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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