Sunday, July 15

Week 54 - “Corporate Leaders Trust” -- Sound Like an Oxymoron??

Situation: In our blog discussion for this week, we are going to try to convince you that purchasing a stock and then holding those shares for a period of time can be a wise investment strategy. The leading proponent of what is called “buy and hold” investing is Warren Buffett. He learned it from Benjamin Graham who taught a course at Columbia Business School and also wrote a book on the topic (Security Analysis, by Benjamin Graham and David Dodd). Prof. Graham’s idea gained traction during the Great Depression. In 1935, one of his followers set up a mutual fund based on key features of buy and hold investing. We draw your attention to this fund because it’s still around today, though not very popular. It’s name is the ING Corporate Leaders Trust (LEXCX). Thirty companies were selected for inclusion in the fund, and positions of equal size were purchased. Now here’s the interesting part: No further purchases were allowed. Ever. And sale of shares held by the fund was allowed only if a company stopped issuing dividends or defaulted on its bonds. Today, the fund holds positions in the remaining 22 companies which have descended from the original 30. The companies holding the top 6 positions (by market capitalization) include 4 that should by now be very familiar to followers of the ITR Master List (Week 52): ExxonMobil, Praxair, Chevron, and Procter & Gamble.

An excellent article recently appeared in the Wall Street Journal about LEXCX entitled “Pick 30 Stocks, Then Just Sit Back for the Next 77 Years”. Please click this link to read about LEXCX and its history of outperformance. Today’s blog discussion is going to apply the same principles embodied by LEXCX to screen the 2012 S&P 500 Index for companies of similar value going forward.

Mission: Create a new (virtual) mutual fund using the same precepts as were used in 1935 to create Corporate Leaders Trust. There are basically 4 such precepts and you’ve already become familiar with the first 3 in prior blogs (e.g. Week 30) that designate a company as having what Warren Buffett calls a “Durable Competitive Advantage”:
   1) relentless growth in Tangible Book Value (TBV); 
   2) no more than 3 down yrs in the past 10 for TBV;
   3) probable continuation of TBV growth, based on the current trend in core earnings corrected for a scenario of persistent economic depression;
   4) a corporate brand that is generally recognized by consumers, and is considered to be a marketing asset.

Execution: Warren Buffett has outlined an unambiguous method to determine whether a company has a “durable competitive advantage”, and that is to use readily available accounting data (cf. “The Warren Buffett Stock Portfolio”, ISBN-10: 085720842X by Mary Buffett and David Clark, 2011). For each company, Standard & Poor’s publishes a report on the company’s stock and the necessary numbers for our analysis are found on pg 3 of that report. You will most likely need a business calculator if you want to follow the steps outlined by Mary Buffett. Here’s how the analysis is done: 

If growth in TBV for the past 10 yrs meets the definition of a “business case” (i.e., the company’s stock has at least doubled in value), then we accept that precept #1 has been satisfied. This growth would represent a total return of at least 7.2%/yr.

If TBV fell no more than 3 yrs, then we accept that precept #2 has been satisfied.

Precept #3 requires a calculation. First, growth rate in core earnings for the last 10 yrs is calculated and entered as “percent interest” (%i), then the value for the most recent year of core earnings is entered as “present value” (PV); 10 is the number of yrs (N). The “future value” of core earnings 10 yrs from now is computed (FV). Multiply that number by the lowest price/earnings (P/E) ratio over the last 10 yrs (reflecting a poor business climate). To that number, add the current dividend payout multiplied by 10 (the assumption being that the company will continue to pay the same dividend annually for 10 yrs but will be unable to raise the dividend due to a poor business climate). The result is the estimated stock price for the company 10 yrs from now. That is entered as FV, the current stock price is entered as PV, N is 10, and %i is computed--which is annualized total return. If that number is at least 7.2%, we then accept that precept #3 has been satisfied. 

For precept #4, we use both of the leading online databases to determine the estimated dollar value of the top 100 brands in the world: BrandZ and Interbrand. It turns out that the brands (on those somewhat different lists) are for products sold by 60 of the companies listed in the S&P 500 Index; 14 of those companies meet requirements for precepts #1 thru #4. The attached TABLE ranks those 14 by Finance Value (Return minus Risk). We’ve added 5 mutual funds (LEXCX, VIPSX, MDLOX, VWINX, VFIAX) for comparison. 

Three of the companies are on our updated ITR Master List (Week 52): ExxonMobil (XOM), Microsoft (MSFT), and Wal*Mart (WMT). Of the remaining 11 companies, 7 are from the information technology industry: Apple (AAPL), Google (GOOG), Accenture (ACN), Mastercard (MA), Adobe (ADBE), eBay (EBAY), and Yahoo! (YHOO). Starbucks (SBUX), JP Morgan Chase (JPM), John Deere (DE), and Nike (NKE) complete the list. 

Bottom Line: Our readers know we recommend a “buy and hold” investment strategy for stocks issued by well-selected companies. The trick is in the selection process. We advocate well-established companies that pay an increasing dividend and have a dividend that beats the yield on the S&P 500 Index. But there are other styles of “value” investing that rely more on companies having a “durable competitive advantage” and strong brands: 77 yrs ago those criteria were used to select 30 stocks for a mutual fund (LEXCX) that couldn’t accept additional positions. Today that fund continues to outperform and we think that’s worth trying to clone using today's companies.

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