Happiness Is ... a Portfolio Like This

What makes the perfect portfolio? The following stocks, perhaps:

• JPMorgan Chase (NYSE:JPM)
• Berkshire Hathaway (NYSE:BRK-B)
• Boeing (NYSE:BA)
• Best Buy
• McDonald's (NYSE:MCD)
• Paychex (NASDAQ:PAYX)
• Whole Foods (NASDAQ:WFMI)

Why did I pick these? Truth be told, they're just some of many that came to mind, and most people would be better off owning more than just seven stocks. But bear with me.

I chose these companies for a bunch of reasons: They've all had great runs in the stock market and have made many investors rich. They're companies I have admired over the years. Some have played a big part in America's economic past, while others are major players in its future -- and some straddle both camps. Their strong brands make it hard for others to compete with them. They have serious competitive advantages, too, such as sheer size, and they tend to have robust profit margins.

It's all in the timing
But you know -- this isn't enough. Timing plays a critical role in anyone's portfolio. You and I might have the same portfolio of stocks, but if I've owned them for just a year and you bought them a decade ago, the picture will differ quite a bit. Let's see how this portfolio would have fared if you'd owned it over the past decade versus just owning it over the past year. Here are the companies' annualized returns to shareholders for the trailing 10-year period and recent trailing-12-month gains:

One lesson to draw from this: Although these baskets of stocks beat the market in both periods, their various performances were quite different. For some stocks, the trailing-12-month period might be the more exciting one, but remember, the market is rather unpredictable over short periods. You could just as easily have lost to the market, significantly, while remaining invested in companies that would go on to perform well later. The important thing is to find the most promising companies you can, and invest in them when they're undervalued.

Of course, no one knows exactly when to invest in any company. Still, smart investors do their best to determine the right time, which often proves to be "a long time." Over longer periods, strong, growing companies tend to perform well. The right time also includes some discrete periods, which become apparent in retrospect but take some skill to estimate.

For example, check out these returns for Intel:

Clearly, if you'd invested in Intel 10 years ago, you wouldn't have fared so well (3%). Still, the future is paramount, and if you aim to hold it for another 10 years, you might still do very well overall. If you'd invested in it 20 years ago, you'd have done rather well indeed (21%), but two intervening 10-year periods offered much higher growth rates (44%). Your level of happiness in having Intel in your portfolio would likely have varied widely, depending on when you put that stock in it.

So how would you have known when to invest in such a stock? Well, luck can certainly be a factor for many investors. Other than that, it wouldn't have been enough to just spot hefty profit margins or a strong earnings growth rate. Such measures can decline over time. Ideally, you'd have wanted to be well versed in the company's industry and familiar with its competitors and emerging technologies, and you'd have wanted a strong grasp of Intel's competitive advantages, operational risks, and future promise. You'd also have been looking out for a good price at which to buy into the company. All of this research can't guarantee any kind of return, but it can significantly increase your odds of doing well.

Get guidance
That's all easier said than done. If you're not confident in your ability to find such promising companies at the right time, look for some trusted advisors. One resource I use is our Motley Fool Stock Advisor newsletter, which recommends two promising companies each month. Over five years, its average recommendation has gained 76% over the S&P 500's 32%. A free, no-obligation 30-day trial will give you full access to all recommendations and past issues.

Regardless, when you envision your perfect portfolio, don't look only at the quality of the company. Think about the stock's price as well, and whether this is a good time to jump aboard. When in doubt, focus on the long term! A growing company may falter over the short run, but in the long run, it usually fares well. And when a healthy company falters, that could be the best time to buy.

Here's to a more perfect portfolio!

This article was originally published on April 2, 2007. It has been updated. 

Longtime contributor Selena Maranjian owns shares of Berkshire Hathaway and McDonald's. Berkshire, Best Buy, and Intel are Motley Fool Inside Value recommendations. JPMorgan Chase is a Motley Fool Income Investor recommendation. Berkshire, Best Buy, and Whole Foods are Stock Advisor recommendations. The Motley Fool is Fools writing for Fools.