Sunday, June 24

Week 51 - International Stocks

Situation: In last week’s blog, Lifeboat Stocks Revisited (Week 50), we described unexpected changes in 3 iconic Lifeboat Stocks (KO, PEP, PG) that occurred during the 2007-09 bear market. Losses to investors (i.e., the total return from dividends and sale) were greater than 20%. While this loss is better than the more than 40% loss for investors in the S&P 500 Index, it is still a shock. How did this happen? Well, those companies had come to a point where half or more of their profits were generated outside the US, and those profits couldn’t be repatriated because of US tax laws. This required Coca-Cola, PepsiCo, and Procter & Gamble to invest those profits in their countries of origin, mainly China. In other words, KO, PEP and PG have become international companies, like 3M, VFC and MCD. Unfortunately, international stock markets were especially hard hit by the 2007-09 recession. Typical returns are shown in the accompanying Table (as represented by Artisan International Fund).

Our advice at ITR is that 1/6th of your equity holdings should consist of stock in companies whose focus is on international sales. And, we also advise investing in US companies that sell products aggressively in emerging markets like Brazil, Russia, Mexico, China and India. Why not invest in foreign companies, in case the dollar loses value relative to international currencies? That might be a good idea someday but for the current situation the dollar is regarded as a safe haven. We recommend that you hedge that “currency risk” by investing 1/3rd of your bond holdings in an international bond fund like T. Rowe Price International Bond Fund (RPIBX). That fund tracks the value of a trade-weighted basket of non-dollar currencies but has more volatility than a comparable investment-grade US bond fund like T. Rowe Price New Income Fund (see the attached Table).

Overseas markets are going to outperform, ultimately. Think about it. “There are 270 cities with a population of 1 million in Asia today that don’t have an airport. Emerging Asia is clearly where the opportunities are in the next 20 or 30 years.” (Mr. D. Lavigne of Frost & Sullivan, as quoted in the NYT on 6/13/12.) The same article noted that the Asia-Pacific segment of the airline industry will earn $2B in 2012, i.e., twice the airline industry’s earnings from the rest of the world combined. This means we need to take the long-term view of events in Asia and make a point of regularly adding to a dividend re-investment plan (DRIP) for one or two of the 6 International Stocks in the ITR Master List (Week 39) that earn most of their profits there: KO, PEP, PG, MCD, VFC, MMM (see the attached Table). McDonald’s (MCD) looks like a good candidate for a “starter” DRIP for those investors who are new to DRIP investing.

Bottom Line: This will be Asia’s Century. Make sure you invest some money there and reap some of the rewards that will be found.

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Sunday, June 17

Week 50 - Lifeboat Stocks Revisited

Situation: If you invest in stocks, you’d like some protection from serious losses during a bear market. Such “defensive” stocks are those issued by companies in 3 key industries: health care, consumer staples and regulated electric utilities. We call the highest quality companies in these 3 areas Lifeboat Stocks. This week's blog takes into consideration the “safety” of these stocks by comparing the Finance Value (reward minus risk) of Lifeboat Stocks in the S&P 500 Index with competing investments. We selected 2 inflation-protected bond funds and the 2 stock/bond mutual funds that best served investors during the 2007-09 bear market. Our benchmark is the lowest-cost S&P 500 Index fund (see the attached Table), since the "promise" of Lifeboat Stocks is to almost keep up with the performance of the S&P 500 Index during a bull market but do much better in a bear market.

Of the 14 Lifeboat Stocks in our Master List (Week 39), 6 kept the “promise” (SO, NEE, WEC, MKC, HRL and ABT). WMT, JNJ, SYY and MDT had 10 yr returns that fell somewhat behind the S&P 500 fund. In terms of Finance Value, however, WMT and JNJ did quite well because losses to the investor during the bear market were either modest (JNJ) or were actually a surprising gain (WMT). Returns for PG, PEP, BDX and KO during the bear market were disappointing, although much less disappointing than those for the S&P 500 Index. Here at ITR, “disappointing” means that losses exceed the standard definition of a bear market (i.e., more than 20%). After all, the principle behind owning a Lifeboat Stock is that you’ll be shielded from such a loss.

Bottom Line: No stock has a chance to make you feel “safe” during a bear market unless it is issued by a company that feeds people (WMT, HRL, MKC, SYY), sells essential health care products (JNJ, ABT, BDX, MDT), or provides electricity (SO, NEE, WEC). Companies that sell soda pop, snacks, and laundry detergent (KO, PEP, PG) will do all right compared to the S&P 500 Index but still disappoint. Our retrospective analysis of returns and risks for Lifeboat Stocks shows that only 6 of the 14 rewarded investors well over the past 10 yrs without scaring them half to death during the bear market. Those 6 are: ABT, SO, NEE, WEC, MKC and HRL. Three were standout performers on all counts: Wisconsin Energy (WEC), NextEra Energy (NEE), and Abbott Laboratories (ABT). Neither of the top-performing mutual funds during the 2007-2009 bear market did well by our criteria. MDLOX lost more than 20% during the bear market even though it beat the S&P 500 Index over 10 yrs, while VWINX provided good protection during the bear market but barely beat the S&P 500.

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Sunday, June 10

Week 49 - Commodity Index

Situation: Before investing in commodity producers, it is useful to look at an index of economic activity in countries with the highest demand for commodities (US, China), and an index of commodity prices (e.g. Dow Jones UBS Commodity Index). Commodity prices are extra-vulnerable to economic winds because the costs for up-grading production are large and lead-times are long. Commodity prices therefore depend not only on the strength of the economy in end-user countries but also on a ~35-yr “supercycle” that reflects expansion of production when commodity prices are high, and “slack” when the supply of the commodity finally becomes plentiful. This slackening usually coincides with a fall-off in demand that is frequently related to constraints on credit. You, however, are a long-term dividend re-investor who is interested in owning stock in commodity-related companies, not futures contracts. As such, you need an index of stock prices that includes dividend payouts. 

To construct our index, we selected 8 of the most solvent, well-established and dominant players among commodity-related companies tracked by Standard & Poors (for background info see Week 40, Week 42, Week 45 & Week 48). Two are based in Canada (SU & CNI) and the rest in the United States. Four are oil & gas producers: Suncor Energy (SU), ExxonMobil (XOM), Chevron (CVX), and Schlumberger (SLB). One company mines gold and copper (Newmont Mining - NEM), one produces heavy equipment used on farms and at mining and drilling sites (Caterpillar - CAT), one is a railroad that gets ~90% of its revenues from transporting commodities (Canadian National Railway - CNI), and one produces genetically engineered seeds and matching herbicides (Monsanto - MON).

The baseline investment for the ITR Commodity Index is a "virtual" purchase of 100 shares of each of these 8 companies at the close of business (COB) on 7/1/02 (transaction costs not included), which had a cost of $30,353. At COB on 6/6/12, that “virtual” investment had a market value of $109,256, and had generated $13,043 in dividends over 10 yrs, for a total return of $122,299 (15.0%/yr). During the bear market of 10/1/07 through 4/1/09, stock in those 8 companies fell an average of 32.0% in value. The dividend yield for the index is currently $2,448 (2.24%/yr), which means the original investment of $30,353 now pays 8.1%/yr. Presently (and since the beginning), CVX, CAT and CNI have been the most valuable components of the index and now pay 62% of the dividends. Because of stock splits, the index now holds 200 shares each of SU, CVX, CAT, MON, SLB and 300 shares of CNI, as well as the original 100 shares each of XOM and NEM.

Bottom Line: Commodity-related companies anchor most portfolios that outperform a broad-based stock index. However, the ups and downs can be disheartening so it helps if the investor has some idea of why that is happening and whether it is attributable to “the usual course of doing business”. To assist readers of our blog, we have set up a stock price index for 8 prominent commodity-related companies. The index started at a value of $37.94/share on 7/1/02 and has a current value (6/6/2012) of $72.83/share, thus it has grown almost 14%/yr. For comparison, the Dow Jones UBS Index of raw commodity prices has grown 3.8%/yr. In other words, someone who owns stock in companies that turn raw commodities into useful products is likely to accumulate wealth much faster than someone who invests in commodity futures.

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Sunday, June 3

Week 48 - Oil & Gas Producers

Situation: Oil & Gas producers have been the cornerstone of the world’s economic edifice for 50 yrs and will likely serve in that capacity for another 50. But when it comes to pricing those products, companies are left at the mercy of worldwide demand. China is now driving 40% of demand for commodities, even though it has only 20% of the world’s population. With respect to oil & gas, the US still ranks first but China is gaining fast and is #1 with respect to demand for iron ore and copper. China’s appetite is so great that commodity producers are in danger of over-expanding just as China reaches its monetary borrowing limit. Investors have to keep an eye on supply & demand, except with respect to oil & gas (because supply rarely outstrips demand for any length of time).

Our mission in this week’s blog is to document the return and risk from owning stock in oil & gas producers, relative to owning other types of stock. We can start with a database of global stocks - the 2,157 companies larger than $1B in stock market value in the Kiplinger Stock screener found at this link. We narrowed that list to 97 companies of the type we find attractive. In other words, these companies meet our criteria of having a:
    market capitalization >$5B,
    dividend yield greater than 1.4%/yr,
    5 yr dividend growth greater than 5.8%/yr,
    current return on investment (ROI) greater than 10%/yr,
    current return on assets (ROA) greater than 6.9%/yr, and 
    price/earnings ratio below 17 (to exclude overpriced companies).
The group of 97 companies that makes our cut includes most of the companies on the ITR Master List (Week 39). 

The oil & gas producers have been placed at the top of the attached Table. For comparison, the cyclical “Core Holding” stocks (Week 22) compose the following group in the Table. Similarly, the non-cyclical “Lifeboat Stocks” (Week 23) are listed next. Gold mining stocks form the last group (Week 45), followed by an S&P 500 Index fund.

Companies in each group are listed in decreasing order of finance value (which is calculated as returns minus risk). Data indicating outstanding company performance are highlighted in light blue, whereas, data indicating sub-par performance are highlighted in red. A quick scanning of the spreadsheet shows oil & gas stocks pick up most of the light blue highlights indicating outstanding company performance.

Bottom Line: A prudent investor cannot escape the necessity and wisdom of investing in oil & gas producing companies. This position, as related to long term investing, is acceptable because the risk of loss in value during a bear market is remarkably low for the oil & gas stocks on our Master List (i.e., XOM, CVX and OXY), particularly given the extent of out-performance during a bull market.

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