Situation: Recession is no longer on the horizon, even though the FOMC will likely keep interest rates “higher for longer.” Investors may even be happy with that, since federal budget deficits are expected to stabilize around 5%/yr . A stockpicker’s job is not to match or exceed the historical returns of the S&P 500. It is to invest in companies with metrics that predict they’ll be safe in a crisis–so that you won’t be tempted to sell shares and sustain a capital loss.
Mission: Analyze our A-rating system for picking stocks (see Appendix). It has 12 red lines you might not want to cross at this uncertain time.
Analysis: Warren Buffett’s favorite metric is found in Column T of the Table: Return on Tangible Capital Employed. He thinks a 20% return for the last fiscal year (lfy) is a good number. Seven companies do so: LMT, HSY, SNA, PEP, JNJ, PG, CSCO. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar reports (see Column AQ) and is negatively impacted by the degree to which managers capitalize the company by issuing long-term bonds (see Column Z). Three companies have a BUY rating from Morningstar (LMT, WEC, NEE), and 10 companies have a Long-term Debt to Equity ratio lower than 1.0 (ADM, GD, ATO, SNA, APD, JNJ, WMT, PG, HRL, CSCO). Mr. Buffett also states that a high Free Cash Flow Yield (Column K) reflects good management because Retained Earnings allow the company to expand operations (or pay down debt) at zero cost; 11 companies meet that standard (LMT, ADM, GD, HSY, ATO, SNA, JNJ, WMT, PG, HRL, CSCO). His third point (that the stock be available “at a sensible price”) is addressed by 1-yr and 3-year Forward PEG ratios (see Columns O and P); 4 companies (GD, APD, NEE) have PEGs under 2.5 at both intervals. Five companies carry our “Value Stock” rating (Column AN): ADM, SNA, XEL, WEC, HRL. No companies are cited 4 times.
Bottom Line: There is no system for picking stocks that won’t leave you feeling frustrated during some future Bear Market. At that moment, you’ll either wish you’d bought more shares of investment-grade bond funds or you’ll be confident that your portfolio can ride out the storm.
Risk Rating: 5 (where 10-yr Treasury Notes = 1, S&P 500 = 5, gold = 10).
Full Disclosure: I dollar-average into LMT, SNA, PEP, JNJ, WMT, NEE, PG, and also own shares of ADM, HSY, ATO, APD, CSCO, HRL.
Appendix: Twelve criteria required for stocks to receive an A-rating: 1) being listed at VYM (the Vanguard High Dividend Yield ETF); 2) being listed on a public U.S. Stock Exchange for 20+ years; 3) having at least an A- S&P rating on it’s corporate bond, 4) having at least a B+/M S&P rating on it’s common stock, 5) growth in earnings per share (EPS) for the trailing twelve month period (TTM), 6) having a positive book value, 7) having long-term debt no greater than 2.5 times equity, 8) having a 10-year actual rate of return that is greater than the 10-year required rate of return (RRR), 9) having had no dividend cuts in the past two years, 10) having a 5-year Beta lower than 1.00, 11) having a ratio of total debt to EBITDA (mrq) that is no greater than 2.5 (unless debt is covered by collateral in the form of tangible book value), 12) being listed in Vanguard’s Dividend Appreciation ETF (VIG), which eliminates the 25% of dividend-paying stocks that have the highest dividend yields (since such high yields are likely unsustainable). Rating: 5 (where 10-yr Treasury Notes = 1, S&P 500 = 5, gold = 10).
Full Disclosure: I dollar-average into LMT, SNA, PEP, JNJ, WMT, NEE, PG, and also own shares of ADM, HSY, ATO, APD, CSCO, HRL.
Appendix: Twelve criteria required for stocks to receive an A-rating: 1) being listed at VYM (the Vanguard High Dividend Yield ETF); 2) being listed on a public U.S. Stock Exchange for 20+ years; 3) having at least an A- S&P rating on it’s corporate bond, 4) having at least a B+/M S&P rating on it’s common stock, 5) growth in earnings per share (EPS) for the trailing twelve month period (TTM), 6) having a positive book value, 7) having long-term debt no greater than 2.5 times equity, 8) having a 10-year actual rate of return that is greater than the 10-year required rate of return (RRR), 9) having had no dividend cuts in the past two years, 10) having a 5-year Beta lower than 1.00, 11) having a ratio of total debt to EBITDA (mrq) that is no greater than 2.5 (unless debt is covered by collateral in the form of tangible book value), 12) being listed in Vanguard’s Dividend Appreciation ETF (VIG), which eliminates the 25% of dividend-paying stocks that have the highest dividend yields (since such high yields are likely unsustainable).
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