Happiness Is ... a Portfolio Like This

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

• Citigroup (NYSE: C)
• Exxon Mobil (NYSE: XOM)
• Target
• Procter & Gamble (NYSE: PG)
• Altria Group (NYSE: MO)
• American Express (NYSE: AXP)
• Caterpillar (NYSE: CAT)

Why did I pick these? In fact, they're some of many that came to mind. Most people are better off owning more than only seven stocks. But bear with me.

I chose these companies for several reasons: Each one has had outstanding runs in the stock market and made many investors rich. They're companies I have admired for years. Some have played a big part in America's economic past, 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 size, and they tend to have robust profit margins.

It's true, though, that sometimes even sturdy giants stumble -- Citigroup had a very rough 2007, for example, and it's not yet out of the woods.

When timing is everything
But these elements aren't enough to produce winners; timing plays an equally critical role. You and I might have the same portfolio of stocks, but if I've owned them for 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 owning it over the past year. Here are the companies' annualized returns to shareholders for the trailing 10-year period and for 2007:

One lesson to draw from this: The performances for this basket of stocks vs. the market are quite different for the two time periods. For some stocks, the 2007 performance might be the more exciting one (or vice versa) -- 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 for the long term, 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 at 4% per year. 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 21 years ago, you'd have done rather well indeed at 22% per year, but an intervening 10-year period offered a much higher growth rate, 44% annually.

Your level of happiness in having Intel in your portfolio would likely have varied widely, depending on when you put that stock in it.

How would you have known when to invest in such a stock? Well, luck is certainly a factor for some investors. Other than that, it wouldn't have been enough to 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 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 promising companies at the right time, find instead 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 57%, versus 16% for like amounts invested in the S&P 500. 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, it could provide 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. 

Selena Maranjian owns no shares of any company in this article. Intel is a Motley Fool Inside Value recommendation. The Motley Fool is Fools writing for Fools.