Month 111 - Nine A-rated non-Financial GARP Stocks in the S&P 100 Index - September 2020

Situation: “Growth at a reasonable price (GARP)" is an equity investment strategy that seeks to combine tenets of both growth investing and value investing to select individual stocks.” Different analysts use different metrics (and management assessments) to guesstimate favorable returns. Peter Lynch originated the concept and highlighted the usefulness of one ratio: Price/Earnings:Growth, commonly referred to as PEG. “Earnings” reference Earnings per Share (EPS) for the Trailing Twelve Month (TTM) period. “Growth” references an estimate of growth in EPS over the next 5 years. Yahoo Finance publishes the PEG ratio for each public company under Valuation Measures (see Column AH in the Table). The PEG ratio is kept up to date by Thomson Reuters. Peter Lynch is arguably the greatest stock-picker of all time. My interest in investing started through reading his books, which are practical down-to-earth primers. So, his reliance on PEG carries some gravitas. The basic idea is that a stock’s price ought to approximate the rate at which the company’s earnings grow (PEG = 1.0). That rarely happens in the real world but some companies come close (see Column AH in the Table).  

Mission: Look at the 23 A-rated non-financial high-yielding stocks in the S&P 100 Index and highlight the 9 that have 5-yr PEG numbers no higher than 2.5. 

Execution: see Table.

Administration: A-rated stocks are those that have:

            a) an above market dividend yield (see portfolio of Vanguard High Dividend Yield Index Fund ETF - VYM),

            b) positive Book Value, 

            c) positive earnings (TTM), 

            d) an S&P bond rating of A- or better, 

            e) an S&P stock rating of B+/M or better, and 

            f) a 20+ year trading history. 

Bottom Line: Merck (MRK), Target (TGT), Intel (INTC), Comcast (CMCSA), and Lockheed Martin (LMT) have the overall highest quality among stocks on this list (see Column AL in the Table). INTC and CMCSA are also Value Stocks, meaning that their price (50-day moving average) is less than twice their Graham Number (see Column AC) and their 7-year P/E is no higher than 25 (see Column AE). 

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 MRK, PFE and INTC, and also own shares of TGT and CMCSA. 

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Month 108 - 14 Buy-and-Hold Stocks in both the Dow Jones Composite Index and the S&P 100 Index - June 2020

Situation: If you’re a stock picker, you’ll need Buy-and-Hold stocks that are suitable for retirement but you’ll also need to know how to “buy low.” The job of an investor, according to Joel Greenblatt (CEO of Gotham Capital), “is to figure out what a business is worth and pay a lot less”. Those two words (buy low) separate investors from savers. 

The objective way to “buy low” is to listen to Warren Buffett and dollar-cost average a fixed amount each month into shares of large, well managed, and long-established companies with clean Balance Sheets. You do this by using an online Dividend Re-Investment Plan (DRIP). When the price of that stock falls during a Bear Market, you’ll automatically BUY LOW and acquire more shares per month than usual. 

The subjective way to “buy low” is to resort to labor-intensive Fundamental Analysis, which uses a bespoke set of metrics to repeatedly examine stocks in each sub-industry and decide which are bargain-priced. My requirements for a company to be “A-rated” and join my Watch List of “large and well-managed companies with clean Balance Sheets” can be seen in the Tables for each month’s blog. For example, a large company is one in the S&P 100 Index. A well-managed company is one picked by the Managing Editor of The Wall Street Journal for inclusion in the 65-stock Dow Jones Composite Index. A clean Balance Sheet is one earning an S&P Bond Rating of A- (or better), with positive Book Value for the most recent quarter (mrq). I also require that Tangible Book Value (TBV) be a positive number but a negative TBV is acceptable if the company is mainly capitalized by Common Stock and its Total Debt is no greater than 2.5X EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) for the Trailing Twelve Months (TTM). The companies I analyze are listed in both the iShares Russell Top 200 Value ETF (IWX) and the Vanguard High Dividend Yield Index ETF (VYM). I interpret “long-established” to mean a 20+ year history of being traded on a public stock exchange.

Mission: Using our Standard Spreadsheet, analyze A-rated stocks that are in both the 65-stock Dow Jones Composite Average and the S&P 100 Index.

Execution: see Table. Columns AP and AQ give annual costs and the vendor URL for each dividend reinvestment plan (DRIP). 

Administration: The idea behind owning “value” stocks is to lose less during Bear Markets. The idea behind owning “growth” stocks is to earn more during Bull Markets. Column AO shows how much the price of each stock changed in 2008. Column D shows how much the price of each stock changed in 2018 (when the S&P 500 Index lost 19.9% in the 4th quarter). These 14 stocks lost 5% less than the S&P 500 ETF (SPY) in 2018, and 17.3% less in 2008. An additional benefit of owning shares in these “value” companies that pay above-market dividends is that 7 are also listed in the iShares Russell Top 200 Growth ETF (IWY): MRK, KO, PG, JNJ, CAT, MMM, IBM. You can have “the best of both worlds” by owning those. 

Bottom Line: The secret of stock picking is to have a short Watch List because you’ll need to practice due diligence: follow the evolution of each company’s “story” and the effectiveness of its managers. This takes time and money: online subscriptions to The Wall Street Journal, Barron’s, Bloomberg Businessweek, and The New York Times don’t come cheap. Neither do online DRIPs: For example, the average expense ratio in the first year of using a DRIP to buy into these 14 companies is 1.56% (see Column AP in the Table: $18.76/$1200 = 1.56%). And, you’ll get a bigger bill from your accountant if you decide to sell a DRIP, besides spending more time yourself to get the paperwork ready. For example, you’ll have to list the “cost basis” for each of the 16 purchases you made each year (12 monthly purchases plus 4 purchases to reinvest quarterly dividends) of each stock so your accountant can calculate capital gains.

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

Full Disclosure: I dollar-average into PFE, NEE, INTC, KO, PG, WMT, JPM, JNJ, CAT and IBM, and also own shares of MRK, DUK, SO and MMM. 

NOTE: Aside from dollar-cost averaging, there is second objective way to buy low: make “one-off” purchases of any of these 14 stocks that appear on the “Dogs of the Dow” list, which is updated every New Year’s Day. For example, the 10 dogs on this year’s list include: International Business Machines (IBM), Pfizer (PFE), 3M (MMM), and Coca-Cola (KO).

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Month 106 - A-rated Value Stocks in the S&P 100 Index - April 2020

Situation: Growth at a reasonable price (GARP) is often mentioned as an investing goal because value underlies the decision to buy. Warren Buffett is the king of value investing and has over $80 Billion in cash (his “elephant gun”) that he’d like to spend. We’re in a Bear Market fueled by the adverse economic consequences of the COVID-19 pandemic. So, he’ll soon spend that cash pile to buy a large company. Let’s look at his options, considering the ways he has prioritized purchases in the past. Firstly, he likes large and long-established companies. Why large companies? Because those have multiple product lines, one of which is usually designed to help the company maintain a stream of revenue during a recession. In addition, those companies are large enough to have the marketing power needed to maintain and grow their brands. 

Mission: Let’s see which choices look attractive among A-rated “haven stocks” in the S&P 100 Index (see Month 104). Remember: These companies reliably pay an above-market dividend, so they’re found in the Vanguard High Dividend Yield Index (VYM), and they’re also listed in the iShares Russell Top 200 Value ETF (IWX). Warren Buffett places high store in companies that don’t overuse debt and also retain Tangible Book Value, so we’ll exclude companies with negative Tangible Book Value that also have a total debt load greater than 2.5 times EBITDA (Earnings Before Interest, Tax, Depreciation & Amortization) or have sold long-term bonds to build more than 50% of their market capitalization. Finally, the company's stock price has to meet both of our two value criteria: 1) Share price isn't more than twice the Graham Number; 2) share price isn't more than 25 times average 7-yr earnings per share. 

Execution: (see Table).

Administration: These 9 companies include 4 from the two most deeply cyclical industries: banks and semiconductor manufacturers. Berkshire Hathaway’s portfolio already includes the 3 banks on the list, i.e., JPMorgan Chase (JPM), U.S. Bancorp (USB), and Wells Fargo (WFC) but doesn’t include the semiconductor manufacturer, Intel (INTC). Berkshire Hathaway is at heart an insurance company, so Warren Buffett always needs to diversify away from the Financial Services industry. There are only 4 non-financial companies on the list: Intel (INTC), Cisco Systems (CSCO), Pfizer (PFE), and Target (TGT), and only TGT is within the price range that Mr. Buffett is looking to spend ($80 to $100 Billion). 

Bottom Line: Target (TGT) appears to be the most attractive company to add to Berkshire’s stable, given that it is priced right and Mr. Buffett already has experience owning companies in the Consumer Discretionary industry.. 

Risk Rating: 7 (where 10-yr U.S. Treasury Notes = 1, S&P 500 Index = 5, and gold = 10).

Full Disclosure: I dollar-average into INTC and JPM, and also own shares of PFE, CSCO, TGT, USB, BLK and WFC.

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Month 103 - Berkshire Hathaway's A-rated "Value" Stocks with High Dividend Yields - January 2020

Situation: In case your reason for buying stocks in your working years is to have growing income from dividends in your retirement years, we suggest that you prioritize “value stocks.” The bible of value investing is a book (The Intelligent Investor) written by Benjamin Graham, who was Warren Buffett’s instructor while Warren was earning his Master of Science in Economics degree at Columbia University. 

Why value investing, and what is a value stock? The main idea is to not overpay for either Earnings Per Share (EPS over the trailing twelve months, abbreviated ttm) or Book Value per share in the most recent quarter (abbreviated mrq). On page 349 of the Revised Edition (1973) of The Intelligent Investor, Benjamin Graham says “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings [per share] below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb, we suggest that the product of the [EPS] multiplier times the ratio of price to book value should not exceed 22.5.” That is, 1.5 x 15 = 22.5.

How do you calculate the “Graham Number” -- the “rational” stock price listed in Column AA of the Table? It is the square root of 22.5, times (Earnings Per Share for the ttm), times Book Value per share for the mrq. We suggest that you think of the share price of a value stock as being no greater than: a) twice the Graham Number, b) 25 times average 7-year Earnings Per Share (see page 159 of The Intelligent Investor), c) 3 times Book Value per share (ttm), and d) 3 times sales per share (mrq). If a company meets 3 out of 4 of those criteria, we call its stock a “value stock” in Column AF of the Table. 

Berkshire Hathaway’s stock portfolio contains 48 holdings worth $214,673,311,000 as of the last 13F SEC filing dated 11/14/19. The top 5 holdings (AAPL, BAC, KO, WFC, AXP) are worth ~$142B (66% of the total). We rate 8 of the 48 as being high-yielding “value” stocks (KO, PG, JPM, JNJ, TRV, USB, PNC, WFC), in that those companies meet an additional 4 criteria we like to use: 1) their bonds are rated A- or better by Standard & Poor’s (S&P), 2) their stocks are rated B+/M or better by S&P, 3) their stocks have the 16+ year trading record that is required for quantitative analysis using the BMW Method, and 4) their stocks are listed in both the iShares Russell 200 Value Index (IWX) and the Vanguard High Dividend Yield Index (VYM). You’ve probably figured out, by this point, that I’m encouraging you to think along these lines when building your own portfolio of retirement stocks. You can get a feel for the process by looking at 8 such stocks Warren Buffett has picked for Berkshire Hathaway’s portfolio.

Mission: Update our Month 98 blog, using our Standard Spreadsheet to analyze value stocks in Berkshire Hathaway’s stock portfolio.  

Execution: see Table.

Administration: The 10 largest positions in Berkshire Hathaway’s portfolio are:

Apple AAPL ($56B)
Bank of America BAC ($27B)
Coca-Cola KO ($22B)
Wells Fargo WFC ($19B)
American Express AXP ($18B)
Kraft Heinz KHC ($9B)
U.S. Bancorp USB ($7B)
JPMorgan Chase JPM ($7B)
Moody’s MCO ($5B)
Delta Air Lines DAL ($4B)

Six of those 10 are are either not high-yielding stocks or not “value” stocks (AAPL, BAC, AXP, KHC, MCO, DAL). Data for those 6 companies can be found in the BACKGROUND Section of the Table. 

A system for buying stocks can be boiled down and presented in a spreadsheet, as long as you realize that it omits assumptions used to estimate intrinsic value. But our Standard Spreadsheet won’t go far in helping you decide to sell a stock. All we have to go by is that Warren Buffett has told us he might sell for two reasons: 1) When a higher return is expected by trading to another asset (to include the loss incurred by capital gains tax); 2) When the company changes its fundamentals. He has also named two stocks he would never sell: Coca-Cola (KO) and American Express (AXP). American Express didn’t make our list for two reasons: 1) the S&P Rating for the company’s bonds is BBB+ as opposed to our minimum requirement of A-, and 2) the company is not in the Vanguard High Dividend Yield Index ETF VYM.

Bottom Line: The 8 A-rated high-yielding value stocks account for $57B (27%) of Berkshire’s stock portfolio. Five of those are in the Financial Services industry (Warren Buffett’s area of expertise). Take-home points include a) don’t overpay for a stock, b) buy what you know, and c) remember that the best bargains are to be found in the Financial Services industry. But note that all 4 of his bank stocks have above-market volatility in share prices (see Column I in the Table), which goes far toward explaining why they’re underpriced (average P/E = 13). Also note that while Coca-Cola (KO) and Procter & Gamble (PG) seem overpriced (see Columns AB-AH in the Table), you’d need to consider intrinsic value before coming to that conclusion.  

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

Full Disclosure: I dollar average into PG, JPM, JNJ and USB, and also own shares of KO, TRV and WFC.

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Month 98 - Berkshire Hathaway’s A-rated High Dividend Yield “Value” Stocks - August 2019

Situation: In case your reason for buying stocks in your working years is to have a growing income from dividends in your retirement years, this blog has emphasized “value stocks.” The bible of value investing is Benjamin Graham’s book: The Intelligent Investor. His most famous student is Warren Buffett, who graduated from Columbia University in 1951 with a Masters Degree in Economics. 

Why value investing, and what is a value stock? The central thought is to discipline yourself not to overpay for earnings and/or assets (“book value”). On page 349 of the Revised Edition (1973) of The Intelligent Investor, Benjamin Graham says “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb, we suggest that the product of the [earnings] multiplier times the ratio of price to book value should not exceed 22.5.” In other words, 1.5 times 15 equals 22.5.

How do you calculate the “Graham Number” or rational stock price? It is the square root of 22.5 times Earnings Per Share for the Trailing Twelve Months (TTM) times Book Value per share for the most recent quarter (mrq). We suggest that you think of the share price of a value stock as being no greater than: a) twice the Graham Number, b) 25 times the 7-year average for Earnings Per Share (see page 159 of The Intelligent Investor), and c) no more than 4 times Book Value per share. When you purchase a stock meeting those 3 requirements, it is demonstrably worth what you paid for it. The details are shown in Columns AA-AE of Tables accompanying our recent blogs. 

Berkshire Hathaway’s stock portfolio contains 46 holdings worth $201,828,368,888 as of the last 13F SEC filing dated 8/14/19. The top 5 holdings (AAPL, BAC, KO, AXP, WFC) are worth $133,600,000,000 (66% of the total). Eight of the 46 companies have issued A-rated value stocks, since the company meets the following 4 criteria: 1) its bonds are rated A- or better by Standard & Poor’s (S&P), 2) its stocks that are rated B+/M or better by S&P, 3) its stocks have the 16+ year trading record that is required for quantitative analysis using the BMW Method, and 4) its stocks are listed in both the iShares Russell 1000 Value Index (IWD) and the Vanguard High Dividend Yield Index (VYM). 

The top 10 stocks in Berkshire Hathaway’s portfolio, listed by valuation, are:

Apple AAPL ($51B)
Bank of America BAC ($25B)
Coca-Cola KO ($21B)
American Express AXP ($19B)
Wells Fargo WFC ($18B)
Kraft Heinz KHC ($8B)
U.S. Bancorp USB ($7B)
JPMorgan Chase JPM ($6B)
Moody’s MCO ($5B)
Delta Air Lines DAL ($4B)

Mission: Use our Standard Spreadsheet to analyze value stocks in the portfolio, based on the 4 criteria listed above.  

Execution: see Table.

Administration: Six of the top 10 stocks in the portfolio are not value stocks (AAPL, BAC, AXP, KHC, MCO, DAL). Data for those can be found in the BACKGROUND Section of the Table.

Bottom Line: The 8 A-rated value stocks account for $54 Billion (27%) of the portfolio’s value. These show that Warren Buffett’s area of expertise is not only value stocks generally but financial services stocks specifically, since 5 of the 8 companies are from that industry. The take-home points for retail investors are: a) don’t overpay for a stock, b) buy what you know, and c) remember that the best bargains are often in the Financial Services industry. But those stocks also tend to have the greatest volatility, which is a key reason why they are underpriced.

Risk Rating: 7 (where 1 = 10-year U.S. Treasuries, 5 = S&P 500 Index, and 10 = gold bullion) 

Full Disclosure: I dollar average into KO, PG, JPM and JNJ, and also own shares of AAPL and TRV.

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Month 96 - Watch List for S&P 100 Companies in the Vanguard High Dividend Yield Index - June 2019

Situation: All investors have an objective as well as a plan to reach that objective. I started with the objective of getting my children through college, then moved on to having a comfortable retirement. Direct stock ownership has been a key part of both plans. Why stocks? Because mutual funds are sold on the basis of long-term performance records, not safety from market crashes. But a small group of stocks are relatively safe because of being issued by a large company that reliably pays a good and growing dividend. The trick is to have a Watch List of 20-30 such companies and know “the story” behind each company.

Mission: Use our Standard Spreadsheet to evaluate companies in the S&P 100 Index that also appear in the FTSE High Dividend Yield Index, i.e., the ~400 companies in the FTSE Russell 1000 Index that reliably pay an above-market dividend. Our source document is the list of companies in VYM (the capitalization-weighted Vanguard High Dividend Yield ETF,
which is the US version of the FTSE High Dividend Yield Index.

Execution: see Table showing a spreadsheet with 36 columns of information for commons stocks issued by 27 US companies.

Administration: 54 companies are common to both indexes but 27 have been  excluded from our Watch List because an item of information needed to populate a cell in the spreadsheet is missing and/or the company's S&P ratings are too low to denote above-average safety. We require an A- bond rating or better and a B+/M stock rating or better.

A key requirement is to avoid overpaying for a stock. I’m a numbers guy, so I use two numbers to decide if a stock is overpriced (where “price” or P is defined as the 50-day moving average):
   1) the 7-yr P/E is greater than 30 (see Column AD in the Table. 
   2) the stock’s Graham Number, which is the square root of 22.5 times EPS (Earnings Per Share) multiplied by BV/Sh (Book Value Per Share), is greater than 250% of its price (see Column AB in the Table). 

If only one of those two numbers is over the limit, the stock is still overpriced if the other number is close to the limit (more than 25 or 200%, respectively).

Another key requirement is to know whether a company's stock is a worthwhile investment, given its current price. As a starting place, I’ve devised a Basic Quality Screen that has only 6 elements and a maximum score of 4 (see Table):
   1) If price appreciation over the past 16 years has been greater than 1/3rd the risk of short-term loss as determined by the BMW method, one point is added. In other words, 16-Yr price appreciation in Column K is greater than 1/3rd the risk in Column M.
   2) If Tangible Book Value in Column S is negative and either LT-debt represents more than 50% of Total Capital (Column O), or Total Debt is more than 250% of EBITDA (Column P), one point is subtracted. 
   3) If the S&P Bond Rating in Column U is A- or better, one point is added. 
   4) If the S&P Stock Rating in Column V is B+/M or better, one point is added. 
   5) If Net Present Value of dividend growth (based on trailing 5-Yr dividend growth in Column H) and cash-out value after a 10 year Holding Period (determined by extrapolation of trailing 16-Yr price appreciation in Column K) is a positive number when applying a Discount Rate of 10% (see Column Z), one point is added. 
   6) If the two markers of an overpriced stock noted above (see Columns AB and AD) indicate that the stock is indeed overpriced, half a point is subtracted.

The final SCORE is found in Column AJ.

Bottom Line: As expected, these 27 companies have not performed as well as SPY, the S&P 500 Index ETF (see Line 29 to Line 35 at Columns C through F in the Table). But these 27 companies pay a higher dividend (Column G) and have lower price volatility (see Columns I & M) than SPY. Estimates for Net Present Value after a 10 year holding period (assuming a continuation of the trailing 5 year dividend growth rate and the trailing 16 year price growth rate and trading costs of 2.5% at the time of purchase and sale) were higher than SPY (see Column Z).  

Conclusion: These 9 stocks appear to be over-priced (see Columns AB and AD): CSCO, KO, TXN, PEP, JNJ, LMT, MMM, CL and UPS. These 12 appear to be bargain-priced “value stocks” based on Book Value, Graham Number and average 7 year P/E (see Columns AA-AE): PFE, NEE, DUK, INTC, TGT, SO, JPM, CMCSA, USB, BLK, XOM and WFC. These 10 appear to be worthwhile investments because of having a score of either 3 or 4 on our Basic Quality Screen (see Column AJ): PFE, NEE, DUK, INTC, PG, SO, JPM, WMT, CAT, BLK.

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

Full Disclosure: I dollar-average into NEE, KO, INTC, PG, JNJ, JPM, WMT, CAT and IBM. I also own shares of PFE, CSCO, DUK, SO, PEP, MMM, BLK, UPS and XOM. Note that all but two (BLK and PEP) of those 18 are in the 65-stock Dow Jones Composite Average.

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Month 95 - Dow Jones Industrial Average - Spring 2019 Update

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

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

Execution: see Table.

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

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

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

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

The final SCORE is found in Column AJ.

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

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

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

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

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

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

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


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

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Week 391 - Members of “The 2 and 8 Club” in the FTSE Russell 1000 Index

THIS IS THE LAST WEEKLY ISSUE. FUTURE ISSUES WILL APPEAR MONTHLY.

Situation: “The 2 and 8 Club” is based on the FTSE High Dividend Yield Index, which represents the ~400 companies in the FTSE Russell 1000 Index that reliably have a dividend yield higher than S&P 500 Index. Accordingly, a complete membership list for “The 2 and 8 Club” requires screening all ~400 companies in the FTSE High Dividend Yield Index periodically to capture new members and remove members that no longer qualify. This week’s blog is the first complete screen.

Mission: Use our Standard Spreadsheet to analyze all members of “The 2 and 8 Club.”

Execution: see Table

Administration: The requirements for membership in “The 2 and 8 Club” are:
1) membership in the FTSE High Dividend Yield Index;
2) a 5-Yr dividend growth rate of at least 8%;
3) a 16+ year trading record that has been quantitatively analyzed by the BMW Method;
4) a BBB+ or better rating from S&P on the company’s bond issues;
5) a B+/M or better rating from S&P on the company’s common stock issues.

In addition, the company cannot become or remain a member if Book Value for the most recent quarter (mrq) is negative or Earnings per Share for the trailing 12 months (TTM) are negative. Finally, there has to be a reference index that is a barometer of current market conditions, i.e., has a dividend yield that fluctuates around 2% and a 5-Yr dividend growth rate that fluctuates around 8%. The Dow Jones Industrial Average ETF (DIA) is that reference index. In the event that the 5-Yr dividend growth rate for that reference index moves down 50 basis points to 7.5% for example, we would use that cut-off point for membership instead of 8%.   

Bottom Line: There are 40 current members. Only 9 are in “defensive” S&P Industries (Utilities, Consumer Staples, and Health Care). At the other end of the risk scale, there are 12 banks (or bank-like companies) and 5 Information Technology companies; 13 of the 40 have Balance Sheet issues that are cause for concern (see Columns N-P). While the rewards of “The 2 and 8 Club” are attractive (see Columns C, K, and W), such out-performance is not going to be seen in a rising interest rate environment (see Column F in the Table). Why? Because the high dividend payouts (see Column G in the Table) become less appealing to investors when compared to the high interest payouts of Treasury bonds).

NOTE: This week’s Table will be updated at the end of each quarter.

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 JPM, NEE and IBM, and also own shares of TRV, CSCO, BLK, MMM, CMI and R.

Caveat Emptor: If a capitalization-weighted Index of these 40 stocks were used to create a new ETF, it would be 5-10% more risky (see Columns D, I, J, and M in the Table) than an S&P 500 Index ETF like SPY. But the dividend yield and 5-Yr dividend growth rates would be ~50% higher, which means the investor’s money is being returned quite a bit more rapidly. That will have the effect of reducing opportunity cost.

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

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Week 380 - Are Stocks in “The 2 and 8 Club” Overpriced?

Situation: There’s a lot of talk suggesting that an “overpriced” stock market is headed for a fall. And sure, stocks do have rich valuations because the Federal Reserve has kept money cheap for 10 years and bonds don’t pay enough interest to compete for investor’s money (because the Federal Reserve bought up long-dated bonds). Now the Federal Reserve is determined to reverse those policies and investors are having to get used to the idea that stocks will revert to true value. But we have to specify which metrics define “overpriced” and use at least two of those before concluding that a particular stock is overpriced (see our blogs for the past two weeks).

Mission: Run our Standard Spreadsheet, using colors in Columns Y and Z to highlight Graham Numbers and 7-Yr P/Es that are overpriced (purple) or underpriced (green).

Execution: see Table.

Bottom Line: In the aggregate, the 32 stocks in “The 2 and 8 Club” have Graham Numbers that are more than 200% of their current valuation. This leaves room for at least a 50% fall from present prices. However, our confirmation metric does not support such a dire prediction: The average 7-Yr P/E is a little under the upper limit of the normal range for valuations (25). 

Stocks issued by some companies appear to clearly be overpriced, in that the Graham Number is more than twice the stock’s price and the 7-Yr P/E is more than 30: TXN, ADP, UPS, HSY and CAT. Other companies appear to clearly be underpriced in that the Graham Number is less than the stock’s price and the 7-Yr P/E is less than 25: CMCSA, PNC, ADM, PFG and MET. The fact that 5/32 stocks are overpriced and 5/32 stocks are underpriced is indicative of normal distribution (Bell Curve). So, we’ll use this approach often in future blogs.

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

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

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

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Week 379 - Are “Blue Chip” Stocks Overvalued?

Situation: There are two subjective issues that we need to quantify for “buy and hold” investors: 1) Define a “blue chip” stock. 2) Define an “overvalued” stock. 

Our previous effort to define a “blue chip” stock in quantitative terms (see Week 361) left room for subjective interpretation and was more complicated than necessary. Here’s the new and improved definition: Any US-based company in the S&P 100 Index whose stock has been tracked by modern quantitative methods for 30+ years, and enjoys an S&P rating of B+/M or better. The very important final requirement is that the company issues bonds carrying an S&P rating of A- or better. 

In last week’s blog, we introduced two different quantitative methods for deciding whether or not a stock is overvalued: 1) the Graham Number, which sets an optimal price by using Book Value for the most recent quarter (mrq) and Earnings Per Share for the trailing 12 months (TTM); 2) the 7-Yr P/E, which removes aberrations that are introduced by “blowout earnings” or the negative impact on earnings that is often introduced by “mergers and acquisitions” and “company restructurings.” Either metric can be misleading if used alone, but that problem is largely negated when both are used together. 

Mission: Set up our Standard Spreadsheet for the 40 companies that meet criteria. Show the Graham Number in Columns X and the 7-Yr P/E in Column Z.

Execution: see Table.

Administration: In our original blog about Blue Chip stocks (Week 361), we thought the definition needed to require that companies pay a good and growing dividend. However, there are no objective reasons why a company’s stock will be of more value if profits are paid out piecemeal to investors rather than entirely in the form of capital gains. That’s one of the things you learn in business school from professors of Banking and Finance. Accounting professors also point out that a dividend is a mini-liquidation, as well as a second round of taxation on the company’s profits. There are subjective reasons to prefer companies that pay a good and growing dividend, like building brand value (an intangible asset) and showing that the company is “shareholder friendly.” Dividends also reduce risk by returning some of the original investment quickly with inflation-protected dollars.

Bottom Line: In the aggregate, these company’s shares are overpriced but not to an unreasonable degree (see Columns X-Z in the Table). However, only 8 are bargain-priced: Altria Group (MO), Comcast (CMCSA), Berkshire Hathaway (BRK-B), JP Morgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFB), US Bancorp (USB), and Exxon Mobil (XOM). You’ll note that all 8 face challenges that will cause investors to pause before snapping up shares. 

Shares in 9 companies are overpriced by both metrics (Graham Number and 7-Yr P/E): Home Depot (HD), UnitedHealth (UNH), Lowe’s (LOW), Costco Wholesale (COST), Microsoft (MSFT), Texas Instruments (TXN), Raytheon (RTN), Honeywell International (HON), and Caterpillar (CAT). You’ll need to think about taking profits in those, if you’re a share-owner.

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, NEE, KO, JNJ, JPM, UNP, PG, WMT, CAT, XOM, and IBM. I also own shares of COST, MMM, BRK-B, and INTC.

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

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Week 378 - Which “Dow Jones Industrial Average” Stocks Are Not Overpriced?

Situation: Is the US stock market overpriced? We need to know because Warren Buffett keeps reminding us how important it is to avoid overpaying for a stock. Buffet says: “No matter how successful a company is, don’t overpay for its stock. Wait until Wall Street sours on a company you like and drives the price down into bargain territory. By making a watch list of interesting stocks, and waiting for their prices to drop, you increase the potential for future capital gains.”
The author of this link suggests that none of us “mere mortals” are as smart as Warren Buffett at getting the price right. It’s perhaps better to either dollar-average your investment, or leave it to professionals to do the stock-picking for you. We suggest that there is a third option, which is to use a couple of simple mathematical formulas to guide your stock-picking. Those formulas can be found in the book that Warren Buffett calls “by far the best book on investing every written.” The book is entitled: The Intelligent Investor by Benjamin Graham, Revised Edition, Harper, New York, 1973. There, you will find the value of calculating the 7-year P/E instead of the usual 12-month P/E, and also learn how to calculate the “Graham Number.” The Graham Number is what the stock would sell for if it were priced at 1.5 times Book Value and 15 times trailing 12-month (TTM) earnings. Calculating and using the Graham Number is important because it allows for variation in Book Value and earnings. Multiplying the two values just has to be ~22.5 (15 X 1.5) for the stock to be optimally priced.

Mission: To test both methods on stocks issued by the 30 companies in the Dow Jones Industrial Average (DJIA). See columns X, Y and Z on our Standard Spreadsheet (Table).

Execution: see Table.

Administration: Here’s how to calculate the Graham Number, as shown on p. 349 in the book cited above). [Clicking this link will take you to the Amazon website and the book).] Start by multiplying 1.5 (ideal ratio of Book Value/share) by 15 (ideal ratio of TTM Earnings/share) = 22.5. By multiplying two numbers you have created a Power Function. So, you’ll have to take the Square Root of the Final Number to arrive at the Graham Number. Final Number = 22.5 X actual Book Value/share for the most recent quarter (new) X actual TTM Earnings/share. To access Earnings/share, go to any company’s page at Yahoo Finance, e.g. Apple’s. In the right column find EPS (TTM) of $11.038. To access Book Value/share, click on “statistics” at the top of that page and scroll down the left column to “Balance Sheet.” Book Value/share for the most recent quarter (mrq) is the last entry: $23.74. Graham Number = square root of 22.5 X $11.038 X $23.74 = $76.79. This is the true value (Graham Number) for a single share of Apple stock. If it sells for less, that’s a bargain. Right now, it’s selling for almost 3 times as much. If you own some shares, either think about selling those or think about the company’s ability to scale-up the “Apple ecosystem”. Perhaps you’ll decide that those prospects make holding onto the shares for a while longer a worthwhile risk.

Calculating the 7-Yr P/E (p. 159 in the book cited above). You’ll need a website that provides the past 7 years of TTM earnings, or a library with S&P stock reports. Simply add the most recent 7 years’ earnings and divide by 7 to arrive at the denominator. Look up the current price of the stock (or its 50 Day Moving Average price found in the right column of the statistics page under “Stock Price History”) to arrive at the numerator. Divide numerator by denominator to calculate the 7-Yr P/E, which must be 25 or less to reflect “normative” earnings growth over 7 years for a stock with a 12-month P/E of ~20 during most years. By using the 7-yr P/E you avoid being mislead by a year of blowout earnings or negligible earnings.

Bottom Line: As a group, these 30 stocks are overpriced. Nonetheless, 12 companies have stocks that are priced within reason vs. their Graham Numbers and 7-Yr P/Es (see Columns X-Z in the Table): TRV, DIS, WBA, INTC, VZ, JPM, PFE, PG, GS, UTX, CVX, XOM. But only one company, Goldman Sachs (GS), can be called a bargain with respect to both values (those values being highlighted in green in the Table). Note that Berkshire Hathaway (BRK-B at Line 35 in the Table) is an even better bargain. Perhaps Warren Buffett noticed these markers of high intrinsic value when he recently spent part of Berkshire Hathaway’s cash hoard to buy back the stock. 

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

Full Disclosure: I dollar-average into 3 stocks on the “not overpriced list” -- JPM, PG and XOM, and also own shares in two others: INTC and TRV. Additionally, I dollar-average into MSFT, KO, JNJ, WMT, CAT and IBM, and own shares in MCD, MMM and CSCO. 

Comment: I focus on Dow Stocks because each is covered by dozens of analysts and business journalists, and its stock options are actively traded on the Chicago Board Options Exchange. The result of this microscopic attention is that price discovery is efficient, and surprise earnings are rare. In addition, all 30 companies have a long record of business experience, and are large enough to have multiple product lines that provide internal lines of support during a crisis. DJIA companies are famously able to weather almost any storm: Seven DJIA companies went through a near death experience during The Great Recession of 2008-2009 (General Electric, Citigroup, General Motors, Pfizer, Home Depot, Caterpillar, and American Express) but only 3 had to be removed in the aftermath of that “Lehman Panic” (General Electric, Citigroup, and General Motors).

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

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

Week 371 - Know What You’re Buying: Graham Numbers for “The 2 and 8 Club”

Situation: Stock prices are a function of 3 variables: book value, earnings, and market sentiment. The first two numbers come from the company’s most recent quarterly report. Market sentiment drives the movement in buy and sell orders for a particular block of shares on a public exchange. In the days before electronic trading systems took over, traders would get together after work and make back-of-the-envelope calculations of future book values and earnings for stocks that interested them. This would give them an idea about the price at which the company’s stock would open the next morning. Benjamin Graham gave traders a starting point for those discussions on page 349, Chapter 14, of his book The Intelligent Investor (cf. the Revised Edition of 2003, annotated by Jason Zweig). There he makes clear that a rational price is the square root of 15 times earnings/share (EPS) and 1.5 times book value/share (BVPS), which is the square root of 22.5 X EPS x BVPS. For example, on June 18, 2018, JP Morgan Chase & Co. (JPM) closed at $108.17, with EPS of $6.35 and BVPS of $72.00. The Graham Number equals the square root of (22.5 X 6.35 X 72 = 10,287) or $101.42. Conclusion: JPM is 6.66% overvalued ($108.17/$101.42 = 1.0666).  

Mission: Run our Standard Spreadsheet for the 22 companies in “The 2 and 8 Club” to include Graham Numbers.

Execution: see Columns Z and AA in this week’s Table.

Bottom Line: The average company on this list is overvalued by a factor of three (see Column AA), reflecting the end-of-times for the second longest Bull Market since the Great Depression. You have to ask yourself why you still own shares of a stock that is priced more than 3 times its fundamental value. Those reasons will always reflect market sentiment unless you know of a specific reason why earnings and book value are going increase above trend, and you’re almost certain it will play out that way.

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

Full Disclosure: I dollar-average into MSFT, NEE, JPM, CAT and IBM and also own shares of TRV, MMM, CSCO and CMI.

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

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

Week 277 - Counter-cyclical Barron’s 500 Dividend Achievers

Situation: What’s the biggest problem with owning stocks? When JP Morgan was asked this question, he answered: “It will fluctuate.” Benjamin Graham was more specific, noting in Chapter 14 (Stock Selection for the Defensive Investor) of his famous book (The Intelligent Investor, 4th Revised Edition, Harper & Row, New York, 1973, p.195) that:
     “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.” 

But a stock’s price will rise far higher when investors clamor to “get in on the story.” All too often, that story reflects the investment that the company’s managers have made in Public Relations (e.g. advertising) at the expense of investments that grow Tangible Book Value (e.g. property, plant, equipment, and software). As a result, the company’s stock price will falter whenever the macro-economic outlook is negative. 

Mission: This week we’ll build on Warren Buffett’s observation that “only when the tide goes out do you discover who’s been swimming naked.” That last happened with the 4.5 yr Housing Crisis, i.e., year-over-year house prices (for conforming new sales nationwide) turned negative in Q3 of 2007 and didn’t turn positive again until Q1 of 2012. Most companies were exposed as naked swimmers, and their stock prices soon fell to a level more consistent with Benjamin Graham’s formula (see above). But a few outperformed during that 4.5 yr period. Total Returns/Yr proved to be greater than Total Returns/Yr have been over the 26+ yr period since the Savings & Loan Crisis of 1990-91. Do those companies have anything in common? We’d like to know, since owning shares in 2 or 3 such companies would help protect our portfolios from the ravages of the next crisis.

Mission: Look for companies in the Barron’s 500 List that 1) outperformed in the Housing Crisis, 2) have improved revenues and cash flow over the past 3 yrs, 3) have high S&P ratings on their bond and stock issues, and 4) are Dividend Achievers.

Execution: (see Table)

Administration: The first 3 companies in our Table (ROST, TJX, MCD) represent the Consumer Discretionary industry and see thrifty consumers as “core” clientele. Their Business Plan is designed to outperform in a recession because people will have an ongoing need to purchase their products and services, and more people will have become thrifty-minded. Four companies at the bottom of the list (WEC, XEL, ES, ED) are regulated public utilities that play a similar role: everyone needs to turn on lights and recharge their cell phones every day. Somehow the money will be found to pay the utility bill. 

It is harder to explain how the remaining two companies, IBM and WW Grainger (GWW), made the list. When a company needs information technology maintenance or upgrades, IBM has always had the reputation of being a safe and effective recommendation for a company’s Chief Information Officer to make. A deep recession is exactly when such upgrades are in demand, given that the company has had to reduce staffing to avoid being bought out by a stronger competitor. Automation and global sourcing are the paramount strategies to deploy in a recession. Similarly, GWW is the leading supplier of maintenance, repair, and operating products to businesses. So, demand for at least some of their products will have remained steady.

Among the BENCHMARKS and Standard Indices in our Table, note that only two asset classes that outperformed their long-term trend during the Housing Crisis: bonds and gold. This will always be the case in a financial crisis.

In the aggregate, these 9 stocks have a 5-Yr Beta below 0.5 (see Column I in the Table) which suggests that there would be less risk of loss vs. the S&P 500 Index in a Bear Market. But statistical analysis of weekly prices over the past 25 yrs suggests otherwise (see Column M in the Table). Taking both metrics into consideration, we see that WEC Energy Group (WEC) and Consolidated Edison (ED) are the only low-risk investments. 

Bottom Line: The “common thread” of our 9 recession-proof companies is a combination of skilled management and having a product line that includes goods and services exhibiting near-zero elasticity. Companies like Ross Stores (ROST), TJX (TJX) and McDonald’s (MCD), which appeal to the budget-minded among us, will ride out almost any storm. Electric utilities that are well-managed, like WEC Energy Group (WEC), or serve upscale markets, like Denver (XEL), Boston (ES) and New York City (ED), will emerge unscathed from recession. Finally, there are companies like IBM and Grainger (GWW) that provide maintenance and information technology to a long roster of companies, and these often cannot be pushed into the next quarter.

Risk Rating: 5 (where Treasuries = 1, and gold = 10)

Full Disclosure: I own shares of ROST, TJX, MCD, and IBM.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 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 = moving average for 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 10-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Use of such a long-term trendline CAGR instead of a shorter-term current CAGR emphasizes the predictive value of “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small number of large-cap stocks where selection bias is paramount. That stock index is the S&P MidCap 400 Index.

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