Situation: Is the US stock market overpriced? We need to know because Warren Buffett keeps reminding us how important it is to avoid overpaying for a stock. Buffet says: “No matter how successful a company is, don’t overpay for its stock. Wait until Wall Street sours on a company you like and drives the price down into bargain territory. By making a watch list of interesting stocks, and waiting for their prices to drop, you increase the potential for future capital gains.”
The author of this link suggests that none of us “mere mortals” are as smart as Warren Buffett at getting the price right. It’s perhaps better to either dollar-average your investment, or leave it to professionals to do the stock-picking for you. We suggest that there is a third option, which is to use a couple of simple mathematical formulas to guide your stock-picking. Those formulas can be found in the book that Warren Buffett calls “by far the best book on investing every written.” The book is entitled: The Intelligent Investor by Benjamin Graham, Revised Edition, Harper, New York, 1973. There, you will find the value of calculating the 7-year P/E instead of the usual 12-month P/E, and also learn how to calculate the “Graham Number.” The Graham Number is what the stock would sell for if it were priced at 1.5 times Book Value and 15 times trailing 12-month (TTM) earnings. Calculating and using the Graham Number is important because it allows for variation in Book Value and earnings. Multiplying the two values just has to be ~22.5 (15 X 1.5) for the stock to be optimally priced.
Mission: To test both methods on stocks issued by the 30 companies in the Dow Jones Industrial Average (DJIA). See columns X, Y and Z on our Standard Spreadsheet (Table).
Execution: see Table.
Administration: Here’s how to calculate the Graham Number, as shown on p. 349 in the book cited above). [Clicking this link will take you to the Amazon website and the book).] Start by multiplying 1.5 (ideal ratio of Book Value/share) by 15 (ideal ratio of TTM Earnings/share) = 22.5. By multiplying two numbers you have created a Power Function. So, you’ll have to take the Square Root of the Final Number to arrive at the Graham Number. Final Number = 22.5 X actual Book Value/share for the most recent quarter (new) X actual TTM Earnings/share. To access Earnings/share, go to any company’s page at Yahoo Finance, e.g. Apple’s. In the right column find EPS (TTM) of $11.038. To access Book Value/share, click on “statistics” at the top of that page and scroll down the left column to “Balance Sheet.” Book Value/share for the most recent quarter (mrq) is the last entry: $23.74. Graham Number = square root of 22.5 X $11.038 X $23.74 = $76.79. This is the true value (Graham Number) for a single share of Apple stock. If it sells for less, that’s a bargain. Right now, it’s selling for almost 3 times as much. If you own some shares, either think about selling those or think about the company’s ability to scale-up the “Apple ecosystem”. Perhaps you’ll decide that those prospects make holding onto the shares for a while longer a worthwhile risk.
Calculating the 7-Yr P/E (p. 159 in the book cited above). You’ll need a website that provides the past 7 years of TTM earnings, or a library with S&P stock reports. Simply add the most recent 7 years’ earnings and divide by 7 to arrive at the denominator. Look up the current price of the stock (or its 50 Day Moving Average price found in the right column of the statistics page under “Stock Price History”) to arrive at the numerator. Divide numerator by denominator to calculate the 7-Yr P/E, which must be 25 or less to reflect “normative” earnings growth over 7 years for a stock with a 12-month P/E of ~20 during most years. By using the 7-yr P/E you avoid being mislead by a year of blowout earnings or negligible earnings.
Bottom Line: As a group, these 30 stocks are overpriced. Nonetheless, 12 companies have stocks that are priced within reason vs. their Graham Numbers and 7-Yr P/Es (see Columns X-Z in the Table): TRV, DIS, WBA, INTC, VZ, JPM, PFE, PG, GS, UTX, CVX, XOM. But only one company, Goldman Sachs (GS), can be called a bargain with respect to both values (those values being highlighted in green in the Table). Note that Berkshire Hathaway (BRK-B at Line 35 in the Table) is an even better bargain. Perhaps Warren Buffett noticed these markers of high intrinsic value when he recently spent part of Berkshire Hathaway’s cash hoard to buy back the stock.
Risk Rating: 5 where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10
Full Disclosure: I dollar-average into 3 stocks on the “not overpriced list” -- JPM, PG and XOM, and also own shares in two others: INTC and TRV. Additionally, I dollar-average into MSFT, KO, JNJ, WMT, CAT and IBM, and own shares in MCD, MMM and CSCO.
Comment: I focus on Dow Stocks because each is covered by dozens of analysts and business journalists, and its stock options are actively traded on the Chicago Board Options Exchange. The result of this microscopic attention is that price discovery is efficient, and surprise earnings are rare. In addition, all 30 companies have a long record of business experience, and are large enough to have multiple product lines that provide internal lines of support during a crisis. DJIA companies are famously able to weather almost any storm: Seven DJIA companies went through a near death experience during The Great Recession of 2008-2009 (General Electric, Citigroup, General Motors, Pfizer, Home Depot, Caterpillar, and American Express) but only 3 had to be removed in the aftermath of that “Lehman Panic” (General Electric, Citigroup, and General Motors).
"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.
Showing posts with label apple. Show all posts
Showing posts with label apple. Show all posts
Sunday, September 30
Sunday, June 3
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 9
Week 175 - Gold, Apple and Your Inner Gambler
Situation: Why do many of us keep trying to make money on chancy investments like gold or zippy growth stocks? Because we think we're clever enough to make it work (even though few of us have a degree in finance or a job in financial services). I know you wouldn't be reading this blog if you didn't already know this is not a sound investment strategy but the temptation is still there. It’s the voice of our Inner Gambler. Why is that? Quite simply, we're competitive... all of us. Disposable income allows us to compete, whether in material terms or by positioning our children and grandchildren for success. Status carries with it a propensity to gamble for more status. An investor, however, measures success less by material proof and more by assets under management. An investor is unlikely to put money toward anything where the long-term Return On Invested Capital (ROIC) is unlikely to exceed the Weighted Average Cost of Capital (WACC) by at least 5%/yr. Therefore, long-term investment in life-enhancing events, such as educating one’s children, take top priority.
For today’s blog, we would like to examine how our Inner Gambler works, so as to gain power over it through situational awareness. In order to exist, gambling has to fulfill a need. But gambling differs from other addictions in a profound way: If successful, it enhances self-esteem and allows us to gain respect through the appearance of success and by helping others. In addition, we may be able to afford the trappings of self-importance and use those as a route to impressing other people.
Retirement is serious. And it’s becoming more serious with each passing year (and our government’s trillion-dollar addition to social safety net insolvency). With modern medicine, you may enjoy 40 years of retirement, if you’ve saved enough. The secret of retirement planning lies in distant gratification, not instant gratification. Most gamblers prefer instant gratification and allowing it to overcome their reasoning ability. We all know stressors arise from time to time and demand instant gratification. But we can also learn to “firewall” our key assets, such as the deed to our house, the title to our car, our wedding ring, and our retirement accounts.
Wait, how does one firewall a retirement account? You set up automatic monthly withdrawals from your checking account into your IRA and DRIPs, and divert at least 10% of your salary to your workplace retirement plan. It’s all on automatic pilot and you’d have to go to some trouble to stop those diversions, which would also result in a big tax bill.
More importantly, rules are needed that keep you from getting in a credit crisis: 1) Never buy stock with borrowed money (i.e., buying “on margin”); 2) Backup stock investments 1:1 with Treasuries unless you’re buying a "hedge" stock (see Week 150); 3) Create a budget that dedicates a piece of your monthly income to match each recurring monthly expense.
For this week's Table, we examine the two smartest gambles of the past decade: Apple stock (AAPL) and the iShares gold ETF (GLD). You'll want to know how these stack up against the lowest-cost and best-hedged mutual funds like Vanguard Wellesley Income Fund (VWINX) and Vanguard Balanced Index Fund (VBINX), as well as the lowest-cost S&P 500 Index fund, Vanguard’s 500 Index Fund (VFINX). Red highlights indicate underperformance relative to VBINX. For comparison, we include stocks that prosper in bad times: Wal-Mart Stores (WMT) and Ross Stores (ROST), as well as an intermediate-term US Treasury fund (VFITX) and a long-term US Treasury fund (PRULX). GLD did well during the Great Recession but the two recession-proof stocks did well then and have continued to do well. GLD predictably collapsed in price when the economy started recovering. Treasuries are the “steady Eddies” of finance and really shine during recessions, but fade during recoveries.
Let’s assume that you were clever and bought a lot of AAPL and GLD 10 yrs ago. But were you clever enough to sell GLD 5 yrs ago and buy VFINX just as the stock market was taking off? Or did you wait until the price of gold collapsed two years ago? And, would you have been clever enough to not sell your AAPL shares in 2012 when the price fell 20%, or in 2013 when the price fell 40%? Very few investors who bought GLD and/or AAPL 10 yrs ago would have known “when to hold and when to fold.” And, those few probably wouldn’t have acted. Why? Because that would have meant going against herd behavior. In summary, being clever is about making three smart moves (buy:hold:sell) in a timely manner, not just one, and making those moves regardless of the opinions that others may hold.
Bottom Line: In hindsight, even the best gambles carry too much emotional baggage and volatility to warrant a place in your retirement account. But Apple (AAPL) shares have been a great investment for those who studied the company carefully throughout its ups and downs and refused to sell. The problem: AAPL is so successful that naysayers abound, and they’re not just short-sellers. It is simply human nature to highlight negative factlets about successful people or enterprises.
Risk Rating: 8
Full Disclosure: I've never owned GLD or AAPL shares.
For today’s blog, we would like to examine how our Inner Gambler works, so as to gain power over it through situational awareness. In order to exist, gambling has to fulfill a need. But gambling differs from other addictions in a profound way: If successful, it enhances self-esteem and allows us to gain respect through the appearance of success and by helping others. In addition, we may be able to afford the trappings of self-importance and use those as a route to impressing other people.
Retirement is serious. And it’s becoming more serious with each passing year (and our government’s trillion-dollar addition to social safety net insolvency). With modern medicine, you may enjoy 40 years of retirement, if you’ve saved enough. The secret of retirement planning lies in distant gratification, not instant gratification. Most gamblers prefer instant gratification and allowing it to overcome their reasoning ability. We all know stressors arise from time to time and demand instant gratification. But we can also learn to “firewall” our key assets, such as the deed to our house, the title to our car, our wedding ring, and our retirement accounts.
Wait, how does one firewall a retirement account? You set up automatic monthly withdrawals from your checking account into your IRA and DRIPs, and divert at least 10% of your salary to your workplace retirement plan. It’s all on automatic pilot and you’d have to go to some trouble to stop those diversions, which would also result in a big tax bill.
More importantly, rules are needed that keep you from getting in a credit crisis: 1) Never buy stock with borrowed money (i.e., buying “on margin”); 2) Backup stock investments 1:1 with Treasuries unless you’re buying a "hedge" stock (see Week 150); 3) Create a budget that dedicates a piece of your monthly income to match each recurring monthly expense.
For this week's Table, we examine the two smartest gambles of the past decade: Apple stock (AAPL) and the iShares gold ETF (GLD). You'll want to know how these stack up against the lowest-cost and best-hedged mutual funds like Vanguard Wellesley Income Fund (VWINX) and Vanguard Balanced Index Fund (VBINX), as well as the lowest-cost S&P 500 Index fund, Vanguard’s 500 Index Fund (VFINX). Red highlights indicate underperformance relative to VBINX. For comparison, we include stocks that prosper in bad times: Wal-Mart Stores (WMT) and Ross Stores (ROST), as well as an intermediate-term US Treasury fund (VFITX) and a long-term US Treasury fund (PRULX). GLD did well during the Great Recession but the two recession-proof stocks did well then and have continued to do well. GLD predictably collapsed in price when the economy started recovering. Treasuries are the “steady Eddies” of finance and really shine during recessions, but fade during recoveries.
Let’s assume that you were clever and bought a lot of AAPL and GLD 10 yrs ago. But were you clever enough to sell GLD 5 yrs ago and buy VFINX just as the stock market was taking off? Or did you wait until the price of gold collapsed two years ago? And, would you have been clever enough to not sell your AAPL shares in 2012 when the price fell 20%, or in 2013 when the price fell 40%? Very few investors who bought GLD and/or AAPL 10 yrs ago would have known “when to hold and when to fold.” And, those few probably wouldn’t have acted. Why? Because that would have meant going against herd behavior. In summary, being clever is about making three smart moves (buy:hold:sell) in a timely manner, not just one, and making those moves regardless of the opinions that others may hold.
Bottom Line: In hindsight, even the best gambles carry too much emotional baggage and volatility to warrant a place in your retirement account. But Apple (AAPL) shares have been a great investment for those who studied the company carefully throughout its ups and downs and refused to sell. The problem: AAPL is so successful that naysayers abound, and they’re not just short-sellers. It is simply human nature to highlight negative factlets about successful people or enterprises.
Risk Rating: 8
Full Disclosure: I've never owned GLD or AAPL shares.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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