Sunday, June 28

Week 208 - Stockpickers Secret Fishing Hole: Dividend Achievers with Improving Fundamentals

Situation: The 65-stock Dow Jones Composite Average (DJCA) typically outperforms the S&P 500 Index by about 1%/yr. It is composed of 30 Blue Chips, 20 Transports and 15 Utilities picked by the Managing Editor of the Wall Street Journal. The DJCA is a haven for "value" investors because the companies are long-standing members of mature industries and typically have predictable earnings. We call it the Stockpickers Secret Fishing Hole because total returns over 20 yrs are 1% greater than for the S&P 500 Index while bear market losses are 5% lower (see Table). Of the 65 companies, 29 are S&P Dividend Achievers (i.e., companies that have raised their dividend annually for at least the past 10 yrs, see Week 205). Now that the 2015 Barron’s 500 List has come out, we can check on Dividend Achievers and see which have improved their operations over the last 3 yrs.

Mission: Review the 2015 Barron's 500 List of the largest companies on the New York and Toronto stock exchanges to determine which of the 29 Dividend Achievers have moved up in rank compared to 2014. 

Execution: Barron’s uses 3 equally-weighted metrics to determine a company’s rank:   
   1) median 3-yr return on investment (ROIC),
   2) the most recent year’s ROIC relative to the 3-yr median, and
   3) revenue growth for the most recent fiscal year.
Each company’s 2015 rank is compared to its 2014 rank, and the highest rank is given a “1.” All 29 Dividend Achievers have high enough revenues to be included in the 2015 Barron’s 500 List. However, only 9 have a higher rank than in 2014 and only 5 of those have an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher (see Table). One is a Blue Chip, Nike (NKE), meaning it is in the Dow Jones Industrial Average. Two companies are in the Dow Jones Utility Average, namely, Southern Company (SO) and NextEra Energy (NEE). Two companies are in the Dow Jones Transportation Average: Norfolk Southern Railroad (NSC) and Expeditors International of Washington (EXPD). 

Bottom Line: We occasionally revisit the Stockpickers Secret Fishing Hole to see if there’s a stock worth catching. Currently there are 5 but only two of those (NKE and NEE) look like “better bets” than the bond-hedged S&P 500 Index, i.e., the Vanguard Balanced Index Fund (VBINX).

Risk Rating: 5

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

NOTE: metrics highlighted in red indicate underperformance vs. VBINX. Metrics 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, June 21

Week 207 - Starter Stocks

Situation: The stock market is pricey and the bond market is becoming less pricey. This suggests that stock prices are going to plateau for a while because bonds will be paying higher interest. Dividends will no longer be the best way for you to get an income from your investments.

Mission: Find stocks that are suitable for a newcomer to stock-picking. 

Execution: We can’t change our stripes, so we’ll fall back on the two most important considerations for a newcomer to stock-picking: (1) start with large companies and (2) confine your attention to those that are Dividend Achievers, which is S&P’s name for companies with 10 or more yrs of annual dividend increases. Risky stocks need to be excluded from the newcomer’s portfolio, so we eliminate any companies that either have a S&P bond rating lower than A- or an S&P stock rating lower than A+/M (see the Table). And, we exclude companies with a 3-yr history of declining operational metrics according to research done to produce the annual Barron’s 500 List with one exception. Any company that ranked in the top 250 on both the 2015 and 2014 lists is acceptable. Metrics from the BMW Method are also used to exclude companies with price trends that don’t track the market and companies that are predicted to lose 40% or more in the next Bear Market. Companies that lost more than the hedged S&P 500 Index (i.e., Vanguard’s Balanced Index Fund, VBINX) during the 18-month Lehman Panic are also excluded, as are companies in the most cyclical industries: Energy, Basic Materials, Finance, and Information Technology.

Bottom Line: We were able to come up with only 4 “starter stocks”: Nike (NKE), NextEra Energy (NEE), Johnson & Johnson (JNJ) and PepsiCo (PEP). You would need to dollar-average equal amounts of money into each stock every month online to achieve the best gain during bull markets and the least loss during bear markets. In other words, diversify your bets and make small bets often rather than big bets occasionally.

Risk Rating: 4

Full Disclosure: I dollar-average into all 4 of these stocks.

NOTE: metrics highlighted in red indicate underperformance vs. our key benchmark, which is the Vanguard Balanced Index Fund (VBINX). Metrics are brought current for the Sunday of publication.

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

Sunday, June 14

Week 206 - Low-risk S&P 500 Stocks that Beat the S&P 500 Index Over 10, 16 and 20 Yrs

Situation: One of our recurring themes in this blog is that index investing is a more rational and efficient way to save for retirement than stock-picking. But many of you will want to pick dividend-growing stocks that have a good chance of providing you with retirement income that will grow 2-3 times faster than inflation vs. balanced index funds that barely keep up with inflation. If you’re going to try the stock-picking option, you should pick stocks that are likely to have total returns as good as the lowest-cost S&P 500 Index fund (VFINX) after adjusting for cost and risk. We call such hard-to-find stocks “unicorns.” 

Mission: Develop a formal plan for identifying unicorns.

Execution: The goal is to bracket your stock choices between two limiting conditions:
 (1) performance that is at least as good as the S&P 500 Index (^GSPC);  and 
 (2) price variance that is no worse than ^GSPC. 
Criteria are applied over the following periods: 0-20 yrs, 0-16 yrs, 0-10 yrs, Lehman Panic (10/07-4/09), 0-5 yrs and 0-3 yrs. Stock performance is assessed after 10, 16 and 20 yrs. Stock variance is assessed at all 6 periods.  

0-20 years (Columns M & N in the Table)
        Tool: BMW Method 20-yr data (see Week 199). We screen the ticker list for stocks with CAGRs that are as good or better than the CAGR for ^GSPC, located after “Z” in the alphabetical ticker list. GAGR = 3.1%/yr at this writing. This multi-input CAGR is a “rolling” least-squares logarithmic calculation of trendline growth based on hundreds of weekly prices over the past 20 yrs and refreshed weekly. Note that in the upper left corner RF=0.66, which means there is a 34% drop in price at -2 Standard Deviations (-2SD) below the trendline. That is the extent of loss predicted to occur within 19-20 yrs. To summarize, we’re looking for stocks with a trendline rate equal to or greater than 3.1%/yr and an RF value equal to or higher than 0.66 (i.e., predicting a loss at -2SD of 34% or less).

0-16 years (Columns O & P in the Table)
        Tool: BMW Method employed as above but for 16-yr data. ^GSPC trendline growth at this writing is 2.0%/yr and RF is 0.68 (i.e., a loss at -2SD of 32%).

0-10 years (Column C in the Table)
        Tool: total return for a single stock purchase made 10 yrs ago, arrived at by consulting the Buyupside website. Because dividend payments are added to the 10-yr CAGR to arrive at total return, we input the Vanguard 500 Index Fund ticker (VFINX) instead of ^GSPC to arrive at baseline total return. Any stock that has a lower total return than VFINX is rejected. Variance is assessed from 18-month Lehman Panic losses (see Column D in the Table). 

Lehman Panic
        Tool: We use the same Buyupside website, inputting a Start Date of 10/1/2007 and an End Date of 3/31/2009 for each stock that has passed the above tests. Note that the total return listed in Column D (usually a loss) is for the entire 18-month period. Our baseline, VFINX, had a -46.5% total return over that 18-month period. We reject any stock with a greater loss because its price variance exceeds that for VFINX.

0-5 years (Column I in the Table)
        Tool: 5-yr Beta. Reject any stock with a 5-yr Beta higher than 0.9 because a higher value is too close to 1.00, which denotes price variance (reset daily) for ^GSPC over the past 5 yrs.

0-3 years
        Tool: We use recent BMW Method prices to assess a stock’s price performance relative to the track followed by ^GSPC prices. In other words, both tracks have to be similar. We exclude stocks that deviate more than 1SD from the track being followed by ^GSPC over the past 3 yrs because that indicates variance (deviation from market behavior). For example, in the 16-yr ^GSPC chart you see that prices since the end of 2012 have risen to almost 2SD above the long-term trendline. Any stock that is still tracking its long-term trendline has to be excluded because its price variance is too far removed from market behavior. Remember, traders expect a rising market to “lift all boats.”

Bottom Line: We’ve set up performance windows at 6 time periods over the past 20 yrs to find stocks that outperform the market while incurring less risk of loss. Only 5 S&P 500 stocks met all of our criteria (see Table). All 5 are in one of the 4 “defensive” S&P industries, those being Consumer Staples, Utilities, Healthcare and Communication Services. Past behavior does not predict future performance: At some point in the future, all 5 of these “unicorns” will move outside one or more of the limiting conditions that we’ve set up. If this method appeals to you, remember to periodically reassess your picks. And remember to consider costs. Our baseline stock index fund (VFINX) has an expense ratio of only 0.22%/yr. You can’t do worse than the market by putting your money there. The average investor who picks stocks has an expense ratio of 2.2%/yr, which is 10 times higher than VFINX. That investor’s expenditures on transaction costs, fees, and investment advice are therefore a material consideration. Even if you hold transaction costs and other expenses of stock-picking to only 1%/yr, total return has to exceed 20%/yr before transaction costs become immaterial in the eyes of an accountant. 

Risk Rating: 4

Full Disclosure: I own shares of GIS and PEP.

NOTE: metrics are brought current for the Sunday of publication; metrics highlighted in red denote underperformance relative to our key benchmark (VBINX, at Line 18 in the Table).

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

Sunday, June 7

Week 205 - Barron’s 500 Dividend Achievers with Improving Fundamentals

Situation: We recommend Vanguard Group mutual funds for retirement investing. Specifically, their S&P 500 index fund (VFINX) hedged 50:50 with their investment-grade intermediate-term bond index fund (VBIIX). That investment has paid ~7.7%/yr over the past 20 yrs (5.4%/yr after correcting for inflation of 2.3%/yr). Similar index funds are among the options available in almost any 401(k) plan. Why are Index funds better than “managed” funds? Because they can’t zig when the economy zags. However, Vanguard Group also markets managed funds that have performed well. One such fund that we like is Vanguard Wellesley Income Fund (VWINX) which is 55% bonds, 45% stocks, and handily beat a group of above-average hedge funds during the Lehman Panic. It has returned 8.4%/yr over the past 20 yrs. The benchmark we like to use is the Vanguard Balanced Index Fund (VBINX) which is 60% stocks, 40% bonds, and has returned ~8.2%/yr over the past 20 yrs. There’s just one problem: After you retire, these 3 choices for your retirement years don’t produce a lot of income from dividends and interest. You’ll be lucky if those quarterly payments keep up with inflation. In other words, you’ll have to sell shares periodically to maintain your spending power. That is bound to make you wonder whether or not you’ll outlive your nest egg.

Mission: Come up with a list of companies that have improving fundamentals and a 10+ yr history of increasing their dividend annually (companies that S&P labels Dividend Achievers, see Week 168). We’re looking for well-run companies that have grown their dividend more than twice as fast as inflation over the past 20 yrs, meaning 5%/yr or better.

Execution: To find companies with improving fundamentals, we depend on the Barron’s 500 List, published each year in May. In a now-standard fashion, the 2015 list gives a letter grade to the 500 largest companies in the US and Canada by using 3 equally-weighted metrics:
   1) median 3-yr return on investment (ROIC),
   2) the most recent year’s ROIC relative to the 3-yr median, and
   3) revenue growth for the most recent fiscal year.
Each company’s 2015 rank is compared to its 2014 rank, and the highest rank is given a “1.” 

To find companies that have grown their dividend annually for at least the past 10 yrs, we refer to the holdings of PFM, which is an Exchange-Traded Fund that invests in every company on Standard & Poor’s list of Dividend Achievers.

To construct this week’s Table, we combine the two lists. Any company with a 2015 Barron’s 500 rank that is higher than its 2014 Barron’s 500 rank we consider to have “improving fundamentals.” If such a company is also a Dividend Achiever, it will appear in our Table, with certain notable exceptions. A company is excluded if its S&P bond rating is lower than BBB+ or its S&P stock rating is lower than B+/M. A company that has a 20-yr dividend growth rate less than 5%/yr is excluded. Companies with fewer than 20 yrs of being listed on either the New York or Toronto stock exchange are excluded.

Additional data is provided in Columns K and L of the Table referencing the BMW Method (see Week 199), where Standard Deviations of trendline price appreciation over the past 20 yrs are listed, as well as the extent of loss that would be incurred if prices fell by 2 Standard Deviations. 

Bottom Line: We’ve found 20 Dividend Achievers that have exhibited improving fundamentals over the past 3 yrs (see Table), as assessed by three metrics used to assemble the 2015 Barron’s 500 List. Their average dividend growth rate over the past 20 yrs beats inflation by ~10%/yr (see Column H in the Table). The top 9 companies in the Table outperformed our key benchmark, the Vanguard Balanced Index Fund (VBINX). VBINX is a version of the S&P 500 Index that is hedged 40% with investment-grade bonds. There is an online Dividend Reinvestment Plan (DRIP) or Direct Purchase Plan (DPP) available for all 9 of those stocks (see Column O of the Table), available either through computershare or Wells Fargo

Risk Rating: 4

Full Disclosure: I dollar-average into NKE and NEE, and also own shares of ITW, PEP, BDX, and INTC.

NOTE: metrics are brought current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark VBINX at Line 29 in the Table.

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