Sunday, October 30

Week 278 - Living From One Month To The Next On Social Security

Situation: 60℅ of Americans over age 65 are “overwhelmingly” dependent on Social Security and 20% are totally dependent (“Animal Spirits”, George A. Akerlof and Robert J. Shiller, Princeton University Press, Princeton and Oxford, 2009, p. 124). To maintain Social Security in its current form, with cost of living adjustments (COLA), would consume ~2℅ of the country's taxable income going forward. The average monthly benefit (July 2016) for a retired worker is $1350. Contrast this with the US “poverty threshold” of $1200/mo.

Mission: Outline constraints on the 20% who are totally dependent on Social Security and the 40% who have some savings but remain overwhelmingly dependent on Social Security. Create a spreadsheet of the types of assets held by the latter group.

Execution: To live independently on $1350/mo, an individual or couple would have to start retirement debt-free and remain so. If they are living rent and mortgage free in their home, they will not be able to afford the expenses (maintenance, property tax, utilities) unless they take in a renter. A car would also not be affordable due to expenses (insurance, tires, maintenance, registration). The discipline of sticking to a budget rules out the use of credit cards; a debit card and checking account are a better plan. They would need to use accrual accounting. That is, assign all $1350 of income each month to budgeted expense, including a savings account for non-recurring capital expenditures on new clothes, vacations, income taxes and medical/dental expenses. 

The 40% who find themselves overwhelmingly dependent on Social Security probably had no intention of ever owning stocks or stock mutual funds, preferring instead to use FDIC-insured savings accounts, Savings Bonds, whole life insurance, 1/10th ounce gold coins and a money market fund (or short-term bond fund) obtained from a broker. They are savers rather than investors and don’t want to place their savings at risk. They’d like to avoid losing money to inflation, and may be aware that the only zero-risk/zero-cost investments are 10-Yr Inflation-protected Treasury Notes and IRA-like Inflation-protected Savings Bonds obtained online

This cohort doesn’t want to gamble, which means they don’t want to invest in asset classes that always seem to fall in value during a recession. That restraint rules out stocks, corporate bonds, and REITs but not the equity in their own home. They may strive to own a home, but until the Housing Crisis they weren’t fully aware of the risk. Now they know that only Treasury Notes and gold can be counted on to rise in value during a financial crisis. 

Administration: see Table.

Bottom Line: Live small, stay out of debt, close any credit card accounts and keep track of every penny in an accrual accounting ledger.

Risk Rating: 3 (where Treasury Notes = 1 and gold = 10).

Full Disclosure: I dollar-average into Savings Bonds and hold Treasury Notes at www.treasurydirect.gov. I hold an intermediate-term US Treasury Bond Fund in a retirement account. 

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table.

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

Sunday, October 23

Week 277 - Counter-cyclical Barron’s 500 Dividend Achievers

Situation: What’s the biggest problem with owning stocks? When JP Morgan was asked this question, he answered: “It will fluctuate.” Benjamin Graham was more specific, noting in Chapter 14 (Stock Selection for the Defensive Investor) of his famous book (The Intelligent Investor, 4th Revised Edition, Harper & Row, New York, 1973, p.195) that:
     “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.” 

But a stock’s price will rise far higher when investors clamor to “get in on the story.” All too often, that story reflects the investment that the company’s managers have made in Public Relations (e.g. advertising) at the expense of investments that grow Tangible Book Value (e.g. property, plant, equipment, and software). As a result, the company’s stock price will falter whenever the macro-economic outlook is negative. 

Mission: This week we’ll build on Warren Buffett’s observation that “only when the tide goes out do you discover who’s been swimming naked.” That last happened with the 4.5 yr Housing Crisis, i.e., year-over-year house prices (for conforming new sales nationwide) turned negative in Q3 of 2007 and didn’t turn positive again until Q1 of 2012. Most companies were exposed as naked swimmers, and their stock prices soon fell to a level more consistent with Benjamin Graham’s formula (see above). But a few outperformed during that 4.5 yr period. Total Returns/Yr proved to be greater than Total Returns/Yr have been over the 26+ yr period since the Savings & Loan Crisis of 1990-91. Do those companies have anything in common? We’d like to know, since owning shares in 2 or 3 such companies would help protect our portfolios from the ravages of the next crisis.

Mission: Look for companies in the Barron’s 500 List that 1) outperformed in the Housing Crisis, 2) have improved revenues and cash flow over the past 3 yrs, 3) have high S&P ratings on their bond and stock issues, and 4) are Dividend Achievers.

Execution: (see Table)

Administration: The first 3 companies in our Table (ROST, TJX, MCD) represent the Consumer Discretionary industry and see thrifty consumers as “core” clientele. Their Business Plan is designed to outperform in a recession because people will have an ongoing need to purchase their products and services, and more people will have become thrifty-minded. Four companies at the bottom of the list (WEC, XEL, ES, ED) are regulated public utilities that play a similar role: everyone needs to turn on lights and recharge their cell phones every day. Somehow the money will be found to pay the utility bill. 

It is harder to explain how the remaining two companies, IBM and WW Grainger (GWW), made the list. When a company needs information technology maintenance or upgrades, IBM has always had the reputation of being a safe and effective recommendation for a company’s Chief Information Officer to make. A deep recession is exactly when such upgrades are in demand, given that the company has had to reduce staffing to avoid being bought out by a stronger competitor. Automation and global sourcing are the paramount strategies to deploy in a recession. Similarly, GWW is the leading supplier of maintenance, repair, and operating products to businesses. So, demand for at least some of their products will have remained steady.

Among the BENCHMARKS and Standard Indices in our Table, note that only two asset classes that outperformed their long-term trend during the Housing Crisis: bonds and gold. This will always be the case in a financial crisis.

In the aggregate, these 9 stocks have a 5-Yr Beta below 0.5 (see Column I in the Table) which suggests that there would be less risk of loss vs. the S&P 500 Index in a Bear Market. But statistical analysis of weekly prices over the past 25 yrs suggests otherwise (see Column M in the Table). Taking both metrics into consideration, we see that WEC Energy Group (WEC) and Consolidated Edison (ED) are the only low-risk investments. 

Bottom Line: The “common thread” of our 9 recession-proof companies is a combination of skilled management and having a product line that includes goods and services exhibiting near-zero elasticity. Companies like Ross Stores (ROST), TJX (TJX) and McDonald’s (MCD), which appeal to the budget-minded among us, will ride out almost any storm. Electric utilities that are well-managed, like WEC Energy Group (WEC), or serve upscale markets, like Denver (XEL), Boston (ES) and New York City (ED), will emerge unscathed from recession. Finally, there are companies like IBM and Grainger (GWW) that provide maintenance and information technology to a long roster of companies, and these often cannot be pushed into the next quarter.

Risk Rating: 5 (where Treasuries = 1, and gold = 10)

Full Disclosure: I own shares of ROST, TJX, MCD, and IBM.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. 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 = 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. Price Growth Rate is the 25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Use of such a long-term trendline CAGR instead of a shorter-term current CAGR emphasizes the predictive value of “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small number of large-cap stocks where selection bias is paramount. That stock index is the S&P MidCap 400 Index.

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

Sunday, October 16

Week 276 - Barron’s 500 Companies With Clean Balance Sheets and Improving Fundamentals

Situation: Stock market valuations are still in nosebleed territory. The S&P 500 Index is 25 times trailing 12-mo earnings. The cyclically-adjusted PE ratio is 27 times trailing 10-yr earnings, i.e., just shy of the last peak reached in October of 2007. You get the point, so you’re in “risk-off” mode. But you’re not going to save for the future by hiding money under your mattress. How should a prudent investor continue adding money to the market, knowing that a precipice looms? With dollar-cost averaging, an investor can add small amounts each month to stocks from several different industries, i.e., more shares per dollar when the market swoons. But which stocks? When you’re in risk-off mode, those need to be A-rated, large-capitalization stocks with improving fundamentals, and at least a 25 yr trading record.

Mission: Screen the 2016 Barron’s 500 List for companies that have improved in rank and have 25 yrs of quantitative data at the BMW Method website. Eliminate companies that don’t have a clean Balance Sheet (as defined in the Appendix for Week 271). Assess growth prospects by calculating Net Present Value (NPV) for each stock. For companies with Top 500 Global Brands, provide 2016 and 2015 brand ranks.

Execution: see Table.

Bottom Line: We’ve used a tight screen to come up with 10 companies worth dollar-averaging through a Bear Market. Three represent the Consumer Staples industry: HRL, COST, WMT. Four represent the Consumer Discretionary industry: ROST, TJX, NKE, DIS. There’s also one Industrial company (PH), an Information Technology company (ADP) and a Basic Materials company (APD). All but the 3 companies with strong brands (NKE, COST, ADP) are likely to fall in value as much as the S&P 500 Index in the next Bear Market (see Columns AC and AD in the Table). NPV calculations (see Column V in the Table) suggest that buying shares in any of the 10 companies would result in a greater gain after 10 yrs than buying shares in the lowest cost S&P 500 Index fund (VFINX at Line 18 in the Table).

Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, and gold = 10)

Full Disclosure: I dollar-average into NKE and also own shares of ROST, TJX, HRL and WMT.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. 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 = moving average for stock price over 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. Price Growth Rate for this week is the25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/), done to emphasize “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index.

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

Sunday, October 9

Week 275 - Food Processors With Improving Fundamentals

Situation: Grain prices are low, which means equipment and seed vendors find that few farmers are eager to buy. But grain processors benefit when prices are low. 

Mission: Look for improvements in cash flow and revenue among the largest food processors, and assess the benefits and risks of investing in those companies. Look for Brand Value and clean Balance Sheets in addition to calculating Net Present Value.

Execution: see Table.

Administration: We’ve found 12 food processing companies that rank higher on the 2016 Barron’s 500 List than they did on the 2015 List. Those companies had a better overall score based on 3 criteria: A) Cash flow-based ROIC, B) 2015 ROIC vs. the 3-yr median, and C) sales growth in 2015 vs. 2014. All 12 companies have a 16+ year trading history that has been analyzed quantitatively by using the BMW Method; see Columns K-M in the Table

With respect to broad indications of quality (i.e., S&P bond and stock ratings at Columns P and Q in the Table), only 6 companies meet our standards. Our measures include a bond rating of BBB+ or better and a stock rating of B+/M or better. The 6 stocks are: Hershey (HSY), General Mills (GIS), Hormel Foods (HRL), Coca-Cola (KO), Campbell Soup (CPB), Archer Daniels Midland (ADM). Only 4 of those stocks are Dividend Achievers (annual dividend increases for 10+ yrs): GIS, HRL, KO, ADM

With respect to Net Present Value (see Column V in the Table), the top 4 companies are Ingredion (INGR), Hormel Foods (HRL), JM Smucker (SJM), Tyson Foods (TSN).

Hormel Foods (HRL) is the only company with a clean Balance Sheet. We have a problem when evaluating Balance Sheets for food processors (see Columns Y-AB). Those companies are able to be somewhat unconcerned about bankruptcy, since food prices tend to be inelastic (i.e., food is an “essential good”). This allows company managers to spend more on advertising than on growing Tangible Book Value. In the aggregate, these 12 companies carry too much debt. Their total debt is 160% of equity whereas 100% is the upper limit for a clean Balance Sheet. Long-term debt is 29% of total assets, which is barely acceptable. Tangible Book Value is 1% of each share’s price, which is barely acceptable. In the first half of 2016, two of the Dividend Achievers, Coca-Cola (KO) and Archer Daniels Midland (ADM), had insufficient free cash flow (FCF) to pay dividends. That means they either had to borrow the necessary funds or sell a non-strategic asset. 

With respect to brand value, Best Global Brands ranks the top 500 brand names annually. Three of the companies in our Table are among the top 500 for 2016. Those 3 are: Coca-Cola (KO), Kellogg (K), Tyson Foods (TSN). Two additional Coca-Cola brands appear on the list, Sprite and Fanta. Coca-Cola ranks #17 (down from #12), Kellogg ranks #183 (down from #181), Tyson ranks #307 (up from #353), Sprite ranks #411 (down from #391), and Fanta ranks #488 (unchanged). Interestingly, Hershey (HSY) is not a top 500 global brand.

Bottom Line: The “take-home message” is that stocks whose prices vary with the weather and global crop yields are speculative. The investment that farmers make in equipment, software, irrigation systems, seeds and chemicals will determine their crop yields, given favorable weather. Over the past 3 yrs of good weather (El Nino), those investments have paid off in all the countries of the Northern Hemisphere that have a strong agriculture sector. That means the prices that food processors pay for wheat, soybeans, rice, corn and meat have fallen. The other key fact that drives those growing profits is the addition of some 20 million people a year to the middle class, meaning they can finally afford to eat a 60 gm protein diet every day.


Risk Rating: 7 (where 10-Yr US Treasury Notes = 1 and gold = 10).

Full Disclosure: I own shares of HRL, KO and ADM but recently sold shares of GIS. I thought GIS shares had become overpriced but the current NPV calculation suggests that GIS shares continue to have considerable value (see Line 3 in the Table, at Column V).


NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. 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 = moving average for stock price over 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. Price Growth Rate is the 16-Yr CAGR found at Column K. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index at Line 26. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 20. The NPV calculation for MDY (at Column V and Line 20) includes transaction costs of 2.5% on purchase and 2.5% on sale.

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

Sunday, October 2

Week 274 - Alternative Investments: American REITs

Situation: You need to hold assets other than stocks and bonds in your retirement portfolio. Stocks can become too volatile, and credit-worthy bonds can become unworthy credits. Both problems are plaguing investors these days, so we need to look at alternatives. Alternative investments usually relate to either real estate or natural resources. The idea is to combine the best feature of stocks (good dividends) with the best feature of bonds (good collateral). 

Mission: Introduce readers to Real Estate Investment Trusts (REITs) based in the US, taking care to separate “the wheat from the chaff”.

Execution: REITs are mutual funds of rental properties, but with a difference. The SEC requires REITs to transfer at least 90% of income to investors as dividends. While these payouts are taxed as ordinary income instead of being taxed as capital gains, part of the payout “. . . comes from depreciation and other expenses and is considered a nontaxable return of capital.”

The largest REIT index fund is marketed by Vanguard Group as The Vanguard REIT Index Fund Investor Shares Fund (VGSIX). 

Given that REITs are “real assets” in the ground, the BENCHMARK section of this week’s Table compares REITs to other investments that depend on real assets in the ground: 1) the leading oil company (XOM), 2) the leading corn processor (INGR), and 3) the NYSE ARCA Gold Bugs Index (^HUI). 

Administration: We have identified 9 REITs with above-average quality (see Table), of which 5 are Dividend Achievers (10+ years of annual dividend increases). Column D in the Table shows returns that span the 4.5 year housing crisis (7/1/07-1/1/12). Specifically, the Federal Housing Finance Agency’s “seasonally-adjusted” Home Price Index (HPI) indicates that the year-over-year (YOY) median price for houses purchased with a conforming mortgage started falling in the Q3 of 2007 and began rising in Q1 of 2012. That number from Column D is added to long-term returns (i.e., since the S&P 500 Index bottomed on 10/9/02) from Column C to yield Finance Value in Column E. 

You’ll notice that only two BENCHMARK investments beat their long-term returns during the 4.5 year housing crisis: 20+ year US Treasury Bonds (TLT at Line 15 in the Table) and the Gold Bugs Index (^HUI at Line 27). This is typical of recessions originating in the Finance Sector and represents the main rationale for owning long-dated sovereigns and gold.

Bottom Line: Houses and shopping centers are illiquid assets but their REITs can be bought and sold like stocks. Over the long term, returns from REITs are better than returns from Treasuries but REITs lose value in a recession whereas Treasuries gain value. In summary, REITs are moderate-risk high-reward investments. To invest in REITs, start with an Index fund (VGSIX). If you’re not distracted by the ups and downs, graduate to a low-risk REIT like Public Storage (PSA).


Risk Rating: 6 (where 10-Yr Treasury Notes = 1, and gold = 10).

Full Disclosure: I own units of TIREX in a retirement fund.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. 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 = moving average for stock price over 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 current 16-Yr CAGR found at Column L in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to a portfolio of individual large-cap stocks, i.e., the S&P MidCap 400 Index at Line 28 in the Table. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 17.

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