Sunday, July 30

Week 317 - 2017 Barron’s 500 List: A-rated “Growth” Companies That Moved Up In Rank During The Commodity Recession

Situation: If you’re a stock-picker, your job description and mission is to beat the lowest-cost S&P 500 Index ETF (SPY) by ~3%/yr over 5 years. Why? To overcome the frictional costs of do-it-yourself investing, mainly transaction costs and erratic capital gains taxes. In last week’s blog, we highlighted hedging, i.e., over-weighting “defensive” stocks. This week we highlight growth, i.e., picking stocks that grow fast enough to compensate for the drag created by defensive stocks. You should do fine most years, if you invest in 15-20 companies from each category, follow their quarterly reports, and track industry trends. You’ll have to trade often, so find a way to keep trading costs down (~1% of Net Asset Value). 

Commodities anchor the economy, so the recent Commodity Recession (7/14-7/16) made it easy to see which companies are efficient, i.e., their “cash-flow-based return on investment” grew during that period. The Barron’s 500 List ranks companies by tracking that growth over the most recent 3 years.

Mission: Identify companies that moved up in rank last year. 

Execution: Eliminate companies that do not have S&P bond ratings of A- (or better) and S&P stock ratings of A-/M (or better). In the Table, emphasize Balance Sheet metrics (see Columns P-S). In the evaluation of Net Present Value (Columns V-Z), use a Discount Rate of 9%/yr and a Holding Period of 10 years. Assume that the investor pays the average transaction cost when buying or selling stock (2.5%). Highlight potential money-losing issues in purple.

Administration: This is where you come into the picture. You need to assemble information and make a choice. The Table has only 27 Columns of metrics, but it’s a start. Column Z (NPV) is a convenient summary of the combined effects of the current dividend, its rate of growth (using the past 4 years), and the approximate capital gain that would be realized upon selling the stock ten years from now (which is arrived at by extrapolating the 16-Yr CAGR in Column K). That NPV estimate is only as good as management’s ability to build the company’s Brand while maintaining a clean Balance Sheet. 

Bottom Line: The list has the names of only 9 companies. You’ll need to invest in more than 50 growth companies (to avoid Selection Bias). But these 9 are about as problem-free as any you’ll find. Why is it so difficult to identify reliably growing companies? Because growth never lasts. It has a beginning, a middle, and an end--when sales grow only as fast as the population in the company’s “catchment area.” Competition and innovation are huge factors. One cancels out the other over time.

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

Full Disclosure: I own shares of TJX.

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