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.
The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Showing posts with label brand. Show all posts
Showing posts with label brand. Show all posts
Sunday, April 26
Sunday, April 22
Week 355 - Companies in “The 2 and 8 Club” with a Durable Competitive Advantage
Situation: It is now 10 years since The Great Recession began with the collapse of Bear Stearns. Trust in markets was broken and has barely begun to recover. The Securities and Exchange Commission (SEC) grew out of The Great Depression because investors lost trust in markets. One of the ways it tried to rebuild trust was to require private companies to still have a strong balance sheet after a successful Initial Public Offering (IPO). If the SEC wasn’t convinced this would happen at the proposed price for the IPO, then the IPO wouldn’t be permitted.
Before the Great Recession of 2008, fewer than a third of companies in the S&P 500 Index had steadily growing Tangible Book Value (TBV), i.e., property, plant, equipment, and software priced at original cost (see Week 54, Week 94, Week 158, Week 241, Week 251, Week 271). After 2008, Balance Sheets were in need of repair, and that was facilitated by low interest rates. Now, perhaps a quarter of S&P 500 companies again have steady TBV growth.
Mission: Apply our Standard Spreadsheet to companies in the Extended Version of “The 2 and 8 Club” that have shown steady TBV growth (with no more than 3 down years) since 2008. Warren Buffett suggests that such companies have a Durable Competitive Advantage (see blogs listed above), as long as TBV meets the Business Case of doubling after 10 years (i.e., a growth rate of at least 7%/yr).
Execution: see Table.
Administration: Risk works both ways for stock investors, i.e., you’ll either lose or gain +20% every few years. Our investing behavior isn’t governed by numbers, so we don’t act appropriately when warning signs of a market crash emerge. Why? Because we can’t know for certain when and whether a market crash will indeed happen. Many of us will remain sitting at the table even after it has clearly become a gambling table. You know when that occurs because the risk-off investors have already cashed out. Those of us who remain are governed by a desire to have. After a few market cycles, we come to realize that having more is going to be either boring or exciting, based on one’s appetite for risk. To have more, and have it be exciting, involves good study habits and an ability to live with chronic anxiety. Simply being human will matter less and less.
The trick is to maintain discipline 24/7/365, by using a system for monitoring and researching your investments. This has to be combined with a weird ability to stick with your system through good times and bad. Numbers won’t save you when the market is turning. Instead, you have to know whether or not the “story” that underpins the reason for each of your holdings has retained its agency. Truth be told, the moves you make (or don’t make) at turning points will come down to a gut feeling as to whether your holdings are overbought or oversold. Any decision you make at a turning point is a risk-on decision. Caveat emptor: This is not a formula for marital bliss. (Warren Buffett was mystified when his wife left to become an artist in San Francisco.)
Bottom Line: Now is a good time to have a boring investment posture, which means choosing to dollar-average into companies that have bullet-proof Balance Sheets and strong Global Brands. This week we look at the bedrock of strong Balance Sheets, which is steady growth in Tangible Book Value. Five of these 9 companies are part of S&P’s Finance Industry. Their strong Balance Sheets reflect the regulatory requirements of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. If Dodd-Frank becomes eroded by a Risk-on Congress, you’ll have to dig deeper into Annual Reports when investing in a Financial Services company. REMEMBER: common stocks issued by Financial Services and Real Estate companies are the most risky places to park your money, aside from commodity futures.
Risk Rating: 7 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM, and also own shares of CSCO and TRV.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Before the Great Recession of 2008, fewer than a third of companies in the S&P 500 Index had steadily growing Tangible Book Value (TBV), i.e., property, plant, equipment, and software priced at original cost (see Week 54, Week 94, Week 158, Week 241, Week 251, Week 271). After 2008, Balance Sheets were in need of repair, and that was facilitated by low interest rates. Now, perhaps a quarter of S&P 500 companies again have steady TBV growth.
Mission: Apply our Standard Spreadsheet to companies in the Extended Version of “The 2 and 8 Club” that have shown steady TBV growth (with no more than 3 down years) since 2008. Warren Buffett suggests that such companies have a Durable Competitive Advantage (see blogs listed above), as long as TBV meets the Business Case of doubling after 10 years (i.e., a growth rate of at least 7%/yr).
Execution: see Table.
Administration: Risk works both ways for stock investors, i.e., you’ll either lose or gain +20% every few years. Our investing behavior isn’t governed by numbers, so we don’t act appropriately when warning signs of a market crash emerge. Why? Because we can’t know for certain when and whether a market crash will indeed happen. Many of us will remain sitting at the table even after it has clearly become a gambling table. You know when that occurs because the risk-off investors have already cashed out. Those of us who remain are governed by a desire to have. After a few market cycles, we come to realize that having more is going to be either boring or exciting, based on one’s appetite for risk. To have more, and have it be exciting, involves good study habits and an ability to live with chronic anxiety. Simply being human will matter less and less.
The trick is to maintain discipline 24/7/365, by using a system for monitoring and researching your investments. This has to be combined with a weird ability to stick with your system through good times and bad. Numbers won’t save you when the market is turning. Instead, you have to know whether or not the “story” that underpins the reason for each of your holdings has retained its agency. Truth be told, the moves you make (or don’t make) at turning points will come down to a gut feeling as to whether your holdings are overbought or oversold. Any decision you make at a turning point is a risk-on decision. Caveat emptor: This is not a formula for marital bliss. (Warren Buffett was mystified when his wife left to become an artist in San Francisco.)
Bottom Line: Now is a good time to have a boring investment posture, which means choosing to dollar-average into companies that have bullet-proof Balance Sheets and strong Global Brands. This week we look at the bedrock of strong Balance Sheets, which is steady growth in Tangible Book Value. Five of these 9 companies are part of S&P’s Finance Industry. Their strong Balance Sheets reflect the regulatory requirements of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. If Dodd-Frank becomes eroded by a Risk-on Congress, you’ll have to dig deeper into Annual Reports when investing in a Financial Services company. REMEMBER: common stocks issued by Financial Services and Real Estate companies are the most risky places to park your money, aside from commodity futures.
Risk Rating: 7 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM, and also own shares of CSCO and TRV.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 15
Week 354 - Production Agriculture
Situation: Commodity production is quietly starting its next ~20-Yr supercycle. The last one was strong, due to the epic buildout of the Chinese economy. The coming supercycle also will be based in China, which is emerging as a superpower. For a capsule view of what’s happening, look at US soybean exports in 2016. Soybeans mainly become animal feed, and pork is the favorite source of protein for China’s burgeoning middle class. However, raw commodities in general and grains in particular remain underpriced. Why? Because advances in technology and logistics almost guarantee that supplies will outstrip demand:
“In business literature, commoditization is defined as the process by which goods that have economic value and are distinguishable in terms of attributes (uniqueness or brand) end up becoming simple commodities in the eyes of the market or consumers. It is the movement of a market from differentiated to undifferentiated price competition and from monopolistic to perfect competition. Hence, the key effect of commoditization is that the pricing power of the manufacturer or brand owner is weakened: when products become more similar from a buyer's point of view, they will tend to buy the cheapest.”
Farmers worldwide see that their average income tends to fall, as prices paid for their average harvest tends to fall. In most years, they can’t afford to pay as much for inputs to next year’s harvest as the prior year. We’re seeing a wave of consolidation among companies that supply farmers with seeds, insecticides, herbicides, fungicides and fertilizer chemicals. Famous companies like Agrium, duPont, Dow Chemical, Syngenta, Potash Corporation of Saskatchewan, and Smithfield Foods have either merged with a competitor or been acquired.
Mission: Use our Standard Spreadsheet to analyze the few long-established companies that remain active supporters of farm production.
Execution: see Table.
Bottom Line: Production agriculture has become commoditized. (No surprise there.) But investors can still make money in that financial space from vertically integrated meat producers, i.e., the top 4 companies listed the Table. Why do they stand out? Because China is a big country and has gone far toward eliminating poverty. A long-standing love of pork products in particular will continue to track growth of the middle class. That appetite for animal protein resulted in a 8-26% increase in beef, pork and chicken products from the US in 2017 alone, compared to an increase of only 5-6% for confectionary items, fruit, and nuts.
Risk Rating: 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MON, and own stock in Hormel Foods (HRL) and Union Pacific (UNP).
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
“In business literature, commoditization is defined as the process by which goods that have economic value and are distinguishable in terms of attributes (uniqueness or brand) end up becoming simple commodities in the eyes of the market or consumers. It is the movement of a market from differentiated to undifferentiated price competition and from monopolistic to perfect competition. Hence, the key effect of commoditization is that the pricing power of the manufacturer or brand owner is weakened: when products become more similar from a buyer's point of view, they will tend to buy the cheapest.”
Farmers worldwide see that their average income tends to fall, as prices paid for their average harvest tends to fall. In most years, they can’t afford to pay as much for inputs to next year’s harvest as the prior year. We’re seeing a wave of consolidation among companies that supply farmers with seeds, insecticides, herbicides, fungicides and fertilizer chemicals. Famous companies like Agrium, duPont, Dow Chemical, Syngenta, Potash Corporation of Saskatchewan, and Smithfield Foods have either merged with a competitor or been acquired.
Mission: Use our Standard Spreadsheet to analyze the few long-established companies that remain active supporters of farm production.
Execution: see Table.
Bottom Line: Production agriculture has become commoditized. (No surprise there.) But investors can still make money in that financial space from vertically integrated meat producers, i.e., the top 4 companies listed the Table. Why do they stand out? Because China is a big country and has gone far toward eliminating poverty. A long-standing love of pork products in particular will continue to track growth of the middle class. That appetite for animal protein resulted in a 8-26% increase in beef, pork and chicken products from the US in 2017 alone, compared to an increase of only 5-6% for confectionary items, fruit, and nuts.
Risk Rating: 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MON, and own stock in Hormel Foods (HRL) and Union Pacific (UNP).
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 11
Week 349 - Dividend Achievers with high Long-term Debt offset by a Strong Global Brand
Situation: Some highly indebted companies manage to pass through economic cycles with little difficulty, even though though they sometimes find it expensive to roll-over (refinance) their Long-Term Debt. This is a conundrum, given the impairment of their Balance Sheets (debt maturing in more than one year represents more than one third of their total assets). Think of having $200,000 left on your mortgage but your household assets (including equity in your home) are only worth $600,000.
I try to avoid investing in such companies. When I do, I look for an excuse to sell. But there has to be a rational explanation for why these companies prosper, given the cost of servicing long-term debt. Two explanations come to mind:
1) These companies have a lower cost of capital, since so much of their capitalization is in the form of debt, where interest payments have not been taxed until recently. (The new tax law levies a 21% tax on interest payments that consume more than 30% of earnings.)
2) These companies have a strong Global Brand, which is an Intangible Asset that increases their acquisition value. That is, a strong Global Brand would increase the purchase price at least 5% above Tangible Book Value.
3) These companies sell products that are remarkably “inelastic”, meaning that sales volumes are insensitive to price: “The price elasticity of supply measures how the amount of a good that a supplier wishes to supply changes in response to a change in price.[2] In a manner analogous to the price elasticity of demand, it captures the extent of horizontal movement along the supply curve relative to the extent of vertical movement [in price]. If the price elasticity of supply is zero the supply of a good supplied is ‘totally inelastic’ and the quantity supplied is fixed.”
Mission: Analyze high-yielding Dividend Achievers (companies that have increased their dividend annually for at least the past 10 years). Select companies that have long-term Debt amounting to more than 33% of Total Assets, as shown in Column P of the Table. Reject companies that do not have a strong Global Brand. Also reject companies that do not have A ratings from S&P for both the bonds and common stocks that they have issued (see Columns T and U in the Table). Brand rankings are shown in Columns AB-AC of the Table. Examine a comparison group of companies in the Benchmark Section of the Table.
Execution: see Table.
Bottom Line: The outperformance and low price volatility of these stocks, even during difficult market conditions (see Column D in the Table), cannot be explained by unique Tangible Assets such as strong Patent Protections or Tax Advantages. That leaves Brand Values (i.e., consumers prefer a brand they can trust) and Inelasticity (i.e., unit sales are not price sensitive) to account for the resiliency of their stock prices. That resiliency ultimately comes from pricing power.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Coca-Cola (KO), and also own shares of IBM and McDonald’s (MCD).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
I try to avoid investing in such companies. When I do, I look for an excuse to sell. But there has to be a rational explanation for why these companies prosper, given the cost of servicing long-term debt. Two explanations come to mind:
1) These companies have a lower cost of capital, since so much of their capitalization is in the form of debt, where interest payments have not been taxed until recently. (The new tax law levies a 21% tax on interest payments that consume more than 30% of earnings.)
2) These companies have a strong Global Brand, which is an Intangible Asset that increases their acquisition value. That is, a strong Global Brand would increase the purchase price at least 5% above Tangible Book Value.
3) These companies sell products that are remarkably “inelastic”, meaning that sales volumes are insensitive to price: “The price elasticity of supply measures how the amount of a good that a supplier wishes to supply changes in response to a change in price.[2] In a manner analogous to the price elasticity of demand, it captures the extent of horizontal movement along the supply curve relative to the extent of vertical movement [in price]. If the price elasticity of supply is zero the supply of a good supplied is ‘totally inelastic’ and the quantity supplied is fixed.”
Mission: Analyze high-yielding Dividend Achievers (companies that have increased their dividend annually for at least the past 10 years). Select companies that have long-term Debt amounting to more than 33% of Total Assets, as shown in Column P of the Table. Reject companies that do not have a strong Global Brand. Also reject companies that do not have A ratings from S&P for both the bonds and common stocks that they have issued (see Columns T and U in the Table). Brand rankings are shown in Columns AB-AC of the Table. Examine a comparison group of companies in the Benchmark Section of the Table.
Execution: see Table.
Bottom Line: The outperformance and low price volatility of these stocks, even during difficult market conditions (see Column D in the Table), cannot be explained by unique Tangible Assets such as strong Patent Protections or Tax Advantages. That leaves Brand Values (i.e., consumers prefer a brand they can trust) and Inelasticity (i.e., unit sales are not price sensitive) to account for the resiliency of their stock prices. That resiliency ultimately comes from pricing power.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Coca-Cola (KO), and also own shares of IBM and McDonald’s (MCD).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 14
Week 341 - Companies in “The 2 and 8 Club” with Strong Global Brands
Situation: You’d like to own stocks that won’t give you heartburn when the market crashes. There are only two ways a company can predictably weather a recession better than others in its industry. By having 1) a clean Balance Sheet (see Columns P-S in any of our Tables) and/or 2) a strong Global Brand. During a recession, consumers will have less money to spend because they’re not making as much. They’ll cut back on frills but keep spending on necessities marketed by companies they respect. Economists call such spending inelastic, and also speak of those companies as having a strong brand. Accountants struggle to define brand value, even though it obviously runs to the billions of dollars for a number of companies, so they call it an intangible asset.
Mission: Use our Standard Spreadsheet to analyze the 33 companies in the Extended Version of “The 2 and 8 Club” (see Week 329), selecting only those that have a Top 500 Global Brand.
Execution: see Table, where all 21 such companies are ranked by brand value in Column AC.
Administration: We need to know what fraction of sales for each company originate outside the United States. That information should be in every company’s Annual Report but is often missing. Perhaps the reason is that those companies often retain revenues in the country of origin (to avoid double taxation should revenues be repatriated to the USA). But we know that Microsoft, the largest company in this week’s Table, draws more than 60% of its revenues from outside the United States. Over the past 5 years, I have seen two articles estimating that 45-50% of all revenues for S&P 500 companies occur outside the United States.
For you to attempt to own shares in a third or half of the 21 companies on our list (see Table), you’ll need to keep track of two variables: 1) Dividends (Yield & Growth rates), and 2) Global Brand value. Both will change over time. Brand values are easy to follow (see link above). But some companies will mature in their market and no longer be able to grow dividends faster than 8% a year. A company might cut its dividend, in which case it would no longer be listed in the US version of the FTSE Global High Dividend Yield Index. There will also be new members of “The 2 and 8 Club.”
To move in and out of positions as indicated by your research, you’ll have to become an active stock trader. Dollar-cost averaging is still a good idea, but you’ll likely find that an online Dividend Re-Investment Plan (DRIP) doesn’t have the flexibility you’ll require. A recent study of 13 broker-dealers offers detailed information about those that have the low transaction costs and attractive reward programs. Ally Financial (ALLY) is their top-ranked brand.
Bottom Line: There are only two ways a company can insulate itself from a looming recession: 1) maintain a Clean Balance Sheet, and 2) keep making money because of having a strong Global Brand. This week’s Table highlights 21 brand leaders, over half of which have clean Balance Sheets.
Risk Rating: 6 (where 10-Yr Treasury Note = 1, S&P 500 Index = 5, and gold bullion =10)
Full Disclosure: I dollar-cost average into MFST, MMM, IBM, KO and JPM, and also own shares of MO, TRV, PFE, CAT, and TXN.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Mission: Use our Standard Spreadsheet to analyze the 33 companies in the Extended Version of “The 2 and 8 Club” (see Week 329), selecting only those that have a Top 500 Global Brand.
Execution: see Table, where all 21 such companies are ranked by brand value in Column AC.
Administration: We need to know what fraction of sales for each company originate outside the United States. That information should be in every company’s Annual Report but is often missing. Perhaps the reason is that those companies often retain revenues in the country of origin (to avoid double taxation should revenues be repatriated to the USA). But we know that Microsoft, the largest company in this week’s Table, draws more than 60% of its revenues from outside the United States. Over the past 5 years, I have seen two articles estimating that 45-50% of all revenues for S&P 500 companies occur outside the United States.
For you to attempt to own shares in a third or half of the 21 companies on our list (see Table), you’ll need to keep track of two variables: 1) Dividends (Yield & Growth rates), and 2) Global Brand value. Both will change over time. Brand values are easy to follow (see link above). But some companies will mature in their market and no longer be able to grow dividends faster than 8% a year. A company might cut its dividend, in which case it would no longer be listed in the US version of the FTSE Global High Dividend Yield Index. There will also be new members of “The 2 and 8 Club.”
To move in and out of positions as indicated by your research, you’ll have to become an active stock trader. Dollar-cost averaging is still a good idea, but you’ll likely find that an online Dividend Re-Investment Plan (DRIP) doesn’t have the flexibility you’ll require. A recent study of 13 broker-dealers offers detailed information about those that have the low transaction costs and attractive reward programs. Ally Financial (ALLY) is their top-ranked brand.
Bottom Line: There are only two ways a company can insulate itself from a looming recession: 1) maintain a Clean Balance Sheet, and 2) keep making money because of having a strong Global Brand. This week’s Table highlights 21 brand leaders, over half of which have clean Balance Sheets.
Risk Rating: 6 (where 10-Yr Treasury Note = 1, S&P 500 Index = 5, and gold bullion =10)
Full Disclosure: I dollar-cost average into MFST, MMM, IBM, KO and JPM, and also own shares of MO, TRV, PFE, CAT, and TXN.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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, October 16
Week 276 - Barron’s 500 Companies With Clean Balance Sheets and Improving Fundamentals
Situation: Stock market valuations are still in nosebleed territory. The S&P 500 Index is 25 times trailing 12-mo earnings. The cyclically-adjusted PE ratio is 27 times trailing 10-yr earnings, i.e., just shy of the last peak reached in October of 2007. You get the point, so you’re in “risk-off” mode. But you’re not going to save for the future by hiding money under your mattress. How should a prudent investor continue adding money to the market, knowing that a precipice looms? With dollar-cost averaging, an investor can add small amounts each month to stocks from several different industries, i.e., more shares per dollar when the market swoons. But which stocks? When you’re in risk-off mode, those need to be A-rated, large-capitalization stocks with improving fundamentals, and at least a 25 yr trading record.
Mission: Screen the 2016 Barron’s 500 List for companies that have improved in rank and have 25 yrs of quantitative data at the BMW Method website. Eliminate companies that don’t have a clean Balance Sheet (as defined in the Appendix for Week 271). Assess growth prospects by calculating Net Present Value (NPV) for each stock. For companies with Top 500 Global Brands, provide 2016 and 2015 brand ranks.
Execution: see Table.
Bottom Line: We’ve used a tight screen to come up with 10 companies worth dollar-averaging through a Bear Market. Three represent the Consumer Staples industry: HRL, COST, WMT. Four represent the Consumer Discretionary industry: ROST, TJX, NKE, DIS. There’s also one Industrial company (PH), an Information Technology company (ADP) and a Basic Materials company (APD). All but the 3 companies with strong brands (NKE, COST, ADP) are likely to fall in value as much as the S&P 500 Index in the next Bear Market (see Columns AC and AD in the Table). NPV calculations (see Column V in the Table) suggest that buying shares in any of the 10 companies would result in a greater gain after 10 yrs than buying shares in the lowest cost S&P 500 Index fund (VFINX at Line 18 in the Table).
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, and gold = 10)
Full Disclosure: I dollar-average into NKE and also own shares of ROST, TJX, HRL and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 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 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 for this week is the25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/), done to emphasize “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 portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Screen the 2016 Barron’s 500 List for companies that have improved in rank and have 25 yrs of quantitative data at the BMW Method website. Eliminate companies that don’t have a clean Balance Sheet (as defined in the Appendix for Week 271). Assess growth prospects by calculating Net Present Value (NPV) for each stock. For companies with Top 500 Global Brands, provide 2016 and 2015 brand ranks.
Execution: see Table.
Bottom Line: We’ve used a tight screen to come up with 10 companies worth dollar-averaging through a Bear Market. Three represent the Consumer Staples industry: HRL, COST, WMT. Four represent the Consumer Discretionary industry: ROST, TJX, NKE, DIS. There’s also one Industrial company (PH), an Information Technology company (ADP) and a Basic Materials company (APD). All but the 3 companies with strong brands (NKE, COST, ADP) are likely to fall in value as much as the S&P 500 Index in the next Bear Market (see Columns AC and AD in the Table). NPV calculations (see Column V in the Table) suggest that buying shares in any of the 10 companies would result in a greater gain after 10 yrs than buying shares in the lowest cost S&P 500 Index fund (VFINX at Line 18 in the Table).
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, and gold = 10)
Full Disclosure: I dollar-average into NKE and also own shares of ROST, TJX, HRL and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 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 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 for this week is the25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/), done to emphasize “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 portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 9
Week 275 - Food Processors With Improving Fundamentals
Situation: Grain prices are low, which means equipment and seed vendors find that few farmers are eager to buy. But grain processors benefit when prices are low.
Mission: Look for improvements in cash flow and revenue among the largest food processors, and assess the benefits and risks of investing in those companies. Look for Brand Value and clean Balance Sheets in addition to calculating Net Present Value.
Execution: see Table.
Administration: We’ve found 12 food processing companies that rank higher on the 2016 Barron’s 500 List than they did on the 2015 List. Those companies had a better overall score based on 3 criteria: A) Cash flow-based ROIC, B) 2015 ROIC vs. the 3-yr median, and C) sales growth in 2015 vs. 2014. All 12 companies have a 16+ year trading history that has been analyzed quantitatively by using the BMW Method; see Columns K-M in the Table.
With respect to broad indications of quality (i.e., S&P bond and stock ratings at Columns P and Q in the Table), only 6 companies meet our standards. Our measures include a bond rating of BBB+ or better and a stock rating of B+/M or better. The 6 stocks are: Hershey (HSY), General Mills (GIS), Hormel Foods (HRL), Coca-Cola (KO), Campbell Soup (CPB), Archer Daniels Midland (ADM). Only 4 of those stocks are Dividend Achievers (annual dividend increases for 10+ yrs): GIS, HRL, KO, ADM.
With respect to Net Present Value (see Column V in the Table), the top 4 companies are Ingredion (INGR), Hormel Foods (HRL), JM Smucker (SJM), Tyson Foods (TSN).
Hormel Foods (HRL) is the only company with a clean Balance Sheet. We have a problem when evaluating Balance Sheets for food processors (see Columns Y-AB). Those companies are able to be somewhat unconcerned about bankruptcy, since food prices tend to be inelastic (i.e., food is an “essential good”). This allows company managers to spend more on advertising than on growing Tangible Book Value. In the aggregate, these 12 companies carry too much debt. Their total debt is 160% of equity whereas 100% is the upper limit for a clean Balance Sheet. Long-term debt is 29% of total assets, which is barely acceptable. Tangible Book Value is 1% of each share’s price, which is barely acceptable. In the first half of 2016, two of the Dividend Achievers, Coca-Cola (KO) and Archer Daniels Midland (ADM), had insufficient free cash flow (FCF) to pay dividends. That means they either had to borrow the necessary funds or sell a non-strategic asset.
With respect to brand value, Best Global Brands ranks the top 500 brand names annually. Three of the companies in our Table are among the top 500 for 2016. Those 3 are: Coca-Cola (KO), Kellogg (K), Tyson Foods (TSN). Two additional Coca-Cola brands appear on the list, Sprite and Fanta. Coca-Cola ranks #17 (down from #12), Kellogg ranks #183 (down from #181), Tyson ranks #307 (up from #353), Sprite ranks #411 (down from #391), and Fanta ranks #488 (unchanged). Interestingly, Hershey (HSY) is not a top 500 global brand.
Bottom Line: The “take-home message” is that stocks whose prices vary with the weather and global crop yields are speculative. The investment that farmers make in equipment, software, irrigation systems, seeds and chemicals will determine their crop yields, given favorable weather. Over the past 3 yrs of good weather (El Nino), those investments have paid off in all the countries of the Northern Hemisphere that have a strong agriculture sector. That means the prices that food processors pay for wheat, soybeans, rice, corn and meat have fallen. The other key fact that drives those growing profits is the addition of some 20 million people a year to the middle class, meaning they can finally afford to eat a 60 gm protein diet every day.
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1 and gold = 10).
Full Disclosure: I own shares of HRL, KO and ADM but recently sold shares of GIS. I thought GIS shares had become overpriced but the current NPV calculation suggests that GIS shares continue to have considerable value (see Line 3 in the Table, at Column V).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 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 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 16-Yr CAGR found at Column K. 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 portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index at Line 26. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 20. The NPV calculation for MDY (at Column V and Line 20) includes transaction costs of 2.5% on purchase and 2.5% on sale.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Look for improvements in cash flow and revenue among the largest food processors, and assess the benefits and risks of investing in those companies. Look for Brand Value and clean Balance Sheets in addition to calculating Net Present Value.
Execution: see Table.
Administration: We’ve found 12 food processing companies that rank higher on the 2016 Barron’s 500 List than they did on the 2015 List. Those companies had a better overall score based on 3 criteria: A) Cash flow-based ROIC, B) 2015 ROIC vs. the 3-yr median, and C) sales growth in 2015 vs. 2014. All 12 companies have a 16+ year trading history that has been analyzed quantitatively by using the BMW Method; see Columns K-M in the Table.
With respect to broad indications of quality (i.e., S&P bond and stock ratings at Columns P and Q in the Table), only 6 companies meet our standards. Our measures include a bond rating of BBB+ or better and a stock rating of B+/M or better. The 6 stocks are: Hershey (HSY), General Mills (GIS), Hormel Foods (HRL), Coca-Cola (KO), Campbell Soup (CPB), Archer Daniels Midland (ADM). Only 4 of those stocks are Dividend Achievers (annual dividend increases for 10+ yrs): GIS, HRL, KO, ADM.
With respect to Net Present Value (see Column V in the Table), the top 4 companies are Ingredion (INGR), Hormel Foods (HRL), JM Smucker (SJM), Tyson Foods (TSN).
Hormel Foods (HRL) is the only company with a clean Balance Sheet. We have a problem when evaluating Balance Sheets for food processors (see Columns Y-AB). Those companies are able to be somewhat unconcerned about bankruptcy, since food prices tend to be inelastic (i.e., food is an “essential good”). This allows company managers to spend more on advertising than on growing Tangible Book Value. In the aggregate, these 12 companies carry too much debt. Their total debt is 160% of equity whereas 100% is the upper limit for a clean Balance Sheet. Long-term debt is 29% of total assets, which is barely acceptable. Tangible Book Value is 1% of each share’s price, which is barely acceptable. In the first half of 2016, two of the Dividend Achievers, Coca-Cola (KO) and Archer Daniels Midland (ADM), had insufficient free cash flow (FCF) to pay dividends. That means they either had to borrow the necessary funds or sell a non-strategic asset.
With respect to brand value, Best Global Brands ranks the top 500 brand names annually. Three of the companies in our Table are among the top 500 for 2016. Those 3 are: Coca-Cola (KO), Kellogg (K), Tyson Foods (TSN). Two additional Coca-Cola brands appear on the list, Sprite and Fanta. Coca-Cola ranks #17 (down from #12), Kellogg ranks #183 (down from #181), Tyson ranks #307 (up from #353), Sprite ranks #411 (down from #391), and Fanta ranks #488 (unchanged). Interestingly, Hershey (HSY) is not a top 500 global brand.
Bottom Line: The “take-home message” is that stocks whose prices vary with the weather and global crop yields are speculative. The investment that farmers make in equipment, software, irrigation systems, seeds and chemicals will determine their crop yields, given favorable weather. Over the past 3 yrs of good weather (El Nino), those investments have paid off in all the countries of the Northern Hemisphere that have a strong agriculture sector. That means the prices that food processors pay for wheat, soybeans, rice, corn and meat have fallen. The other key fact that drives those growing profits is the addition of some 20 million people a year to the middle class, meaning they can finally afford to eat a 60 gm protein diet every day.
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1 and gold = 10).
Full Disclosure: I own shares of HRL, KO and ADM but recently sold shares of GIS. I thought GIS shares had become overpriced but the current NPV calculation suggests that GIS shares continue to have considerable value (see Line 3 in the Table, at Column V).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 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 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 16-Yr CAGR found at Column K. 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 portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index at Line 26. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 20. The NPV calculation for MDY (at Column V and Line 20) includes transaction costs of 2.5% on purchase and 2.5% on sale.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 4
Week 270 - Dividend Achievers Among the Top 100 Global BrandZ
Situation: You know that brand recognition drives sales. And the managers of those highly-recognized companies know that sales will keep rising in almost any economic environment. They’d rather expand operations and buy more advertising space than tidy up their Balance Sheets, which means needing to borrow money at some point to pay the quarterly dividend. If that were to persist, investors and banks would start to withhold cash needed for strategic initiatives.
But if the brand is strong enough, that day just never seems to arrive. Look at Colgate-Palmolive (CL) and Coca-Cola (KO). CL has negative book value, and KO shares trade at 8 times book value, instead of a reasonable 2-3 times book value, which is enough to account for intangibles (brand value, patents) and appreciation of items carried on the books at cost (property, plant and equipment).
Mission: Determine the importance of brand value vs. a clean Balance Sheet in protecting stock prices during a Bear Market.
Execution: Assemble a list of companies sponsoring the strongest global brands, specifically US companies that have raised their dividend annually for 10+ yrs (Dividend Achievers). Assess their Balance Sheets and growth trends; calculate Net Present Value (NPV) of purchasing each company’s stock.
Administration: We’ll start with the 100 Top Global BrandZ list for 2016. Brand rank and brand value for each of the 18 Dividend Achievers among them are summarized at Columns AC-AE in the Table. We compare long-term total returns in Column C (i.e., since the Vanguard Balanced Index Fund started trading on September 28, 1992) with 6-yr total returns during the 6-yr “sub-prime crisis” in Column D. We chose that “risk” period because the Case-Shiller Home Price Index (1890 = 100) peaks at 198.01 in the first quarter of 2006 and falls to a trough of 113.89 in the first quarter of 2012. That original index now has a value just over 160 but it has been sold and is now called the S&P CoreLogic Case-Shiller US National Index. The new index is normalized to have a value of 100 in January of 2000 (instead of 100 in 1890). That resets the “old” values given above to 183 for the peak in the “new” index, 140 for the trough, and 180+ for the current value.
Home prices relate to brand values because both tend to be driven by the spending habits of high net-worth individuals.
The US stock market has recovered even faster than home prices to reach all-time highs. The cyclically-adjusted price earnings ratio (CAPE Index) has only been this high 3 times in the past century (1929, 1999 and 2007), which is a matter of concern to the US Treasury economists. Why? Because it correlates with other predictive metrics that have also reached historic extremes.
Our goal is to see which of the 18 companies performed better during the 6-yr crisis vs. the 24-yr period overlapping the crisis. We then examine the Balance Sheets of those companies, by using the same 4 ratios that we have used in recent blogs (see Columns Y thru AB in the Table) to see whether those resilient companies make a habit of keeping a clean Balance Sheet.
During the 2006-2012 crisis, 6 of these 18 companies outperformed their 24-yr total return records: McDonald’s (MCD), YUM, Nike (NKE), International Business Machines (IBM), Coca-Cola (KO) and Verizon Communications (VZ). However, VZ, YUM and MCD have credit ratings of BBB+ or lower, which indicates that S&P auditors have identified Balance Sheet “issues”. NPV calculations are based on long-term rates of price appreciation and dividend growth. Those calculations show that 3 of the 6 “out-performers” (NKE, MCD and YUM) are among the 4 most rewarding stocks to own out of the 18. But NKE is the only one to be found among the 5 companies that have a clean Balance Sheet (NKE, COST, MSFT, WMT, FDX).
Bottom Line: Managers of companies with strong brands don’t have to worry much about credit ratings. Why? Because a strong brand is worth tens of billions of dollars; so, an investor or loan officer can always be found. Look no further than Yum! Brands (YUM at Line 3 in the Table). It has a sub-prime S&P credit rating (BB) vs. an excellent S&P stock rating (A+/M).
Risk Rating: 5 (where Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average monthly into XOM, NKE, MSFT, PG and T, and also own shares of CVS, KO, WMT, and MCD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 25 in the Table. 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 = the 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 in the Table. Price Growth Rate is the mean 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
But if the brand is strong enough, that day just never seems to arrive. Look at Colgate-Palmolive (CL) and Coca-Cola (KO). CL has negative book value, and KO shares trade at 8 times book value, instead of a reasonable 2-3 times book value, which is enough to account for intangibles (brand value, patents) and appreciation of items carried on the books at cost (property, plant and equipment).
Mission: Determine the importance of brand value vs. a clean Balance Sheet in protecting stock prices during a Bear Market.
Execution: Assemble a list of companies sponsoring the strongest global brands, specifically US companies that have raised their dividend annually for 10+ yrs (Dividend Achievers). Assess their Balance Sheets and growth trends; calculate Net Present Value (NPV) of purchasing each company’s stock.
Administration: We’ll start with the 100 Top Global BrandZ list for 2016. Brand rank and brand value for each of the 18 Dividend Achievers among them are summarized at Columns AC-AE in the Table. We compare long-term total returns in Column C (i.e., since the Vanguard Balanced Index Fund started trading on September 28, 1992) with 6-yr total returns during the 6-yr “sub-prime crisis” in Column D. We chose that “risk” period because the Case-Shiller Home Price Index (1890 = 100) peaks at 198.01 in the first quarter of 2006 and falls to a trough of 113.89 in the first quarter of 2012. That original index now has a value just over 160 but it has been sold and is now called the S&P CoreLogic Case-Shiller US National Index. The new index is normalized to have a value of 100 in January of 2000 (instead of 100 in 1890). That resets the “old” values given above to 183 for the peak in the “new” index, 140 for the trough, and 180+ for the current value.
Home prices relate to brand values because both tend to be driven by the spending habits of high net-worth individuals.
The US stock market has recovered even faster than home prices to reach all-time highs. The cyclically-adjusted price earnings ratio (CAPE Index) has only been this high 3 times in the past century (1929, 1999 and 2007), which is a matter of concern to the US Treasury economists. Why? Because it correlates with other predictive metrics that have also reached historic extremes.
Our goal is to see which of the 18 companies performed better during the 6-yr crisis vs. the 24-yr period overlapping the crisis. We then examine the Balance Sheets of those companies, by using the same 4 ratios that we have used in recent blogs (see Columns Y thru AB in the Table) to see whether those resilient companies make a habit of keeping a clean Balance Sheet.
During the 2006-2012 crisis, 6 of these 18 companies outperformed their 24-yr total return records: McDonald’s (MCD), YUM, Nike (NKE), International Business Machines (IBM), Coca-Cola (KO) and Verizon Communications (VZ). However, VZ, YUM and MCD have credit ratings of BBB+ or lower, which indicates that S&P auditors have identified Balance Sheet “issues”. NPV calculations are based on long-term rates of price appreciation and dividend growth. Those calculations show that 3 of the 6 “out-performers” (NKE, MCD and YUM) are among the 4 most rewarding stocks to own out of the 18. But NKE is the only one to be found among the 5 companies that have a clean Balance Sheet (NKE, COST, MSFT, WMT, FDX).
Bottom Line: Managers of companies with strong brands don’t have to worry much about credit ratings. Why? Because a strong brand is worth tens of billions of dollars; so, an investor or loan officer can always be found. Look no further than Yum! Brands (YUM at Line 3 in the Table). It has a sub-prime S&P credit rating (BB) vs. an excellent S&P stock rating (A+/M).
Risk Rating: 5 (where Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average monthly into XOM, NKE, MSFT, PG and T, and also own shares of CVS, KO, WMT, and MCD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 25 in the Table. 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 = the 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 in the Table. Price Growth Rate is the mean 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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