Month 150 - 18 Dow Jones Composite Average Companies That Issue A-rated Bonds - January 2024

Situation: Median home prices are 7.4 times median income, which is higher than the 6.8 times median income reading at the peak of the 2008 housing crisis, and well above the long-term average of 3-4 times income . This is a bubble, and when it pops there will be a recession (if history is any guide). At such junctures, I hope for the best and plan for the worst. I focus on the professionally-curated 65-stock Dow Jones Composite Average (DJCA). Why? Because a third of those companies have strong Balance Sheets and reliably cover their costs of capital with earnings. 

Mission: Use our standard spreadsheet to analyze DJCA companies that 1) issue bonds rated A- or better by S&P, 2) have a 10-yr Actual Rate of Return that is higher than their 10-yr Required Rate of Return (calculated by the Capital Asset Pricing Model), and 3) sustained less capital loss than the S&P 500 (SPY) during 2022.  

Execution: see Table of 18 companies.

Analysis:  Warren Buffett’s favorite metric is Return on Tangible Capital Employed (Column T in the Table). He thinks a 20% return for the last fiscal year is a good number. Eight companies qualify: MRK, UNH, V, JNJ, PG, MSFT, AAPL, HD. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar Reports (Column AT) and is negatively impacted by the degree to which the company is capitalized by issuing long-term bonds (Column AC). Four companies have a BUY rating from Morningstar (AEP, JNJ, NEE, AWK), and 8 have a Debt to Equity ratio lower than 1.0 (MRK, UNH, ATO, V, JNJ, WMT, PG, MSFT). Mr. Buffett also likes Free Cash Flow Yield (Column K) to be higher than Dividend Yield (Column J) because Retained Earnings allow the company to expand operations (or pay down debt) at zero cost; 13 companies qualify (MRK, CAT, UNH, ATO, V, JNJ, WMT, PG, MSFT, AAPL, JPM, UNP, HD). His third point (that the stock be available “at a sensible price”) is addressed by 1-yr and 5-year Forward PEG ratios (Columns O and P); 7 companies have PEGs under 2.5 at both time intervals (MRK, UNH, AEP, V, JNJ, NEE, MSFT). Eight companies are A-rated (Column AU): MRK, ATO, XCEL, JNJ, WMT, NEE, PG, UNP. Seven companies are cited 4 or more times (MRK, UNH, V, JNJ, WMT, PG, MSFT).

Bottom Line: Companies that issue A-rated bonds rarely suffer as much capital loss in a market crash as SPY. Companies that consistently cover their cost of capital (meet or beat their Required Rate of Return calculated by the Capital Asset Pricing Model) are even better insulated from capital loss. 

Risk Rating: 6 (where 10-yr US Treasury Note = 1, S&P 500 Index = 5, gold = 10)

Full Disclosure: I dollar-average into MRK, CAT, AEP, JNJ, WMT, NEE, PG, MSFT, JPM, UNP, HD, and also own shares of UNH, ED, ATO, XE, V.

"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.

Month 149 - 16 Risk-averse Stocks in the Dow Jones Composite Average - December 2023

Situation: Because of increased macroeconomic uncertainty, most investors, banks, and stock brokerages have adopted a “risk-off” posture. At such times, I look at the professionally curated list of stocks in the Dow Jones Composite Average (DJCA). Why? Because a quarter of those are risk-averse and reliably cover their cost of capital with earnings. 

Mission: Use our standard spreadsheet to analyze DJCA companies that issue bonds rated A- or better by S&P, but exclude those that have a lower Finance Value (see Column G in the Table) than the S&P 500 Index ETF (SPY): UPS, CSCO, NKE, CRM, DIS, INTC. Also exclude smaller companies, meaning those that are not in IWL (the iShares Russell Top 200 ETF): TRV, ED, ATO, XEL, AWK. Also exclude those that have a 10-yr Actual Rate of Return less than their 10-yr Required Rate of Return (CVX, KO, HON, IBM). However, include the two quasi-monopolies that issue bonds rated BBB+ by S&P: Southern Company (SO), which has a monopoly on the distribution of electric power in three contiguous southern states (Alabama, Georgia and Mississippi), and McDonald’s (MCD), which dominates the fast food industry. 

Execution: see Table of 16 companies.

Analysis:  Warren Buffett’s favorite metric is Return on Tangible Capital Employed (Column T in the Table). He thinks a 20% return for the last fiscal year is a good number. Nine companies qualify: MRK, UNH, V, MCD, JNJ, PG, MSFT, AAPL, HD. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar Reports (Column AR) and negatively impacted by the degree to which the company is capitalized by issuing long-term bonds (Column AA). Four companies have a BUY rating from Morningstar (AEP, MCD, JNJ, NEE), and 7 have a Debt to Equity ratio lower than 1.0 (MRK, UNH, V, JNJ, WMT, PG, MSFT). Mr. Buffett also likes Free Cash Flow Yield (Column K) to be higher than Dividend Yield (Column J) because Retained Earnings allow the company to expand operations (or pay down debt) at zero cost; 13 companies qualify (MRK, CAT, UNH, V, MCD, JNJ, WMT, PG, MSFT, AAPL, JPM, UNP, HD). His third point (that the stock be available “at a sensible price”) is addressed by 1-yr and 5-year Forward PEG ratios (Columns O and P); 6 companies have PEGs under 2.5 at both intervals (MRK, UNH, V, JNJ, NEE, MSFT). Six companies are A-rated (MRK, AEP, JNJ, WMT, NEE, PG). 6 companies are cited 4 or more times (MRK, UNH, V, JNJ, PG, MSFT).

Bottom Line: Changes in macroeconomic factors eventually impact asset values. When uncertainty increases (with respect to interest rates, national productivity, or geopolitical turmoil) in any of the 10 advanced economies, investors need to adopt a more “risk-off” posture. Companies in the Dow Jones Industrial Average get almost 50% of their sales from markets outside the United States. Investors in such companies are well-positioned to anticipate the impact of macroeconomic factors. 

Risk Rating: 6 (where 10-yr US Treasury Note = 1, S&P 500 Index = 5, gold = 10)

Full Disclosure: I dollar-average into MRK, CAT, AEP, SO, JNJ, NEE, WMT, PG, MSFT, JPM, UNP, HD, and also own shares of UNH, MCD, AAPL, V.

"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