Month 110 - Buy Low! 12 A-rated Haven Stocks in the S&P 100 Index that aren’t overpriced - August 2020

Situation: There’s no mystery to saving for retirement. A good working game plan is to divert 15-20% of your monthly income to the purchase of stocks and government bonds, and then keep those assets in a 60:40 balance of stocks:bonds. You can also use any bond substitutes (e.g. gold, T-bills, and utility stock ETFs) that typically hold their value in a stock market crash. Mainly use stock index ETFs for your retirement savings but also buy stock in companies that tend to have an above-market dividend yield. Those “shareholder-friendly payouts” happen because the company has good collateral: Liabilities are protected by Tangible Book Value and a cushion of Cash Equivalents. In other words, avoid stocks issued by companies that have become over-indebted. 

Think of the bonds in your portfolio as the collateral that backs your stocks. So, a good way to start saving for retirement is to over-emphasize collateral-thinking: Dollar-average into the low-cost Vanguard Wellesley Income Fund (VWINX), which is 60% bonds and 40% stocks picked from the Vanguard High Dividend Yield Index Fund ETF (VYM). VWINX has lost money in only 7 of the past 50 years, those losses always being less than 10%. Since its inception on 7/1/1970, VWINX has returned 9.7%/yr vs. 10.8%/yr for the S&P 500 Index with dividends reinvested.

The harder task is to stop putting additional money into stocks that have become overpriced. To do that you have to know how to calculate the Graham Number. Benjamin Graham wrote the first edition of The Intelligent Investor almost 100 years ago. It is hard to read because he uses numbers to express almost every pearl of knowledge. The “Graham Number” is simply the rational market price for any stock at any given moment, calculated as the square root of: 15 times earnings for the Trailing Twelve Months (TTM) multiplied by 1.5 times Book Value for the most recent quarter (mrq) multiplied by 22.5 (i.e., 1.5 times 15). So, the Graham Number is nothing more than what the stock’s price would be if it were to reflect a P/E of 15 and a Book Value of 1.5.  The purpose of doing this calculation on your stocks is to know their underlying worth. Benjamin Graham also explained why the 7-year P/E should not exceed 25, assuming that a single year’s P/E (TTM) should not exceed 20, which is an earnings yield of 5%/yr: In a normal inflationary environment, a company’s earnings are likely to grow 3% to 3.5% per year. After 7 years, a CAGR (Compound Annual Growth Rate) of 3.2%/yr takes a P/E of 20 to 25.

My definition of an Overpriced Stock is one that a) has a market price (50-day Moving Average) that is more than 2.5 times the Graham Number and b) has a 7-year P/E that is more than 30. Looking at the 30-stock Dow Jones Industrial Average (DJIA), I see that 5 A-rated stocks are overpriced (see Column AC-AH in Comparisons section of Table):

     Microsoft (MSFT), 

     Apple (AAPL), 

     Nike (NKE), 

     Coca-Cola (KO) and 

     Procter & Gamble (PG). 

Stocks get overpriced because they become popular with investors, leading to a Crowded Trade. Assuming that your goal is to Buy Low, why would you continue to add money to any of these 5 stocks that you already own? You would only do so because you harbor a Positive Sentiment regarding their future prospects, In other words, you would be making a speculative investment (“gambling”). To avoid gambling and instead employ a “risk-off” approach to buying individual stocks, you’ll need clear definitions for A-rated stocks and for Haven stocks to supplement the numbers-based system used above to avoid Overpriced stocks. You’ll also want to favor stocks issued by large companies, since those typically have multiple product lines and unencumbered lines of credit.

Mission: Define “A-rated stocks” and “Haven stocks”. Analyze A-rated Haven stocks in the S&P 100 Index that aren’t overpriced by using our Standard Spreadsheet.

Execution: see Table.

Administration: A-rated stocks are those that have a) an above market dividend yield (see portfolio of Vanguard High Dividend Yield Index Fund ETF - VYM), b) positive Book Value, c) positive earnings (TTM), d) an S&P rating on the company’s bonds that is A- or better, e) an S&P rating on the company’s stock that is B+/M or better, and f) a 20+ year trading history. 

Haven Stocks are A-rated stocks issued by companies that aren’t encumbered with risk factors that are likely to threaten the company’s solvency during a recession. So, companies in the Real Estate Industry (i.e., REITs) and companies in the Financial Services Industry (i.e., banks) are excluded, as are companies with negative Tangible Book Value if Total Debt is more than 2.5 times EBITDA (TTM) or Total Debt is more than 2.0 times Shareholder Equity. 

Bottom Line: With the S&P 500 Index being priced at 29 times TTM earnings (see SPY at Line 28 and Column K in the Table), the stock market is overpriced relative to its long-term P/E of 15-16. But its 50-day Moving Average price is still less than 2.5 times its Graham Number (i.e., 2.1), and its 7-yr P/E is still less than 30 (i.e., 28), per Columns AC and AE at Line 28 in the Table. Using our example of the DJIA, the timely thing to do would be to avoid buying more shares of the overpriced A-rated stocks (MSFT, NKE, PG, KO, AAPL) but to continue buying more shares of SPY. This strategy allows you to retain exposure to volatility in stocks that are Overpriced (because of their future prospects) while using diversification to reduce your risk of serious loss.

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

Full Disclosure: I dollar-average into NEE, INTC, WMT, JNJ, CAT, and also own shares of MRK, CSCO, TGT, DUK, SO, MMM. From late February through April 2020, I added shares of 6 new companies to my brokerage account--Comcast (CMCSA), Costco Wholesale (COST), Home Depot (HD), Merck (MRK), Disney (DIS) and Target (TGT), while selling shares of Norfolk Southern (NSC) and United Parcel Service (UPS). Regarding the 5 overpriced but A-rated stocks in the DJIA, I’ve stopped dollar-averaging into KO but continue to dollar-average into MSFT, NKE and PG because I expect those companies to continue to dominate their competitors. I have no plans to sell the shares of KO and AAPL that I already own.

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Month 107 - A-rated Food & Agriculture-related Companies - May 2020

Situation: Food is an “essential good.” The COVID-19 Pandemic has made us all acutely aware of this, now that we’re being told to shun restaurants and eat at home. But companies that process row crops into breakfast food have faced a topsy-turvy marketing climate in recent years. General Mills (GIS) and Kellogg (K) have had to endure an existential crisis because consumers chose to distance themselves from processed breakfast foods in favor of more nutritious, fresh, and  “organic” offerings. This was partly because fewer families came together each day for a sit-down breakfast. People became concerned about sugars being added to so much of what we eat, as well as the preservatives and obscure ingredients (like dyes) listed on each box of cereal. Debates arose about nutritional value and safety for children. Now, several years after the fact, those former icons of the food industry have admitted their failures and are marketing foods that are demonstrably good for children and contain no obscure or unsafe ingredients. Cereals contain dried strawberries or blueberries, sliced almonds, and other fruits or nuts. Serious investors welcome this state of affairs because changes in consumer behavior create volatility in the market, which translates into opportunity. And who’s to argue against a wider choice of more healthy foods? But for the casual investor, who doesn’t devote hours a week to following the food industry, this is not a good thing. Now is a good time to look at the food and agriculture companies that are left standing. 

Mission: Use our Standard Spreadsheet to analyze food and agriculture-related companies that have an A- or better S&P rating on their bonds, as well as B+/M or better S&P ratings on their stocks.

Execution: See Table.

Administration: Four of the 12 companies appear to offer exceptional value: Coca-Cola (KO), PepsiCo (PEP), Walmart (WMT) and Target (TGT). Those are all Dividend Achievers as well as being listed in the S&P 100 Index (OEF), the Vanguard High Dividend Yield Index (VYM), and the iShares Top 200 Value Index (IWX) (see Columns AL to AO of the Table).

Bottom Line: Companies close to the production of raw commodities have stock prices that tend to follow the commodity cycle, which is dominated by oil. Investors in Deere (DE) and Archer Daniels Midland (ADM) profit if the farmer profits. Investors in food processors and grocery stores face a fickle food consumer, whose only concern is to get the best taste and nutrition per dollar. The companies that have proven they can persevere in that arena are Hormel Foods (HRL), Costco Wholesale (COST), Coca-Cola (KO), Target (TGT), Hershey (HSY), Walmart (WMT), and PepsiCo (PEP). Those companies will still be doing well 10 years from now. 

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

Full Disclosure: I dollar-average into COST, UNP, KO, WMT and CAT, and also own shares of DE, BRK-B, TGT and PEP.

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Week 384 - Which Dividend Achievers Are Likely To Be Safe & Effective Investments?

Situation: The US stock market is overpriced, as we have documented in recent blogs (see Week 378, Week 379, Week 380). So, the question becomes: Which companies will retain value (relatively speaking) during a correction, yet continue to reliably grow their earnings? We’re likely to find such companies in the 3 remaining Defensive Industries (Utilities, Consumer Staples, and HealthCare). S&P’s Defensive Sector used to include Telecommunication Services but that Industry has recently merged Media to become Communication Services. Newly added companies include Netflix (NFLX), Facebook (FB), Alphabet (GOOGL), Twitter (TWTR), Comcast (CMCSA), and Disney (DIS) -- all of which are Growth companies (as opposed to less risky companies in Defensive Industries).

Mission: Use our Standard Spreadsheet to analyze high-quality companies in Defensive Industries that have increased their dividend annually for at least the past 10 years (earning the S&P designation of Dividend Achiever).

Execution: see Table.

Administration: First, we need to define terms.

SAFE:
1) 16-Yr price volatility is less than that for the Dow Jones Industrial Average ETF (DIA -- see Column M in the Table); 
2) 3-Yr Beta is less than 0.7 (see Column I in the Table); 
3) 7-Yr P/E is less than 36 (see Column Z in the Table);
4) S&P Rating on bonds issued by the company is A- or better (see Column R in the Table). 

EFFECTIVE: 
1) 16-Yr price appreciation is at least 1/3rd as great as 16-Yr price volatility (compare Columns K and M in the Table);
2) S&P stock rating is at least A-/M and S&P Stars rating is at least 3 (see Column S in the Table).

Bottom Line: To be clear, there is no such thing as a “safe” stock. When confidence in the company’s future cash flow evaporates, the stock is quickly priced at Tangible Book Value (TBV) per share. That value is out of reach to stockholders in the event of bankruptcy, since it serves as collateral for the company’s bond issues. So, this week’s blog has 4 criteria for safety (plus S&P’s criteria for its Dividend Achiever designation). When those are added to criteria for relatively stable price performance over the past 16 years, we are left with only 9 stocks to consider. Ask Santa Claus to put a sampling of those in your stocking this Christmas.  

Risk Rating: 4 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into NEE, JNJ, PG, WMT and DIA, and also own shares in PEP and HRL.

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Week 373 - 10 Dividend Achievers In Defensive Industries That Are Suitable For Long-term Dollar-cost Averaging

Situation: Which asset class do you favor? Stocks, bonds, real estate or commodities? On a risk-adjusted basis, none of those are likely to grow your savings faster than inflation over the near term. You might want to hold off making “risk-on” investments, unless you're a speculator, because markets are likely to fluctuate more than usual. If you think a “risk-off” approach is best, then you need to pick “defensive” stocks for monthly (or quarterly) investment of a fixed dollar amount (dollar-cost averaging). To minimize transaction costs, you’ll want to invest automatically in each stock through an online Dividend Re-Investment Plan (DRIP). 

Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.

Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.

Execution: see Table.

Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.

Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M). 

Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).

Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Week 362 - “The 2 and 8 Club” (Extended Version) = Non-S&P 100 Companies In The Russell 1000 Index

Situation: The risk of loss from owning small-capitalization stocks vs. large-capitalization stocks is material, i.e., greater than 5%. Stocks in the S&P 100 Index are safest to own, given that those are required to have actively-traded Put and Call options on the CBOE (Chicago Board Option Exchange), and are usually followed by at least a dozen analysts. Large companies also have the advantage of multiple product lines, one of which is likely to do well in a recession. This same lack of uncertainty makes their stocks boring to own, even though a number of S&P 100 stocks are statistically more likely to weather a Bear Market than the S&P 500 Index (see Column M in any of our Tables). Index investing is even more boring and predictable. 

You’re left trying to find a winner among the other 900 companies of The Russell 1000 Index. A sign that you’ve selected well for your investment occurs when you find that company highlighted in a Wall Street Journal article. Our blog for this week tries to help you do exactly that. We’ve already found a handy way to identify trendy S&P 500 companies, which we call “The 2 and 8 Club” (see Week 348). And, we published an Extended Version (see Week 350) that takes you through promising companies in The Barron’s 500 List. 

Caveat Emptor: “The 2 and 8 Club” focuses exclusively on companies in The Russell 1000 Index that have historically paid an above-market dividend and are judged (by The Financial Times) likely to continue doing so. That means they’re bond-like, and attract investors because of the near-certainty that they will continue to pay a good and growing dividend. The downside of this benefit is that price appreciation will flatten and decline in a rising interest rate environment, just as bond prices do. Why? Because of competition from newly-issued bonds that pay a higher rate of interest and have less risk of default. 

Mission: This week we double-down and identify putative winners in The Russell 1000 Index.

Execution: see Table.

Administration: Rules for membership in “The 2 and 8 Club”: 
   1) The company is listed on the FTSE High Dividend Yield Index (US), which contains the ~400 highest-yielding companies in the Russell 1000 Index. Those are companies that have historically paid an above-market dividend (usually ~2%) without reducing that payout in periods of market stress.
   2) The company has raised its regular quarterly dividend at least 8%/yr over the past 5 years.
   3) The company’s bonds carry an S&P Rating of at least BBB+.
   4) The company’s stock carries an S&P Rating of at least B+/M.
   5) The company’s end-of-week stock price has been analyzed quantitatively by using the BMW Method for the past 16 years.
   6) The company is graded annually as to cash flow trends and revenue growth by the editors of Barron’s.
   7) The company is required to be a Dividend Achiever, to offset the risk of loss of carried by these companies because of being less well capitalized than those in the S&P 100 Index.

Bottom Line: Of the 7 companies in this week’s Table, only two are reasonably safe bets: The Travelers (TRV) and WEC Energy (WEC). In other words, their risk of loss in the next Bear Market is lower than that for investors in the Dow Jones Industrial Average ETF (DIA) (see Column M of the Table). So, why not simply buy shares of DIA instead of gambling on one of the other 5 companies? After all, DIA has an ~2% dividend yield and grows its dividend ~8%/yr. Answer: You’re a speculator and think you can do better than settle for the 7-8% long-term Total Return/Yr you’d realize from owning shares of DIA.

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

Full Disclosure: I own shares of The Travelers (TRV) and Cummins (CMI).

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Week 361 - Blue Chips

Situation: What is a “Blue Chip” stock, and why should you think highly of such stocks? There are several definitions but traders are generally talking about a stock in the Dow Jones Industrial Average when they use the phrase “Blue Chip.” More generally, they’re talking about a very large company that pays a good and growing dividend, and has a trading record that covers at least the past 40 years. This also includes any very large company that has a negligible risk of bankruptcy. These characteristics are important because traders think Blue Chip stocks are the only relatively safe bets for a “buy-and-hold” investor to place. Warren Buffett often highlights the importance of these same characteristics whenever he’s being interviewed, and Berkshire Hathaway (BRK-B) owns shares in several: Apple (AAPL), Coca-Cola (KO), International Business Machines (IBM), Johnson & Johnson (JNJ), Procter & Gamble (PG) and Walmart (WMT).

Mission: Develop specific definitions for the above characteristics, and list all companies that meet those definitions. Use our Standard Spreadsheet to analyze those companies.

Execution: see Table.

Administration: Here are my specific definitions for the qualitative terms used above:
   "A very large company": Any company in the S&P 100 Index (OEF)

   "A good dividend": Any company in the Vanguard High Dividend Yield Index (VYM)

   "A growing dividend": Any company in the Powershares Dividend Achiever Portfolio (PFM)

   "A 40+ year trading record": Any company in the 40-Yr BMW Method Portfolio

   "A negligible risk of bankruptcy": Any very large company issuing bonds that carry an S&P Rating of AA+ or AAA. There are only 5 such companies: Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), Johnson & Johnson (JNJ), and Exxon Mobil (XOM). 

Bottom Line: If you want to include common stocks in your retirement portfolio, Blue Chips are the ones you’ll want to Buy and Hold, provided you buy shares in at least half a dozen. Those that carry a statistical risk of loss greater than “The “Dow” (DIA, see Column M in the Table) best purchased by dollar-cost averaging. But the 6 that carry no more than a Market Risk can be owned by using a “buy the dip” strategy: MCD, PEP, KO, JNJ, PG and WMT. Of course, those are still stocks and market volatility will still affect their prices. 

Caveat Emptor: Corporate debt has been steadily increasing over most of the past 10 years. Why? Because the Federal Reserve reduced to cost of borrowing money to almost nothing. So, pay attention to companies that have purple highlights in Columns P and R (see Table). In the next recession, you’ll be surprised how far their stock prices will fall.

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

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

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Week 358 - Hedge the Crash With Low-Beta Dividend Achievers

Situation: It’s really tough to own stocks when the market crumps. Yes, you can follow Warren Buffett’s advice and tough it out with dollar-cost averaging. His other main idea, which is to buy great businesses at a fair price, may be useful someday down the road. He hasn’t been able to find any in this overpriced market, and neither will you. But after the market crashes, you’ll both be glad you kept a hefty dollop of cash in reserve to serve that very purpose. 

But what about hedging against the crash? That’s what hedge funds are supposed to do. Why can’t you and I do it? It’s not that simple. Hedging means that your portfolio pulls ahead in a Bear Market but lags on a Bull Market. Given that the market is historically up 3 years out of 4, you see the problem with hedging. But looking deeper, volatility is what you want to hedge against. You can do that year in and year out by adopting the “School Solution”: overweight low-beta stocks in your portfolio at all times. 

By hedging against volatility, your portfolio won’t necessarily fall behind in a Bull Market. Having less volatility only means that your gains will be less than those for the S&P 500 Index in a Bull Market, AND your losses will be less in a Bear Market. It doesn’t mean you’ll underperform that Index long-term. Why? Because trending stocks become overbought in a Bull Market. But you’re underweighting those high-beta Financial Services and Information Technology stocks! Half of the market capitalization in the S&P 500 Index is currently in those two industries, vs. the long-term average of 30%. Owning high-beta stocks will make you richer faster, but you’ll have to do daily research so that you know when to BUY and when to SELL. My approach to those two industries is to dollar-average into Microsoft (MSFT), International Business Machines (IBM) and JP Morgan Chase (JPM). And keep dollar-averaging no matter what.

Mission: Run our Standard Spreadsheet to identify low-beta stocks of high quality: 
   1. S&P Bond Ratings of A- or better (Column T in the Table);
   2. S&P Stock Ratings of B+/M or better (Column U in the Table);
   3. 5-Yr Beta of less than 0.7 (Column I in the Table);
   4. Lower statistical risk of loss than the S&P 500 Index (Column M in the Table);
   5. Higher Finance Value than the S&P 500 Index (Column E in the Table)
   6. Dividend Achiever status (Column AC in the Table).

Execution: see Table.

Bottom Line: Try not to be a momentum investor. The exciting stories that underlie every Bull Market create a crowded trade for stocks issued by Financial Services and Information Technology companies. To usefully deploy the cash that’s rolling into their coffers, those companies will try to innovate and deploy new services and equipment sooner than planned. Things will get messy, bordering on chaos. Parts of the “story” will collapse, or end in court. Current examples abound. So, we’re back to the Tortoise and Hare story because it will be trotted out at the end of every market cycle. Will you channel the Hare, or will you channel the Tortoise?

Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)

Full Disclosure: I dollar-average into NEE, PEP and NKE, and also own shares of KO and JNJ.

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

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Week 357 - Dividend Achievers That Support Commodity Production

Situation: Commodities crashed in 2014 but the only S&P industries to be affected were Energy, Industrials (specifically railroads) and Basic Materials. A new Commodity Supercycle began to take hold in early 2017.

Which companies stand to benefit?

Mission: Under the best of circumstances, commodity-related investments are highly speculative. If you gamble at this casino long enough, you’ll lose big and win big. So, let’s confine our attention to “the best of circumstances,” i.e., set up our Standard Spreadsheet to look at companies meeting these requirements: 
   1) S&P credit rating for long-term bonds is BBB+ or better; 
   2) S&P stock rating is B+/M or better; 
   3) Long-term Debt doesn’t exceed 33% of Total Assets; 
   4) Tangible Book Value is a positive number; 
   5) the company is a Dividend Achiever.

Execution: see Table.

Administration: Seven companies meet our requirements. Only the two railroads (UNP, CSX) and Exxon Mobil (XOM) meet the key requirement Warren Buffett has for saying that a company enjoys a “Durable Competitive Advantage” (see Week 54), i.e., steady growth in Tangible Book Value exceeding 7%/yr (see Columns AD and AE in the Table). It is also important to note that all areas of commodity production (aside from aquaculture) employ equipment that digs in the dirt. That makes Caterpillar (CAT) a useful barometer, and its stock has done well since the Commodity Crash of 2014-2016.

Bottom Line: If you’ve held shares in any of these 7 companies (see Table) for more than a few years, I commend your perseverance. Stick it out awhile longer and you may be rewarded. A new Commodity Supercycle appears to be starting, and will likely take hold if China stays the course and becomes a Superpower.

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 Union Pacific (UNP) and Exxon Mobil (XOM).

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Week 355 - Companies in “The 2 and 8 Club” with a Durable Competitive Advantage

Situation: It is now 10 years since The Great Recession began with the collapse of Bear Stearns. Trust in markets was broken and has barely begun to recover. The Securities and Exchange Commission (SEC) grew out of The Great Depression because investors lost trust in markets. One of the ways it tried to rebuild trust was to require private companies to still have a strong balance sheet after a successful Initial Public Offering (IPO). If the SEC wasn’t convinced this would happen at the proposed price for the IPO, then the IPO wouldn’t be permitted.

Before the Great Recession of 2008, fewer than a third of companies in the S&P 500 Index had steadily growing Tangible Book Value (TBV), i.e., property, plant, equipment, and software priced at original cost (see Week 54, Week 94, Week 158, Week 241, Week 251, Week 271). After 2008, Balance Sheets were in need of  repair, and that was facilitated by low interest rates. Now, perhaps a quarter of S&P 500 companies again have steady TBV growth. 

Mission: Apply our Standard Spreadsheet to companies in the Extended Version of “The 2 and 8 Club” that have shown steady TBV growth (with no more than 3 down years) since 2008. Warren Buffett suggests that such companies have a Durable Competitive Advantage (see blogs listed above), as long as TBV meets the Business Case of doubling after 10 years (i.e., a growth rate of at least 7%/yr).

Execution: see Table.

Administration: Risk works both ways for stock investors, i.e., you’ll either lose or gain +20% every few years. Our investing behavior isn’t governed by numbers, so we don’t act appropriately when warning signs of a market crash emerge. Why? Because we can’t know for certain when and whether a market crash will indeed happen. Many of us will remain sitting at the table even after it has clearly become a gambling table. You know when that occurs because the risk-off investors have already cashed out. Those of us who remain are governed by a desire to have. After a few market cycles, we come to realize that having more is going to be either boring or exciting, based on one’s appetite for risk. To have more, and have it be exciting, involves good study habits and an ability to live with chronic anxiety. Simply being human will matter less and less. 

The trick is to maintain discipline 24/7/365, by using a system for monitoring and researching your investments. This has to be combined with a weird ability to stick with your system through good times and bad. Numbers won’t save you when the market is turning. Instead, you have to know whether or not the “story” that underpins the reason for each of your holdings has retained its agency. Truth be told, the moves you make (or don’t make) at turning points will come down to a gut feeling as to whether your holdings are overbought or oversold. Any decision you make at a turning point is a risk-on decision. Caveat emptor: This is not a formula for marital bliss. (Warren Buffett was mystified when his wife left to become an artist in San Francisco.)

Bottom Line: Now is a good time to have a boring investment posture, which means choosing to dollar-average into companies that have bullet-proof Balance Sheets and strong Global Brands. This week we look at the bedrock of strong Balance Sheets, which is steady growth in Tangible Book Value. Five of these 9 companies are part of S&P’s Finance Industry. Their strong Balance Sheets reflect the regulatory requirements of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. If Dodd-Frank becomes eroded by a Risk-on Congress, you’ll have to dig deeper into Annual Reports when investing in a Financial Services company. REMEMBER: common stocks issued by Financial Services and Real Estate companies are the most risky places to park your money, aside from commodity futures.

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

Full Disclosure: I dollar-average into NEE and JPM, and also own shares of CSCO and TRV.

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

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Week 349 - Dividend Achievers with high Long-term Debt offset by a Strong Global Brand

Situation: Some highly indebted companies manage to pass through economic cycles with little difficulty, even though though they sometimes find it expensive to roll-over (refinance) their Long-Term Debt. This is a conundrum, given the impairment of their Balance Sheets (debt maturing in more than one year represents more than one third of their total assets). Think of having $200,000 left on your mortgage but your household assets (including equity in your home) are only worth $600,000. 

I try to avoid investing in such companies. When I do, I look for an excuse to sell. But there has to be a rational explanation for why these companies prosper, given the cost of servicing long-term debt. Two explanations come to mind: 
   1) These companies have a lower cost of capital, since so much of their capitalization is in the form of debt, where interest payments have not been taxed until recently. (The new tax law levies a 21% tax on interest payments that consume more than 30% of earnings.) 
   2) These companies have a strong Global Brand, which is an Intangible Asset that increases their acquisition value. That is, a strong Global Brand would increase the purchase price at least 5% above Tangible Book Value.
   3) These companies sell products that are remarkably “inelastic”, meaning that sales volumes are insensitive to price: “The price elasticity of supply measures how the amount of a good that a supplier wishes to supply changes in response to a change in price.[2] In a manner analogous to the price elasticity of demand, it captures the extent of horizontal movement along the supply curve relative to the extent of vertical movement [in price]. If the price elasticity of supply is zero the supply of a good supplied is ‘totally inelastic’ and the quantity supplied is fixed.” 

Mission: Analyze high-yielding Dividend Achievers (companies that have increased their dividend annually for at least the past 10 years). Select companies that have long-term Debt amounting to more than 33% of Total Assets, as shown in Column P of the Table. Reject companies that do not have a strong Global Brand. Also reject companies that do not have A ratings from S&P for both the bonds and common stocks that they have issued (see Columns T and U in the Table). Brand rankings are shown in Columns AB-AC of the Table. Examine a comparison group of companies in the Benchmark Section of the Table. 

Execution: see Table.

Bottom Line: The outperformance and low price volatility of these stocks, even during difficult market conditions (see Column D in the Table), cannot be explained by unique Tangible Assets such as strong Patent Protections or Tax Advantages. That leaves Brand Values (i.e., consumers prefer a brand they can trust) and Inelasticity (i.e., unit sales are not price sensitive) to account for the resiliency of their stock prices. That resiliency ultimately comes from pricing power. 

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 Coca-Cola (KO), and also own shares of IBM and McDonald’s (MCD).

"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

Week 343 - Raise Cash For The Crash

Situation: By now, you know that many are predicting that we are in the late stages of a bull market. Euphoria is the last stage, and in the present climate, one would expect that euphoria will begin happening as the new tax bill takes effect. Two or 3 years later, the stock market will over-correct to the downside and recession will likely soon follow. Now would be a good time for small investors to begin to protect themselves. One way to do that would be to “bulk up” on cash equivalents and Treasuries. The money you still have in equities will need to move in the direction of high-yielding Dividend Achiever type stocks. 

Why should we start making these changes now? Because the yield curve is flattening (see Appendix below), which is the best indicator that Financial Services professionals have to predict a market crash.

Mission: Draw up a portfolio of stocks and bonds that will carry you through a market crash relatively unscathed.

Execution: see Table.

Administration: There are 4 ways to raise cash for a crash.
   1) Have a Rainy Day Fund that covers 6 months of expenses and is inflation-protected. All of us resist maintaining this “Dead Money Account.” Why? Because it keeps taking money away from spending as our income increases. The trick is to make it painless by a) eliminating transaction costs, tax payments, and inflation risk, and b) paying into the Account automatically. Sounds great, but how? By going to the US Treasury website and directing that a transfer of $25+/mo be made from your checking account into an Inflation-Protected Savings Bond (ISB). Follow a First In/First Out (FIFO) policy when cashing-out your Rainy Day Fund, since you’ll lose an interest payment if you cash-out sooner than 5 years. Taxes are only due after you’ve drawn down the Account.

   2) Increase your Cash-Equivalents Allocation: dollar-average into 2-Yr Treasury Notes. Normally, this allocation is whatever cash cushion you like to maintain in your Savings, Checking, and Brokerage Accounts. But now isn’t a normal time. You need to plus-up those cash holdings and build a “backstop.” Why? Because there’s a material risk that your household will soon be living on less income (that is, a reduction upwards of 5%/yr). The easiest way to build a temporary backstop is to go back into www.treasurydirect.com and invest $1000 every 2 months in a 2-Yr Treasury Note. After 2 years, you’re done. You’ve allocated $12,000 that will start paying $1000 into your Checking Account every 2 months. Meantime, you can track the value of this investment through the ticker SHY (iShares 1-3 Year Treasury Bond ETF -- see Line 20 in the Table),  

   3) Reduce your Equity Allocation but retain Dividend Achievers with above-market yields. This week’s Table has suggestions that may assist you. Those stocks were chosen largely on the basis of a) high ratings from S&P, b) above-market yields, c) the likelihood of payouts continuing to increase in a recession, d) P/E ratios at or below market, and e) predicted losses in a bear market (see Column M in the Table) that are less than or equal to those predicted for the S&P 500 Index (at Line 20). When the crash hits, you will be tempted to sell these (your most crash-resistant stocks) because you’re afraid they’ll fall further. Don’t. Instead of reinvesting dividends, just have the dividend checks sent to your mailbox. If you aren’t a stock picker, simply invest in VYM (Vanguard High Dividend Yield ETF at Line 17 in Table) and XLU (SPDR Utilities Select Sector ETF at Line 14).

   4) Increase your Fixed-Income Allocation: dollar-average into 20+ Yr Treasury Bonds. In a Bear Market, you may need to raise cash by selling assets. You might want to sell assets that have temporarily spiked upward in value because stocks are crashing. Only one asset that will predictably do that for you: 20+ Year Treasury Bonds, which are already being bought up and flattening the yield curve (see Appendix below). These are the Treasuries you’ll be buying, and later turning around to sell. So, you’ll need to have a brokerage account that is fee-based (that is, you’re charged ~1% of Net Asset Value/yr in return for transaction costs being waived). Then dollar-average into TLT (iShares 20+ Year Treasury Bond ETF at Line 15 in the Table). Sell those when you think the stock market has bottomed, and spend the proceeds on stocks in that Fire Sale. 

Bottom Line: To avoid sleepless nights and migraine headaches, pull in your horns now. Stop gambling (but restart after the market collapses). Build up your Rainy Day Fund, and invest in cash equivalents, high-yielding high-quality stocks, and long-term Treasuries. When the crash hits, people will tell you to stop buying stocks altogether. Why do they say that? Because nobody can say for sure how long the market will keep going down. But Walmart (WMT) and McDonald’s (MCD) will be booming, even while layoffs in the Industrial Sector continue to make headlines. The End of the World isn’t happening. Get over it. Read the Wall Street Journal. When the Bear looks to be getting tired, call your stock broker and buy.  

Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into NEE and TGT, and also own shares of PEP, PFE, HRL, and MO. I am executing on the 4 suggestions above for raising cash.

APPENDIX: The yield curve is Flattening. What does that jargon term mean? Savvy investors are moving money out of growth stocks and into Long-Term Treasuries, even while the Federal Reserve is raising Short-Term interest rates. It doesn’t make sense. Long-Term rates would typically move up in tandem with Short-Term rates, provided the economy is truly gaining strength. 

You can follow that increase in Long-Term Treasury Bond prices (which move in the opposite direction of interest rates) by going to Yahoo Finance and entering TLT (for iShares 20+ Yr Treasury Bond ETF). Click on “chart” and select the 2 Year chart. Then on “indicator” and choose a 200-day moving average. That will show the steady upward movement in the price of those bonds—because buyers outnumber sellers. That results in a steady downward movement in the rate of interest being earned by new buyers, which flattens the yield curve. 

There are several explanations why Long-Term interest rates might fall even as Short-Term rates are rising: “the likeliest...is the simplest: markets are losing confidence in the Fed’s ability to raise [Short-Term] rates without inflation sagging.” You might want to learn more about the falling yield curve, so read on.

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

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Week 341 - Companies in “The 2 and 8 Club” with Strong Global Brands

Situation: You’d like to own stocks that won’t give you heartburn when the market crashes. There are only two ways a company can predictably weather a recession better than others in its industry. By having 1) a clean Balance Sheet (see Columns P-S in any of our Tables) and/or 2) a strong Global Brand. During a recession, consumers will have less money to spend because they’re not making as much. They’ll cut back on frills but keep spending on necessities marketed by companies they respect. Economists call such spending inelastic, and also speak of those companies as having a strong brand. Accountants struggle to define brand value, even though it obviously runs to the billions of dollars for a number of companies, so they call it an intangible asset.  

Mission: Use our Standard Spreadsheet to analyze the 33 companies in the Extended Version of “The 2 and 8 Club” (see Week 329), selecting only those that have a Top 500 Global Brand.

Execution: see Table, where all 21 such companies are ranked by brand value in Column AC.

Administration: We need to know what fraction of sales for each company originate outside the United States. That information should be in every company’s Annual Report but is often missing. Perhaps the reason is that those companies often retain revenues in the country of origin (to avoid double taxation should revenues be repatriated to the USA). But we know that Microsoft, the largest company in this week’s Table, draws more than 60% of its revenues from outside the United States. Over the past 5 years, I have seen two articles estimating that 45-50% of all revenues for S&P 500 companies occur outside the United States.  

For you to attempt to own shares in a third or half of the 21 companies on our list (see Table), you’ll need to keep track of two variables: 1) Dividends (Yield & Growth rates), and 2) Global Brand value. Both will change over time. Brand values are easy to follow (see link above). But some companies will mature in their market and no longer be able to grow dividends faster than 8% a year. A company might cut its dividend, in which case it would no longer be listed in the US version of the FTSE Global High Dividend Yield Index. There will also be new members of “The 2 and 8 Club.”

To move in and out of positions as indicated by your research, you’ll have to become an active stock trader. Dollar-cost averaging is still a good idea, but you’ll likely find that an online Dividend Re-Investment Plan (DRIP) doesn’t have the flexibility you’ll require. A recent study of 13 broker-dealers offers detailed information about those that have the low transaction costs and attractive reward programs. Ally Financial (ALLY) is their top-ranked brand.

Bottom Line: There are only two ways a company can insulate itself from a looming recession: 1) maintain a Clean Balance Sheet, and 2) keep making money because of having a strong Global Brand. This week’s Table highlights 21 brand leaders, over half of which have clean Balance Sheets.

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

Full Disclosure: I dollar-cost average into MFST, MMM, IBM, KO and JPM, and also own shares of MO, TRV, PFE, CAT, and TXN.

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

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com