Week 201 - Barron’s 500 Companies with 16 years of Below-market Variance and Above-market Returns

Situation: You should invest in the lowest-cost S&P 500 Index fund (VFINX) unless your stock picks have a history of doing better while taking on less risk. Why? Because stock-picking takes up a lot of your time and costs more money than buying shares in an index fund. For investing in smaller capitalization stocks or foreign stocks, don’t even consider any option other than low-cost index funds. Those are the rules so what are the exceptions? There’s really only one, and that is to pick from large capitalization stocks have a history of granting annual dividend increases that more than compensate for inflation. The trick is to find a low-cost dividend reinvestment plan (DRIP) to dollar-average your monthly purchases. After you retire, have those dividends sent to your mailbox and enjoy the one source of retirement income that grows faster than inflation.

Mission: Identify large-capitalization stocks that have below-market variance and above-market returns while paying a dividend that grows more than twice as fast as inflation.

Execution: In our Week 193 and Week 199 blogs, we have presented a system for assessing price variance at multiple points over 25 yrs. The BMW Method provides monthly updates of 16-yr, 20-yr, 25-yr, 30-yr, 35-yr and 40-yr variance, which are “least squares” calculations based on the logarithm of weekly prices for over 500 stocks (fewer at 30, 35 and 40yr intervals). The graphs give a trendline (CAGR at Column S in the Table) with adjacent lines at one and two Standard Deviations from the trendline. The spread between the base trendline and the -2SD trendline is the percent loss you can expect once every 20 yrs (see Column U in the Table). In constructing the Table, a stock that follows a track one Standard Deviation away from the S&P 500 Index (^GSPC) over recent months is at variance with ^GSPC and has therefore been excluded (see Column T in the Table). To further assess variance exceeding that for the S&P 500 Index, we look at Total Return during the Lehman Panic (see Column D in the Table), and at the 5-yr Beta (see Column I in the Table). S&P ratings are used to exclude companies that issue bonds with a rating lower than BBB+ and stocks with a rating lower than B+/M.

Using this information, we’ve come up with 14 companies, all but one of which is a Dividend Achiever (see Column R in the Table). You’ll remember that "Dividend Achiever" is S&P’s term for a company that increases its dividend annually for at least the past 10 yrs. That one exception on our list is Campbell Soup (CPB), and S&P will soon designate it a Dividend Achiever. Several columns in the Table point to the outperformance of these 14 stocks, as well as documenting less volatility than the S&P 500 Index. What is their key to success? Column L (estimated 5-yr earnings growth/yr) offers the key: 3/4ths of these companies are expected to grow earnings slower than the average company in the S&P 500 Index. By itself, that speaks volumes about why these companies outperform with less risk. Their earnings growth is relentless, with only minor hiccoughs. When earnings balk, a stock’s price will usually fall and it may take years to recover (certainly many months). IBM is a case in point. It recently sold off a couple of slow-growth divisions and re-tasked a couple of others, taking an earnings hit. The stock price fell 20% as soon as these moves were announced, and it has stayed at that level for more than 6 months. Is the company worse off or better off as a result of those structural adjustments? Warren Buffett decided that it is better off and bought more shares of IBM for Berkshire Hathaway.

Bottom Line: Companies that rarely disappoint on earnings enjoy steady growth in their stock price. Mature companies with stable earnings growth can outperform the S&P 500 Index, even with earnings growth that is predictably less than for the average S&P 500 company. We’ve only found 14 companies that have better growth with less risk, but those “diamonds in the rough” are worth close examination as prospective investments for your retirement portfolio.

Risk Rating: 4

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

NOTE: Metrics in the Table that underperform our key benchmark (VBINX) are highlighted in red. All metrics are brought current for the Sunday of publication.

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