Sunday, January 27

Week 82 - 37 Dividend-Growing Hedge Stocks in the S&P 500 Index

Situation: Many of you have been interested in our Lifeboat Stocks category (see Week 8) and have followed the updates (see Week 23 & Week 50) we’ve posted. We’ve created this category of stocks in an attempt to take your interest off risky investments and provide a class of investment that will provide some security for doing as well as the overall market. In other words, Lifeboat Stocks are an introduction into a hedging strategy. Hedge Funds, you’ll remember from our blogs on the topic (see Week 46 & Week 76), seek to beat the S&P 500 Index over long time periods while sidestepping market downdrafts. They achieve this by having an overall low Beta--something lower than 0.65, and that means holding lots of bonds to backstop what could be chancy investments like stocks in emerging markets. 

But there are also stocks that behave in a bond-like manner. Of these, regulated utilities are the main group, with master limited partnerships (which operate oil and gas pipelines) being the second largest group. Both encompass government regulation alongside government subsidies, which act to tempt investors into financing upfront fixed costs that are huge. In other words, government regulation is accepted by investors because returns are stable and bankruptcy is not a concern. But there is also a third option for hedging, and that is what we call hedge stocks because they behave like hedge funds. There are 37 stocks in the S&P 500 Index that have beaten the index over the past 15 years, partly by falling less than 65% as far as the index during the Lehman Panic, and have a 5-yr Beta of less than 0.65 (Table). 

You might expect most of those stocks to be from the 3 “defensive” S&P industries that contribute our Lifeboat Stocks, namely: Utilities, Health Care, and Consumer Staples. And you would be right:

8 are utilities:  Southern (SO), NextEra Energy (NEE), Dominion Resources (D), PG&E (PCG), Consolidated Edison (ED), Sempra Energy (SRE), Xcel Energy (XEL), Wisconsin Energy (WEC).

4 are Health Care companies:  Abbott Laboratories (ABT), AmerisourceBergen (ABC), CR Bard (BCR), Johnson & Johnson (JNJ).

15 are Consumer Staples companies, subdivided into 4 groups. 
     7 food stocks:  PepsiCo (PEP), Hormel Foods (HRL), General Mills (GIS)
HJ Heinz (HNZ), Hershey (HSY), JM Smucker (SJM), McCormick (MKC).
     4 housewares stocks:  Procter & Gamble (PG), Colgate-Palmolive (CL), Kimberly-Clark (KMB), Clorox (CLX).
     2 broad discounters:  Wal-Mart Stores (WMT), Costco (COST).
     2 tobacco stocks:  Altria (MO), Lorillard (LO). 

Interestingly, that leaves 10 companies that are from the remaining 7 “non-defensive” S&P industries:

3 Consumer Discretionary:  Family Dollar Stores (FDO), McDonald’s (MCD), TJX Stores (TJX).
3 Materials:  Ecolab (ECL), Sherwin-Williams (SHW), Bemis (BMS).
2 Financial:  Chubb (CB), Progressive (PGR).
1 Industrial:  CH Robinson Worldwide (CHRW).
1 Technology:  International Business Machines (IBM). 

For comparison, the Table includes several benchmarks (in capital letters) ranked at their respective Finance Value: gold bullion, the largest gold mining stock (ABX), the largest hedge fund (BRK-A), 3 bond funds, and 3 stock funds. Red flags are used to denote concerns, or underperformance vs. the lowest cost S&P 500 Index fund with data extending over 15 years (VFINX).

Bottom Line: A single stock is at least 3 times riskier than a single investment-grade bond, so you need to own well-chosen stocks to come out ahead. The 37 stocks highlighted in the Table are special in that they don’t need to be backed with an equal investment in a safe bond (e.g. an inflation-protected US Savings Bond) as long as you pick several. If you’re only going to pick a few, then pick from the ten that compose our Master List (Week 78) and don’t have red flags in Columns I through L of the Master List Table: WMT, IBM, JNJ, PEP, MCD, ABT, NEE, CHRW, HRL, MKC (in order of stock market value).

Risk Rating: 3.

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