Sunday, October 28

Week 69 - Making a Business Case for the “Steady Eddies”

Situation: In Week 62, we introduced yet another strategy, which we dubbed “The Steady Eddies”, to help you prepare for retirement without fearing that your nest egg will crack open and leak its contents during the first year of your retirement. Steady Eddies are Lifeboat Stocks (see Week 23) except without the life jackets that make Lifeboat Stocks so attractive (like an emphasis on state-regulated utilites).

Once again, we screen Zack’s database of 6,000+ world stocks for companies that meet the following basic criteria:
   (a) dividend 2% or better
   (b) dividend growth 3% or better
   (c) ROI 10% or better
   (d) 5-yr average ROI 10% or better. 

Next, we check the Buyupside database and eliminate companies with a greater than 30% drop in total return during the Lehman Panic, and also eliminate companies without 5 and 10 yr total returns of at least 7%. Next, we use our favorite tools to screen out volatility, inefficiecy, and risk by requiring, respectively: 5-yr beta of 0.7 or less, ROIC of 12% or more, and long-term debt of no more than 50% total capitalization.

After these analyses, we were left with 10 companies that qualify for inclusion in this week’s special list for sound long-term investment potential. If we include all 5 companies with 5-yr Betas higher than 0.7 (red-flagged in the Table), our list grows to 15 companies. All 15 have a DDG (dividend + 5-yr dividend growth) of greater than 7%.

The purpose of our blog this week is to determine which of the Steady Eddies have a “business case” for investment. By this, we mean that you’re likely to double your money in 10 yrs (i.e., realize total returns of 7.2%/yr). We’ve turned up 15 companies but the question we know you'll be asking is: "Which of those are currently underpriced?" After all, you don’t want to “buy high and sell low.” The answer turns out to be that it doesn’t matter much over the long run if you dollar-cost average (i.e., purchase a little stock each month using a dividend reinvestment plan). 

The only method we know for calculating whether a stock is currently underpriced or overpriced is the Buffett Buy Analysis (BBA, explained in Week 30): 1) determine whether the company has grown its tangible book value (TBV) steadily over the past 10 yrs; 2) project the trendline of Core Earnings for the past 8-9 yrs into the future for 10 yrs; 3) assume the economy is going to be bleak (P/E sinks to the lowest value seen in the past 10 yrs and the company can’t raise its dividend). That gives you a projected stock price which you can compare to the current price.

If the projected growth rate is higher than TBV growth rate over the past 10 yrs, the stock is probably underpriced at present (Table). The data needed to run these numbers are available from S&P, but only for large companies (LANC and FLO aren’t big enough). When we examine the remaining 13 companies, we find that 6 don’t qualify for analysis, either because they’ve spent some of their TBV or they’ve had more than 3 down yrs in TBV growth. Upon calculating the BBA for the remaining 7, however, we find that HD and BMY are overpriced, HRL is fairly priced, and the remaining 4 are underpriced. That gives you 5 stocks to reflect upon as potential purchases: HRL, MCD, CVX, ADP and UNP

Bottom Line: Don’t take chances with your retirement money. If you lose 50% on an investment, you have to achieve returns of 100% just to get back to where you started. That’s why “smart money” people favor fixed income investing, as exemplified in the attached Table by investing in PRCIX and VWINX. On the other hand, stock investments make an interesting hobby (and you’ll learn much about how the world works). Just make sure you have a dozen or so companies in your portfolio and you don’t get carried away, i.e., have at least 50% of your wealth in utilities (Week 50), bonds (Week 67), Rainy Day Funds (Week 15) and your domicile. Speaking as a doctor, a retiree and an investor, my most practical advice for the run-up to retirement is: Go to the dentist often. Don’t get a divorce. If your doctor prescribes a blood pressure medication, de-stress your life by selling the stocks. Invest the proceeds in a bond-heavy mix of VWINX, PRCIX, VFAIX, and ISBs (inflation-protected US Savings Bonds). And pay off your mortgage.

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