Sunday, December 31

Week 339 - HealthCare Companies in the Vanguard High Dividend Yield Index

Situation: American culture has increasingly disparate trends, but almost every adult is interested in occasionally partaking of a mood-altering substance. The cultural shift toward “Better Living Through Chemistry” now extends well beyond recreational drug use. Drugs are successfully being marketed for “wellness” without evidence-based research attesting to their efficacy. (These are medications that the FDA has approved for use in other conditions or diseases than those being touted in marketing materials.) As an example, WebMD has a list of 46 drugs and vitamins that are used to help prevent or treat Alzheimer’s Disease while noting that none have proof of efficacy.

Mission: Use our Standard Spreadsheet to list established HealthCare companies that pay a good and growing dividend.

Execution: see Table.

Administration: Eight of the 400 US companies in the FTSE Global High Dividend Yield Index are 1) in the S&P HealthCare Industry, 2) have trading records that extend for at least the 16 year period needed for statistical analysis by the BMW Method, and 3) are in the 2017 Barron’s 500 Index that ranks companies by using cash-flow based metrics.

Bottom Line: The main thing to remember about HealthCare companies is that their revenues will grow approximately three times faster than GDP, and (here’s the good part) growth is likely to continue during a recession when GDP is falling. In other words, some pharmaceuticals like anti-platelet drugs enjoy steady (inelastic) demand regardless of price. Investors also need to remember that prescription drugs have only 20 years of patent protection, and that clock starts ticking when clinical trials begin. Drug development is an expensive multi-year process which fails more often than it succeeds. Risk-adjusted returns on investment for these companies are no better than those for the aggregate of companies in the S&P 500 Index.

Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into JNJ, and also own shares of ABT, PFE and AMGN.

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Sunday, December 24

Week 338 - Alternative Investments (REITs, Pipelines, Copper, Silver and Gold)

Situation: You want to minimize losses from the next stock market crash. News Flash: The safe and effective way to do that is to have 50% of your assets in medium-term investment-grade bonds. Those will go up 10-25% whenever stocks swoon. But a plain vanilla form of protection won’t resonate with your neighbors after the crash hits. You’ll want to tell them about something cool that you did to protect yourself. And, while waiting for the next crash you don’t like the low interest income that you’d receive from a low-cost Vanguard intermediate-term investment-grade bond index fund like VBIIX or BIV. The exotic-seeming alternative is to bet on something related to land and its uses. Those bets carry valuations that track long supercycles, which overlap 3 or 4 economic cycles. But supercycles contain pitfalls for the unwary, and even for professional commodity traders.

Mission: Use our Standard Spreadsheet to examine Alternative Investments, and describe the pros and cons of owning those.

Execution: see Table.

Administration: The main bets are on real estate, oil/gas pipelines, copper, silver and gold. Traders mitigate losses during a recession by hoarding such assets until prices recover. Let’s look at the odds of success. The SEC (Securities and Exchange Commission) is responsible for guiding the average investor away from loss-making bets. For example, the SEC doesn’t allow a stock to be listed on a public exchange unless it has Tangible Book Value (TBV) and appears likely to continue having TBV after being listed. So, S&P identifies 10 Industries that have the structural profitability needed to maintain TBV and dividend payouts for retail investors. 

Real Estate is not such an industry. However, S&P has started evaluating Real Estate Investment Trusts (REITs) with a view toward someday including those. However, the Financial Times of London does not include Real Estate companies in either its FTSE Global High Dividend Yield Index, or the US version of that index, which you can invest in at low cost through an ETF marketed by the Vanguard Group (VYM). Nonetheless, we’ll list what we think are the 7 best REITs in the accompanying Table.

Oil and gas pipelines offer a way to capture tax-advantaged dividend income that transcends the ups and downs of the economy, but typically requires you to buy into a Limited Partnership. To do so, the SEC requires you to be an Accredited Investor. “To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income.” You’re also liable for taxes levied by most states through which the pipelines run. As a retail investor, you aren’t going to buy shares of a Limited Partnership. So, none are listed in our Table. But a few “midstream” oil & gas companies issue common stock to help fund a large network of integrated pipelines. Those pay the same high dividends expected of Limited Partnerships, and two companies are listed in the FTSE High Dividend Yield Index for US companies (VYM): ONEOK (OKE) and Williams (WMB). This indicates that each company’s dividend policy is thought to be sustainable. ONEOK has the additional distinction of being an S&P Dividend Achiever because of 10+ years of annual dividend increases.

Gold is the traditional Alternative Investment, which also brings copper and silver into play given that all 3 are found in the same geological formations. Any copper mine that fails to process the small amounts of gold it unearths is a copper mine not worth owning. The same can be said of gold miners who ignore silver deposits. The problem for investors is that mines are costly to develop and have an unknown shelf life. So, owning common stocks issued by miners has fallen out of favor: Dividends are rare and fleeting, and long-term price appreciation is neither substantial nor steady. Nonetheless, we have listed 4 miners in the Table: Freeport McMoRan (FCX) and Southern Copper (SCCO) both focus on mining copper; Newmont Mining (NEM, focused on mining gold), and Pan American Silver (PAAS). 

A better way to invest in precious metals is to buy stock in financial companies based on loaning money to miners on condition of being paid later either in royalties or ownership of a stream of product, should the mine become a successful enterprise. We have listed two such companies: Royal Gold (RGLD), which seeks royalties; Wheaton Precious Metals (WPM), which mainly seeks silver streaming contracts. See our Week 307 blog for a detailed discussion of silver. 

Bottom Line: If you want to venture into Alternative Investments, and would like to take a relatively safe and effective approach, we suggest that you buy shares in the REIT ETF marketed by the Vanguard Group (VNQ at Line 19 in the Table). Better yet, stick to companies in “The 2 and 8 Club” that represent more reasonable bets in the Natural Resources space: ExxonMobil (XOM), Caterpillar (CAT), and Archer Daniels Midland (ADM). One pipeline company is also worth your consideration: ONEOK (OKE, see comments above). 

Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into XOM, and also own shares of OKE, CAT and WPM.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, December 17

Week 337 - Agriculture-related Companies in “The 2 and 8 Club” (Extended Version)

Situation: We’ve narrowed our “universe” to large & established US companies that reliably pay a good & growing dividend, and called it The 2 and 8 Club. Why? Because “good ” means 2% or better and “growing” means 8% or better. We use a wash/rinse/repeat method to find those companies. 

In the “wash” cycle, we collect companies that are listed at each of the 3 online spreadsheets we value: 1) The capitalization-weighted FTSE High Dividend Yield Index for US companies, which is simply the 400 companies in the Vanguard High Dividend Yield ETF. 2) The S&P 100 Index, which has the advantage of price discovery through the requirement that stocks in these large companies have active markets in Put and Call Options. 3) The BMW Method List of statistical data for stocks that have been traded on a public exchange for at least 16 years. 

In the “rinse” cycle, we look up information online about each stock that passed through the wash: 1) We make sure bonds issued by that company have an S&P Rating of A- or better. 2) We make sure stocks issued by that company have an S&P Rating of B+/M or better (go to your broker’s website). 3) We make sure the company’s annual dividend payout has been growing 8% or faster over the past 5 years, i.e., we get a list of payouts from the relevant Yahoo Finance page then put the most recent year’s payout and the payout for 5 years ago into a Compound Annual Growth Rate calculator

In the “repeat” cycle, we take the same steps 3 months later, then select stocks to add or delete by using a brokerage that charges you a flat fee of ~1% of Net Asset Value/yr. This allows you to trade without incurring transaction costs (including dividend reinvestment). 

If you’re a glutton for punishment, you can extend your oversight beyond S&P 100 stocks to include those on the Barron’s 500 List, published each year in May, which has the advantage of ranking companies by using 3 cash flow metrics. Then you’ll be running the Extended Version of The 2 and 8 Club, which currently has 32 companies (see Table for Week 329). This week’s blog drills down on the 10 companies in the Extended Version that ultimately depend on feedstocks provided by farmers, to ultimately market foods & beverages, motor engine fuels, animal feed, cigarettes, cotton shirts, and plastics made from corn. 

Mission: Set up a Standard Spreadsheet of those 10 companies.

Execution: see Table.

Administration: Farmers operate a capital-intensive business that requires large-scale production on ~1000 acres to justify the cost of chemicals and fertilizer plus the main cost, which is for the purchase and maintenance of equipment (e.g. combines, tractors, grain carts, center-pivot irrigation systems, sprayers, semi-tractors that haul 30 tons of grain, grain-drying bins, grain storage bins, and satellite navigation links needed for weather forecasting and precision agriculture). Their mobile powered equipment requires diesel fuel, and their grain-drying bins require natural gas or propane. 

Archer-Daniels-Midland is the only pure Ag company on the list. ADM collects crops at railheads for further shipment and initial processing, and distributes products worldwide. Much of that distribution begins by loading grain onto barges in the Mississippi River. 

Weather is the key variable. The software and hardware on weather satellites is IBM gear, and IBM owns The Weather Channel. GPS-based software is an important part of precision agriculture, and similarly depends on satellites running IBM equipment. Cummins (CMI) and Caterpillar (CAT) provide diesel engines, and ExxonMobil (XOM) is one of the largest sources of diesel fuel. CAT also makes skid-loaders and backhoe/end-loaders that some farmers use.

PepsiCo (PEP) and Coca-Cola (KO) process a variety of farm products (including milk, cheese, oranges, oats, coffee and tea) into dozens of branded foods and beverages that are found worldwide. Altria Group (MO) processes tobacco plants into cigarettes and smokeless tobacco for the US market. VF Corporation (VFC) is the largest company that fabricates clothing for a variety of markets, and depends on farmers to produce its main feedstock (cotton). Target (TGT) markets clothing, and Super Target stores offer a large variety of foods and beverages. 

Bottom Line: Farm incomes have fallen 20%/yr over the last 3 years, but appear to have stabilized with this year’s harvest. Cost-cutting and scaling-up are the main survival strategies. Farms that are large enough to sustain a family are multi-million dollar enterprises that cultivate more than a square mile of ground. When farmers are forced to cut costs, suppliers are forced into being acquired by (or merged with) other companies. To further complicate matters, efficient transportation networks now circle the planet. The supply of crop commodities outstrips demand enough that the effects of drought or war in one place are mitigated by bumper crops in another place. 

Risk Rating: 8 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).

Full Disclosure: I dollar-cost average into KO, XOM, and IBM, and also own shares of CAT and MO.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, December 10

Week 336 - Version 3.0 of The Growing Perpetuity Index Reflects “The 2 and 8 Club”

Situation: We started this blog six years ago with the idea to create a Growing Perpetuity Index as a way to save for retirement, by selecting from a workable “watch list” of high-quality stocks (see Week 21). We chose to base the index on companies in the 65-stock Dow Jones Composite Average (^DJA), and ended up selecting 12 from the 14 that had earned S&P’s designation of Dividend Achiever, i.e., companies that had raised their dividend annually for the previous 10 years or longer:
        Exxon Mobil
        Wal-Mart Stores
        Procter & Gamble
        Johnson & Johnson
        United Technologies
        Norfolk Southern
        NextEra Energy

Our thought was that investors could select stocks from this index to safely dollar-cost average automatic online contributions into their Dividend Reinvestment Plan (DRIP). That would allow relatively safe and efficient growth in their retirement assets. Version 2.0 (see Week 224) added back the two companies that had been left out, Caterpillar (CAT) and Southern Company (SO), plus two newly qualified companies: Microsoft (MSFT) and CSX (CSX).

Now we’ll apply a lesson learned from running Net Present Value (NPV) calculations, namely that Discounted Cash Flows from good and growing dividends are more likely to predict rewards to the investor than Capital Gains from a history of price appreciation. Accordingly, Version 3.0 re-casts the index to include only those ^DJA companies that are in “The 2 and 8 Club” (see Week 329) of high-quality companies with a dividend yield of at least 2% and a dividend growth rate of at least 8% for the past 5 years. The result is a 13 company Watch List, not all of which are Dividend Achievers. Only 7 are holdovers from Growing Perpetuity Index, v2.0:
   NextEra Energy
   Exxon Mobil

Mission: Apply our standard spreadsheet (see Table) to the 13 companies in the 65-company Dow Jones Composite Index that are in “The 2 and 8 Club.”

Execution: see Table.

Bottom Line: The value of picking from among the highest-quality stocks in the Dow Jones Composite Index is not just that it’s the smallest and oldest index, but also that it is continuously vetted by the managing editor of The Wall Street Journal. Companies that don’t stand muster are replaced by companies that do. By adding the several requirements for inclusion in “The 2 and 8 Club” (e.g. S&P bond ratings cannot be lower than A-), you have a good chance of selecting half a dozen stocks that will beat the S&P 500 Index over a 10-Yr Holding Period (see Column Y in the Table). You’ll also be taking on more risk (see Columns D, I, and M in the Table), which you’ll ameliorate by trading new entrants to “The 2 and 8 Club” for those that are leaving.

Risk Rating: 6 (where 10-Yr Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10) 

Full Disclosure: I dollar-cost average into MSFT, XOM, NEE, KO, JPM and IBM, and also own shares of TRV, PFE, MMM, and CAT.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, December 3

Week 335 - Invest in “The 2 and 8 Club” Without Gambling

Situation: You’d like to invest in stocks without leaving money on the table. The alternative is to invest in the S&P 500 Index, which is a derivative subject to the kind of Program Trading that caused the “Black Monday” crash on October 19, 1987. Even after 3 decades of refining New York Stock Exchange technology to apply lessons learned from that crash, its recurrence remains a distinct possibility

You can invest in stocks without getting swept up in full fury of the next crash by using a few precautions: 1) Avoid stocks that have a statistical likelihood of losing more money than the S&P 500 Index per the BMW Method, i.e., avoid stocks highlighted in red at Column M in our Tables. 2) Use dollar-cost averaging to invest through a Dividend Re-Investment Plan (DRIP) in stocks that aren’t highlighted in red, and continue automatically investing in those each month throughout the next crash. 3) Avoid non-mortgage debt and have at least 25% of your assets in Savings Bonds, 2-10 Year US Treasury Notes, cash and cash equivalents

Mission: Looking at the 30 stocks in “The 2 and 8 Club” (see Week 329), set up a spreadsheet of those that do not have red highlights in Column M.

Execution: There are 12 such stocks (see Table).

Administration: Note that Costco Wholesale (COST) is not listed in the FTSE High Dividend Yield Index upon which “The 2 and 8 Club” is based. While dividend growth rate is 13.0%/yr, its dividend yield is only 1.3%, which is much lower than the ~2%/yr required for inclusion in the FTSE High Dividend Yield Index. This overlooks the fact that Costco Wholesale issues special dividends of $5 or more every other year! So, I’ve chosen to make COST an honorary member of “The 2 and 8 Club.”  

Bottom Line: You do have a chance of beating the S&P 500 Index without gambling, by investing in high quality growth stocks that are unlikely to lose as much as that index in the next market crash. But we find only 12 such stocks, which means you’d need to invest in all 12 to avoid selection bias.

Risk Rating is 5, where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10. 

Full Disclosure: I dollar-cost average into IBM, KO, XOM and NEE, and also own shares of MO and TRV.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, November 26

Week 334 - Barron’s 500 Commodity Producers That Pay Good And Growing Dividends

Situation: In recent weeks, we’ve seen how difficult it is for a stockpicker to beat the S&P 500 Index. But by selecting a number of stocks from a high quality list of 30 stocks with good and growing dividends, i.e., “The 2 and 8 Club” (see Week 329), you might meet that goal. 

The downside is that you have to worry about risk-adjusted returns. After all, a low-cost S&P 500 Index fund has transaction costs of less than 0.2%/yr, and doesn’t confront you with capital gains taxes until you after you retire (when you’ll be in a lower tax bracket). As a stockpicker, your transaction costs will be at least 1% of Net Asset Value (NAV) each year. And, if you’re diligent about selling stocks whenever their 5-Yr dividend growth rate drops below 8%/yr, you’ll face a capital gains tax of ~1% of NAV because you’ll have real gains after almost every sale. That means you have to pick a discount rate (to project likely returns) that is 2%/yr higher than the discount rate for the S&P 500 Index, which is 7.0%/yr, since the 20-Yr total return for SPY (the SPDR S&P 500 Index ETF) is 7.0%/yr. That’s why we use a 9% Discount Rate when calculating Net Present Value (NPV) for columns V through Y in our Tables.

You’re chances of beating the S&P 500 Index in a risk-adjusted manner come down to two options: 1) pick only those stocks that have less volatility than the S&P 500 Index (see companies without red highlights in Column M in any of our Tables); 2) pick stocks issued by companies that have the most volatile earnings because those will outperform the S&P 500 Index by the widest margin when their industry is in a Bull Market. This week we’ll look at Commodity Producers, since that’s the highest risk industry outside real estate. Note: Real Estate stocks are excluded from our baseline index for “The 2 and 8 Club”, which is the FTSE High Dividend Yield Index.

Mission: Set up a spreadsheet limited to Commodity Producers in “The 2 and 8 Club”, because almost all of those have shown higher price volatility over the past 16 years than the S&P 500 Index per the BMW Method.  

Execution: see the 12 companies in this week’s Table.

Administration: Starting with Commodity Producers in the FTSE High Dividend Yield Index that are also in the 2017 Barron’s 500 List, we exclude any that do not have an S&P credit rating of BBB (or better) and an S&P stock rating of B/M (or better). We also exclude any that do not have the 16 years of price data required for statistical analysis by the BMW Method

Bottom Line: Commodity Producers have one thing in common. They’re inefficient deployers of capital (see Columns Z and AA in the Table). In other words, these companies fail to meet the standard metric for efficiency, which is that Return on Invested Capital (ROIC) is more than twice the Weighted Average Cost of Capital (WACC). Pulling stuff out of the ground almost always wastes capital at some point, unless there is an opportunity for combining a) Economies of Scale with b) oversight of each worksite by a Funds Administrator.

Note that 3 companies (ADM, APD, PX) in the 30-stock Extended Version of “The 2 and 8 Club” (see Week 329) are among the 12 companies that pass this week’s screen of Commodity Producers (see Table). Those 3 are the best place to start your research.

Risk Rating = 9, where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10.

Full Disclosure: I dollar-cost average into XOM and also own shares of CAT.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, November 19

Week 333 - $175/wk For An IRA That Uses DRIPs Backed By Savings Bonds

Situation: If you don’t have a workplace retirement plan, then you most likely have concerns that you won’t have enough savings to support retirement. You should be able to replace at least 85% of your final year’s salary by withdrawing 4%/yr from your retirement savings, which amount is increased in subsequent years to allow for inflation. But the median Social Security payout only replaces 46% of median household income. If you don’t have a workplace retirement plan, you’ll have to set savings goals, eliminate non-mortgage debt, and start cutting costs long before retiring. For example, move to an apartment after your children finish high school.

Most of us don’t think about allocating money to Savings Bonds and an IRA until we’re 50. So, let’s be realistic. How much could you augment your retirement income by contributing the maximum $6500/yr starting at age 50 to an IRA consisting of Dividend ReInvestment Plans (DRIPs) for stocks, and backing that up by contributing $2600/yr to tax-deferred Inflation-protected Savings Bonds (ISBs). You’d be saving $175/wk ($9100/yr), which is 15% of median household income for 2016 ($59,039). This plan is approximately one part Treasury Bonds and 2 parts stocks. Over the past 20 years, the lowest-cost S&P 500 Index fund has returned 7.0%/yr. The lowest-cost intermediate-term investment-grade bond index fund (composed mainly of the same 7-10 year US Treasury Bonds used for ISBs) has returned 5.4%/yr. Overall return for the 2:1 private retirement plan would have been 6.5%/yr, but 2.1%/yr of that would have been lost to inflation. 

Starting at age 50, IRA contributions of $6500/yr to stocks in a DRIP IRA, and ISB contributions of $2600/yr, would have built up a private retirement account worth $314,101 by the time you retire at age 67. Spending 4% of that in your first year of retirement would add $1047/mo to the $2260/mo provided by Social Security, if you and your spouse have a the 2016 median household income of $59,039. A complicated formula will determine your exact benefit, so start learning the basics. 

Mission: Develop our standard spreadsheet for 6 DRIPs using stocks issued by companies in the FTSE High Dividend Yield Index, specifically those that grow dividends 8% or more per year. In other words, pick stocks from the Extended Version of “The 2 and 8 Club” (see Week 327 and Week 329).

Execution: (see Table). 

Administration: To augment your Social Security income by using a private retirement account, you’ll need to build an IRA for stocks that is backed by Inflation-protected Savings Bonds (ISBs). Make sure your accountant declares to the Internal Revenue Service that 6 DRIPs above represent your IRA, noting that annual contributions to those will not exceed $6500/yr unless the US Treasury raises the contribution limit. 

We have used high-quality stocks instead of index funds in our example above, given that index funds are now thought to carry the same risks as other derivatives. 

Bottom Line: It is practically impossible for you to fund your retirement without contributing at least 15%/yr to a workplace retirement plan for 25+ years. The private retirement plan outlined above envisions contributing the maximum amount allowed for an IRA, supplemented by Savings Bonds, to channel 15% of your income into tax-deferred savings for the 17 years after you turn 50, which is when you can start making the largest annual contributions to your IRA. But if you’d started that plan 17 years ago (when you were 50), you’d now receive ~$1050/mo in your first year of retirement, which is less than half your Social Security check.

Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold = 10).

Full Disclosure: I dollar-average into all 6 stocks, as well as ISBs.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, November 12

Week 332 - Defensive Companies in “The 2 and 8 Club”

Situation: The Dow Jones Industrial Average keeps making new highs, “confirmed” by new highs in the Dow Jones Transportation Average. According to Dow Theory, we are in a “primary” Bull Market. That is a period when investors should be paying off their debts and/or building up cash reserves. It is also a period when stocks in “growth” companies become overpriced, and stocks in “defensive” companies become reasonably priced (after having been overpriced). It’s a good time to research high-quality companies in “defensive” industries: Consumer Staples, Health Care, Utilities, and Communication Services. 

Mission: Develop our standard spreadsheet for companies in “The 2 and 8 Club” (see Week 327) that are in defensive industries (see Week 327), and add any companies that are close to qualifying.

Execution: (see Table)

Administration: We’ll use the Extended Version of “The 2 and 8 Club”, which simply matches companies on two lists: The Barron’s 500 List and the 400+ companies in the FTSE High Dividend Yield Index. The Barron’s 500 List is published annually in May, and ranks companies by their 1 & 3 year Cash Flows from Operations, as well as their past year’s Revenues. The FTSE High Dividend Yield Index lists US companies that pay more than a market yield (~2%) and are thought unlikely to reduce dividends during a Bear Market. Companies that appear on both lists but do not have a 5-Yr Compound Annual Growth Rate (CAGR) of at least 8% for their quarterly dividend payout are excluded, as are any companies that carry an S&P Rating lower than A- for their bonds or lower than B+/M for their stocks.

Note the inclusion of Costco Wholesale (COST) at Line 4 in the Table. Although it has an annual yield lower than the required 2% for its quarterly dividend, the company has also issued a supplementary dividend every other year for the past 5 years. In those years, the dividend yield exceeds 5%. In calculating Net Present Value (see Column Y in the Table), we have used adjusted values for Dividend Yield (5.4%) and 5-Yr Dividend Growth (2.1%) in an effort to present an assessment closer to reality. That boosts NPV 42% over what it would be had supplemental dividends been ignored.

Note the inclusion of Coca-Cola (KO) at Line 9 in the Table. Although it has a 5-year dividend CAGR of 7.7%, which is slightly lower than our 8% cut-off, KO is a “mega-capitalized” company that has a major influence on prospects for the Consumer Staples industry.  

Bottom Line: Experienced stock-pickers can usually look forward to a decent night’s sleep, if experience has taught them to overweight their portfolio in high-quality “defensive” stocks that pay a good and growing dividend. By restricting our Watch List to companies in “The 2 and 8 Club”, we’ve found that there are only 10 defensive stocks you need to consider during this opportune time, i.e, when valuations are lower for “defensive” stocks because “growth” stocks become the overcrowded trade in a primary Bull Market.

Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)

Full Disclosure: I dollar-cost average into KO and NEE, and also own shares of COST, AMGN, MO, and HRL.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, November 5

Week 331 - Barron’s 500 Stocks in Berkshire Hathaway’s Portfolio

Situation: There are 43 publicly-traded companies in Berkshire Hathaway’s $180B stock portfolio, 29 of which are in the 2017 Barron’s 500 List. The 10 largest holdings are Kraft-Heinz (KHC - $28B), Wells Fargo (WFC - $23B), Apple (AAPL - $19B), American Express (AXP - $12B), Coca-Cola (KO -$17B), Bank of America (BAC - $17B), IBM - $14B), Phillips 66 (PSX - $7B), US Bancorp (USB - $4B), and Wal-Mart Stores (WMT - $4B). Warren Buffett often speaks of the importance of investing in large and well-established companies, particularly those at the top of their peer group that have long trading records. We’d like to know more about those stocks he’s picked for Berkshire Hathaway’s portfolio.

Mission: Run our standard spreadsheet on the 29 companies in the 2017 Barron’s 500 List, taking care to exclude any that do not have the 16+ year trading history that is required for quantitative analysis per the BMW Method.

Execution: 20 companies fit the bill (see Table).

Administration: The list is dominated by 9 companies in the two highest-risk industries among the 10 standard S&P industries. He has picked 7 companies from Financial Services (AXP, WFC, BAC, USB, MTB, BK, GS) and two from Information Technology (AAPL, IBM). Taken together, the 20 companies have risk parameters that are higher than those for the S&P 500 Index. For example, returns during the recent two-year Bear Market for commodities were 3.8%/yr vs. 6.6%/yr for the S&P 500 Index (see Column D in the Table). The extent of loss (at -2 standard deviations from trendline) in the next Bear Market is predicted to average 38% vs. 30% for the S&P 500 Index (see Column M in the Table). 

Bottom Line: Warren Buffett is “all-in” on his long-standing bet that the US economy will do well going forward. Financial Services stand to gain the most in that event, and 7 of the 20 companies in the Table are in that industry, where he is the unchallenged expert when it comes to pricing their brands and analyzing their black-box financial reports. If you’re like me and hold stock in Berkshire Hathaway, you should be happy that he is sticking to basics, i.e., invest in what you know. The downside is that Warren Buffett is one of a kind. We’re left to hope that he will indeed leave the company in good hands. 

Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into KO, JNJ, MON, and IBM. I also own shares of AAPL, COST, and WMT.

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Sunday, October 29

Week 330 - $150/wk For An Online Retirement Fund

Situation: You’ve heard a lot about saving for retirement, and you’ve probably heard that Social Security plus your workplace retirement plan probably won’t get you to a comfortable retirement any more. Why? Because people only reduce their spending by 15% after they retire, which means you will need a private savings plan to make up for the lost income. This savings plan can take the form of an IRA, payments into a low-cost annuity, proceeds from the sale of your home (if you move to smaller quarters), or perhaps even gold you’ve hidden away, and other choices. But when retirement is more than 5 years in the future, stocks remain your best bet.

We recommend that you minimize costs by using a stock index fund backed by a bond index fund. The Vanguard Balanced Index Fund (VBINX) provides both in one package, allocated 60% to stocks and 40% to bonds. It is rebalanced daily, so you won’t get burned if a stock market bubble bursts. (Most of those stock gains would already have been converted to bonds as part of daily rebalancing, and bonds typically increase in value when stocks crash.) Or, you can choose a low-cost managed fund that uses an excess of bonds to balance both the inherent risk of stocks and the difficulty managers have of knowing when to move away from stocks and into bonds. The Vanguard Wellesley Income Fund (VWINX) has the best record. It is bond-heavy and therefore has less volatility than VBINX but performs about as well.

The third low-cost option is to study the markets yourself and invest in stocks online through a Dividend ReInvestment Plan (DRIP) at computershare, and in bonds at treasurydirect. This third option allows you to pick only the most stable stocks and bonds.

Mission: Detail one example of a personal online retirement fund (mine). I dollar-cost average $100/mo automatically (online) into 5 stocks: NextEra Energy (NEE), Coca-Cola (KO), JP Morgan Chase (JPM), Microsoft (MSFT), and IBM (IBM), then dollar-cost average $150/mo into ISBs--inflation-protected Savings Bonds (treasurydirect). 

Execution: In the Table, note that the iShares 7-10 Year Treasury Bond ETF (IEF) reflects returns from the main asset that the US Treasury uses to back its ISB accounts. Also note that we use red highlights to denote metrics that underperform our benchmark, i.e., the SPDR S&P 500 ETF (SPY). Metrics highlighted in purple indicate issues that accountants will raise with that company’s CFO.

Administration: ISBs are a tax-deferred investment much like an IRA. Contributions from your checking account can be set up for automatic monthly deposits at treasurydirect. You can have your accountant designate the money that you spend to buy stocks online through a DRIP as an IRA. Compare this week’s blog to an earlier blog with the same title (see Week 120).

Bottom Line: Dividend Reinvestment Plans (DRIPs) take time to set up, but are on “automatic pilot” the rest of the time. Savings Bonds are even easier to manage (treasurydirect). So, the key difficulty is deciding exactly which stocks you’d like to own for an extended period.

Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).

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Sunday, October 22

Week 329 - Capitalization-weighted Index of “The 2 and 8 Club”

Situation: You would like a “safe and effective” way to own stocks and match total returns for the S&P 500 Index over time. There is no such way, if you define a “safe” stock portfolio as one with long-term price volatility that compares favorably with that of the S&P 500 Index. See, for example, red highlights in Column M of any of our Tables. Those denote unsafe stocks. You have to choose whether to prioritize safe or effective. Since insider trading is illegal, the only way you can beat the S&P 500 Index is by embracing more risk. 

The 2 and 8 Club” is our program for success using more risk (see Week 327). Those 16 large companies are all in the S&P 100 Index, whose members are required to have efficient price discovery through robust trading in put and call options on the Chicago Board of Options Exchange. Companies in The 2 and 8 Club are required to pay a predictably growing above-market dividend, i.e., yield over 2%/yr and dividend growth of over 8%/yr (over the past 5 yrs). They also have to have S&P bond ratings of A- or better and S&P stock ratings of B+/M or better. Finally, there need to be 16+ years of trading records to enable statistical analysis by the BMW Method

Why do we measure growth using 5 years of dividends instead of 5 years of earnings? Earnings have to be reported by using Generally Accepted Accounting Principles (GAAP). Those are a mish-mash of offsets that can be manipulated by CEOs. So, earnings can look good when they really aren’t. Dividend growth is a product of steady growth in free cash flow, which is Operating Earnings minus Capital Expenditures to grow the company through additions to property, plant, and equipment. Boards of Directors must approve the dividend checks that are sent out to shareholders, which is money that might instead have remained with the company. Remember what Warren Buffett says: “Writing a check separates a commitment from a conversation.

1) Enlarge the pool of companies by extending The 2 and 8 Club concept beyond the S&P 100 Index to embrace qualified companies in the Barron’s 500 Index.
2) Add a column in the Table to show Market Capitalization for each company relative to Market Capitalization of all companies in the Table. Rank companies by Market Capitalization.

Execution: see Table.

Administration: Rules for extending the list of qualified companies (beyond the original 16 found in the S&P 100 Index) are as follows:
   1. Include S&P 100 Companies that are in the reference data set, i.e., the FTSE High Dividend Yield Index but have seen either a recent price accumulation that takes their dividend yield under 2%/yr or slightly less than 8%/yr dividend growth. There are two such companies: Raytheon (RTN) and Coca-Cola (KO).
   2. Include companies in both the reference data set (FTSE High Dividend Yield Index) and the current Barron’s 500 List. That produces 6 additional companies: WEC Energy Group (WEC), Automatic Data Processing (ADP), Air Products & Chemicals (APD), VF (VFC), Archer Daniels Midland (ADM) and Travelers (TRV). 

Bottom Line: The extended version of “The 2 and 8 Club” has 24 companies (see Table), with relative Market Capitalizations being shown in Column AC. Past performance of the aggregate is remarkably high, e.g. see Columns E and K, while risk (in proportion to that outperformance) is acceptable (see Columns I and M). You, of course, want to capture some of that outperformance going forward. To do so, you’ll need to focus on buying stock in the companies most responsible, i.e., those with the largest market capitalization, such as Microsoft (MSFT) and JP Morgan Chase (JPM).  

Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)

Full Disclosure: I dollar-average into NEE, KO, JPM, MSFT and IBM. I also own shares of MMM, CAT, TRV, AMGN, and TXN.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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Sunday, October 15

Week 328 - Precision Agriculture

Situation: Production Agriculture has created its own problems. Worldwide supply has exceeded demand for years. In early 2017, the USDA projected that farm income would fall for a 4th straight year. But it hasn’t turned out to be that bad, since crop prices have coalesced near last year’s levels, and sales volumes have risen. Much of the oversupply results from technological improvements in farming, starting with the buildout of center-pivot irrigation in the 70s and 80s. Weather prediction started improving in the 1990s, and the National Oceanic and Atmospheric Administration (NOAA) now has a number of online tools available to farmers at no cost. 

To integrate weather information with soil characteristics on a given farm, we now have professional agronomists who provide specific advice on the use of seeds, fertilizer, water, insecticides, herbicides and fungicides. Agronomists are sometimes employed by equipment or seed vendors, who offer Wi-Fi connections that link information collected on tractors to agronomists. More often, Agronomists are employed on retainer by farmers. Many have university degrees, and others with less training work under supervision for an agronomy service, such as Servi-Tech, Inc

The application of Global Positioning Systems to agriculture began with patent approval in 1998. Increasingly, agronomists encourage farmers to adopt GPS-based services addressing their entire set of specific needs, a tactic called “Precision Agriculture.” For example, satellite imagery and soil sampling can be used for variable rate seeding and watering. Results at harvest time are analyzed using Wi-Fi linked to a crop-yield computer program on GPS equipped combines. Trimble, Inc. (TRMB) is a leader in this technology, and new combines are increasingly equipped with Trimble receivers.

Mission: Present a table of publicly-traded companies that provide precision agriculture equipment, and explain in the Administration section the specific offerings of each company in the Table.

Execution: see Table.


* Provides a variety of digital tools through strategic collaborations with 1) Lindsay Corporation (manufacturer of center-pivot irrigation systems) to match soil and seed characteristics with water needs; 2) Ag Connections to present a complete range of farm management software in a digital platform.  
* Recently purchased Blue River Technology, because it makes “tractor-towed robots that can analyze crops and apply fertilizer and pesticides plant-by-plant.
* Has started using its experience with thousands of corn seed varieties in various soil conditions in “self-teaching algorithm” to predict how a particular seed variety will perform after a farmer plants it. But the key to Monsanto’s emerging dominance of precision farming is due to a subsidiary: The Climate Corporation. It’s FieldView Platform is mounted on tractors and provides software for integration of various planting and harvesting inputs. 
* Has purchased Precision Planting LLC, which had been part of a Monsanto subsidiary--The Climate Corporation, and is licensed to retain connectivity with The Climate Corporation’s FieldView Platform.
* Has developed the AgSense software app for optimal GPS-managed control of variable center-pivot irrigation systems.
* Provides daily information and analytic tools essential for precision agriculture planning, augmented by its recent purchase of the Agrible news service.
* Precision agriculture is increasingly dependent on GPS systems and images of farmland generated by orbiting satellites. Detailed images of quarter sections of farmland are now available, using satellites designed to transmit different types of information with specific uses in farming. Agriculture research has been a specific mission of NASA since 2015. IBM owns “The Weather Channel” and has worked with NOAA since 1996 to improve weather forecasting at a “hyper-local” level. IBM provides most of the hardware and software that makes this possible, and has started applying this to precision agriculture, specifically in Brazil.
* Is a pioneer in field navigation equipment and tractor-mounted computers. Its product line has been successful with farmers and is being upgraded almost annually.

Bottom Line: Precision Agriculture is in its early years, but the consolidation phase is well underway. We’ve presented the leading publicly-traded companies above, along with investor information (see Table). These are powerful tools in the hands of the farmer, and will no doubt improve the efficiency and scope of crop production worldwide.

Risk Rating: 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10)

Full Disclosure: I dollar-average into MON and IBM, and also own shares of CAT and RAVN.

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