Sunday, August 21

Week 268 - "Buy and Hold" Barron’s 500 Growth Stocks

Situation: Every investor has to know when to leave the party. Or, as Warren Buffett says, “be fearful when others are greedy and greedy when others are fearful.

Mission: Design a template for leaving the party.

Execution: You’ll need a Central Thought. Mine is to stay invested in growth stocks, the ones that do badly in a recession. That means continue to invest in companies from the following 6 S&P industries: Consumer Discretionary, Financial, Information Technology, Industrial, Basic Materials, and Energy. The trick is to dump stocks with problematic Balance Sheets and buy stocks with clean Balance Sheets. 

Administration: Start by defining a clean Balance Sheet. Accountants do this by picking their favorite ratios. My favorite ratios are (see Columns Y thru AB in the Table):

1. Total Debt:Equity is under 200%. That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is under 30%. Long-term debt has to either be renewed upon maturity or returned to the lender. In a crisis, the rate of interest that bankers charge for a renewal loan (called a “rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling company assets at firesale prices or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies in the perceived value of their brand.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow. 

There are other ways to know a company is likely to come through a Bear Market or recession unharmed. S&P stock and bond ratings are worth taking seriously: try to hold stock in A-rated companies (see Columns P and Q in the Table). Stick to companies with multiple product lines, i.e., those large enough to warrant inclusion in the Barron’s 500 List (see Columns N and O in the Table). That list ranks companies by cash flow and revenue. You can tell how a company is doing by comparing this year’s rank to last year’s

You’ll also want to restrict your choices to companies that pay growing dividends, even if the dividend is low. An S&P Dividend Achiever is a company that has raised its dividend annually for the past 10 yrs. With one exception, all of the companies in this week’s Table are Dividend Achievers. Union Pacific is the exception but UNP will become a Dividend Achiever next February with a scheduled dividend increase. 

Bottom Line: You can’t hope to keep up with the lowest-cost S&P 500 Index fund (VFINX at Line 21 in the Table) unless you stay invested in growth stocks. So, learn to pick growth stocks with clean Balance Sheets. Those are the ones likely to hold value in a Bear Market. Invest small amounts at a time by dollar-averaging your stock purchases automatically online. Then you’re certain to buy more shares per dollar invested when the market’s down.

Risk Rating: 6 (Treasuries = 1 and gold = 10)

Full Disclosure: I dollar-average into NKE, MSFT and UNP, and also own shares of ROST, TJX, MMM, and EMR.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days, corrected for transaction costs of 2.5% when buying ~$5000 worth of shares. Dividend Growth Rate is the dividend CAGR for the past 16 years. Price Growth Rate is mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/). Price Return from selling all shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, August 14

Week 267 - Interesting Q3 Stock Picks From Merrill Lynch

Situation: At the beginning of each quarter, Merrill Lynch picks 10 stocks (often including two “shorts” to bet against). I have come to respect their picks but rarely act on those. Why? Because they are, for the most part, risky companies in risky industries. But when the Q3 picks came out on June 30, I was startled. Most of the picks are Dividend Achievers, i.e., companies with a record of increasing dividends for 10+ yrs. As the industry leader, with $2.2 Trillion in client assets under management, Merrill Lynch is encouraging its clients to make defensive investments. They see a Bear Market coming.

Mission: Highlight reasons to expect a Bear Market, and analyze the recommendations by Merrill Lynch.

Execution: The US economy is on solid footing. Jobs are becoming more plentiful, and wages are climbing faster than inflation. The unemployment rate in June 2016 was 4.9% (vs. 4.6% in June of 2006). However, labor market participation (62.7% in June 2016) hasn’t returned to it’s high from 10 yrs ago (66.2% in June 2006). When those who are underemployed (i.e., part-time workers), and those who are out of work but too discouraged to look for jobs, are added to the officially unemployed (i.e., job seekers), the “U-6” unemployment rate for June 2016 was 9.7% (vs. 8.4% in June 2006). Another problem is that many of the jobs that had been available to those without a college education, and paid well enough to allow those workers to become homeowners, have disappeared. The Information Revolution is replacing the Industrial Revolution but beneficiaries need to have a 4-yr college degree in math, science, engineering or technology to participate fully.  

On a global scale, the US economy is an outlier. No other economy can be said to have recovered from the Lehman Panic. Great Britain was recovering but now faces recession due to fallout from Brexit. The rest of Europe is mired in economic troubles mainly caused by an over-reliance on debt financing that cannot be resolved without increases in productivity through education, “creative destruction” of outmoded industries and employment practices, automation, and increased free trade to leverage its competitive advantages. China has an “800 pound elephant in the room” called State-Owned Enterprises. Those continue to grow through municipal borrowing despite the best efforts of China’s economic leaders. Japan has found no way to emerge from decades of recession. Brazil and Russia are in deep recessions. India and South Africa are on growth trajectories but remain mired in structural unemployment. The “Arab Spring” unleashed unimaginable levels of discontent that remain poorly understood but affect the entire globe. The economies of those countries will remain in stasis until political solutions acceptable to those populations can be implemented. What is the “root cause” for underperformance in so many regional economies? Experts point to modern communications, like social media. Anyone with access to a cell phone, laptop or TV is a candidate to develop a more materialistic lifestyle, by whatever means necessary. 

We don’t know how the next Bear Market will be triggered, so the S&P 500 Index continues to make new highs driven by ever-lower interest rates. There are many candidates, overvaluation being prominent among them, with the S&P 500 Index sporting a P/E of 25. Growth of the US economy (GDP) faster than 3%/yr could cure that problem but it doesn’t appear to be happening. Perhaps our government agencies, our corporations and our households have borrowed too much money, and interest payments consume too much of those budgets to allow enough investment in growth. There is also too much uncertainty about the future, so companies are reluctant to move forward with hiring and expand operations. No one issue, whether Brexit or the upcoming US election, has the capacity to trigger a recession on its own. But the above-mentioned points will amplify any crisis atmosphere that arises out of a destabilizing event like a natural disaster, a nuclear accident, or a civil war.  

Administration: The Merrill Lynch Q3 recommendations include two candidates for short sales and a company that recently went public. We’re not interested in those. But do check out the other 7 (including 6 Dividend Achievers) that are worth a look by anyone seeking “buy-and-hold” stocks for a retirement portfolio (see Table). 

Bottom Line: Merrill Lynch analysts apparently think a Bear Market is coming soon, and have advised clients to pick stocks that are likely to hold value in such an environment. Seven appear suitable as long-term holdings (see Table). Six of those are Dividend Achievers: NextEra Energy (NEE), Realty Income (O), AT&T (T), Raytheon (RTN), Walgreen Boots Alliance (WBA) and Lowe’s (LOW). The non-dividend paying stock, salesforce.com (CRM), is the seventh and has growth prospects that could support continued price accumulation in a recession. However, our analysis suggests that only NEE is worth buying when the market is overheated (see Table).

Risk Rating: 6 (Treasuries = 1 and gold = 10)

Full disclosure: I dollar-average each month into NEE and T.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% used to buy ~$5000 worth of shares), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is the mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/), and Price Return for selling shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, August 7

Week 266 - “Buy-and-hold” Barron's 500 Dividend Achievers in the Consumer Staples Industry

Situation: Let’s say you’re in your 50s and have made good investments through the tax-deferred retirement plan at your workplace, and your IRA. But you doubt those investments will replace 80% of your income after you retire. Taxable investments will have to fill the breach, mainly stocks that throw off ~2.5%/yr in dividends and grow those dividends ~10%/yr. There is no mutual fund that will do that for you. You have to pick stocks and reinvest dividends while you’re still working. By the time you retire, annual dividends/share will probably amount to more than 4% of your initial investment in shares. You can have the dividends sent to your bank and spend that income while preserving the shares. Utilities (and Communication Services companies) pay higher dividends but grow those more slowly, so you’ll probably do as well by holding stock in Consumer Staples companies. 

Mission: Find high quality Consumer Staples stocks to “buy-and-hold.” That’s not easy, given that the market for consumer staples grows slowly. However, the market has the advantage of low elasticity (i.e., it doesn’t stop growing during a recession). That stability means companies can try to grow earnings faster (enough to attract investors) by using leverage, i.e., over-borrowing. Usually, that leaves companies with negative Tangible Book Value. But their managers don’t worry about that because the risk of bankruptcy is low, since elasticity is low. The beauty of leverage is two-fold: 1) the government picks up the tab (interest isn’t taxable); 2) Return on Equity (ROE) soars because the company is mainly capitalized with long-term bonds. But you’re investing for your retirement, and know that leverage always creates risk, i.e., the stock’s price will collapse, someday. 

Execution: As a prudent investor, you always want to avoid owning stock in companies that 1) carry twice as much debt as equity, 2) are capitalized more than 50% with long-term bonds, and 3) have negative Tangible Book Value (see Columns AD through AF in this week’s Table). Among the 20 Consumer Staples industry Dividend Achievers on the 2016 Barron’s 500 List, those restrictions leave us with only 8 to consider (see Table).

Bottom Line: You don’t want to outlive your retirement savings, so you’ll spend no more than 4% of your savings each year. But stocks are different than mutual funds because you can select stocks that pay a good and growing dividend. By using dividend reinvestment during your working years, those stocks can by paying a 4% dividend (on their initial cost) by the time you retire. That allows you to avoid selling any shares and simply spend the income. Those shares will continue to grow in value and spin off proportionately higher dividends. Your nest egg of shares in individual stocks becomes the rarest of retirement asset classes. It is one that grows during retirement while allowing you to take out 4%/yr. The trick is to find high quality companies that reliably pay a good and growing dividend. Most likely, you’ll find such companies in only 3 of the 10 S&P industries: Utilities, Communication Services, and Consumer Staples. This week we cover Consumer Staples.

Risk Rating: 4 (where US Treasuries = 1 and gold = 10)

Full Disclosure: I dollar-average into PG, and also own stock in WMT, KO, HRL and ADM.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, July 31

Week 265 - How Do We Create Quality Time in Our Sunset Years?

     “For last year's words belong to last year's language
      And next year's words await another voice.
      And to make an end is to make a beginning."
                                           Little Gidding, by T.S. Eliot

Situation: After your career of gainful employment ends, you’ll need to make a new beginning. New beginnings are comparatively rare over the course of our lives, and frequently the changes made amount to nothing more than defenses thrown up to improve our situational control. Retirement is an excellent opportunity to examine such habits, as some may no longer have utility. But beware. People who have looked at personality adjustments in retirement suggest that whatever little monster lives inside us won't remain so little after we retire and dial back those defenses. Academic studies, however, reveal no universal trends. There’s just a complex tableau of effects. That said, we all know that our working life frequently required us to whittle ourselves into a machine of a person. That’s what we’ve been doing. And now we’re going to un-whittle, whether we want to or not. Prepare for that day by investing in yourself. Drop the job-related defenses without losing sight of the need we all have for routine and purpose. Build new routines that have a new purpose.

Mission: Retirement, like marriage, purports to be about quality-of-life. Both are influenced by two important factors: our health and our ability to pay. Opportunity becomes a function of maintaining our body and our balance sheet. 

Step #1 is to craft a retirement identity, now that your Facebook Page isn’t being monitored by your employer. Each of us needs to understand that there will be a new twist to the way we answer key questions: “Deep down, who am I? How do I get a life?” There will be moments of grieving over the loss of friends, particularly the loss of your best friend (yourself). Elisabeth Kubler-Ross has taught us that grieving happens in identifiable stages: denial, anger, bargaining, depression, and acceptance. These steps “can occur in any order.” From my decades employed as a doctor (neurosurgeon), I think that 95% of us will exhibit Kubler-Ross symptoms during retirement. Often, the trigger is not the loss of livelihood but the loss of personhood, which was gained through the roles and missions of our job. But psychotherapists say that explanation is too simplistic. They suggest instead that the vacuity of our interpersonal relationships away from work brings on a sense of loss that can no longer be covered up by work.

Step #2 is to take care of our bodies. This is a two-part problem because the things we do to damage our health often function to allay our feelings of stress: smoking, drinking, and continuing to eat after our appetite has been satisfied. And, stress is a contributing cause of most illnesses. Almost all of us have found ways to de-stress as often as necessary. (Prohibition failed for a reason.) Psychologists say the healthy way to do this is to take frequent 3 or 4 day vacations instead of the annual multi-week expedition. Of course, psychologists who say this are “arguing against interest” because part of their business comes from people overwhelmed by relationships that blew up during Christmas and annual vacations.

Step #3 is to fund your retirement. The trick here is not to gamble. Gambling mainly comes in two forms. Borrowing money is most common way people gamble. So don’t borrow money for anything other than a mortgage on your principal residence. The other form is to make risky investments. What is risk? Taking a risk is to bet on an uncertain outcome. In finance, “risk-on” means to have confidence in a future stream of earnings growth (for a stock) or the full repayment of principal on time (for a bond). “Risk-off” means confidence has evaporated; the investor will usually want to close out her position, perhaps at a loss. We caution you to make bond-like investments that are highly rated by S&P. With a highly-rated bond, the borrower almost always returns the original investment to the lender on time. With a highly-rated stock, bond-like features, such as good and growing dividends or a low debt/equity ratio, will often prevent the stock’s price from falling in a recession. Start your career as a stock-picker with the list of Dividend Achievers. For those of us who don’t have time to make a hobby of stock-picking, the way to avoid gambling is to invest in either a bond-heavy mutual fund like Vanguard Wellesley Income Fund (VWINX), or a stock-heavy index fund like Vanguard Balanced Index Fund (VBINX). 

In this week’s Table (Columns N-P), we introduce a third way to avoid gambling on stocks: avoid those that don’t exhibit reversion to the mean. In other words, confine your selections to stocks that are priced close to their 30-yr trendline. To demonstrate, we’ve picked 10 Dividend Achievers at the BMW Method 30-yr website, using Coca-Cola (KO) as the limit for risk of loss (Column P in the Table) and extent of leverage (Columns AC and AD in the Table), and the S&P 500 Index (^GSPC) as the limit for loss during the correction of 2011 (Column D in the Table). Companies with a Return on Invested Capital (ROIC) that is less than the Weighted Average Cost of Capital (WACC) are excluded (Columns AA-AB), as are companies with a negative book value, which makes it impossible to calculate the Graham Number (Column U). 

Execution: How might one craft a retirement identity? Start by coming up with a plan for preventing or minimizing Kubler-Ross symptoms. Or better yet, how about just facing them? The plan has to separately address distinct parts of your being, i.e., mental health, physical health, renewal through travel and recreation, and substitution. Why substitution? Because you’ll need to substitute for your work persona through the gradual and planned development of your natural personality, untethered to the habits necessitated by your working life. While it is impossible to detach entirely from ingrained habits, we all know that many of our co-workers (40% of all workers in one large study) report to work simply to make money and have health insurance. They were not there to either sustain or nourish their personality. Karl Marx was right about “alienation.” If you spent your working years as one of those unfortunates, retirement is a chance to recover, dial back your stress level and grow a little. But if you identified strongly with your workplace persona, you’ll need to remain somewhat tethered, perhaps by becoming “historian” of your trade association. 

How might one improve health? Given that many of our poor health habits exist because of work-related stress, experiment with dialing back unhealthy habits.

How might one plus-up retirement savings without gambling? We all know you can’t retire while you have debts. If that’s you, make sure you can migrate to a part-time job soon after retiring from your full-time job. Once your debts have been paid off, do the math and see if you can maintain your lifestyle by using income from Social Security, pensions & annuities, and your retirement portfolio. If there’s still not enough, you’ll have to continue with part-time work or dial back your lifestyle. But behavior is hard to change, so you’ll be tempted instead to borrow money, gamble, or borrow money to gamble. Don’t. There are no short-cuts. It’s too late in the game for you to invest in anything with an uncertain payoff. The only investments that can help you now are to be found at treasurydirect. You’ll have to keep working, dial back your lifestyle, or sponge off friends and relatives. If you are disabled, apply to the appropriate government agency for assistance.  

Administration: 
Mental Health: Here you’ll need to reach out. Start by paying closer attention to your network of friends and relatives. Technology also helps by providing vicarious relationships through your laptop: Facebook, movies, and feature presentations viewable with 360 degree “virtual reality” headsets. And remember, New York museums and Broadway plays are popular with tourists for a reason. Find a way to avail yourself of live theater or a museum visit at least once a year.

Physical Health: The trick here is 30 minutes of exercise a day (e.g. brisk walking), and eating a balanced diet that includes green vegetables, fruit, nuts and coffee (or some other antioxidant). If you live alone, there’s a good chance you’re not getting enough protein and Vitamin D. So, take a supplement like “Ensure Enlive” (Abbott Laboratories) each day. Finally, the need for extra sleep is easily forgotten. It may be hard to understand the importance of sleeping each night until rested, but “you’ll know it when you see it”.

Travel and Recreation: “Get a life!” That’s what we say to boring people who appear to have no excitement in their lives. But many senior citizens lack the wherewithal to travel, or even take up a renewing pastime. Fortunately, the internet makes it easy to find affinity groups and charitable organizations that will help you avoid becoming a “shut-in.”  

Substitution: learn routines for a new purpose in life, one that suits you. Here you’ll need a little professional help from someone who knows how to select and evaluate a psychological test that addresses someone like you. You’d best do this at least 3 yrs before you retire, since you may need to reacquire lost skills or encourage new skills. 

Bottom Line: Half of us will need to continue working in our sunset years. During the run-up to retirement, we’ll have to learn a new career/vocation/hobby, one that is less stressful and time-consuming. Those of us who don’t fear outliving our retirement assets will have a similar task, but will also have the luxury of free associating a plan for new routines that match a new purpose in life. Both groups soon realize they’ll have to pay a lot more attention to physical health than anticipated. That will lead to paying closer attention to mental health, which creates a positive feedback loop that stabilizes physical health. For example, we continue to eat after our appetite has been satisfied mainly because it decreases stress. By learning more about the sources of stress in our lives, and taking remedial action, we’ll find that losing weight is not so difficult. So, the key part of our makeover is to de-stress, which is most easily accomplished through frequent 3-4 day periods of Travel and Recreation. Academic studies also suggest that to de-stress we’ll need to nurture more friendships.

Risk Rating: 5 (US Treasuries = 1; gold = 10)

Full Disclosure: I dollar-average into NKE, JNJ, and T, and also own shares of ROST and KO. 

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. NPV inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, July 24

Week 264 - High-quality Food and Agriculture Companies in the 2016 Barron's 500 List

Situation: The performance of food-related stocks is linked to the commodity supercycle, which has just completed a successful test of its 1998 low. Now would be a good time for you to prepare for the next commodity supercycle. You can buy mining and energy stocks while prices are low, but we’d rather have you think about buying food & agriculture stocks. Why? Because mining and energy stocks carry higher risk, whereas, food is both a daily requirement and in a growth market. This is because the number of people in East Asia alone who can afford to be adequately nourished has been increasing by almost 20 million persons a year for the past 20 yrs. The price of food also faces upward pressure, and is more likely to outstrip general inflation than to continue tracking it. Why? Because agriculture is the greatest consumer of water, and the steady expansion of drought-stricken areas is reducing the inventory of arable land that is able to support agriculture without irrigation.

Mission: Provide an update of food and agriculture companies listed on the New York and Toronto stock exchanges, by referencing the 2016 Barron’s 500 List of the largest companies by revenue. That list ranks companies by fundamental metrics (cash flow from operations, revenue) for the past 3 yrs. We highlight (using green) the companies that have improved their rank (see Table). We also exclude any that do not have an S&P bond rating of at least BBB+ and an S&P stock rating of at least B+/M. Companies with a BBB bond rating are also included if they carry an S&P stock rating of at least A-/M.

Execution: see Table.

Bottom Line: In the aggregate, these 12 companies are good investments. And, they’re safe enough to be long-term holdings in a retirement portfolio. The problem is that you’ll only choose to invest in two or three. To help you pick those, we’ve calculated Net Present Value (NPV) in Column AA of the Table. Ranked by NPV, and also considering safety metrics like Dividend Achiever status, General Mills (GIS), Hormel Foods (HRL) and Deere (DE) look like good bets. 

Risk Rating: 6 (where US Treasuries = 1 and gold = 10).

Full Disclosure: I own shares of GIS, HRL, KO, PEP, ADM, and DE.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 18 in the Table. NPV inputs are described and justified in the Appendix to Week 256. A shorthand way to estimate that a stock will have an investable NPV is highlighted in yellow at Column Q in the Table, i.e., 16-Yr CAGR (Column N) + Dividend Yield (Column G) needs to be 11.4% or higher.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, July 17

Week 263 - “Bond-like” Stocks That Fly Under The Radar

Situation: The stock market is overpriced, which is the obvious outcome of “quantitative easing” and ultra-low interest rates. US Treasury bonds and notes carry an interest rate that is close to the projected inflation rate over their holding period. Stocks, in spite of their added risk, are the only path to portfolio growth. For that reason, the business news increasingly talks up “bond-like” stocks. 

Mission: In last week’s blog, we set up criteria for defining “bond-like” stocks, starting with the requirement that they be Dividend Achievers, i.e., the dividend has been increased annually for at least the past 10 yrs. Now we’ll use those same criteria to highlight “below the radar” stocks, e.g. those issued by companies that don’t have sufficient revenue to be included in the 2016 Barron’s 500 List.

Execution: We exclude any Dividend Achiever from consideration if one or more of the following conditions apply:

1. Revenues are insufficient to warrant inclusion in the 2016 Barron’s 500 List;
2. S&P bond rating is less than BBB+ or (in the absence of a rating) debt/equity is less than or equal to one;
3. S&P stock rating is less than B+/M or S&P assigns a denominator of “H” to the rating (indicating high risk of loss);
4. WACC exceeds ROIC;
5. Finance Value (Column E in our Tables) falls more than for the Vanguard 500 Index Fund (VFINX);
6. Dividend yield is less than for VFINX;
7. 16-yr CAGR is less than for the S&P 500 Index (^GSPC);
8. Dividend yield + 16-yr CAGR is less than 11.4%. NOTE: This metric has predictive value for Net Present Value (NPV) and is highlighted in yellow at Column Q in the Table.
9. Predicted loss to the investor at 2 standard deviations below 16-yr price CAGR is more than 36% (see Column P in the Table).

Bottom Line: We’ve found a dozen Dividend Achievers that appear attractive for long-term investment, even though most reside in the S&P 400 MidCap Index. Not surprisingly, 7 of the 12 are utility stocks. But the strongest stock of the group is Tanger Factory Outlet Centers (SKT), a real estate investment trust.

Risk Rating: 5 (where US Treasuries = 1 and gold = 10)

Full Disclosure: I own shares of Lincoln Electric (LECO).

Note: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance relative to our key benchmark (VBINX at Line 25 in the Table). NPV inputs are listed and justified in the Appendix for Week 256. 

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, July 10

Week 262 - The Master List for 2016

Situation: You’d like not to outlive your retirement savings. And you probably want to find a path toward that goal that doesn’t involve gambling. For that reason, non-gamblers who work on Wall Street have traditionally invested in bonds because bond pricing is stable unless the borrower faces bankruptcy. Even then, the creditor gets back most of the money owed, after the court liquidates and distributes the borrower’s assets. High quality bonds also come with fairy dust. They go up in price during recessions. Stock pricing depends on the perceived value of future cash flows discounted to the present. High quality stocks mostly go down in price during recessions because cash flows depend on demand for the company’s goods and services. 

Bonds now pay only enough interest to cover inflation. You have little choice but to invest in “bond-like” stocks that don’t fall much in value during recessions, and maybe even go up. Examples include Wal-Mart and McDonald’s, both of which went up during the Lehman Panic. We’ve constructed the 2016 Master List around that idea. It starts of course with companies that pay a good and growing dividend, the ones S&P calls Dividend Achievers because they’ve raised their dividend annually for at least the past 10 yrs. Those companies have a captive audience of some sort, people who will keep shelling out cash for a product or service, even during recessions.

Mission: Identify Dividend Achievers likely to hold their value during recessions.

Execution: You’ll know them by how little their total return to investors fell during the most recent “bear market” in an important asset class. That would be the middle two quarters of 2011, when the S&P 400 MidCap Index ETF (MDY) fell 21%. We exclude any Dividend Achiever from consideration if one or more of the following conditions apply:

1. Revenues are insufficient to warrant inclusion in the 2016 Barron’s 500 List;
2. S&P bond rating is less than BBB+ or (in the absence of a rating) debt/equity is less than or equal to one;
3. S&P stock rating is less than B+/M (or S&P assigns a denominator of “H” to the rating, denoting high risk of loss to the investor);
4. WACC exceeds ROIC;
5. Finance Value (Column E in our Tables) falls more than for the Vanguard 500 Index Fund (VFINX);
6. Dividend yield is less than for VFINX;
7. 16-yr CAGR is less than for the S&P 500 Index (^GSPC);
8. Dividend yield + 16-yr CAGR is less than 11.4%. NOTE: this metric has predictive value for Net Present Value (NPV) and is highlighted in yellow at Column Q in the Table;
9. Predicted loss to the investor at 2 standard deviations below 16-yr price CAGR is more than 36% (see Column P in the Table).

Bottom Line: We’ve found 24 Dividend Achievers in the 2016 Barron’s 500 List that defy gravity. All 24 have outgrown the Vanguard S&P 500 Index Fund (VFINX) over the past 16 yrs AND dropped no more in Finance Value during the 2011 bear market than did MDY, the S&P 400 MidCap Index ETF (see Column E in the Table). More importantly, the first 10 companies in the Table beat out 10-Yr Treasury Notes in Finance Value. Thirteen of the 24 improved their cash flow and sales numbers in 2015 compared to 2014 (highlighted in green in Columns R & S of the Table). All 24 continue to more than repay their cost of capital (see Columns AB and AC in the Table). The discounted cash flow (NPV) over the next 10 yrs, projected from 16-yr dividend and price appreciation rates by using a 9%/yr discount rate, shows that all 24 are likely to beat out Berkshire Hathaway (BRK-A), MDY, Microsoft (MSFT), and VFINX (see Columns W-AA in the Table). 

Risk Rating: 4 (where 1 = Treasury Notes and 10 = gold).

Full Disclosure: I dollar-average into JNJ and NEE, and own shares of GIS, KO and MCD.

Note: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance relative to our key benchmark (VBINX at Line 37 in the Table). NPV inputs are listed and justified in the Appendix for Week 256.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, July 3

Week 261 - Growing Perpetuity Index v2.1

Situation: Our blog started 5 years ago with the idea that saving for retirement could be more efficient if savers were to “dollar-average” $50-200 online each month into stocks. The purchases would be spread out over several companies in different sectors of the market, i.e., companies that pay a good and growing dividend. The saver’s accountants would declare to the IRS that those savings constitute an IRA. This week’s blog revisits our initial strategy, examines its performance, and looks for ways to enhance the way we measure performance. 

By using the 65-stock Dow Jones Composite Average or ^DJA, we picked an initial 12 stocks and called those the Growing Perpetuity Index (see Week 4). ^DJA is not only a shorter list than the S&P 500 Index (^GSPC) but also outperforms ^GSPC over the long term (compare Lines 32 and 33 at Column C in the Table). Our strategy was to exclude stocks that don’t pay at least a market dividend (currently 2.0%/yr), and those issued by companies that don’t have S&P ratings of at least BBB+ for their bonds and B+/M for their common stock. Most importantly, the companies needed to have a record of increasing their dividend annually for 10 or more years. S&P calls those companies Dividend Achievers.

Mission: List all companies that currently qualify for inclusion in the Growing Perpetuity Index (see Table), and highlight important metrics for the investor to consider. Five years ago, we found 14 companies and eliminated two to reach our goal of having only a dozen. At Week 224 there were 16 qualifiers; we gave up the idea having a dozen favorites and called the 16-stock portfolio Growing Perpetuity Index v2.0. Now, 19 companies meet our criteria, and we’ve added one (Union Pacific) that will soon be designated a Dividend Achiever. You get to choose from the 20 stocks in Growing Perpetuity Index v2.1. 

Execution: Highlighting “important metrics for the investor to consider” has become “the tail that wags the dog.” For example, we’ve come around to the idea that Net Present Value (NPV) needs to be calculated for every stock appearing in our tables. Explaining that math trick can start with pretending that you bought one of the stocks having a $0.00 transaction cost online, e.g. 50 shares of Exxon Mobil (XOM) at $100/Sh. If you’re looking for that $5000.00 investment to have a 9%/yr rate of price appreciation over a 10 year holding period, you’ll sell those 50 shares for $11835.00 ($236.72/Sh). The calculated Present Value of Expected Cash Flows on that price return works out to be $5000, meaning Net Present Value will be $0.00 because you spent $5000 of Present Value to buy it. 

You get the point: The discount rate (9%/yr) is like the inflation rate but instead reduces your return because of the Time Value of Money. For example, the impact of that 9%/yr “discount” on each dollar of dividends paid out 10 yrs from now is to leave you with a NPV of 39 cents. The dividend growth you expect is also 9%/yr, which (if realized) would also generate an NPV of $0.00. (A detailed explanation of the inputs to the NPV calculation can be found at Week 256). 

The amount of the dividend is important in the NPV calculation. Why? Because large dividend cash flows may be paid out in the early years, when the discount rate has less impact. XOM pays a high 3.3% dividend, which turns out to give it a positive NPV even though other factors work against its having a positive NPV. Those factors are 1) the NPV calculation includes transaction costs of 2.5% at both the front and back end, 2) the dividend growth rate is only 8.0%/yr, and 3) the price appreciation rate is only 7.9%/yr (see Columns G, H, M and Y at Line 16 in the Table). After buying XOM, almost 20% of its purchase price is returned to you as dividends within 5 yrs. 

Administration: Market returns have but two sources: asset allocation and security selection. We recommend bond-like stocks for retirement planning, backed 2:1 with 10-yr US Treasury Notes that are purchased online to avoid transaction costs. Diversification to gain exposure to foreign markets or small-mid capitalization companies is not necessary because the average company in the Table gains 40% of revenues outside the US and several of the companies (JNJ, MSFT, IBM, PG, KO, XOM, UTX, MMM) buy up small companies almost every year.

That leaves “security selection” as the key source of returns. This is the hard part, since you aren’t going to buy all 20 stocks. But it’s really a 2-part problem, given that transaction costs may outweigh selection bias as a source of poor returns for the average investor. So, let’s look at those costs as a fraction of the asset’s purchase price, the so-called expense ratio. For automatic purchases of $100/mo online, the average expense ratio for the 20 stocks we highlight this week is 1.4% (see Column AB in the Table). Note: 8 of those 20 stocks carry zero or minimal transaction costs.

When buying stocks through a discount broker, the expense ratio is typically 2.5%. Index funds purchased through the Vanguard Group have expense ratios of 0.25% or less, which is the main reason Warren Buffett recommends that his friends and relatives buy the Vanguard 500 Index Fund (VFINX at Line 28 in the Table) instead of trying to pick stocks.

Selection bias is an important problem for investors holding fewer than 40 stocks. We try to help you by emphasizing the importance of diversification, e.g. having stocks in all 10 of the S&P industries (see Week 236). Mostly, you need to emphasize quality when picking stocks (see our rationale above for making this week’s selections). Then see how to get the most value from the stocks you like by running NPV calculations before you buy (c.f. Columns U through Y in the Table). Also, pay attention to the Graham Number in Column T and compare it to the Stock Price in Column U. The Graham Number is what the price of the stock would be at 15X earnings and 1.5X book value.  

Bottom Line: We have refreshed our Growing Perpetuity Index. Now it is v2.1 and composed of 20 companies which, in the aggregate, handily outperform our benchmarks. We find that only 3 companies have a lower “finance value” than VFINX using our method of calculating performance: 16-yr total return minus the loss incurred in the 2011 market correction (see Column 5 of the Table). Those companies are 3M (MMM), CSX Railroad, and Caterpillar (CAT). In terms of NPV, all 20 companies outperformed the benchmarks (see Column Y in the Table). Those benchmarks include VFINX, Berkshire Hathaway (BRK-A), and the SPDR MidCap 400 ETF (MDY). 

Risk Rating is 6, where Treasuries = 1 and gold = 10.

Full Disclosure: I dollar-average into XOM, JNJ, MSFT, NEE, PG, and UNP. I also own shares of MCD, MMM, IBM, KO, and WMT.

NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance vs. VBINX (Vanguard Balanced Index Fund at Line 26 in the Table), which is our key benchmark.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, June 26

Week 260 - Barron’s 500 Global “Systemically Important Financial Institutions”

Situation: Unless you just returned from 10 yrs on another planet, you know that financial innovation almost crashed this planet’s largest economies in 2008. The financial services industry in the US had earlier been given free reign to “innovate” by the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999. Prior to that Act, any one financial services institution had been prohibited “from acting as any combination of an investment bank, a commercial bank, and an insurance company.” Not only did such combinations become legal but the Securities and Exchange Commission was denied authority to regulate the “large investment bank holding companies” enabled by the Act: The fox would be running the henhouse. 

Once the consequences of that became clear in 2008, the US Congress was moved to pass the Dodd-Frank Wall Street Reform and Consumer Protection Act; President Obama signed it into law on July 21, 2010. Most of the reforms enabled by that Act will be extended worldwide when the Third Basel Accord (Basel III) takes effect on March 31, 2019. However, we note that Mervyn King, the former Bank of England Governor, doubts whether Basel III will prevent another financial calamity

Now that the status quo ante has largely been restored, we can take a fresh look at financial services institutions, beginning with the remaining Bank Holding Companies. Those 33 money center banks are now called Global SIFIs (Systemically Important Financial Institutions) or G-SIBs. To remain Bank Holding Companies, each is required to carry large amounts of reserve capital and publish a “living will” that has been approved by its central bank. So, if a financial calamity were to consume all of a holding company’s reserve capital, there is a plan in place to resolve the difficulty in an orderly manner. To prepare for that day, each G-SIB has to lock away tens of billion dollars. Those funds are unavailable for making loans or serving as collateral. The idea is to have G-SIBs gradually go away, since restrictions on their ability to provide loans or collateral make it difficult for them to sustain competition against investment banks, commercial banks and insurance companies. Three of the original 33 G-SIBs have already been broken up.

Mission: Given that G-SIB CEOs believe there is a competitive advantage to providing a complete range of financial services for their customers, we’ll look at a variety of metrics and decide whether or not they’re on a quixotic mission. Why should we care? Because the severity of regulation being applied by central bankers almost guarantees that G-SIBs won’t collapse. If you own stock in one, you’ll almost certainly make money. We’ll limit our attention to the 8 G-SIBs in North America, i.e., those that appear in the recently published 2016 Barron’s 500 List.

Execution: We’ll deploy our recently expanded spreadsheet (see Table). There you’ll find performance data and new metrics designed to scope out future prospects for success. Column L in the Table shows the consensus of analyst’s estimates for the trend in each company’s earnings over the next 5 yrs. The green highlights in Columns P and Q indicate that cash-flow based ROIC and sales have been improving at each of the 8 companies for the past 3 yrs. Column T gives the Graham Number and Column U gives the stock price. The Graham Number is where the stock price would be if it were to reflect 15 times earnings per share and 1.5 times book value per share. Benjamin Graham is the “father of value investing” and was the Professor of Economics at Columbia Business School who had such a large effect on Warren Buffett (MSc Economics, 1951).

Bottom Line: Wall Street banks have become a thicket of thorns. Financial engineering has not paid off for them, and the various routes they have discovered for creative finance are now blocked. Workarounds have been forged, and may yet pay off. For the retail investor, these are not promising stocks. The only exception is Wells Fargo (WFC), which has long avoided the kind of creative finance that brought us the Lehman Panic.

Risk Rating = 9 (Treasuries = 1 and gold = 10).

Full Disclosure: I dollar-average into JPM.

NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 14 in the Table). Metrics highlighted in green at Columns P and Q in the Table indicate improving performance trends for fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, June 19

Week 259 - Barron’s 500 Utilities

Situation: You’ve been here before. We like utility stocks as bond substitutes. They grow, albeit slowly, giving investors some protection against the risk posed by rising interest rates. On the downside, utilities are a “crowded trade” because persistently low interest rates continue to drive investors away from bonds. If you’re migrating away from a 50:50 allocation for bonds and stocks, you’re probably targeting 60% stocks and 40% bonds. That means you’ll need to hold sizable positions in several utility companies, or an Exchange Traded Fund (ETF) for utilities such as iShares US Utilities ETF (IDU at Line 19 in the Table). Be aware that variable costs are high for these companies because of extensive maintenance requirements that exceed depreciation allowances. On the other hand, they are monopolies that benefit from state and Federal regulations which lower borrowing costs and ensure that customers will pay a fair price for utility services.

Mission: Provide a capsule summary for investors in Utilities. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Exclude any company that does not have an S&P bond rating of BBB+ or better, and an S&P stock rating of B+/M or better. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).

Execution: see Table.

Bottom Line: The numbers in the Table reflect high returns and low risk from investing in utility companies. However, this is partly because eight yrs of “monetary easing” has made bond-like stocks more valuable by pushing investors away from buying bonds. Prices for the group of 10 stocks in the Table are than 30% higher than can be justified by their earnings and book values (compare Columns T and U in the Table).

Risk Rating = 4 (Treasuries = 1 and gold =10)

Full Disclosure: I dollar-average into NEE.

NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 16 in the Table). Metrics highlighted in green at Columns P and Q indicate improving performance in fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA indicate a company in current difficulty, ROIC being lower than WACC.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com