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.

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