Monday, November 25

Month 101 - Moving the Needle: A-rated S&P 100 Companies in “The 2 and 8 Club” - November 2019

Situation: You’re now in your 50s. The “sunset years” loom ahead. While you have the advantage of being a more experienced investor, you’re losing time and may retire short of where you need to be. Even now, you need to have a “nest egg” at least 6 times your current salary. Your retirement account is likely to be 60% in stocks but that allocation falls to 50% by the time you retire. You’ll need to hold safer but more effective stocks. “The 2 and 8 Club” is one way to do that: buy stocks that carry both a higher dividend yield and a faster rate of dividend growth compared to the S&P 500 Index (SPY), i.e., stocks that yield at least 2%/yr and grow dividends at least 8%/yr. For safety, confine your picks to stocks issued by “mega-cap” companies in the S&P 100 Index. Why those? Because they’re large enough to have multiple product lines, i.e., they’re more able to respond to diverse market conditions. And, they’re required to have active hedging positions at the Chicago Board Options Exchange. Those “put and call” stock options are side-bets made by professional traders, which makes “price discovery” for the underlying stocks more rational. 

Mission: Use our standard spreadsheet to analyze companies in the S&P 100 Index that a) issue debt rated at least A- by S&P, b) issue stock rated B+/M or better by S&P,  c) are listed in the U.S. version of the FTSE High Dividend Yield Index--marketed by Vanguard Group as VYM, d) have the 16+ year trading record that is needed for quantitative analysis by the BMW Method, and e) have grown their dividend at least 8%/yr for the past 5 years. 

Execution: see the 13 companies at the top of this week’s Table.

Administration: Let’s explain the Basic Quality Screen (see Column AH in the Table). The idea is to give readers a quick take on which stocks are worthwhile to consider as a new BUY. The maximum score is 4. Overpriced stocks (see Column AF) are penalized half a point. Reading from left to right across the spreadsheet, the first opportunity to score a point is found in Column K. Stocks that have a 16-yr price appreciation that is more than 1/3rd the risk of ownership (Column M) score one point. A negative value in Column S for Tangible Book Value (highlighted in purple) results in a loss of one point if the debt load is either greater than 2.5 times EBITDA (Column R) or LT-debt represents more than 50% of the company’s total capitalization (Column Q). In Columns U and V, all 13 companies earn 2 points because their S&P ratings meet the requirement of being at least A- for the company’s debt and B+/M for the company’s stock. In Column Z, one point is earned if the stock appears likely to meet our Required Rate of Return over the next 10 years, which is 10%/yr, i.e., the dollar value is not highlighted in purple.

Bottom Line: As you approach retirement, look more closely at the stocks and ETFs in your portfolio. Those equities will need to be half your retirement savings. Where possible, choose stocks issued by large companies that offer higher dividend yields and faster dividend growth than the S&P 500 Index. Five of this week’s stocks are worth researching for possible purchase because of being rated 3 or 4 on our Basic Quality Screen (see Column AH): CSCO, JPM, USB, CAT and BLK.   

Risk Rating: 6 (where 10-yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into NEE, JPM, USB, CAT and IBM, and also own shares of AMGN, CSCO, PEP, BLK and MMM.

"The 2 and 8 Club" (CR) 2017 Invest Tune All rights reserved.

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Sunday, October 27

Month 100 - The Clubhouse Turn: A-rated Companies in the 65-Stock Dow Jones Composite Index - October 2019

Situation: Last month, we came up with 10 stocks that are “safe and effective” bets for the neophyte stock-picker. Our starting point was the S&P 100 Index of the largest publicly-traded companies that benefit from price discovery through a robust market in stock options. Very large companies have the built-in safety feature of multiple product lines, which provide management with internal options for responding to an economic crisis. I excluded companies with less-than-stellar S&P ratings on the stocks and bonds they have issued, as well as companies trading for fewer than 16 years. I have also excluded companies with volatile stocks--those with a 3-yr Beta that is higher than 0.75--as well as companies that are not listed in both of the “value” sub-indices (VYM and IWD) for the Russell 1000 Index

This month I’ve dialed back on those safety requirements by including stocks that likely carry more reward at the expense of greater risk. My assumption is that the stock-picker has accumulated 10+ years of experience and now needs to face up to the responsibility of carefully investing for retirement. The “savings race” has reached The Clubhouse Turn but she still needs guideposts for selecting safe and effective stocks.

Mission: Run our Standard Spreadsheet on only the companies in the 65-stock Dow Jones Composite Average that have either issued bonds rated at least  A- by S&P or carry no long-term debt on their balance sheet. (Those 65 companies are picked by a committee chaired by the Managing Editor of the Wall Street Journal.)

Execution: see Table.  

Administration: Five companies that met the above criteria had to be excluded because they lack information we need for analysis: a full 16+ years of trading records (V, AWK) or an S&P stock rating of at least B+/M (CVX, DD, MRK). One company, PepsiCo (PEP) has been added to the BACKGROUND section because it is the only company among last month’s list of 10 Starter Stocks that isn’t in the Dow Jones Composite Index.

Bottom Line: A mid-career stock-picker who doesn’t have a degree in accounting or business administration is at a disadvantage. It would be in her best interest to narrow her choices to the gold standard of stock-picker lists, which is the 65-stock Dow Jones Composite Index, then further narrow her choices to companies that issue bonds rated A- or better by S&P and have at least a 16 year trading record for their stock. That leaves 28 companies to research. The goal, of course, is to find stocks that have outperformed the S&P 500 Index over the past 5 and 10 years while losing less value than the Index did in its worst year of the past 10. In other words, I’m suggesting that she should focus her research on the 9 companies that have no red highlights in Columns C through F of the Table: Microsoft (MSFT), UnitedHealth (UNH), Nike (NKE), Boeing (BA), Intel (INTC), Union Pacific (UNP), Disney (DIS), NextEra Energy (NEE), and American Electric Power (AEP).   

Risk Rating: 6 (where 10-yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into MSFT, NKE, BA, UNP, NEE, JPM, INTC, KO, WMT, JNJ, PG, CAT and IBM, and also own shares of AAPL, CSCO, PFE, TRV, DUK, UPS, SO, MMM and XOM. So, I am invested in 22 of the 28 companies. It is difficult to follow that many companies, but it is nonetheless essential: Academic studies suggest that a stock-picker needs to be invested in at least 30 companies to have a good chance of matching market returns (see Columns C, F, and K in the Table) while enjoying less risk that the portfolio will lose value (see Columns D, I, and M of the Table).

APPENDIX: “Investment” is a nice word for the deployment of capital. As with any other capital expenditure, its effectiveness (profit margin) is what accountants call Operating Margin, which is Operating Income divided by Sales Revenue. Sales Revenue comes to the stock investor from dividends and the liquidation of shares. Operating Income is Earnings Before Interest and Taxes (EBIT) “after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax.” 

As an investor who buys stocks, your variable costs of production are transaction costs (fees and commissions paid for purchase and sale of shares) plus rent/utilities/supplies for your “home office” and the cost of your business services (e.g. subscriptions to business magazines, newspapers, and websites). For money used to purchase stocks, EBIT is Gross Income (Sales Revenue after subtracting the variable costs of production) minus Depreciation (which is inflation).

"The 2 and 8 Club" (CR) 2017 Invest Tune All rights reserved.

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