Sunday, February 2

Week 135 - There are 42 Companies in the S&P 500 Index with a Durable Competitive Advantage

Situation: This blog is dedicated to the idea that the best way to save for retirement is to invest in stocks of companies that have a long history of increasing their dividend ~10%/yr. That places us in the “value” camp, which carries with it a need to minimize transaction costs. We recommend that you purchase stocks online, dollar-averaging into a dividend reinvestment plan (DRIP). But let’s not forget the “growth” camp, where the idea is to avoid owning stock in companies that make significant dividend payouts. Why? Because that is a waste of free cash flow and represents double taxation (company + shareholder). So, we periodically put out a blog like this week's that screens for companies likely to have sustainable growth. Few such companies pay a good dividend and most have a 5-yr Beta in the red zone, but some are appropriate retirement vehicles.

We use Warren Buffett’s approach (see Week 94 and Week 59), which is to find companies that have grown their Tangible Book Value steadily over the past 10 yrs (with no more than 2 down yrs). If that growth meets the "business case" of doubling the initial investment inside of 10 yrs (i.e., a total return of +7.2%/yr), the company is said to have a Durable Competitive Advantage (DCA). Then, we calculate the compound annual growth rate (CAGR) for "core earnings” over the past 8-10 yrs and extrapolate that line to give an estimate of earnings 10 yrs from now. Over that future decade, we then assume that a) the P/E remains stuck at the lowest level seen in the past 10 yrs and b) the company is unable to raise its dividend (if it pays one). Juggling those numbers gives a conservative estimate for the stock’s price 10 yrs from now. Comparing that to today’s stock price gives a projected total return/yr, termed the Buffett Buy Analysis (BBA). Those 3 metrics (DCA, CAGR, and BBA) are in columns F, G, and H of the Table. You’ll notice that there are no values under 7.2%/yr. All of the companies are creditworthy, i.e., have investment-grade bond ratings or get less than 1% of their total capitalization from long-term bonds.

Many of the companies (i.e., 15) are linked to the extraction of raw commodities, and we’ve broken those out as a separate category at the bottom of the Table. Red highlights denote metrics that underperform our key benchmark for a retirement savings plan--the Vanguard Balanced Index Fund (VBINX). Red highlights are also used to warn you away from the 10 stocks that Standard & Poor’s considers to be high risk (Column I in the Table). Long-term total returns in Column C date to 9/30/02, which is when the stock market bottomed in the “ recession.”

It is remarkable that we can still identify 42 companies with a DCA, the same number found the last time we did this exercise (see Week 94). Why? Because when the stock market is overpriced like it is now (in anticipation of higher earnings "just around the corner"), the price we project 10 yrs from now often isn’t that much greater than the current price, i.e., the total return/yr (BBA) will be less than 7.2%/yr. Note that some stocks appear in all 3 of our DCA blogs: AAPL, QCOM, FAST, CERN, FLIR, TROW, EXPD, COH, ROST, XOM, HP, DO, CAM and NOV

Bottom Line: If stocks excite you enough to take away all fear of market crashes, then our  3 DCA blogs will be your favorites. Invest heartily and prosper. But hold "growth" stocks in a different account from your retirement savings, except for those that also appear in our "universe" of 55 companies geared to retirement plans (see Week 122). This week's Table has 8 such companies: MON, PX, CVX, XOM, WMT, ROST, SYK, MSFT. Three companies are notable in meeting high criteria for overall investment value, i.e., Long-term Finance Value (Column E), recent acceleration in growth of sales and cash flow (Column J vs. Column K), and an S&P stock rating of A- or better (Column I): Monsanto (MON), Ross Stores (ROST), and Baxter International (BAX). 

Risk Rating: 7

Full Disclosure: I have stock in WMT, CVX, XOM, ACN, MON, and MSFT.

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