A Portfolio Named ‘Service’

In an effort to make stock-picking more fun, I thought it would be interesting to create a diversified portfolio of stocks using a randomly selected theme. In addition to creating a diversified portfolio, I’ll find one or two ETFs that own all of the individual stocks in the portfolio. I’ll then report on the performance of the simulated portfolios (both individual stocks and ETFs) on a monthly or quarterly basis to see how they compare. I’m hoping this becomes a regular series. If nothing else, it should be good for a few laughs.

First, the ground rules. The stocks must have a share price greater than $10, a market capitalization of at least $100 million and be traded on the New York Stock Exchange, NASDAQ or American Stock Exchange. There will be no stocks trading over the counter. The portfolios will have a minimum of eight stocks and a maximum of 12, with no fewer than four sectors represented to ensure diversification. Finally, the ETFs should not have an annual expense ratio of more than 0.75% and a turnover above 50%. After all, the point of ETFs is to reduce fees and taxes while delivering good returns through proper diversification.

Today’s theme is service — not companies in the service sector, but rather those stocks whose company name includes the word “service.” A quick search at Yahoo! Finance (NASDAQ:YHOO) produces a list of 48 companies that meet the requirements above and also have the word “service” in their name. Not surprisingly, 14 of the businesses are indeed in the service sector. The financial-services sector is also well-represented. All told, there’s at least one company from each of seven different sectors: health care, industrial goods, basic materials, utilities, technology and the two mentioned previously. So it shouldn’t be difficult to put together a portfolio. The hard part will be finding enough large-caps.

1. The first selection is the easiest: ServiceSource Corporation (NASDAQ:SREV), a small-cap technology company (the only one) that helps companies such as Adobe Systems (NASDAQ:ADBE) and Verizon Communications (NYSE:VZ) grow their service revenue by increasing the number of customers who opt for maintenance, support and subscription agreements. Its current market cap is $1.2 billion, and it’s profitable on an adjusted Non-GAAP basis.

2. Out of a list of four utilities, I’ll go with Public Service Enterprise Group (NYSE:PEG). It has a good dividend yield at 4.5%, it’s a largec-ap and it’s relatively undervalued.

3. In the basic-materials sector, I have a group of seven stocks to select from. I’m going to go with Superior Energy Services (NYSE:SPN), a New Orleans-based oilfield-services company. The stock is down about 18% in the last year through Feb. 10. With an enterprise value of 6.3 times EBITDA, I like it.

4. Next up is the industrial-goods sector, with four choices. Here I’m going to go with another large-cap in Republic Services (NYSE:RSG), the second-largest nonhazardous-waste-management company in the U.S., behind only Waste Management (NYSE:WM). Both companies are held by the Bill and Melinda Gates Foundation. Also,�RSG pays a nice dividend.

5. In the health-care arena, I’ll select Transcend Services (NASDAQ:TRCR), a micro-cap providing transcription services to hospitals across the country. It has pretty good margins and room to grow.

6. As they say in sports, the team that gets the best player in a trade usually wins the trade. Therefore, I’m going to go with PNC Financial Services Group (NYSE:PNC) and Discover Financial Services (NYSE:DFS), the two biggest and arguably best opportunities of the 11 financial-services companies that meet our criteria.

7. On the services front, I’m picking JB Hunt Transport Services (NASDAQ:JBHT), Total System Services (NYSE:TSS) and ITT Educational Services (NYSE:ESI). The first two are mid-caps and the third is a small-cap, providing a trucking, payment-processing and post-secondary technology degrees. I like the services in the services sector.

So the portfolio consists of 10 stocks: four large-caps, three mid-caps, two small-caps and one micro-cap. With an average market cap of $8.94 billion, this “Services” portfolio rocks! Now all I have to do is find some ETFs to cover off all 10 stocks and we’re done.

The two smallest companies, Transcend Services and Superior Energy Services, can be owned through the iShares Russell 2000 Index Fund (NYSE:IWM). The remaining eight companies are all found in Guggenheim’s Wilshire 5000 Total Market ETF (NYSE:WFVK).

The bottom line: If you invested $10,000 in each of these 10 stocks in February 2011, today you would have $114,600. If you invested the same amount in the two ETFs, you would have $102,530. While past performance doesn’t indicate future returns, it will be interesting to see how we do.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.