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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