Situation: Which asset class do you favor? Stocks, bonds, real estate or commodities? On a risk-adjusted basis, none of those are likely to grow your savings faster than inflation over the near term. You might want to hold off making “risk-on” investments, unless you're a speculator, because markets are likely to fluctuate more than usual. If you think a “risk-off” approach is best, then you need to pick “defensive” stocks for monthly (or quarterly) investment of a fixed dollar amount (dollar-cost averaging). To minimize transaction costs, you’ll want to invest automatically in each stock through an online Dividend Re-Investment Plan (DRIP).
Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.
Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.
Execution: see Table.
Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.
Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M).
Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Showing posts with label communication. Show all posts
Showing posts with label communication. Show all posts
Sunday, August 26
Sunday, June 17
Week 363 - Big Pharma
Situation: There are 11 pharmaceutical companies in the S&P 100 Index, with an average market capitalization of ~$130 Billion. Stocks issued by healthcare companies (including hospital chains, pharmacy benefit managers, medical insurance vendors, and drugstores) are thought to be defensive “risk-off” bets, like stocks issued by utility, communication services, or consumer staples companies. But they’re not. Healthcare consumes almost 20% of GDP but it is a highly fragmented industry, rife with government interference seeking full control. Medical innovation for the entire planet has to take place in the United States because the healthcare industry is socialized elsewhere and large amounts of private capital are needed to conduct clinical trials. That innovation makes US healthcare into an ongoing research enterprise. For biotechnology companies, there is an ever-present risk of being eclipsed by another company’s research team. Stockpickers who have some appreciation for biochemistry can perhaps identify biotechnology groups that are onto a good thing. But Big Pharma companies survive by looking to buy those same startups. Can you really scope-out a “good thing” better than their scientists?
Mission: Run our Standard Spreadsheet for the 11 pharmaceutical companies in the S&P 100 Index.
Execution: see Table.
Bottom Line: This is not a game for the retail investor. All she can do is buy stock in one or two of the 11 “Big Pharma” companies, and hope that its CEO can find small biotechnology groups conducting breakthrough science, then buy at least one a year to throw money at. That’s an iffy business. Why? Because large-scale clinical studies (costing hundreds of million dollars) have to be conducted before the bet pays off. Usually it doesn’t. If you’re a stock-picker new to this industry, start by researching the old standbys that reliably pay good dividends: Johnson & Johnson (JNJ), Merck (MRK), Pfizer (PFE) and Eli Lilly (LLY).
Risk Rating: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into JNJ and also own shares of ABT.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Run our Standard Spreadsheet for the 11 pharmaceutical companies in the S&P 100 Index.
Execution: see Table.
Bottom Line: This is not a game for the retail investor. All she can do is buy stock in one or two of the 11 “Big Pharma” companies, and hope that its CEO can find small biotechnology groups conducting breakthrough science, then buy at least one a year to throw money at. That’s an iffy business. Why? Because large-scale clinical studies (costing hundreds of million dollars) have to be conducted before the bet pays off. Usually it doesn’t. If you’re a stock-picker new to this industry, start by researching the old standbys that reliably pay good dividends: Johnson & Johnson (JNJ), Merck (MRK), Pfizer (PFE) and Eli Lilly (LLY).
Risk Rating: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into JNJ and also own shares of ABT.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 29
Week 356 - Defensive Companies in “The 2 and 8 Club” (Extended Version)
Situation: You don’t want to lose money but you’re starting to. That comes with having your savings in an overbought stock market. It’s time for a cautionary warning light to click on in your head. That would mean moving some money into cash equivalents and making sure that at least a third of your stock portfolio is in defensive stocks, i.e., utility, healthcare, consumer staples, and telecommunication services companies. And, review the stocks you’re dollar-averaging into. Be comfortable with the prospect of building up your share-count in those stocks throughout a market crash.
Mission: Run our Standard Spreadsheet on defensive companies in “The 2 and 8 Club” (Extended Version).
Execution: see Table.
Administration: If their dividend growth rates continue to fall, Coca-Cola (KO) and Pfizer (PFE) will no longer be members of “The 2 and 8 Club.” Conversely, Hormel Foods (HRL at Line 13 in the Table) recently raised its dividend and now has a yield that is well above the yield for the S&P 500 Index. That means it will soon be included in the US version of the FTSE High Dividend Yield Index. HRL already meets the other requirements for membership in “The 2 and 8 Club.” So, it will become a member upon being listed in that Index. The ETF for that Index is VYM (the Vanguard High Dividend Yield ETF at Line 18 in the Table).
Bottom Line: There aren’t a lot of great defensive stocks, but the 8 included in “The 2 and 8 Club” are worth your close attention. Why? Because a set of trade policies are being promulgated by several countries that restrict the cross-border flow of goods and services. If those policies blossom into a tit-for-tat Trade War, Robert Shiller (Nobel Prize winning economist) thinks a recession would be triggered: “It’s just chaos,” he said on CNBC. “It will slow down development in the future if people think that this kind of thing is likely.”
Risk Rating: 5 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into NextEra Energy (NEE) and PepsiCo (PEP), and also own shares of Coca-Cola (KO) and Hormel Foods (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
Mission: Run our Standard Spreadsheet on defensive companies in “The 2 and 8 Club” (Extended Version).
Execution: see Table.
Administration: If their dividend growth rates continue to fall, Coca-Cola (KO) and Pfizer (PFE) will no longer be members of “The 2 and 8 Club.” Conversely, Hormel Foods (HRL at Line 13 in the Table) recently raised its dividend and now has a yield that is well above the yield for the S&P 500 Index. That means it will soon be included in the US version of the FTSE High Dividend Yield Index. HRL already meets the other requirements for membership in “The 2 and 8 Club.” So, it will become a member upon being listed in that Index. The ETF for that Index is VYM (the Vanguard High Dividend Yield ETF at Line 18 in the Table).
Bottom Line: There aren’t a lot of great defensive stocks, but the 8 included in “The 2 and 8 Club” are worth your close attention. Why? Because a set of trade policies are being promulgated by several countries that restrict the cross-border flow of goods and services. If those policies blossom into a tit-for-tat Trade War, Robert Shiller (Nobel Prize winning economist) thinks a recession would be triggered: “It’s just chaos,” he said on CNBC. “It will slow down development in the future if people think that this kind of thing is likely.”
Risk Rating: 5 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into NextEra Energy (NEE) and PepsiCo (PEP), and also own shares of Coca-Cola (KO) and Hormel Foods (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, November 12
Week 332 - Defensive Companies in “The 2 and 8 Club”
Situation: The Dow Jones Industrial Average keeps making new highs, “confirmed” by new highs in the Dow Jones Transportation Average. According to Dow Theory, we are in a “primary” Bull Market. That is a period when investors should be paying off their debts and/or building up cash reserves. It is also a period when stocks in “growth” companies become overpriced, and stocks in “defensive” companies become reasonably priced (after having been overpriced). It’s a good time to research high-quality companies in “defensive” industries: Consumer Staples, Health Care, Utilities, and Communication Services.
Mission: Develop our standard spreadsheet for companies in “The 2 and 8 Club” (see Week 327) that are in defensive industries (see Week 327), and add any companies that are close to qualifying.
Execution: (see Table)
Administration: We’ll use the Extended Version of “The 2 and 8 Club”, which simply matches companies on two lists: The Barron’s 500 List and the 400+ companies in the FTSE High Dividend Yield Index. The Barron’s 500 List is published annually in May, and ranks companies by their 1 & 3 year Cash Flows from Operations, as well as their past year’s Revenues. The FTSE High Dividend Yield Index lists US companies that pay more than a market yield (~2%) and are thought unlikely to reduce dividends during a Bear Market. Companies that appear on both lists but do not have a 5-Yr Compound Annual Growth Rate (CAGR) of at least 8% for their quarterly dividend payout are excluded, as are any companies that carry an S&P Rating lower than A- for their bonds or lower than B+/M for their stocks.
Note the inclusion of Costco Wholesale (COST) at Line 4 in the Table. Although it has an annual yield lower than the required 2% for its quarterly dividend, the company has also issued a supplementary dividend every other year for the past 5 years. In those years, the dividend yield exceeds 5%. In calculating Net Present Value (see Column Y in the Table), we have used adjusted values for Dividend Yield (5.4%) and 5-Yr Dividend Growth (2.1%) in an effort to present an assessment closer to reality. That boosts NPV 42% over what it would be had supplemental dividends been ignored.
Note the inclusion of Coca-Cola (KO) at Line 9 in the Table. Although it has a 5-year dividend CAGR of 7.7%, which is slightly lower than our 8% cut-off, KO is a “mega-capitalized” company that has a major influence on prospects for the Consumer Staples industry.
Bottom Line: Experienced stock-pickers can usually look forward to a decent night’s sleep, if experience has taught them to overweight their portfolio in high-quality “defensive” stocks that pay a good and growing dividend. By restricting our Watch List to companies in “The 2 and 8 Club”, we’ve found that there are only 10 defensive stocks you need to consider during this opportune time, i.e, when valuations are lower for “defensive” stocks because “growth” stocks become the overcrowded trade in a primary Bull Market.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-cost average into KO and NEE, and also own shares of COST, AMGN, MO, and HRL.
"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
Mission: Develop our standard spreadsheet for companies in “The 2 and 8 Club” (see Week 327) that are in defensive industries (see Week 327), and add any companies that are close to qualifying.
Execution: (see Table)
Administration: We’ll use the Extended Version of “The 2 and 8 Club”, which simply matches companies on two lists: The Barron’s 500 List and the 400+ companies in the FTSE High Dividend Yield Index. The Barron’s 500 List is published annually in May, and ranks companies by their 1 & 3 year Cash Flows from Operations, as well as their past year’s Revenues. The FTSE High Dividend Yield Index lists US companies that pay more than a market yield (~2%) and are thought unlikely to reduce dividends during a Bear Market. Companies that appear on both lists but do not have a 5-Yr Compound Annual Growth Rate (CAGR) of at least 8% for their quarterly dividend payout are excluded, as are any companies that carry an S&P Rating lower than A- for their bonds or lower than B+/M for their stocks.
Note the inclusion of Costco Wholesale (COST) at Line 4 in the Table. Although it has an annual yield lower than the required 2% for its quarterly dividend, the company has also issued a supplementary dividend every other year for the past 5 years. In those years, the dividend yield exceeds 5%. In calculating Net Present Value (see Column Y in the Table), we have used adjusted values for Dividend Yield (5.4%) and 5-Yr Dividend Growth (2.1%) in an effort to present an assessment closer to reality. That boosts NPV 42% over what it would be had supplemental dividends been ignored.
Note the inclusion of Coca-Cola (KO) at Line 9 in the Table. Although it has a 5-year dividend CAGR of 7.7%, which is slightly lower than our 8% cut-off, KO is a “mega-capitalized” company that has a major influence on prospects for the Consumer Staples industry.
Bottom Line: Experienced stock-pickers can usually look forward to a decent night’s sleep, if experience has taught them to overweight their portfolio in high-quality “defensive” stocks that pay a good and growing dividend. By restricting our Watch List to companies in “The 2 and 8 Club”, we’ve found that there are only 10 defensive stocks you need to consider during this opportune time, i.e, when valuations are lower for “defensive” stocks because “growth” stocks become the overcrowded trade in a primary Bull Market.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-cost average into KO and NEE, and also own shares of COST, AMGN, MO, and HRL.
"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, July 23
Week 316 - 2017 Barron’s 500 List: A-rated “Defensive” Companies That Moved Up In Rank During The Commodity Recession
Situation: A stock-picker can’t beat the market, given that transaction costs and tax inefficiencies reduce returns by 1-3%/yr compared to the lowest-cost S&P 500 Index fund (VFINX), which returns 7-8%/yr. To effectively compete with that, stock picks would need to return 9%/yr. That’s one of the reasons why we use a discount rate of 9% when calculating Net Present Value.
In business school, I was taught that there are only two ways to beat the market: Plan A is to trade on “insider information” (patently illegal); Plan B is to take outsize risks (i.e., run a portfolio where the capitalization-weighted 5-Yr Beta is greater than 1.0). Those of us who are employed full time in Financial Services may become good stock-pickers because we know a particular industry very well, the result being that we overweight our picks in that industry. In other words, we’re engaged in a legal form of insider trading. For example, doctors and dentists are often savvy traders of health-care stocks.
The stock-picker who had the longest run beating the S&P 500 Index was Peter Lynch, who managed Fidelity’s Magellan Fund from 1977 through 1990. He relied on diversification, running ~1000 stocks with the help of a dozen analysts, but focussed on retail stocks. He claimed that the insights his wife shared with him after a day of shopping were pivotal to his success. You get the point: Invest in what you know.
But what about Plan B (risk taking)? Like Plan A, that approach requires you to run a portfolio concentrated in particular industries. But unlike Plan A, those stocks have to be in boring “Defensive” industries, i.e., the ones where sales grow only as fast as the population grows (Consumer Staples, Healthcare, Communication Services, and Utilities). By overweighting defensive industries, you insulate your portfolio. When the market crashes, those industries tend to keep on growing their earnings. Than means you’re following Warren Buffett’s Rule #1: Never Lose Money.
Mission: Analyze the recent Commodity Recession (see Column D at Line 26 in the Table), which was almost severe enough to keep both GDP and the S&P 500 Index from growing.
Execution: see Table.
Administration: Commodities are a key driver of the economy, so the Commodity Recession gave us a rare opportunity to see which companies out-perform without that key driver. You’ll need some background information. Of the 22 commodity futures contracts that compose the Bloomberg Commodity Index, the 5 classified as “Energy” are strongest, with a combined weight of 30.57% (Natural Gas, Brent Crude Oil, West Texas Intermediate Crude Oil, Ultra-Low Sulfur Diesel, and Unleaded Gasoline). When those are down ~20%, the S&P 500 Index will barely rise even though GDP might keep going up. Whether we like it or not, the prices of petroleum products will be the best predictors of the stock market for the next 10+ yrs. To be successful, a stock-picker has to anticipate the ups and downs in prices for energy commodities, and be positioned to reap good returns from stocks of A-rated S&P 500 companies that maintain or improve their valuation metrics during a commodity recession.
Key metrics relate to cash-flow based ROIC, specifically the most recent year vs. the 3-Yr median, as well as sales growth for the most recent year. The Barron’s 500 List (published each May) ranks the largest 500 companies on the New York and Toronto stock exchanges in terms of those 3 metrics. We’re interested in knowing the names of ALL the A-ranked S&P 500 companies that moved up in rank. Most of those will be in “Defensive” industries. The few that are in “Growth” industries either have a business plan that allows them to be “hardy perennials,” or enjoy a special situation that allows them to take advantage of a Commodity Recession. This week we cover “Defensive” industries. Next week we’ll cover the few “Growth” industry out-performers.
Bottom Line: The costs associated with owning the Vanguard 500 Index Fund (VFINX) are nil, whereas, the costs of owning (and trading) stock in a few dozen companies are substantial. And, the capital gains taxes that you’ll pay each year for trading those stocks are erratic and immediate vs. what you’ll pay upon eventually selling your VFINX shares. Your stock portfolio has to outperform the S&P 500 Index by 2-3%/yr to equal the returns you’d realize from owning VFINX shares. Invest smart, by knowing that the market goes down eventually and doing something about it ahead of time. Either stick to industries you know, or hedge by overweighting the stocks of companies in “Defensive Industries.” The 14 shown in the Table are a good place to start your research. Pay close attention to Columns P-S because even these companies can swoon in a market crash if they have messy Balance Sheets (messiness is highlighted in purple).
Risk Rating: 6 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold)
Full Disclosure: I dollar-average into JNJ and KO, and also own shares of HRL and WMT.
In business school, I was taught that there are only two ways to beat the market: Plan A is to trade on “insider information” (patently illegal); Plan B is to take outsize risks (i.e., run a portfolio where the capitalization-weighted 5-Yr Beta is greater than 1.0). Those of us who are employed full time in Financial Services may become good stock-pickers because we know a particular industry very well, the result being that we overweight our picks in that industry. In other words, we’re engaged in a legal form of insider trading. For example, doctors and dentists are often savvy traders of health-care stocks.
The stock-picker who had the longest run beating the S&P 500 Index was Peter Lynch, who managed Fidelity’s Magellan Fund from 1977 through 1990. He relied on diversification, running ~1000 stocks with the help of a dozen analysts, but focussed on retail stocks. He claimed that the insights his wife shared with him after a day of shopping were pivotal to his success. You get the point: Invest in what you know.
But what about Plan B (risk taking)? Like Plan A, that approach requires you to run a portfolio concentrated in particular industries. But unlike Plan A, those stocks have to be in boring “Defensive” industries, i.e., the ones where sales grow only as fast as the population grows (Consumer Staples, Healthcare, Communication Services, and Utilities). By overweighting defensive industries, you insulate your portfolio. When the market crashes, those industries tend to keep on growing their earnings. Than means you’re following Warren Buffett’s Rule #1: Never Lose Money.
Mission: Analyze the recent Commodity Recession (see Column D at Line 26 in the Table), which was almost severe enough to keep both GDP and the S&P 500 Index from growing.
Execution: see Table.
Administration: Commodities are a key driver of the economy, so the Commodity Recession gave us a rare opportunity to see which companies out-perform without that key driver. You’ll need some background information. Of the 22 commodity futures contracts that compose the Bloomberg Commodity Index, the 5 classified as “Energy” are strongest, with a combined weight of 30.57% (Natural Gas, Brent Crude Oil, West Texas Intermediate Crude Oil, Ultra-Low Sulfur Diesel, and Unleaded Gasoline). When those are down ~20%, the S&P 500 Index will barely rise even though GDP might keep going up. Whether we like it or not, the prices of petroleum products will be the best predictors of the stock market for the next 10+ yrs. To be successful, a stock-picker has to anticipate the ups and downs in prices for energy commodities, and be positioned to reap good returns from stocks of A-rated S&P 500 companies that maintain or improve their valuation metrics during a commodity recession.
Key metrics relate to cash-flow based ROIC, specifically the most recent year vs. the 3-Yr median, as well as sales growth for the most recent year. The Barron’s 500 List (published each May) ranks the largest 500 companies on the New York and Toronto stock exchanges in terms of those 3 metrics. We’re interested in knowing the names of ALL the A-ranked S&P 500 companies that moved up in rank. Most of those will be in “Defensive” industries. The few that are in “Growth” industries either have a business plan that allows them to be “hardy perennials,” or enjoy a special situation that allows them to take advantage of a Commodity Recession. This week we cover “Defensive” industries. Next week we’ll cover the few “Growth” industry out-performers.
Bottom Line: The costs associated with owning the Vanguard 500 Index Fund (VFINX) are nil, whereas, the costs of owning (and trading) stock in a few dozen companies are substantial. And, the capital gains taxes that you’ll pay each year for trading those stocks are erratic and immediate vs. what you’ll pay upon eventually selling your VFINX shares. Your stock portfolio has to outperform the S&P 500 Index by 2-3%/yr to equal the returns you’d realize from owning VFINX shares. Invest smart, by knowing that the market goes down eventually and doing something about it ahead of time. Either stick to industries you know, or hedge by overweighting the stocks of companies in “Defensive Industries.” The 14 shown in the Table are a good place to start your research. Pay close attention to Columns P-S because even these companies can swoon in a market crash if they have messy Balance Sheets (messiness is highlighted in purple).
Risk Rating: 6 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold)
Full Disclosure: I dollar-average into JNJ and KO, and also own shares of HRL and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 18
Week 311 - A-rated S&P 100 “Defensive” Companies With Tangible Book Value
Situation: We know for certain that this is a period of great anxiety in credit markets. Trillions of dollars in loans have been made by banks in Southern Europe and East Asia that are now worth less than a third of their face value. Many of these loans were made by private banks, but governments are ultimately “on the hook” for the debt. With non-performing debts on their books, banks have less ability to make worthwhile loans to support economic growth, education and upgrades of infrastructure. A credit crunch is going to happen, unless these bad debts are boxed up, tied with a ribbon, and sold to the highest bidder. Remember: the credit crunch of 2008-09 quickly cut worldwide GDP growth per capita in half, from 2%/yr to 1%/yr. And it didn’t start to recover until this year.
What’s the best way for you to drill down on this subject? I suggest that you read Peter Coy’s article, which appeared in Bloomberg Business Week last October. His analysis responds to the International Monetary Fund’s 2016 Global Financial Stability Report that was hot off the press. Here are bullet points from that report: “medium-term risks continue to build”, meaning 1) growing political instability; 2) persistent weakness of financial institutions in China and Southern Europe; 3) excessive corporate debt in emerging markets. In China, combined public and private debt almost doubled over the past 10 years, and is now 210% of GDP (worldwide it’s 225% of GDP).
Mission: What’s the best way to tailor your retirement portfolio in response to these global risks? Become defensive. That doesn’t just mean having a Rainy Day Fund that is well-stocked with interest-earning cash-equivalents (Savings Bonds, Treasury Bills, and 2-Yr Treasury Notes). It means overweighting high quality “defensive stocks” in your equity portfolio. What is the Gold Standard? Companies in the S&P 100 Index that are in the 4 S&P Defensive Industries:
Consumer Staples;
Healthcare;
Utilities; and
Communication Services.
Large companies have multiple product lines, and membership in the S&P 100 Index requires a healthy options market for the company’s stock, to facilitate price discovery. You have to drill deeper in your analysis, to be sure the company’s S&P credit rating is A- or better, and its stock rating is A-/M or better. Statistical information has to be available from the 16-Yr series of the BMW Method and the 2017 Barron’s 500 List. Check financial statements for signs of high debt: long-term bonds that represent more than a third of total assets, operating cash flow that covers less than 40% of current liabilities, or an inability to meet dividend payments out of free cash flow (FCF). Exclude companies with negative Tangible Book Value.
Execution: By using the above criteria, we uncover 7 companies out of the 32 “defensive” companies in the S&P 100 Index (see Table).
Bottom Line: Defensive companies are less interesting than growth companies or companies involved in the production of raw commodities. But high-quality defensive companies, such as Johnson & Johnson (JNJ) and NextEra Energy (NEE), consistently grow earnings faster than GDP and are quick to correct any earnings shortfall. All an investor need do is learn to read financial statements, and regularly examine websites for data on companies of interest.
Risk Rating: 4 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold bullion).
Full Disclosure: I dollar-average into Coca-Cola (KO), NextEra Energy (NEE), and Johnson & Johnson (JNJ). I also own shares in Costco Wholesale (COST) and Wal-Mart Stores (WMT).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 15 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 4-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 20 in the Table. The ETF for that index is MDY at Line 14. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
What’s the best way for you to drill down on this subject? I suggest that you read Peter Coy’s article, which appeared in Bloomberg Business Week last October. His analysis responds to the International Monetary Fund’s 2016 Global Financial Stability Report that was hot off the press. Here are bullet points from that report: “medium-term risks continue to build”, meaning 1) growing political instability; 2) persistent weakness of financial institutions in China and Southern Europe; 3) excessive corporate debt in emerging markets. In China, combined public and private debt almost doubled over the past 10 years, and is now 210% of GDP (worldwide it’s 225% of GDP).
Mission: What’s the best way to tailor your retirement portfolio in response to these global risks? Become defensive. That doesn’t just mean having a Rainy Day Fund that is well-stocked with interest-earning cash-equivalents (Savings Bonds, Treasury Bills, and 2-Yr Treasury Notes). It means overweighting high quality “defensive stocks” in your equity portfolio. What is the Gold Standard? Companies in the S&P 100 Index that are in the 4 S&P Defensive Industries:
Consumer Staples;
Healthcare;
Utilities; and
Communication Services.
Large companies have multiple product lines, and membership in the S&P 100 Index requires a healthy options market for the company’s stock, to facilitate price discovery. You have to drill deeper in your analysis, to be sure the company’s S&P credit rating is A- or better, and its stock rating is A-/M or better. Statistical information has to be available from the 16-Yr series of the BMW Method and the 2017 Barron’s 500 List. Check financial statements for signs of high debt: long-term bonds that represent more than a third of total assets, operating cash flow that covers less than 40% of current liabilities, or an inability to meet dividend payments out of free cash flow (FCF). Exclude companies with negative Tangible Book Value.
Execution: By using the above criteria, we uncover 7 companies out of the 32 “defensive” companies in the S&P 100 Index (see Table).
Bottom Line: Defensive companies are less interesting than growth companies or companies involved in the production of raw commodities. But high-quality defensive companies, such as Johnson & Johnson (JNJ) and NextEra Energy (NEE), consistently grow earnings faster than GDP and are quick to correct any earnings shortfall. All an investor need do is learn to read financial statements, and regularly examine websites for data on companies of interest.
Risk Rating: 4 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold bullion).
Full Disclosure: I dollar-average into Coca-Cola (KO), NextEra Energy (NEE), and Johnson & Johnson (JNJ). I also own shares in Costco Wholesale (COST) and Wal-Mart Stores (WMT).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 15 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 4-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 20 in the Table. The ETF for that index is MDY at Line 14. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 28
Week 269 - “Buy and Hold” Barron’s 500 Defensive Companies
Situation: You will become a “risk-off” investor the day you retire. The most you’ll be able to draw from your retirement savings is 4%/yr, preferably 3.5%. That amount has to be re-calculated each year by adding enough to compensate for inflation. You’ll also need to match revenues with expenses, with the goal of spending 1/12th of that yearly income each month. Inflation won’t be your main problem, as long as 50% of your retirement savings are in the stock market, where prices inflate at about the same rate as your food and utility bills. In normal economic times, the interest paid on bonds you own will also track inflation. For example, the yield on 10-yr Treasuries has stayed at 2.3%/yr ahead of inflation since 2000, and over the past 140 yrs. Your problem will be living on a fixed income with an inflexible budget. Money to buy new clothes or take a vacation will have to come from a savings account that you’ve set up for non-recurring capital expenditures, an account that you contribute to every month.
To increase your spending power, three options are relatively common: 1) rent out part of your house and raise the rent faster than inflation raises your expenses; 2) find a part-time job where your after-tax income is likely to grow faster than inflation; and/or 3) benefit from “risk-off” stocks that you bought before retiring, stocks that you never plan to sell (because they pay a good and growing dividend). Let’s dig deeper on Option 3, living off dividend income.
Mission: Provide fundamental information about each company that pays “risk-off” dividends likely to grow faster than inflation.
Execution: I know what you’re thinking: this is alchemy. And you’re right. In a world that arbitrages every financial asset every day, there is no such thing as free money after accounting for inflation and transaction costs. So, let’s start with how finance professionals do it. They invest in AAA sovereign bonds. These days, they have to pay for that privilege. In other words, the safest bonds (German Bunds) pay negative interest. You’re not going to do that, so you’ll have to take a little bit of risk.
What is a “risk-off” dividend-growing stock? The risk that a dividend won’t increase continuously relates to the health of that company’s Balance Sheet. You’ve heard the phrase: “Bullet-proof Balance Sheet.” That means the company keeps cash (and cash-equivalents like US Treasury Bills) in a bank vault or with the US Treasury, and also has non-strategic assets that traders know can be sold for a good price, even during a recession. In recent blogs, we’ve talked about companies that have a “clean Balance Sheet” and have boiled that term down to tracking 4 ratios:
1. Total Debt:Equity is under 100% (or under 200% if the company is a regulated public utility). That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is the most important marker of a company’s “general financial condition." That ratio needs to be under 30% (35% if a regulated public utility). Long-term debt has to either be renewed at maturity or returned to the lender. In a financial crisis, the rate of interest that bankers charge for a renewal (“rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling assets or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies mainly in the perceived value of their brand, which accountants call “goodwill” when the company is sold for more than its book value. But remember that property, plant and equipment are carried at historic cost when calculating book value. So, goodwill is more than just the perceived value of the brand. It’s the buyer’s perception of current value for property, plant, and equipment. TBV may be negative for a short period after a company restructures, e.g. by selling non-strategic assets to pay down LT debt as Procter & Gamble (at Line 7 in the Table) did recently. If the other 3 ratios indicate a clean Balance Sheet, the TBV will likely continue to be raised on schedule.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow (i.e., “cash from operations” minus capital expenditures).
Administration: Most companies with A-rated stocks pay good and growing dividends. S&P calls those with a 10+ yr record of annual dividend boosts Dividend Achievers. Another quick way to find relatively safe stocks is to take a close look at those issued by companies in “defensive” industries (Consumer Staples, HealthCare, Utilities, and Communications Services). Why? Because they sell essential goods and services. Unfortunately, that extra bulwark against bankruptcy leads many of those companies away from maintaining a clean Balance Sheet and toward a reliance on borrowed money. And banks will comply. Even during the Lehman Panic, Johnson & Johnson (with its AAA credit rating) had no difficulty borrowing money at attractive interest rates. We also use another safety factor when looking for “risk-off” companies, which is to confine our search to Barron’s 500 companies. Why? Because those companies have large revenue streams, capturing revenue from multiple product lines. One or two of those lines will continue to grow during a recession, reducing the impact from lines that loose sales.
We find 7 Dividend Achievers in defensive industries that are sufficiently “risk-off” to be suitable for inclusion in a “buy and hold” retirement savings plan (see Table).
Bottom Line: It’s a nice idea, to find “safe companies” that pay a good and growing dividend. A retiree who paid $50,000 for stock in such companies over a 10 yr period prior to retirement will not be confined to living on a fixed income. By the time she retires, those stocks will be yielding 4-5% of their initial cost, and that $2000+/yr of income can be expected to grow 9+%/yr going forward. Ten yrs into retirement, she’ll be receiving dividend checks totaling ~$5000/yr. We’ve turned up 7 Dividend Achievers that are good bets for accomplishing that feat. In the aggregate, they’ve increased their dividend 12%/yr over the past 16 yrs (see Column H in the Table). None have a statistical risk of price loss in a Bear Market that exceeds the 31% loss projected for the S&P 500 Index, and their average projected loss is only 25% (see Column M in the Table).
Risk Rating: 4 (where Treasuries
= 1 and gold = 10)
Full Disclosure: I dollar-average monthly (www.computershare.com) into NEE, PG and JNJ, and also own shares in WMT and HRL.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is 16-Yr CAGR. Price Growth Rate is the mean or trendline 16-Yr Price CAGR (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
To increase your spending power, three options are relatively common: 1) rent out part of your house and raise the rent faster than inflation raises your expenses; 2) find a part-time job where your after-tax income is likely to grow faster than inflation; and/or 3) benefit from “risk-off” stocks that you bought before retiring, stocks that you never plan to sell (because they pay a good and growing dividend). Let’s dig deeper on Option 3, living off dividend income.
Mission: Provide fundamental information about each company that pays “risk-off” dividends likely to grow faster than inflation.
Execution: I know what you’re thinking: this is alchemy. And you’re right. In a world that arbitrages every financial asset every day, there is no such thing as free money after accounting for inflation and transaction costs. So, let’s start with how finance professionals do it. They invest in AAA sovereign bonds. These days, they have to pay for that privilege. In other words, the safest bonds (German Bunds) pay negative interest. You’re not going to do that, so you’ll have to take a little bit of risk.
What is a “risk-off” dividend-growing stock? The risk that a dividend won’t increase continuously relates to the health of that company’s Balance Sheet. You’ve heard the phrase: “Bullet-proof Balance Sheet.” That means the company keeps cash (and cash-equivalents like US Treasury Bills) in a bank vault or with the US Treasury, and also has non-strategic assets that traders know can be sold for a good price, even during a recession. In recent blogs, we’ve talked about companies that have a “clean Balance Sheet” and have boiled that term down to tracking 4 ratios:
1. Total Debt:Equity is under 100% (or under 200% if the company is a regulated public utility). That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is the most important marker of a company’s “general financial condition." That ratio needs to be under 30% (35% if a regulated public utility). Long-term debt has to either be renewed at maturity or returned to the lender. In a financial crisis, the rate of interest that bankers charge for a renewal (“rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling assets or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies mainly in the perceived value of their brand, which accountants call “goodwill” when the company is sold for more than its book value. But remember that property, plant and equipment are carried at historic cost when calculating book value. So, goodwill is more than just the perceived value of the brand. It’s the buyer’s perception of current value for property, plant, and equipment. TBV may be negative for a short period after a company restructures, e.g. by selling non-strategic assets to pay down LT debt as Procter & Gamble (at Line 7 in the Table) did recently. If the other 3 ratios indicate a clean Balance Sheet, the TBV will likely continue to be raised on schedule.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow (i.e., “cash from operations” minus capital expenditures).
Administration: Most companies with A-rated stocks pay good and growing dividends. S&P calls those with a 10+ yr record of annual dividend boosts Dividend Achievers. Another quick way to find relatively safe stocks is to take a close look at those issued by companies in “defensive” industries (Consumer Staples, HealthCare, Utilities, and Communications Services). Why? Because they sell essential goods and services. Unfortunately, that extra bulwark against bankruptcy leads many of those companies away from maintaining a clean Balance Sheet and toward a reliance on borrowed money. And banks will comply. Even during the Lehman Panic, Johnson & Johnson (with its AAA credit rating) had no difficulty borrowing money at attractive interest rates. We also use another safety factor when looking for “risk-off” companies, which is to confine our search to Barron’s 500 companies. Why? Because those companies have large revenue streams, capturing revenue from multiple product lines. One or two of those lines will continue to grow during a recession, reducing the impact from lines that loose sales.
We find 7 Dividend Achievers in defensive industries that are sufficiently “risk-off” to be suitable for inclusion in a “buy and hold” retirement savings plan (see Table).
Bottom Line: It’s a nice idea, to find “safe companies” that pay a good and growing dividend. A retiree who paid $50,000 for stock in such companies over a 10 yr period prior to retirement will not be confined to living on a fixed income. By the time she retires, those stocks will be yielding 4-5% of their initial cost, and that $2000+/yr of income can be expected to grow 9+%/yr going forward. Ten yrs into retirement, she’ll be receiving dividend checks totaling ~$5000/yr. We’ve turned up 7 Dividend Achievers that are good bets for accomplishing that feat. In the aggregate, they’ve increased their dividend 12%/yr over the past 16 yrs (see Column H in the Table). None have a statistical risk of price loss in a Bear Market that exceeds the 31% loss projected for the S&P 500 Index, and their average projected loss is only 25% (see Column M in the Table).
Risk Rating: 4 (where Treasuries
= 1 and gold = 10)
Full Disclosure: I dollar-average monthly (www.computershare.com) into NEE, PG and JNJ, and also own shares in WMT and HRL.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is 16-Yr CAGR. Price Growth Rate is the mean or trendline 16-Yr Price CAGR (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 7
Week 266 - “Buy-and-hold” Barron's 500 Dividend Achievers in the Consumer Staples Industry
Situation: Let’s say you’re in your 50s and have made good investments through the tax-deferred retirement plan at your workplace, and your IRA. But you doubt those investments will replace 80% of your income after you retire. Taxable investments will have to fill the breach, mainly stocks that throw off ~2.5%/yr in dividends and grow those dividends ~10%/yr. There is no mutual fund that will do that for you. You have to pick stocks and reinvest dividends while you’re still working. By the time you retire, annual dividends/share will probably amount to more than 4% of your initial investment in shares. You can have the dividends sent to your bank and spend that income while preserving the shares. Utilities (and Communication Services companies) pay higher dividends but grow those more slowly, so you’ll probably do as well by holding stock in Consumer Staples companies.
Mission: Find high quality Consumer Staples stocks to “buy-and-hold.” That’s not easy, given that the market for consumer staples grows slowly. However, the market has the advantage of low elasticity (i.e., it doesn’t stop growing during a recession). That stability means companies can try to grow earnings faster (enough to attract investors) by using leverage, i.e., over-borrowing. Usually, that leaves companies with negative Tangible Book Value. But their managers don’t worry about that because the risk of bankruptcy is low, since elasticity is low. The beauty of leverage is two-fold: 1) the government picks up the tab (interest isn’t taxable); 2) Return on Equity (ROE) soars because the company is mainly capitalized with long-term bonds. But you’re investing for your retirement, and know that leverage always creates risk, i.e., the stock’s price will collapse, someday.
Execution: As a prudent investor, you always want to avoid owning stock in companies that 1) carry twice as much debt as equity, 2) are capitalized more than 50% with long-term bonds, and 3) have negative Tangible Book Value (see Columns AD through AF in this week’s Table). Among the 20 Consumer Staples industry Dividend Achievers on the 2016 Barron’s 500 List, those restrictions leave us with only 8 to consider (see Table).
Bottom Line: You don’t want to outlive your retirement savings, so you’ll spend no more than 4% of your savings each year. But stocks are different than mutual funds because you can select stocks that pay a good and growing dividend. By using dividend reinvestment during your working years, those stocks can by paying a 4% dividend (on their initial cost) by the time you retire. That allows you to avoid selling any shares and simply spend the income. Those shares will continue to grow in value and spin off proportionately higher dividends. Your nest egg of shares in individual stocks becomes the rarest of retirement asset classes. It is one that grows during retirement while allowing you to take out 4%/yr. The trick is to find high quality companies that reliably pay a good and growing dividend. Most likely, you’ll find such companies in only 3 of the 10 S&P industries: Utilities, Communication Services, and Consumer Staples. This week we cover Consumer Staples.
Risk Rating: 4 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into PG, and also own stock in WMT, KO, HRL and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Find high quality Consumer Staples stocks to “buy-and-hold.” That’s not easy, given that the market for consumer staples grows slowly. However, the market has the advantage of low elasticity (i.e., it doesn’t stop growing during a recession). That stability means companies can try to grow earnings faster (enough to attract investors) by using leverage, i.e., over-borrowing. Usually, that leaves companies with negative Tangible Book Value. But their managers don’t worry about that because the risk of bankruptcy is low, since elasticity is low. The beauty of leverage is two-fold: 1) the government picks up the tab (interest isn’t taxable); 2) Return on Equity (ROE) soars because the company is mainly capitalized with long-term bonds. But you’re investing for your retirement, and know that leverage always creates risk, i.e., the stock’s price will collapse, someday.
Execution: As a prudent investor, you always want to avoid owning stock in companies that 1) carry twice as much debt as equity, 2) are capitalized more than 50% with long-term bonds, and 3) have negative Tangible Book Value (see Columns AD through AF in this week’s Table). Among the 20 Consumer Staples industry Dividend Achievers on the 2016 Barron’s 500 List, those restrictions leave us with only 8 to consider (see Table).
Bottom Line: You don’t want to outlive your retirement savings, so you’ll spend no more than 4% of your savings each year. But stocks are different than mutual funds because you can select stocks that pay a good and growing dividend. By using dividend reinvestment during your working years, those stocks can by paying a 4% dividend (on their initial cost) by the time you retire. That allows you to avoid selling any shares and simply spend the income. Those shares will continue to grow in value and spin off proportionately higher dividends. Your nest egg of shares in individual stocks becomes the rarest of retirement asset classes. It is one that grows during retirement while allowing you to take out 4%/yr. The trick is to find high quality companies that reliably pay a good and growing dividend. Most likely, you’ll find such companies in only 3 of the 10 S&P industries: Utilities, Communication Services, and Consumer Staples. This week we cover Consumer Staples.
Risk Rating: 4 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into PG, and also own stock in WMT, KO, HRL and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 5
Week 257 - Barron’s 500 Defensive Stocks That Have Outperformed the S&P 500 for 16 Years
Situation: This is Blog #3 of a 3-blog series on S&P 500 Index stocks that have outperformed that Index for 16 yrs, i.e., up more and down less (see Week 255 and Week 256). For each blog, the companies we analyze are S&P Dividend Achievers and have high S&P ratings on their stocks and bonds. This week we cover companies in “defensive” S&P industries that have revenues sufficient for inclusion in the recently published 2016 Barron’s 500 List.
Mission: We select Dividend Achievers in defensive industries (Consumer Staples, HealthCare, Utilities, and Communication Services) that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks were up more and down less: 16-yr total returns/yr were greater and losses in the last market correction (April through September of 2011) were less. In addition, all companies must have an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher. Net Present Values are calculated; NPV data points are presented in U-Y of the Table. [A full explanation of inputs for NPV calculations is given in the Appendix of last week’s blog (Week 256).]
Execution: see Table.
Bottom Line: Five companies are outstanding. MO, COST, HRL, NEE and CVS have NPVs that are above the group average, as well as improving 3-yr trends in cash-flow based Return on Invested Capital (ROIC) and sales (which determine a company’s Barron’s 500 rank), and an ROIC that exceeds the company’s weighted average cost of capital (WACC).
Risk Ranking: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into JNJ, NEE and PG, and own shares of ABT, HRL, CVS, KO and PEP.
NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 26 in the Table). Metrics highlighted in green at Columns Q and R in the Table indicate improving performance trends for fundamental business parameters. Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC. Aside from NPV calculations for May 12, 2016, metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: We select Dividend Achievers in defensive industries (Consumer Staples, HealthCare, Utilities, and Communication Services) that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks were up more and down less: 16-yr total returns/yr were greater and losses in the last market correction (April through September of 2011) were less. In addition, all companies must have an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher. Net Present Values are calculated; NPV data points are presented in U-Y of the Table. [A full explanation of inputs for NPV calculations is given in the Appendix of last week’s blog (Week 256).]
Execution: see Table.
Bottom Line: Five companies are outstanding. MO, COST, HRL, NEE and CVS have NPVs that are above the group average, as well as improving 3-yr trends in cash-flow based Return on Invested Capital (ROIC) and sales (which determine a company’s Barron’s 500 rank), and an ROIC that exceeds the company’s weighted average cost of capital (WACC).
Risk Ranking: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into JNJ, NEE and PG, and own shares of ABT, HRL, CVS, KO and PEP.
NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 26 in the Table). Metrics highlighted in green at Columns Q and R in the Table indicate improving performance trends for fundamental business parameters. Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC. Aside from NPV calculations for May 12, 2016, metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 27
Week 247 - S&P 500 Dividend Achievers That Have Tangible Book Value And Are In Defensive Industries
Situation: When the stock market is shaky, an investor’s thoughts turn to safety. You need an algorithm. Which stocks do you want to stick with, and maybe buy more of, while they’re on sale? More importantly, how did you get in this jam in the first place?
Mission: Come up with stocks likely to weather down markets without falling behind in up markets. Using a baseball term, we’re looking for a way to hit singles regularly.
Execution: Step #1 is to list all the Dividend Achievers (companies that have increased their dividend annually for at least the past 10 yrs) in “Defensive” S&P industries of the S&P 500 Index (Consumer Staples, HealthCare, Utilities, Communication Services). Step #2 is to eliminate companies that have no Tangible Book Value (TBV), meaning companies whose Liabilities have a higher dollar value than their Tangible Assets. Step #3 is to eliminate any that have an S&P Bond Rating lower than A- or an S&P Stock Rating lower than A-/M. Step #4 is to eliminate any that don’t have enough revenue to appear on the 2015 Barron’s 500 List. Step #5 is to eliminate any whose stocks haven’t been traded on a public exchange for more than 16 yrs.
Administration: There are 11 stocks that meet our requirements for reasonable and prudent investing (see Table), an algorithm for all seasons. But that begs the question: Why do so many of us avoid reasonable and prudent investing and instead “play” the market? After all, 95% of stock-pickers would do better (in the long run) simply by dollar-averaging into the bond-heavy Vanguard Wellesley Income Fund (compare VWINX at Line 16 in the Table to VFINX at Line 19). So, we’re not really picking stocks just to make money. We also need the outlet, a way to bring our “animal spirits” safely to life and hope to make our lives a little grander. The trick then is to analyze why we invest the way we do, and decide who we hope to impress.
Bottom Line: “It will fluctuate.” That’s how JP Morgan answered a young man’s question about the stock market. But stocks of some companies fluctuate less. Those companies are in “defensive” industries: Consumer Staples, HealthCare, Utilities, and Communication Services. To avoid that sinking feeling in the pit of your stomach whenever the market swoons, pick A-rated stocks from among Dividend Achievers in those industries. Focus on companies that are valued as much for their real assets as their brand.
Risk Rating: 4
Full Disclosure: I own shares of ABT, JNJ, NEE, HRL, KO, 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 9/1/2000, a peak of the S&P 500 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Come up with stocks likely to weather down markets without falling behind in up markets. Using a baseball term, we’re looking for a way to hit singles regularly.
Execution: Step #1 is to list all the Dividend Achievers (companies that have increased their dividend annually for at least the past 10 yrs) in “Defensive” S&P industries of the S&P 500 Index (Consumer Staples, HealthCare, Utilities, Communication Services). Step #2 is to eliminate companies that have no Tangible Book Value (TBV), meaning companies whose Liabilities have a higher dollar value than their Tangible Assets. Step #3 is to eliminate any that have an S&P Bond Rating lower than A- or an S&P Stock Rating lower than A-/M. Step #4 is to eliminate any that don’t have enough revenue to appear on the 2015 Barron’s 500 List. Step #5 is to eliminate any whose stocks haven’t been traded on a public exchange for more than 16 yrs.
Administration: There are 11 stocks that meet our requirements for reasonable and prudent investing (see Table), an algorithm for all seasons. But that begs the question: Why do so many of us avoid reasonable and prudent investing and instead “play” the market? After all, 95% of stock-pickers would do better (in the long run) simply by dollar-averaging into the bond-heavy Vanguard Wellesley Income Fund (compare VWINX at Line 16 in the Table to VFINX at Line 19). So, we’re not really picking stocks just to make money. We also need the outlet, a way to bring our “animal spirits” safely to life and hope to make our lives a little grander. The trick then is to analyze why we invest the way we do, and decide who we hope to impress.
Bottom Line: “It will fluctuate.” That’s how JP Morgan answered a young man’s question about the stock market. But stocks of some companies fluctuate less. Those companies are in “defensive” industries: Consumer Staples, HealthCare, Utilities, and Communication Services. To avoid that sinking feeling in the pit of your stomach whenever the market swoons, pick A-rated stocks from among Dividend Achievers in those industries. Focus on companies that are valued as much for their real assets as their brand.
Risk Rating: 4
Full Disclosure: I own shares of ABT, JNJ, NEE, HRL, KO, 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 9/1/2000, a peak of the S&P 500 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 10
Week 236 - A 10-Stock Retirement Portfolio (One Stock For Each S&P Industry)
Situation: If you don’t want to depend entirely on index funds to fund your retirement, you’ll need a plan for buying stocks. One approach is to only choose stocks from defensive industries, i.e., Consumer Staples, HealthCare, Utilities and Communication Services (see Week 231). Another strategy would be to have all 10 S&P industries represented, which would make your portfolio more diversified. (Academic studies show that returns are higher from owning stocks that are diversified across industries.)
Mission: Pick one stock from each of the 10 S&P industries, meaning the 4 defensive industries listed above, plus Industrials, Financial Services, Consumer Discretionary, Information Technology, Basic Materials, and Energy.
Execution: To avoid “cherry-picking” from a list of currently impressive stocks, I’ll simply present the 10 stocks in the S&P 100 list that I dollar-average into (see Table). To be complete, 9 alternates from the S&P 100 Index are listed.
Administration: Five of the stocks can be purchased online and without additional fees by making pre-programed monthly additions with automatic dividend reinvestment using computershare: Exxon Mobil (XOM), NextEra Energy (NEE), Abbott Laboratories (ABT), IBM (IBM) and Union Pacific (UNP). One exception is that IBM levies a 2% fee for reinvesting dividends. The remaining 5 stocks are available at reasonable cost, also from computershare: Monsanto (MON), JP Morgan (JPM), PepsiCo (PEP), AT&T (T), and Nike (NKE). 10-yr US Treasury Notes can be purchased at no cost at treasurydirect but automatic purchase is not available and you’ll need to point-and-click each purchase, as well as reinvest interest payments. Total transaction costs per year come to ~$137 if you invest $1200 (or $19,200/yr) in each of the 10 stocks and 6 Treasury bonds. This results in an expense ratio of 0.71% (see Column U in the Table).
Bottom Line: We’ve shown that you can dollar-average $100/mo into one stock for each S&P industry, and back that up with $600/mo in 10-yr US Treasury Notes, to achieve a total return/yr of ~7.0% dating back to the S&P 500 Index peak on 9/1/2000 (after subtracting transaction costs of 0.71%/yr). This beats our key benchmark (the Vanguard Balanced Index Fund, VBINX) by approximately 2.0%/yr without incurring additional volatility, according to standard measures (see Columns D, I, and O in the Table). However, you are responsible for the considerable risk of sampling bias, since you’ll be selecting only one stock to represent each of the 10 S&P industries.
Risk Rating: 6
Note: Metrics in the Table that are highlighted in red indicate underperformance relative to our key benchmark (VBINX). Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Pick one stock from each of the 10 S&P industries, meaning the 4 defensive industries listed above, plus Industrials, Financial Services, Consumer Discretionary, Information Technology, Basic Materials, and Energy.
Execution: To avoid “cherry-picking” from a list of currently impressive stocks, I’ll simply present the 10 stocks in the S&P 100 list that I dollar-average into (see Table). To be complete, 9 alternates from the S&P 100 Index are listed.
Administration: Five of the stocks can be purchased online and without additional fees by making pre-programed monthly additions with automatic dividend reinvestment using computershare: Exxon Mobil (XOM), NextEra Energy (NEE), Abbott Laboratories (ABT), IBM (IBM) and Union Pacific (UNP). One exception is that IBM levies a 2% fee for reinvesting dividends. The remaining 5 stocks are available at reasonable cost, also from computershare: Monsanto (MON), JP Morgan (JPM), PepsiCo (PEP), AT&T (T), and Nike (NKE). 10-yr US Treasury Notes can be purchased at no cost at treasurydirect but automatic purchase is not available and you’ll need to point-and-click each purchase, as well as reinvest interest payments. Total transaction costs per year come to ~$137 if you invest $1200 (or $19,200/yr) in each of the 10 stocks and 6 Treasury bonds. This results in an expense ratio of 0.71% (see Column U in the Table).
Bottom Line: We’ve shown that you can dollar-average $100/mo into one stock for each S&P industry, and back that up with $600/mo in 10-yr US Treasury Notes, to achieve a total return/yr of ~7.0% dating back to the S&P 500 Index peak on 9/1/2000 (after subtracting transaction costs of 0.71%/yr). This beats our key benchmark (the Vanguard Balanced Index Fund, VBINX) by approximately 2.0%/yr without incurring additional volatility, according to standard measures (see Columns D, I, and O in the Table). However, you are responsible for the considerable risk of sampling bias, since you’ll be selecting only one stock to represent each of the 10 S&P industries.
Risk Rating: 6
Note: Metrics in the Table that are highlighted in red indicate underperformance relative to our key benchmark (VBINX). Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 6
Week 231 - Can the 4% Rule Sustain You in Retirement Without Eroding Principal?
Situation: You don’t want to outlive your money. So, you’ll need a retirement plan that is robust enough to stay on track until you’re 100. Monthly payments from Social Security, plus Required Minimal Distributions from a 401(k) Plan, should see you through. However, a fixed-income private annuity or a workplace pension plan won’t keep up with inflation. After age 50, you’re allowed to add $6,500/yr to your IRA, which can contain stocks, bonds and mutual funds of your own choosing. To spend from your “Nest Egg” in retirement, most advisors recommend some variation of the “4% Rule." Its originator, Bill Bengen, back-tested the math (assuming an even split between bonds and stocks) and “found that retirees who withdrew 4 percent of their initial retirement portfolio balance, and then adjusted that dollar amount for inflation each year thereafter, would have created a paycheck that lasted for 30 years”. Nowadays, interest rates are being held at artificially low levels by almost every Central Bank. So, you’d better start your retirement with an appropriate adjustment (~60% stocks and ~40% bonds).
Mission: Find out if a new retiree who has stocks and bonds in a 60:40 mix can follow the 4% rule without drawing down principal (the initial retirement balance adjusted for inflation). Given that retirement savings are defensive by definition, those bonds should be 10-yr US Treasury Notes and/or a low-cost intermediate-term investment-grade bond fund like the Vanguard Interm-Term Bond Index (VBINX in the Table). Those stocks should be issued by 6 or 7 large-capitalization companies (i.e., those in the S&P 100 Index) selected from the list of Dividend Achievers representative of the 4 defensive S&P industries (HealthCare, Utilities, Communication Services, and Consumer Staples).
Execution: The Table reflects a 20 yr period of analysis using our standard spreadsheet. The assumption is that retirement began 20 yrs ago, and that each line item had the same value as every other line item at that time. No additional funds have been added. PLAN A represents my approach, i.e., to invest in 7 stocks that are collateralized with 10-yr US Treasury Notes (reinvested upon reaching maturity). PLAN B uses a bond fund instead of 10-yr Treasuries and stocks that are more growth-oriented (see Column L in the Table). Overall, there are 12 stocks in the S&P 100 Index that qualify by having Dividend Achiever status, an S&P stock rating of B+/M or better, and an S&P bond rating of BBB+ or better. NOTE: NextEra Energy (NEE) meets all criteria for inclusion in the S&P 100 and will likely be added soon, making a total of 13 stocks that are suitable for inclusion in a conservative retirement plan.
Bottom Line: Inflation averaged ~2.2%/yr over the past 20 yrs, so the 4% rule would fail to maintain principal if the average total return/yr for Plan A or Plan B were less than 4.0% + 2.2%. Plan A returned over 7%/yr and Plan B returned approximately 10%/yr. So, the value of the original investment, corrected for inflation, remained intact over the first 20 yrs of retirement. The same is true for the past 5 yrs (shown in Column F of the Table) when inflation averaged ~1.5%/yr. There is no material difference between PLAN A and PLAN B, given the slightly higher risk profile of PLAN B (see Columns J through L in the Table).
Risk Ratings: 4 (PLAN A) and 5 (PLAN B)
Full Disclosure: I have stock in KO, JNJ and WMT, and dollar-average into NEE, T, PEP and ABT as well as 10-yr T-Notes.
Note: Metrics highlighted in red denote underperformance vs. our benchmark (VBINX). Metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Find out if a new retiree who has stocks and bonds in a 60:40 mix can follow the 4% rule without drawing down principal (the initial retirement balance adjusted for inflation). Given that retirement savings are defensive by definition, those bonds should be 10-yr US Treasury Notes and/or a low-cost intermediate-term investment-grade bond fund like the Vanguard Interm-Term Bond Index (VBINX in the Table). Those stocks should be issued by 6 or 7 large-capitalization companies (i.e., those in the S&P 100 Index) selected from the list of Dividend Achievers representative of the 4 defensive S&P industries (HealthCare, Utilities, Communication Services, and Consumer Staples).
Execution: The Table reflects a 20 yr period of analysis using our standard spreadsheet. The assumption is that retirement began 20 yrs ago, and that each line item had the same value as every other line item at that time. No additional funds have been added. PLAN A represents my approach, i.e., to invest in 7 stocks that are collateralized with 10-yr US Treasury Notes (reinvested upon reaching maturity). PLAN B uses a bond fund instead of 10-yr Treasuries and stocks that are more growth-oriented (see Column L in the Table). Overall, there are 12 stocks in the S&P 100 Index that qualify by having Dividend Achiever status, an S&P stock rating of B+/M or better, and an S&P bond rating of BBB+ or better. NOTE: NextEra Energy (NEE) meets all criteria for inclusion in the S&P 100 and will likely be added soon, making a total of 13 stocks that are suitable for inclusion in a conservative retirement plan.
Bottom Line: Inflation averaged ~2.2%/yr over the past 20 yrs, so the 4% rule would fail to maintain principal if the average total return/yr for Plan A or Plan B were less than 4.0% + 2.2%. Plan A returned over 7%/yr and Plan B returned approximately 10%/yr. So, the value of the original investment, corrected for inflation, remained intact over the first 20 yrs of retirement. The same is true for the past 5 yrs (shown in Column F of the Table) when inflation averaged ~1.5%/yr. There is no material difference between PLAN A and PLAN B, given the slightly higher risk profile of PLAN B (see Columns J through L in the Table).
Risk Ratings: 4 (PLAN A) and 5 (PLAN B)
Full Disclosure: I have stock in KO, JNJ and WMT, and dollar-average into NEE, T, PEP and ABT as well as 10-yr T-Notes.
Note: Metrics highlighted in red denote underperformance vs. our benchmark (VBINX). Metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 15
Week 193 - Barron’s 500 Companies with 25 years of Below-Market Variance in Stock Price Appreciation
Situation: Now that US stock and bond markets appear to be fully valued, it is time to pause and reflect. The metric we refer to as Finance Value is derived by subtracting risk from reward. But what is reward and what is risk? Reward is stock-price appreciation (plus appreciation due to reinvested dividend payments) over the long term. Let’s call it the 25 yr period that for most people is the most active time of saving for retirement. Risk can be summed up by a term from statistics: variance.
As defined at the Investopedia website, variance is “a measurement of the spread between numbers in a data set. The variance measures how far each number in the set is from the mean. Variance is calculated by taking the differences between each number in the set and the mean, squaring the differences (to make them positive), and dividing the sum of the squares by the number of values in the set . . . Since variance measures the variability (volatility) from an average or mean, and volatility is a measure of risk, the variance statistic can help determine the risk an investor might take on when purchasing a specific security.” What does this mean in practical terms? Variance tells us how closely a company skirts the edge of oblivion (bankruptcy). The quickest way to track variance is to always check out the S&P credit report.
The S&P 500 Index has 4-5 times the level of variance that is found in an investment grade bond index. If stocks represent more than 25% of your retirement savings, you'll feel pain from a stock market crash. (Stocks can go down a lot just when you need the money.) The solution is to overweight bonds in your portfolio, or buy shares of a mutual fund that will do that for you (e.g. VWINX at Line 20 in the Table). However, few people who haven’t been to business school can embrace that idea of overweighting bonds. Why? Because it is much more entertaining to own stocks, and the incentives are greater. Those incentives include 1) greater returns over the very long term; 2) greater transparency of valuation metrics; 3) a narrower spread between bid and ask prices; 4) dividend payments that track earnings vs. interest payments that are fixed; 5) earnings growth that usually stays ahead of inflation, whereas, bonds lose value with inflation. Bondholders, however, benefit from two distinct advantages: 1) the return of principal upon maturity of the bond, whereas, stocks merely provide a return on principal; 2) in the event of bankruptcy, bondholders get money from the sale of assets but stockholders get nothing.
We'll look at several measures of risk over a 25-yr time period, to see if we can come up with a few stocks in the Barron’s 500 List that are less risky than the S&P 500 Index by every one of those measures.
We’ll start with the “BMW Method” to examine variance in CAGR (compound average growth rate) for stock prices over the past 25 yrs. This analysis will tell us the rate of price appreciation arrived at from the “least squares” calculation defined above for daily prices over 25 yrs. Applying the "least squares" test creates a trendline for the logarithm of daily prices. The BMW Method data set has 25-yr log-linear plots for the stocks of 560 companies, revised forward at the first of each month. At the BMW website, you’ll find that each regression line (of price over time) has two parallel lines above it and two parallel lines below it. Those represent one or two Standard Deviations (1SD or 2SD) from the rate of price appreciation. For example, the S&P 500 Index (^GSPC) has a 25-yr price appreciation of 6.4%/yr and the -1SD CAGR is 20% less (5.2%/yr).
In the Table, we list the 25-year rate of price appreciation in Column Q and the Standard Deviation (plus or minus 1SD or 2SD) in Column R. Most stocks, and the S&P 500 Index, are currently “on trend.” We’ve excluded companies whose current stock prices are 1SD or 2SD off trend, since that represents the volatility we’re trying to avoid. We’ve also excluded stocks that have a 5-yr Beta greater than the 5-yr Beta for the hedged S&P 500 Index (VBINX at Line 22 in the Table), as well as stocks with a 25-yr growth rate that has greater variance than the S&P 500 Index. Stocks that haven’t exceeded their best price in last bull market, which ended in October of 2007, are also excluded. In addition to these variance criteria, we’ve excluded companies that lost more than the 46.5% that the lowest-cost S&P 500 Index fund (VFINX at Line 24 in the Table) lost during the 18-month Lehman Panic. And, we’ve excluded companies with S&P bond ratings below BBB+ and/or S&P stock ratings below B+/M.
Only 15 companies remain (Table). Its not surprising that 11 of those are Dividend Aristocrats, i.e., companies that have been growing their dividends annually for at least 25 years (see Column V in the Table).
Now let’s look at valuation metrics like P/E and EV/EBITDA (Columns J and K in the Table). And, we’ll add a new twist: PEGY (Column N), which is P/E divided by two metrics: estimated 5-yr rate of Growth in earnings (Column L) and dividend Yield (Column G). Recall that any P/E higher than 20 suggests that the stock is overpriced, since earnings yield then falls below 5%. Similarly, any company with an Enterprise Value that is more than 13 times higher than year-over-year operating earnings is overpriced (in our opinion). For PEGY, we think any number over 2.0 suggests that the stock is overpriced while any number under 1.2 suggests that the stock is underpriced. Taking these 3 metrics together (P/E, EV/EBITDA, and PEGY), which of the 15 stocks flunk all 3 tests? There are 4: CLX, CL, KO, HSY. The only stocks that are not overpriced by any of those 3 metrics are: McDonald’s (MCD), Microsoft (MSFT) and Comcast (CMCSA).
Bottom Line: This week we’ve tried to take the sting out of the stock market by finding stocks that have a 25-yr history of being less risky than the S&P 500 Index by every one of several volatility tests. We found 15, and 12 of those companies happen to be “defensive” stocks as defined by Standard & Poors (i.e., companies in the Consumer Staples, Healthcare, Utilities, and Communication Services industries). Then we looked at valuations, finding that 4 of the 15 are pricey by 3 metrics: P/E, EV/EBITDA, and PEGY. Those 6 are balanced by 5 stocks that aren't pricey (McDonald’s, Microsoft and Comcast).
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and MSFT, and also own shares of PG, PEP, KO and MCD.
NOTE: Metrics in the Table are brought current as of the Sunday of publication; red highlights 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
As defined at the Investopedia website, variance is “a measurement of the spread between numbers in a data set. The variance measures how far each number in the set is from the mean. Variance is calculated by taking the differences between each number in the set and the mean, squaring the differences (to make them positive), and dividing the sum of the squares by the number of values in the set . . . Since variance measures the variability (volatility) from an average or mean, and volatility is a measure of risk, the variance statistic can help determine the risk an investor might take on when purchasing a specific security.” What does this mean in practical terms? Variance tells us how closely a company skirts the edge of oblivion (bankruptcy). The quickest way to track variance is to always check out the S&P credit report.
The S&P 500 Index has 4-5 times the level of variance that is found in an investment grade bond index. If stocks represent more than 25% of your retirement savings, you'll feel pain from a stock market crash. (Stocks can go down a lot just when you need the money.) The solution is to overweight bonds in your portfolio, or buy shares of a mutual fund that will do that for you (e.g. VWINX at Line 20 in the Table). However, few people who haven’t been to business school can embrace that idea of overweighting bonds. Why? Because it is much more entertaining to own stocks, and the incentives are greater. Those incentives include 1) greater returns over the very long term; 2) greater transparency of valuation metrics; 3) a narrower spread between bid and ask prices; 4) dividend payments that track earnings vs. interest payments that are fixed; 5) earnings growth that usually stays ahead of inflation, whereas, bonds lose value with inflation. Bondholders, however, benefit from two distinct advantages: 1) the return of principal upon maturity of the bond, whereas, stocks merely provide a return on principal; 2) in the event of bankruptcy, bondholders get money from the sale of assets but stockholders get nothing.
We'll look at several measures of risk over a 25-yr time period, to see if we can come up with a few stocks in the Barron’s 500 List that are less risky than the S&P 500 Index by every one of those measures.
We’ll start with the “BMW Method” to examine variance in CAGR (compound average growth rate) for stock prices over the past 25 yrs. This analysis will tell us the rate of price appreciation arrived at from the “least squares” calculation defined above for daily prices over 25 yrs. Applying the "least squares" test creates a trendline for the logarithm of daily prices. The BMW Method data set has 25-yr log-linear plots for the stocks of 560 companies, revised forward at the first of each month. At the BMW website, you’ll find that each regression line (of price over time) has two parallel lines above it and two parallel lines below it. Those represent one or two Standard Deviations (1SD or 2SD) from the rate of price appreciation. For example, the S&P 500 Index (^GSPC) has a 25-yr price appreciation of 6.4%/yr and the -1SD CAGR is 20% less (5.2%/yr).
In the Table, we list the 25-year rate of price appreciation in Column Q and the Standard Deviation (plus or minus 1SD or 2SD) in Column R. Most stocks, and the S&P 500 Index, are currently “on trend.” We’ve excluded companies whose current stock prices are 1SD or 2SD off trend, since that represents the volatility we’re trying to avoid. We’ve also excluded stocks that have a 5-yr Beta greater than the 5-yr Beta for the hedged S&P 500 Index (VBINX at Line 22 in the Table), as well as stocks with a 25-yr growth rate that has greater variance than the S&P 500 Index. Stocks that haven’t exceeded their best price in last bull market, which ended in October of 2007, are also excluded. In addition to these variance criteria, we’ve excluded companies that lost more than the 46.5% that the lowest-cost S&P 500 Index fund (VFINX at Line 24 in the Table) lost during the 18-month Lehman Panic. And, we’ve excluded companies with S&P bond ratings below BBB+ and/or S&P stock ratings below B+/M.
Only 15 companies remain (Table). Its not surprising that 11 of those are Dividend Aristocrats, i.e., companies that have been growing their dividends annually for at least 25 years (see Column V in the Table).
Now let’s look at valuation metrics like P/E and EV/EBITDA (Columns J and K in the Table). And, we’ll add a new twist: PEGY (Column N), which is P/E divided by two metrics: estimated 5-yr rate of Growth in earnings (Column L) and dividend Yield (Column G). Recall that any P/E higher than 20 suggests that the stock is overpriced, since earnings yield then falls below 5%. Similarly, any company with an Enterprise Value that is more than 13 times higher than year-over-year operating earnings is overpriced (in our opinion). For PEGY, we think any number over 2.0 suggests that the stock is overpriced while any number under 1.2 suggests that the stock is underpriced. Taking these 3 metrics together (P/E, EV/EBITDA, and PEGY), which of the 15 stocks flunk all 3 tests? There are 4: CLX, CL, KO, HSY. The only stocks that are not overpriced by any of those 3 metrics are: McDonald’s (MCD), Microsoft (MSFT) and Comcast (CMCSA).
Bottom Line: This week we’ve tried to take the sting out of the stock market by finding stocks that have a 25-yr history of being less risky than the S&P 500 Index by every one of several volatility tests. We found 15, and 12 of those companies happen to be “defensive” stocks as defined by Standard & Poors (i.e., companies in the Consumer Staples, Healthcare, Utilities, and Communication Services industries). Then we looked at valuations, finding that 4 of the 15 are pricey by 3 metrics: P/E, EV/EBITDA, and PEGY. Those 6 are balanced by 5 stocks that aren't pricey (McDonald’s, Microsoft and Comcast).
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and MSFT, and also own shares of PG, PEP, KO and MCD.
NOTE: Metrics in the Table are brought current as of the Sunday of publication; red highlights 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, August 3
Week 161 - Food Processors That Stock Grocery Store Shelves
Situation: I think we’ve all become a little bit leery of the current stock market. Market analysts keep anticipating GDP growth of 3% but the International Monetary Fund projects that GDP growth in the US is only going to be 1.6% for 2014, and Janet Yellen (the new Chairperson of the Federal Reserve) says that our economy won’t return to 3% GDP growth until 2016 at the earliest. Investors have responded by again sheltering in safe harbors like companies in the 4 “defensive” S&P Industries. Those would be: Consumer Staples, Healthcare, Utilities, and Communication Services. That means those stocks are overpriced according to their Price/Earnings ratio--price divided by earnings over the past 4 quarters (P/E) has moved into the danger zone. P/E ratios higher than 20 are considered too high because returns to the investor drop below 5%/yr. When returns from “defensive” stocks fall that far, professional investors will start to cut their risk profile by moving money into corporate bonds, e.g. Vanguard’s Intermediate-Term Investment-Grade Bond Fund (VFICX, see Table).
This week, our task is to look at the safest sub-industry (after regulated utilities) within the 4 defensive industries: Food Processors. To get a clear picture, we’ve included all 20 of the publicly-traded companies that stock your grocery store’s shelves to a material degree and have long-term trading records (see Table). The first column of data (Col C) tells the story. All 20 have total returns that equal or exceed that of our benchmark, the Vanguard Balanced Index Fund (VBINX, see Table), which has returned a little over 5%/yr since the most recent inflation-corrected peak in the S&P 500 Index occurred on 9/1/00. Because it’s hedged, VBINX performed better than the lowest-cost S&P 500 Index fund (VFINX in Table). Risk for the 20 aggregated food processors (Line 22 in the Table), as measured by both total return over the 18-month Lehman Panic panic period and 5-yr Beta (Columns D & J), was less than for VBINX even though total returns after both 14 yrs and 5 years were much greater (Columns C & F).
Now that we’ve got your attention, let’s “muddy the waters.” Look at the Table and note that only PEP, GIS, and SJM provide the investor with what she wants, which is to be at least as good as VBINX in terms of performance (Columns C, F, G, H, I) as well as safety (Columns D, J, K, M, N, O). The aggregated data on Line 22 look great but you’ll need stock-picking skills to capture those high returns at low risk. Remember: data points that underperform VBINX are highlighted in red. Column K (P/E) has an abundance of those, indicating that the market is pricey.
Bottom Line: Food Processors are a mother lode of opportunity for investors but that sub-industry is highly fragmented. Out of the 20 companies in the Table, only 5 are sizable: Nestle (NSRGY), Danone (DANOY), Mondelez International (MDLZ), Coca-Cola (KO) and PepsiCo (PEP). But size (Col L) and bond ratings (Col O) don’t matter much when a company is selling an essential product. The exception occurs when government regulation imposes price controls, as is the case with milk, e.g. Dean Foods (DF at Line 17 in the Table), which is the largest milk producer in the US.
How should you prioritize your research into the “story” that supports the market value for each of these stocks? We suggest that you assign the same priority as the PowerShares Dividend Achievers Portfolio (PFM, Line 36 in the Table), an exchange-traded fund or ETF. That priority is: KO, PEP, GIS, HRL, SJM, MKC, FLO, LANC.
Risk Rating: 4
Full Disclosure: I don’t plan to purchase any stock listed in the Table, but do own shares of MKC, KO, HRL, GIS, and PEP.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
This week, our task is to look at the safest sub-industry (after regulated utilities) within the 4 defensive industries: Food Processors. To get a clear picture, we’ve included all 20 of the publicly-traded companies that stock your grocery store’s shelves to a material degree and have long-term trading records (see Table). The first column of data (Col C) tells the story. All 20 have total returns that equal or exceed that of our benchmark, the Vanguard Balanced Index Fund (VBINX, see Table), which has returned a little over 5%/yr since the most recent inflation-corrected peak in the S&P 500 Index occurred on 9/1/00. Because it’s hedged, VBINX performed better than the lowest-cost S&P 500 Index fund (VFINX in Table). Risk for the 20 aggregated food processors (Line 22 in the Table), as measured by both total return over the 18-month Lehman Panic panic period and 5-yr Beta (Columns D & J), was less than for VBINX even though total returns after both 14 yrs and 5 years were much greater (Columns C & F).
Now that we’ve got your attention, let’s “muddy the waters.” Look at the Table and note that only PEP, GIS, and SJM provide the investor with what she wants, which is to be at least as good as VBINX in terms of performance (Columns C, F, G, H, I) as well as safety (Columns D, J, K, M, N, O). The aggregated data on Line 22 look great but you’ll need stock-picking skills to capture those high returns at low risk. Remember: data points that underperform VBINX are highlighted in red. Column K (P/E) has an abundance of those, indicating that the market is pricey.
Bottom Line: Food Processors are a mother lode of opportunity for investors but that sub-industry is highly fragmented. Out of the 20 companies in the Table, only 5 are sizable: Nestle (NSRGY), Danone (DANOY), Mondelez International (MDLZ), Coca-Cola (KO) and PepsiCo (PEP). But size (Col L) and bond ratings (Col O) don’t matter much when a company is selling an essential product. The exception occurs when government regulation imposes price controls, as is the case with milk, e.g. Dean Foods (DF at Line 17 in the Table), which is the largest milk producer in the US.
How should you prioritize your research into the “story” that supports the market value for each of these stocks? We suggest that you assign the same priority as the PowerShares Dividend Achievers Portfolio (PFM, Line 36 in the Table), an exchange-traded fund or ETF. That priority is: KO, PEP, GIS, HRL, SJM, MKC, FLO, LANC.
Risk Rating: 4
Full Disclosure: I don’t plan to purchase any stock listed in the Table, but do own shares of MKC, KO, HRL, GIS, and PEP.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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