Sunday, May 29

Week 256 - Barron's 500 Growth Stocks That Have Outperformed the S&P 500 for 16 Years

Situation: You need a menu that limits your choices when looking for “buy-and-hold” growth stocks in the S&P 500 Index. This is the second blog in a 3-week series for building that menu. Part #1 (see Week 255) looked at S&P 500 stocks that do not have sufficient revenues for inclusion in the recently published 2016 Barron’s 500 List. Those are the largest US and Canadian companies by revenue. It is a valuable resource, which ranks companies by their 3-yr growth in sales and cash-flow based ROIC. This week we introduce a menu of larger S&P 500 growth companies found in the 2016 Barron’s 500 List. Next week, we’ll cover S&P 500 “defensive” companies. 

Mission: All 3 blogs use the same screening tools, starting with a requirement that companies be Dividend Achievers. From those company’s stocks, we select the ones that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks are up more and down less: 16-yr total returns/yr were greater and losses in the last market correction (April through September of 2011) were less. In addition, all companies must be of high quality, with an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher.

Execution: We have assembled a number of metrics for each company that you’ve seen before (see Table). In addition, we calculate the Net Present Value (NPV) for each company by using a standard flow chart. The NPV calculation has been explained briefly in last week’s blog (see Week 255). A detailed description of inputs to that flowchart, and the rationale for those inputs, is explained in the Appendix below. 

Bottom Line: We have screened for S&P 500 growth stocks that have been up more and down less than the S&P 500 Index over the past 16 yrs. The only companies that have been examined are a) Dividend Achievers, b) on the just-published 2016 Barron’s 500 List, and c) have high S&P bond & stock ratings. Net Present Value (NPV) calculations are for stock prices on May 28, 2016. We find that 17 companies meet our criteria (see Table). As a group, their stocks have no greater risk of loss than the S&P 500 Index by even the most severe statistical test per the BMW Method, found at Column P in the Table. Four of the companies offer outstanding long-term value to investors, in that they have NPVs higher than the average for the group, have improving fundamentals according to assessments by the Barron’s 500 editors, and have a Return on Invested Capital (ROIC) that exceeds their Weighted Average Cost of Capital (WACC) as indicated in Columns Z and AA of the Table. Note that 8 of the 17 appear overpriced in that EV/EBITDA is higher than the S&P 500 multiple of 12 (see Column K in the Table).

Risk Rating = 6 (Treasuries = 1 and gold = 10).

Full Disclosure: I dollar-average into NKE, MSFT and XOM, and own TJX, ROST and MCD shares.

NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 23 in the Table). Metrics highlighted in green at Columns Q and R in the Table indicate improving performance trends for fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC. Aside from NPV calculations, metrics are current for the Sunday of publication. 

APPENDIX: Inputs to NPV Calculator:

Discount Rate = 9.0%. Why? Because that is the expected rate of return going forward using the reference index of our choice, the S&P MidCap 400 Index. This index fund has a dividend yield of ~1.5% and a 16-yr price CAGR of ~7.5% (1.5% + 7.5% = 9.0%). Standard practice is to select a Discount Rate that has comparable risk and reward features to the asset class being examined, which in our case are individual stocks in the S&P 500 Index. Therefore, our NPV calculation would yield an NPV of zero if the stock in question merely had a projected return of 9.0%/yr to the investor over the Life of the Project (10 years). A positive number for NPV is necessary to justify investment in a particular stock as opposed to simply choosing to invest in the reference index. 
Initial Cost is the price for ~$5,000 worth of an even number of shares, plus 2.5% in transaction costs. That means $5,128.21 becomes the Initial Cost for XX number of shares priced at exactly $5,000.00. $5,128.21 is entered in the flowchart with a minus sign in front of it. Why? Because the Present Value of Expected Cash Flows is the output of the flow chart, which represents cash received minus cash paid. 
Life of the Project is 10 years. So, the shares purchased at an Initial Cost of $5128.21 are sold in the 10th year for XX amount minus a 2.5% penalty for transaction costs. 
Cash Flow 1 is the annual dividend multiplied by the number of shares purchased. 
Cash Flow 2 is that amount multiplied by the rate of dividend growth over the past 16 yrs (Column H in the Table). For example, a dividend yield of 1% for a stock selling at $100.00 is $1.00; multiplying that by 40 shares gives Cash Flow 1 of $40.00. If the 16-yr Dividend Growth is 10.0%/yr, Cash Flow 2 is 1.1 times $40.00 = $44.00. 
Cash Flows 3-9 are handled the same way to generate estimated dividend payments. 
Cash Flow 10 is the sum of the estimated dividend payment for Year 10 plus the selling price for the shares originally purchased. That price is determined by using the 16-yr price CAGR for that stock in Column N in the Table, to project the original price 10 yrs ahead per the BMW Method. That price return is then decreased by 2.5% to account for transaction costs. Upon clicking Calculate, you arrive at the PV of Expected Cash Flows and NPV which is the PV of Expected Cash Flows left after subtracting 9.0%/yr for the Discount Rate.

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Sunday, May 22

Week 255 - “Buy and Hold” Mid Cap Dividend Achievers

Situation: Over long periods, Mid-Capitalization companies tend to outperform Large Capitalization companies. Mid Caps often have a more focused business plan and use less credit. Overshadowing these advantages, both the weighted average cost of capital (WACC) and the risk of bankruptcy are higher for Mid Caps. In addition, there are fewer product lines to offset poor performance, thus making these companies more difficult to analyze. Our favorite tool for following fundamental performance metrics, the Barron’s 500 List, doesn’t help us analyze Mid Caps because those don’t have sufficient revenue for inclusion. But the larger and more stable Mid Caps are easy to identify, since they’re S&P 500 companies that have been excluded from the Barron’s 500 List (a list that includes both Canadian and US companies). Mid Caps traditionally have a market capitalization of $2-10 Billion, whereas, the smaller S&P 500 companies that we reference have a market capitalization of $3-20 Billion. So, we’re stretching the Mid Cap definition.  

Mission: Help investors decide which of these smaller S&P 500 companies are “Buy-and-Hold” candidates. We’ll exclude companies that haven’t outperformed the Vanguard 500 Index Fund (VFINX) over the past 16 yrs, haven’t increased their dividend annually for 10+ yrs to become Dividend Achievers, and/or haven’t obtained an S&P bond rating of at least BBB+ and an S&P stock rating of at least B+/M.

Execution: We’ll calculate the Net Present Value (NPV) of buying stock and holding it for 10 yrs. The tricky part of that calculation is picking the discount rate. We’ll use 9.0% because that is the sum of the CAGR for the S&P 400 Mid Cap Index at 7.6%/yr (see Column N at Line 22 in the Table), and the S&P 400 Mid Cap Index ETF dividend yield at 1.4% (MDY at Line 18 in the Table). The 16-yr dividend growth rate (Column H in the Table) and the 16-yr CAGR for price appreciation (Column N in the Table) are used to complete the NPV calculation on each stock. Transaction costs are 2.5% upon buying the stock and 2.5% upon selling the stock. Dividends are not re-invested.

The discount rate is supposed to be a “hurdle” rate for an investment under consideration. In other words, there needs to be a comparable investment “opportunity” with a readily determined growth rate that we’re trying to beat. That rate is then discounted or subtracted from the rate of growth of the investment under consideration. If we did beat it, the NPV is a positive number. 

Bottom Line: We have found 8 Mid Cap Dividend Achievers in the S&P 500 Index. All 8 have positive Net Present Values (see Column W in the Table). NPV is important because it represents the profit you can expect (before subtracting inflation and taxes) over and above the rate at which your money would likely have grown were you to make the comparable “reference” investment. For these 8 stocks, we chose as our reference investment the Vanguard 400 MidCap Index ETF (MDY), currently growing at 9.0%/yr (the discount rate).

We have identified an interesting slice of the stock market, one where the reward/risk ratio is skewed in the direction of reward.

Risk Rating = 6 (where 1 = Treasuries and 10 = gold).

Full Disclosure: I own shares of MKC.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red reflect underperformance vs. VBINX, the Vanguard Balanced Index Fund.

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Sunday, May 15

Week 254 - Cattle (Bos taurus) vs. Row Crops as a Protein Source

Situation: The total mass of humans on earth recently passed 1.0 Trillion pounds. That seems like a lot until you consider that the total mass of cattle recently passed 1.8 Trillion pounds. On average, one member of Bos taurus helps to nourish and allay the hunger of 6 Homo sapiens. Then further consider this information about processing that animal for meat: 

“...carcasses are generally 63 to 65% of the 1,250 pounds, or approximately 790 pounds. Some of that carcass is fat that is not consumed, and some is bone (15% or so). Therefore, edible meat cuts and ground beef may be 600 pounds. So, with the example above of 50 bushels of corn fed to a finished animal, now 4.67 pounds of corn were required for each 1 pound of beef...” 

While the world population has been increasing at the rate of 1%/yr for the past two decades, the number of people living in poverty has been falling by almost 20 million per year over that period, and is now less than 900 Million. Now that they can afford it, what is the best way to achieve an adequate protein intake for the 20 Million people coming out of poverty each year? Nutritionists have determined that a “Dietary Reference Intake” of 0.8 grams of protein per kilogram of body weight (i.e., 0.36 grams per pound) is needed. This results in a need for 60 grams of protein per day for a sedentary man/woman weighing 165 pounds. 

Mission: Determine the most efficient way to achieve a 60 gm/d protein intake without neglecting essential amino acids, lipids, vitamins and vitamin-like substances. 

Execution: That mission can be accomplished by eating a 0.6 pound hamburger per day at an estimated cost of $3.00/d at the average US supermarket. That’s too expensive for people living an emerging market economy like China, where in October, 2015, the World Bank updated the International Poverty Line to $1.90/d. 

Returning to our earlier example of beef cattle, a steer weighing 1250 lbs has 600 lbs of muscle available for making hamburger that is 85% lean meat and 15% fat. Each pound (16 oz) has ~100 grams of protein and costs ~$5.00 (31 cents/oz). For comparison, a liter of whole milk (34 oz) has 34 grams of protein and costs ~$3.40 (10 cents/oz). A liter of lactose-free milk (Fairlife brand) has 54 grams of protein and costs ~$3.70 (11 cents/oz). A pound of white corn has 44 grams of protein and costs ~$2.50/lb (16 cents/oz). A pound of soybeans has 50 grams of protein and costs ~$3.20/lb when purchased in 10-pound containers (20 cents/oz). A pound of peas has 26 grams of protein and costs ~$0.66/lb when purchased in 20-pound containers (4 cents/oz). A pound of long-grain white rice has 12 grams of protein and costs ~$0.45/lb when purchased in 20-pound containers (3 cents/oz). A pound of whole wheat bread has 58 grams of protein and costs ~$1.95/lb (12 cents/oz). 

Cost per gram of protein
Beefsteak                               $0.130 
Whole milk                              $0.100
FairLife lactose-free milk           $0.069
Soybeans                                $0.064
White corn                               $0.057
Hamburger (85% lean)             $0.050
Long-grain white rice                $0.038
Whole wheat bread                   $0.034
Peas                                        $0.025

As you can see, beefsteak is the most expensive way to meet the 60gm/d protein requirement (13 cents/gm). Whole milk is next most expensive at 10 cents/gm. But when lactose is filtered out of milk (and the remaining constituents are reconstituted), there are 13 grams of protein in a 240 ml serving vs. 8 grams in 240 ml of whole milk. That lactose-free product is marketed by Coca-Cola under the “Fairlife” brand and costs ~10% more than whole milk. 

As the sole source of a 60gm/d protein intake, Fairlife costs $3.87/d, 85% lean hamburger costs $3.00/d, whole wheat bread costs $2.07/d, and peas cost $1.52/d. An adult male living at the poverty line ($1.90/d) could be adequately nourished with peas and have 38 cents left for needs like clothing and shelter. 

Wheat protein (gluten) and rice protein are among is the least expensive sources of protein. However, both are deficient in one of the essential amino acids. Pea protein is the least expensive source and contains sufficient amounts of all 9 essential amino acids. Milk protein (casein) is deficient in the essential amino acid histidine but histidine is only essential for infants. Corn protein (zein) is deficient in another essential amino acid (threonine). Hamburger, milk, peas and soybeans have all 8 of the amino acids that are essential for adult humans. But only hamburger and milk contain adequate amounts of all of the essential amino acids, vitamins and minerals, and other vitamin-like molecules (carnosine, docosahexaenoic acid, and creatine). Plants lack Vitamin D (except for mushrooms and lichens), Vitamin B12, creatine, carnosine, and docosahexaenoic acid (except for algae and seaweed sources). 

In summary, a balanced diet requires that we consume milk and/or meat daily in addition to vegetables, fruit, and cereal grains. Milk and/or meat can be eliminated from the diet only by taking a multivitamin supplement each day that includes Vitamin D, Vitamin B12, creatine, docosahexaenoic acid, and carnosine. A vegetarian also would need to consume peas and/or soybeans every day to ensure that adequate amounts of all 8 essential amino acids have been consumed.

Administration: Create a spreadsheet of publicly-traded companies that package beef and dairy products for sale in grocery stores, and companies that package row crops for sale in grocery stores (see Table). Include only those companies that have a) stock traded for at least 16 yrs, and b) annual revenues sufficient for inclusion in the Barron’s 500 List.

Bottom Line: When it comes to meeting protein requirements in a cost-effective way, companies that package and sell beef and milk products should be at a disadvantage compared to companies that package and sell row crops. Why? Because using row crops as animal feed to produce meat or milk is inefficient. For example, 5 pounds of corn are needed to produce a pound of hamburger meat, given that a 600 lb steer is taken to a “finishing lot” and fed ~2500 pounds of corn over 170 days to gain the 600 lbs of weight needed to be ready for slaughter. However, vegetarians must supplement their diets with vitamin B12, vitamin D, carnosine, docosahexaenoic acid (DHA) and creatine. Once the cost of those supplements is considerable, a vegetarian’s diet has only a minor cost advantage over a diet that includes meat and dairy products. The trend is away from vegetarianism. Since 2002, ~20 Million people a year have emerged from poverty and the demand for meat and dairy products has grown dramatically. This is evident from the 5-year total returns/yr for the 3 meat-packing companies in this week’s Table (see Column F): Hormel Foods (HRL), Tyson Foods (TSN), and Pilgrim’s Pride (PPC). 

Risk Rating is 7 on a scale where 1 is a 10-yr US Treasury Note and 10 is gold.

Full Disclosure: I own stock in GIS, HRL, KO, and PEP.

NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance relative to the Vanguard Balanced Index Fund (VBINX at Line 18 in the Table). Long-term total returns in Column C of the Table date to 9/1/2000, which is our reference peak for the S&P 500 Index (1520.77). There have been two peaks since then: October 9, 2007 (1565.15) and May 21, 2015 (2130.82).

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Sunday, May 8

Week 253 - Gold

Situation: For many of us, our concept of personal financial security meshes with our concept of personal safety. Recent TV commercials highlighting the benefits of owning gold are a case in point. The idea is that an investor may not need to worry so much about government debt, and its effect on inflation, if his or her retirement plan includes a “Gold IRA.” Given that the IRS classifies gold as a “collectible” (because it doesn’t pay interest and can’t be rented), its dollar value is defined by the eagerness of prospective owners, i.e., gold’s value increases only if there are more buyers than sellers. The main reason to buy into a “crowded trade” is to hedge against the likelihood of a future event that would negatively affect the buyer’s personal financial security.  

One possible event is that the US government’s debt per capita would increase to the point of “currency debasement.” The more people become concerned about that possibility, the more valuable gold becomes. The fact that the US government’s debt per capita has been falling since the Great Recession doesn't remove this concern. Why? Because the US government is increasingly seen as the “payer of last resort.” For example, Puerto Rico is no longer solvent and needs an $80B bailout. Another example: thousands of municipal water systems have lead pipes that urgently need replacing. Finally, such a large number of senior citizens (“baby boomers”) are retiring that Medicare expenditures will increase dramatically. 

To sum up, there is too much government, corporate, and household debt worldwide. The tendency of Central Banks to drive interest rates ever lower (to “jump-start” their economies) only makes borrowing more attractive, and the likely result of that will be greater indebtedness.

Mission: Look at 12-yr returns for GLD, an exchange-traded fund (ETF) for gold bullion, as well as the Market Vectors Gold Miners ETF (GDX) and Newmont Mining (NEM), the largest US gold miner. Two other large mining companies are also important to consider: Agnico Eagle Mines Ltd (AEM) and Barrick Gold (ABX). Gold mining is accomplished by getting rock out of the ground and using massive electric-drive Caterpillar (CAT) trucks to carry it out of the mine. That stock’s price is a good barometer of mining activity. It is also important to consider the only Dividend Achiever among gold stocks, Royal Gold (RGLD), which is a company that obtains royalties on gold production in exchange for financing gold mines. Compare those returns (see Table) to more typical US stocks in the commodity space, such as NextEra Energy (NEE), Union Pacific (UNP) and Exxon Mobil (XOM). 

Bottom Line: By owning gold you’re giving up the opportunity to make another investment that provides you with a steady income from interest, dividends or rent. You also miss out on paying the low capital gains tax for income-producing investments. Gold is a “collectible” and the proceeds are taxed as income. This may not matter, if you think hyperinflation is a looming threat. Just remember, gold is the most speculative of investments because of its price volatility and lack of income. 

Risk Rating: 10

Full Disclosure: I dollar-average into NEE, UNP, and XOM.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).

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Sunday, May 1

Week 252 - Barron’s 500 AgriBusiness Companies

Situation: We follow companies that support grain production closely because they’re “withering on the vine.” Farmers can’t afford to purchase supplies and replace worn-out equipment because grain prices have collapsed due to overproduction. Mainly, the weather is responsible. El Nino, with warm water collecting in the Eastern Pacific Ocean, means there is almost enough rainfall worldwide. But El Nino will soon be followed by La Nina; then there will be droughts and the price of grain will rise. Should that happen, many farmers will have higher incomes and be able to buy new equipment from companies like Deere (DE).

Mission: Develop a spreadsheet that includes all the major US and Canadian AgriBusiness companies, i.e., those that meet the agronomy, equipment, and distribution needs of farmers. To identify companies with the highest revenue, we’ll confine our attention to those that appear on the 2015 Barron’s 500 List.

Execution: There are 13 companies that have at least a 15-yr trading record. Six are chemical and seed companies that address agronomy needs; 4 are equipment companies that supply tractors, harvesters, and support for those; 3 are distribution and marketing companies for the raw commodity (wheat, soybeans, corn, rice, and sorghum).

Bottom Line: These 13 companies are not doing well (see Table). Total returns/yr for the past 5 yrs are negative for the average company but have become worse over the past two years. Perhaps Dow Chemical (DOW) and duPont (DD) are managing better than the rest, but even they have suffered so much that they’re planning to merge operations.

Risk Rating: 8

Full Disclosure: I dollar-average into MON, and also own shares of DD, ADM, and DE.  

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).

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