Sunday, August 19

Week 59 - We counted and there are 90 companies in the S&P 500 Index with a Durable Competitive Advantage

Situation: Investing is a numbers game, even though valuations over the near term are somewhat influenced by fear and greed. In Week 54, we defined the calculations we use to arrive at what is called a “durable competitive advantage” (DCA) by Warren Buffet. The final step of the analysis generates what is called Buffett’s Buy Analysis (BBA) and gives a specific market price for a company’s stock 10 yrs from now. That price estimate is based on using today’s market price to project a 10 yr Total Return. If the stock is overpriced today, its projected Total Return will likely be less than the “business case”, in other words, less than 7.2%/yr which is the Annualized Total Return for an asset that doubles in value over 10 yrs.

Similarly, if the company’s Tangible Book Value hasn’t grown at least 7.2%/yr over the past 9-10 yrs (with no more than 3 down yrs), there isn’t any point in calculating the Buffett Buy Analysis. This is because a less than stellar past performance rarely gives way to an outstanding future performance. For our blog topic this week, we examined all 500 companies in the S&P 500 Index and found that 90 of those companies have a Durable Competitive Advantage. We’ve identified borderline companies as well (Table), by setting the cut-off point at 6.5% for both the past growth in Tangible Book Value (DCA - Column J) and the expected future growth in Total Return (BBA - Column K).

We’ve also provided additional information on the 90 companies that passed our math quiz. You’ll peruse this Table and think we’ve gone to a lot of trouble to highlight dozens of companies that rarely are mentioned on TV or in newspapers, and you’ll also notice that oil & gas producers are here in abundance. In addition, there are many companies that we are used to seeing highlighted for performance which don’t appear on the our list. Now why is that? Well, some (like Procter & Gamble) are so confident they’ll have a steady (and growing) stream of revenue that management sees no point in the company “saving for a rainy day.” Other companies are so well run (like Coca-Cola) that large numbers of investors have decided to overpay for the privilege of owning its shares. A company doesn’t really have to maintain Tangible Book Value if it has
   a) low debt;
   b) steady and reliable growth in Free Cash Flow; and
   c) never gets caught borrowing money to pay its quarterly dividend.
Many companies have “corner office” occupants who will say “Oh, that would be us!” if asked that question but don’t believe them. If a company doesn’t appear in our Table it is either breaking one of those three rules, or its stock is overpriced thus making its BBA less than 6.5%, or the company doesn’t have a long enough track record for our analysis. In the Table, you’ll again see red & blue highlighting. Red means performance as bad or worse than the S&P 500 Index. Blue means bear market losses of less than 65% those seen for the S&P 500 Index (Column D). Blue in Column E means Finance Value was as good or better than that of an above-average hedge fund (see Week 46). 

Bottom Line: Stock ownership has been receiving negative press lately. We find this to be strange given that bond ownership is merely a hedge that is unlikely to beat inflation even after government spending stabilizes. Partly, the bad stock ownership vibes are due to the dismal performance of the S&P 500 Index over the past 10+ yrs. Keep in mind though, that has been a period that has seen two recessions. This week we take a close, number-crunching look at all the stocks in the S&P 500 Index to see if stock ownership is really that bad for your financial health (i.e., cholesterol for your retirement portfolio). It takes a big table to encapsulate relevant information about all 90 stocks that have done well over the past 10 yrs and are likely to continue doing well, but at least we can cross the other 410 companies off our watch list for now. We ranked those 90 companies by their Finance Value (reward minus risk). We arrived at those numbers (for columns C & D in the Table) by going to the website. I’ve cross-checked their math many times and it’s spot-on. Of those 90 companies, 28 were “clean,” meaning that their 10+ yr Annualized Total Return was greater than the S&P 500 Index and their 18 month bear market losses were less than 65% of the S&P 500 Index losses. Six of those 28 companies are in the current iteration of our Master List (see Week 52): Occidental Petroleum (OXY), Hormel Foods (HRL), NextEra Energy (NEE), Becton Dickinson (BDX), Chevron (CVX), and ExxonMobil (XOM).

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