Sunday, November 11

Week 384 - Which Dividend Achievers Are Likely To Be Safe & Effective Investments?

Situation: The US stock market is overpriced, as we have documented in recent blogs (see Week 378, Week 379, Week 380). So, the question becomes: Which companies will retain value (relatively speaking) during a correction, yet continue to reliably grow their earnings? We’re likely to find such companies in the 3 remaining Defensive Industries (Utilities, Consumer Staples, and HealthCare). S&P’s Defensive Sector used to include Telecommunication Services but that Industry has recently merged Media to become Communication Services. Newly added companies include Netflix (NFLX), Facebook (FB), Alphabet (GOOGL), Twitter (TWTR), Comcast (CMCSA), and Disney (DIS) -- all of which are Growth companies (as opposed to less risky companies in Defensive Industries).

Mission: Use our Standard Spreadsheet to analyze high-quality companies in Defensive Industries that have increased their dividend annually for at least the past 10 years (earning the S&P designation of Dividend Achiever).

Execution: see Table.

Administration: First, we need to define terms.

SAFE:
1) 16-Yr price volatility is less than that for the Dow Jones Industrial Average ETF (DIA -- see Column M in the Table); 
2) 3-Yr Beta is less than 0.7 (see Column I in the Table); 
3) 7-Yr P/E is less than 36 (see Column Z in the Table);
4) S&P Rating on bonds issued by the company is A- or better (see Column R in the Table). 

EFFECTIVE: 
1) 16-Yr price appreciation is at least 1/3rd as great as 16-Yr price volatility (compare Columns K and M in the Table);
2) S&P stock rating is at least A-/M and S&P Stars rating is at least 3 (see Column S in the Table).

Bottom Line: To be clear, there is no such thing as a “safe” stock. When confidence in the company’s future cash flow evaporates, the stock is quickly priced at Tangible Book Value (TBV) per share. That value is out of reach to stockholders in the event of bankruptcy, since it serves as collateral for the company’s bond issues. So, this week’s blog has 4 criteria for safety (plus S&P’s criteria for its Dividend Achiever designation). When those are added to criteria for relatively stable price performance over the past 16 years, we are left with only 9 stocks to consider. Ask Santa Claus to put a sampling of those in your stocking this Christmas.  

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

Full Disclosure: I dollar-average into NEE, JNJ, PG, WMT and DIA, and also own shares in PEP and HRL.

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Sunday, November 4

Week 383 - Dow Theory: A Primary Uptrend Resumed on 9/20/2018

Situation: The Dow Jones Industrial Average (DJIA) fell 9% from the end of January to the end of March because of a developing trade war. The Dow Jones Transportation Average (DJTA) confirmed this move, suggesting that a new primary downtrend was developing. However, neither the DJIA nor the DJTA reached previous lows. By 9/20/2018, the DJIA reached a new high confirming the new high reached a month earlier by the DJTA. So, the decade-long primary uptrend had resumed after an 8-month hiccup. Why? Because trade war fears had abated. 

Both the DJIA (DIA) and DJTA (ITY) have out-performed Berkshire Hathaway (BRK-B) over the past 5 years, which is unusual. This leads stock-pickers to pay more attention to the stocks that are most heavily weighted in constructing those price-weighted indices. 

Mission: Take a close look at the top 10 companies in each index by applying our Standard Spreadsheet.

Execution: see Table.

Bottom Line: Eleven of the 20 companies issue bonds that carry an S&P rating of A- or better, and 6 of those 11 carry an S&P stock rating of A-/M or better: Home Depot (HD), UnitedHealth (UNH), 3M (MMM), Boeing (BA), International Business Machines (IBM), and Union Pacific (UNP). In that group, only IBM has failed to outperform BRK-B over the past 5 and 10 year periods.

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

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Sunday, October 28

Week 382 - Steady Eddies

Situation: Some high-quality companies don’t pay good and growing dividends, don’t have high sustainability (ESG) scores, and aren’t blue chips, but do hold up well in bear markets. In theory, a hedge fund will take long positions in such companies (until retail investors take notice and the shares become overpriced). After reading this preamble, you’ll have figured out that we’re mostly talking about utilities. But that’s OK. You can still dollar-average into the non-utilities and do well, even though they’re often overpriced.

Mission: Run our Standard Spreadsheet on companies with A- or better S&P bond ratings and B+/L or better S&P stock ratings. Exclude companies in popular categories: “The 2 and 8 Club” (see Week 380), Blue Chips (see Week 379), the Dow Jones Industrial Average (see Week 378), and Sustainability Leaders (see Week 377). Also exclude companies that don’t do well in Bear Markets (see Column D in any of our Tables).

Execution: see Table.

Administration: This is a work in progress. The 7 examples in the Table are well-known to me; no doubt there are others in the S&P Index

Bottom Line: A smart investor knows that a Bear Market in a particular S&P industry will usually begin with little or no warning. By the time she starts to think about selling shares, it’s too late. Some kind of insurance will have to be in place before that happens. Warren Buffett’s well-known recommendation is that you dollar-average your stock investments and back those up with a short-term investment-grade bond fund. (He also recommends that you avoid the two habits that in his experience are likely to derail investors: drinking alcohol and borrowing money.) Here we add a third option, which is to find stocks that “fly under the radar” and hold up well in a Bear Market.

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

Full Disclosure: I own shares of HRL.

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Sunday, October 21

Week 381 - Dividend-paying Production Agriculture Companies

Situation: Now we come to feeding the planet. Yes, row crops are a commodity so spot prices can go to extremes and stay there awhile. And yes, agricultural equipment makers can only sell product if farmers have money to spend. On the other hand, there have been improvements in satellite-based technology, 3rd party logistics, and financial services that dial back much of the risk introduced by weather. However, markets and prices have become sufficiently reliable that major countries no longer back up food supplies with large reserves. Similarly, investors are left to cope with consolidation brought on by global sourcing and improvements in planting and harvesting technologies. The supply chains for insecticides, herbicides, fungicides, and fertilizer have been disrupted to such a degree that companies have had to enter into wave after wave of cross-border merger & acquisition activity. To their credit, Dow Chemical and DuPont are US leaders in the Ag Chemical space who have merged without bringing in companies from other countries. Even DowDuPont will have to split into 3 companies in order to devote one enterprise to Ag Chemicals and Seed Development: Corteva Agriscience

Mission: Highlight the leading companies that support farm production by using our Standard Spreadsheet. Include beef, pork, and poultry processors that have a controlling interest in animal breeding and egg production facilities. Include IBM because it has a monopoly on weather satellites and owns The Weather Channel.

Execution: see Table.

Bottom Line: This is a dicey area for investors, even those who make a study of it. The good news is that the common stocks in all 10 companies remain reasonably priced (see Columns Y-AA), which is saying a lot.

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

Full Disclosure: I dollar-average into IBM and CAT, and own shares of HRL.

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

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Sunday, October 14

Week 380 - Are Stocks in “The 2 and 8 Club” Overpriced?

Situation: There’s a lot of talk suggesting that an “overpriced” stock market is headed for a fall. And sure, stocks do have rich valuations because the Federal Reserve has kept money cheap for 10 years and bonds don’t pay enough interest to compete for investor’s money (because the Federal Reserve bought up long-dated bonds). Now the Federal Reserve is determined to reverse those policies and investors are having to get used to the idea that stocks will revert to true value. But we have to specify which metrics define “overpriced” and use at least two of those before concluding that a particular stock is overpriced (see our blogs for the past two weeks).

Mission: Run our Standard Spreadsheet, using colors in Columns Y and Z to highlight Graham Numbers and 7-Yr P/Es that are overpriced (purple) or underpriced (green).

Execution: see Table.

Bottom Line: In the aggregate, the 32 stocks in “The 2 and 8 Club” have Graham Numbers that are more than 200% of their current valuation. This leaves room for at least a 50% fall from present prices. However, our confirmation metric does not support such a dire prediction: The average 7-Yr P/E is a little under the upper limit of the normal range for valuations (25). 

Stocks issued by some companies appear to clearly be overpriced, in that the Graham Number is more than twice the stock’s price and the 7-Yr P/E is more than 30: TXN, ADP, UPS, HSY and CAT. Other companies appear to clearly be underpriced in that the Graham Number is less than the stock’s price and the 7-Yr P/E is less than 25: CMCSA, PNC, ADM, PFG and MET. The fact that 5/32 stocks are overpriced and 5/32 stocks are underpriced is indicative of normal distribution (Bell Curve). So, we’ll use this approach often in future blogs.

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

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

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

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Sunday, October 7

Week 379 - Are “Blue Chip” Stocks Overvalued?

Situation: There are two subjective issues that we need to quantify for “buy and hold” investors: 1) Define a “blue chip” stock. 2) Define an “overvalued” stock. 

Our previous effort to define a “blue chip” stock in quantitative terms (see Week 361) left room for subjective interpretation and was more complicated than necessary. Here’s the new and improved definition: Any US-based company in the S&P 100 Index whose stock has been tracked by modern quantitative methods for 30+ years, and enjoys an S&P rating of B+/M or better. The very important final requirement is that the company issues bonds carrying an S&P rating of A- or better

In last week’s blog, we introduced two different quantitative methods for deciding whether or not a stock is overvalued: 1) the Graham Number, which sets an optimal price by using Book Value for the most recent quarter (mrq) and Earnings Per Share for the trailing 12 months (TTM); 2) the 7-Yr P/E, which removes aberrations that are introduced by “blowout earnings” or the negative impact on earnings that is often introduced by “mergers and acquisitions” and “company restructurings.” Either metric can be misleading if used alone, but that problem is largely negated when both are used together. 

Mission: Set up our Standard Spreadsheet for the 40 companies that meet criteria. Show the Graham Number in Columns X and the 7-Yr P/E in Column Z.

Execution: see Table.

Administration: In our original blog about Blue Chip stocks (Week 361), we thought the definition needed to require that companies pay a good and growing dividend. However, there are no objective reasons why a company’s stock will be of more value if profits are paid out piecemeal to investors rather than entirely in the form of capital gains. That’s one of the things you learn in business school from professors of Banking and Finance. Accounting professors also point out that a dividend is a mini-liquidation, as well as a second round of taxation on the company’s profits. There are subjective reasons to prefer companies that pay a good and growing dividend, like building brand value (an intangible asset) and showing that the company is “shareholder friendly.” Dividends also reduce risk by returning some of the original investment quickly with inflation-protected dollars.

Bottom Line: In the aggregate, these company’s shares are overpriced but not to an unreasonable degree (see Columns X-Z in the Table). However, only 8 are bargain-priced: Altria Group (MO), Comcast (CMCSA), Berkshire Hathaway (BRK-B), JP Morgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFB), US Bancorp (USB), and Exxon Mobil (XOM). You’ll note that all 8 face challenges that will cause investors to pause before snapping up shares. 

Shares in 9 companies are overpriced by both metrics (Graham Number and 7-Yr P/E): Home Depot (HD), UnitedHealth (UNH), Lowe’s (LOW), Costco Wholesale (COST), Microsoft (MSFT), Texas Instruments (TXN), Raytheon (RTN), Honeywell International (HON), and Caterpillar (CAT). You’ll need to think about taking profits in those, if you’re a share-owner.

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

Full Disclosure: I dollar-average into MSFT, NEE, KO, JNJ, JPM, UNP, PG, WMT, CAT, XOM, and IBM. I also own shares of COST, MMM, BRK-B, and INTC.

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Sunday, September 30

Week 378 - Which “Dow Jones Industrial Average” Stocks Are Not Overpriced?

Situation: Is the US stock market overpriced? We need to know because Warren Buffett keeps reminding us how important it is to avoid overpaying for a stock. Buffet says: “No matter how successful a company is, don’t overpay for its stock. Wait until Wall Street sours on a company you like and drives the price down into bargain territory. By making a watch list of interesting stocks, and waiting for their prices to drop, you increase the potential for future capital gains.
The author of this link suggests that none of us “mere mortals” are as smart as Warren Buffett at getting the price right. It’s perhaps better to either dollar-average your investment, or leave it to professionals to do the stock-picking for you. We suggest that there is a third option, which is to use a couple of simple mathematical formulas to guide your stock-picking. Those formulas can be found in the book that Warren Buffett calls “by far the best book on investing every written.” The book is entitled: The Intelligent Investor by Benjamin Graham, Revised Edition, Harper, New York, 1973. There, you will find the value of calculating the 7-year P/E instead of the usual 12-month P/E, and also learn how to calculate the “Graham Number.” The Graham Number is what the stock would sell for if it were priced at 1.5 times Book Value and 15 times trailing 12-month (TTM) earnings. Calculating and using the Graham Number is important because it allows for variation in Book Value and earnings. Multiplying the two values just has to be ~22.5 (15 X 1.5) for the stock to be optimally priced.

Mission: To test both methods on stocks issued by the 30 companies in the Dow Jones Industrial Average (DJIA). See columns X, Y and Z on our Standard Spreadsheet (Table).

Execution: see Table.

Administration: Here’s how to calculate the Graham Number, as shown on p. 349 in the book cited above). [Clicking this link will take you to the Amazon website and the book).] Start by multiplying 1.5 (ideal ratio of Book Value/share) by 15 (ideal ratio of TTM Earnings/share) = 22.5. By multiplying two numbers you have created a Power Function. So, you’ll have to take the Square Root of the Final Number to arrive at the Graham Number. Final Number = 22.5 X actual Book Value/share for the most recent quarter (new) X actual TTM Earnings/share. To access Earnings/share, go to any company’s page at Yahoo Finance, e.g. Apple’s. In the right column find EPS (TTM) of $11.038. To access Book Value/share, click on “statistics” at the top of that page and scroll down the left column to “Balance Sheet.” Book Value/share for the most recent quarter (mrq) is the last entry: $23.74. Graham Number = square root of 22.5 X $11.038 X $23.74 = $76.79. This is the true value (Graham Number) for a single share of Apple stock. If it sells for less, that’s a bargain. Right now, it’s selling for almost 3 times as much. If you own some shares, either think about selling those or think about the company’s ability to scale-up the “Apple ecosystem”. Perhaps you’ll decide that those prospects make holding onto the shares for a while longer a worthwhile risk.

Calculating the 7-Yr P/E (p. 159 in the book cited above). You’ll need a website that provides the past 7 years of TTM earnings, or a library with S&P stock reports. Simply add the most recent 7 years’ earnings and divide by 7 to arrive at the denominator. Look up the current price of the stock (or its 50 Day Moving Average price found in the right column of the statistics page under “Stock Price History”) to arrive at the numerator. Divide numerator by denominator to calculate the 7-Yr P/E, which must be 25 or less to reflect “normative” earnings growth over 7 years for a stock with a 12-month P/E of ~20 during most years. By using the 7-yr P/E you avoid being mislead by a year of blowout earnings or negligible earnings.

Bottom Line: As a group, these 30 stocks are overpriced. Nonetheless, 12 companies have stocks that are priced within reason vs. their Graham Numbers and 7-Yr P/Es (see Columns X-Z in the Table): TRV, DIS, WBA, INTC, VZ, JPM, PFE, PG, GS, UTX, CVX, XOM. But only one company, Goldman Sachs (GS), can be called a bargain with respect to both values (those values being highlighted in green in the Table). Note that Berkshire Hathaway (BRK-B at Line 35 in the Table) is an even better bargain. Perhaps Warren Buffett noticed these markers of high intrinsic value when he recently spent part of Berkshire Hathaway’s cash hoard to buy back the stock

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

Full Disclosure: I dollar-average into 3 stocks on the “not overpriced list” -- JPM, PG and XOM, and also own shares in two others: INTC and TRV. Additionally, I dollar-average into MSFT, KO, JNJ, WMT, CAT and IBM, and own shares in MCD, MMM and CSCO. 

Comment: I focus on Dow Stocks because each is covered by dozens of analysts and business journalists, and its stock options are actively traded on the Chicago Board Options Exchange. The result of this microscopic attention is that price discovery is efficient, and surprise earnings are rare. In addition, all 30 companies have a long record of business experience, and are large enough to have multiple product lines that provide internal lines of support during a crisis. DJIA companies are famously able to weather almost any storm: Seven DJIA companies went through a near death experience during The Great Recession of 2008-2009 (General Electric, Citigroup, General Motors, Pfizer, Home Depot, Caterpillar, and American Express) but only 3 had to be removed in the aftermath of that “Lehman Panic” (General Electric, Citigroup, and General Motors).

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Sunday, September 23

Week 377 - Russell 1000 Non-financial Companies With High Sustainability and S&P Ratings

Situation: You’d like information about the durability of your investments. Sustainability is the jargon term that investment professionals have assigned to this topic. The problem is to quantify it by rating the 3 main components: Environment, Social, and Governance (ESG). The Yahoo Finance website now has a heading for sustainability that attempts to do exactly that. The editors of Barron’s also have a recent article looking more closely at the “100 Most Sustainable Companies”, with date suggesting that these may outperform the S&P 500 Index. We’d like to know which of those have also been examined by S&P. Specifically, which of those 100 Most Sustainable Companies have issued bonds that S&P has rated A or better?

Mission: Use our Standard Spreadsheet to analyze all of the Barron’s “100 Most Sustainable Companies” that are on the Russell 1000 List, selecting only the non-financial companies that have an S&P bond rating of A or better, and an S&P stock rating of B+/M or better. To identify stocks that are possibly overpriced, include columns for “Graham Numbers” and “7-Yr P/E”.

Execution: see Table.

Bottom Line: 18 companies meet criteria, 14 of which already appear on our two major lists: “The 2 and 8 Club” (see Week 360); “Blue Chips” (see Week 361). The new companies are Stanley Black & Decker (SWK), WW Grainger (GWW), Colgate-Palmolive (CL) and Deere (DE).

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

Full Disclosure: I dollar-average into MSFT and PG, and also own shares of CSCO and CMI.

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

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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).

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

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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).

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

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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.

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

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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.

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

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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.

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

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.

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

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

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.

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

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.

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

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.

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

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