Sunday, February 4

Week 344 - “The 2 and 8 Club” Updated

Situation: Stock-pickers need a Watch List of companies to pick from, one that is short enough to allow buyers to make a timely decision to buy or sell. “The 2 and 8 Club” (see Week 327) currently has 21 members that we’ve picked from the S&P 100 Index. Although our Tables are filled with data, those numbers are necessary but not sufficient for investors to take action. There needs to be a story that explains why this or that company in “The 2 and 8 Club” is likely to outperform, given that the S&P 100 Index ETF (OEF) is even harder to beat than the S&P 500 Index ETF (SPY). For example, compare Line 29 in the Table to Line 31. 

“The story” will change as circumstances dictate. Each company’s Board of Directors will have to assess inevitable challenges to The Business Plan, then decide to either endorse the changes recommended by the CEO or replace the CEO. It isn’t easy. Looking at the past 35 yrs of statistical data, only 4 stocks in “The 2 and 8 Club” have outperformed the S&P 500 Index with no greater volatility: 
   Caterpillar (CAT),
   CVS Health (CVS),
   3M (MMM),
   NextEra Energy (NEE).

This suggests that the biggest and best companies are unlikely to grow their dividends faster than 8%/yr for more than two market cycles. Many will drop out of “The 2 and 8 Club” and be replaced by upstarts. To use “The 2 and 8 Club” as a Watch List, you need to be an active trader. That means tracking the performance of all S&P 100 companies that are found in the Vanguard High Dividend Yield Fund VYM, which is managed by Morningstar to represent all of the American companies listed in the FTSE All-World High Dividend Yield Index. Think of VYM as the ~400 companies in the Russell 1000 Index that a) pay an above-market dividend, and b) are unlikely to cut their dividend during a recession. 

Mission: Update “The 2 and 8 Club” (see Week 327).

Execution: see Table.

Administration: Over a market cycle, you can expect to make more money at less risk by investing in VYM than by investing in the largest S&P 500 Index ETF (SPY), i.e., compare Lines 28 and 31 in the Table. To create “The 2 and 8 Club”, we simply take the S&P 100 companies from VYM that a) have grown their dividend at least 8%/yr over the past 5 yrs, b) have a 16+ year trading record for statistical purposes, c) have an S&P bond rating of at least BBB+ (this is a change from our initial requirement of at least an A- rating), and d) have an S&P stock rating of at least B+/M.

Bottom Line: Successful stock-pickers are a tad compulsive, happy to toil alone at their hobby. (Warren Buffett couldn’t understand why his wife left him to become an artist living in San Francisco.) It helps to have a workable Watch List, one that has a high signal-to-noise ratio. We like the companies in the S&P 100 Index because they have a) multiple product lines, and b) efficient price discovery, i.e., are required to have active put and call options on the CBOE (Chicago Board Options Exchange). We also look for companies in the S&P 100 Index that have a high Net Present Value, which is difficult to achieve for companies that don’t pay a good and growing dividend. So, we require at least a 2% dividend and an 8% dividend growth rate for membership in our Watch List, accordingly named “The 2 and 8 Club”. 

Caveat Emptor: If you choose to pick stocks by using this algorithm, you’re a gambler (see red highlights in Columns I and M in the Table). In other words, you’re taking on more risk than you would by owning an S&P 500 Index fund like SPY. Yes, you’ll likely have higher returns but that will be accompanied by higher volatility. As a frequent trader, you’ll also be paying higher taxes and absorbing higher transaction costs.

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, JPM, MMM, IBM and NEE, and also own shares of CSCO, PEP, AMGN, MO, TXN, CAT and TGT.

"The 2 and 8 Club" (CR) 2017 Invest Tune

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