Sunday, September 16

Week 376 - What Does A Simple IRA Look Like?

Situation: You’re bombarded with advice about how to save for retirement. But unless you’re already rich, the details are simple. Dollar-cost average 60% of your contribution into a stock index fund and 40% into a short or intermediate-term bond index fund. If you know you’ll never be in “the upper middle class”, opt for the short-term bond index fund. But maybe you have a workplace retirement plan, which makes saving for retirement a little more complicated. Either way, you’ll want to contribute the maximum amount each year to your IRA, which is currently $5500/yr until you reach age 50; then it’s $6500/yr.

Here’s our KISS (Keep It Simple, Stupid) suggestion: Make your IRA payments with Vanguard Group by using a Simple IRA (Vanguard terminology) composed only of the Vanguard High Dividend Yield Index ETF or VYM. Then, contribute 2/3rds of that amount into Inflation-protected US Savings Bonds. These are called ISBs and work just like an IRA. No tax is due from ISBs until you spend the money but there’s a penalty for spending the money early (you’ll lose one interest payment if you cash out before 5 years). The annual contribution limit is $10,000/yr. A convenient proxy for ISBs, with similar total returns, is the Vanguard Short-Term Bond Index ETF or BSV

Mission: Create a Table showing a 60% allocation to VYM and 40% allocation to BSV. Include appropriate benchmarks, to allow the reader to create her own variation on that theme.

Execution: see Table.

Bottom Line: However you juggle the numbers, it looks like you’ll make ~7%/yr overall through your IRA + ISB retirement plan, with no taxes due until you spend the money. In other words, each year’s contribution will double in value every 10 years. The beauty of this plan is that transaction costs are almost zero, and the chance that it will give you headaches is almost zero.

Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into Inflation-protected Savings Bonds and the Dow Jones Industrial Average ETF (DIA).

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Sunday, September 9

Week 375 - Producers Of Gold, Silver And Copper In The 2017 Barron’s 500 List

Situation: Commodity producers have a dismal record. Spot prices fall whenever mining (or drilling or harvesting) becomes more efficient. To make matters worse, supply-chain management and investment has become increasingly global and professionalized. Nonetheless, copper sales remain the best barometer of fixed-asset investment, particularly the ongoing proliferation of industrial plants and equipment in China. Silver has a growing role, thanks to the buildout of solar power. And gold remains a check on the propensity of government leaders everywhere to finance their dreams with debt, as opposed to revenue from taxes.

Mission: Use our Standard Spreadsheet to highlight the largest companies producing gold, silver, and copper.

Execution: see Table.

Administration: Gold and silver prices remain stuck where they were 35 years ago but are characterized by high volatility. Commodity prices (in the aggregate) trace supercycles that last approximately 20 years. The most recent came from a 1999 low and fell back to that level in 2016; since then it has ever so slowly risen from that low.

Bottom Line: The basic rule for commodity producers is that 3 years out of 30 will be good years, and you’ll make a lot of money. But over any 20-30 year period, you’ll lose money (measured by inflation-adjusted dollars). Our Table for this week confirms these points but does show that copper (SCCO) is worth an investor’s attention. But beware! That company’s share price is falling because of a falloff in trade with China and could fall further if a trade war takes hold.

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

Full Disclosure: I do not have positions in any commodity producers aside from Exxon Mobil (XOM), but do dollar-average into the main provider of mining equipment: Caterpillar (CAT).

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Sunday, September 2

Week 374 - Bet With The House By Picking Companies In The 2 And 8 Club

Situation: In the U.S., capital-intensive industries with strategic importance are tightly regulated (see Week 230). Electric power grids and railroad networks are expensive to install, maintain and upgrade but those chores are absorbed by shareholders in private companies. Regulatory bodies grant these companies monopoly-like pricing power, oversee safety practices, and set rates high enough to pay for maintenance and upgrades. 

Since the Great Recession, international Money Center banks have also come under intense regulation to meet Basel III requirements for sustainability and reduce systemic risks. A more specific definition now replaces Money Center Bank, which is Systemically Important Financial Institution (SIFI). 

Looked at from the shareholder’s point of view, companies in these three industries have enough government regulation (and monopoly-like pricing power) that bankruptcy is no longer a material risk. One downside risk is that the US market for their goods and services is largely saturated. So, significant growth in the “bottom line” requires innovation and international outreach that will be overseen by government regulators. 

Mission: Use our Standard Spreadsheet to highlight members of “The 2 and 8 Club” that are in the Electric Utilities, SIFI banking, and Railroad industries.  

Execution: see Table.

Bottom Line: The safest tactic in gambling is to “bet with the house” whenever you can. Politicians are now in effective control of three industries: Electric utilities, railroads, and international Money Center banks (now called Systemically Important Financial Institutions or SIFIs). These industries are not in danger of being “nationalized” because politicians would much prefer that shareholders (as opposed to taxpayers) put up the large amounts of capital needed to keep these industries safe and effective. 

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

Full Disclosure: I dollar-average into NEE and JPM.

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Sunday, August 26

Week 373 - 10 Dividend Achievers In Defensive Industries That Are Suitable For Long-term Dollar-cost Averaging

Situation: Which asset class do you favor? Stocks, bonds, real estate or commodities? On a risk-adjusted basis, none of those are likely to grow your savings faster than inflation over the near term. You might want to hold off making “risk-on” investments, unless you're a speculator, because markets are likely to fluctuate more than usual. If you think a “risk-off” approach is best, then you need to pick “defensive” stocks for monthly (or quarterly) investment of a fixed dollar amount (dollar-cost averaging). To minimize transaction costs, you’ll want to invest automatically in each stock through an online Dividend Re-Investment Plan (DRIP). 

Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.

Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.

Execution: see Table.

Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.

Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M). 

Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).

Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.

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Sunday, August 19

Week 372 - DJIA Companies in “The 2 and 8 Club”

Situation: The Dow Jones Industrial Average (DJIA) is generally thought to be the most stable reflection of the stock market. As it should be. Those 30 companies are picked by the Managing Editor of the Wall Street Journal to do exactly that. Here at ITR, we have our own, less subjective, measure of stability: companies that pay a good and growing dividend. In other words, companies with a dividend yield and dividend growth rate that are as good (or better than) the DJIA’s ~2% yield and ~8% growth rate. We propose that you pick such stocks out of the DJIA, thinking you’ll just have to do better than you would have done by investing in the Exchange Traded Fund (ETF) for the DJIA (DIA), which is called “Diamonds” for good reason. 

Mission: Run our Standard Spreadsheet for the 8 companies in the DJIA that are members of “The 2 and 8 Club” (see Week 360).

Execution: see Table.

Administration: We have made two changes to “The 2 and 8 Club”: 1) Companies with a BBB+ S&P rating for their bonds are no longer accepted (see Column T in the Table); 2) all companies in the Russell 1000 Index that meet requirements (see Week 327) are included in “The 2 and 8 Club”(see Week 366). So, that phrase no longer refers specifically to companies in the S&P 100 Index.  

Bottom Line: These 8 stocks have performed remarkably well vs. DIA. Total Returns over the past 11 years (see Column C) were 26% greater, Finance Values (see Column E) were 25% better, dividend yields were almost 30% better (see Column G), dividend growth was almost 80 faster (see Column H), and the rate of price appreciation over the past 16 years was more than 70% faster (see Column K). So far so good, but the devil is in the details. We also measure risk. The story there is a bit shocking, even though these very stable companies were able to shake off challenges posed by the recent crash in commodity markets (see Column D). 

Five year price volatility was almost 25% greater (see Column I), P/E was twice as great (see Column J), and quantitative analysis of stock prices over the past 16 years predicts that losses will be almost 40% greater in the next Bear Market (see Column M). In other words, the risk-adjusted returns for these 8 companies are not significantly different than those for the DJIA. This conclusion is consistent with what we were taught in Business School, i.e., there are only two ways for a stock picker to “beat the market.” 1) use insider information (illegal), 2) take on more risk. Your best chance to beat the market without incurring more risk is to invest in the highest quality utilities, beverages, and pharmaceuticals (see Week 367).

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

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

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Sunday, August 12

Week 371 - Know What You’re Buying: Graham Numbers for “The 2 and 8 Club”

Situation: Stock prices are a function of 3 variables: book value, earnings, and market sentiment. The first two numbers come from the company’s most recent quarterly report. Market sentiment drives the movement in buy and sell orders for a particular block of shares on a public exchange. In the days before electronic trading systems took over, traders would get together after work and make back-of-the-envelope calculations of future book values and earnings for stocks that interested them. This would give them an idea about the price at which the company’s stock would open the next morning. Benjamin Graham gave traders a starting point for those discussions on page 349, Chapter 14, of his book The Intelligent Investor (cf. the Revised Edition of 2003, annotated by Jason Zweig). There he makes clear that a rational price is the square root of 15 times earnings/share (EPS) and 1.5 times book value/share (BVPS), which is the square root of 22.5 X EPS x BVPS. For example, on June 18, 2018, JP Morgan Chase & Co. (JPM) closed at $108.17, with EPS of $6.35 and BVPS of $72.00. The Graham Number equals the square root of (22.5 X 6.35 X 72 = 10,287) or $101.42. Conclusion: JPM is 6.66% overvalued ($108.17/$101.42 = 1.0666).  

Mission: Run our Standard Spreadsheet for the 22 companies in “The 2 and 8 Club” to include Graham Numbers.

Execution: see Columns Z and AA in this week’s Table.

Bottom Line: The average company on this list is overvalued by a factor of three (see Column AA), reflecting the end-of-times for the second longest Bull Market since the Great Depression. You have to ask yourself why you still own shares of a stock that is priced more than 3 times its fundamental value. Those reasons will always reflect market sentiment unless you know of a specific reason why earnings and book value are going increase above trend, and you’re almost certain it will play out that way.

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

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

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Sunday, August 5

Week 370 - Ways To Win At Stock-picking #1: Dollar-cost Average Into 10 Of The 30 DJIA Companies

Situation: You’re troubled by the dominance of the S&P 500 Index. After all, it is a derivative and you wonder whether it is really the safest and most effective way to build retirement savings. Your biggest concern is that it is a capitalization-weighted index, which is a design that favors momentum investing: Mid-Cap companies that garner investor enthusiasm become included in the S&P 500 Index because their stock is appreciating; Mid-Cap companies that have managed to be included in the S&P 500 Index investors are in danger of being excluded because investors have lost their enthusiasm and the stock’s price is falling. Many investors buy/sell shares in a company’s stock because of that trend in sentiment. Fundamental sources of value (revenue, earnings, and cash flow) often have little to do with their enthusiasm, or the fact that it has evaporated. Articles in the business press may carry greater weight, and those articles may be influenced by analyses introduced by short sellers, who are betting on a fall in price, or hedge fund traders with long positions, who are betting on a rise in price. In other words, most retail investors are paying attention to market sentiment when buying or selling shares, not due diligence that comes from a careful study of a company’s prospects and Balance Sheet. 

Your second biggest concern is likely to be that few S&P 500 companies have a good credit rating backing their debts. In other words, they’re paying too high a rate of interest on the bonds they’ve issued, or the bank loans they’ve taken out. The company’s Net Tangible Book Value is therefore likely to be drifting deeper into negative territory because of interest expenses, part of which are no longer tax deductible due to changes in U.S. tax law.

Both of these problems fall by the wayside if you invest in the 30 companies that make up the Dow Jones Industrial Average, either separately or together in the price-weighted Dow Jones Industrial Average Index (DIA at Line 18 in the Table). Investing in the “Dow” may be a little smarter for retirement savers than investing in the S&P 500 Index (SPY at Line 16 in the Table) for two reasons: 1) DIA has a dividend yield that is ~10% greater; 2) DIA pays dividends monthly, whereas, SPY pays dividends quarterly. A higher dividend yield means that your original investment is returned to you more quickly, which translates as a higher net present value, if other factors (e.g. dividend growth and long-term price appreciation) are not materially different.

Mission: Use our Standard Spreadsheet to illustrate how I dollar-cost average into stocks issued by 10 DJIA companies.

Execution: see Table.

Administration: It has been necessary to use 3 separate Dividend Re-Investment Plans (DRIPs) to dollar-cost average into the 10 DJIA stocks I’ve chosen (see Column AE in the Table). Those DRIPs automatically extract $100 each month for each of the 10 stocks; transaction costs average $18.68/yr (see Column AD), which includes automatic reinvestment of dividends. The expense ratio is 1.56% for each year’s investments, but expenses relative to Net Asset Value fall to less than 0.01% after 10-20 years.

Bottom Line: This week’s blog compares my long-standing pick of 10 Dow stocks (for an automatic monthly investment of $100 each using an online DRIP) to investing $1500/qtr in the entire 30-stock index (DIA) using a regional broker-dealer, which is something I’ve just started doing to facilitate comparison going forward. (You’ll see each year’s total returns in future blogs published the first week of July.)  

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

Full Disclosure: If one of the 10 stocks I’ve chosen is dropped from the Dow Jones Industrial Average (DJIA), I’ll sell those shares and use those dollars to start a DRIP with shares issued by another DJIA company.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Sunday, July 29

Week 369 - High Quality Producers & Transporters of Industrial Commodities in the 2017 Barron’s 500

Situation: Here in the U.S., debt/capita is growing at an alarming rate and is now greater than $60,000. U.S. Government debt is almost $20 Trillion and has been growing at a rate of 5.5%/yr (i.e., twice as fast as inflation) since 1990. By 2020, the Federal budget deficit will start to exceed $1 Trillion/Yr and the dollar’s status as the world’s reserve currency will be threatened. The gold reserves that stand behind the U.S. dollar (currently worth ~$185 Billion) would have to be increased on a regular basis, as would foreign currency reserves (currently worth ~$125 Billion)

The US economy is no longer capable of growing fast enough to balance the budget for even a single year, without introducing draconian measures. Nonetheless, it is worth noting that those can be effective given that Greece appears to have emerged from that process successfully. But the U.S. could not go through that process and still remain the “top dog” militarily. So, the trade-weighted value of the U.S. dollar will fall at some point, and we will no longer be able to afford imported goods and services. Before that happens, U.S. citizens will need to gradually move their retirement savings into commodity-related investments, as well as bonds and stocks issued in reserve currencies other than the U.S. dollar. 

Mission: Use our Standard Spreadsheet to highlight large U.S. and Canadian companies that produce, refine and transport raw commodities, i.e., materials that are extracted from the ground. Select such companies from the 2017 Barron’s 500 list, but exclude any that issue bonds with an S&P rating lower than A- or stocks with an S&P rating lower than B+/M. 

Execution: see Table.

Administration: The S&P Commodity Index has the following components and weightings:
Natural Gas (17.66%)
Unleaded Gas (12.16%)
Heating Oil (12.13%)
Crude Oil (11.41%)
Wheat (5.15%)
Live Cattle (4.87%)
Corn (4.48%)
Coffee (3.88%)
Soybeans (3.84%)
Sugar (3.80%)
Silver (3.67%)
Copper (3.39%)
Cotton (3.22%)
Soybean Oil (2.98%)
Cocoa (2.79%)
Soybean Meal (2.57%)
Lean Hogs (2.04%)

53.36% of the index represents petroleum products, 32.71% represents row crops, 7.06% represents industrial metals, and 6.91% represents live animals. Ground has to be mined, drilled, or planted & harvested with the help of heavy equipment to yield raw commodities. Those have to be transported by barge, rail, truck, or pipeline before being processed for market. 

We find 8 companies that warrant inclusion in this week’s Table. Seven are obviously appropriate, but the presence of Berkshire Hathaway (BRK-B) needs some explanation (unless you already know it owns the Burlington Northern & Santa Fe railroad). Berkshire Hathaway is the largest shareholder of Phillips 66 (PSX), which has 13 oil refineries and supplies diesel for the largest marketing outlet of that fuel: Pilot Flying J Centers LLC. Berkshire Hathaway purchased 38.6% of that company’s stock on October 3, 2017, and plans to increase its stake in 2023 to 80%.

Bottom Line: Commodity futures haven’t been a good investment, given that their aggregate value is back to where it was 25 years ago, given that the most recent 20-year supercycle recently finished and another is just starting. Nonetheless, the companies that produce, process, and transport those commodities did well over those 25 years (see Column AB in Table). The problem is the volatility of their stocks (see Column M in the Table), and the extent to which their stocks get whacked when commodities become oversupplied relative to demand (see Column D in the Table). If you choose to own shares in these companies (aside from CNI, BRK-B and perhaps UNP), you’d be flat-out gambling. 

Risk Rating: 7-9 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into UNP, ADM, CAT and XOM, and also own shares of CNI and BRK-B.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Sunday, July 22

Week 368 - Are You A Baby Boomer (54 to 72 years old) With Only $25,000 In Retirement Savings?

Situation: Here in the United States, a third of you have less than $25,000 in Retirement Savings.

Mission: Assess options for a healthy married couple with a household income of $59,000/yr, whose breadwinner will retire when he or she reaches age 66 and the household starts receiving an initial Social Security check of $2,123/mo . Assume that they have $25,000 in retirement savings in an IRA, with an initial payout of $75/mo.

Execution: see Table.

Administration: The options for the couple to receive an income from their $25,000 IRA are unattractive. They’ll need a relatively safe way to come up with an income of 3-4%/yr from that $25,000, a way that grows the principal at least as fast as inflation (historically 3.1%/yr). That growth rate can be predicted from the 5-yr growth rate for the quarterly dividend. To have enough confidence in that stream of income, their only option is to find half a dozen high-quality stocks with low price variance (5-yr Beta less than 0.7) and secure dividends. 

They should be able to live reasonably well on $2,198/mo, given that the poverty line for a household of two is $1,372/mo. But let’s break it down: They’ll pay at least $900/mo for housing (rent, tenant’s insurance, and utilities), so they’re left with $1,300/mo to cover the consumer price index categories of food and beverages, apparel, transportation, medical care, recreation, education and communication, and other goods and services. “Other goods and services” include restaurant meals, delivery services, and cigarettes. Food will cost at least $250/mo. Now they’re down to ~$1,050/mo to cover clothing, car expenses, Medicare premium plus deductibles and co-payments, smartphones, meals out, vacations, delivery services, and cigarettes. Owning, maintaining, and operating a used car for 5,000 miles/yr will cost ~$625/mo, which leaves $425/mo for clothing, healthcare, smartphones, meals out, vacations, delivery services, and cigarettes. To avoid selling the car, one of them will need to find a part-time job. New clothes, dining out, and travel will be hard to fund. Out-of-pocket healthcare costs will go up, so they’ll need to save money by avoiding alcohol, tobacco, caffeine, and sweets. 

Bottom Line: When a couple is facing a retirement that will be funded only by the average Social Security payout at full retirement age ($25,476/yr), they won’t be living much above the Federal Poverty Level for a household of two ($16,460/yr). It they own a home, they’ll no longer be able to afford to maintain it and pay property taxes. So, they’ll need to sell it and invest the residual equity. Maintaining their car will barely be affordable. Having $25,000 in an IRA will help, but a third of couples in their situation will retire with an even smaller cushion. In our Table for this week, we show how $75/mo is the expected income from an IRA of $25,000 value that has an average dividend yield of 3.6%/yr.

Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into NEE, KO, and JNJ.

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Sunday, July 15

Week 367 - Safe and Effective Stocks

Situation: The stock market is becalmed, waiting for wind to fill its sails. "Risk-On" investors seem to be out of ideas, except for a renewal of interest in the energy sector. The bond market is experiencing hard-to-predict volatility. Safe stocks that will grow your money effectively are hard to find. The formula for Net Present Value tells us that more value is found when your original investment is returned to you quickly. Therefore, an “effective” stock is one that pays a good and growing dividend. 

Mission:Safe stocks” = an oxymoron. Basically, we’re looking for a group of high-quality stocks issued by companies in “defensive” industries (Utilities, HealthCare, Consumer Staples, and Communication Services). “Effective stocks” are those that a) pay an above-market dividend, b) grow that dividend at an above-market rate, and c) have an above-market 16-Yr CAGR. Our reference for the “market” is the Dow Jones Industrial Average ETF (DIA). 

Execution: see Table.

Administration: What are “high-quality” stocks? Those are either “Blue Chips” (see Week 361) or members of “The 2 and 8 Club” (see Week 327 and Week 348) plus its Extended Version (see Week 362). “Safe and effective” stocks are those that have no red highlights in Columns D, E, G, I, K, and M of the reference Tables. (Red highlights indicate underperformance vs. DIA.) In addition, we require that the company be a Dividend Achiever, and that its long-term bonds have an S&P rating of A- or better (see Column T).   

Bottom Line: We find that only 5 companies issue “safe and effective” stocks (see Table). Were you to own shares of similar value in all 5, you wouldn’t be gambling. In other words, your risk-adjusted returns would likely “beat the market” by 1-2%/yr over a market cycle. But your transaction costs would also be 1-2% higher vs. owning shares in the leading S&P 500 Index Fund (SPY).  

Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into NEE, KO, and JNJ.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Sunday, July 8

Week 366 - A Capitalization-weighted Watch List for Russell 1000 Companies

Situation: Every stock-picker needs to confine her attention to a manageable list of companies, called a “Watch List.” Here at ITR, the focus is on investing for retirement. So, our interest is in companies that have a higher dividend yield than the S&P 500 Index. Why? Because your original investment will be returned to you faster, which automatically gives your portfolio a higher “net present value” than a portfolio composed of companies that pay either no dividend or a small dividend. Once you’ve retired, you’ll switch from reinvesting dividends to spending dividends.

Mission: Assemble a Watch List composed of companies that are “Blue Chips” (see Week 361), companies that are in “The 2 and 8 Club” (see Week 344), and companies that are in the Extended Version of “The 2 and 8 Club” (see Week 362). 

Execution: see Table.

Bottom Line: If you’re saving for retirement and would like to pick some individual stocks to supplement your index funds, here is an effective and reasonably safe Watch List. However, the mutual funds that pick individual stocks haven’t done very well compared to benchmark index funds. So, your chances of doing well as a stock-picker also aren’t good. But index funds like the SPDR S&P 500 (SPY) expose you to significant downside risk. There is one conservatively managed mutual fund that we think is an excellent retirement investment, the Vanguard Wellesley Income Fund, which is mostly composed of bonds. Your risk of loss from owning VWINX is less than half that from owning SPY; the 10-Yr Total Return is 7.0%/yr vs. 9.0%/yr for SPY.

Risk Rating for our Watch List: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).

Full Disclosure: I dollar-average into MSFT, JPM, XOM, WMT, PG, KO, IBM, CAT and NEE, and also own shares of GOOGL, CSCO, MCD, MMM, TRV, CMI and ADM.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Sunday, July 1

Week 365 - “Dogs of the Dow” (Mid-Year Review)

Situation: The 10 highest-yielding stocks in the Dow Jones Industrial Average are called The Dogs of the Dow (see Week 305 and Week 346). The only time-tested formula for beating an index fund (specifically the Dow Jones Industrial Average) is based on investing equal dollar amounts in each Dog at the start of the year. That would have worked in 6 of the past 8 years. Why? Because those are high quality stocks that have suffered a price decline and are likely to recover within ~2 years, which would lower their dividend yield and release them from the “Dog pen.” 

Mission: Predict which Dogs will emerge from the Dog pen by the end of 2018, using our Standard Spreadsheet.

Execution: see Table.

Administration: For various reasons, the 2018 Dogs are unlikely to post greater total returns this year than the Dow Jones Industrial Average (DIA). But we can still try to play the game by predicting which of this year’s Dogs will be missing from next year’s Dog pen. Those will probably come from those posting lower dividend yields at the mid-year point (see Column G in the Table): Coca-Cola (KO), Cisco Systems (CSCO), General Electric (GE), Merck (MRK) and Chevron (CVX).

Bottom Line: Given current trends, Cisco Systems (CSCO) and Chevron (CVX) are likely to be released from the Dog pen at the end of the year.

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

Full Disclosure: I dollar-average into KO, PG, XOM and IBM, and also own shares of CSCO.


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Sunday, June 24

Week 364 - Ethanol Producers

Situation: “Market research analysts at Technavio have predicted that the global bio-fuels market will grow steadily at a CAGR of almost 6% by 2020”. But arguments against blending ethanol with gasoline are building. In 2016, 15.2 billion gallons were produced at 214 plants, with Archer Daniels Midland (ADM), Valero Energy (VLO) and Green Plains Renewable Energy (GPRE) being the main publicly-traded producers. For example, those 3 companies operate 4 ethanol plants in Nebraska that together produced 2.2 billion gallons, representing 31% of the state’s crop. Not only is fuel a big business for the agriculture sector, but the by-product (“distillers grains”) is a rich source of animal feed. For every ton of ethanol produced, there are 0.24 tons of distillers grains

You need to think of ethanol plants as a permanent feature of the Corn Belt, i.e., the 11 states of the Upper Midwest. Government subsidies for ethanol plants in Europe and the United States aren’t going away, for two important reasons. Ethanol is a renewable fuel, and adding it to gasoline makes tailpipe emissions less damaging to the atmosphere. Furthermore, ethanol plants represent the only stable market for the dominant farm product of those 11 states (North Dakota, South Dakota, Nebraska, Kansas, Minnesota, Iowa, Missouri, Wisconsin, Illinois, Indiana, and Ohio). But, before you buy shares in one of the 6 companies we highlight here, you need to understand a number of factors that impact the feedstocks and ultimate markets served by those plants. Start by reading this summary prepared for Green Plains (GPRE) investors.

Mission: Analyze the 6 publicly-traded US companies in the ethanol business, using our Standard Spreadsheet.

Execution: see Table.

Administration: Ethanol plants have changed the lives of farmers in the Corn Belt from being a speculator to being a professional businessman. Iowa, the state that produces the most corn, almost exclusively grows #2 field corn  destined for ethanol plants. 20% of that corn becomes “distillers grains”, and dry distillers grains are shelf-stable and greatly valued as animal feed all over the world. So, that’s a stable and global market. And, ethanol is increasingly being shipped out of the US, either separately or blended with gasoline. For example, China recently adopted the same 10% ethanol content requirement for gasoline that the US has been using. That is seen as an export opportunity for US ethanol plants.

Bottom Line: Corn Belt = ethanol plants. That’s the equation you need to remember. It’s all based on #2 field corn. The #1 sweet corn that we like to eat is rarely grown in the Corn Belt. A state outside the Corn Belt (Washington) is the leading producer. But it’s only been 11 years since the Bush Administration pushed Congress to blend 10% ethanol with gasoline. Yes, hundreds of ethanol plants were built as a result but the economics of running those plants is only now being sorted out. If you invest in any those, you’re a speculator by definition. 

Addendum: Here’s the definition of a red line for “speculation” given in the May 28, 2018 Bloomberg Businessweek on page 8: “...a conservative threshold for volatility, typically lower than that of the broader market for relevant assets…” Column M in all of our tables lists the 16-year volatility of each company (with the required trading record) and highlights in red those that have a greater volatility than the Dow Jones Industrial Average (DIA). Of the 6 companies in this week’s Table, even Archer Daniels Midland (ADM), the longest-established (and highest rated by S&P) company, has a volatility well above that of DIA.

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

Full Disclosure: I dollar-average into Archer Daniels Midland (ADM), which is a member of “The 2 and 8 Club” (Extended Version; see Week 362).

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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

Sunday, June 17

Week 363 - Big Pharma

Situation: There are 11 pharmaceutical companies in the S&P 100 Index, with an average market capitalization of ~$130 Billion. Stocks issued by healthcare companies (including  hospital chains, pharmacy benefit managers, medical insurance vendors, and drugstores) are thought to be defensive “risk-off” bets, like stocks issued by utility, communication services, or consumer staples companies. But they’re not. Healthcare consumes almost 20% of GDP but it is a highly fragmented industry, rife with government interference seeking full control. Medical innovation for the entire planet has to take place in the United States because the healthcare industry is socialized elsewhere and large amounts of private capital are needed to conduct clinical trials. That innovation makes US healthcare into an ongoing research enterprise. For biotechnology companies, there is an ever-present risk of being eclipsed by another company’s research team. Stockpickers who have some appreciation for biochemistry can perhaps identify biotechnology groups that are onto a good thing. But Big Pharma companies survive by looking to buy those same startups. Can you really scope-out a “good thing” better than their scientists?

Mission: Run our Standard Spreadsheet for the 11 pharmaceutical companies in the S&P 100 Index.

Execution: see Table.

Bottom Line: This is not a game for the retail investor. All she can do is buy stock in one or two of the 11 “Big Pharma” companies, and hope that its CEO can find small biotechnology groups conducting breakthrough science, then buy at least one a year to throw money at. That’s an iffy business. Why? Because large-scale clinical studies (costing hundreds of million dollars) have to be conducted before the bet pays off. Usually it doesn’t. If you’re a stock-picker new to this industry, start by researching the old standbys that reliably pay good dividends: Johnson & Johnson (JNJ), Merck (MRK), Pfizer (PFE) and Eli Lilly (LLY). 

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

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

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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

Sunday, June 10

Week 362 - “The 2 and 8 Club” (Extended Version) = Non-S&P 100 Companies In The Russell 1000 Index

Situation: The risk of loss from owning small-capitalization stocks vs. large-capitalization stocks is material, i.e., greater than 5%. Stocks in the S&P 100 Index are safest to own, given that those are required to have actively-traded Put and Call options on the CBOE (Chicago Board Option Exchange), and are usually followed by at least a dozen analysts. Large companies also have the advantage of multiple product lines, one of which is likely to do well in a recession. This same lack of uncertainty makes their stocks boring to own, even though a number of S&P 100 stocks are statistically more likely to weather a Bear Market than the S&P 500 Index (see Column M in any of our Tables). Index investing is even more boring and predictable. 

You’re left trying to find a winner among the other 900 companies of The Russell 1000 Index. A sign that you’ve selected well for your investment occurs when you find that company highlighted in a Wall Street Journal article. Our blog for this week tries to help you do exactly that. We’ve already found a handy way to identify trendy S&P 500 companies, which we call “The 2 and 8 Club” (see Week 348). And, we published an Extended Version (see Week 350) that takes you through promising companies in The Barron’s 500 List

Caveat Emptor:The 2 and 8 Club” focuses exclusively on companies in The Russell 1000 Index that have historically paid an above-market dividend and are judged (by The Financial Times) likely to continue doing so. That means they’re bond-like, and attract investors because of the near-certainty that they will continue to pay a good and growing dividend. The downside of this benefit is that price appreciation will flatten and decline in a rising interest rate environment, just as bond prices do. Why? Because of competition from newly-issued bonds that pay a higher rate of interest and have less risk of default. 

Mission: This week we double-down and identify putative winners in The Russell 1000 Index.

Execution: see Table.

Administration: Rules for membership in “The 2 and 8 Club”: 
   1) The company is listed on the FTSE High Dividend Yield Index (US), which contains the ~400 highest-yielding companies in the Russell 1000 Index. Those are companies that have historically paid an above-market dividend (usually ~2%) without reducing that payout in periods of market stress.
   2) The company has raised its regular quarterly dividend at least 8%/yr over the past 5 years.
   3) The company’s bonds carry an S&P Rating of at least BBB+.
   4) The company’s stock carries an S&P Rating of at least B+/M.
   5) The company’s end-of-week stock price has been analyzed quantitatively by using the BMW Method for the past 16 years.
   6) The company is graded annually as to cash flow trends and revenue growth by the editors of Barron’s.
   7) The company is required to be a Dividend Achiever, to offset the risk of loss of carried by these companies because of being less well capitalized than those in the S&P 100 Index.

Bottom Line: Of the 7 companies in this week’s Table, only two are reasonably safe bets: The Travelers (TRV) and WEC Energy (WEC). In other words, their risk of loss in the next Bear Market is lower than that for investors in the Dow Jones Industrial Average ETF (DIA) (see Column M of the Table). So, why not simply buy shares of DIA instead of gambling on one of the other 5 companies? After all, DIA has an ~2% dividend yield and grows its dividend ~8%/yr. Answer: You’re a speculator and think you can do better than settle for the 7-8% long-term Total Return/Yr you’d realize from owning shares of DIA.

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

Full Disclosure: I own shares of The Travelers (TRV) and Cummins (CMI).

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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

Sunday, June 3

Week 361 - Blue Chips

Situation: What is a “Blue Chip” stock, and why should you think highly of such stocks? There are several definitions but traders are generally talking about a stock in the Dow Jones Industrial Average when they use the phrase “Blue Chip.” More generally, they’re talking about a very large company that pays a good and growing dividend, and has a trading record that covers at least the past 40 years. This also includes any very large company that has a negligible risk of bankruptcy. These characteristics are important because traders think Blue Chip stocks are the only relatively safe bets for a “buy-and-hold” investor to place. Warren Buffett often highlights the importance of these same characteristics whenever he’s being interviewed, and Berkshire Hathaway (BRK-B) owns shares in several: Apple (AAPL), Coca-Cola (KO), International Business Machines (IBM), Johnson & Johnson (JNJ), Procter & Gamble (PG) and Walmart (WMT).

Mission: Develop specific definitions for the above characteristics, and list all companies that meet those definitions. Use our Standard Spreadsheet to analyze those companies.

Execution: see Table.

Administration: Here are my specific definitions for the qualitative terms used above:
   "A very large company"Any company in the S&P 100 Index (OEF)

   "A good dividend": Any company in the Vanguard High Dividend Yield Index (VYM)

   "A growing dividend": Any company in the Powershares Dividend Achiever Portfolio (PFM)

   "A 40+ year trading record": Any company in the 40-Yr BMW Method Portfolio

   "A negligible risk of bankruptcy": Any very large company issuing bonds that carry an S&P Rating of AA+ or AAA. There are only 5 such companies: Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), Johnson & Johnson (JNJ), and Exxon Mobil (XOM). 

Bottom Line: If you want to include common stocks in your retirement portfolio, Blue Chips are the ones you’ll want to Buy and Hold, provided you buy shares in at least half a dozen. Those that carry a statistical risk of loss greater than “The “Dow” (DIA, see Column M in the Table) best purchased by dollar-cost averaging. But the 6 that carry no more than a Market Risk can be owned by using a “buy the dip” strategy: MCD, PEP, KO, JNJ, PG and WMT. Of course, those are still stocks and market volatility will still affect their prices. 

Caveat Emptor: Corporate debt has been steadily increasing over most of the past 10 years. Why? Because the Federal Reserve reduced to cost of borrowing money to almost nothing. So, pay attention to companies that have purple highlights in Columns P and R (see Table). In the next recession, you’ll be surprised how far their stock prices will fall.

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

Full Disclosure: I dollar-average into KO, JNJ, PG, MSFT, WMT, IBM, CAT and XOM, and also own shares of MCD and MMM.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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