Situation: The purpose of a retirement portfolio is to accumulate wealth during working years and distribute that wealth during sunset years. The laws of finance that govern accumulation are “reversion to the mean” and “compound interest”. The closest we have to a law of finance that governs distribution is “the 4% rule”.
If we dollar-cost average our purchase of shares on a monthly schedule during the accumulation period, we’ll never overpay over a given market cycle, i.e., we’ll “buy low” as often as we’ll “buy high” as reversion to the mean works its magic. If we automatically reinvest quarterly dividend payouts, this quarter’s dividend will pay a dividend on last quarter’s dividend as “compound interest” works its magic. During retirement, we’ll spend 4% of our total asset value, as calculated on December 31st of the year just ended, in the coming year.
A-rated high-yield growth stocks in the Dow Jones Industrial Average (DJIA) have a dividend yield of ~3%/yr. So, if you’ve been dollar-averaging into those stocks you’ll occasionally want to sell shares in one of those stocks to meet next year’s spending goal. But given the stability of those reliable and growing payouts, I’d suggest that you look elsewhere to make up the projected shortfall. Why? Well, look at the spreadsheet of this month’s 8 DJIA growth stocks. If you own shares in all eight companies, you’re likely to enjoy a dividend yield of more than a 3%/yr for years to come.
Mission: Find A-rated non-financial growth stocks in the DJIA that have an above-market dividend yield; analyze those by using our Standard Spreadsheet.
Execution: see Table.
Administration: A-rated means that S&P assigns the company’s bonds a rating of A- or higher, and assigns the company’s common stock a rating of B+/M or higher. It also means that debt levels are reasonable. So, in a setting of negative Tangible Book Value it is unreasonable for a company to be capitalized more than 50% with debt or to have total debts greater than 2.5 times EBITDA. Exclude financial stocks and stocks that have been traded on public exchanges for less than 20 years. Select only from DJIA stocks that are held in both of these portfolios: Vanguard High Dividend Yield ETF (VYM) and iShares Russell Top 200 Growth ETF (IWY).
Bottom Line: Market volatility is the key concern for investors who plan to maintain their lifestyle during retirement. So, you might as well make money off it. That means automatically buy low (through dollar-cost averaging) whenever the market collapses, and automatically take advantage of mean regression while you’re at it. In other words, use dollar-averaging to buy shares in high-yielding companies for nothing by using a DRIP (dividend reinvestment plan), where dividends pay dividends on previously reinvested dividends.
Risk Rating: 5 (where 10-yr US Treasury Notes = 1, S&P 500 Index ETFs = 5, and gold = 10).
Full Disclosure: I dollar-average into PG, JNJ and CAT, and also own shares of MRK, CSCO and MMM
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 capital gains. Show all posts
Showing posts with label capital gains. Show all posts
Sunday, July 26
Sunday, January 26
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.
"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
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.
"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, November 25
Week 386 - Retirement Savings Plan For The Self-Employed
Situation: Let’s follow the Kiss Rule (Keep It Simple, Stupid). There are many jobs that don’t offer a workplace retirement plan. For example, if you’re a long-haul truck driver and own your Class 8 tractor, i.e., you’re an “Owner/Operator”, you make over $100,000 per year but have high expenses. As an S corporation, you don’t pay taxes on the 15% of gross income that you try to set aside for retirement.
How do you invest it? If you follow the KISS Rule, you’re best off putting all of it in Vanguard’s Wellesley Income Fund. That fund has an expense ratio of 0.22% and is half stocks and half bonds. The ~70 stocks are selected from the FTSE High Dividend Yield Index (i.e., the ~400 companies in the Russell 1000 Index that reliably pay an above-market dividend). You’ll recognize that Index as the same source we use to pick stocks for “The 2 and 8 Club”.
Mission: Run our Standard Spreadsheet using the 10 stocks that reliably pay good and growing dividends and are less likely to fall as much as the Dow Jones Industrial Average in a Bear Market. Compare that portfolio to the Vanguard Wellesley Income Fund (VWINX), the Vanguard High Dividend Yield Index ETF (VYM), and the SPDR S&P 500 Index ETF (SPY).
Execution: see Table.
Bottom Line: If you’re self-employed (e.g. do seasonal work), you need a flexible retirement plan with low transaction costs. Safety is the main goal. Take no risks! If you want to pick your own stocks, all right. You can keep costs for that low by dollar-averaging but then your bonds have to be very low risk, i.e., US Savings Bonds.
Risk Rating: 4
Full Disclosure: I dollar-average into NEE, KO, T, JNJ and DIA, and also own shares of HRL.
"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
How do you invest it? If you follow the KISS Rule, you’re best off putting all of it in Vanguard’s Wellesley Income Fund. That fund has an expense ratio of 0.22% and is half stocks and half bonds. The ~70 stocks are selected from the FTSE High Dividend Yield Index (i.e., the ~400 companies in the Russell 1000 Index that reliably pay an above-market dividend). You’ll recognize that Index as the same source we use to pick stocks for “The 2 and 8 Club”.
Mission: Run our Standard Spreadsheet using the 10 stocks that reliably pay good and growing dividends and are less likely to fall as much as the Dow Jones Industrial Average in a Bear Market. Compare that portfolio to the Vanguard Wellesley Income Fund (VWINX), the Vanguard High Dividend Yield Index ETF (VYM), and the SPDR S&P 500 Index ETF (SPY).
Execution: see Table.
Bottom Line: If you’re self-employed (e.g. do seasonal work), you need a flexible retirement plan with low transaction costs. Safety is the main goal. Take no risks! If you want to pick your own stocks, all right. You can keep costs for that low by dollar-averaging but then your bonds have to be very low risk, i.e., US Savings Bonds.
Risk Rating: 4
Full Disclosure: I dollar-average into NEE, KO, T, JNJ and DIA, and also own shares of HRL.
"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, October 7
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.
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 30
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.
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.
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Sunday, December 10
Week 336 - Version 3.0 of The Growing Perpetuity Index Reflects “The 2 and 8 Club”
Situation: We started this blog six years ago with the idea to create a Growing Perpetuity Index as a way to save for retirement, by selecting from a workable “watch list” of high-quality stocks (see Week 21). We chose to base the index on companies in the 65-stock Dow Jones Composite Average (^DJA), and ended up selecting 12 from the 14 that had earned S&P’s designation of Dividend Achiever, i.e., companies that had raised their dividend annually for the previous 10 years or longer:
Exxon Mobil
Wal-Mart Stores
Procter & Gamble
Johnson & Johnson
IBM
Chevron
Coca-Cola
McDonald’s
United Technologies
3M
Norfolk Southern
NextEra Energy
Our thought was that investors could select stocks from this index to safely dollar-cost average automatic online contributions into their Dividend Reinvestment Plan (DRIP). That would allow relatively safe and efficient growth in their retirement assets. Version 2.0 (see Week 224) added back the two companies that had been left out, Caterpillar (CAT) and Southern Company (SO), plus two newly qualified companies: Microsoft (MSFT) and CSX (CSX).
Now we’ll apply a lesson learned from running Net Present Value (NPV) calculations, namely that Discounted Cash Flows from good and growing dividends are more likely to predict rewards to the investor than Capital Gains from a history of price appreciation. Accordingly, Version 3.0 re-casts the index to include only those ^DJA companies that are in “The 2 and 8 Club” (see Week 329) of high-quality companies with a dividend yield of at least 2% and a dividend growth rate of at least 8% for the past 5 years. The result is a 13 company Watch List, not all of which are Dividend Achievers. Only 7 are holdovers from Growing Perpetuity Index, v2.0:
NextEra Energy
3M
Exxon Mobil
Coca-Cola
IBM
Microsoft
Caterpillar
Mission: Apply our standard spreadsheet (see Table) to the 13 companies in the 65-company Dow Jones Composite Index that are in “The 2 and 8 Club.”
Execution: see Table.
Bottom Line: The value of picking from among the highest-quality stocks in the Dow Jones Composite Index is not just that it’s the smallest and oldest index, but also that it is continuously vetted by the managing editor of The Wall Street Journal. Companies that don’t stand muster are replaced by companies that do. By adding the several requirements for inclusion in “The 2 and 8 Club” (e.g. S&P bond ratings cannot be lower than A-), you have a good chance of selecting half a dozen stocks that will beat the S&P 500 Index over a 10-Yr Holding Period (see Column Y in the Table). You’ll also be taking on more risk (see Columns D, I, and M in the Table), which you’ll ameliorate by trading new entrants to “The 2 and 8 Club” for those that are leaving.
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 MSFT, XOM, NEE, KO, JPM and IBM, and also own shares of TRV, PFE, MMM, and CAT.
"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
Exxon Mobil
Wal-Mart Stores
Procter & Gamble
Johnson & Johnson
IBM
Chevron
Coca-Cola
McDonald’s
United Technologies
3M
Norfolk Southern
NextEra Energy
Our thought was that investors could select stocks from this index to safely dollar-cost average automatic online contributions into their Dividend Reinvestment Plan (DRIP). That would allow relatively safe and efficient growth in their retirement assets. Version 2.0 (see Week 224) added back the two companies that had been left out, Caterpillar (CAT) and Southern Company (SO), plus two newly qualified companies: Microsoft (MSFT) and CSX (CSX).
Now we’ll apply a lesson learned from running Net Present Value (NPV) calculations, namely that Discounted Cash Flows from good and growing dividends are more likely to predict rewards to the investor than Capital Gains from a history of price appreciation. Accordingly, Version 3.0 re-casts the index to include only those ^DJA companies that are in “The 2 and 8 Club” (see Week 329) of high-quality companies with a dividend yield of at least 2% and a dividend growth rate of at least 8% for the past 5 years. The result is a 13 company Watch List, not all of which are Dividend Achievers. Only 7 are holdovers from Growing Perpetuity Index, v2.0:
NextEra Energy
3M
Exxon Mobil
Coca-Cola
IBM
Microsoft
Caterpillar
Mission: Apply our standard spreadsheet (see Table) to the 13 companies in the 65-company Dow Jones Composite Index that are in “The 2 and 8 Club.”
Execution: see Table.
Bottom Line: The value of picking from among the highest-quality stocks in the Dow Jones Composite Index is not just that it’s the smallest and oldest index, but also that it is continuously vetted by the managing editor of The Wall Street Journal. Companies that don’t stand muster are replaced by companies that do. By adding the several requirements for inclusion in “The 2 and 8 Club” (e.g. S&P bond ratings cannot be lower than A-), you have a good chance of selecting half a dozen stocks that will beat the S&P 500 Index over a 10-Yr Holding Period (see Column Y in the Table). You’ll also be taking on more risk (see Columns D, I, and M in the Table), which you’ll ameliorate by trading new entrants to “The 2 and 8 Club” for those that are leaving.
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 MSFT, XOM, NEE, KO, JPM and IBM, and also own shares of TRV, PFE, MMM, and CAT.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
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Sunday, October 8
Week 327 - The 2 and 8 Club: A Strategy To Beat The S&P 500
Situation: You enjoy learning about economics through investing in specific companies but then you learn that you are “leaving money on the table.” How does that happen? Because Warren Buffett has explained to us that the Vanguard S&P 500 Admiral Fund (VFIAX) will beat professional stock-pickers 90% of the time. Why? Because a) it has an expense ratio of only 0.04%, b) it reaches all sectors of the economy, and c) capital gains taxes are negligible because there’s no point selling VFIAX shares before you retire. Instead, you can continue to dollar-average into your VFIAX account until you retire, regardless of market fluctuations.
But we can suggest a strategy for picking stocks without losing much money vs. VFIAX. Firstly, you’d need a watch list positioned in all 11 S&P sectors. Secondly, you’d need a fee-based trading account at your brokerage, one costing ~1%/yr of net asset value that allows you to buy and sell shares as needed without paying transaction costs. Alternatively, you can employ a Dividend Re-Investment Plan when transaction costs are lower. For example, computershare’s DRIP for NextEra Energy (NEE) carries no transaction costs. Thirdly, you’d need to have plan for picking stocks from your watch list, and the discipline to stick with that plan.
Our blog for this week has a workable plan that we call “The 2 and 8 Club.” [Note: "The 2 and 8 Club" is copyrighted and reserved for use by Invest Tune Retire.com.] It sticks to a watch list of the largest and most frequently traded companies, i.e., those in the S&P 100 Index. It picks companies that pay more than a market yield (~2%) by using the S&P 100 companies listed in the FTSE High Dividend Yield Index, which most investors in the US know as VYM, the Vanguard High Dividend Yield ETF. Not all high-yielding companies in the S&P 100 Index are found there because companies have to meet international standards of dividend predictability.
Now you know the “2” part of The 2 and 8 Club, i.e., 2% market yield. The “8” part is a requirement that selected companies pay a dividend that has had a Compound Annual Growth Rate (CAGR) over the past 5 yrs of at least 8.0%/yr. Companies whose bonds are rated lower than A- by S&P are excluded, as are those whose stock is rated lower than B+/M.
Mission: List the current members of The 2 and 8 Club.
Execution: see Table.
Administration: To use this Plan, you simply keep track of the current members of The 2 and 8 Club, then dollar-average into half of those. Some will reach a point where they no longer qualify for membership. Chances are you will decide to stop investing in those companies but we suggest you consider replacing them with newly qualified companies. Each position is predicted to have at least a 10%/yr return (2+8=10), which is 3%/yr more than the long-term return for the S&P 500 Index. That 3% safety factor will likely be nibbled away by transaction costs of at least 1%/yr and capital gains taxes of at least 2%/yr.
Bottom Line: There are fewer than a dozen finance professionals in history with a record of beating the S&P 500 Index every year for more than 2 market cycles. So, a stock-picker like you or me is essentially a gambler. For example, 11 of the 16 companies in the Table that qualify for inclusion in The 2 and 8 Club have shown more extreme fluctuations in market price over the past 16 years than has the S&P 500 Index (see red highlights in Column M of the Table). As finance professors like to say, there are only two ways to beat the S&P 500 Index: 1) use insider information (which is illegal), or 2) have a portfolio that carries more risk of loss than the S&P 500 Index.
But you’re more than a gambler. You’re participating in an experiential school that teaches you (through trial and error) how the economy operates, and you’re learning more about the behavior of groups (sociology) and the governance of countries (politics).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into MSFT, IBM, MMM, CAT, JPM, AMGN, UNP and NEE.
NOTE: Candidates for The 2 and 8 Club are listed at the bottom of the Table. These are S&P 100 companies that have recently been paying an above-market (SPY) dividend yield and have grown that dividend faster than 8%/yr over the past 5 years, but are not yet included in the US version of the FTSE High Dividend Yield Index.
"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
But we can suggest a strategy for picking stocks without losing much money vs. VFIAX. Firstly, you’d need a watch list positioned in all 11 S&P sectors. Secondly, you’d need a fee-based trading account at your brokerage, one costing ~1%/yr of net asset value that allows you to buy and sell shares as needed without paying transaction costs. Alternatively, you can employ a Dividend Re-Investment Plan when transaction costs are lower. For example, computershare’s DRIP for NextEra Energy (NEE) carries no transaction costs. Thirdly, you’d need to have plan for picking stocks from your watch list, and the discipline to stick with that plan.
Our blog for this week has a workable plan that we call “The 2 and 8 Club.” [Note: "The 2 and 8 Club" is copyrighted and reserved for use by Invest Tune Retire.com.] It sticks to a watch list of the largest and most frequently traded companies, i.e., those in the S&P 100 Index. It picks companies that pay more than a market yield (~2%) by using the S&P 100 companies listed in the FTSE High Dividend Yield Index, which most investors in the US know as VYM, the Vanguard High Dividend Yield ETF. Not all high-yielding companies in the S&P 100 Index are found there because companies have to meet international standards of dividend predictability.
Now you know the “2” part of The 2 and 8 Club, i.e., 2% market yield. The “8” part is a requirement that selected companies pay a dividend that has had a Compound Annual Growth Rate (CAGR) over the past 5 yrs of at least 8.0%/yr. Companies whose bonds are rated lower than A- by S&P are excluded, as are those whose stock is rated lower than B+/M.
Mission: List the current members of The 2 and 8 Club.
Execution: see Table.
Administration: To use this Plan, you simply keep track of the current members of The 2 and 8 Club, then dollar-average into half of those. Some will reach a point where they no longer qualify for membership. Chances are you will decide to stop investing in those companies but we suggest you consider replacing them with newly qualified companies. Each position is predicted to have at least a 10%/yr return (2+8=10), which is 3%/yr more than the long-term return for the S&P 500 Index. That 3% safety factor will likely be nibbled away by transaction costs of at least 1%/yr and capital gains taxes of at least 2%/yr.
Bottom Line: There are fewer than a dozen finance professionals in history with a record of beating the S&P 500 Index every year for more than 2 market cycles. So, a stock-picker like you or me is essentially a gambler. For example, 11 of the 16 companies in the Table that qualify for inclusion in The 2 and 8 Club have shown more extreme fluctuations in market price over the past 16 years than has the S&P 500 Index (see red highlights in Column M of the Table). As finance professors like to say, there are only two ways to beat the S&P 500 Index: 1) use insider information (which is illegal), or 2) have a portfolio that carries more risk of loss than the S&P 500 Index.
But you’re more than a gambler. You’re participating in an experiential school that teaches you (through trial and error) how the economy operates, and you’re learning more about the behavior of groups (sociology) and the governance of countries (politics).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into MSFT, IBM, MMM, CAT, JPM, AMGN, UNP and NEE.
NOTE: Candidates for The 2 and 8 Club are listed at the bottom of the Table. These are S&P 100 companies that have recently been paying an above-market (SPY) dividend yield and have grown that dividend faster than 8%/yr over the past 5 years, but are not yet included in the US version of the FTSE High Dividend Yield Index.
"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, August 20
Week 320 - Key Players In The Food Chain That Have Tangible Book Value
Situation: As a stock-picker, you need to invest some of your assets in mature industries. Those are the industries where sales growth is a function of population growth. Companies in those industries typically retain value during recessions. Food & beverage companies are the prime example.
Mission: Set up a spreadsheet of key players in the food chain. Exclude any that do not have positive net Tangible Book Value. Why? Because the SEC requires that before a company can issue stock for sale on a public exchange. Include S&P stock and bond ratings, as well as key Balance Sheet debt ratios. Determine whether Free Cash Flow (FCF) covered company dividend payments for the last two quarters. Determine whether the company is an efficient deployer of capital by comparing Weighted Average Cost of Capital (WACC) to Return on Invested Capital (ROIC). The latter number should be at least twice the former.
Execution: see Table.
Administration: You’re a stock-picker because you think you have a strategy for beating a broad market index fund (e.g. SPY). You’re unlikely to succeed unless you avoid paying Capital Gains taxes until after you drop into a lower tax bracket (i.e., retire). Try to stick with companies that issue A-rated bonds and stocks, and practice other risk-reducing measures (e.g. deploy capital efficiently, have a clean Balance Sheet, and build a strong brand).
You’re also unlikely to succeed if you invest in a volatile stock, i.e., one where the price varies more widely than the price of the S&P 500 Index. We identify that 3 ways:
1) Stock price change vs. change in the S&P 500 Index is greater in response to withdrawal of a key market support, e.g. the cost of taking out a loan or buying a house goes up 20%, or spot prices for key commodities go down 20% (see Column D in any of our Tables);
2) 5-Yr Beta exceeds 1 (see Column I in any of our Tables);
3) 16-Yr stock price volatility is statistically greater than S&P 500 Index volatility per the BMW Method, which we highlight in red (see Column M of any of our Tables).
Bottom Line: We have uncovered only 2 “buy-and-hold” stocks: Costco Wholesale (COST) and Coca-Cola (KO). Consider investing in a sector fund, e.g. SPDR Consumer Staples Select Sector ETF (XLP).
Risk Rating: 7 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-average into KO and MON, and also own shares of HRL, COST, AGU, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Set up a spreadsheet of key players in the food chain. Exclude any that do not have positive net Tangible Book Value. Why? Because the SEC requires that before a company can issue stock for sale on a public exchange. Include S&P stock and bond ratings, as well as key Balance Sheet debt ratios. Determine whether Free Cash Flow (FCF) covered company dividend payments for the last two quarters. Determine whether the company is an efficient deployer of capital by comparing Weighted Average Cost of Capital (WACC) to Return on Invested Capital (ROIC). The latter number should be at least twice the former.
Execution: see Table.
Administration: You’re a stock-picker because you think you have a strategy for beating a broad market index fund (e.g. SPY). You’re unlikely to succeed unless you avoid paying Capital Gains taxes until after you drop into a lower tax bracket (i.e., retire). Try to stick with companies that issue A-rated bonds and stocks, and practice other risk-reducing measures (e.g. deploy capital efficiently, have a clean Balance Sheet, and build a strong brand).
You’re also unlikely to succeed if you invest in a volatile stock, i.e., one where the price varies more widely than the price of the S&P 500 Index. We identify that 3 ways:
1) Stock price change vs. change in the S&P 500 Index is greater in response to withdrawal of a key market support, e.g. the cost of taking out a loan or buying a house goes up 20%, or spot prices for key commodities go down 20% (see Column D in any of our Tables);
2) 5-Yr Beta exceeds 1 (see Column I in any of our Tables);
3) 16-Yr stock price volatility is statistically greater than S&P 500 Index volatility per the BMW Method, which we highlight in red (see Column M of any of our Tables).
Bottom Line: We have uncovered only 2 “buy-and-hold” stocks: Costco Wholesale (COST) and Coca-Cola (KO). Consider investing in a sector fund, e.g. SPDR Consumer Staples Select Sector ETF (XLP).
Risk Rating: 7 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-average into KO and MON, and also own shares of HRL, COST, AGU, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 30
Week 317 - 2017 Barron’s 500 List: A-rated “Growth” Companies That Moved Up In Rank During The Commodity Recession
Situation: If you’re a stock-picker, your job description and mission is to beat the lowest-cost S&P 500 Index ETF (SPY) by ~3%/yr over 5 years. Why? To overcome the frictional costs of do-it-yourself investing, mainly transaction costs and erratic capital gains taxes. In last week’s blog, we highlighted hedging, i.e., over-weighting “defensive” stocks. This week we highlight growth, i.e., picking stocks that grow fast enough to compensate for the drag created by defensive stocks. You should do fine most years, if you invest in 15-20 companies from each category, follow their quarterly reports, and track industry trends. You’ll have to trade often, so find a way to keep trading costs down (~1% of Net Asset Value).
Commodities anchor the economy, so the recent Commodity Recession (7/14-7/16) made it easy to see which companies are efficient, i.e., their “cash-flow-based return on investment” grew during that period. The Barron’s 500 List ranks companies by tracking that growth over the most recent 3 years.
Mission: Identify companies that moved up in rank last year.
Execution: Eliminate companies that do not have S&P bond ratings of A- (or better) and S&P stock ratings of A-/M (or better). In the Table, emphasize Balance Sheet metrics (see Columns P-S). In the evaluation of Net Present Value (Columns V-Z), use a Discount Rate of 9%/yr and a Holding Period of 10 years. Assume that the investor pays the average transaction cost when buying or selling stock (2.5%). Highlight potential money-losing issues in purple.
Administration: This is where you come into the picture. You need to assemble information and make a choice. The Table has only 27 Columns of metrics, but it’s a start. Column Z (NPV) is a convenient summary of the combined effects of the current dividend, its rate of growth (using the past 4 years), and the approximate capital gain that would be realized upon selling the stock ten years from now (which is arrived at by extrapolating the 16-Yr CAGR in Column K). That NPV estimate is only as good as management’s ability to build the company’s Brand while maintaining a clean Balance Sheet.
Bottom Line: The list has the names of only 9 companies. You’ll need to invest in more than 50 growth companies (to avoid Selection Bias). But these 9 are about as problem-free as any you’ll find. Why is it so difficult to identify reliably growing companies? Because growth never lasts. It has a beginning, a middle, and an end--when sales grow only as fast as the population in the company’s “catchment area.” Competition and innovation are huge factors. One cancels out the other over time.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I own shares of TJX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Commodities anchor the economy, so the recent Commodity Recession (7/14-7/16) made it easy to see which companies are efficient, i.e., their “cash-flow-based return on investment” grew during that period. The Barron’s 500 List ranks companies by tracking that growth over the most recent 3 years.
Mission: Identify companies that moved up in rank last year.
Execution: Eliminate companies that do not have S&P bond ratings of A- (or better) and S&P stock ratings of A-/M (or better). In the Table, emphasize Balance Sheet metrics (see Columns P-S). In the evaluation of Net Present Value (Columns V-Z), use a Discount Rate of 9%/yr and a Holding Period of 10 years. Assume that the investor pays the average transaction cost when buying or selling stock (2.5%). Highlight potential money-losing issues in purple.
Administration: This is where you come into the picture. You need to assemble information and make a choice. The Table has only 27 Columns of metrics, but it’s a start. Column Z (NPV) is a convenient summary of the combined effects of the current dividend, its rate of growth (using the past 4 years), and the approximate capital gain that would be realized upon selling the stock ten years from now (which is arrived at by extrapolating the 16-Yr CAGR in Column K). That NPV estimate is only as good as management’s ability to build the company’s Brand while maintaining a clean Balance Sheet.
Bottom Line: The list has the names of only 9 companies. You’ll need to invest in more than 50 growth companies (to avoid Selection Bias). But these 9 are about as problem-free as any you’ll find. Why is it so difficult to identify reliably growing companies? Because growth never lasts. It has a beginning, a middle, and an end--when sales grow only as fast as the population in the company’s “catchment area.” Competition and innovation are huge factors. One cancels out the other over time.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I own shares of TJX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 4
Week 283 - Investing for Retirement Income
Situation: Investing for Capital Appreciation is mainly about reward, whereas, investing for Income is mainly about risk aversion. Upon retirement, you should try to forget about Capital Gains, i.e., selling growth stocks after a 10-yr Holding Period using a target discount rate of 9% (see Week 281). That’s what you do in your working years. In retirement, your discount rate is the average payout rate for interest and dividends from your bonds and stocks. Instead of using the S&P 400 MidCap Index as your benchmark, you’re now using the Vanguard Total Bond Market Index Fund (VBMFX), paying 2.3%/yr, and the Dow Jones Industrial Average (DIA), paying 2.5%/yr.
However, this could create a new problem given that half your retirement savings are in bonds and half are in stocks. This implies that you will have 2.4% of your savings available to spend each year, unless you’re willing to sell some stocks or bonds. Try those sales for a few years, and see if you start having nightmares about outliving your money.
Financial advisors (and you should have one) address that concern by recommending clients initially follow The 4% Rule for annual spending, adjusted for inflation. That rule was created decades ago by Bill Bengen, an aerospace engineer who had access to a really powerful computer that could run partial differential equations with 3 variables. People live longer now, and assets pay less. So, Bill Bengen is having second thoughts. Maybe a withdrawal rate of 3%/yr is more prudent for today’s retirees. But the message is clear. Whenever a retiree’s assets pay less than 4%/yr, she’ll have to sell stocks (to capture Capital Gains) or risk outliving her money.
Mission: Set up a spreadsheet of A-rated Dividend Achievers that a) pay at least 2.5%/yr, and b) have a statistically lower risk of loss than the S&P 500 Index (see Column M in the Table). Eliminate companies that have long-term bonds that account for more than 1/3rd of total assets. Eliminate companies with insufficient revenue to be on the Barron’s 500 List published 4/30/16, as well as companies with insufficient Free Cash Flow to fund dividends paid in the first half of 2016. Also exclude companies if their Weighted Average Cost of Capital (WACC) exceeds their Return on Invested Capital (ROIC).
Execution: Only 8 companies meet our requirements (see Table).
Bottom Line: As a group, these companies pay ~3.0%/yr and have dividend growth of almost 10%/yr. Except for Wal-Mart Stores (WMT), they offer a positive NPV (see Column X in the Table) and will likely have good Capital Gains over the next 10 yrs should you have need of more income.
Risk Rating: 4 (where 1 = 10-yr US Treasury Notes, and 10 = gold bullion).
Full Disclosure: I dollar-average into JNJ, PG, and NEE, and also own shares of 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 = 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 10-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% approximates Total Returns/yr from a stock index of similar risk to owning 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 23 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
However, this could create a new problem given that half your retirement savings are in bonds and half are in stocks. This implies that you will have 2.4% of your savings available to spend each year, unless you’re willing to sell some stocks or bonds. Try those sales for a few years, and see if you start having nightmares about outliving your money.
Financial advisors (and you should have one) address that concern by recommending clients initially follow The 4% Rule for annual spending, adjusted for inflation. That rule was created decades ago by Bill Bengen, an aerospace engineer who had access to a really powerful computer that could run partial differential equations with 3 variables. People live longer now, and assets pay less. So, Bill Bengen is having second thoughts. Maybe a withdrawal rate of 3%/yr is more prudent for today’s retirees. But the message is clear. Whenever a retiree’s assets pay less than 4%/yr, she’ll have to sell stocks (to capture Capital Gains) or risk outliving her money.
Mission: Set up a spreadsheet of A-rated Dividend Achievers that a) pay at least 2.5%/yr, and b) have a statistically lower risk of loss than the S&P 500 Index (see Column M in the Table). Eliminate companies that have long-term bonds that account for more than 1/3rd of total assets. Eliminate companies with insufficient revenue to be on the Barron’s 500 List published 4/30/16, as well as companies with insufficient Free Cash Flow to fund dividends paid in the first half of 2016. Also exclude companies if their Weighted Average Cost of Capital (WACC) exceeds their Return on Invested Capital (ROIC).
Execution: Only 8 companies meet our requirements (see Table).
Bottom Line: As a group, these companies pay ~3.0%/yr and have dividend growth of almost 10%/yr. Except for Wal-Mart Stores (WMT), they offer a positive NPV (see Column X in the Table) and will likely have good Capital Gains over the next 10 yrs should you have need of more income.
Risk Rating: 4 (where 1 = 10-yr US Treasury Notes, and 10 = gold bullion).
Full Disclosure: I dollar-average into JNJ, PG, and NEE, and also own shares of 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 = 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 10-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% approximates Total Returns/yr from a stock index of similar risk to owning 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 23 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 20
Week 281 - Investing for Capital Gains
Situation: Don’t leave money on the table. That means don’t accept a lower rate of return when you could get a higher rate of return by investing in the same asset class while taking the same risk.
This week we’ll focus on A-rated companies with over 9%/yr long-term growth in both Dividend and Price. Investing for Capital Gains starts with avoiding stocks that grow their dividends slower than 9%/yr. Why? Because you’ll soon find that 80% of the worthwhile companies are S&P Dividend Achievers, companies that have raised their dividend each year for at least the past 10+ years. Your benchmark is the S&P 400 MidCap Index, or its ETF (MDY). That index has a long-term growth rate of 9-10%/yr, which is higher than the growth rate for the S&P 500 Index while having a lower risk of loss (see Columns K & M at Lines 32 & 33 in the Table).
Mission: Make a spreadsheet of Dividend Achievers that have 1) grown their dividend at least 9%/yr over the past 10 yrs, and 2) have demonstrated price appreciation of at least 9%/yr over the past 25 yrs. We define price appreciation statistically, i.e., as the trendline derived from a “least squares” calculation of Standard Deviation for weekly price points . We exclude companies that have either an S&P stock rating lower than A-/M or an S&P bond rating lower than A-. We also exclude companies having a) Long-Term debt that amounts to more than 1/3rd of total assets (see Column N of the Table), b) insufficient revenue to be on the Barron’s 500 List published 4/30/16, c) insufficient Free Cash Flow in the most recent two quarters to fund their dividend (see Column O of the Table), and d) negative Tangible Book Value (see Column P in the Table). We also exclude any companies with a Weighted Average Cost of Capital (WACC) that exceeds their Return on Invested Capital (ROIC), as shown in Columns AB & AC of the Table. In other words, all of the companies listed have a clean Balance Sheet.
Execution: We find that 17 companies meet our requirements. Some have performed poorly under stress, i.e., during the 4.5 year Housing Crisis (e.g. the 5 stocks highlighted in red in Column D), or have a history of price volatility that predicts a greater loss in the next Bear Market than the S&P 500 Index (e.g. the 7 stocks highlighted in red in Column M not already highlighted in Column D). You might want to pay more attention to the 5 companies that had neither problem, namely, GWW, HRL, WEC, PH, APD.
Administration: Picking large-capitalization stocks for your retirement portfolio is fraught with risks, no matter how high you set the quality bar. Why? Because those companies typically have multiple product lines and strong brands, which allows them to borrow lots of money at low cost. Managers are incentivized to do this because their performance is often measured by Return on Equity (ROE). The more they use borrowed money, the higher ROE goes because returns go up while equity remains unchanged. Mid-Capitalization companies don’t yet have multiple product lines or strong brands, so their managers can’t borrow as much money. For those same reasons, it is rarely prudent to own stock in a Mid-Cap company, unless its Tangible Book Value is remarkably high. But a large aggregate of Mid-Cap companies (e.g. the S&P 400 MidCap Index) makes an excellent investment because there is little risk posed by long-term debt.
Owning individual stocks in a 401(k) through a mutual fund costs at least 1.59% more per year than owning index funds. Your costs, as an individual who likes to pick her own stocks, are at least 2%/yr more. Why would you do that? For starters, index funds are inefficient in ways that cost you almost 1%/yr. We all know another reason, which is that you can invest in Berkshire Hathaway (e.g. low-cost “B shares”) and beat the lowest-cost S&P 500 Index fund long-term while incurring less risk (compare Lines 23 & 28 in the Table). You can say the same about a few other companies, such as Johnson & Johnson at Line 22 in the Table. The cost of dollar-averaging $200/mo into JNJ stock online is 0.5%/yr.
I think the best reason to go with stock-picking is that a majority of companies in the S&P 500 Index have messy Balance Sheets and weak brands. If you confine your picks to companies with strong Balance Sheets and strong brands, as shown in Columns N through R in the Table, you will minimize losses in a downturn, as shown in Column D of the Table. Not losing money is the secret of making money. As Warren Buffett says, "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."
Bottom Line: Investing requires a disciplined approach to goals. When capital appreciation is the goal, you’ll want to use a benchmark that achieves that goal with the least risk. We think the S&P 400 MidCap Index is appropriate, given that it has 20% less risk of loss than the S&P 500 Index and 10% greater price appreciation. By using the S&P 400 MidCap Index as our benchmark, we arrive at a 9% discount rate for the Net Present Value (NPV) calculation (see Appendix to Week 256). If your growth stock selections generate a negative NPV, you’d be better off investing in MDY, the SPDR Exchange-Traded Fund that tracks the S&P 400 MidCap Index. This week’s Table has 17 Dividend Achievers with positive NPVs after being “handicapped” by the 9% discount rate. Those are worthwhile dividend-growing stocks for your retirement portfolio, as evidenced by how well their price held up during the Housing Crisis (see Column D in the Table).
Risk Rating: 6 (where 1 = 10-yr US Treasury Notes and 10 = gold bullion).
Full Disclosure: I dollar-average into MSFT, NKE, and UNP. I also own shares of ROST, TJX, HRL, WMT, and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
This week we’ll focus on A-rated companies with over 9%/yr long-term growth in both Dividend and Price. Investing for Capital Gains starts with avoiding stocks that grow their dividends slower than 9%/yr. Why? Because you’ll soon find that 80% of the worthwhile companies are S&P Dividend Achievers, companies that have raised their dividend each year for at least the past 10+ years. Your benchmark is the S&P 400 MidCap Index, or its ETF (MDY). That index has a long-term growth rate of 9-10%/yr, which is higher than the growth rate for the S&P 500 Index while having a lower risk of loss (see Columns K & M at Lines 32 & 33 in the Table).
Mission: Make a spreadsheet of Dividend Achievers that have 1) grown their dividend at least 9%/yr over the past 10 yrs, and 2) have demonstrated price appreciation of at least 9%/yr over the past 25 yrs. We define price appreciation statistically, i.e., as the trendline derived from a “least squares” calculation of Standard Deviation for weekly price points . We exclude companies that have either an S&P stock rating lower than A-/M or an S&P bond rating lower than A-. We also exclude companies having a) Long-Term debt that amounts to more than 1/3rd of total assets (see Column N of the Table), b) insufficient revenue to be on the Barron’s 500 List published 4/30/16, c) insufficient Free Cash Flow in the most recent two quarters to fund their dividend (see Column O of the Table), and d) negative Tangible Book Value (see Column P in the Table). We also exclude any companies with a Weighted Average Cost of Capital (WACC) that exceeds their Return on Invested Capital (ROIC), as shown in Columns AB & AC of the Table. In other words, all of the companies listed have a clean Balance Sheet.
Execution: We find that 17 companies meet our requirements. Some have performed poorly under stress, i.e., during the 4.5 year Housing Crisis (e.g. the 5 stocks highlighted in red in Column D), or have a history of price volatility that predicts a greater loss in the next Bear Market than the S&P 500 Index (e.g. the 7 stocks highlighted in red in Column M not already highlighted in Column D). You might want to pay more attention to the 5 companies that had neither problem, namely, GWW, HRL, WEC, PH, APD.
Administration: Picking large-capitalization stocks for your retirement portfolio is fraught with risks, no matter how high you set the quality bar. Why? Because those companies typically have multiple product lines and strong brands, which allows them to borrow lots of money at low cost. Managers are incentivized to do this because their performance is often measured by Return on Equity (ROE). The more they use borrowed money, the higher ROE goes because returns go up while equity remains unchanged. Mid-Capitalization companies don’t yet have multiple product lines or strong brands, so their managers can’t borrow as much money. For those same reasons, it is rarely prudent to own stock in a Mid-Cap company, unless its Tangible Book Value is remarkably high. But a large aggregate of Mid-Cap companies (e.g. the S&P 400 MidCap Index) makes an excellent investment because there is little risk posed by long-term debt.
Owning individual stocks in a 401(k) through a mutual fund costs at least 1.59% more per year than owning index funds. Your costs, as an individual who likes to pick her own stocks, are at least 2%/yr more. Why would you do that? For starters, index funds are inefficient in ways that cost you almost 1%/yr. We all know another reason, which is that you can invest in Berkshire Hathaway (e.g. low-cost “B shares”) and beat the lowest-cost S&P 500 Index fund long-term while incurring less risk (compare Lines 23 & 28 in the Table). You can say the same about a few other companies, such as Johnson & Johnson at Line 22 in the Table. The cost of dollar-averaging $200/mo into JNJ stock online is 0.5%/yr.
I think the best reason to go with stock-picking is that a majority of companies in the S&P 500 Index have messy Balance Sheets and weak brands. If you confine your picks to companies with strong Balance Sheets and strong brands, as shown in Columns N through R in the Table, you will minimize losses in a downturn, as shown in Column D of the Table. Not losing money is the secret of making money. As Warren Buffett says, "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."
Bottom Line: Investing requires a disciplined approach to goals. When capital appreciation is the goal, you’ll want to use a benchmark that achieves that goal with the least risk. We think the S&P 400 MidCap Index is appropriate, given that it has 20% less risk of loss than the S&P 500 Index and 10% greater price appreciation. By using the S&P 400 MidCap Index as our benchmark, we arrive at a 9% discount rate for the Net Present Value (NPV) calculation (see Appendix to Week 256). If your growth stock selections generate a negative NPV, you’d be better off investing in MDY, the SPDR Exchange-Traded Fund that tracks the S&P 400 MidCap Index. This week’s Table has 17 Dividend Achievers with positive NPVs after being “handicapped” by the 9% discount rate. Those are worthwhile dividend-growing stocks for your retirement portfolio, as evidenced by how well their price held up during the Housing Crisis (see Column D in the Table).
Risk Rating: 6 (where 1 = 10-yr US Treasury Notes and 10 = gold bullion).
Full Disclosure: I dollar-average into MSFT, NKE, and UNP. I also own shares of ROST, TJX, HRL, WMT, and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 8
Week 253 - Gold
Situation: For many of us, our concept of personal financial security meshes with our concept of personal safety. Recent TV commercials highlighting the benefits of owning gold are a case in point. The idea is that an investor may not need to worry so much about government debt, and its effect on inflation, if his or her retirement plan includes a “Gold IRA.” Given that the IRS classifies gold as a “collectible” (because it doesn’t pay interest and can’t be rented), its dollar value is defined by the eagerness of prospective owners, i.e., gold’s value increases only if there are more buyers than sellers. The main reason to buy into a “crowded trade” is to hedge against the likelihood of a future event that would negatively affect the buyer’s personal financial security.
One possible event is that the US government’s debt per capita would increase to the point of “currency debasement.” The more people become concerned about that possibility, the more valuable gold becomes. The fact that the US government’s debt per capita has been falling since the Great Recession doesn't remove this concern. Why? Because the US government is increasingly seen as the “payer of last resort.” For example, Puerto Rico is no longer solvent and needs an $80B bailout. Another example: thousands of municipal water systems have lead pipes that urgently need replacing. Finally, such a large number of senior citizens (“baby boomers”) are retiring that Medicare expenditures will increase dramatically.
To sum up, there is too much government, corporate, and household debt worldwide. The tendency of Central Banks to drive interest rates ever lower (to “jump-start” their economies) only makes borrowing more attractive, and the likely result of that will be greater indebtedness.
Mission: Look at 12-yr returns for GLD, an exchange-traded fund (ETF) for gold bullion, as well as the Market Vectors Gold Miners ETF (GDX) and Newmont Mining (NEM), the largest US gold miner. Two other large mining companies are also important to consider: Agnico Eagle Mines Ltd (AEM) and Barrick Gold (ABX). Gold mining is accomplished by getting rock out of the ground and using massive electric-drive Caterpillar (CAT) trucks to carry it out of the mine. That stock’s price is a good barometer of mining activity. It is also important to consider the only Dividend Achiever among gold stocks, Royal Gold (RGLD), which is a company that obtains royalties on gold production in exchange for financing gold mines. Compare those returns (see Table) to more typical US stocks in the commodity space, such as NextEra Energy (NEE), Union Pacific (UNP) and Exxon Mobil (XOM).
Bottom Line: By owning gold you’re giving up the opportunity to make another investment that provides you with a steady income from interest, dividends or rent. You also miss out on paying the low capital gains tax for income-producing investments. Gold is a “collectible” and the proceeds are taxed as income. This may not matter, if you think hyperinflation is a looming threat. Just remember, gold is the most speculative of investments because of its price volatility and lack of income.
Risk Rating: 10
Full Disclosure: I dollar-average into NEE, UNP, and XOM.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
One possible event is that the US government’s debt per capita would increase to the point of “currency debasement.” The more people become concerned about that possibility, the more valuable gold becomes. The fact that the US government’s debt per capita has been falling since the Great Recession doesn't remove this concern. Why? Because the US government is increasingly seen as the “payer of last resort.” For example, Puerto Rico is no longer solvent and needs an $80B bailout. Another example: thousands of municipal water systems have lead pipes that urgently need replacing. Finally, such a large number of senior citizens (“baby boomers”) are retiring that Medicare expenditures will increase dramatically.
To sum up, there is too much government, corporate, and household debt worldwide. The tendency of Central Banks to drive interest rates ever lower (to “jump-start” their economies) only makes borrowing more attractive, and the likely result of that will be greater indebtedness.
Mission: Look at 12-yr returns for GLD, an exchange-traded fund (ETF) for gold bullion, as well as the Market Vectors Gold Miners ETF (GDX) and Newmont Mining (NEM), the largest US gold miner. Two other large mining companies are also important to consider: Agnico Eagle Mines Ltd (AEM) and Barrick Gold (ABX). Gold mining is accomplished by getting rock out of the ground and using massive electric-drive Caterpillar (CAT) trucks to carry it out of the mine. That stock’s price is a good barometer of mining activity. It is also important to consider the only Dividend Achiever among gold stocks, Royal Gold (RGLD), which is a company that obtains royalties on gold production in exchange for financing gold mines. Compare those returns (see Table) to more typical US stocks in the commodity space, such as NextEra Energy (NEE), Union Pacific (UNP) and Exxon Mobil (XOM).
Bottom Line: By owning gold you’re giving up the opportunity to make another investment that provides you with a steady income from interest, dividends or rent. You also miss out on paying the low capital gains tax for income-producing investments. Gold is a “collectible” and the proceeds are taxed as income. This may not matter, if you think hyperinflation is a looming threat. Just remember, gold is the most speculative of investments because of its price volatility and lack of income.
Risk Rating: 10
Full Disclosure: I dollar-average into NEE, UNP, and XOM.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 6
Week 244 - Will You Profit From Owning Stocks?
Situation: People used to say “yes” whenever asked that question. Now, the answer is more problematic. Let’s assume that “the past is prologue” and calculate how much you’d profit from the “best-case scenario.” If on August 9, 1999, you purchased 25 shares of the lowest cost S&P 500 Index fund online, the Vanguard 500 Index Fund (VFINX), for $120.07/Sh ($3001.75), and spent dividends along the way, then sold your 25 shares 16 yrs later on 8/7/2015 for $192.03/Sh ($4800.75), you would have averaged a 3.0%/yr price return. According to the Buyupside website, your total return averaged 4.9%/yr, which included price appreciation of 3.0%/yr, plus an average dividend yield of 1.9%/yr.
Your initial $3001.75 investment has grown to $6400.00. Of that growth, $1599.25 is due to dividends and $4800.75 is due to capital appreciation, as noted above. But the annual 15% tax on dividends has reduced the value of those payouts to $1359.36, and the 20% capital gains tax has reduced your gain from selling 25 shares to $4440.95. That leaves you with $5800.31, for an after-tax return of 4.2%/yr. Now let’s account for the 2.2%/yr average rate of inflation over those 16 years, which brings your gain down to 2.0%/yr. Transaction costs of 0.2%/yr are folded into the share price, so you’re left with an average profit from your initial investment of 2.0%/yr net of costs. So far, so good. But consider this: The average retail investor spends 2.2%/yr on transaction costs vs. the 0.2%/yr that you’ve spent. Your entire 2.0%/yr profit came from choosing an investment run by computers.
There was no one at Vanguard Group to call on the phone when the S&P 500 Index crashed twice. You flew solo. That’s the best-case scenario, disintermediation. But no one you’ll ever meet invests that way. Why? Because the ups and downs of the S&P 500 Index cannot be looked upon with equanimity by anyone other than a professional trader. Another reason is human nature. People can’t seem to make a plain vanilla investment that all available evidence says is the best investment on the planet. Instead, they’ll entertain themselves by trying to beat the S&P 500 Index.
Then there’s the 4% rule to consider. That’s the maximum amount you can sell each year from a balanced retirement portfolio (50% bond, 50% stock), after adding a percentage to account for recent inflation, without running the risk that you’ll out-live your money. VFINX is 100% large-capitalization stocks and pays only a 2% dividend. You’d have to sell some shares every year to collect the other 2%. The market might be down a lot when you sell those shares, so it might be preferable to find a way to live off dividends and preserve your principal.
Our benchmarks for retirement savings are the Vanguard Balanced Index Fund and the Vanguard Wellesley Income Fund at Lines 27 & 28 in this week’s Table. Both have payouts less than 3%/yr, and payouts over the past 16 yrs have fallen because interest rates have fallen and those funds are hedged with bonds. The only way to reach 4%/yr in dividend payouts is to own stock in companies that grow dividends faster than inflation.
Mission: Find a source of retirement income that reliably grows at least twice as fast as inflation and gives you a chance to live off dividends without eroding principal. That means you’re looking to own stock in companies that S&P calls Dividend Aristocrats (because they’ve increased their dividend annually for at least the past 25 yrs).
Execution: Which of the 51 Dividend Aristocrats meet our quality criteria for inclusion in a retirement portfolio, and have grown their dividend more than three times as fast as inflation over the past 16 yrs, i.e., at least 6.0%/yr? And which of those have revenues high enough to be in the 2015 Barron’s 500 List, and S&P ratings of BBB+ or better for bonds and B+/M or better for stocks. Of the 30 stocks that emerge from that screen, which fluctuate in price more than the S&P 500 Index? During the most recent market correction (4/1/11 through 9/30/11), 8 were more volatile so we’ve excluded those. Four others have a dividend yield that is lower than VFINX, so we’ve excluded those. That leaves 18 companies that meet all criteria; those grew their dividends more than 11%/yr over the past 16 yrs (see Column H in the Table).
Bottom Line: Yes, you can profit from owning shares in the lowest-cost S&P 500 Index fund (VFINX) over two market cycles. But you can do better by owning a basket of stocks issued by companies that have increased their dividend annually for at least the past 25 yrs. These are companies that S&P calls Dividend Aristocrats. We’ve found 18 such companies that meet our quality criteria, and all but 2 (Coca-Cola and Wal-Mart Stores) have outperformed the lowest-cost S&P 500 Index fund (VFINX) over the past 23 yrs. As a group, they have a dividend yield of ~3.0% and grew their dividends 5 times faster than inflation. They all meet the 4% rule for annual withdrawals from a retirement fund. In other words, dividend growth is so rapid that you’re getting at least a 4% dividend yield on your original investment within a few years, and dividend yield is likely to grow more than twice as fast as inflation.
Risk Rating: 4
Full Disclosure: I dollar-average monthly into ABT and XOM (neither have transaction costs at www.computershare.com), and also own shares of MCD, JNJ, KO, PEP, and WMT.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark. Total Returns in Column C of the Table date to 9/28/1992 because that marks the onset of trading in VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Your initial $3001.75 investment has grown to $6400.00. Of that growth, $1599.25 is due to dividends and $4800.75 is due to capital appreciation, as noted above. But the annual 15% tax on dividends has reduced the value of those payouts to $1359.36, and the 20% capital gains tax has reduced your gain from selling 25 shares to $4440.95. That leaves you with $5800.31, for an after-tax return of 4.2%/yr. Now let’s account for the 2.2%/yr average rate of inflation over those 16 years, which brings your gain down to 2.0%/yr. Transaction costs of 0.2%/yr are folded into the share price, so you’re left with an average profit from your initial investment of 2.0%/yr net of costs. So far, so good. But consider this: The average retail investor spends 2.2%/yr on transaction costs vs. the 0.2%/yr that you’ve spent. Your entire 2.0%/yr profit came from choosing an investment run by computers.
There was no one at Vanguard Group to call on the phone when the S&P 500 Index crashed twice. You flew solo. That’s the best-case scenario, disintermediation. But no one you’ll ever meet invests that way. Why? Because the ups and downs of the S&P 500 Index cannot be looked upon with equanimity by anyone other than a professional trader. Another reason is human nature. People can’t seem to make a plain vanilla investment that all available evidence says is the best investment on the planet. Instead, they’ll entertain themselves by trying to beat the S&P 500 Index.
Then there’s the 4% rule to consider. That’s the maximum amount you can sell each year from a balanced retirement portfolio (50% bond, 50% stock), after adding a percentage to account for recent inflation, without running the risk that you’ll out-live your money. VFINX is 100% large-capitalization stocks and pays only a 2% dividend. You’d have to sell some shares every year to collect the other 2%. The market might be down a lot when you sell those shares, so it might be preferable to find a way to live off dividends and preserve your principal.
Our benchmarks for retirement savings are the Vanguard Balanced Index Fund and the Vanguard Wellesley Income Fund at Lines 27 & 28 in this week’s Table. Both have payouts less than 3%/yr, and payouts over the past 16 yrs have fallen because interest rates have fallen and those funds are hedged with bonds. The only way to reach 4%/yr in dividend payouts is to own stock in companies that grow dividends faster than inflation.
Mission: Find a source of retirement income that reliably grows at least twice as fast as inflation and gives you a chance to live off dividends without eroding principal. That means you’re looking to own stock in companies that S&P calls Dividend Aristocrats (because they’ve increased their dividend annually for at least the past 25 yrs).
Execution: Which of the 51 Dividend Aristocrats meet our quality criteria for inclusion in a retirement portfolio, and have grown their dividend more than three times as fast as inflation over the past 16 yrs, i.e., at least 6.0%/yr? And which of those have revenues high enough to be in the 2015 Barron’s 500 List, and S&P ratings of BBB+ or better for bonds and B+/M or better for stocks. Of the 30 stocks that emerge from that screen, which fluctuate in price more than the S&P 500 Index? During the most recent market correction (4/1/11 through 9/30/11), 8 were more volatile so we’ve excluded those. Four others have a dividend yield that is lower than VFINX, so we’ve excluded those. That leaves 18 companies that meet all criteria; those grew their dividends more than 11%/yr over the past 16 yrs (see Column H in the Table).
Bottom Line: Yes, you can profit from owning shares in the lowest-cost S&P 500 Index fund (VFINX) over two market cycles. But you can do better by owning a basket of stocks issued by companies that have increased their dividend annually for at least the past 25 yrs. These are companies that S&P calls Dividend Aristocrats. We’ve found 18 such companies that meet our quality criteria, and all but 2 (Coca-Cola and Wal-Mart Stores) have outperformed the lowest-cost S&P 500 Index fund (VFINX) over the past 23 yrs. As a group, they have a dividend yield of ~3.0% and grew their dividends 5 times faster than inflation. They all meet the 4% rule for annual withdrawals from a retirement fund. In other words, dividend growth is so rapid that you’re getting at least a 4% dividend yield on your original investment within a few years, and dividend yield is likely to grow more than twice as fast as inflation.
Risk Rating: 4
Full Disclosure: I dollar-average monthly into ABT and XOM (neither have transaction costs at www.computershare.com), and also own shares of MCD, JNJ, KO, PEP, and WMT.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark. Total Returns in Column C of the Table date to 9/28/1992 because that marks the onset of trading in VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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