors, the 2MP stocks for 2021 produced an average yield of 3.6 per cent as of Dec. 31. Baked into this number are high-yielding stocks, like Brookfield Property Partners LP at 9.3 per cent and Enbridge Inc. at 8.2 per cent, and low-yielding names, like Constellation Software Inc. at 0.31 per cent and Alimentation Couche-Tard Inc. at 0.81 per cent.

For further reading on the 2MP, do a “two-minute portfolio” search on google. A few investment firms and bloggers have commented on it, and at least a couple of papers have been written on it by university students studying finance and business.

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Published at Mon, 11 Jan 2021 17:04:55 +0000