Sunday, July 31

Week 4 - Introducing the ITR Growing Perpetuity Index

Goal: To compose a value stock index that tracks the S&P 500 Index over two market cycles but with greater total returns and less risk. In the ITR Mission and Goals statement we define these companies as composing what we call the ITR Growing Perpetuity Index (GPI).

  • Companies selected for the GPI must: 
    • be members of the 65-stock Dow Jones Composite Index;
    • have a dividend yield greater than or equal to the yield for SPY (the exchange-traded fund that mimics the S&P 500 index);
    • have increased their dividend for 10+ years;
    • issue stock that has an S&P Quality Rating of A- or higher;
    • issue bonds that have an S&P Bond Rating of BBB+ or higher.
  • Currently, we find there are 12 companies that meet our criteria and thereby make up ITR's GPI:
    • ExxonMobil (XOM)
    • WalMart (WMT)
    • Procter & Gamble (PG)
    • Chevron (CHV)
    • Johnson & Johnson (JNJ)
    • Coca-Cola (KO)
    • McDonalds (MCD)
    • IBM (IBM)
    • United Technologies (UTX)
    • 3M (MMM)
    • NextEra Energy (NEE)
    • Norfolk Southern (NSC)
  • We used two benchmarks to test the validity of our selection method. One is the longest-running exchange-traded fund that mimics the S&P 500 Index (SPY). The other is the S&P 500 Index mutual fund that carries the lowest expense ratio (0.06%): Vanguard 500 Index Admiral (VFIAX). SPY is traded like any other stock on the New York Stock Exchange (NYSE), whereas, VFIAX is a no-load mutual fund that requires an initial investment of $100,000 and cannot be traded.
  • We need two market cycles to show that stocks selected for the GPI really do outperform SPY. SPY started trading on January 29, 1993, and for the first time it became possible to make "apples to apples" comparisons, i.e., purchase the Index and simultaneously purchase a stock. SPY "went live" two years and 4 months after the (250-day moving average of the) S&P 500 Index hit bottom due to the 1990-92 recession. The next bottom occurred in June '03 and the last in October '09, completing two market cycles. January 31, 2012 will be the two market cycle anniversary for SPY since it began trading exactly 19 years earlier.
  • To specifically compare the total return of a GPI stock to SPY, we calculate the total return from an investment of $200/month from 2/1/93 until the present day. Our virtual purchases follow the rules for a DRIP account using the ING website (ShareBuilder): namely, a $4 commission is charged for stock purchases but dividends are re-invested for free. For the 18 years from 1993 to 2011, we find that the total return for SPY was 5.1%/yr, whereas, the total return for each of the selected 12 stocks in the GPI was greater. For example, the total return for WalMart (WMT) was 7.3%/yr, for Coca-Cola (KO) was 5.4%/yr, and for NextEra Energy (NEE) was 7.6%/yr.
  • We are developing a methodology for anticipating when a Dow Jones Composite Index company is soon going to meet all 5 criteria for membership in the GPI. For example, it became clear in 2007 that Wal*Mart’s Chief Financial Officer (CFO) intended to rapidly increase dividend payouts such that WMT would soon have a yield greater than that of the S&P 500 Index. Given that WMT already met the other 4 criteria for inclusion in the GPI, we could have predicted that WMT would be added to the GPI by 2010.
  • Similarly, we are developing a methodology for anticipating when it will soon be necessary to remove a company from membership in the GPI. For example, the 2008 Panic negatively impacted 4 companies that already met all 5 criteria for the GPI – Caterpillar (CAT), Home Depot (HD), Pfizer (PFE), and General Electric (GE). Those companies were soon forced to withdraw plans to raise their dividend; PFE and GE eventually cut their dividend.
  • One of our goals is to highlight companies outside the Dow Jones Composite Index that otherwise meet criteria for inclusion in the GPI. Approximately 20 such companies exist in the S&P 500 Index. Some of these strong performers will eventually replace companies now in the Dow Jones Composite Index, and thereby become members of the ITR GPI. In our blog next week, we will introduce you to the ITR Master List of those companies in the S&P 500 Index.
Bottom line: Here’s 12 stocks that can be comfortably added to a very long term DRIP investment portfolio.

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