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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