Sunday, September 11

Week 271 - Barron’s 500 Dividend Achievers with a Durable Competitive Advantage

Situation: Warren Buffett likes to know a company’s Tangible Book Value (TBV) before digging deeper to see if the stock price is attractive. TBV represents physical assets that can be sold. Intangibles include patents, and the dollars above book value that were paid for strategic acquisitions that enhanced the company’s brand value. TBV is the company’s brand value, and estimates can vary widely on what that’s worth. Mr. Buffett looks for steady growth of TBV (at least 8% a year) with no more than two down years in the prior decade. Such companies have what he calls a Durable Competitive Advantage (see “The Warren Buffett Stock Portfolio” by Mary Buffett and David Clark, Scribner, New York, 2011). Remember: TBV is stuff that has real value, not patents, not brand names, and not the difference between the original cost (for property, plant, and equipment) and the estimated replacement cost. 

The problem is that most large companies have negative TBV. Why? Because their managers think it is preferable to borrow money for expansion and advertising, using TBV as collateral. But some companies hold out for the old way and maintain a strong Balance Sheet. Investors gravitate toward buying stock in those companies, which often results in those stocks becoming overpriced. That means stockpickers need to dig deeper into Balance Sheets, and look at each company’s prospects for growth, to find the few remaining bargains.

Mission: Find the few Dividend Achievers that have a Durable Competitive Advantage. 

Execution: Compare 2016 & 2015 Barron’s 500 rankings using the buyupside website to determine Total Return/yr since our key benchmark (VBINX) was introduced on 9/28/1992, and the BMW Method website for the 25-yr CAGR in each stock’s mean price. Include our Balance Sheet package (see Appendix below), and calculate the Net Present Value for buying $5000 worth of each stock.

Administration: see Table.

Bottom Line: We’ve come up with 8 Dividend Achievers that have a Durable Competitive Advantage. Five look to be good long-term bets for dollar-cost averaging. Exxon Mobil (XOM) cannot pay its dividend from Free Cash Flow (FCF) because the price of oil has collapsed, and its Weighted Average Cost of Capital (WACC) still exceeds its Return On Invested Capital (ROIC) even though the price of oil has retraced 20% of its 70% loss. The two financial companies, Travelers (TRV) and Franklin Resources (BEN), are still recovering from the Lehman Panic, which pulls their 2016 Barron’s rank lower than their 2015 Barron’s rank and produces volatility in their stock prices (see Column I in the Table). 

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

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

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Purple highlights denote Balance Sheet issues and shortfalls in TBV growth. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table ( Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found here

APPENDIX: These are our criteria for a clean Balance Sheet.

1. Total Debt:Equity is under 100% (or under 200% if the company is a regulated public utility). That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is the most important marker of a company’s “general financial condition.” That ratio needs to be under 30% (35% if a regulated public utility). Long-term debt has to either be renewed at maturity or returned to the lender. In a financial crisis, the rate of interest that bankers charge for a renewal (“rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling assets or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies mainly in the perceived value of their brand, which accountants call “goodwill” when the company is sold for more than its book value. But remember that property, plant and equipment are carried at historic cost when calculating book value. So, goodwill is more than just the perceived value of the brand. It’s the buyer’s perception of current value for patents, property, plant, and equipment. TBV may be negative for a short period after a company restructures by selling non-strategic assets to pay down LT debt. Procter & Gamble (at Line 16 in the Table) is a current example. 
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow (i.e., “cash from operations” minus capital expenditures).

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