Situation: Last month, we came up with 10 stocks that are “safe and effective” bets for the neophyte stock-picker. Our starting point was the S&P 100 Index of the largest publicly-traded companies that benefit from price discovery through a robust market in stock options. Very large companies have the built-in safety feature of multiple product lines, which provide management with internal options for responding to an economic crisis. I excluded companies with less-than-stellar S&P ratings on the stocks and bonds they have issued, as well as companies trading for fewer than 16 years. I have also excluded companies with volatile stocks--those with a 3-yr Beta that is higher than 0.75--as well as companies that are not listed in both of the “value” sub-indices (VYM and IWD) for the Russell 1000 Index.
This month I’ve dialed back on those safety requirements by including stocks that likely carry more reward at the expense of greater risk. My assumption is that the stock-picker has accumulated 10+ years of experience and now needs to face up to the responsibility of carefully investing for retirement. The “savings race” has reached The Clubhouse Turn but she still needs guideposts for selecting safe and effective stocks.
Mission: Run our Standard Spreadsheet on only the companies in the 65-stock Dow Jones Composite Average that have either issued bonds rated at least A- by S&P or carry no long-term debt on their balance sheet. (Those 65 companies are picked by a committee chaired by the Managing Editor of the Wall Street Journal.)
Execution: see Table.
Administration: Five companies that met the above criteria had to be excluded because they lack information we need for analysis: a full 16+ years of trading records (V, AWK) or an S&P stock rating of at least B+/M (CVX, DD, MRK). One company, PepsiCo (PEP) has been added to the BACKGROUND section because it is the only company among last month’s list of 10 Starter Stocks that isn’t in the Dow Jones Composite Index.
Bottom Line: A mid-career stock-picker who doesn’t have a degree in accounting or business administration is at a disadvantage. It would be in her best interest to narrow her choices to the gold standard of stock-picker lists, which is the 65-stock Dow Jones Composite Index, then further narrow her choices to companies that issue bonds rated A- or better by S&P and have at least a 16 year trading record for their stock. That leaves 28 companies to research. The goal, of course, is to find stocks that have outperformed the S&P 500 Index over the past 5 and 10 years while losing less value than the Index did in its worst year of the past 10. In other words, I’m suggesting that she should focus her research on the 9 companies that have no red highlights in Columns C through F of the Table: Microsoft (MSFT), UnitedHealth (UNH), Nike (NKE), Boeing (BA), Intel (INTC), Union Pacific (UNP), Disney (DIS), NextEra Energy (NEE), and American Electric Power (AEP).
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 MSFT, NKE, BA, UNP, NEE, JPM, INTC, KO, WMT, JNJ, PG, CAT and IBM, and also own shares of AAPL, CSCO, PFE, TRV, DUK, UPS, SO, MMM and XOM. So, I am invested in 22 of the 28 companies. It is difficult to follow that many companies, but it is nonetheless essential: Academic studies suggest that a stock-picker needs to be invested in at least 30 companies to have a good chance of matching market returns (see Columns C, F, and K in the Table) while enjoying less risk that the portfolio will lose value (see Columns D, I, and M of the Table).
APPENDIX: “Investment” is a nice word for the deployment of capital. As with any other capital expenditure, its effectiveness (profit margin) is what accountants call Operating Margin, which is Operating Income divided by Sales Revenue. Sales Revenue comes to the stock investor from dividends and the liquidation of shares. Operating Income is Earnings Before Interest and Taxes (EBIT) “after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax.”
As an investor who buys stocks, your variable costs of production are transaction costs (fees and commissions paid for purchase and sale of shares) plus rent/utilities/supplies for your “home office” and the cost of your business services (e.g. subscriptions to business magazines, newspapers, and websites). For money used to purchase stocks, EBIT is Gross Income (Sales Revenue after subtracting the variable costs of production) minus Depreciation (which is inflation).
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Showing posts with label benchmark. Show all posts
Showing posts with label benchmark. Show all posts
Sunday, October 27
Sunday, February 24
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 16
Week 376 - What Does A Simple IRA Look Like?
Situation: You’re bombarded with advice about how to save for retirement. But unless you’re already rich, the details are simple. Dollar-cost average 60% of your contribution into a stock index fund and 40% into a short or intermediate-term bond index fund. If you know you’ll never be in “the upper middle class”, opt for the short-term bond index fund. But maybe you have a workplace retirement plan, which makes saving for retirement a little more complicated. Either way, you’ll want to contribute the maximum amount each year to your IRA, which is currently $5500/yr until you reach age 50; then it’s $6500/yr.
Here’s our KISS (Keep It Simple, Stupid) suggestion: Make your IRA payments with Vanguard Group by using a Simple IRA (Vanguard terminology) composed only of the Vanguard High Dividend Yield Index ETF or VYM. Then, contribute 2/3rds of that amount into Inflation-protected US Savings Bonds. These are called ISBs and work just like an IRA. No tax is due from ISBs until you spend the money but there’s a penalty for spending the money early (you’ll lose one interest payment if you cash out before 5 years). The annual contribution limit is $10,000/yr. A convenient proxy for ISBs, with similar total returns, is the Vanguard Short-Term Bond Index ETF or BSV.
Mission: Create a Table showing a 60% allocation to VYM and 40% allocation to BSV. Include appropriate benchmarks, to allow the reader to create her own variation on that theme.
Execution: see Table.
Bottom Line: However you juggle the numbers, it looks like you’ll make ~7%/yr overall through your IRA + ISB retirement plan, with no taxes due until you spend the money. In other words, each year’s contribution will double in value every 10 years. The beauty of this plan is that transaction costs are almost zero, and the chance that it will give you headaches is almost zero.
Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Inflation-protected Savings Bonds and the Dow Jones Industrial Average ETF (DIA).
"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
Here’s our KISS (Keep It Simple, Stupid) suggestion: Make your IRA payments with Vanguard Group by using a Simple IRA (Vanguard terminology) composed only of the Vanguard High Dividend Yield Index ETF or VYM. Then, contribute 2/3rds of that amount into Inflation-protected US Savings Bonds. These are called ISBs and work just like an IRA. No tax is due from ISBs until you spend the money but there’s a penalty for spending the money early (you’ll lose one interest payment if you cash out before 5 years). The annual contribution limit is $10,000/yr. A convenient proxy for ISBs, with similar total returns, is the Vanguard Short-Term Bond Index ETF or BSV.
Mission: Create a Table showing a 60% allocation to VYM and 40% allocation to BSV. Include appropriate benchmarks, to allow the reader to create her own variation on that theme.
Execution: see Table.
Bottom Line: However you juggle the numbers, it looks like you’ll make ~7%/yr overall through your IRA + ISB retirement plan, with no taxes due until you spend the money. In other words, each year’s contribution will double in value every 10 years. The beauty of this plan is that transaction costs are almost zero, and the chance that it will give you headaches is almost zero.
Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Inflation-protected Savings Bonds and the Dow Jones Industrial Average ETF (DIA).
"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
Sunday, September 10
Week 323 - “Toto, I’ve A Feeling We’re Not In Kansas Any More.”
Situation: A storm has hit international relations. It’s not as though we haven’t been warned. In his 2014 book, “World Order,” Henry Kissinger mentions dark trends could undermine the principles of international governance, which were established by (and adhered to since) the Peace of Westphalia ended the Thirty Years War in 1648. Those principles are 1) the inviolability of national sovereignty, and 2) the self-determination of peoples free from religious intolerance. But Russia has recently annexed Crimea, and Great Britain’s vote to leave the European Union reflects growing religious intolerance. Here in America, we have echoed Brexit by electing Donald J. Trump to be our President.
Investors abhor uncertainty and wonder whether they’ll continue to prosper in the absence of International Order. The issue is one of governance. Picture a tent with many people of various nationalities inside, debating ideas about how best to get along together. This metaphor worked for hundreds of years, even though a camel would occasionally stick its nose under a tent. Now countries and economic unions are having to grapple with anarchists seeking Jihad.
What does it all mean? Investors need a mental picture, one where cause and effect assume a pattern that allows us to anticipate how events on the world stage are likely to play out. Artists often arrive at formulations before events unfold. The disruption of Victorian Order that culminated in World War One is one example. The writings of Franz Kafka and paintings of Picasso spring to mind as heralds of Modernism. Similarly, Existentialists like Albert Camus and Jean Paul Sartre anticipated the Second World War and gave us The Theatre of the Absurd. The effect reached music with the 12-tone scale, choreography with ballets no longer anchored in stories, paintings lacking both content and message, and the “deconstruction” of classical poetry.
The art world has evolved beyond Modernism to become Post-Modern, but more recently that has been replaced by Contemporary Art, which anticipates the crumbling of World Order we’re now seeing. Formerly, art was about feelings, music, and imagery; reasoned discourse was left out. In Contemporary Art, the intellect is finally engaged but still without reasoned discourse. The tent ropes have come loose. We are left to manage without Cliff’s Notes, religious precepts, party politics, or judicial constraint; mood-altering drugs are used to let light in as often as to keep it out. A piece of Contemporary Art (if we are open to it at all) might lead any one of us to see, hear, read, imagine, or think along a unique trajectory, then use that as a basis for free association.
There are no guideposts, and the unhinging has been accelerated by the ready availability of computing power and networking via one’s cell phone. The artist typically has no interest in channeling the viewer or listener’s thoughts, feelings, or mental images. Why presume, given that each of us is unique? A poet might apply the words levitation, unmooring, kaleidoscopic, or ricochet to characterize the mental effects that the artist ignites in some people. If people join together, it might become participatory theater. Think of stadium performances by iconic figures like The Grateful Dead, Janis Joplin, or even Donald J. Trump. The traditional format used by the music industry is also “going down the tubes.” Few artists make an “album” any longer with a recording studio contract. It’s all small entrepreneurs selling a single song via the internet, using social media as advertising.
Prepare your portfolio. Think about limiting key retirement investments to US Treasury bonds and well-capitalized A-rated stocks that have a Durable Competitive Advantage (see Table). VYM is the Benchmark Index for Russell 1000 companies that pay at least a market dividend. “Durable Competitive Advantage” (see Column O in the Table) is a term that Warren Buffett coined to denote a 7% (or higher) rate of growth in a company’s Tangible Book Value (TBV) over the past 10 yrs, provided that TBV is down no more than 3 years (see Week 158 and Week 241).
Administration: The sky is not falling. Civilization won’t end, and neither will Westphalian Principles of Governance. Be patient but don’t take risks. Some good is bound to come from abandoning “received wisdom” or “group think.” Why? Because “received wisdom” gives rise to dogma, and dogma prevents innovation. Don’t worry about nuclear war. Sure, it could happen. Maybe there’s even a “material” risk (odds higher than one in twenty). That would amount to an existential crisis for many survivors. We’d all become more focussed on survival, so behavior would become more collegial.
Bottom Line: Uncertainty is on the move. So, this is not a good time to speculate in financial assets. Hard assets like farmland are another matter (see next week’s blog).
Risk Rating: 6 (where 10-Yr T-Notes = 1, S&P 500 Index = 5, gold = 10)
Full Disclosure: I dollar-average into MSFT and NEE, and own shares of NKE, TJX, ACN, JPM, and TRV.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Investors abhor uncertainty and wonder whether they’ll continue to prosper in the absence of International Order. The issue is one of governance. Picture a tent with many people of various nationalities inside, debating ideas about how best to get along together. This metaphor worked for hundreds of years, even though a camel would occasionally stick its nose under a tent. Now countries and economic unions are having to grapple with anarchists seeking Jihad.
What does it all mean? Investors need a mental picture, one where cause and effect assume a pattern that allows us to anticipate how events on the world stage are likely to play out. Artists often arrive at formulations before events unfold. The disruption of Victorian Order that culminated in World War One is one example. The writings of Franz Kafka and paintings of Picasso spring to mind as heralds of Modernism. Similarly, Existentialists like Albert Camus and Jean Paul Sartre anticipated the Second World War and gave us The Theatre of the Absurd. The effect reached music with the 12-tone scale, choreography with ballets no longer anchored in stories, paintings lacking both content and message, and the “deconstruction” of classical poetry.
The art world has evolved beyond Modernism to become Post-Modern, but more recently that has been replaced by Contemporary Art, which anticipates the crumbling of World Order we’re now seeing. Formerly, art was about feelings, music, and imagery; reasoned discourse was left out. In Contemporary Art, the intellect is finally engaged but still without reasoned discourse. The tent ropes have come loose. We are left to manage without Cliff’s Notes, religious precepts, party politics, or judicial constraint; mood-altering drugs are used to let light in as often as to keep it out. A piece of Contemporary Art (if we are open to it at all) might lead any one of us to see, hear, read, imagine, or think along a unique trajectory, then use that as a basis for free association.
There are no guideposts, and the unhinging has been accelerated by the ready availability of computing power and networking via one’s cell phone. The artist typically has no interest in channeling the viewer or listener’s thoughts, feelings, or mental images. Why presume, given that each of us is unique? A poet might apply the words levitation, unmooring, kaleidoscopic, or ricochet to characterize the mental effects that the artist ignites in some people. If people join together, it might become participatory theater. Think of stadium performances by iconic figures like The Grateful Dead, Janis Joplin, or even Donald J. Trump. The traditional format used by the music industry is also “going down the tubes.” Few artists make an “album” any longer with a recording studio contract. It’s all small entrepreneurs selling a single song via the internet, using social media as advertising.
Prepare your portfolio. Think about limiting key retirement investments to US Treasury bonds and well-capitalized A-rated stocks that have a Durable Competitive Advantage (see Table). VYM is the Benchmark Index for Russell 1000 companies that pay at least a market dividend. “Durable Competitive Advantage” (see Column O in the Table) is a term that Warren Buffett coined to denote a 7% (or higher) rate of growth in a company’s Tangible Book Value (TBV) over the past 10 yrs, provided that TBV is down no more than 3 years (see Week 158 and Week 241).
Administration: The sky is not falling. Civilization won’t end, and neither will Westphalian Principles of Governance. Be patient but don’t take risks. Some good is bound to come from abandoning “received wisdom” or “group think.” Why? Because “received wisdom” gives rise to dogma, and dogma prevents innovation. Don’t worry about nuclear war. Sure, it could happen. Maybe there’s even a “material” risk (odds higher than one in twenty). That would amount to an existential crisis for many survivors. We’d all become more focussed on survival, so behavior would become more collegial.
Bottom Line: Uncertainty is on the move. So, this is not a good time to speculate in financial assets. Hard assets like farmland are another matter (see next week’s blog).
Risk Rating: 6 (where 10-Yr T-Notes = 1, S&P 500 Index = 5, gold = 10)
Full Disclosure: I dollar-average into MSFT and NEE, and own shares of NKE, TJX, ACN, JPM, and TRV.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 6
Week 318 - Growing Perpetuity Index: A-Rated Dow Jones Composite Companies With Tangible Book Value that pay a “Good and Growing” Dividend
Situation: You need a way to save for retirement that is safe and effective. We agree with Warren Buffett’s approach which is to use a low-cost S&P 500 Index fund combined with a low-cost short-intermediate term US Treasury fund. If you’re wealthy, make the stock:bond mix 90:10. If not, move toward a 50:50 mix.
If you’re a stock-picker but fully employed outside the financial services industry, find a formula that won’t require a lot of your time for oversight and maintenance. The S&P 500 Index has too many stocks, so stick to analyzing the Dow Jones Composite Index. Those stocks have been picked by the Managing Editor of the Wall Street Journal. Start with the 20 companies in that 65-stock index that pay at least a “market dividend” and are Dividend Achievers, i.e., have raised their dividend annually for at least the past 10 years. We call that shortened version The Growing Perpetuity Index (see Week 261). It also excludes companies with less than a BBB+ S&P Bond Rating or B+/M S&P Stock Rating. But companies with with ratings lower than A- tend to develop problems, as do companies with negative net Tangible Book Value. (The SEC requires that the sale of newly-issued shares on a US stock exchange not dilute a company’s net Tangible Book Value below zero.)
Mission: Revise “The Growing Perpetuity Index” to exclude companies with negative Tangible Book Value, as well as companies with an S&P Bond Rating less than A- or an S&P Stock Rating less than A-/M.
Execution: We’re down to 9 companies (see Table).
Administration: Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 14 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers.
In next week’s blog, we highlight the 11 companies in VYM that aren’t in the Dow Jones Composite Index. Then you’ll need to track only 20 companies on your adventure into stock-picking! But be aware: 30% of those 20 companies are boring utilities, meaning that clear-eyed stock-picking isn’t glamorous at all. It’s just making money by not losing money, which is Warren Buffett’s #1 Rule.
Bottom Line: Stock-picking becomes a problem for non-gamblers at the Go/No-Go point, i.e., after 5 years of trying, you need to think about giving up if you can’t beat the total return/yr for an S&P 500 Index fund (SPY or VFINX) by at least 2%/yr. This is because you need to cover your greater transaction costs and capital gains taxes that are being expensed out. We’re suggesting that you start with 9 “blue chip” stocks that have a reasonable likelihood of letting you stay in the game after a 5 year probation period. Of course, you’d be opening yourself up to selection bias because there is a greater risk of loss vs. investing in all 500 stocks. Academic studies have shown that you’d need to own shares in at least 50 companies to largely overcome that risk.
Risk Rating: 6 (10-Yr Treasury Note = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into NEE, MSFT, JNJ, KO, and UNP. I also own shares of MMM, TRV, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
If you’re a stock-picker but fully employed outside the financial services industry, find a formula that won’t require a lot of your time for oversight and maintenance. The S&P 500 Index has too many stocks, so stick to analyzing the Dow Jones Composite Index. Those stocks have been picked by the Managing Editor of the Wall Street Journal. Start with the 20 companies in that 65-stock index that pay at least a “market dividend” and are Dividend Achievers, i.e., have raised their dividend annually for at least the past 10 years. We call that shortened version The Growing Perpetuity Index (see Week 261). It also excludes companies with less than a BBB+ S&P Bond Rating or B+/M S&P Stock Rating. But companies with with ratings lower than A- tend to develop problems, as do companies with negative net Tangible Book Value. (The SEC requires that the sale of newly-issued shares on a US stock exchange not dilute a company’s net Tangible Book Value below zero.)
Mission: Revise “The Growing Perpetuity Index” to exclude companies with negative Tangible Book Value, as well as companies with an S&P Bond Rating less than A- or an S&P Stock Rating less than A-/M.
Execution: We’re down to 9 companies (see Table).
Administration: Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 14 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers.
In next week’s blog, we highlight the 11 companies in VYM that aren’t in the Dow Jones Composite Index. Then you’ll need to track only 20 companies on your adventure into stock-picking! But be aware: 30% of those 20 companies are boring utilities, meaning that clear-eyed stock-picking isn’t glamorous at all. It’s just making money by not losing money, which is Warren Buffett’s #1 Rule.
Bottom Line: Stock-picking becomes a problem for non-gamblers at the Go/No-Go point, i.e., after 5 years of trying, you need to think about giving up if you can’t beat the total return/yr for an S&P 500 Index fund (SPY or VFINX) by at least 2%/yr. This is because you need to cover your greater transaction costs and capital gains taxes that are being expensed out. We’re suggesting that you start with 9 “blue chip” stocks that have a reasonable likelihood of letting you stay in the game after a 5 year probation period. Of course, you’d be opening yourself up to selection bias because there is a greater risk of loss vs. investing in all 500 stocks. Academic studies have shown that you’d need to own shares in at least 50 companies to largely overcome that risk.
Risk Rating: 6 (10-Yr Treasury Note = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into NEE, MSFT, JNJ, KO, and UNP. I also own shares of MMM, TRV, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 2
Week 313 - High-quality Dividend Achievers That Beat The S&P 500 For 35 Years With Less Risk
Situation: Most investors don’t like to micromanage their stock holdings, preferring instead to “buy-and-hold.” But we occasionally lose money because we haven’t been paying adequate attention. Deciding when to sell is much harder than deciding when to buy. The basic rule is to buy stocks with an ROIC (Return On Invested Capital) that is more than twice their WACC (Weighted Average Cost of Capital), then sell when they no longer meet that standard. But that approach doesn’t work for technology stocks, where the ROIC is many times greater than the WACC, or for many stable and/or slowly growing companies. For example, Berkshire Hathaway (BRK-B) has had an ROIC that is only a little higher than its WACC for long periods.
If we are to “buy-and-hold” a stock, the underlying company needs to have a long record of stable price growth that outperforms the lowest-cost S&P 500 Index fund (VFINX). Otherwise, we would simply invest in VFINX and forget about picking stocks. We would also like those companies to have had less stock price volatility than VFINX over a long period of time . . . decades. The necessary statistical data is found at the BMW Method website.
Mission: For this week’s blog, we’ll look at how publicly-traded stocks have performed over 35 year holding periods. Next week, we’ll run the same spreadsheet for 25 year holding periods and the following week we’ll look at the 30 year period.
Execution: see Table.
Administration: We exclude companies that do not have high ratings from S&P on their stocks and bonds. We also exclude companies that S&P hasn’t designated as Dividend Achievers. “Less risk” is defined as a statistically lower risk of loss at 2 standard deviations below trendline than that for the S&P 500 Index (see Column M in the Table, where red highlights denote more risk).
Bottom Line: After analysis, we find that all 10 companies had better price returns than our benchmark (VBINX) over the two year correction in commodity prices from July of 2014 to July of 2016. Most of these companies showed unusually strong performance, meaning investors chose to shunt money away from commodity-related companies and into these companies. It is instructive to get an idea as to why these company’s products and services seemed more valuable to investors. Yes, it was a “risk-off” decision. This is because investors know that the best way to make money is to avoid losing money. Of the 10 stocks highlighted here, only 3 (MCD, MMM, APD) are in “growth” industries; the others are in “defensive” industries (healthcare, consumer staples, and utilities) where earnings tend to hold up better in a downturn. But why not build a portfolio of “risk-off” investments in the first place, given that those appear to outperform the S&P 500 Index over long periods? We’ll check that theory out at 25 and 30 year holding periods, to see how well it holds up. In the meantime, remember Warren Buffett’s Rule #1: “Never lose money.”
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I own shares of GIS, MCD, MKC, and MMM.
Note: We use discounted cash flow from dividends and sale of the stock (after a 10-Yr holding period) to estimate Net Present Value; see Columns U-Y in the Table. The exponential growth rate in stock price over the next 10 years is estimated to be an extrapolation of the growth in stock price over the past 16 years. The Discount Rate is set at 9%, meaning that a stock with a positive NPV would return more over 10 years than a 10-Yr US Treasury Note paying 9%/Yr. Dividend Growth over the next 10 years is extrapolated from Dividend Growth over the past 4 years. Be aware that our NPV calculation is for comparative purposes only. Any rise in the rate of interest paid by 10-Yr Treasury Notes would diminish stock NPVs, provided that those Notes continue to carry a AAA credit rating from S&P.
Red highlights in the Table denote underperformance relative to our benchmark: Vanguard Balanced Index Fund (VBINX) at Line 18. Purple highlights denote metrics of concern.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
If we are to “buy-and-hold” a stock, the underlying company needs to have a long record of stable price growth that outperforms the lowest-cost S&P 500 Index fund (VFINX). Otherwise, we would simply invest in VFINX and forget about picking stocks. We would also like those companies to have had less stock price volatility than VFINX over a long period of time . . . decades. The necessary statistical data is found at the BMW Method website.
Mission: For this week’s blog, we’ll look at how publicly-traded stocks have performed over 35 year holding periods. Next week, we’ll run the same spreadsheet for 25 year holding periods and the following week we’ll look at the 30 year period.
Execution: see Table.
Administration: We exclude companies that do not have high ratings from S&P on their stocks and bonds. We also exclude companies that S&P hasn’t designated as Dividend Achievers. “Less risk” is defined as a statistically lower risk of loss at 2 standard deviations below trendline than that for the S&P 500 Index (see Column M in the Table, where red highlights denote more risk).
Bottom Line: After analysis, we find that all 10 companies had better price returns than our benchmark (VBINX) over the two year correction in commodity prices from July of 2014 to July of 2016. Most of these companies showed unusually strong performance, meaning investors chose to shunt money away from commodity-related companies and into these companies. It is instructive to get an idea as to why these company’s products and services seemed more valuable to investors. Yes, it was a “risk-off” decision. This is because investors know that the best way to make money is to avoid losing money. Of the 10 stocks highlighted here, only 3 (MCD, MMM, APD) are in “growth” industries; the others are in “defensive” industries (healthcare, consumer staples, and utilities) where earnings tend to hold up better in a downturn. But why not build a portfolio of “risk-off” investments in the first place, given that those appear to outperform the S&P 500 Index over long periods? We’ll check that theory out at 25 and 30 year holding periods, to see how well it holds up. In the meantime, remember Warren Buffett’s Rule #1: “Never lose money.”
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I own shares of GIS, MCD, MKC, and MMM.
Note: We use discounted cash flow from dividends and sale of the stock (after a 10-Yr holding period) to estimate Net Present Value; see Columns U-Y in the Table. The exponential growth rate in stock price over the next 10 years is estimated to be an extrapolation of the growth in stock price over the past 16 years. The Discount Rate is set at 9%, meaning that a stock with a positive NPV would return more over 10 years than a 10-Yr US Treasury Note paying 9%/Yr. Dividend Growth over the next 10 years is extrapolated from Dividend Growth over the past 4 years. Be aware that our NPV calculation is for comparative purposes only. Any rise in the rate of interest paid by 10-Yr Treasury Notes would diminish stock NPVs, provided that those Notes continue to carry a AAA credit rating from S&P.
Red highlights in the Table denote underperformance relative to our benchmark: Vanguard Balanced Index Fund (VBINX) at Line 18. Purple highlights denote metrics of concern.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 5
Week 293 - Berkshire Hathaway’s “Core Holdings”: Stock in 7 A-rated Barron’s 500 Companies
Situation: We can all agree that Warren Buffett is a good stock-picker. So, why does he favor the same “plain vanilla” stocks that get talked-up by your cab driver and the shoe shine guy at the airport?
Mission: Find out which stocks he’s purchased for Berkshire Hathaway, then put those through the wringer (our standard spreadsheet).
Execution: Scan Berkshire Hathaway’s latest 13F quarterly filing of 46 common stock holdings for companies have a) revenues large enough to be on the 2016 Barron’s 500 List, b) at least 16 yrs of trading records, and c) Standard & Poor’s credit ratings of at least A- and stock ratings of at least A-/M.
Administration: Berkshire Hathaway holds 7 A-rated stocks, which are worth ~$56 Billion (see Columns AB and AC in the Table) and represent ~43% of the portfolio’s value. All 7 are “high quality” companies with household names: Costco Wholesale, IBM, Coca-Cola, Johnson & Johnson, Procter & Gamble, Wal-Mart Stores, and Wells Fargo.
Bottom Line: If someone new to investing had asked you to name some good stocks, most of you would have mentioned stocks on our list. Is that because we like to read about Warren Buffett’s stock picks? Or is it because Warren Buffett likes to read about companies that have products and services that are consistently praised by consumers and businesses? Either way, you need (and want) to mimic his best stock picks, no matter how boring and obvious. How do we know they’re his best stock picks? Because he calls Berkshire Hathaway’s stock portfolio a “float”, meaning the place where insurance premiums are stored until they’re needed to pay for some catastrophe. These 7 high-quality stocks account for 43% of the 46-stock portfolio he uses for safe-keeping. They’re the anchor that will keep the company “afloat” through storms.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into IBM, PG and JNJ, and own shares in KO and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is chosen to approximate Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 22 in the Table. The ETF for that index is MDY at Line 15.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Find out which stocks he’s purchased for Berkshire Hathaway, then put those through the wringer (our standard spreadsheet).
Execution: Scan Berkshire Hathaway’s latest 13F quarterly filing of 46 common stock holdings for companies have a) revenues large enough to be on the 2016 Barron’s 500 List, b) at least 16 yrs of trading records, and c) Standard & Poor’s credit ratings of at least A- and stock ratings of at least A-/M.
Administration: Berkshire Hathaway holds 7 A-rated stocks, which are worth ~$56 Billion (see Columns AB and AC in the Table) and represent ~43% of the portfolio’s value. All 7 are “high quality” companies with household names: Costco Wholesale, IBM, Coca-Cola, Johnson & Johnson, Procter & Gamble, Wal-Mart Stores, and Wells Fargo.
Bottom Line: If someone new to investing had asked you to name some good stocks, most of you would have mentioned stocks on our list. Is that because we like to read about Warren Buffett’s stock picks? Or is it because Warren Buffett likes to read about companies that have products and services that are consistently praised by consumers and businesses? Either way, you need (and want) to mimic his best stock picks, no matter how boring and obvious. How do we know they’re his best stock picks? Because he calls Berkshire Hathaway’s stock portfolio a “float”, meaning the place where insurance premiums are stored until they’re needed to pay for some catastrophe. These 7 high-quality stocks account for 43% of the 46-stock portfolio he uses for safe-keeping. They’re the anchor that will keep the company “afloat” through storms.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into IBM, PG and JNJ, and own shares in KO and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is chosen to approximate Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 22 in the Table. The ETF for that index is MDY at Line 15.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 3
Week 235 - How Are Our 4 Key AgriBusiness Stocks Doing?
Situation: Ten weeks ago, we took a close look at the 20 largest AgriBusiness companies (see Week 225). We didn’t find much to love. When a commodity “supercycle” ends, it takes down all sectors, including oil & gas, mining, and agriculture. Nonetheless, we concluded that 4 AgriBusiness companies have strong enough balance sheets and wide enough marketing to “muddle through” this downturn. Each of the four firms we selected is a widely known and respected brand: Monsanto (MON), Hormel Foods (HRL), Archer Daniels Midland (ADM) and Deere (DE). Now that the commodity bear market has deepened, let’s look in on these companies to see how they’re holding up.
Mission: Perform our standard spreadsheet analysis and make comparisons to relevant benchmarks (see Table).
Bottom Line: Hormel Foods (HRL) continues to outperform because of the “great meat rally.” Monsanto (MON) stock fell in price last year after a failed merger attempt with Syngenta (SYT) but is now recovering amid speculation that major agribusinesses will have to merge (given the imbalance between supply and demand for commodities). Indeed, duPont (DD) and Dow Chemical (DOW) have already agreed to do so. Archer Daniels Midland (ADM) and Deere (DE) are both in deepening bear markets due to a sharp fall in revenues. ADM coordinates agribusiness infrastructure worldwide but also gets ~10% of its revenues from ethanol production. That market is under pressure due to several factors, the most important being that a “blend wall” has been reached for blending gasoline that is 10% ethanol. No more ethanol is needed, and gasoline with 15% ethanol can’t be used in cars built before 2002. The blend wall became an issue because cars are increasingly fuel-efficient, and many car owners prefer not to use 10% ethanol. Deere (DE) manufactures heavy equipment for construction and mining in addition to the iconic green tractors and harvesters used in farming. All of those markets have collapsed now that China has largely completed its infrastructure buildout and is going through its own mini-recession. Another important market pressure is that consumers are getting fussier about how foodstuffs are produced and processed. These preferences are undermining the “factory farming” innovations that brought us cheap and abundant food, known as the “green revolution.” In summary, it looks like the AgriBusiness sector will remain under downward pressure for several more years.
Risk Rating: 8
Full Disclosure: I own stock in DE, ADM, MON, and HRL.
Note: Metrics highlighted in red denote underperformance vs. our key benchmark (VBINX). Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Perform our standard spreadsheet analysis and make comparisons to relevant benchmarks (see Table).
Bottom Line: Hormel Foods (HRL) continues to outperform because of the “great meat rally.” Monsanto (MON) stock fell in price last year after a failed merger attempt with Syngenta (SYT) but is now recovering amid speculation that major agribusinesses will have to merge (given the imbalance between supply and demand for commodities). Indeed, duPont (DD) and Dow Chemical (DOW) have already agreed to do so. Archer Daniels Midland (ADM) and Deere (DE) are both in deepening bear markets due to a sharp fall in revenues. ADM coordinates agribusiness infrastructure worldwide but also gets ~10% of its revenues from ethanol production. That market is under pressure due to several factors, the most important being that a “blend wall” has been reached for blending gasoline that is 10% ethanol. No more ethanol is needed, and gasoline with 15% ethanol can’t be used in cars built before 2002. The blend wall became an issue because cars are increasingly fuel-efficient, and many car owners prefer not to use 10% ethanol. Deere (DE) manufactures heavy equipment for construction and mining in addition to the iconic green tractors and harvesters used in farming. All of those markets have collapsed now that China has largely completed its infrastructure buildout and is going through its own mini-recession. Another important market pressure is that consumers are getting fussier about how foodstuffs are produced and processed. These preferences are undermining the “factory farming” innovations that brought us cheap and abundant food, known as the “green revolution.” In summary, it looks like the AgriBusiness sector will remain under downward pressure for several more years.
Risk Rating: 8
Full Disclosure: I own stock in DE, ADM, MON, and HRL.
Note: Metrics highlighted in red denote underperformance vs. our key benchmark (VBINX). Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 13
Week 219 - Agricultural Production Equipment
Situation: Investing in commodities, or commodity-related companies, is a good way to lose money fast if you invest in the commodity when the commodity “supercycle” is ending. Agricultural commodity-related companies are the least risky way to invest in the commodity “supercycle.” Why? Because food is a necessity and, 10 million people a year emerge from poverty and will earn enough income to increase their dietary protein to the required 60 gm/d minimum. For example, investors in General Mills (GIS) and Deere (DE) have enjoyed a 30-yr total return that beat the S&P 500 Index while having a statistically lower risk of loss in a bear market. For all types of commodities (e.g. gold, oil, iron ore, cereal grains), suppliers of equipment typically make more money than those (e.g. farmers) who produce the raw commodity. In the United States, this phenomenon first became common knowledge during the California Gold Rush of 1849. So, this week’s blog is about companies that supply equipment to farmers.
Mission: Examine key metrics for all the agricultural equipment suppliers among the 1000 largest US companies by revenue, i.e., those in the 2015 Fortune 500 list with its supplemental material on the next largest 500.
Execution: The 2015 Fortune 500 list has 11 companies that make agricultural production equipment (see Table); 6 of those companies are also in the 2015 Barron’s 500 List of the largest companies by revenue that are listed on the New York or Toronto stock exchanges: Tractor Supply (TSCO), Cummins (CMI), Deere (DE), AGCO (AGCO), Caterpillar (CAT), Terex (TEX). For comparison purposes, the benchmarks at the bottom of this week’s Table include commodity-production companies involved in oil & gas exploration, gold & copper mining, metals production, and meat production, as well as indices for prices of 24 commodities (GSG) and gold/silver prices (^XAU).
The story, as you can see from the Table, is a depressing one. We’re near the end of the latest commodity “supercycle.” And, we won’t know if the supercycle has ended until developing nations can again afford to build out their infrastructure. There are some hints that the next supercycle is emerging, e.g., improved performance by several large companies in the metals and mining sector (see Week 217). But much depends on China, where 40% of the world’s appetite for commodities resides. Demand there continues to fall, and the government’s penchant for manipulating the stock market could forestall any recovery in confidence that would be sufficient to increase the demand for commodities.
But we should be advised of the prospects for each of the 11 companies identified in the Table. Perhaps there is one positioned to herald a new dawn. Five of the companies make, service and/or equip farm tractors, skid loaders, backhoes, end-loaders, and combines. Those five are: Deere (DE), AGCO Corp (AGCO), Tractor Supply (TSCO), Caterpillar (CAT), Terex (TEX). Trimble Navigation (TRMB) makes computerized equipment to outfit tractors for "precision agriculture" dependent on GPS, whether for planting seeds or guiding sprayers of fertilizer, insecticides, herbicides, and fungicides. Valmont (VAL) makes center-pivot irrigation systems that use well water pumped by electric or diesel motors. Flowserve (FLS) is a major supplier of pumps, and Cummins (CMI) is a major supplier of diesel motors. Fastenal (FAST) supplies building materials and has outlets throughout the Midwest and Great Plains. Toro (TTC) supplies the latest generation of plant watering systems, which is a metered drip irrigation that depends on a grid of buried "tapes"; Deere (DE) also provides a drip irrigation system.
As elsewhere, technology seems to be the game-changer. Drip irrigation systems use 40% less water than center-pivot systems which, in turn, use 40% less water than flood irrigation. Precision guidance of tractors from space (via GPS), combined with soil monitoring and interpretation via a wireless hookup to centers run by Monsanto (MON) and duPont (DE), means that the right amounts of water, fertilizer, insecticides, herbicides, and fungicides will be deployed to nurture the right kinds of seeds for each variety of soil in a farmer’s acreage--all combined with computerized weather analysis in real time (based on satellite interpretation of local rainfall patterns combined with meteorological prediction). This is called the Agronomy Revolution, and it’s where the future lies. The problem is that it has doubled the prices that farmers have to pay for new tractors with their attached gizmos. Typically, we would expect farmers to have trouble affording all of this “new paint” unless something had increased crop prices enough to give them a feeling of wealth. That happened with the drought of 2012, and conveniently during the Great Recession because Congress had mandated a surge in ethanol production.
The problem for you, as an investor, is that there is no company in the Table (including those named under Benchmarks) whose stock meets our requirements to be a candidate for inclusion in your retirement portfolio. Those requirements are a) the company is an S&P Dividend Achiever, having raised its dividend annually for at least the past 10 yrs; b) the company is large enough to appear on the 2015 Barron’s 500 List; c) the company’s stock has beat the S&P 500 Index for the past 16 yrs without incurring as great a risk of loss in a future bear market, per the BMW Method; d) the company’s bonds have an S&P rating no lower than BBB+ and its stock has an S&P rating no lower than B+/M, and e) the stock lost less money during the Lehman Panic than our key benchmark, the Vanguard Balanced Index Fund (VBINX). The only commodity-related companies we’re aware of that meet those requirements are Chevron (CVX) and Exxon Mobil (XOM). However, Chevron has gone 18 months without raising its dividend (because of negative cash flow related to a 60% drop in oil prices over the past year).
Bottom Line: Commodities, and commodity-related companies, are at a historic low point in valuation. Even the companies that supply farmers and ranchers with equipment are limping along. Deere (DE) has the best 30-yr record but remains a speculative investment, given that it’s stock lost more than the lowest-cost S&P 500 Index fund (VFINX) during the 18-month Lehman Panic period (see Column D in the Table). But Deere is also the company best positioned to benefit from the Agronomy Revolution that is bringing us the next big step up in agricultural productivity. The devil’s advocate will ask the obvious question: “If these stocks are all at historic lows, doesn’t that suggest that now is the time to buy?” That game has a name: Catch the Falling Knife. Which is fine, given that great rewards only go to those who take great risks. Professional investors often pass through a phase where they try their skill at catching the knife as it falls, after which they give up trying. From that point on, they studiously avoid buying any asset while it is falling in price.
Risk Rating: 7
Full Disclosure: I have FLS, CMI, and DE stock.
Note: Metrics in the Table are current for the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Mission: Examine key metrics for all the agricultural equipment suppliers among the 1000 largest US companies by revenue, i.e., those in the 2015 Fortune 500 list with its supplemental material on the next largest 500.
Execution: The 2015 Fortune 500 list has 11 companies that make agricultural production equipment (see Table); 6 of those companies are also in the 2015 Barron’s 500 List of the largest companies by revenue that are listed on the New York or Toronto stock exchanges: Tractor Supply (TSCO), Cummins (CMI), Deere (DE), AGCO (AGCO), Caterpillar (CAT), Terex (TEX). For comparison purposes, the benchmarks at the bottom of this week’s Table include commodity-production companies involved in oil & gas exploration, gold & copper mining, metals production, and meat production, as well as indices for prices of 24 commodities (GSG) and gold/silver prices (^XAU).
The story, as you can see from the Table, is a depressing one. We’re near the end of the latest commodity “supercycle.” And, we won’t know if the supercycle has ended until developing nations can again afford to build out their infrastructure. There are some hints that the next supercycle is emerging, e.g., improved performance by several large companies in the metals and mining sector (see Week 217). But much depends on China, where 40% of the world’s appetite for commodities resides. Demand there continues to fall, and the government’s penchant for manipulating the stock market could forestall any recovery in confidence that would be sufficient to increase the demand for commodities.
But we should be advised of the prospects for each of the 11 companies identified in the Table. Perhaps there is one positioned to herald a new dawn. Five of the companies make, service and/or equip farm tractors, skid loaders, backhoes, end-loaders, and combines. Those five are: Deere (DE), AGCO Corp (AGCO), Tractor Supply (TSCO), Caterpillar (CAT), Terex (TEX). Trimble Navigation (TRMB) makes computerized equipment to outfit tractors for "precision agriculture" dependent on GPS, whether for planting seeds or guiding sprayers of fertilizer, insecticides, herbicides, and fungicides. Valmont (VAL) makes center-pivot irrigation systems that use well water pumped by electric or diesel motors. Flowserve (FLS) is a major supplier of pumps, and Cummins (CMI) is a major supplier of diesel motors. Fastenal (FAST) supplies building materials and has outlets throughout the Midwest and Great Plains. Toro (TTC) supplies the latest generation of plant watering systems, which is a metered drip irrigation that depends on a grid of buried "tapes"; Deere (DE) also provides a drip irrigation system.
As elsewhere, technology seems to be the game-changer. Drip irrigation systems use 40% less water than center-pivot systems which, in turn, use 40% less water than flood irrigation. Precision guidance of tractors from space (via GPS), combined with soil monitoring and interpretation via a wireless hookup to centers run by Monsanto (MON) and duPont (DE), means that the right amounts of water, fertilizer, insecticides, herbicides, and fungicides will be deployed to nurture the right kinds of seeds for each variety of soil in a farmer’s acreage--all combined with computerized weather analysis in real time (based on satellite interpretation of local rainfall patterns combined with meteorological prediction). This is called the Agronomy Revolution, and it’s where the future lies. The problem is that it has doubled the prices that farmers have to pay for new tractors with their attached gizmos. Typically, we would expect farmers to have trouble affording all of this “new paint” unless something had increased crop prices enough to give them a feeling of wealth. That happened with the drought of 2012, and conveniently during the Great Recession because Congress had mandated a surge in ethanol production.
The problem for you, as an investor, is that there is no company in the Table (including those named under Benchmarks) whose stock meets our requirements to be a candidate for inclusion in your retirement portfolio. Those requirements are a) the company is an S&P Dividend Achiever, having raised its dividend annually for at least the past 10 yrs; b) the company is large enough to appear on the 2015 Barron’s 500 List; c) the company’s stock has beat the S&P 500 Index for the past 16 yrs without incurring as great a risk of loss in a future bear market, per the BMW Method; d) the company’s bonds have an S&P rating no lower than BBB+ and its stock has an S&P rating no lower than B+/M, and e) the stock lost less money during the Lehman Panic than our key benchmark, the Vanguard Balanced Index Fund (VBINX). The only commodity-related companies we’re aware of that meet those requirements are Chevron (CVX) and Exxon Mobil (XOM). However, Chevron has gone 18 months without raising its dividend (because of negative cash flow related to a 60% drop in oil prices over the past year).
Bottom Line: Commodities, and commodity-related companies, are at a historic low point in valuation. Even the companies that supply farmers and ranchers with equipment are limping along. Deere (DE) has the best 30-yr record but remains a speculative investment, given that it’s stock lost more than the lowest-cost S&P 500 Index fund (VFINX) during the 18-month Lehman Panic period (see Column D in the Table). But Deere is also the company best positioned to benefit from the Agronomy Revolution that is bringing us the next big step up in agricultural productivity. The devil’s advocate will ask the obvious question: “If these stocks are all at historic lows, doesn’t that suggest that now is the time to buy?” That game has a name: Catch the Falling Knife. Which is fine, given that great rewards only go to those who take great risks. Professional investors often pass through a phase where they try their skill at catching the knife as it falls, after which they give up trying. From that point on, they studiously avoid buying any asset while it is falling in price.
Risk Rating: 7
Full Disclosure: I have FLS, CMI, and DE stock.
Note: Metrics in the Table are current for the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 18
Week 185 - Transportation-related Companies with Good Credit
Situation: Dow Theory predicts that a bull market will continue if the primary trend is upward, i.e., both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) are making new highs. The idea is that the movement of goods to satisfy demand is every bit as important as producing the goods. As of this writing, the DJTA continues to “confirm” the bull market denoted by the DJIA’s current all-time highs. The problem is that very few companies in that important Transportation Average are investment-grade quality. Only 5 of the 20 companies have 1) a long-term S&P credit rating of BBB+ or better; 2) an S&P stock rating of B+/M or better; and 3) enough revenue to appear on the Barron’s 500 List of the largest public companies on the New York and Toronto Stock Exchanges.
Those 5 are:
CSX Railroad (CSX),
Norfolk Southern Railroad (NSC),
Union Pacific Railroad (UNP),
Expeditors International of Washington (EXPD), and
JB Hunt Transportation Services (JBHT),
We’ve come up with 9 more companies that meet all 3 requirements and derive much (but not all) of their revenue from transportation-related activities. Three of the 9 happen to be among the 30 companies on the DJIA list:
United Technologies (UTX),
Caterpillar (CAT), and
Boeing (BA).
The remaining 6 are:
Canadian National Railway (CNI),
Sysco (SYY),
Canadian Pacific Railway (CP),
PACCAR (PCAR),
Cummins (CMI), and
Honeywell (HON).
How does our newfangled list of these 14 companies help? For starters, the quality is there. You can invest in any of the stocks issued by those companies at any time, as long as you only invest a small and fixed amount over regular intervals (dollar-cost averaging). Second, fundamental information is readily available because all 14 appear on the Barron’s 500 List published annually (in May). There you can find the most recent year’s sales, and the cash-flow related ROIC (Return on Invested Capital) vs. its 3-yr average. Then you can see how those data rank each company and how that ranking compares to the previous year. Third, we show whether the company was a small loser or a big loser during the Lehman Panic (see Column D in all the Table), and whether the company’s long-term total return (Column C in the Table) mitigated that risk (see Column E in the Table). If the Finance Value in Column E beats our benchmark’s (VBINX), you’re likely to benefit from owning the company’s stock instead of shares in VBINX.
Bottom Line: These stocks are the pulse of the economy, meaning they're high-risk high-reward. Only 5 of the 14 are Dividend Achievers, and only one of those (NSC) has a Finance Value that beat’s our key benchmark, the Vanguard Balanced Index Fund (see Table). But there is one other reasonable approach to investing in this sector, and that is to gradually build a position in iShares Transportation Average (IYT), which is an exchange-traded fund (ETF) that tracks the performance of stocks in the Dow Jones Transportation Average. When the earnings of transportation company stocks are growing at a nice clip, you can be confident that the economy is doing well. And vice versa. So own a few of these stocks and learn from their price movements. Then you won’t be mystified by the next lurch upward or downward in the stock market, and you won’t panic (sell) when others do. Except for the railroads (which are government-regulated to protect both customers and investors), the stocks in this week’s Table are not the “buy-and-hold” variety.
Risk Rating: 7
Full Disclosure: I own shares of CNI, UTX, and CMI.
NOTE: Metrics in the Table are current as of the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Those 5 are:
CSX Railroad (CSX),
Norfolk Southern Railroad (NSC),
Union Pacific Railroad (UNP),
Expeditors International of Washington (EXPD), and
JB Hunt Transportation Services (JBHT),
We’ve come up with 9 more companies that meet all 3 requirements and derive much (but not all) of their revenue from transportation-related activities. Three of the 9 happen to be among the 30 companies on the DJIA list:
United Technologies (UTX),
Caterpillar (CAT), and
Boeing (BA).
The remaining 6 are:
Canadian National Railway (CNI),
Sysco (SYY),
Canadian Pacific Railway (CP),
PACCAR (PCAR),
Cummins (CMI), and
Honeywell (HON).
How does our newfangled list of these 14 companies help? For starters, the quality is there. You can invest in any of the stocks issued by those companies at any time, as long as you only invest a small and fixed amount over regular intervals (dollar-cost averaging). Second, fundamental information is readily available because all 14 appear on the Barron’s 500 List published annually (in May). There you can find the most recent year’s sales, and the cash-flow related ROIC (Return on Invested Capital) vs. its 3-yr average. Then you can see how those data rank each company and how that ranking compares to the previous year. Third, we show whether the company was a small loser or a big loser during the Lehman Panic (see Column D in all the Table), and whether the company’s long-term total return (Column C in the Table) mitigated that risk (see Column E in the Table). If the Finance Value in Column E beats our benchmark’s (VBINX), you’re likely to benefit from owning the company’s stock instead of shares in VBINX.
Bottom Line: These stocks are the pulse of the economy, meaning they're high-risk high-reward. Only 5 of the 14 are Dividend Achievers, and only one of those (NSC) has a Finance Value that beat’s our key benchmark, the Vanguard Balanced Index Fund (see Table). But there is one other reasonable approach to investing in this sector, and that is to gradually build a position in iShares Transportation Average (IYT), which is an exchange-traded fund (ETF) that tracks the performance of stocks in the Dow Jones Transportation Average. When the earnings of transportation company stocks are growing at a nice clip, you can be confident that the economy is doing well. And vice versa. So own a few of these stocks and learn from their price movements. Then you won’t be mystified by the next lurch upward or downward in the stock market, and you won’t panic (sell) when others do. Except for the railroads (which are government-regulated to protect both customers and investors), the stocks in this week’s Table are not the “buy-and-hold” variety.
Risk Rating: 7
Full Disclosure: I own shares of CNI, UTX, and CMI.
NOTE: Metrics in the Table are current as of the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 28
Week 182 - Our Current List of Hedge Stocks
Situation: It has been 32 weeks since we published our list of Hedge Stocks (see Week 150). That list of 17 companies grows shorter due to market volatility and overvaluation. Even so, the idea of owning stock in a company that is relatively immune from “shorting” by hedge funds remains worthwhile. Why? Because the 10-yr Treasury Notes that professional investors typically use to immunize their portfolio against short sales will continue to pay a lower-than-inflation rate of interest, as long as the Federal Reserve continues its policy of “financial repression” (see Week 79). That means any high-quality bond will have a historically low interest rate, limiting its utility as a portfolio protector. In this environment, stocks that have none of the features that attract hedge fund traders gain added value because it is unlikely that such stocks will plummet in a bear market. That means Hedge Stocks don’t need to be backed by high-quality bonds or low-risk bond funds.
Initially, the stocks we were looking for had these features (see Week 150):
a) low volatility (5-yr Beta less than 0.7);
b) a P/E of 22 or less;
c) higher returns over both the past 5 and 14 yrs than our benchmark (VBINX);
d) higher Finance Value than VBINX (see Column E in our Tables);
e) an S&P rating of BBB+ or better on the company’s bonds.
With experience, we’ve decided to modify those criteria. One change is that we’ll only consider companies large enough to appear on the Barron’s 500 List, which is published each year in May. That gives us a way to evaluate fundamental metrics year-over-year: “median three-year cash-flow-based return on investment; the one-year change in that measure, relative to the three-year median; and adjusted sales growth in the latest fiscal year.” Another change is that we’ll only consider companies which either appear in the top 2/3rds of that list (i.e., rank in the top 333) for the two most recent years or have a higher ranking in the most recent year. The third change is to measure valuation by EV/EBITDA (Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation, and Amortization) instead of by P/E (stock price divided by the past 4 quarters of earnings). EV/EBITDA is the market value of all the stock and bond issues that are used to capitalize the company, divided by operating earnings. The use of cash, which is gained from operating earnings plus the issuance of stocks and bonds, is not addressed by EV/EBITDA. We have set the upper limit for valuation of a Hedge Stock at an EV/EBITDA of 13, instead of at a P/E of 22. Finally, to exclude under-analyzed companies, we’ll require an S&P stock rating of at least B+/M.
Bottom Line: Of the 17 companies in our last list of Hedge Stocks (see Week 150), only 9 remain: WMT, MCD, ED, SO, GIS, NEE, XEL, PEP, KMB (see Table). Three companies have been added: Altria Group (MO), Archer-Daniels-Midland (ADM), and Lockheed Martin (LMT). As it happens, all 12 companies are Dividend Achievers. That should tell you something.
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and NEE, and also own shares of MCD, GIS and PEP.
NOTE: Metrics in the Table are current as of the Sunday of publication; red highlights denote underperformance relative to our benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Initially, the stocks we were looking for had these features (see Week 150):
a) low volatility (5-yr Beta less than 0.7);
b) a P/E of 22 or less;
c) higher returns over both the past 5 and 14 yrs than our benchmark (VBINX);
d) higher Finance Value than VBINX (see Column E in our Tables);
e) an S&P rating of BBB+ or better on the company’s bonds.
With experience, we’ve decided to modify those criteria. One change is that we’ll only consider companies large enough to appear on the Barron’s 500 List, which is published each year in May. That gives us a way to evaluate fundamental metrics year-over-year: “median three-year cash-flow-based return on investment; the one-year change in that measure, relative to the three-year median; and adjusted sales growth in the latest fiscal year.” Another change is that we’ll only consider companies which either appear in the top 2/3rds of that list (i.e., rank in the top 333) for the two most recent years or have a higher ranking in the most recent year. The third change is to measure valuation by EV/EBITDA (Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation, and Amortization) instead of by P/E (stock price divided by the past 4 quarters of earnings). EV/EBITDA is the market value of all the stock and bond issues that are used to capitalize the company, divided by operating earnings. The use of cash, which is gained from operating earnings plus the issuance of stocks and bonds, is not addressed by EV/EBITDA. We have set the upper limit for valuation of a Hedge Stock at an EV/EBITDA of 13, instead of at a P/E of 22. Finally, to exclude under-analyzed companies, we’ll require an S&P stock rating of at least B+/M.
Bottom Line: Of the 17 companies in our last list of Hedge Stocks (see Week 150), only 9 remain: WMT, MCD, ED, SO, GIS, NEE, XEL, PEP, KMB (see Table). Three companies have been added: Altria Group (MO), Archer-Daniels-Midland (ADM), and Lockheed Martin (LMT). As it happens, all 12 companies are Dividend Achievers. That should tell you something.
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and NEE, and also own shares of MCD, GIS and PEP.
NOTE: Metrics in the Table are current as of the Sunday of publication; red highlights denote underperformance relative to our benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 7
Week 179 - The ITR “Master List” for Fall 2014
Situation: Twice a year, we try to look into the future using the lens of the past. Currently, the US stock market has reached a plateau due to overvaluation. Alan Greenspan, in his recent book “The Map and the Territory” (The Penguin Press, New York, 2013), explains overvaluation by saying that "demand to acquire the stock of a company is sated as the company becomes adequately funded [and such companies] will yield low prospective rates of profit until the excess capital is withdrawn and presumably reinvested in more promising ventures." In other words, there is no such thing as a stock that looks like a good bet year in and year out. That’s why you need to pick stocks wisely and then dollar-cost average your choices.
You’ve no doubt noticed that our Master List keep getting shorter as the risk of a Bear Market increases. We began with 34 (large and small) companies (see Week 5) and now we’re down to 10 large companies (see Table). Those 10 are chosen from our 9 Lifeboat Stocks (see Week 174) and 17 Core Holdings (see Week 172). We eliminate any that aren’t "Dividend Aristocrats" (25+ yrs of dividend growth) or lost more during the Lehman Panic than the 28% that our “risk-on” benchmark (VBINX) lost.
This week, for the first time, we ask whether you’d be better off investing in all 10 of those companies, or would you be better off investing in Vanguard Wellesley Income Fund (VWINX), which is the “risk-off” benchmark that we recommend for retirement portfolios. It is not too difficult to build a portfolio of stocks with a higher dividend yield and/or faster dividend growth rate than the S&P 500 Index, particularly if you stick to companies have grown their dividend annually for at least 25 yrs. Those companies have a long and stable history of rewarding their investors through good times and bad. By owning shares in a few such companies you can look forward to receiving dividend checks in retirement that grow faster than inflation. But will you end up with more retirement assets by doing that? This week’s blog tries to answer that question.
Long term, VWINX has been the most stable and rewarding mutual fund. It is balanced roughly 40:60 between high quality stocks and investment-grade bonds, respectively. VWINX has returned 10.6%/yr over the past 35 yrs, which is identical to the return for the lowest-cost S&P 500 Index fund, the Vanguard 500 Index Fund (VFINX). Bonds in VWINX go up in value whenever stocks go down. That means VWINX has had only 4 down years in 35 (average loss of 6.3%) vs. 8 for VFINX (average loss of 11%). The lesson here is to hedge your stocks with high quality bonds. We suggest that you use inflation-protected US Savings Bonds because those never lose money and carry all the tax advantages of an IRA.
We’ve blogged often about the risk of owning individual stocks, and use several metrics like 5-yr Beta (Column I in our Tables) to highlight that risk. But there’s only one sure-fire metric: How much did investors lose during the last Bear Market (Column D in our Tables)? Warren Buffett likes to make analogies about core principles, and his analogy for this one is “You can only tell who’s swimming naked when the tide goes out.” With bonds, risk is easier to gauge because the interest that a corporate bond pays vs. the interest that a US Treasury bond (with the same maturity) pays is a direct measure of credit risk. The difference between those two interest rates is called “the spread” and the higher the spread, the riskier the bond. In other words, you’re paid more interest because you’re willing to take on more of the risk of bankruptcy. US Savings Bonds purchased online at treasurydirect are a zero-cost, tax-advantaged way to invest in 10-yr US Treasury Notes, the safest investment on the planet (according to Warren Buffett). You’ll appreciate having those Savings Bonds available to fund the non-recurring capital expenditures that are bound to appear during the next market calamity. (You certainly won’t want to sell stocks at a loss.)
The 10 “buy and hold” stocks in this week’s Table include 4 Hedge Stocks (see Week 150): WMT, CB, JNJ, PEP. Those stocks don’t need to be backed with inflation-protected Savings Bonds (ISBs). To answer our question (Is it better to invest in those 10 stocks or in VWINX?), we’ll make a virtual investment of $50/mo in each of the 10 stocks ($500/mo) backed by another virtual investment of $300/mo in ISBs. (Thus, you see 6 entries for ISBs in the Table). We’ve made stock purchases online at a dividend reinvestment sites like computershare or shareowneronline wherever transaction costs can be less than ~2%/yr. If the costs are higher, we’ve resorted to using a discount brokerage like Edward Jones (one of several that are available). For our virtual portfolio, we found it necessary to do that for 3 stocks (GWW, CB, PEP), buying one a year in that order. Our virtual investment then totaled $1800 once a year for 3 yrs with reinvested dividends, which accomplishes the same goal as investing $50/mo for 3 yrs at a dividend reinvestment site online.
Bottom Line: You can construct a 10-stock portfolio and be ahead of VWINX while maintaining the same risk profile (e.g. a 5-yr Beta of ~0.45). Over the past 14 yrs, our virtual portfolio returned ~9.5%/yr vs. ~7.3%/yr for VWINX. However, that ~2.2%/yr advantage is reduced to ~1.8%/yr after you subtract transaction costs of ~0.4%/yr: $321.65 spent during the first 3 yrs (Column R in the Table) divided by an investment of $28,800 = 1.12%, which is ~0.4%/yr. Dividend yield plus dividend growth is also better with 10 stocks than with VWINX (8.6% vs. 2.2%, see Columns G and H in the Table). During retirement, you’ll probably be able to cash those quarterly dividend checks without needing to sell the underlying shares, as opposed to having to sell shares of VWINX to come up with the same amount of cash. Of course, there is greater selection bias in picking 10 stocks than in owning shares of a managed stock/bond mutual fund like VWINX. Getting an extra ~1.8%/yr might justify the additional time and energy you’ll spend managing your portfolio but always consider opportunity costs. For example, a better choice for building retirement wealth might be to invest in VWINX, then use the time and energy you’ve saved to further your education and get a better day job.
Risk Rating: 3
Full Disclosure: I dollar-average into ISBs, WMT, ABT, and PEP. I also own shares of HRL, JNJ, and BDX.
NOTE: Metrics in the Table are current as of the Sunday of publication.
Post comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
You’ve no doubt noticed that our Master List keep getting shorter as the risk of a Bear Market increases. We began with 34 (large and small) companies (see Week 5) and now we’re down to 10 large companies (see Table). Those 10 are chosen from our 9 Lifeboat Stocks (see Week 174) and 17 Core Holdings (see Week 172). We eliminate any that aren’t "Dividend Aristocrats" (25+ yrs of dividend growth) or lost more during the Lehman Panic than the 28% that our “risk-on” benchmark (VBINX) lost.
This week, for the first time, we ask whether you’d be better off investing in all 10 of those companies, or would you be better off investing in Vanguard Wellesley Income Fund (VWINX), which is the “risk-off” benchmark that we recommend for retirement portfolios. It is not too difficult to build a portfolio of stocks with a higher dividend yield and/or faster dividend growth rate than the S&P 500 Index, particularly if you stick to companies have grown their dividend annually for at least 25 yrs. Those companies have a long and stable history of rewarding their investors through good times and bad. By owning shares in a few such companies you can look forward to receiving dividend checks in retirement that grow faster than inflation. But will you end up with more retirement assets by doing that? This week’s blog tries to answer that question.
Long term, VWINX has been the most stable and rewarding mutual fund. It is balanced roughly 40:60 between high quality stocks and investment-grade bonds, respectively. VWINX has returned 10.6%/yr over the past 35 yrs, which is identical to the return for the lowest-cost S&P 500 Index fund, the Vanguard 500 Index Fund (VFINX). Bonds in VWINX go up in value whenever stocks go down. That means VWINX has had only 4 down years in 35 (average loss of 6.3%) vs. 8 for VFINX (average loss of 11%). The lesson here is to hedge your stocks with high quality bonds. We suggest that you use inflation-protected US Savings Bonds because those never lose money and carry all the tax advantages of an IRA.
We’ve blogged often about the risk of owning individual stocks, and use several metrics like 5-yr Beta (Column I in our Tables) to highlight that risk. But there’s only one sure-fire metric: How much did investors lose during the last Bear Market (Column D in our Tables)? Warren Buffett likes to make analogies about core principles, and his analogy for this one is “You can only tell who’s swimming naked when the tide goes out.” With bonds, risk is easier to gauge because the interest that a corporate bond pays vs. the interest that a US Treasury bond (with the same maturity) pays is a direct measure of credit risk. The difference between those two interest rates is called “the spread” and the higher the spread, the riskier the bond. In other words, you’re paid more interest because you’re willing to take on more of the risk of bankruptcy. US Savings Bonds purchased online at treasurydirect are a zero-cost, tax-advantaged way to invest in 10-yr US Treasury Notes, the safest investment on the planet (according to Warren Buffett). You’ll appreciate having those Savings Bonds available to fund the non-recurring capital expenditures that are bound to appear during the next market calamity. (You certainly won’t want to sell stocks at a loss.)
The 10 “buy and hold” stocks in this week’s Table include 4 Hedge Stocks (see Week 150): WMT, CB, JNJ, PEP. Those stocks don’t need to be backed with inflation-protected Savings Bonds (ISBs). To answer our question (Is it better to invest in those 10 stocks or in VWINX?), we’ll make a virtual investment of $50/mo in each of the 10 stocks ($500/mo) backed by another virtual investment of $300/mo in ISBs. (Thus, you see 6 entries for ISBs in the Table). We’ve made stock purchases online at a dividend reinvestment sites like computershare or shareowneronline wherever transaction costs can be less than ~2%/yr. If the costs are higher, we’ve resorted to using a discount brokerage like Edward Jones (one of several that are available). For our virtual portfolio, we found it necessary to do that for 3 stocks (GWW, CB, PEP), buying one a year in that order. Our virtual investment then totaled $1800 once a year for 3 yrs with reinvested dividends, which accomplishes the same goal as investing $50/mo for 3 yrs at a dividend reinvestment site online.
Bottom Line: You can construct a 10-stock portfolio and be ahead of VWINX while maintaining the same risk profile (e.g. a 5-yr Beta of ~0.45). Over the past 14 yrs, our virtual portfolio returned ~9.5%/yr vs. ~7.3%/yr for VWINX. However, that ~2.2%/yr advantage is reduced to ~1.8%/yr after you subtract transaction costs of ~0.4%/yr: $321.65 spent during the first 3 yrs (Column R in the Table) divided by an investment of $28,800 = 1.12%, which is ~0.4%/yr. Dividend yield plus dividend growth is also better with 10 stocks than with VWINX (8.6% vs. 2.2%, see Columns G and H in the Table). During retirement, you’ll probably be able to cash those quarterly dividend checks without needing to sell the underlying shares, as opposed to having to sell shares of VWINX to come up with the same amount of cash. Of course, there is greater selection bias in picking 10 stocks than in owning shares of a managed stock/bond mutual fund like VWINX. Getting an extra ~1.8%/yr might justify the additional time and energy you’ll spend managing your portfolio but always consider opportunity costs. For example, a better choice for building retirement wealth might be to invest in VWINX, then use the time and energy you’ve saved to further your education and get a better day job.
Risk Rating: 3
Full Disclosure: I dollar-average into ISBs, WMT, ABT, and PEP. I also own shares of HRL, JNJ, and BDX.
NOTE: Metrics in the Table are current as of the Sunday of publication.
Post comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 2
Week 174 - Lifeboat Stocks for an Overpriced Market
Situation: The S&P 500 Index has been priced at or close to 20 times trailing earnings for several months now. That means equity yield is 5.0%, which is the bottom of its historic range of 5-10%. However, 10-yr Treasury Notes are only yielding 2.5%. That means the equity premium is 2.5% (5.0% minus 2.5%), suggesting stocks are still a “buy.”
At these lofty valuations, what is prudent stock-buying behavior? I would say this is a time to maintain your current plan, and think about dollar-averaging any additional funds into either the Vanguard Wellesley Income Fund (if you’re a “Risk-Off” investor) or the Vanguard Balanced Index Fund (if you’re a “Risk-On” investor). Those funds are highlighted in the “BENCHMARKS” section of all our Tables. That being said, we know you’ll be tempted to place additional funds in “Lifeboat Stocks” during this uncertain period (see Week 151). But be careful. So many investors are going in that direction that such stocks have become a “crowded trade.”
For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A/M or better. Companies that don’t have a Finance Value (Column E Table) higher than that for VBINX are excluded. So are companies paying a dividend that amounts to more than ~50% of earnings (“payout ratio,” Column I Table), or ~60% in the case of a regulated public utility.
Only 9 companies survive our screen, as of this date (9/24/14). Wal-Mart Stores (WMT), Johnson & Johnson (JNJ), and PepsiCo (PEP) are household names. CVS Caremark is familiar to many, but few know that it was recently renamed “CVS Health” because the stores stopped selling tobacco products. The JM Smucker Company is associated in the minds of most of us with jelly and jam but is actually the largest purveyor of coffee in the US, both at grocery stores (Folgers, Millstone) and along Main Street (Dunkin’ Donuts). Metrics that reflect underperformance vs. VBINX have been highlighted in red. In particular, note that 7 companies have red highlights in Column K of the Table (P/E).
Bottom Line: You can still find “Lifeboat Stocks” that are worthwhile investments but it is time to tread lightly. For those stocks, stick to dollar-averaging small amounts of money into an online DRIP each month. Better yet, give Vanguard’s balanced mutual funds like VWINX and VBINX a closer look.
Risk Rating: 4
Full Disclosure: I dollar-average into NEE, ABT, and WMT each month.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
At these lofty valuations, what is prudent stock-buying behavior? I would say this is a time to maintain your current plan, and think about dollar-averaging any additional funds into either the Vanguard Wellesley Income Fund (if you’re a “Risk-Off” investor) or the Vanguard Balanced Index Fund (if you’re a “Risk-On” investor). Those funds are highlighted in the “BENCHMARKS” section of all our Tables. That being said, we know you’ll be tempted to place additional funds in “Lifeboat Stocks” during this uncertain period (see Week 151). But be careful. So many investors are going in that direction that such stocks have become a “crowded trade.”
For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A/M or better. Companies that don’t have a Finance Value (Column E Table) higher than that for VBINX are excluded. So are companies paying a dividend that amounts to more than ~50% of earnings (“payout ratio,” Column I Table), or ~60% in the case of a regulated public utility.
Only 9 companies survive our screen, as of this date (9/24/14). Wal-Mart Stores (WMT), Johnson & Johnson (JNJ), and PepsiCo (PEP) are household names. CVS Caremark is familiar to many, but few know that it was recently renamed “CVS Health” because the stores stopped selling tobacco products. The JM Smucker Company is associated in the minds of most of us with jelly and jam but is actually the largest purveyor of coffee in the US, both at grocery stores (Folgers, Millstone) and along Main Street (Dunkin’ Donuts). Metrics that reflect underperformance vs. VBINX have been highlighted in red. In particular, note that 7 companies have red highlights in Column K of the Table (P/E).
Bottom Line: You can still find “Lifeboat Stocks” that are worthwhile investments but it is time to tread lightly. For those stocks, stick to dollar-averaging small amounts of money into an online DRIP each month. Better yet, give Vanguard’s balanced mutual funds like VWINX and VBINX a closer look.
Risk Rating: 4
Full Disclosure: I dollar-average into NEE, ABT, and WMT each month.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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