Sunday, October 19

Week 172 - Core Holdings for an Overpriced Market

Situation: The stock market is currently overpriced when assessed by several criteria. Economists, including the Nobel Laureate Robert J. Shiller, are trying to figure out why this is so. As a small investor, all you need to know is that the stocks in your portfolio that have a price/earnings (P/E) ratio higher than 20 are in a danger zone. In other words, your total return from that investment is less than 5% unless earnings improve. On a risk-adjusted basis, you’d do better parking any newly available funds in US Savings Bonds

Even though stocks are overpriced, advantages remain for you to accumulate more for your portfolio. That is because you will receive growing dividends in retirement, however, to purchase more it is best to stick to dollar-cost averaging. Invest a little each month into an online Dividend Reinvestment Plan (DRIP). That way, you automatically smooth out the fluctuations in price. The bigger problem right now is that people prefer to cut back on investments in growth stocks when the market is overpriced. That’s not a good investment strategy, and we explain why below. 

Bonds, and hard assets like gold and real estate, just don’t have the growth horizon that stocks currently have. Trouble will come for stocks from only 3 broad categories:
  1. if interest rates and inflation spike upward (unlikely);
  2. if companies stop growing earnings almost 10%/yr (unlikely);
  3. if economic indicators herald a recession in a major economy (somewhat likely for the EuroZone and China). 
Because stocks remain the asset of choice, they are becoming overpriced. In particular, the buyers of bond-like stocks (i.e., those that have historically had a good total return and increase their dividend ~10% year after year) are crowding out the sellers. Prices for strong and stable “defensive” stocks, like Abbott Laboratories (ABT) and Colgate-Palmolive (CL), drift higher than what their earnings can justify. 

Does this really matter? Yes it does because timid investors see that price action and come off the sidelines to buy stock. Eventually, there’s almost no one left who wants to buy an overpriced stock and the market develops cracks. Buyers will only emerge when prices have fallen far enough for fundamental measures of value to justify the purchase. By that time, a lot of investors are underwater and are selling their Savings Bonds to fund cash-flow emergencies. The important point here is that a bear market can happen when the economy is doing just fine, as we saw on October 19, 1987. The Dow Jones Industrial Average fell 22.6% that day for no apparent reason other than “the big guys were selling their stock” because the market had gone up 44% in the previous 6 months.

For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A-/M or better. (That “M” in the denominator denotes medium risk, whereas, “L” denotes low risk.) To focus on growth companies we’ve excluded companies in the 4 “defensive” industries: healthcare, utilities, communication services, and consumer staples. The remaining 6 S&P industries are where we look for our “Core Holdings” (high-quality growth companies, see Week 102). Those industries represent 66% of the capitalization of the S&P 500 Index. Quite simply, your stock portfolio can’t capture market returns unless 2/3rds of it is in stocks issued by companies in those 6 industries: materials, energy, financial, industrial, consumer discretionary, and information technology. Even though those stocks will scare you when the market swoons, don’t sell unless the company’s “story” is broken. 

Most of the stocks in the Table are fully valued at present, i.e., have elevated P/E ratios (Column J) because investors expect those companies to have strong earnings growth over the next year. You don’t know what the future will bring, so look for companies that don’t have a P/E over 20. Try to spend your research time on the few companies that have hardly any metrics highlighted in red, which denotes underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX). 

Note: Companies that don’t have a Finance Value (Column E in the Table) higher than that for VBINX were excluded, as were companies that pay a dividend that amounts to more than 55% of their earnings (the “payout ratio,” Column I Table). Finally, companies that had a lower Barron’s 500 rank in 2014 than in 2013 were excluded, unless they ranked in the top 2/3rds both years (see Columns L&M Table).
Bottom Line: There are still some bargains to be found among growth stocks. The 17 companies in the Table meet our criteria for Core Holdings, but most are overpriced (average P/E = 22). Their investors have already enjoyed a strong run (Column F Table), and many will be looking to take profits. But there are 6 companies on the list that still offer good value relative to risk: ROST, QCOM, CB, IBM, LMT, GPC.

Risk Rating: 6

Full Disclosure: I dollar-average into NKE and IBM.

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Sunday, October 12

Week 171 - Thinking of Owning Farmland As An Investment?

Situation: Here on the Great Plains, owning farmland is the Great Game. Throughout the midwest, 60% of the land being farmed is rented. With corn prices down 50% from their 2012 peak, fixed rents are having to be renegotiated to reflect the falloff in farm incomes. “Custom financing” is becoming more prevalent, meaning that instead of a fixed rent the landlord gets half, 40% or 1/3rd of the revenue generated from crop sales at the end of the growing season. The tenant farmer pays all expenses other than property tax and insurance. 

Over very long time periods, farmland appears to be a better asset class to own than stocks. For example, farmland in southwest Iowa (Audubon County) that sold for $266/acre in 1963 was worth $9466/acre in 2013 for a price return of 7.4%/yr. Compare that to 6.6%/yr for the S&P 500 Index. You also need to consider that both asset classes produce income (rents or dividends) and are hammered by inflation, which averaged 4.2%/yr across that 50-yr interval. Farmland rents stay close to 5% of land value, bringing total return to 12.4%/yr. Reinvesting dividends on the S&P 500 Index over the past 50 yrs brings total return to 9.9%/yr. Accounting for inflation, those numbers drop to 8.2%/yr and 5.7%/yr. Farmland prices also show less volatility than stock prices, so farmland looks to be the hands-down winner!

Prime farmland in Eastern Nebraska or Western Iowa currently costs ~$9600/ac and is sold in quarter section (160 acre) parcels. You’ll need a big mortgage for that $1,536,000 price tag, even if you can come up with the $307,200 down payment. But unless you are yourself a farmer, this is not as wise an investment as it appears to be. Why? Like investing in gold, it predates and is outside the built-in benefits of capitalism: There’s no accrual accounting or compounding of interest (see Week 157). More importantly, you'll lose money when crop prices collapse like they did in 2013 and have continued to do this year.

For both tenant and landlord, the Great Game is to bet on the weather cycle as opposed to the economic cycle. The farmer can always tune in to a local AM radio station that will provide instant pricing for “futures” on farm commodities. As he’s driving his tractor, he can trade futures on the Chicago Mercantile Exchange (CME) by using his smartphone. When prices spike upward, farmers (and their landlords) can reap windfall profits if they act quickly. When prices spike downwards, the crop insurance that is built into every US Farm Bill will likely prevent efficient farmers from having to “cash out.” Farmers also have the option of buying grain bins to store their crop until the market recovers. And, most farmers “hedge” 20-30% of their crop against the risk that prices will fall, agreeing to sell at a pre-set price when the growing season ends by entering into a futures contract on the CME.

Farmers are gamblers, as are those among their landlords who take a cut of crop sales in lieu of a fixed rent. More often than not, their gambles pay off. Why? Because planet-wide protein production can’t keep up with the demand created by population growth and rising incomes, and weather-related crises are out of sync with economic crises. Now you know why Omaha came through the Great Recession better than any other American city.

For our readers, we’d better stress that owning farmland is another way to gamble on a commodity (see Week 163). Yes, big profits can occur but they’re a hit-or-miss thing with long dry spells punctuated by some bad years, such as 2014. That being said, the prudent move is to take the time-proven route to commodity profits, which is to invest in companies that service the producer (e.g. farmer) rather than the commodity itself (e.g. farmland and crop futures). In this case, it means investing in stock issued by companies that provide inputs (and outputs such as railroads) to “production agriculture.” Then add a couple of food-processing companies. Why? Because those companies supply food to grocery stores and can pass commodity costs on to the consumer.

How then might you make a farmland investment that benefits from the insights of capitalism (accrual accounting and compound interest)? That would be through dollar-cost averaging your stock purchases then reinvesting your dividends. We find only 10 companies that meet our criteria for inclusion in a retirement portfolio (Table). Our benchmark is the Vanguard Balanced Index Fund (VBINX) at Line 17 in the Table; red highlights denote metrics that underperform VBINX. Our criteria are:

        1) the company is an S&P Dividend Achiever, i.e., one that has raised its dividend annually for at least the past 10 yrs;
        2) the company has an S&P bond rating of BBB+ or higher;
        3) the company has an S&P stock rating of B+/M or higher;
        4) the company’s stock has a dividend yield of 1.4% or higher.

Now let’s see how those 10 stocks have done over the past 14 yrs as opposed to returns on owning farmland in Audubon County, Iowa, the benchmark we used above. Farmland values have grown 12.4%/yr and inflation has been 2.4%/yr. Adding 5%/yr in rental income and subtracting 2.4%/yr inflation leaves 15%/yr. For our 10 stocks, total return is close to 15%/yr, which makes after-inflation return ~12.5%/yr.

Bottom Line: Farmland has been the most stable and rewarding asset class to own for many decades, if not centuries. But is that extra 2.5%/yr (compared to Ag-related stocks over the past 14 yrs or the S&P 500 Index over the past 50 yrs) worth all the trouble and disappointments of being a tenant farmer's landlord? Property taxes are high, and slow to reset; fixed rents leave you with insufficient funds (after paying interest on the mortgage) to pay property taxes. But, if you have the patience of Job, live near the land you'd be renting, and want to gamble a million dollars, it probably is worth the trouble and disappointments. But to come out ahead you’ll need to have your tenant farmer pay you a revenue-based “custom” rent instead of a fixed rent. That saves him from having to pay you any rent at all in bad years like this one, so try to get him to settle for a 50:50 split of revenues (from crop sales at the end of the growing season).

Risk Rating: 8

Full Disclosure: I own shares of MON, HRL, GIS, MKC, PEP, and DE.

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Sunday, October 5

Week 170 - Growing Perpetuity Index (UPDATED)

Situation: Our blog (Invest Tune Retire) grew from the idea that owning “buy-and-hold” stocks only makes sense if you a) plan on using dividends from those stocks to supplement your retirement income, and b) pick the right stocks. The goal is to receive dividend checks during retirement that grow faster than inflation (see Column H in our Table). We began writing our blog using an unchanging index of a dozen stocks that would bring this idea into focus. To have a catchy name for that index, we borrowed a finance term that is used to describe a rare type of bond that pays out more interest year after year, called a growing perpetuity.

To pick stocks for our Growing Perpetuity Index (see Week 4), we turned to the Dow Jones Composite Index of 65 stocks, which includes the 30-stock Dow Jones Industrial Average (DJIA), the 20-stock Dow Jones Transportation Average and the 15-stock Dow Jones Utility Average. To qualify, stocks were required to: 

1) have a dividend yield no less than that for the exchange-traded fund (ETF) that mimics the S&P 500 Index (SPY);
2) be an S&P “Dividend Achiever” with 10+ years of annual dividend increases;
3) have an S&P stock rating of A- or better;
4) have an S&P bond rating of BBB+ or better.

We turned up 14 stocks but chose to limit our list to 12. Two utilities qualified, NextEra Energy (NEE) and Southern Company (SO), but we decided to include only one. We kept NEE because it is the dominant player in renewable energy (wind and solar). One transportation stock qualified, Norfolk Southern (NSC). There were 11 that qualified from the DJIA, so we needed to exclude one. Caterpillar (CAT) was excluded because the company had not raised the dividend for 24 months during the Great Recession, even though S&P still granted it Dividend Achiever status. After more than 3 yrs, the same 14 are the only companies that continue to qualify. Red highlights in the Table denote underperformance relative to our benchmark, Vanguard Balanced Index Fund (VBINX). For comparison purposes, the Table includes a section for stocks in the Barron’s 500 List that meet our criteria but aren’t in the Growing Perpetuity Index.

Bottom Line: It is not easy to identify high quality, buy-and-hold stocks that pay good and growing dividends. The 65-stock Dow Jones Composite Index has 14 such stocks by our criteria, the same number as in July of 2011 (see Week 4). We use 12 of those stocks to make up our Growing Perpetuity Index (see Table) but there are 28 more in the Barron’s 500 List that meet our criteria, including Microsoft which becomes a Dividend Achiever later this year. In both the list of 12 Growing Perpetuity Index stocks and the list of 28 similar stocks, the majority are S&P Dividend Aristocrats (see Column P in the Table), meaning that there has been a dividend increase approximately every year for at least the past 25 yrs. That’s the best sign that you’ve picked the right stock for your retirement portfolio (see Week 146).

Risk Rating for the Growing Perpetuity Index: 4

Full Disclosure: I dollar-average into XOM, WMT, JNJ, MSFT, ABT, PG, and NEE.

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Sunday, September 28

Week 169 - Barron’s 500 “Industrials” That Are Dividend Achievers With Good Credit Ratings

Situation: There is increasing evidence that the US economy is moving away from the deflationary effects brought about by chronic trade deficits. This translates most directly into a recovery of the manufacturing sector, which we’re already starting to see. But emerging markets are the driver of industrial equipment sales, and those markets remain in a state of flux). Let’s take a closer look at what S&P classifies as “industrial” companies, since 11% of the S&P 500 Index consists of stocks issued by companies in that industry. 

We’ve taken the Barron’s 500 List and pulled out the 16 “industrial” companies that are Dividend Achievers with good S&P bond ratings (Table). Of those 16 companies, 12 are manufacturers. Five are either defense companies, such as Lockheed-Martin (LMT), Northrop Grumman (NOC), and General Dynamics (GD), or they manufacture and service equipment for the aerospace industry, i.e., United Technologies (UTX) and Parker-Hannifin (PH). Two build agriculture, construction and mining equipment, Deere (DE) and Caterpillar (CAT). The 5 remaining companies are niche operators, Stanley Black & Decker (SWK), Illinois Tool Works (ITW), 3M (MMM), Dover (DOV) and Emerson Electric (EMR).

What about the other 4, the ones that don’t build stuff? Well, that’s the same story you’ve heard since the California Gold Rush days, namely that gold miners didn’t make nearly as much money as their suppliers, who made a lot. Industrial companies that supply and distribute parts (WW Grainger, GWW), transport manufactured goods (Norfolk Southern, NSC) or clean up messes (Waste Management, WM and Republic Services, RSC) do quite well.

Bottom Line: The US trade balance looks to be improving, which means our manufacturing sector is seeing an uptrend in exports. These “industrial” companies endured a hard decade to start the 21st century but are now in recovery mode, steady but slow.

Risk Rating: 6

Full Disclosure: I own shares of UTX, DE and MMM.

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Sunday, September 21

Week 168 - Food-related Dividend Achievers With Good Credit Ratings

Situation: We’ve blogged often about the value to be gained from investing in food-related stocks (see Week 152 and Week 161). But there’s a problem. Many of those companies have market values in the mid-cap range and don’t have sterling credit ratings. This poses a problem because elsewhere in this blog we stress the importance of relying on large-cap companies with good credit ratings for your retirement portfolio. We also emphasize the importance of selecting the stocks to include in that portfolio from the list of 239 Dividend Achievers. That way you’ll have dividend income in retirement that grows faster than inflation.

This week we’ve bundled those ideas together to come up with a list of 14 companies (Table) for you to consider for your retirement portfolio. All 3 branches of the food supply chain are represented: production, processing, and distribution. The smallest company to meet our criteria is McCormick (MKC), a spice processor with a market capitalization of $8.6 Billion. As a group, stock in these companies rewarded investors with approximately a 12% total return/yr since the inflation-corrected S&P 500 Index peaked on 9/1/00, and lost 20% over the 18-month Lehman Panic period (Table). This compares well with our “Risk Off” benchmark, the Vanguard Wellesley Income Fund (VWINX), which returned 7.5%/yr since 9/1/00 and lost 16% during the Lehman Panic. Of course, the S&P 500 Index fund (VFINX) did much worse, returning 4% and losing 46.5%.

Bottom Line: You’ll get a lot better “bang for your buck” (and sleep better as well) if you have 3 or 4 food-related stocks in your retirement portfolio. Those have remarkably strong returns, and prices that don’t drop much when the market crashes. After all, everyone needs to eat!

Risk Rating: 4

Full Disclosure: I dollar-average into WMT and also own shares in MCD, HRL, MON, MKC, PEP, GIS, DE and KO.

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Sunday, September 14

Week 167 - Have Commodity-Related Stocks Hedged Against the Lack of Real Growth in the S&P 500 Index?

Situation: The S&P 500 Index made its all-time inflation-adjusted high on 9/1/00. Fourteen years is a long time for the stock market to be in the tank, even though the main hedging tool (10-yr US Treasury Notes) has been effective. After adjusting for 2.4%/yr inflation since 9/1/00, the Vanguard Intermediate-Term Treasury Fund (VFITX) has returned 3.3%/yr vs. 1.3%/yr for the Vanguard 500 Index fund (VFINX) with dividends reinvested, as of 8/16/14. Robert Shiller maintains a long-term series for both 10-yr US Treasury Notes and the S&P 500 Index. After adjusting for inflation, returns were 1.5%/yr for 10-yr Notes vs. -0.2%/yr for the S&P 500 Index (1.6%/yr with dividends reinvested). Without adjusting for inflation, 10-yr T-Notes were up 3.9%/yr and the S&P 500 Index was up 2.1%/yr (4.0%/yr with dividends reinvested). 

The general explanation for this 14-yr period of low 2.4% inflation is that it results from the lack of real growth in economies around the world, and this lack of growth can be associated with two global recessions that have occurred. Most observers think that a growing reliance on borrowed funds has been a major contributor to those recessions, i.e., interest payments were shackling growth. This culminated in the credit crisis of 2007-08. The problem is slowly being corrected through deleveraging, including government action to reduce spending and raise taxes. 

When central banks lower interest rates to stimulate growth during a recession, the currency is said to be weakened or debased. (The official term is financial repression, see Week 76 and Week 79.) This will correct itself when the economy recovers, i.e., central bankers will reverse their policy by withdrawing the excess reserves that they had been pushing into the banking system. During the period of currency debasement, the prices paid for “hard assets” naturally drift upward. (Think of the “bubble” that formed in US housing prices when the Federal Reserve kept interest rates too low for too long after the “” recession (March 2001 through November 2001.) 

What does this information mean for readers of this blog? Do we need to protect our retirement savings during periods of “financial repression” by investing in real estate, gold, commodity-related stocks, or commodity futures? All of these have real economic utility and are therefore bound to go up in price when the value of the dollar is falling. These are also inherently volatile investments, so we need to think long and hard before making that leap. They’ll start to lose that pricing power when the Federal Reserve starts to wind down its policy of financial repression. (Look at what has happened to the price of gold. It fell 35% between the summer of 2011 and the summer of 2013.)  

Let’s take a closer look at how commodity-related stocks have responded. Those stocks typically pay dividends and are easily traded, which are advantages not shared by other hard assets. On 9/10/13, we published an index of 15 commodity-related stocks (see Week 115). It showed that commodity-related stocks did indeed enjoy pricing power between 1992 and 2013, returning 14.5%/yr while the return for gold bullion was 13.7%/yr, twice the return on Vanguard’s S&P 500 Index fund (VFINX). 

Now that another year has passed, let’s see how the unwinding of financial repression has impacted those results. The accompanying Table shows that both gold bullion and commodity-related stocks haven’t done as well as the S&P 500 Index fund (VFINX) over the past 5 yrs but are still ahead since 9/1/00. One of our benchmarks for this week is the T Rowe Price New Era Fund (PRNEX), a low-cost, low-risk natural resources mutual fund. Red highlights denote metrics that underperform our main benchmark, the Vanguard Balanced Index Fund (VBINX).

Bottom Line: Commodity-related stocks and gold bullion are volatile assets, but worth owning during periods of financial repression. You just need to think about switching to an S&P 500 Index fund the moment you think the Federal Reserve is starting to wind down its policy of “printing money” to “prime the pump.” Most financial professionals can’t time that trade correctly, so you’ll do better by simply owning shares in one or two of the highest quality commodity-related companies for the long term, taking care to pick companies with dividend growth that outpaces inflation (see Column H in the Table). Chevron (CVX), Exxon Mobil (XOM), Canadian National Railway (CNI), and Monsanto (MON) look like suitable candidates for long-term dollar-averaging. But there are others to consider (see Week 163), such as Archer Daniels Midland (ADM). 

Risk Rating for the 15 stocks in the Table: 7

Full Disclosure: I dollar-average into a DRIP for XOM, and also own shares of CVX, CNI, POT, BBL, DD and MON.

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Sunday, September 7

Week 166 - “Risk-On/Risk-Off” Investing in Response to Global Economic Patterns

Situation: Most of us take more risks with our investments when the world looks to be in good shape economically, and fewer risks when it doesn’t. For example, throughout 2008 investors were risk-averse and tended to sell their losing positions. It was a “Risk-Off” year by all accounts, and that selling did great damage to the retirement savings of roughly a billion people worldwide. The freed-up funds mostly went into US Treasury Bonds and German Bunds, lowering interest rates enough to leave investors in those bonds with no inflation-adjusted income for years. You see the problem, don’t you? Investors should have continued trading stocks in 2008 instead of holding a “fire sale.” The result of all this selling was that stocks became increasingly underpriced relative to their value, as assessed by time-tested methods of fundamental analysis. But where were the buyers? They showed up two years later.

We all need to take a deep breath and agree that our “animal spirits” sometimes lead us to take unreasonable risks when global economic patterns look rosey. I’ve done it, you’ve done it. The cure? Develop a consistent “Risk-Off” investment regimen, and stick with it through good times and bad. The only alternative is to panic when things look bad, and that means selling stocks at a loss. Remember, Warren Buffett's #1 Rule is to "never lose money."

What, exactly, is a consistent Risk-Off investment regimen? Warren Buffett has often said he looks for established companies in boring industries, companies that have built their brand through generations of managers. He likes Procter & Gamble, Coca-Cola, Wal-Mart Stores, Johnson & Johnson, IBM, Heinz, Mars, Wells Fargo, American Express, and Exxon Mobil. In 2008, he sold Johnson & Johnson stock only because he wanted to help out some floundering companies like General Electric and Goldman Sachs, but he otherwise continued to invest in a disciplined manner (e.g. moving to buy the Burlington Northern Santa Fe railroad). Once he buys a stock or company, he does so with the intention of never selling it. Exceptions are rare: 1) To free up money for younger associates to invest, he has done some selective selling; and, 2) he’s done some trading while learning to invest in the energy industry. The point is that he’s the quintessential “Risk Off” investor, and a model for us all to follow.

Where do we go to find a tidy list of old and mostly boring companies that stock analysts tend to yawn at (or just plain overlook)? Here at ITR, we go our “stockpickers secret fishing hole” (see Week 68 and Week 105), which is my name for the Dow Jones Composite Index of 65 companies (30 industrials, 15 utilities, and 20 transportation companies). Railroads and electrical utilities are highlighted there, for example, and have been among the best-performing sub-industries over the last few years (see Week 148). But few, if any, stock brokers are going to try and interest you in buying those. Why? Because they’re government-regulated “and regulators might get it wrong.” Regulation in these stocks is necessary for two reasons: 1) the companies are monopolies; 2) prices for their services need to be set high enough for the companies to afford massive fixed costs and still make a profit. In this week’s Table, you’ll find 11 electric utilities and 3 railroads because those companies prosper in good times and bad. 

We’ve screened the 65 companies in the Dow Jones Composite Index, excluding those that a) don’t have long-term trading data, or b) have insufficient revenues to make it onto the Barron’s 500 List. We came up with 37 companies that either showed a higher rank by Barron’s criteria in 2014 than in 2013, or were ranked in the top 2/3rds for both years. The benchmark we use for “Risk Off” investing is the Vanguard Wellesley Income Fund (VWINX), which is 60% bonds/40% stocks. The benchmark we use for “Risk On” investing is the Vanguard Balanced Index Fund (VBINX), which is 40% bonds/60% stocks. VWINX has a low 5-yr Beta of 0.5, whereas, VBINX has a 5-yr Beta of 0.92, which is almost as high as the S&P 500 Index’s 5-yr Beta that is set at 1.0. This wide discrepancy is mainly because bonds have 70-80% less risk than stocks. Red highlights in the Table denote underperformance vs. VBINX.

NOTE: Our screening starts with the Barron’s 500 List of the largest companies (by revenue) on the New York and Toronto stock exchanges. That list is published each year in May and gives letter grades to each company in 3 areas: median three-year cash-flow-based return on investment (ROIC); the one-year change in that measure relative to the three-year median; and adjusted sales growth in the latest fiscal year. Those letter grades are equal-weighted and the combined grade determines the company’s rank for the year.

If you look at total returns for those 37 companies (Table), 20 outperformed VWINX in all 3 time periods (past 22, 10, and 5 yrs) but only 4 of those stocks lost less money for investors than VWINX did during the Lehman Panic: MCD, JBHT, SO, NEE. This was in spite of the fact that aggregate returns of the 37 companies not only beat VWINX at all 3 time periods but also beat the lowest-cost S&P 500 Index fund (VFINX) in all 3 time periods! So, picking safe stocks is trickier than picking a mutual fund that has built-in safety features. The only reason to pick stocks is to have a source of retirement income that outgrows inflation: Note that Dividend Growth values in Column I of the Table are typically 3-4 times greater than the rate of inflation. You have to “pick and track”. No mutual fund will do that for you.

When we look across the 3 market cycles since the 7/90-4/91 recession, we find that a bond-heavy balanced fund (VWINX) protects its investors from most of the stock market losses incurred during each recession. VWINX lost money in only 3 of the last 22 yrs: 1994 (-6.2%), 1999 (-3.6%), and 2008 (-9.1%), whereas, the S&P 500 Index lost money in 6 yrs, including a 33% loss in 2008. The protection that comes from high-quality bonds is what allows VWINX to grow from a point of preserved value at the beginning of recovery from each recession, instead of wasting months (or years) to make up for lost value.

Bottom Line: Stock-picking is the best way to have some retirement income that beats inflation (see Week 159), but it’s not the best way for a “retail investor” to accumulate wealth. We’ve found 37 stocks that (as a group) handily outperformed the S&P 500 Index after holding periods of 22, 10, and 5 yrs. But only 4 of those stocks could beat a bond-heavy balanced fund (VWINX) in all 3 time periods while losing less than the 16% that VWINX lost during the 18-month Lehman Panic. Two are regulated utilities (SO and NEE), the third is a trucking company (JBHT), and the fourth is a downscale restaurant chain (MCD) that thrives on recessions. So, if you didn’t start investing in those 4 companies 22 yrs ago, and kept adding money along the way, you’d have been better off investing in VWINX. Our standard stock-heavy benchmark, the Vanguard Balanced Index Fund (VBINX), only beat VWINX in the most recent 5-yr period because a severe recession has led to a strong bull market in stocks. Conclusion: We all need to learn how to become “Risk Off” investors by making a plan for investing a certain amount each month, then sticking to it through thick and thin.

Risk Ranking for the aggregate of 37 stocks: 6

Full Disclosure: I dollar-average each month into DRIPs for JNJ, NKE, PG, NEE, WMT, and MSFT, and also own shares of IBM, KO, UTX, MMM, MCD, and DD.

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Sunday, August 31

Week 165 - Production Agriculture Companies in the Barron’s 500 List

Situation: Regular readers of this blog have already been introduced to 2 key strategic facts about making investments in food-related companies: 1) food prices tend to rise 1-2% faster than general inflation because demand for protein increases faster than supply; 2) food-related commodities are what we call “countercyclical” because pricing is dictated by the weather, not global economic patterns. If you don’t want all your retirement savings tied to the economic cycle, a good alternative is to consider investing in businesses that supply farmers and help get their products to market. We’ve recently blogged (see Week 161) about companies that process farm products and distribute those items to grocery stores, hospitals, homes, hotels, restaurants, etc. Because food is essential, those companies can raise prices in response to a commodity shortage. But farmers lose money when they can’t deliver commodities because the weather won’t co-operate. In other words, production agriculture is at the mercy of the weather but the processing and distribution of food products is not.

Many companies support production by the farmer, not just the ubiquitous seed and fertilizer stores. There are suppliers of diesel engines that run center-pivot irrigation systems, tractors to plant seed and spread insecticides, fungicides and herbicides, combines to harvest grain, factories to package meat, others that produce ethanol and animal feed from corn, and companies that ship grain and meat overseas. The screen for this week’s Table includes all 15 Production Agriculture companies in the Barron’s 500 List. That list ranks the 500 largest companies (by revenue) on the New York and Toronto stock exchanges. The Barron’s rankings for 2014 and 2013 are in Columns G & H of the Table. Rankings reflect the letter grades for 3 metrics: growth in revenue over the past year, median 3-yr growth in cash-flow based return on invested capital (ROIC), and the past year’s growth in ROIC divided by median 3-yr ROIC. 

Most of the stocks in the Table are volatile in terms of both the 5-yr Beta (Column K) and losses during the 18-month Lehman Panic (Column D) when compared to our benchmark, which is the Vanguard Balanced Index Fund (VBINX). Monsanto (MON) and Archer Daniels Midland (ADM) appear to be the only companies where rewards outweigh risks enough for the stock to fit into a retirement portfolio. But long-term rewards for each of the 15 stocks (Column C) are far greater than for the lowest-cost S&P 500 Index fund (VFINX). Red highlights denote underperformance relative to our benchmark (VBINX).   

Bottom Line: The companies that serve the needs of farmers are at the mercy of the weather. If farmers don’t have money to spend on a) technologically-advanced farm implements, b) seeds engineered to resist drought and disease, and c) fertilizers to correct losses of essential elements from the soil (potassium, phosphorus, and nitrogen), those farmers aren’t going to be efficient producers this season. That means they’ll have less money to spend on such “productivity upgrades” next season, and the companies that supply those upgrades to farmers will make less money. When the weather makes a turn for the better, farmers will have excess cash and those vendors will do well going into the next season. And, when farm operations are productive that increase in supply will dampen price increases for items on grocery store shelves. In other words, the economic cycle tends to be moderated by the weather cycle: the two are out of sync. As investors, we need to have retirement money working for us in both cycles to smooth out our returns on investment.

Risk Rating: 7

Full disclosure: I have no plans to purchases shares in companies that are listed in the Table, but do own stock in MON, POT, CMI, DE, DD, and CAT.

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Sunday, August 24

Week 164 - Our Approach To Picking Stocks For Retirement Income

Situation: What’s the plan? How big a part should ownership of individual stocks play in your retirement savings? How should you pick those? How should you sell those?

We suggest that you plan to depend on "compound interest" to build financial security for you and your heirs, not "capital appreciation" (which is always a gamble in the absence of dividend growth). With few exceptions (see Week 150), stocks need to be backed 1:1 with US Treasury bonds (or mortgage agency debt instruments). Pick stocks by following these guidelines:

First, you’ll need a way to find companies with improving fundamentals. For us, that information can be found on the annual Barron’s 500 List, which ranks the 500 largest companies (by revenue) that are listed on the New York and Toronto stock exchanges by using 3 equal-weighted criteria: sales growth over the most recent year, growth in cash-flow based return on invested capital (ROIC) over the past 3 yrs, and the most recent year’s ROIC divided by median ROIC over the past 3 yrs. We’re most interested in companies that move up in rank year-over-year but we also value those that consistently place in the upper 2/3rds of the Barron’s 500 List (see Week 159). 

Second, you’ll need a way to determine whether or not a company’s management has a primary goal of benefitting all shareholders (as opposed to themselves). Has the company a) raised its dividend annually for at least the past 10 yrs, and b) maintained an S&P bond rating of BBB+ or better? 

Third, does the stock appear to be undervalued relative to risk? For that point, we calculate Finance Value (long-term reward minus Lehman Panic losses) to be sure that it beats the Finance Value for the Vanguard Balanced Index Fund (VBINX), as well as looking to be sure that both the 5-yr Beta and P/E do as well as VBINX.

Fourth, is the company’s dividend growth rate plus its current dividend yield greater than 7%? That would suggest that the “business case” for making the investment (doubling one’s money in 10 yrs) applies.

Fifth, stay on top of the “story.” In other words, what’s supporting the stock price vis-a-vis reported 12-month earnings (P/E). If the P/E is outside the normal range of 10-20, you need to be concerned. The story might be broken (low P/E) or outdated (high P/E).

Sixth, what about a Plan B? Do alternative investments like real estate (owned for rental income), gold (owned for capital appreciation), or commodity futures (owned for gambling that the underlying commodity will change dramatically in price over the near term) make sense? We don’t think any of those alternatives have a low enough risk to justify inclusion in a retirement portfolio. That leaves our benchmark, The Vanguard Balanced Index Fund (VBINX), as the only alternative investment. This week’s Table shows the 17 companies that pass our filter. Red highlights denote underperformance relative to VBINX

Selling stocks that you’ve chosen by using these guidelines shouldn't become an issue if you’ve set up a Dividend Reinvestment Plan (DRIP) and add a small fixed amount of money to it regularly. That will capture “reversion to the mean” pricing. You benefit from the additional shares that a fixed amount of money buys for you whenever the price is down. That said, you will have to sell if the stock fails to meet the above criteria for extended periods. But as long as the company keeps raising its dividend every year enough to beat inflation, there’s little need to worry. We encourage you to think of your DRIPs as a growing perpetuity, which is a type of bond that keeps paying more interest every year. You don't care about the stock's price as long as the company is committed to increasing its dividend every year regardless of economic conditions.

However, the guidance I’ve just given isn’t going to satisfy all of you, so let’s use a golf analogy. The ball has landed off the fairway, out in the weeds: That’s how you feel about the stock because it has fallen in value compared to what you’ve paid for it. You’ll need to exercise due diligence and study the “story” that has been supporting the stock’s price: Has the price fallen because the story is broken? Or has the price fallen because of macroeconomic events that have little impact on the company’s prospects and the story remains intact? Decide whether or not you’d like to continue buying the stock. That decision process takes time to gestate but if at the end of that time you decide you are no longer a buyer then you are a seller. Finally, you’ll need a “tickler,” some kind of alert that stockpickers use to keep from getting very far into the weeds. The one I like is “sell if you’re down more than 90 days.” So, check your positions every 3 months and do some thinking about the losers. But beware, once you become a trader you're returns will increasingly align with capital appreciation rather than dividend growth. You'll get more thrills, and more sinking feelings.

Bottom Line: We've found 17 stocks that meet our criteria as of this writing (7/18/14), given that the goal is to have dividend income during your retirement years that is likely to grow faster than inflation. 

Risk Rating: 4

Full Disclosure of my current or planned purchases of stocks in the Table. I dollar-average into NEE, PG, WMT, and JNJ each month at computershare.

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Sunday, August 17

Week 163 - How To Bet On Commodity-related Stocks While The Children Are Watching

Situation: We all need to know how to drink responsibly, drive responsibly, eat responsibly, and flirt responsibly. But how, exactly, are we to gamble responsibly? If you’re a regular follower of our website, I’m sure you’ve gambled on something at some time in your life. This is behavior that is what John Maynard Keynes blamed on “animal spirits.” Here at ITR, we try to take the gambling out of investing because we think you’ll get a more comfortable retirement that way. 

Now we need a way to gauge whether or not we’re gambling on “hot” stocks. I travel a lot, researching the blog and trying to learn how people like to invest. I hear amazing statements. While riding up a ski lift last winter in Vail, I heard a real estate developer say "People aren't interested in saving for retirement. Look at the choices they make!" He knew what interests most people the most, i.e., moving to a house that better reflects the status they want to project, and he’d made a lot of money feeding that interest. 

More and more though, I’m struck by how carefully children monitor adult behavior. They quickly come to understand how a family gets to be “house poor” by living beyond both its means and its needs. And they’re less sure than ever about what lessons to take away from observing adults. A child will naturally look for someone to model her behavior on, anyone really, whose behavior suggests that he or she has character--a sense of responsibility and respect toward people in their home, their neighborhood, and the larger community. The word I hear them use is “dishonest”, to sum up places and people that don’t do that. 

This week’s blog is about learning to invest in traditionally risky stocks without gambling. We recommend doing this by looking at companies in the riskiest industries. i.e., energy and basic materials. Both are “commodity-related” industries and their stock values show the greatest variance. 5-yr Beta values are typically 50% higher than the S&P 500 Index, and losses during the Lehman Panic were typically 20% greater. A few simple rules will get us there, starting with all 68 such companies in the Barron’s 500 List that have long-term total return records:

        1) Exclude companies with S&P bond ratings of BBB- or lower, since S&P typically uses the BBB rating to designate a company that is doing OK at the moment but gambling with its life. Bear Stearns, for example, had its debt downgraded from “A” to “BBB” on March 13, 2008 just three day before J.P. Morgan Chase purchased it for $2.00/Share with assistance and encouragement from the Federal Reserve.

        2) Exclude companies that had lower scores for 2013 vs. 2012 on the Barron’s 500 List (see Week 158), unless scores for both years were in the top 300.

        3) Assign the “Not Gambling” label to companies that have S&P bond ratings of A- or better, and BBB+ if the company is a Dividend Achiever.

4) Assign the “Gambling” label to the remaining companies.

5) As a final “belt and suspenders” action, move any companies out of the “Not Gambling” category that lost more than the 28% that VBINX lost during the 18-month Lehman Panic period. 

This week’s Table shows the results. There are 7 “Not Gambling” and 19 “Gambling” stocks to choose from. For comparison, the BENCHMARKS section includes PRNEX (T Rowe Price New Era Fund), which is the lowest-cost mutual fund dedicated to the energy and basic materials industries. As always, red highlights denote underperformance relative to our key benchmark, The Vanguard Balanced Index Fund (VBINX). 

Bottom Line: You don’t have to gamble to own commodity-related stocks. Just do the above screen then take more time than usual to research the “story” supporting each company’s stock price. Pick a stock, start a DRIP (e.g. at computershare), and automatically invest $25-200/mo in the company of your choice. When the price swoons, keep investing as long as the “story” holds.

Risk Rating: 7

Full Disclosure: I own shares of MON.

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Sunday, August 10

Week 162 - A “Rainy Day Fund” Using DRIPs That Don’t Have Transaction Costs

Situation: We all have occasions when we need to use our Rainy Day Fund to meet non-recurring capital expenditures. Afterward, we hope that our regular contributions will replenish it before we’re blind-sided again. That Fund needs to have some dividend-paying stocks in it, as well as inflation-protected Savings Bonds that can be cashed anytime without risk of loss (at treasurydirect). Why stocks? If chosen well, they’ll grow in value somewhat faster than Savings Bonds, as long as dividends are automatically reinvested. But when the market is down, you don’t want to sell those stocks at a loss. Instead, a better choice is to cash in some Savings Bonds. But the kind of “safe” stocks that are suitable for the Fund don’t grow very fast, so you need to 1) minimize expenses by using an online dividend reinvestment plan (DRIP), and 2) find DRIPs that are cost-free.

The trick is knowing which stocks to pick. This week’s Table has one stock for each of 4 essential industries: healthcare, consumer staples, utilities, and energy. Those 4 stocks are: Abbott Laboratories (ABT), Procter & Gamble (PG), NextEra Energy (NEE) and Exxon Mobil (XOM). In the next bear market, these should hold their value relatively well. DRIPs for all 4 can be obtained through computershare at essentially zero purchasing cost. There are no fees for either the initial set-up of automatic monthly purchases or for dividend reinvestment. Well, there is one exception to that bold statement. Procter & Gamble has a “processing fee” of two cents a share for purchases. The minimum amounts permitted for each automatic monthly investment are: $25 for ABT and inflation-protected Savings Bonds, $50 for XOM and PG, and $100 for NEE. If you make automatic $100 monthly purchases for each, your expense ratio for the year is going to be $0.24/$6000 = 0.004%, which we consider to be negligible. The Savings Bonds you’re accumulating through automatic monthly investment at treasurydirect are not only cost-free but come with tax advantages identical to those of an IRA (along with the same limits on annual purchases).

Bottom Line: Build a resilient and rewarding Rainy Day Fund. The one I’ve described here has the advantage of being cost-free. Peruse the Table for details, and note that red highlights denote underperformance vs. our favorite benchmark for retirement savings, which is the Vanguard Balanced Fund (VBINX). You’ll see that the Rainy Day Fund performs quite well (Columns C & F in the Table) and carries little risk (Columns D & I in the Table) compared to VBINX. However, the Rainy Day Fund won’t keep up with VBINX in a bull market because it designed for safety, not wealth-building.

Risk Rating: 3

Full Disclosure: This is the Rainy Day Fund that I currently employ.

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Sunday, August 3

Week 161 - Food Processors That Stock Grocery Store Shelves

Situation: I think we’ve all become a little bit leery of the current stock market. Market analysts keep anticipating GDP growth of 3% but the International Monetary Fund projects that GDP growth in the US is only going to be 1.6% for 2014, and Janet Yellen (the new Chairperson of the Federal Reserve) says that our economy won’t return to 3% GDP growth until 2016 at the earliest. Investors have responded by again sheltering in safe harbors like companies in the 4 “defensive” S&P Industries. Those would be: Consumer Staples, Healthcare, Utilities, and Communication Services. That means those stocks are overpriced according to their Price/Earnings ratio--price divided by earnings over the past 4 quarters (P/E) has moved into the danger zone. P/E ratios higher than 20 are considered too high because returns to the investor drop below 5%/yr. When returns from “defensive” stocks fall that far, professional investors will start to cut their risk profile by moving money into corporate bonds, e.g. Vanguard’s Intermediate-Term Investment-Grade Bond Fund (VFICX, see Table). 

This week, our task is to look at the safest sub-industry (after regulated utilities) within the 4 defensive industries: Food Processors. To get a clear picture, we’ve included all 20 of the publicly-traded companies that stock your grocery store’s shelves to a material degree and have  long-term trading records (see Table). The first column of data (Col C) tells the story. All 20 have total returns that equal or exceed that of our benchmark, the Vanguard Balanced Index Fund (VBINX, see Table), which has returned a little over 5%/yr since the most recent inflation-corrected peak in the S&P 500 Index occurred on 9/1/00. Because it’s hedged, VBINX performed better than the lowest-cost S&P 500 Index fund (VFINX in Table). Risk for the 20 aggregated food processors (Line 22 in the Table), as measured by both total return over the 18-month Lehman Panic panic period and 5-yr Beta (Columns D & J), was less than for VBINX even though total returns after both 14 yrs and 5 years were much greater (Columns C & F).

Now that we’ve got your attention, let’s “muddy the waters.” Look at the Table and note that only PEP, GIS, and SJM provide the investor with what she wants, which is to be at least as good as VBINX in terms of performance (Columns C, F, G, H, I) as well as safety (Columns D, J, K, M, N, O). The aggregated data on Line 22 look great but you’ll need stock-picking skills to capture those high returns at low risk. Remember: data points that underperform VBINX are highlighted in red. Column K (P/E) has an abundance of those, indicating that the market is pricey.

Bottom Line: Food Processors are a mother lode of opportunity for investors but that sub-industry is highly fragmented. Out of the 20 companies in the Table, only 5 are sizable: Nestle (NSRGY), Danone (DANOY), Mondelez International (MDLZ), Coca-Cola (KO) and PepsiCo (PEP). But size (Col L) and bond ratings (Col O) don’t matter much when a company is selling an essential product. The exception occurs when government regulation imposes price controls, as is the case with milk, e.g. Dean Foods (DF at Line 17 in the Table), which is the largest milk producer in the US. 

How should you prioritize your research into the “story” that supports the market value for each of these stocks? We suggest that you assign the same priority as the PowerShares Dividend Achievers Portfolio (PFM, Line 36 in the Table), an exchange-traded fund or ETF. That priority is: KO, PEP, GIS, HRL, SJM, MKC, FLO, LANC.

Risk Rating: 4

Full Disclosure: I don’t plan to purchase any stock listed in the Table, but do own shares of MKC, KO, HRL, GIS, and PEP.

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Sunday, July 27

Week 160 - Investment Strategies for Low Incomes

Situation: We all know that credit is a revolving door and that it’s difficult to use credit and still pay it off. Equity behaves in a similar manner. Some portion of equity will accumulate while some (hopefully less) gets distributed and used. Many households and businesses strive to become knee-deep in both credit and equity. But for households living below the poverty line these issues of credit and equity are beyond daily life. How to move the ball ahead? The heads of low income households have no choice but to become better-than-average money managers. Why? Because equity eventually has to exceed credit. 

What does “equity” mean? Equity is a resource that is fungible, meaning it can be turned into dollars. If you have title to a car, that title represents equity. If you “own” a home that you put 20% down on, and have paid off an additional 30% of the original cost through paying your mortgage, you have no equity and no liability, meaning you would likely “break even” upon selling the house, after allowing for transaction costs, taxes and inflation. Equity takes many forms, education being the most important. But all forms of equity have to end up with a positive dollar value after accounting for transaction costs, insurance, taxes and inflation. Otherwise, the household is pulled deeper into poverty through the spiral created by the use of credit and the payment of interest on borrowed monies. 

After education, the next most important equity-builder is a support network that will help you convert that new degree into a higher-paying job with full benefits. In other words, and this is important, friends and family represent equity through the job contacts they can provide. Also, learn to go online and maintain your “profile” at LinkedIn because that is the “go-to” site for employers looking to fill a vacancy in their workforce.

How else might a household living under the poverty line build equity? A home mortgage used to be the favorite route but most all of us have learned by now that houses gain value no faster than inflation, have volatile market values, and can entail expensive maintenance. Many other ways of producing equity have been tried. For instance, the lottery has been tried but it has average returns of only 37 cents per dollar invested. Gold bullion has been tried and it does indeed beat inflation, by 3.4%/yr since 1968 vs. 5.4%/yr for the S&P 500 Index. However, gold bullion beats inflation by only 1%/yr over longer time periods, undergoes sudden shifts in value, is expensive to store, has to be insured, provides no income, and profits from its sale are taxed at the highest rate. 

This means that we have to drill down deeper to find a reasonable way for you to build equity after landing a good job. Home ownership can build equity if you a) invest the lowest down payment needed to qualify for a “conforming” 30-year mortgage, and b) don’t sell the house until after the mortgage is paid off. A government agency will insure that conforming mortgage, and after 10 yrs the mortgage payment will mostly go toward equity. In the meantime, you won’t pay taxes on income that goes toward interest. While the value of the house will merely track inflation for those 30 yrs, you will have invested only a 5-20% down to end up with 100% ownership. Then you get to live the rest of your life rent-free. The equity in your home is called "rent-equivalent income" by government accountants. Much of that gain represents a “gift” from your Uncle Sam. This is because of banking and insurance subsidies paid out by the federal government to produce stability in those market sectors, as well as “tax expenditures” (the official term for allowing you to avoid paying taxes on income used to pay mortgage interest). You are rewarded for your perseverance in paying off your mortgage, while the government benefits from the stability and character you bring to the neighborhood. 

What other choices are there? Treasury Notes and Bonds were once thought of as a way to build equity but this is not the truth and never has been. They’re just seat belts in the car called “life.” Historically they have beaten inflation by 1-2%/yr. That may sound good on the surface but income tax must be paid on both interest and capital gains. The only subsidy that Uncle Sam awards is freedom from having to pay state or local taxes on interest. Transaction costs are zero if you buy at the government website, and Savings Bonds come with an IRA-like feature, namely, no taxes on accrued interest over the life of the bond. Inflation a protected Savings Bonds (ISBs) are an exceptional value, in that you slowly build equity if they're held for more than 5 yrs because transaction and inflation costs are zero; federal tax on accrued interest is paid upon redemption but that cost is typically covered by the basic interest rate.

Now we have 3 ways for a household living below the poverty line to build equity: 1) have a family member obtain enough additional education to land a better job, 2) start building a Rainy Day Fund with ISBs (see Week 119, Week 117 and Week 151), and 3) start paying down a 30-yr mortgage. You notice that we haven’t talked about stock purchases. But paying into an IRA that includes stocks is a smarter next move (after landing a better job and starting a Rainy Day Fund) than becoming a homeowner. 

We’ll start by looking at the lowest-cost and most conservative mutual fund available that places ⅔ in bonds and ⅓ in stocks, which would be the Vanguard Wellesley Income Fund (VWINX, Line 23 in the Table). It requires an initial purchase of $3,000 but you can start by duplicating it online. Assign ⅔ to ISBs and ⅓ to stocks purchased as a dividend reinvestment plan (DRIP), see Column K in the Table, with an up-front investment ranging from $10 to $500, and minimum amounts required for additional investments ranging from $10 to $100. For tax purposes, you can declare that any DRIP you own is part of an IRA. 

What’s not to like? Well, I’m sure you know that precious few stocks make suitable investments for a household trying to dig out of poverty, and those will require watching. We’ve come up with a list of 12, to help you get started (see Table): Wal-Mart Stores (WMT), McDonald’s (MCD), Johnson & Johnson (JNJ), General Mills (GIS), Chubb (CB), International Business Machines (IBM) and VF Corporation (VFC), plus 5 regulated electric utilities: Wisconsin Energy (WEC), Consolidated Edison (ED), NextEra Energy (NEE), Xcel Energy (XEL) and Southern Company (SO). Those are the 12 top companies on our list of 17 “hedge stocks” (see Week 150). 

This week’s Table shows those 12 stocks at the top. They’re likely to build equity at a rate of ~10%/yr (see Column C), which translates to ~6.5%/yr after deducting the 3.2%/yr rate of inflation that has prevailed for the past 101 years. The IRS taxes your dividends and capital gains at a reduced rate. However, DRIPs have an expense ratio (transaction costs divided by account value) of 1-2%/yr (vs. 0.25%/yr for VWINX and 0%/yr for Treasury Notes and Savings Bonds purchased at treasurydirect). NOTE: For this week’s Table only, red highlights denote underperformance relative to VWINX instead of VBINX. Why? Because higher risk factors (see Columns E, I, and J) make VBINX unsuitable as a benchmark (or savings goal) for families trying to dig out of poverty. Higher risk is also why such families should avoid investing in the lottery, gold coins, or a home mortgage. After taking on the expense of higher education (and building a Rainy Day Fund with ISBs), they need to start an IRA.

Bottom Line: Furthering one’s education is the best investment for anyone living below the poverty line. We think the next best move is to make online purchases of inflation-protected Savings Bonds at treasurydirect and DRIPs in selected stocks (declared for tax purposes as IRAs) at computershare. Both can be done by spending as little as $25 at a time, but starting a DRIP requires an initial investment of $10 to $500. Our preferred IRA option for such a family is to regularly invest in the Vanguard Wellesley Income Fund (VWINX), which requires an initial investment of $3000. 

Risk Rating: 3

Full Disclosure of current purchase plans relative to items in the Table: I dollar-average into DRIPs for WMT, JNJ, IBM, and NEE.

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