Selective Ownership of Extraordinary Businesses

Photo by  NASA  on  Unsplash

Photo by NASA on Unsplash

In our “Successful Portfolio Structure” white paper, we outlined the critical role that a well-designed portfolio structure plays in delivering highly valued client outcomes.  We also mentioned the significant role that extraordinary businesses (i.e., purchased through individual stocks) can play in producing attractive risk-adjusted outcomes.  We feel strongly that most investors should retain an open mind about owning individual securities, particularly those that help meet specific cash flow goals and dampen volatility during market corrections.

We believe most, should first build a foundation of low-cost, diversified exchanged-traded funds (ETFs) as the strategic core of their portfolios.  This optimizes the chance of securing comfortable returns while minimizing taxes and costs, and narrowing the potential range of outcomes. “Concentrate to build wealth, diversify to stay rich,” remains an apt piece of investment wisdom.

However, once a solid investment edifice is created and the core portfolio is large enough to sustain your lifestyle, investors who would like to grow their aspirational portfolio* can pursue enhancement of their wealth through the selective ownership of extraordinary businesses, as we detail below.  

* The aspirational portfolio is the portion of investments designed to materially increase the wealth of the investor. It is different from the core portfolio, whose primary purpose is to allow the investor to continue his or her lifestyle in retirement.

Dividends for the Long Run

Academic research has shown that dividend growth has been a driver of total return in the long run.  Furthermore, even for investors not currently focused on income, dividend stocks may offer advantages for long-term capital growth through the reinvestment of that dividend income.  

More importantly, dividend paying stocks have historically outperformed the market and have done so with better risk attributes, such as lower volatility and a certain degree of downside protection when markets decline.  Despite this winning combination, investors have failed to fully capitalize on these benefits because dividend investing is about as exciting as watching paint dry.  As humans, most investors are hard-wired to behave emotionally and are more interested in chasing the elusive winning lottery ticket than in compounding wealth over time through steady capital appreciation and income reinvestment.  

We believe investors who harness a quality dividend strategy not only enhance the likelihood of their financial plan succeeding due to the robustness of the cash flows (and higher yield), but also because it reinforces the value of investing as opposed to speculating.  We have chickens for their eggs, bees for their honey, cows for their milk, and stocks for their dividends!

Why Doesn’t Everyone Do This?

Our most important objective is to deliver the most efficient path to productivity for helping one reach their financial goals.  Naturally, we are intrinsically drawn to a portfolio structure that offers equity-like returns with less risk than the overall market, while producing an attractive combination of income and growth.  We attempt to control the risk of owning stocks by emphasizing specific company attributes such as sustainable dividend growth, lack of debt, and resilient business models.  With financial strength and a disciplined business strategy, the businesses we own can take advantage of opportunities that arise during periods of economic weakness.  

Dividend growth has historically been rewarded with superior stock market performance.

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By pursuing the highest quality dividend streams we can find at the most attractive prices, we expect to provide investors with the opportunity to outpace the rising cost of living through a combination of attractive income and long-term growth potential.  This all-weather approach might not be able to avoid every speed bump, but can certainly smooth the ride and preserve investor capital in difficult markets.  A century’s worth of data suggests that these companies hold up better in down markets, as the dividend not only serves as an anchor to windward in challenging times, but also provides investors with a reliable way to value their stock (thereby preventing selling pressure from becoming overdone).

TJG Investment Approach

To execute such a strategy, we employ a rigorous and systematic multi-step approach in identifying and buying long-term compounding machines that can grow their earnings power over time through any economic environment.  Our experience has taught us that most successful firms have specific business, management and financial attributes that enable value creation through all types of economic and market environments.  These include: 

  • Competitive advantages and strong market position, to sustain high returns on capital and growth 
  • Solid balance sheets which provide for Financial Firepower to invest back into the business
  • Valuation reasonably in line with the overall market and business prospects 

Dividend payers offer both income and growth potential.

Source: Image via Federated Insurance [FederatedRules2017.pdf] data via Morningstar

Source: Image via Federated Insurance [FederatedRules2017.pdf] data via Morningstar

For instance, one can appreciate the inherent structural advantages of a bellwether blue chip like Berkshire Hathaway.  Yet its stock has fallen 35-50% several times in its history.  So, while the stock market is highly efficient over time, it offers large opportunities periodically, and our familiarity with quality businesses gives us an advantage when investors get terrified and sell out of panic for non-economic reasons. 

Five-Step Investment Process

Our formula for building long term wealth though the ownership of extraordinary businesses includes compounding returns over time by taking a value-oriented approach to investing with the objective of protecting and growing wealth, and a willingness to concentrate capital in our best ideas.  As academic research and empirical data has demonstrated, simple systems built upon rigorous processes perform best, so we execute a five-step process to guide us towards the best companies to purchase. 


We begin with all the publicly listed companies available on US stock exchanges, searching for well-established firms that have a history of generating profits and growing cash flows.


Because the best offense is oftentimes defensive in nature, we eliminate firms with a low degree of earnings predictability, either due to too much debt or cyclical end markets.  It is easy to make your financial capital disappear if you fail to understand when cyclical growth is unsustainable or overpay for businesses facing severe operating or financial difficulties.


Since we know that superior economics only matter if properly shared with owners through dividends, share buybacks, capital expenditures, or mergers and acquisitions, we reward excellent stewards of shareholder capital.  Firms with a low return on invested capital, aggressive accounting, and management teams that have not always placed shareholder interests first are not worthy of investment.


We run the resulting list of ideas through a quality screen to find better businesses.  These would include firms with a strong economic moat, or competitive advantages that are likely to persist. By this point, the opportunity set has been narrowed down to roughly 100 stocks.  


We focus on the most attractively priced companies within this elite group, by comparing valuation metrics against peers and searching for a superior combination of dividend growth and yield.

Your Portfolio

This 5-step process results in The Johnston Group Select Equity Portfolio, a collection of extraordinary businesses whose dependable and rising dividend streams offers a prudent way to participate in the wealth-building potential offered by the stocks of good quality companies over the long run.

Business Attributes

  • Easy to understand business with identifiable, sustainable competitive advantages 

  • Dominant position in an attractive market niche offers strong unit growth and pricing power 

  • Recurring revenue generated by essential products or services that meet an economic need 

Management Attributes

  • Shareholder friendly management team

  • Conservative accounting practices

 Financial Attributes 

  • Strong balance sheet created by a history of profitability 

  • High returns on invested capital demonstrate disciplined capital allocation

  • Stock price at a fair or compelling price in relation to intrinsic value 

We have chickens for their eggs, bees for their honey, cows for their milk, and stocks for their dividends!
— John Burr Williams