Sunday, December 29

Week 130 - Seeking Alpha? Here are 10 companies

Situation: More than just a technical term in statistics, “alpha” has come to have Unicorn-like significance for traders. Indeed, some investors think of alpha as the Holy Grail of investing. The non-mathematical definition of alpha carries little cachet. It refers to Annualized Total Return from an investment that is in excess of what can be accounted for by fluctuations in the mean value for that asset class, i.e., market-beating returns. It seems that alpha should be simple to achieve since, by definition, half of investments do better than average. For stocks issued by well-established companies, half would have superior returns. The problem is that many such beknighted companies fall out of that category with remarkable frequency, only to be replaced by others that also fall out with remarkable frequency. The result? You should follow Warren Buffett’s advice to retail investors, which is that you’re best off sticking to a low-cost S&P 500 Index fund like the Vanguard 500 Index Fund (VFINX).

But the myth survives in the lay press that you and I can “beat the market” if we but pay a fee to the investment guru, brokerage, or hedge fund of the hour. Here at ITR, we say forget the fee and do-it-yourself online with dividend reinvestment plans (DRIPs). More importantly, we encourage you to forget the myth. It isn’t achievable anyway, for periods longer than 20 yrs, unless you are Warren Buffett, John Templeton, or Peter Lynch. But there are kernels of wisdom in the writings and quotations of those three luminaries, which you and I can use to our advantage: Don’t buy stock in good companies that make money rapidly in a bull market. Instead, look for good companies that lose money slowly in a bear market. That’s why every one of our tables has a Column D that states how much each company’s stock lost during the Lehman Panic. We don’t think companies that lost more than 28% over that 18 month period are worth your attention, since that is how much the hedged S&P 500 Index lost as measured by the Vanguard Balanced Index Fund (VBINX), vs. the 46.5% lost by the lowest cost S&P 500 Index fund (VFINX). Hedging is necessary. So, the idea is to stick to an index fund and seek your own alpha. To do that, you will need to pick DRIP stocks that have made more than VFINX while losing less than VBINX in the Lehman Panic. 

Let’s look for companies that beat VFINX for both the past 21 yrs (two and a half market cycles) and the past 5 yrs. We’ll pick those from our universe of 55 companies that have beaten that index since 2002 (see Week 122) and eliminate any company that lost more than the 28% loss sustained by VBINX during the Lehman Panic. Surprisingly, we find 10 companies that have pulled off the alpha feat (see Table). Half of those companies have names that are familiar to anyone who shops: Nike (NKE), TJX, Sherwin-Williams (SHW), Hormel Foods (HRL) and Colgate-Palmolive (CL). They are what they are, namely, unexciting but also able to post good profits year in and year out. Who doesn’t need the stuff they sell? Try going a year without toothpaste, meat, shoes, marked-down new clothes, and paint. In short, most of these companies don’t have great performance because they grow earnings rapidly in a bull market. Instead, it’s because their earnings hold up well in a bear market. Remember: when one of your stocks drops 50% in a recession it has to go up 100% just to get back where it was. In the meantime, 3 to 5 yrs have passed while you’ve had that “dead money” sitting in your brokerage account.

Bottom Line: It is possible to “beat the market” over a long period of time by owning stock in companies that have a strong, recession-proof brand.

Risk Rating: 4

Full Disclosure: I have stock in IBM, Nike (NKE), and Hormel Foods (HRL).

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