Month 95 - Dow Jones Industrial Average - Spring 2019 Update

Situation: The S&P 500 Index has recently posted a new all-time high, and “The Dow” is only 1% away from a new all-time high. However, Dow Theory won’t label that achievement (if it happens) as the beginning of a new Primary Uptrend. Why? Because the Dow Jones Transportation Average still has to go somewhat higher before it “corroborates The Dow.” Conclusion: Dow Theory still places the US stock market in a Short-term Downtrend. If you’re a stock-picker, that means you still need to consider selling the overpriced stocks in your portfolio. Why? Because things are likely to get worse before they get better.

Mission: Use our Standard Spreadsheet to highlight DJIA stocks that appear to be overpriced.

Execution: see Table.

Administration: It is almost impossible to distinguish an overpriced stock from a stock that is pulling in more investors because they see a bright future. If the company is already highly regarded because of its Balance Sheet, Product Lines, and Brand Penetration, I would hesitate to call its stock overpriced at any P/E (think of Amazon with its P/E of 81). 

I’m a numbers guy, so I use two numbers to decide if a stock is overpriced (where “price” or P is defined as the 50-day moving average):
   1) the 7-yr P/E is greater than 30. 
   2) the stock’s Graham Number, which is the square root of 22.5 times Earnings Per Share multiplied by Book Value Per Share, is more than 250% of its price. 

If only one of those two numbers is over the limit, the stock is still overpriced if the other number is close to the limit, i.e., more than 25 or 200%, respectively. (For Amazon, those numbers are 53 and 752%. So, it’s overpriced and I sold my shares.)

Deciding whether or not to buy a stock is also tricky. To give a more nuanced estimate of a stock’s value to the investor, I’ve devised a Basic Quality Screen that has only 6 elements and a maximum score of 4 (see Table): 
   1) If price appreciation over the past 16 yrs has been greater than 1/3rd the risk of short-term loss as determined by the BMW Method, one point is added. In other words, price appreciation in Column K is greater than 1/3rd the risk in Column M.
   2) If Tangible Book Value in Column S is negative and LT-debt represents more than 50% of Total Capital (Column O), or Total Debt is more than 250% of EBITDA (Column P), one point is subtracted.
   3) If the S&P Bond Rating in Column U is BBB+ or better, one point is added. 
   4) If the S&P Stock Rating in Column V is B+/M or better, one point is added. 
   5) If Net Present Value of accumulated dividends and cash-out after a 10 year Holding Period is a positive number, when applying a Discount Rate of 10% (see Column Z), one point is added. 
   6) If the two markers of an overpriced stock noted above (see Columns AB and AD) indicate that the stock is indeed overpriced, half a point is subtracted.

The final SCORE is found in Column AJ.

Bottom Line: How to sell a stock is always harder to learn than how to buy a stock. The 30 stocks in the Dow Jones Industrial Average are great companies. So, those are even harder to abandon once you’ve seen the way their stocks perform in your portfolio. And, the prominence of these companies in the press is guaranteed to attract investors who don’t think they need to do their own due diligence before adding stock in a famous company to their portfolio. You see the problem: We have here the makings of a Perfect Storm that will hit someday. 

Conclusion: There are 11 Dow stocks that appear to be overpriced now: MRK, MSFT, V, NKE, BA, UNH, MCD, KO, HD, JNJ and MMM. And, even though the stock market is generally thought to be overpriced, an equal number appear reasonably priced (see Column AJ in the Table): PFE, CSCO, DIS, AAPL, INTC, PG, TRV, JPM, WMT, CAT and UTX.

Risk Rating: 6 (where 1 = 10-yr US Treasury Notes, 5 = S&P 500 Index, and 10 = Gold bullion).

Full Disclosure: I dollar-average into MSFT, NKE, BA, INTC, KO, PG, JNJ, JPM and CAT, and also own shares of PFE, CSCO, MCD, AAPL, TRV, WMT, MMM, XOM and IBM. (All dividends are automatically reinvested.) 

My holdings of stock in those 18 “Dow” companies are meant to represent a cross-section of the US economy. But you shouldn’t think my future returns (adjusted for risk, transaction costs, and capital gains taxes) will beat The Dow. Only a full-time trader has better than a one in twenty chance of beating the Dow Jones Industrial Average over the next two market cycles. And that trader will likely find it necessary to buy and sell stock options (so as to protect large positions from market-turning events). She might also minimize transaction costs by working from a Globex Terminal, meaning her trades are guaranteed by a firm with Globex Registration at the Chicago Board of Trade.

The rational basis for us, as retail investors, to buy shares of stock in specific companies is to have a growing stream of Dividend Income during retirement years, while leaving Principal intact, i.e., the shares that generate those dividends would only be sold to handle a severe financial emergency. 

P.S.: Warren Buffett advises his friends and family to invest 90% of their savings in a low-cost S&P 500 Index fund marketed by the Vanguard Group , such as VFIAX.


NOTE: This text was written on 5/6/2019.

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

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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 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.

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

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Week 332 - Defensive Companies in “The 2 and 8 Club”

Situation: The Dow Jones Industrial Average keeps making new highs, “confirmed” by new highs in the Dow Jones Transportation Average. According to Dow Theory, we are in a “primary” Bull Market. That is a period when investors should be paying off their debts and/or building up cash reserves. It is also a period when stocks in “growth” companies become overpriced, and stocks in “defensive” companies become reasonably priced (after having been overpriced). It’s a good time to research high-quality companies in “defensive” industries: Consumer Staples, Health Care, Utilities, and Communication Services. 

Mission: Develop our standard spreadsheet for companies in “The 2 and 8 Club” (see Week 327) that are in defensive industries (see Week 327), and add any companies that are close to qualifying.

Execution: (see Table)

Administration: We’ll use the Extended Version of “The 2 and 8 Club”, which simply matches companies on two lists: The Barron’s 500 List and the 400+ companies in the FTSE High Dividend Yield Index. The Barron’s 500 List is published annually in May, and ranks companies by their 1 & 3 year Cash Flows from Operations, as well as their past year’s Revenues. The FTSE High Dividend Yield Index lists US companies that pay more than a market yield (~2%) and are thought unlikely to reduce dividends during a Bear Market. Companies that appear on both lists but do not have a 5-Yr Compound Annual Growth Rate (CAGR) of at least 8% for their quarterly dividend payout are excluded, as are any companies that carry an S&P Rating lower than A- for their bonds or lower than B+/M for their stocks.

Note the inclusion of Costco Wholesale (COST) at Line 4 in the Table. Although it has an annual yield lower than the required 2% for its quarterly dividend, the company has also issued a supplementary dividend every other year for the past 5 years. In those years, the dividend yield exceeds 5%. In calculating Net Present Value (see Column Y in the Table), we have used adjusted values for Dividend Yield (5.4%) and 5-Yr Dividend Growth (2.1%) in an effort to present an assessment closer to reality. That boosts NPV 42% over what it would be had supplemental dividends been ignored.

Note the inclusion of Coca-Cola (KO) at Line 9 in the Table. Although it has a 5-year dividend CAGR of 7.7%, which is slightly lower than our 8% cut-off, KO is a “mega-capitalized” company that has a major influence on prospects for the Consumer Staples industry.  

Bottom Line: Experienced stock-pickers can usually look forward to a decent night’s sleep, if experience has taught them to overweight their portfolio in high-quality “defensive” stocks that pay a good and growing dividend. By restricting our Watch List to companies in “The 2 and 8 Club”, we’ve found that there are only 10 defensive stocks you need to consider during this opportune time, i.e, when valuations are lower for “defensive” stocks because “growth” stocks become the overcrowded trade in a primary Bull Market.

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

Full Disclosure: I dollar-cost average into KO and NEE, and also own shares of COST, AMGN, MO, and HRL.

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

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Week 258 - Barron’s 500 Multimodal Transportation Companies

Situation: If you want to feel the pulse of an economy, look at trends in transportation. Those trends won’t tell you where the economy is headed next but they will show you where it’s been, and where the pressure points are. Right now, one pressure point for the US economy is the inefficiency of off-loading cargo from ships to drayage trucks, and transferring containers to warehouses or railroads. Another pressure point is the “final mile,” or how to get goods into the hands of consumers with a minimum of inconvenience. “Vertical integration” appears to be the answer for both problems, meaning companies like FedEx and UPS (and increasingly Amazon) will try to perform as many integrated services in-house as is possible. Finally, there are environmental considerations, namely, how do we move cargo around without leaving such a large carbon footprint. One solution that is off to a good start is replacing diesel truck engines with compressed natural gas (CNG) engines. The largest US truck fleet (JB Hunt Transport Services; JBHT) is an early adopter. Given the centrality of these above-mentioned companies, it would be a good idea for you to hold shares in one, or shares in an Exchange Traded Fund (ETF) for the transportation sector such as the iShares Transportation Average ETF ( IYT at Line 21 in the Table).

Mission: Provide a capsule summary for investors in Air Freight & Logistics companies, as well as multimodal trucking companies and railroads. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).

Execution: see Table.

Bottom Line: Dow Theory is the oldest method to assess current and future value in the stock market. The critical variable is the Dow Jones Transportation Average (DJTA), a running index of stock prices for 20 transportation companies. A “primary uptrend” ( Bull Market) is not declared when the Dow Jones Industrial Average (DJIA) hits new highs, but instead is declared when the DJTA confirms that event by also hitting a new high. We saw a confirmation most recently in November of 2014. The opposite also holds: a “primary downtrend” (Bear Market) must see a new low in the DJIA being confirmed by a new low in the DJTA.

The linchpin that holds transportation together is the Surface Transportation Board (STB), which has “wide discretion...to meet the nation’s changing transportation needs.” The STB is the most powerful Federal regulatory agency that transportation companies (even pipeline carriers) must face. Its power and reach is a boon to investors, since they won’t be permitted to lose much money: There will be volatility but there will be no bankruptcies, or strategic end-runs such as trucking companies underpricing railroads. In this week’s Table, we drill down on the 11 largest companies in the transportation space. Many of you may consider Amazon (AMZN) to be an outlier here, but Amazon is both the largest warehousing operation and the largest logistics company. And there will soon be thousands of Amazon-branded tractor-trailers on the highways. Time is money.

Risk Rating = 7 (where Treasuries = 1 and gold = 10).

Full Disclosure: I dollar-average into UNP and also own shares of CNI.

NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 17 in the Table). Metrics highlighted in green at Columns P and Q in the Table indicate improving performance trends for fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC.

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