Thursday, June 10

Month 117 - STARTER STOCKS: Choose from the 10 Largest A-rated Companies - March 2021

Situation: Retail investors are in the news! It’s been almost 50 years since Merrill Lynch launched its “Thundering Herd” advertisement for the 1971 World Series. Now, every broker-dealer knows there’s serious money to be made servicing the “small” investor but none focused on them until RobinHood came riding to the rescue: They'll sell you a miniscule amount of shares free of charge, the only requirement being that you download their app and link it to your bank account. But the app offers no tutorial on how to avoid risk. Warren Buffett isn’t even mentioned. Maybe that's because his message is that neophytes should buy shares in a cheap S&P 500 ETF (e.g. SPY) and stay away from picking stocks, unless they’re willing to learn basic financial accounting and have time to analyze companies.

My take on this is that you can do almost as well picking stocks as you can by owning shares in an S&P 500 ETF, and sleep better. How’s that done? By crafting a portfolio that is unlikely to suffer as much in a market crash as an S&P 500 ETF (see Columns D and AP in the Table). The trick is to confine yourself to owning stock in A-rated companies. Plenty of those bond-like stocks are available. I’ve found 32 in the iShares Russell Top 200 ETF (IWL). The anchor for your research should be the Vanguard High Dividend Yield Index ETF (VYM) because it lists the ~400 such companies found in the Russell 1000 Large-cap Index. Seven other requirements have to be met before I’d call a company A-rated: a) issue bonds rated A- or higher by S&P, b) issue a common stock rated B+/M or higher by S&P, c) have a 20+ year trading history analyzed by the BMW Method, d) have positive earnings per share (EPS) for the Trailing Twelve Month (TTM) period, e) have positive Book Value for the most recent quarter (mrq), and (f) not be a “Potentially Over Priced Stock” per the BMW Method.

Plan to focus on the largest A-rated companies by market capitalization (megacaps). Those have the most varied line of products (or services), as well as a backup line-of-credit that is both generous and cheap. There are three main reasons why companies get to be very large: They a) consistently make a LOT of money, b) manage expenses well, and c) have learned to meet competitive challenges well and survive periods of economic peril. To put a fine point on their success, Warren Buffett explained (at the 2007 Annual Meeting of Berkshire Hathaway) how he and Charlie Munger go about picking companies for investment. “We are best at evaluating businesses where we can come to a judgment that they will look a lot like they do now in five years.” 

Mission: Analyze the 10 largest A-rated companies by market capitalization by using our Standard Spreadsheet.

Execution: see Table.

Analysis: Warren Buffett’s favorite metric is addressed in Column R of the Table: Return on Tangible Capital Employed. He thinks anything over 20% is a good number. Six companies (CSCO, HD, INTC, PG, JNJ, PEP) pass that test. His second point (that the company is being “run by able and honest managers”) is addressed in Morningstar reports (see Column AM in the Table) and by the propensity managers have to capitalize their company by selling long-term bonds as opposed to common stock (see Column V in the Table). Two companies (PFE and PEP) have BUY ratings from Morningstar, and 5 companies have a ratio of Long-Term Debt to Equity (“gearing”) that is less than 1.0 (PFE, CSCO, INTC, PG, JNJ).  Managers also get graded by the extent to which the company can spend retained earnings for expansion in place of loans. In other words, Free Cash Flow Yield (Column I) becomes an important metric if it exceeds Dividend Yield. Five companies meet that criterion (CSCO, HD, INTC, JPM, CMCSA). Warren’s third point (that the stock be available “at a sensible price”) is addressed by the Expected 3-5 year PEG Ratio (see Column N in the Table). Four companies have PEG ratios of 2.0 or less (LLY, PFE, JNJ and CMCSA). In this analysis, CSCO, INTC, JNJ, PFE are each mentioned 3 out of a possible 5 times.

Bottom Line: Your success will depend on how you see the future unfolding for each company in your portfolio. Start by looking at a small number of large, well established, and easily understood companies. Then narrow your focus to shareholder friendly companies that can be counted on to return much of your original investment within 10 years (through buying back shares and reliably paying a good and growing dividend). Buy more shares in each of your choices as disposable income becomes available. Being a big company is a competitive advantage, so build positions in the largest companies that satisfy reasonable markers of profitability, risk, and sustainability.

An investor who is new to stock-picking should avoid overpriced stocks (see Columns AL and AM in the Table). Accordingly, I do not recommend that you buy shares of LLY, HD and PG in the current market environment, unless you plan to dollar-cost average automatic monthly purchases by using an online Dividend Re-Investment Plan (DRIP). 

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 PFE, HD, CSCO, INTC, PG, JPM and JNJ, and also own shares of PEP. 

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

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