Sunday, December 28

Week 182 - Our Current List of Hedge Stocks

Situation: It has been 32 weeks since we published our list of Hedge Stocks (see Week 150). That list of 17 companies grows shorter due to market volatility and overvaluation. Even so, the idea of owning stock in a company that is relatively immune from “shorting” by hedge funds remains worthwhile. Why? Because the 10-yr Treasury Notes that professional investors typically use to immunize their portfolio against short sales will continue to pay a lower-than-inflation rate of interest, as long as the Federal Reserve continues its policy of “financial repression” (see Week 79). That means any high-quality bond will have a historically low interest rate, limiting its utility as a portfolio protector. In this environment, stocks that have none of the features that attract hedge fund traders gain added value because it is unlikely that such stocks will plummet in a bear market. That means Hedge Stocks don’t need to be backed by high-quality bonds or low-risk bond funds.

Initially, the stocks we were looking for had these features (see Week 150):
        a) low volatility (5-yr Beta less than 0.7);
        b) a P/E of 22 or less;
        c) higher returns over both the past 5 and 14 yrs than our benchmark (VBINX);
        d) higher Finance Value than VBINX (see Column E in our Tables);
        e) an S&P rating of BBB+ or better on the company’s bonds.

With experience, we’ve decided to modify those criteria. One change is that we’ll only consider companies large enough to appear on the Barron’s 500 List, which is published each year in May. That gives us a way to evaluate fundamental metrics year-over-year: “median three-year cash-flow-based return on investment; the one-year change in that measure, relative to the three-year median; and adjusted sales growth in the latest fiscal year.” Another change is that we’ll only consider companies which either appear in the top 2/3rds of that list (i.e., rank in the top 333) for the two most recent years or have a higher ranking in the most recent year. The third change is to measure valuation by EV/EBITDA (Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation, and Amortization) instead of by P/E (stock price divided by the past 4 quarters of earnings). EV/EBITDA is the market value of all the stock and bond issues that are used to capitalize the company, divided by operating earnings. The use of cash, which is gained from operating earnings plus the issuance of stocks and bonds, is not addressed by EV/EBITDA. We have set the upper limit for valuation of a Hedge Stock at an EV/EBITDA of 13, instead of at a P/E of 22. Finally, to exclude under-analyzed companies, we’ll require an S&P stock rating of at least B+/M.

Bottom Line: Of the 17 companies in our last list of Hedge Stocks (see Week 150), only 9 remain: WMT, MCD, ED, SO, GIS, NEE, XEL, PEP, KMB (see Table). Three companies have been added: Altria Group (MO), Archer-Daniels-Midland (ADM), and Lockheed Martin (LMT). As it happens, all 12 companies are Dividend Achievers. That should tell you something.

Risk Rating: 4

Full Disclosure: I dollar-average into WMT and NEE, and also own shares of MCD, GIS and PEP.

NOTE: Metrics in the Table are current as of the Sunday of publication; red highlights denote underperformance relative to our benchmark (VBINX).

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, December 21

Week 181 - Bond Substitutes

Situation: Our long-term investment philosophy balances the risks of stock ownership by hedging those purchases with bonds, bond substitutes, or non-correlated assets. The idea is to have an investment that is capable of ameliorating a 20+% drop in the S&P 500 Index. Otherwise, it could take 2-6 yrs for your retirement portfolio to recover from a Bear Market. If you’re over 50, that doesn’t leave enough time for you to make up for the loss and still have an adequate retirement income. The best hedges are US Treasuries because those go up a lot in price when stock prices plunge. However, most retail investors currently avoid US Treasuries. Why? Because their interest rate is likely to remain low while the Federal Reserve cautiously emerges from “financial repression” (see Week 76 and Week 79). Financial Repression will probably remain with us as long as world debt is more than twice world GDP, and that is currently at a record high of 212%. This means that you need to learn about other ways to protect your retirement portfolio, starting with bond substitutes.

Conservatively managed stock/bond mutual funds, like the Vanguard Wellesley Income Fund (VWINX, at Line 28 in the Table), often substitute short-term bets on corporate bonds for longer term bets on US Treasuries. This has helped to maintain remarkably stable and strong returns for that asset class. VWINX has grown ~7.5% over the past 14 yrs and ~10%/yr over the past 5 yrs. You can separately invest in a corporate bond mutual fund at low cost. We like the Vanguard Intermediate-Term Investment-Grade Bond Fund (VFICX at Line 7 in the Table), which is itself hedged with US Treasuries as needed. See the Morningstar report for more information. VFICX has returned over 6%/yr long-term (e.g. since the S&P 500 Index peaked on 9/2000) as well as over the past 5 yrs. Note that the lowest cost S&P 500 Index fund (VFINX at Line 32 in the Table) has returned only ~4%/yr since 9/2000 with dividends reinvested. Without those gains from dividend reinvestment, it hasn’t even kept up with inflation! You get the point: A low-cost, investment-grade, intermediate-term, managed corporate bond fund is the Gold Standard hedge against stock market crashes.

Now let’s look at other options, like gold (see Week 175) and hedge stocks (see Week 150). Gold did well in the Lehman Panic but has terrible volatility (see Line 20 in the Table), and is still looking for the bottom in its current bear market. (Gold bullion has been falling in price at a rate of ~1.4%/mo for more than 3 yrs now.) An easier option is to pick stocks that hedge-fund managers are unlikely to sell short (see Week 150). The 17 stocks we’ve listed in that blog don’t need to be backed with bonds, since they’re unlikely to lose much money in a stock market crash. 

This week, we’ll look at a variation on that theme and screen the 20 stocks we’re aware of that lost less during the Lehman Panic than their long-term rate of return. In other words, they carry a positive number for Finance Value (see Column E in any of our tables). Five of those 20 companies appear on our list of Hedge Stocks (see Week 150): Wal-Mart Stores (WMT), McDonald’s (MCD), and 3 utilities:  Wisconsin Energy (WEC), Consolidated Edison (ED), and Southern (SO). We’ll call those Bond Substitutes. In the Table, we group those with corporate and international bond funds in a category called TREASURY BOND SUBSTITUTES.

Ten of the 20 stocks didn’t meet our criteria for stability, one requirement of which is to have a current price that is less than 10 times Tangible Book Value (TBV - see Column R in the Table). Another is to have an Enterprise Value (EV) that is less than 15 times Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). EV/EBITDA represents operating earnings relative to the market value of the stocks and bonds that capitalize a company (see column K in the Table). Now we have 5 companies that are hedge stocks (WMT, MCD, WEC, ED, SO) plus an additional 5 that are stable growers but have metrics that could make them attractive for hedge fund traders to “short.” Those 5 are Ross Stores (ROST), JB Hunt Transportation (JBHT), Hormel Foods (HRL), Occidental Petroleum (OXY), and QUALCOMM (QCOM). In the Table, they’re grouped with gold as LESS ATTRACTIVE T-BOND SUBSTITUTES. 

Upon applying the Buffett Buy Analysis (BBA in Column T; see Week 30), only WEC, ROST, QCOM look worthwhile for investment in this overheated market. Caveat Emptor: If you like these stocks, you’ll first need to assess the “story” that supports each company’s prospects for the future. Why? To determine if you want to buy into that story. You might decide the story is “broken” (or about to be), in which case you’ll look for something better to purchase with your retirement funds.

Bottom Line: We’ve introduced the thorny topic of “bond substitutes.” Gold is one such substitute. Stocks with a history of price stability in hard times are another (if they pay a dividend that persistently outgrows inflation). 

Risk Rating: 4

Full Disclosure: I own some Treasury Notes as well as shares of RPIBX, HRL, and MCD. I also dollar-average into WMT each month.

NOTE: Metrics in the Table are current as of the Sunday of publication.

Please leave comments below, or email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, December 14

Week 180 - Reasonably Priced S&P 100 Stocks

Situation: The stock market is overpriced, and will remain so until bonds pay enough interest to compete with stocks toe-to-toe. I doubt that will happen in the next few years, given that inflation-adjusted 10-yr Treasury Notes are selling very well while paying only 0.42% interest, as of 11/1/14. (Full disclosure is needed here: I admit to being a recent buyer.) So, let’s identify and discuss the next best thing to bonds for stabilizing a retirement portfolio. Are there any large-capitalization US stocks left that are reasonably priced?

Good question, and a hard one to answer. The exchange-traded fund for the S&P 100 Index is OEF (Line 19 in the Table). As expected, it has similar metrics to VFINX, Vanguard’s S&P 500 Index fund (see Line 20). But there are interesting differences. OEF can be considered to be a tad less risky because it pays a little higher dividend, has a little lower 5-yr Beta, lost a little less during the Lehman Panic, and has a 15% lower P/E. With respect to the key metric for someone who is saving for retirement, it has 70% higher dividend growth (Column H in the Table). The S&P 100 Index is the place to look for a good retirement stock, particularly when the market is overvalued. Why? Because that’s typically a time when mid-cap and small-cap stocks are even more overvalued than usual.

How can you be sure a stock isn’t overpriced? The best comparison to make is to examine its price in regards to its Tangible Book Value (TBV). If price/TBV is less than 3, the stock isn’t overpriced. We set the cutoff point twice as high in our assessment, at ~6 (see Column O in the Table). Our reason for doing that is to ensure that we identify stocks that have true value. Next, we look at EV/EBITDA: Enterprise Value (market value of all the stocks and bonds used to capitalize the business) divided by Earnings Before Interest, Taxes, Depreciation, and Amortization (i.e., "operating earnings" to an accountant). Cash spent on new projects is not considered in EV/EBITDA, and neither is the cash spent to buy and service loans. EV/EBITDA can be very revealing. For example, Costco Wholesale (COST) has a P/E of almost 30 but its EV/EBITDA is less than half that (see Columns J and K in the Table). 

Another helpful metric is Dividend Payout (Column L in the Table). If a company is sending more than half its profits to shareholders, it won’t have much Free Cash Flow left to produce and market more and/or better products. That means the company’s managers will probably need to borrow money to expand. Issuing more stock isn’t as attractive to them as issuing a bond or borrowing from a bank, since the revenue that will be used to pay interest on that loan isn’t taxable. Choice #1 (using Free Cash Flow to expand) increases TBV, whereas, Choice #2 (borrowing money to expand) reduces TBV.

Bottom Line: After all the number crunching, we find that there are 10 companies in the S&P 100 Index that are reasonably priced and carry high ratings from S&P on both their stock and bond issues.

Risk Rating: 6

Full Disclosure: I dollar-average into WMT and MSFT.

NOTE: Metrics in the Table are current as of the Sunday of Publication.

Post comments below, or email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, December 7

Week 179 - The ITR “Master List” for Fall 2014

Situation: Twice a year, we try to look into the future using the lens of the past. Currently, the US stock market has reached a plateau due to overvaluation. Alan Greenspan, in his recent book “The Map and the Territory” (The Penguin Press, New York, 2013), explains overvaluation by saying that "demand to acquire the stock of a company is sated as the company becomes adequately funded [and such companies] will yield low prospective rates of profit until the excess capital is withdrawn and presumably reinvested in more promising ventures." In other words, there is no such thing as a stock that looks like a good bet year in and year out. That’s why you need to pick stocks wisely and then dollar-cost average your choices.

You’ve no doubt noticed that our Master List keep getting shorter as the risk of a Bear Market increases. We began with 34 (large and small) companies (see Week 5) and now we’re down to 10 large companies (see Table). Those 10 are chosen from our 9 Lifeboat Stocks (see Week 174) and 17 Core Holdings (see Week 172). We eliminate any that aren’t "Dividend Aristocrats" (25+ yrs of dividend growth) or lost more during the Lehman Panic than the 28% that our “risk-on” benchmark (VBINX) lost.

This week, for the first time, we ask whether you’d be better off investing in all 10 of those companies, or would you be better off investing in Vanguard Wellesley Income Fund (VWINX), which is the “risk-off” benchmark that we recommend for retirement portfolios. It is not too difficult to build a portfolio of stocks with a higher dividend yield and/or faster dividend growth rate than the S&P 500 Index, particularly if you stick to companies have grown their dividend annually for at least 25 yrs. Those companies have a long and stable history of rewarding their investors through good times and bad. By owning shares in a few such companies you can look forward to receiving dividend checks in retirement that grow faster than inflation. But will you end up with more retirement assets by doing that? This week’s blog tries to answer that question.

Long term, VWINX has been the most stable and rewarding mutual fund. It is balanced roughly 40:60 between high quality stocks and investment-grade bonds, respectively. VWINX has returned 10.6%/yr over the past 35 yrs, which is identical to the return for the lowest-cost S&P 500 Index fund, the Vanguard 500 Index Fund (VFINX). Bonds in VWINX go up in value whenever stocks go down. That means VWINX has had only 4 down years in 35 (average loss of 6.3%) vs. 8 for VFINX (average loss of 11%). The lesson here is to hedge your stocks with high quality bonds. We suggest that you use inflation-protected US Savings Bonds because those never lose money and carry all the tax advantages of an IRA. 

We’ve blogged often about the risk of owning individual stocks, and use several metrics like 5-yr Beta (Column I in our Tables) to highlight that risk. But there’s only one sure-fire metric: How much did investors lose during the last Bear Market (Column D in our Tables)? Warren Buffett likes to make analogies about core principles, and his analogy for this one is “You can only tell who’s swimming naked when the tide goes out.” With bonds, risk is easier to gauge because the interest that a corporate bond pays vs. the interest that a US Treasury bond (with the same maturity) pays is a direct measure of credit risk. The difference between those two interest rates is called “the spread” and the higher the spread, the riskier the bond. In other words, you’re paid more interest because you’re willing to take on more of the risk of bankruptcy. US Savings Bonds purchased online at treasurydirect are a zero-cost, tax-advantaged way to invest in 10-yr US Treasury Notes, the safest investment on the planet (according to Warren Buffett). You’ll appreciate having those Savings Bonds available to fund the non-recurring capital expenditures that are bound to appear during the next market calamity. (You certainly won’t want to sell stocks at a loss.) 

The 10 “buy and hold” stocks in this week’s Table include 4 Hedge Stocks (see Week 150): WMT, CB, JNJ, PEP. Those stocks don’t need to be backed with inflation-protected Savings Bonds (ISBs). To answer our question (Is it better to invest in those 10 stocks or in VWINX?), we’ll make a virtual investment of $50/mo in each of the 10 stocks ($500/mo) backed by another virtual investment of $300/mo in ISBs. (Thus, you see 6 entries for ISBs in the Table). We’ve made stock purchases online at a dividend reinvestment sites like computershare or shareowneronline wherever transaction costs can be less than ~2%/yr. If the costs are higher, we’ve resorted to using a discount brokerage like Edward Jones (one of several that are available). For our virtual portfolio, we found it necessary to do that for 3 stocks (GWW, CB, PEP), buying one a year in that order. Our virtual investment then totaled $1800 once a year for 3 yrs with reinvested dividends, which accomplishes the same goal as investing $50/mo for 3 yrs at a dividend reinvestment site online.

Bottom Line: You can construct a 10-stock portfolio and be ahead of VWINX while maintaining the same risk profile (e.g. a 5-yr Beta of ~0.45). Over the past 14 yrs, our virtual portfolio returned ~9.5%/yr vs. ~7.3%/yr for VWINX. However, that ~2.2%/yr advantage is reduced to ~1.8%/yr after you subtract transaction costs of ~0.4%/yr: $321.65 spent during the first 3 yrs (Column R in the Table) divided by an investment of $28,800 = 1.12%, which is ~0.4%/yr. Dividend yield plus dividend growth is also better with 10 stocks than with VWINX (8.6% vs. 2.2%, see Columns G and H in the Table). During retirement, you’ll probably be able to cash those quarterly dividend checks without needing to sell the underlying shares, as opposed to having to sell shares of VWINX to come up with the same amount of cash. Of course, there is greater selection bias in picking 10 stocks than in owning shares of a managed stock/bond mutual fund like VWINX. Getting an extra ~1.8%/yr might justify the additional time and energy you’ll spend managing your portfolio but always consider opportunity costs. For example, a better choice for building retirement wealth might be to invest in VWINX, then use the time and energy you’ve saved to further your education and get a better day job.

Risk Rating: 3

Full Disclosure: I dollar-average into ISBs, WMT, ABT, and PEP. I also own shares of HRL, JNJ, and BDX.

NOTE: Metrics in the Table are current as of the Sunday of publication.

Post comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, November 30

Week 178 - Agricultural Cooperatives, Part B

Situation: (This is the second blog in a two-part series.) Agricultural Cooperatives represent a tried and-true-method for maximizing farm productivity. But they don’t do much for the bottom line of anyone other than their farmer-owners, and the companies the co-ops do business with (the focus of our blog for this week). Production Agriculture is at the mercy of the weather. When it’s good, crop prices fall; when its bad, crop prices rise. That’s a roller-coaster ride for farmers but investors seek out asset classes that don’t track GDP, and for the obvious reason (which is to reduce the volatility of their portfolios). The companies that supply farmers (and buy their grain & cattle) are certainly in that category. 

For last week’s and this week’s blogs, we are studying a 14-county section of Central Nebraska to see which public companies co-locate with farmer’s cooperatives. In last week’s blog (Week 177), we analyzed the 7 largest Agricultural Cooperatives in that reference area. For this “pure-Ag” region of the country, we’re not surprised to find that the operations of public companies are clustered around 6 cities, which are all situated near the main source of water for the region, the Platte River. Those cities are: Columbus, Grand Island, Hastings, Kearney, Lexington, and North Platte. We found 21 public companies that service farmers and ranchers in that reference area. Table A shows the juxtapositions of 7 cooperatives and 21 public companies, county by county. In last week’s Table A, those companies were denoted only by their stock tickers because we wanted to wait until this week to focus on financial activities and investment metrics (see this week’s featured Table B). For reference, we’ve included Table A from last week’s blog. You’ll need to work back and forth between these two Tables, since there’s a lot of material to consider. 

All 3 major seed producers are represented: Monsanto (MON), Syngenta AG (SYT), and DuPont-Pioneer (DD), as are the 3 largest farm-equipment manufacturers: Case-International Harvester (CNHI) which manufactures combines in Grand Island; John Deere (DE) which has sales & service outlets in all 14 counties, and Caterpillar (CAT) which has sales & service outlets in Grand Island and North Platte. The Andersons (ANDE) has a large grain storage and marketing facility in Kearney. Other agri-business companies include CF Industries (CF) which produces fertilizers, and Flowserve (FLS) which manufactures irrigation pumps. Archer-Daniels-Midland (ADM) is the largest company in the farm products industry and it operates an ethanol plant in Columbus. Green Plains (GPRE) operates ethanol plants in Hall and Merrick counties. Fastenal (FAST) has sites for manufacturing building components throughout the area. Cummins (CMI) manufactures and services the diesel engines that are the typical power source for center-pivot irrigation systems. Raven (RAVN) manufactures GPS guidance and assisted steering systems for tractors. Tractor Supply (TSCO) has outlets throughout the area. Both of the major center-pivot irrigation companies have plants there as well: Valmont Industries (VMI) and Lindsay (LNN). Tyson Foods (TSN) and JBS South America each have a large meat-packing plant here. NOTE: In 2007, JBS S.A. (JBSAY) acquired Swift & Company (based in Greeley, CO). The US subsidiary of JBS S.A. is Pilgrim’s Pride (PPC), based at the former Swift & Company headquarters in Greeley. 

For the most part, farmers in the area buy their building materials, hardware and other construction supplies from local privately-owned companies, so Big-Box discount stores are underrepresented. Home Depot has one store (in Grand Island) but there isn’t a Lowe’s in our reference area (there’s one in Lincoln, NE). Ace Hardware has 5 stores, with one in Kearney, one in Hastings, and 3 around Grand Island. Wal-Mart Stores (WMT) are found in each of the 6 major cities, and Grand Island has two. Looking again at Table A to see where cooperatives and public companies congregate (Column AK), activity focuses on 3 cities that are within 40 miles of each other, those being Kearney, Hastings and Grand Island, also known as the “Tri-City Area” (Est. population 150,000).

To the uninitiated, it can seem that the production of agricultural commodities would differ little from the production of other commodities, like oil or iron ore. Our first guess would be that facilities can only be expanded slowly and at great cost. Following the laws of supply and demand, one would estimate that technological advances will occur and expansion costs will be met only when supplies are insufficient to meet demand. The resulting bounty is initially profitable but then overproduction turns that bounty into a glut. Prices for those now (too) abundant commodities will fall, and fall far enough to match demand. Agricultural commodities, however, have two advantages over other commodities: 1) Governments cannot remain in power if food is scarce; 2) food production doesn’t depend on the economic cycle (it depends on the weather). Those two facts give investors an advantage. They know that famines won’t be tolerated, and they can hedge their bets on the economic cycle by investing in the companies that sustain Production Agriculture. And, it won’t be long before they’ll also be able to invest in the agricultural cooperatives that are at the heart of Production Agriculture.

Bottom Line: As shown in Table B, your options for investing in Production Agriculture (as practiced in Central Nebraska) come down to 21 publicly-traded common stocks and one preferred stock (CHSCP) which is issued by CHS Inc., the largest agricultural cooperative in the US. For the most part, these companies are not in the business of processing food for sale in grocery stores, although there are two meat-packing plants in our 14-county reference area. Approximately 40% of grain produced there is destined for one of 9 plants in the area that make motor fuels (soydiesel or ethanol), with animal feed being a major byproduct of those plants.

Risk Rating: 7

Full Disclosure: I dollar-average into WMT and MON, and also own shares of CF, CMI, FLS, DE, and DD.

Note: All of the metrics in our Tables are current as of the Sunday of publication.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, November 23

Week 177 - Agricultural Cooperatives, Part A

Situation: Agriculture has become big business in the US, and investing in it requires an understanding of a collection of businesses that support AgriBusiness. These businesses are collectively grouped under the title of “Production Agriculture.” They supply the farmer and market his crops. To really understand Production Agriculture you need to understand farmer’s cooperatives. Most farmers band together in local or regional cooperatives, designed to meet their need for supplies (fuel, tires, feed, seed, crop protectants, fertilizer and equipment) and provide a place to deliver their crops. Nationwide, this $3 Trillion cooperative industry is almost entirely funded by member-owners. However, some of the larger regional cooperatives are finding that they need to issue stocks or bonds to finance opportunities for growth. 

What this means for investors is that investing in Production Agriculture requires paying attention to companies that sell to farmer’s cooperatives. You’ll need to know which companies do business in close association with the farmer’s cooperatives. For example, seed companies pursue a dual path. One group of salesmen will market to “seed advisors” who work with individual farmers but a larger group will market to farmer’s cooperatives. It is obviously important to place seed production plants near cooperatives. 

According to the US Department of Agriculture, there are ~2300 agricultural cooperatives in the US. In 2013, those had record sales of $246B and record net income (before taxes) of $6.2B. A third of those cooperatives had sales under $5M but 33 had sales over a billion dollars. Earnings are either retained by the Cooperative for reinvestment or returned to member-owners. 

The largest agricultural cooperative is CHS, in St. Paul, MN. CHS issued a convertible preferred stock (CHSCP) on March 24, 2003, and a second series (CHSCM) on September 16, 2014. While that route to capitalization brings CHS under regulation by the Securities and Exchange Commission (SEC), it allows CHS to expand into international markets. The growing need for capital simply could not be met by a partnership-style corporation. Over time, most of the largest regional cooperatives will have to go to Wall Street for capital, if they want to grow their brands globally. Those stocks and bonds will be attractive to investors for the simple reason that weather patterns (and growth of the middle class in Asia), govern the profit of farmers cooperatives, not economic patterns. Every investor has to take an interest in such non-correlated assets. Why? Because over time those types of assets will reduce the volatility of her portfolio (Beta). Think of it as insurance against stock market crashes.

This week’s blog will introduce you to farmers' cooperatives here in the Platte River valley of Central Nebraska where I live. We’ll take a close look at AgriBusiness in 14 counties (see Table A). Those counties had a population of 285,282 in 2011, which translates into 26 people per square mile. Ah, yup, that’s right--when you do the math, it means that there are 25 acres per person. And for readers who live in cities, that probably sounds like there are a lot of lonely places. There are also 6 cities with enough people in the urban core (10 to 50 thousand) to be classified as a micropolitan statistical area (microSA): Columbus, Grand Island, Hastings, Kearney, Lexington, and North Platte. The largest microSA is Grand Island, with a population of 73,551, and the smallest is Lexington microSA. There is scheduled airline service at Kearney, Grand Island, and North Platte. The largest college is the University of Nebraska at Kearney, with 7100 students. The 14-county area straddles US highway 30 for 276 miles along the Platte River in the east-west direction, with the halfway point east of Lexington. US highway 281 spans the greatest north-south dimension for 72 miles, with the halfway point at Grand Island.

Seven of “The 100 Largest Agriculture Cooperatives” have operations in that 14 county area (see Table A):

   1. CHS Inc., based in St. Paul, MN, with revenues of $37B in 2011 (including branded fuels). CHS is a Fortune 100 Company with almost ~$90B in assets. It owns and operates two oil refineries. Those support more than 1400 CENEX service stations in 19 states, including stations in all 14 of our reference counties (see Column N in Table A). CENEX co-brands with Cabela’s to offer a VISA card with a rewards program. For every $100 spent at a CENEX station (or Cabela’s) the cardholder is entitled to $2 off on a her next purchase of outdoor equipment at Cabela’s. CHS mainly produces food ingredients from US soybeans for sale worldwide. CHS food brands are marketed by Ventura Foods and include Dean’s Dips, Marie’s salad dressings and dips, and LouAna peanut oil.

   2. Land O’Lakes Inc., based in St. Paul, MN, with revenues of $13B in 2011. Dairy foods are marketed under the Land O Lakes, Alpine Lace, and Kozy Shack brands. Animal feeds are marketed under the Purina Animal Nutrition (formerly Ralston Purina) and Land O’ Lakes Feed brands. Seeds, and crop protection products, are marketed under the WinField brand. NOTE: CHS is partnering with WinField to operate 6 “CHS, WinField Seed and Agronomy Centers” in Nebraska; the first store opened this summer in Minden.  

   3. Ag Processing Inc. (AGP), the world’s largest soybean processing cooperative, is based in Omaha, NE, and had revenues of $4.4B in 2011. Branded products include SoyGold (biodiesel) and AminoPlus (a “bypass protein” that cannot be degraded in a cow’s rumen). AGP’s Nebraska plant is located in Hastings. AGP also partners with Masterfeeds, the second-largest animal feed company in Canada. 

   4. The recently merged Central Valley Ag and United Farmers cooperatives (together they’re now called CVA) is based in York, NE, and had consolidated revenues of $1.0B in 2011.

   5. Aurora Cooperative Elevator Company Inc., based in Aurora, NE, had revenues of $0.9B in 2011. It is the dominant cooperative in our reference area (see Column I in Table A).

   6. Cooperative Producers Inc. (CPI), based in Hastings, NE, with revenues of $0.7B in 2011.

   7. Ag Valley Co-op, based in North Platte, NE, with revenues of $0.4B in 2011.

This week’s Table, called Table A, lists activities by county. Cooperatives are ranked left to right by revenues. Then there is a gap (at Column L) followed by 22 columns arrayed under the ticker symbols for 22 companies (including CHS) that have operations in our 14-county reference area. Those companies will be the focus of next week’s blog, where Table B (which will accompany next week’s blog) will list those companies in descending order of their Finance Value. That order is the same as the left-to-right order of their appearance in this week’s Table A. Looking again at Table A, you’ll see another gap (at Column AI) followed by locations of the 6 ethanol plants that aren’t operated by either Archer-Daniels-Midland (ADM in Column T of Table A) or Green Plains (GPRE in Column AF of Table A), and locations of the 5 Cargill railheads (see Column AK in Table A). Cargill is a large private company based in Minneapolis, MN, with worldwide food logistics and meat-packing operations. 

Bottom Line: This 14-county area in the center of Nebraska is a hot zone of agricultural activity. More than half the profits go to farmer’s cooperatives. Wall Street banks have no interest in those, aside from the largest one, CHS, which issues preferred stocks listed on public exchanges (CHSCP, CHSCM). More cooperatives will offer stocks and bonds if they want to have the capital needed to market their products throughout Asia. People saving for retirement need to pay attention to these developments because the fate of production agriculture stocks and bonds will depend on weather and growth of the middle class in Asia, not global economic patterns. In the meantime, investors can pick stocks from companies that work hand-in-glove with farmer’s cooperatives. You’ll find 20 of those in Table B, which accompanies our blog for next week: Agricultural Cooperatives, Part B. That blog will also include Table A, for ready reference.

Risk Rating: 7

Full Disclosure: I dollar-average into WMT and MON, and also own shares of CF, FLS, CMI, DE, and DD.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, November 16

Week 176 - Non-Speculative Stocks

Situation: Here at ITR, we “mine” data that are readily available on the internet. The idea is to use objective information to help retail investors avoid disappointment. The main problem, of course, is that American corporations tend to expand by borrowing the money needed. Why? Because interest payments aren’t taxable. Each year, the average company spends 5% more on expansion than it can afford to extract from its cash flow. That 5% has to be borrowed. Presumably, the company’s growth plan will bring in enough additional cash flow to pay back the loan. (Would that the world were so kind!) 

If a company keeps growing its long-term debt (instead of paying it down), investors will shy away and its stock price will plateau, or even fall. The company then has to create incentives that keep investors from abandoning it. For our investment purposes, we like the one where the company pays a nice dividend and grows it ~10%  each year. That incentive, however, requires even more cash flow. Now the company may have to borrow more money to remain true to strategy. This means the company will have to revise its business plan, e.g. get rid of underperforming divisions. (Even “blue chip” companies like Procter & Gamble face this dilemma.) Tangible Book Value may disappear as interest payments keep rising. The dividend payout (as a percent of earnings) will likely drift higher, and when it gets higher than 50-60% long-term investors start to bail out of their positions.

You get the point. Even the soundest of companies will eventually face an opportunity for expansion that cannot be afforded without borrowing money. That is why the US government has created an incentive to take out that loan by waiving taxes on the part of earnings that will be used to make interest payments. The government calculates that the expanded company will be able to pay more taxes soon, and everybody wins. In reality, the company is taking a gamble and the government is a partner in that gamble. Now you see why there are very few of what can truly be called “non-speculative” stocks. For this week’s blog, we’ll try anyway to identify some. By using the following screening metrics, we’ve come up with a short list of what we think are “buy-and-hold” companies:
   1. The company’s bonds have an S&P credit rating of A- or better.
   2. The company’s stock has an S&P rating of A-/M or better.
   3. The company is an S&P Dividend Achiever with at least 10 yrs of dividend growth.
   4. The company has a positive tangible book value (TBV), as calculated by S&P.
   5. The stock price is less than 7.5 x TBV.
   6. The company’s dividend payout is no more than 50% of earnings (65% for utilities).
   7. The company’s EV/EBITDA is no more than 14.
   8. The company’s stock investors lost less than 60% during the 18-month Lehman Panic.
   9. The company’s Finance Value (Col E in the Table) is better than -40%.

What’s EV/EBITDA? Its a time-proven way to get a better handle on stock valuation than P/E. EV stands for Enterprise Value, which is what a private equity firm would need to pay if it wanted to buy the company, meaning it would assume responsibility for the company’s debts and purchase all outstanding shares of its stock. EV is “neutral” with respect to capital structure: bonds and stocks are treated the same. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, i.e., operating earnings. EBITDA is “neutral” with respect to capital expenditures. They’re not included. Unlike P/E, EV/EBITDA can’t be fudged.

We’ve identified 13 companies (see Table) that meet all 9 requirements; they’re not overpriced. These companies learned to grow by investing retained earnings rather than borrowing more money. When retained earnings proved insufficient, they tended to issue more stock. Their managers and shareholders accepted the fact that they’ll be paying more taxes than if they’d borrowed the money. This means they’ve learned to delay some capital expenditures. In other words, opportunity risk has replaced credit risk. Metrics in the Table that have been highlighted in red to indicate underperformance relative to our benchmark, the Vanguard Balanced Index Fund (VBINX). 

Stepping back for a moment, to reflect on our method for coming up with that list of 13 buy-and-hold stocks, you’ll note that we depend on measurements of past performance. In a history class, “the past is prologue” but not in Corporate America. The character of management personnel is determinative and difficult to measure, which is why we’ve used multiple metrics to steer you away from companies that are addicted to debt. Fortunately, we can sort out that issue objectively. The future prospects of a company’s sub-industry, however, is an even more important issue and it will require a subjective assessment. You’ll have to do that yourself by learning to evaluate the “story” that supports each company’s stock price. That story emerges from the Business Plan and is carefully designed to hold up even if the company’s competitors prove to be more nimble. But it won’t hold up when a technological breakthrough makes the entire sub-industry obsolescent. For example, the energy industry will be transitioning away from “fossil” fuels because those produce greenhouse gases that pollute the air and heat the atmosphere. Caveat Emptor.

Bottom Line: Company research certainly helps an investor make fewer mistakes. But currently most companies are on a downward path. They’re caught up in “mission creep” that is paid for with an ever-increasing use of debt. Until the US tax code stops incentivizing managers to take that path, stock-pickers will have trouble beating broad-based index funds. Why? Because the Wilshire 5000 Index and The Vanguard Total Stock Market Index Fund (VTSMX) include “startups” and small or mid-cap companies that are unable to qualify for a long-term loan with an acceptable interest rate, meaning a rate that is less than the company’s rate of return on assets (ROA).

Remember that the only reason to be a stock-picker is to nail down a stream of retirement income that grows 2-4 times faster than inflation (see Column H in the Table). There are no mutual funds (or other asset classes) that can do that for you. But you’ll get rich faster by sticking to a low-cost, broad-based mutual fund like VTSMX. And, of course, hedge the volatility risk of that investment with a low-cost, corporate/government bond fund like the Vanguard Intermediate-Term Investment-Grade Fund (VFICX). The “B shares” of Berkshire Hathaway (BRK-B) are another low-cost way to access the kind of diversification without reliance on debt that makes sense to us here at ITR.

Risk Rating: 4

Full Disclosure: I dollar-average into WMT and NEE, and also own shares of HRL, ABT, CVX, XOM, and LECO.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, November 9

Week 175 - Gold, Apple and Your Inner Gambler

Situation: Why do many of us keep trying to make money on chancy investments like gold or zippy growth stocks? Because we think we're clever enough to make it work (even though few of us have a degree in finance or a job in financial services). I know you wouldn't be reading this blog if you didn't already know this is not a sound investment strategy but the temptation is still there. It’s the voice of our Inner Gambler. Why is that? Quite simply, we're competitive... all of us. Disposable income allows us to compete, whether in material terms or by positioning our children and grandchildren for success. Status carries with it a propensity to gamble for more status. An investor, however, measures success less by material proof and more by assets under management. An investor is unlikely to put money toward anything where the long-term Return On Invested Capital (ROIC) is unlikely to exceed the Weighted Average Cost of Capital (WACC) by at least 5%/yr. Therefore, long-term investment in life-enhancing events, such as educating one’s children, take top priority.

For today’s blog, we would like to examine how our Inner Gambler works, so as to gain power over it through situational awareness. In order to exist, gambling has to fulfill a need. But gambling differs from other addictions in a profound way: If successful, it enhances self-esteem and allows us to gain respect through the appearance of success and by helping others. In addition, we may be able to afford the trappings of self-importance and use those as a route to impressing other people.

Retirement is serious. And it’s becoming more serious with each passing year (and our government’s trillion-dollar addition to social safety net insolvency). With modern medicine, you may enjoy 40 years of retirement, if you’ve saved enough. The secret of retirement planning lies in distant gratification, not instant gratification. Most gamblers prefer instant gratification and allowing it to overcome their reasoning ability. We all know stressors arise from time to time and demand instant gratification. But we can also learn to “firewall” our key assets, such as the deed to our house, the title to our car, our wedding ring, and our retirement accounts.

Wait, how does one firewall a retirement account? You set up automatic monthly withdrawals from your checking account into your IRA and DRIPs, and divert at least 10% of your salary to your workplace retirement plan. It’s all on automatic pilot and you’d have to go to some trouble to stop those diversions, which would also result in a big tax bill.

More importantly, rules are needed that keep you from getting in a credit crisis: 1) Never buy stock with borrowed money (i.e., buying “on margin”); 2) Backup stock investments 1:1 with Treasuries unless you’re buying a "hedge" stock (see Week 150); 3) Create a budget that dedicates a piece of your monthly income to match each recurring monthly expense.

For this week's Table, we examine the two smartest gambles of the past decade: Apple stock (AAPL) and the iShares gold ETF (GLD). You'll want to know how these stack up against the lowest-cost and best-hedged mutual funds like Vanguard Wellesley Income Fund (VWINX) and Vanguard Balanced Index Fund (VBINX), as well as the lowest-cost S&P 500 Index fund, Vanguard’s 500 Index Fund (VFINX). Red highlights indicate underperformance relative to VBINX. For comparison, we include stocks that prosper in bad times: Wal-Mart Stores (WMT) and Ross Stores (ROST), as well as an intermediate-term US Treasury fund (VFITX) and a long-term US Treasury fund (PRULX). GLD did well during the Great Recession but the two recession-proof stocks did well then and have continued to do well. GLD predictably collapsed in price when the economy started recovering. Treasuries are the “steady Eddies” of finance and really shine during recessions, but fade during recoveries.

Let’s assume that you were clever and bought a lot of AAPL and GLD 10 yrs ago. But were you clever enough to sell GLD 5 yrs ago and buy VFINX just as the stock market was taking off? Or did you wait until the price of gold collapsed two years ago? And, would you have been clever enough to not sell your AAPL shares in 2012 when the price fell 20%, or in 2013 when the price fell 40%? Very few investors who bought GLD and/or AAPL 10 yrs ago would have known “when to hold and when to fold.” And, those few probably wouldn’t have acted. Why? Because that would have meant going against herd behavior. In summary, being clever is about making three smart moves (buy:hold:sell) in a timely manner, not just one, and making those moves regardless of the opinions that others may hold.

Bottom Line: In hindsight, even the best gambles carry too much emotional baggage and volatility to warrant a place in your retirement account. But Apple (AAPL) shares have been a great investment for those who studied the company carefully throughout its ups and downs and refused to sell. The problem: AAPL is so successful that naysayers abound, and they’re not just short-sellers. It is simply human nature to highlight negative factlets about successful people or enterprises.

Risk Rating: 8

Full Disclosure: I've never owned GLD or AAPL shares.


Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, November 2

Week 174 - Lifeboat Stocks for an Overpriced Market

Situation: The S&P 500 Index has been priced at or close to 20 times trailing earnings for several months now. That means equity yield is 5.0%, which is the bottom of its historic range  of 5-10%. However, 10-yr Treasury Notes are only yielding 2.5%. That means the equity premium is 2.5% (5.0% minus 2.5%), suggesting stocks are still a “buy.”

At these lofty valuations, what is prudent stock-buying behavior? I would say this is a time to maintain your current plan, and think about dollar-averaging any additional funds into either the Vanguard Wellesley Income Fund (if you’re a “Risk-Off” investor) or the Vanguard Balanced Index Fund (if you’re a “Risk-On” investor). Those funds are highlighted in the “BENCHMARKS” section of all our Tables. That being said, we know you’ll be tempted to place additional funds in “Lifeboat Stocks” during this uncertain period (see Week 151). But be careful. So many investors are going in that direction that such stocks have become a “crowded trade.”

For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A/M or better. Companies that don’t have a Finance Value (Column E Table) higher than that for VBINX are excluded. So are companies paying a dividend that amounts to more than ~50% of earnings (“payout ratio,” Column I Table), or ~60% in the case of a regulated public utility. 

Only 9 companies survive our screen, as of this date (9/24/14). Wal-Mart Stores (WMT), Johnson & Johnson (JNJ), and PepsiCo (PEP) are household names. CVS Caremark is familiar to many, but few know that it was recently renamed “CVS Health” because the stores stopped selling tobacco products. The JM Smucker Company is associated in the minds of most of us with jelly and jam but is actually the largest purveyor of coffee in the US, both at grocery stores (Folgers, Millstone) and along Main Street (Dunkin’ Donuts). Metrics that reflect underperformance vs. VBINX have been highlighted in red. In particular, note that 7 companies have red highlights in Column K of the Table (P/E). 

Bottom Line: You can still find “Lifeboat Stocks” that are worthwhile investments but it is time to tread lightly. For those stocks, stick to dollar-averaging small amounts of money into an online DRIP each month. Better yet, give Vanguard’s balanced mutual funds like VWINX and VBINX a closer look.

Risk Rating: 4

Full Disclosure: I dollar-average into NEE, ABT, and WMT each month.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, October 26

Week 173 - Why Vanguard?

Situation: Warren Buffett, in his Annual Report to Berkshire Hathaway investors this spring, included a “letter” to his relatives. It recommended that they structure investments in their “trusts” as follows: 90% in the Vanguard index fund dedicated to the S&P 500 Index (VFINX) or the index fund dedicated to the total US stock market (VTSMX), and 10% in the Vanguard managed fund dedicated to short-term US Treasury Notes (VFISX). His main concern was to minimize their investment costs while tracking stock market returns.

Our readers aren’t as rich as his relatives. So, we suggest that you back your stock investments 1:1 with US Treasury Notes & Bonds, other AAA-rated bonds, Savings Bonds, or the Vanguard Intermediate-term Treasury Fund (VFITX). In other words, the most prudent long-term investment balances large-capitalization US stocks with risk-free AAA bonds. And by “long-term”, we mean that you intend to hold your investment for at least 20 yrs in anticipation of using it for retirement purposes. Our benchmark for “Risk-On” investors is the Vanguard Balanced Index Fund (VBINX), which is composed 60% of a capitalization-weighted index of the total US stock market and 40% of an investment-grade US bond index (mainly US Treasuries). For “Risk-Off” investors, our benchmark is Vanguard’s Wellesley Income Fund (VWINX), which is 60% bonds and 40% stocks. “Risk-Off” investors are those who have moved closer to drawing on retirement income and have less investment time available to recover from market fluctuations.

When calculating your 1:1 stock:bond balance, remember to include the present value of your Social Security account, which would be $164,000 if you were to qualify today for a beginning payout of $2000/mo and were to receive monthly payouts for the next 11 yrs, assuming a discount rate of 5.6%. That discount rate is the sum of the “risk-free” rate (2.6% interest on a 10-yr Treasury Note) and “risk” (i.e., inflation, as reflected in a 3.0%/yr estimated annual cost-of-living adjustment). Total payments would amount to almost $305,000 over 11 yrs, with a monthly payment of $2636 in the 11th yr.

We need to draw attention now to the costs that are associated with investment accounts. How important are those costs? Well, the standard rule of thumb for business accountants is to note any cost as being “material” if it represents more than 5% of revenues or earnings. Upon noting said cost, the accountant will delve deeper to determine whether it is justified. Using that guideline, let’s look at the past 100 yrs of returns from owning 10-yr Treasury Notes and reinvesting interest payments vs. owning shares of the S&P 500 Index and re-investing dividend payments. Over that 100 yr period of time, the key facts  are:

        1) Inflation averaged 3.22%/yr;

        2) Total returns on 10-yr Treasury Notes averaged 5.05%/yr (1.83% after inflation);

        3) Total returns on the S&P 500 Index averaged 10.16%/yr (6.94% after inflation);

        4) Total after inflation returns for our recommended 50:50 allocation averaged 4.39%/yr;

        5) Therefore, transaction costs (expenses) become material when the expense ratio reaches 0.22%/yr, which would bring the after inflation total return down to 4.17%/yr; 

        6) The relevant Vanguard funds are VFITX (intermediate-term Treasuries) with an expense ratio of 0.20%/yr, and VFINX (S&P 500 Index) with an expense ratio of 0.17%. Both of those expense ratios are less than 0.22%/yr, so transaction costs are immaterial. 

Vanguard index funds were invented by John Bogle to provide retail investors with market-tracking investments that have immaterial transaction costs. (The only remaining costs are taxes and inflation.) The issue that concerns Mr. Bogle is that the average retail investor has an expense ratio of 2.2%/yr, which is 10 times too much! That is the reason why Warren Buffett thinks so many investors are being disappointed. Half of their after-inflation returns are being eaten up by costs, 90% of which can be eliminated by sticking to Vanguard index funds. 

Treasury Notes don't provide interest payouts that grow faster than inflation, but Vanguard's S&P 500 index fund (VFINX) has grown its dividend payout 4.7%/yr since 1980, which is 1.5%/yr faster than inflation over that 34-yr period. However, those payouts bounce around a lot because ~150 companies don’t pay a dividend. Only about 150 increase their dividend annually. 

Now you have the explanation why the purpose of this blog is to interest you in buying stock monthly (online) in selected companies that have increased their payout for at least 10 yrs at a rate 3-4 times faster than inflation. Some of those companies charge no transaction costs for automatic monthly investments (see Week 162). Examples include NextEra Energy (NEE), Abbott Laboratories (ABT), and ExxonMobil (XOM) for shares purchased through computershare.

Bottom Line: Here at ITR, we stress two things: minimizing transaction costs and maximizing retirement income. For this week’s Table, we’ve used our “Risk-On” benchmark (VBINX) supplemented with Vanguard’s intermediate-term Treasury fund (VFITX) to construct a 50:50 stock:bond fund, i.e., 75% VBINX and 25% VFITX. By having 25% invested in a Treasury bond fund, you’ll have an investment that goes up in value during a recession, and also provide a way to pay for unforeseen emergencies that often crop up during a recession. Alternatively, you can invest in the Vanguard Wellesley Income Fund, or a 50:50 mix of the Vanguard 500 Index Fund (VFINX) and the Vanguard Intermediate-term Treasury Fund (VFITX). All 3 of these options are worry-free and track the markets in a manner that gives you protection from a crash in the stock market. Plus, you don’t have to fiddle with picking stocks and the added complexity they bring to paying taxes.

Risk Rating: 4.

Full Disclosure: I invest monthly in inflation-protected Savings Bonds at and in NEE and ABT.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, October 19

Week 172 - Core Holdings for an Overpriced Market

Situation: The stock market is currently overpriced when assessed by several criteria. Economists, including the Nobel Laureate Robert J. Shiller, are trying to figure out why this is so. As a small investor, all you need to know is that the stocks in your portfolio that have a price/earnings (P/E) ratio higher than 20 are in a danger zone. In other words, your total return from that investment is less than 5% unless earnings improve. On a risk-adjusted basis, you’d do better parking any newly available funds in US Savings Bonds

Even though stocks are overpriced, advantages remain for you to accumulate more for your portfolio. That is because you will receive growing dividends in retirement, however, to purchase more it is best to stick to dollar-cost averaging. Invest a little each month into an online Dividend Reinvestment Plan (DRIP). That way, you automatically smooth out the fluctuations in price. The bigger problem right now is that people prefer to cut back on investments in growth stocks when the market is overpriced. That’s not a good investment strategy, and we explain why below. 

Bonds, and hard assets like gold and real estate, just don’t have the growth horizon that stocks currently have. Trouble will come for stocks from only 3 broad categories:
  1. if interest rates and inflation spike upward (unlikely);
  2. if companies stop growing earnings almost 10%/yr (unlikely);
  3. if economic indicators herald a recession in a major economy (somewhat likely for the EuroZone and China). 
Because stocks remain the asset of choice, they are becoming overpriced. In particular, the buyers of bond-like stocks (i.e., those that have historically had a good total return and increase their dividend ~10% year after year) are crowding out the sellers. Prices for strong and stable “defensive” stocks, like Abbott Laboratories (ABT) and Colgate-Palmolive (CL), drift higher than what their earnings can justify. 

Does this really matter? Yes it does because timid investors see that price action and come off the sidelines to buy stock. Eventually, there’s almost no one left who wants to buy an overpriced stock and the market develops cracks. Buyers will only emerge when prices have fallen far enough for fundamental measures of value to justify the purchase. By that time, a lot of investors are underwater and are selling their Savings Bonds to fund cash-flow emergencies. The important point here is that a bear market can happen when the economy is doing just fine, as we saw on October 19, 1987. The Dow Jones Industrial Average fell 22.6% that day for no apparent reason other than “the big guys were selling their stock” because the market had gone up 44% in the previous 6 months.

For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A-/M or better. (That “M” in the denominator denotes medium risk, whereas, “L” denotes low risk.) To focus on growth companies we’ve excluded companies in the 4 “defensive” industries: healthcare, utilities, communication services, and consumer staples. The remaining 6 S&P industries are where we look for our “Core Holdings” (high-quality growth companies, see Week 102). Those industries represent 66% of the capitalization of the S&P 500 Index. Quite simply, your stock portfolio can’t capture market returns unless 2/3rds of it is in stocks issued by companies in those 6 industries: materials, energy, financial, industrial, consumer discretionary, and information technology. Even though those stocks will scare you when the market swoons, don’t sell unless the company’s “story” is broken. 

Most of the stocks in the Table are fully valued at present, i.e., have elevated P/E ratios (Column J) because investors expect those companies to have strong earnings growth over the next year. You don’t know what the future will bring, so look for companies that don’t have a P/E over 20. Try to spend your research time on the few companies that have hardly any metrics highlighted in red, which denotes underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX). 

Note: Companies that don’t have a Finance Value (Column E in the Table) higher than that for VBINX were excluded, as were companies that pay a dividend that amounts to more than 55% of their earnings (the “payout ratio,” Column I Table). Finally, companies that had a lower Barron’s 500 rank in 2014 than in 2013 were excluded, unless they ranked in the top 2/3rds both years (see Columns L&M Table).
  
Bottom Line: There are still some bargains to be found among growth stocks. The 17 companies in the Table meet our criteria for Core Holdings, but most are overpriced (average P/E = 22). Their investors have already enjoyed a strong run (Column F Table), and many will be looking to take profits. But there are 6 companies on the list that still offer good value relative to risk: ROST, QCOM, CB, IBM, LMT, GPC.

Risk Rating: 6

Full Disclosure: I dollar-average into NKE and IBM.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com