An update to a simple stock-picking strategy that has left the TSX in the dust over the past decade (2024)

A blowout year for the S&P/TSX Composite Index pretty much guarantees a humbling for an ongoing experiment in simple portfolio building called the Two-Minute Portfolio.

The past year was typical – if you look at total returns based on share price changes plus dividends, the index surged by 22.9 per cent and the Two-Minute Portfolio, or 2MP, made 19.4 per cent. Back in 2016, the index made 21.1 per cent and the 2MP gained just 7.5 per cent. You won’t keep up with index’s highest highs with the 2MP, but past experience suggests you can do very well over the long term.

The 2MP was introduced in this column in 1999 to investigate the idea of simplifying the portfolio-building process by focusing on the largest stocks in the Canadian stock market. The strategy was later refined to include the largest two dividend-paying stocks in each of the 11 subgroups of the S&P/TSX Composite as measured by market capitalization. Market cap is shares outstanding multiplied by share price.

Data for the 2MP is managed by Morningstar CPMS, which has done back-testing that sets Dec. 31, 1985, as the start date. In the 34 years of the 2MP, the past 10 might be the best stretch ever. The total return for the portfolio from 2010 through 2019 was an average annual 10.4 per cent, compared with 6.9 per cent for the index.

The 2MP also outperformed in the three-, five- and 15-year periods to Dec. 31, 2019. Since inception, the 2MP’s annualized return of 10.2 per cent beats the index by two percentage points.

Experienced investors know that past returns are an unreliable indicator of what the future will bring. But the 2MP does seem to have benefited consistently over the long term from the strong commitment of investors in Canadian stocks to big, well-established companies that pay dividends.

The 2MP’s enforced diversification through all the stock market subgroups may help returns as well. The S&P/TSX Composite was about 60 per cent weighted to financials, energy and materials at the beginning of 2020, with a combined weighting of just 7 per cent in technology and health care. In the 2MP, all sectors are weighted equally. The two tech stocks in the portfolio have as much of an effect on returns as the two bank stocks.

Now, let’s consider some of 2MP’s drawbacks. While undemanding in terms of your time on an annual basis – that’s where the two-minute part of the name comes from – you have to be familiar with the workings of an online broker and comfortable trading stocks. If you’re a newcomer to investing, a balanced exchange-traded fund (a diversified portfolio contained in a single ETF) is a good bet, and so is a robo-adviser.

Readers have asked many times over the years where they can find the names and stock symbols for the dividend-paying market cap leaders in each TSX subgroup. The state of free online investing tools is such that I’m unaware of any websites that provide this kind of screening. You’re left to consult the updated 2MP list I publish at the beginning of each year.

Also, the 2MP is suitable for the Canadian portion of your investments only. A properly diversified portfolio would include U.S. and global content, as well as bonds. Finally, the 2MP requires annual fine tuning that will rack up a modest amount of brokerage stock-trading commissions. Paying up to $9.99 per buy and sell will eat into your returns a bit.

The 2MP doesn’t change much from year to year, though. We have three substitutions for 2020: Canadian Apartment Properties REIT takes over for RioCan REIT in the real estate subgroup, Newmont Goldcorp replaces Nutrien in materials and Thomson Reuters replaces Canadian Pacific Railway in industrials. Morningstar CPMS uses a classification scheme for stocks that considers Thomson Reuters an industrial stock.

Investors in the 2MP also have to do some rebalancing at year-end. That means selling some of the year’s top performers and buying more of the laggards so that the 22 stocks in the portfolio have a weighting of 4.5 per cent or thereabouts.

Star 2MP performers for 2019 include Constellation Software, up 48 per cent, Brookfield Infrastructure Partners, up 43.2 per cent, and CP Rail, up 37.9 per cent. The most notable laggards were Rogers Communications, down 5 per cent, and Nutrien, which eked out a gain of 0.6 per cent.

While all 2MP stocks pay a dividend, yields range wildly. The yield leaders in the portfolio as of Dec. 31 included Brookfield Property Partners at 7.3 per cent, Enbridge at 6.3 per cent and BCE Inc. at 5.3 per cent. The overall portfolio yield is brought down to 3.2 per cent by holdings such as Constellation Software, with a yield of 0.4 per cent, and Alimentation Couche-Tard, with a yield of 0.6 per cent.

In the past decade, the 2MP outperformed the S&P/TSX Composite in eight years. There were a few years where the 2MP just outmuscled the index – the 2MP made 23.6 per cent in 2014, while the index made 10.6 per cent. But the 2MP was arguably at its best in down markets.

The S&P/TSX lost 8.7 per cent in 2011 and the 2MP fell 2.8 per cent; in 2015, the index fell 8.3 per cent and the 2MP gained 0.3 per cent; and in 2018, the index fell 8.9 per cent and the 2MP lost 1.7 per cent. Worried about a stock market pullback after the sharp gains of 2019? The 2MP, with its focus on big dividend-payers, might take less of a beating if that happens.

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