Sunday, August 27

Week 321 - Managing Risk in a Stock Portfolio

Situation: Risk is the likelihood that the market will move against your position. You can use statistics to estimate the frequency and severity of such a move. That analysis starts by calculating the trendline for weekly price changes over multi-year periods (e.g. 20 years) by using the BMW Method. Looking at the S&P 500 Index (^GSPC), we see that prices have appreciated 4.9%/yr. In the upper left corner of that display, the Return Factor (RF) denotes the 0.68% reduction (or gain) of price at 2 Standard Deviations from trendline, i.e., a 32% loss (or gain). It has happened twice in the past 20 years. Prices rose almost 32% from trendline in early 2000 and fell more than 32% from trendline in 2008. We consistently list that predicted loss/gain for each stock at Column M in our tables, using a red highlight that percent is greater than 2 Standard Deviations from the percent for ^GSPC. For the non-professional, owning shares in such a stock represents a gamble. 

Mission: Screen stocks by using the BMW Method for the 20 year holding period, selecting those that do not appear to be a gamble, i.e., deviate 32% or less from trendline. Exclude any that aren’t in the 2017 Barron’s 500 List. Also exclude any that can’t beat SPY (the SPDR S&P 500 Index ETF) in terms of total return/yr over the past 10 years (Column C in the Table) and price appreciation over the past 20 years. We also exclude companies that don’t have a Finance Value (Column E in the Table) that exceeds that for SPY. Over 90% of the stocks passing these screens are Dividend Achievers. We have excluded the two that aren’t.

Execution: see Table

Bottom Line: You’re goal is to beat the lowest-cost S&P 500 Index Fund (VFINX) while incurring less risk, but you can’t do that unless your total return over a multi-year period is 2-3%/yr greater. Why? Because an active trader incurs significant transaction costs and capital-gains taxes, neither of which materially affect returns from VFINX. You’ll need a plan. Start by diversifying your investments and taking Warren Buffett’s advice to dollar-cost average. To keep transaction costs low, you’ll have to “cut out the middleman” and resort to an online service like computershare. It is designed to facilitate dividend reinvestment and dollar-cost averaging. 

Given that a large element of risk is introduced by selection bias, you’ll want to ameliorate that risk by investing in at least 20 companies and taking care to pick companies that have less statistical risk than the S&P 500 Index. This week’s Table has 22 for you to consider. 

Risk Rating (for aggregate of 22 stocks): 5 (where a 10-Yr Treasury Note = 1, the S&P 500 Index = 5, and gold = 10)

Full Disclosure: I dollar-average into JNJ and NEE, and also own shares of HRL, MMM, CNI, and ABT.

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

Sunday, August 20

Week 320 - Key Players In The Food Chain That Have Tangible Book Value

Situation: As a stock-picker, you need to invest some of your assets in mature industries. Those are the industries where sales growth is a function of population growth. Companies in those industries typically retain value during recessions. Food & beverage companies are the prime example.

Mission: Set up a spreadsheet of key players in the food chain. Exclude any that do not have positive net Tangible Book Value. Why? Because the SEC requires that before a company can issue stock for sale on a public exchange. Include S&P stock and bond ratings, as well as key Balance Sheet debt ratios. Determine whether Free Cash Flow (FCF) covered company dividend payments for the last two quarters. Determine whether the company is an efficient deployer of capital by comparing Weighted Average Cost of Capital (WACC) to Return on Invested Capital (ROIC). The latter number should be at least twice the former.

Execution: see Table.

Administration: You’re a stock-picker because you think you have a strategy for beating a broad market index fund (e.g. SPY). You’re unlikely to succeed unless you avoid paying Capital Gains taxes until after you drop into a lower tax bracket (i.e., retire). Try to stick with companies that issue A-rated bonds and stocks, and practice other risk-reducing measures (e.g. deploy capital efficiently, have a clean Balance Sheet, and build a strong brand). 

You’re also unlikely to succeed if you invest in a volatile stock, i.e., one where the price varies more widely than the price of the S&P 500 Index. We identify that 3 ways:
1) Stock price change vs. change in the S&P 500 Index is greater in response to withdrawal of a key market support, e.g. the cost of taking out a loan or buying a house goes up 20%, or spot prices for key commodities go down 20% (see Column D in any of our Tables);
2) 5-Yr Beta exceeds 1 (see Column I in any of our Tables);
3) 16-Yr stock price volatility is statistically greater than S&P 500 Index volatility per the BMW Method, which we highlight in red (see Column M of any of our Tables).

Bottom Line: We have uncovered only 2 “buy-and-hold” stocks: Costco Wholesale (COST) and Coca-Cola (KO). Consider investing in a sector fund, e.g. SPDR Consumer Staples Select Sector ETF (XLP).

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

Full Disclosure: I dollar-average into KO and MON, and also own shares of HRL, COST, AGU, and WMT.

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

Sunday, August 13

Week 319 - A-rated Russell 1000 Companies With Tangible Book Value That Pay A "Good and Growing" Dividend

Last week, we surveyed A-rated companies in the 65-stock Dow Jones Composite Index with positive Tangible Book Value. It turned out there are 9 such companies for your Watch List. These 9 stocks constitute the latest version of our Growing Perpetuity Index (see Week 261 for background). This week, we survey all other companies in the Russell 1000 Index that pay a “good and growing” dividend and meet those requirements. There are 11 such companies, bringing the total number to 20.

Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 16 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers

Bottom Line: Our blog is centered on the idea that stock-picking can be a safe and effective way to save for retirement. These 20 companies in the Russell 1000 Index (including the 9 from last week) represent our best effort to create a concise “Watch List” for stock-pickers. But be aware: A safer and more efficient approach is to invest in the Vanguard High Dividend Yield ETF (VYM). Then you won’t be forced (through painful experience) to learn about economics.

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

Full Disclosure: I own shares of HRL.

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

Sunday, August 6

Week 318 - Growing Perpetuity Index: A-Rated Dow Jones Composite Companies With Tangible Book Value that pay a “Good and Growing” Dividend

Situation: You need a way to save for retirement that is safe and effective. We agree with Warren Buffett’s approach which is to use a low-cost S&P 500 Index fund combined with a low-cost short-intermediate term US Treasury fund. If you’re wealthy, make the stock:bond mix 90:10. If not, move toward a 50:50 mix.

If you’re a stock-picker but fully employed outside the financial services industry, find a formula that won’t require a lot of your time for oversight and maintenance. The S&P 500 Index has too many stocks, so stick to analyzing the Dow Jones Composite Index. Those stocks have been picked by the Managing Editor of the Wall Street Journal. Start with the 20 companies in that 65-stock index that pay at least a “market dividend” and are Dividend Achievers, i.e., have raised their dividend annually for at least the past 10 years. We call that shortened version The Growing Perpetuity Index (see Week 261). It also excludes companies with less than a BBB+ S&P Bond Rating or  B+/M S&P Stock Rating. But companies with with ratings lower than A- tend to develop problems, as do companies with negative net Tangible Book Value. (The SEC requires that the sale of newly-issued shares on a US stock exchange not dilute a company’s net Tangible Book Value below zero.) 

Mission: Revise “The Growing Perpetuity Index” to exclude companies with negative Tangible Book Value, as well as companies with an S&P Bond Rating less than A- or an S&P Stock Rating less than A-/M.

Execution: We’re down to 9 companies (see Table).

Administration: Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 14 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers

In next week’s blog, we highlight the 11 companies in VYM that aren’t in the Dow Jones Composite Index. Then you’ll need to track only 20 companies on your adventure into stock-picking! But be aware: 30% of those 20 companies are boring utilities, meaning that clear-eyed stock-picking isn’t glamorous at all. It’s just making money by not losing money, which is Warren Buffett’s #1 Rule.

Bottom Line: Stock-picking becomes a problem for non-gamblers at the Go/No-Go point, i.e., after 5 years of trying, you need to think about giving up if you can’t beat the total return/yr for an S&P 500 Index fund (SPY or VFINX) by at least 2%/yr. This is because you need to cover your greater transaction costs and capital gains taxes that are being expensed out. We’re suggesting that you start with 9 “blue chip” stocks that have a reasonable likelihood of letting you stay in the game after a 5 year probation period. Of course, you’d be opening yourself up to selection bias because there is a greater risk of loss vs. investing in all 500 stocks. Academic studies have shown that you’d need to own shares in at least 50 companies to largely overcome that risk.

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

Full Disclosure: I dollar-average into NEE, MSFT, JNJ, KO, and UNP. I also own shares of MMM, TRV, and WMT.

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