Sunday, April 28

Month 94 - Food and Agriculture Companies - Spring 2019 Update

Situation: Investors should pay attention to asset classes that fluctuate in value out-of-sync with the S&P 500 Index. Such asset classes are said to have minimal or negative “correlation” with large-capitalization US stocks. Emerging markets and raw commodities are important examples. Those are a natural pair, given that most countries in the emerging markets group have an economy that is based on the production of one or more raw commodities. 

The idea that you can find a safe haven for your savings, one which will allow you to ride out a crash in the US stock market, is a pleasant fiction. Articles in support of that idea are published almost daily. But unless you are a trader who can afford to rent or buy a $500,000 seat on the Chicago Mercantile Exchange, you probably aren’t deft enough to arbitrage the various risks accurately enough before they develop (and at low enough transaction costs) to avoid losing money in a crash. 

If you really want to ride out most crashes, invest in a bond-heavy balanced mutual fund that is managed by real humans. The Vanguard Group offers one best, and it comes with very low transaction fees (Vanguard Wellesley Income Fund or VWINX). To refresh yourself on the competitive advantages of investing in food and agriculture companies, see our most recent blog on the subject (see Month 91). To refresh yourself on the competitive disadvantages, study this month’s Table and Bottom Line carefully.

The essential fact is that economies require money for spending and investment. That comes down to having consumers who are confident enough about their employment prospects and entrepreneurs who are confident enough about their ability to invest. Those consumers and entrepreneurs can be relied upon to transfer their successes to the larger economy by saving money, taking out loans, and paying taxes. National economies are interlinked. Because of the size and innovation of its marketplace, the US economy is the main enabler for most of the other national economies. Logic would suggest that the valuation for any asset class will roughly track the ups and downs of the S&P 500 Index, either as a first derivative or second derivative

Mission: Use our Standard Spreadsheet to analyze US and Canadian food and agriculture companies that carry at least a BBB rating on their bonds (see Column R).

Execution: see Table.

Administration: Of the 25 companies listed in the Table, only one meets Warren Buffett’s criteria of low beta (see Column I), low volatility (Column M), high quality (Column S), strong balance sheet (Columns N-R), and TTM (Trailing Twelve Month) earnings plus mrq (most recent quarter) Book Values that yield a Graham Number which is not far from the stock’s current Price (Column Y). That company is Berkshire Hathaway. We use a Basic Quality Screen that is less stringent as his: 1) an S&P stock rating of B+/M or better (Column S), 2) an S&P bond rating of BBB+ or better (Column R), 3) 16-Yr price volatility (Column M) that is less than 3 times the rate of price appreciation (Column K), and 4) a positive dollar amount for net present value (Column W) when using a 10-Yr holding period in combination with a 10% discount rate (to reflect a 10% Required Rate of Return).

Bottom Line: Only 8 companies on the list pass our Basic Quality Screen (see Administration above): HRL, COST, PEP, KO, DE, FAST, CNI, UNP. At the opposite end of the spectrum, 9 companies have a below-market S&P bond rating of BBB. So, those stocks represent outright gambles. 

Aside from Berkshire Hathaway, none of the 25 companies can be said to issue a reasonably priced “value” stock. We’re dealing with 24 “growth” stocks, only a third of which are of high quality. Three of the 9 with BBB bond ratings have high total debt levels relative to EBITDA (see Column O in the Table) that are unprotected by Tangible Book Value (Column P): SJM, MKC, GIS. The good news is that only one of the 9 appears to be overpriced, and that company (MKC) is a quasi-monopoly that has little risk of bankruptcy because it has “cornered” the US spice market

In summary, you can do well by investing in this space as long as you understand that you’re dealing with a fragmented food industry, one that is flush with companies of dubious quality. You might like to be well-informed about these companies because food, like fuel, is an essential good, and the food industry enjoys steady growth. Why? Because the number of people in Asia & Africa who can afford to consume 50 grams of protein per day grows by tens of millions per year.

Risk Rating: ranges from 6 to 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion =10).

Full Disclosure: I dollar-average into TSN, KO and UNP, and also own shares of AMZN, HRL, MO, MKC, BRK-B, CAT and WMT.

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

Post questions and comments in the box below or send email to:

Sunday, March 31

Month 93 - Members of "The 2 and 8 Club" in the S&P 500 Index - Winter 2019 Update

Situation: Some investors are experienced enough to try beating the market, but few tools are available to help them. Business schools professors like to point out that it is a settled issue, with only two routes are available: A stock-picker can either seek information from a company insider (which is illegal) or assume more risk (buy high-beta stocks). The latter route can provide higher returns but those will eventually be eroded by the higher volatility in stock prices. In other words, risk-adjusted returns (at their best) will not beat an S&P 500 Index fund (e.g. VFINX) or ETF (e.g. SPY). 

Mission: Develop an algorithm for investing in high-beta stocks. Use our Standard Spreadsheet for companies likely to have higher quality.

Execution: see Table.

Administration: We call the resulting algorithm “The 2 and 8 Club” because it focuses on companies that a) pay an above-market dividend and b) have grown that dividend at least 8%/yr over the most recent 5 year period. Quality criteria require that a company’s bonds carry an S&P rating of BBB+ or better, and that its common stock carry an S&P rating of B+/M or better. We also require 16 or more years of trading records on a public exchange, so that weekly prices can be analyzed by the “BMW Method”.  We use the SPDR Dow Jones Industrial Average ETF (DIA) as our benchmark, given that it rarely has a dividend yield lower than 2% or a dividend growth rate lower than 8%. And, we use the US companies listed in the Financial Times Stock Exchange (FTSE) High Dividend Yield Index as our only source for stocks paying an above-market dividend. That index is based on the FTSE Russell 1000 Index. The Vanguard Group markets both a mutual fund (VHDYX) and an ETF (VYM) for the ~400 companies in the FTSE High Dividend Yield Index. The same companies are found on each list, and weighted by market capitalization and updated monthly.

Bottom Line: As expected, this algorithm beats the S&P 500 Index (see Columns C, F, K & W) at the expense of greater risk (see Columns D, I, J & M). Its utility lies in risk mitigation (see Columns R & S), where the cutoffs for S&P rankings make these companies above-average for the S&P 500 Index with respect to the risk of bankruptcy. Only 23 companies in the S&P 500 Index qualify for membership in “The 2 and 8 Club”, and only 5 of those are in the Dow Jones Industrial Average (JPM, TRV, CSCO, MMM, IBM). An additional 5 companies are found in the FTSE Russell 1000 Index but have insufficient market capitalization to be included in the S&P 500 Index (WSO, HUBB, SWX, EV, R; see COMPARISONS section in the Table).

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

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

Caveat Emptor: This week’s blog is addressed to investors who a) have been investing in common stocks for more than 20 years, b) don’t use margin loans, and c) have more than $200,000 available for making such investments. Most investors are best served by maintaining a 50-50 balance between stocks and bonds, e.g. by investing in the total US stock and bond markets (VTI and BND at Lines 30 & 38 in the Table). That 50-50 investment has returned ~8%/yr over the past 10 years and ~5%/yr over the past 5 years. The same result can be found by investing in a balanced mutual fund where stocks and bonds are picked for you: The Vanguard Wellesley Income Fund (VWINX at Line 35 in the Table). Either way, you’re likely to have no more than 2 down years per decade: VWINX has had only 7 down years since 1970. NOTE: all of the stocks in VWINX are picked from the same FTSE High Dividend Yield Index that we use for “The 2 and Club”.

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

Post questions and comments in the box below or send email to:

Sunday, February 24

Month 92 - Dow Jones Industrial Average - Winter 2019 Update

Situation: There have been 30 companies in the $7 Trillion “Dow” index since it was expanded from 20 companies on October 1, 1928. Since then 31 changes have been made. On average, a company is swapped out every 3 years. Turnover decisions are made by a committee directed by the Managing Editor of The Wall Street Journal. Dollar value is determined at the end of each trading day by adding the closing price/share for all 30 companies, and correcting that amount with a divisor that changes each time a company is removed & replaced. State Street Global Advisors (SPDR) markets an Exchange-Traded Fund (ETF) for the Dow under the ticker DIA. To get “a feel for the market” before buying or selling a stock, investors around the world look to the Dow. They’re aided in that decision by Dow Theory, which uses movement of the Dow Jones Transportation Average to “confirm” movement in the Dow. If both march together to higher highs and higher lows, the primary trend in the market is said to be up if trading volumes are large. If the reverse is true, then the primary trend is said to down.

Mission: Use our Standard Spreadsheet to analyze all 30 companies in the Dow.

Execution: see Table.

Administration: Many investors use a tried-and-true “system” called Dogs of the Dow (see Week 305), which calls for buying equal dollar-value amounts of stock in each of the 10 highest-yielding companies in the Dow on the first trading day of January and selling those on the last trading day of December. The idea is to have better total returns on your investment over a market cycle than you would from simply investing in DIA. The system works most years and over the long term. Why? Because a high dividend yield a) moderates any price decreases during Bear Markets and b) is such a large contributor to total returns.  

Bottom Line: As a stock-picker, you need to keep up-to-date on Dow Theory and also know which high-yielding Dow stocks are among the 10 Dogs of the Dow. Dow Theory tells us that the stock market switched from being in a primary uptrend to being in a primary downtrend on December 20, 2018. The Dogs of the Dow for 2019 are the same as last year (see bold numbers in Column G of the Table), except that General Electric (GE) has been removed from the Dow and replaced by Walgreens Boots Alliance (WBA), which doesn’t have a high enough dividend yield to be considered a Dog. Instead, General Electric’s place has been taken by JP Morgan Chase (JPM).
        When picking stocks from the Dow Jones Industrial Average, be aware that the historically low interest rates we’ve seen over the past decade have led to excessive corporate borrowing. You’ll want to pay close attention to Columns N-S in the Table, where different consequences of corporate debt are addressed. Companies with items that are highlighted in red carry a greater risk of loss in the upcoming credit crunch than has been recognized in the price of their shares.

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

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

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

Post questions and comments in the box below or send email to:

Sunday, January 27

Month 91 - Food and Agriculture Companies - Winter 2019 Update

Situation: We all have to eat, so food is an essential good. Even in a commodity bear market, the valuations of food and agriculture companies will likely hold up better than the S&P 500 Index ETF (SPY - see Column D in this month’s Table). Which is amazing, given that grains and livestock account for 29% of the Bloomberg Commodity Index. Another way of saying this is that the volumes of food sold are inelastic, much like gasoline. This gives investments in food and agriculture companies a special, almost unique, competitive advantage. 

The most important development in recent years is that the sugar in corn kernels is being processed into ethanol for gasoline. And, to a lesser extent, soybean oil is being processed into diesel fuel (see Week 364). Two US companies are leaders in biofuels production, i.e., Valero (VLO) with a capacity of 1.4 billion gallons per year, and Archer Daniels Midland (ADM) with a capacity of 1.6 billion gallons per year. Animal feeds are an important by-product of ethanol production, marketed as dry and wet distiller grains, that capture 40% of the energy in a kernel of corn. 

Mission: Use our Standard Spreadsheet to highlight important metrics for listed companies in the Food and Agriculture sector.

Execution: see Table.

Administration: The 21 companies in the Table meet specific standards for quality, which are: S&P Bond Rating of BBB or better; S&P Stock Rating of B+/M or better; and trading records that extend for 16+ years to allow analysis by the BMW Method

Bottom Line: In the aggregate, common stocks of these companies look to be a good bet (see Line 23 in the Table). Don’t be fooled. Eight of the 21 stocks track the ups and downs of futures markets in raw commodities (see red highlighted companies at the bottom of Column D in the Table). To build a position in any of those stocks you’ll need to employ dollar-cost averaging. And, only the two companies at the top of the Table have clean Balance Sheets (see Columns N-Q in the Table). 

To invest successfully in this sector, you’ll need to do a lot of research on a continuing basis. For example, note that fertilizer companies and seed companies are missing from the Table. Why? Because of the recent wave of mergers and acquisitions. If you had been an investor in now extinct companies like Monsanto, duPont, Dow Chemical, Potash Corporation of Saskatchewan, and Agrium, you’ll have gained from the pain but also lost money.

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

Full Disclosure: I dollar-average into TSN, KO, CAT, UNP and WMT, and also own shares of HRL and MKC.

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

Post questions and comments in the box below or send email to: