Sunday, May 11

Week 149 - Stock Selection: Start with one for each S&P Industry

Situation: Investing looks like such a cool thing to do. It’s maybe even a way to make money without slacking at our day jobs, that is, by doing the necessary research on Sunday morning over coffee. I started that way 40 years ago, and then found out that the “fun stuff” doesn’t work. In other words, you can’t “guesstimate” where markets are headed. Why? Because the only way to build a base of investing knowledge is to study the past. Unfortunately, as Mark Twain said, “history never repeats itself.” In particular, you can’t estimate which of the 10 S&P industries is going to take the lead over the next few years. Sure, we’re sort of emerging from a recession by fits and starts. Typically, that would mean that the Consumer Discretionary industry would take the lead, followed by the Information Technology and Financial industries. But with the numbers for structural unemployment being up in the teens (when you include people who’ve given up looking for work), where will we get enough consumers to buy all that newly produced stuff? Structural unemployment takes a long time to wind down. Why? Because it is both expensive and time-consuming to retrain displaced workers to do the new types of jobs. It’s easier for companies to simply train workers in foreign countries, like India, where labor costs are lower.

But really, no one knows how the future will play out. Even something as straightforward as interest rates can’t be estimated going forward by examining historical data. In other words, the cost of money you will use to invest isn’t known: Will it go up or will it go down? What this means for the long-term investor is that we need to avoid speculation and simply place small but growing bets on all sectors of the economy. Here at ITR, we suggest that you start by building up positions in key stocks through small automatic monthly investments made online, using Dividend Re-Investment Plans (DRIPs). 

In this week’s Table, we’ve chosen one company for each S&P industry, namely the company that is highest ranking by Finance Value in the Universe of 63 companies that we’ve found to be acceptable for long-term accumulation (see Table for Week 122). If the company chosen for a particular industry doesn’t have a projected rate of return (dividend yield + dividend growth) that exceeds the market rate (6.8%: VFINX), we chose the company with next highest Finance Value. Similarly, if a company’s 5-yr Beta (measuring volatility) is more than 20% higher than the market rate of 1.00, we chose the company with the next highest Finance Value. Remember: each of the companies in the Table for Week 122 has all 3 of the characteristics that we value most highly: 1) Inclusion in the Barron’s 500 Table of companies that show steady growth in cash flow from operations, as well as recent growth in sales; 2) Inclusion in the S&P list of Dividend Achievers--that have grown dividends for 10 or more yrs; 3) a long-term S&P credit rating of “A-” or higher. 

And the winners are:
        Consumer Staples: Wal-Mart Stores (WMT);
        Healthcare: Abbott Laboratories (ABT);
        Utilities: Southern Company (SO);
        Telecommunication Services: AT&T (T);
        Consumer Discretionary: Ross Stores (ROST);
        Information Technology: International Business Machines (IBM);
        Industrial: WW Grainger (GWW);
        Financial: Chubb (CB);
        Materials: Monsanto (MON);
        Energy: Chevron (CVX).

Stock in most of those companies can be purchased online while starting a DRIP. However, to make an initial purchase in CB, ABT, ROST or GWW you’ll need an online broker such as TD Ameritrade or Merrill Edge, where trades cost $6.95, or a local discount broker such as Edward Jones, where a typical trade costs $54.90. Once you have accumulated a few shares, there are various online services like Computershare that allow you to use those shares to start a low-cost DRIP. 

Remember that red highlights in the Table denote underperformance relative to our key benchmark, the Vanguard Balanced Fund (VBINX). For example, AT&T (Line 11 in the Table) has a rate of growth since the market peak on 9/1/00 (Column C) that is approximately the same as the market’s rate (VFINX in Line 24) but somewhat slower than our benchmark’s rate (VBINX in Line 22). 

Bottom Line: Your investments need to be distributed across different sectors of the economy. If you live in the US, you can be well diversified without investing in foreign markets because US corporations are active in markets worldwide. What’s not to like about building a portfolio that reaches into every sector of the economy? Well, people at social gatherings will wander away if you start talking about investments. They’re seeking information about “hot stocks” and will soon realize that you’re an “old-stick-in-the-mud” who cares little about whether the stock market is up or down this month.

Risk Rating: 4.

Full Disclosure of my investing activity relative to stocks in the Table: I dollar-average into DRIPs for WMT, ABT, and IBM each month, and also own stock in Monsanto, Chevron, and Berkshire Hathaway.

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