Situation: You’re now in your 50s. The “sunset years” loom ahead. While you have the advantage of being a more experienced investor, you’re losing time and may retire short of where you need to be. Even now, you need to have a “nest egg” at least 6 times your current salary. Your retirement account is likely to be 60% in stocks but that allocation falls to 50% by the time you retire. You’ll need to hold safer but more effective stocks. “The 2 and 8 Club” is one way to do that: buy stocks that carry both a higher dividend yield and a faster rate of dividend growth compared to the S&P 500 Index (SPY), i.e., stocks that yield at least 2%/yr and grow dividends at least 8%/yr. For safety, confine your picks to stocks issued by “mega-cap” companies in the S&P 100 Index. Why those? Because they’re large enough to have multiple product lines, i.e., they’re more able to respond to diverse market conditions. And, they’re required to have active hedging positions at the Chicago Board Options Exchange. Those “put and call” stock options are side-bets made by professional traders, which makes “price discovery” for the underlying stocks more rational.
Mission: Use our standard spreadsheet to analyze companies in the S&P 100 Index that a) issue debt rated at least A- by S&P, b) issue stock rated B+/M or better by S&P, c) are listed in the U.S. version of the FTSE High Dividend Yield Index--marketed by Vanguard Group as VYM, d) have the 16+ year trading record that is needed for quantitative analysis by the BMW Method, and e) have grown their dividend at least 8%/yr for the past 5 years.
Execution: see the 13 companies at the top of this week’s Table.
Administration: Let’s explain the Basic Quality Screen (see Column AH in the Table). The idea is to give readers a quick take on which stocks are worthwhile to consider as a new BUY. The maximum score is 4. Overpriced stocks (see Column AF) are penalized half a point. Reading from left to right across the spreadsheet, the first opportunity to score a point is found in Column K. Stocks that have a 16-yr price appreciation that is more than 1/3rd the risk of ownership (Column M) score one point. A negative value in Column S for Tangible Book Value (highlighted in purple) results in a loss of one point if the debt load is either greater than 2.5 times EBITDA (Column R) or LT-debt represents more than 50% of the company’s total capitalization (Column Q). In Columns U and V, all 13 companies earn 2 points because their S&P ratings meet the requirement of being at least A- for the company’s debt and B+/M for the company’s stock. In Column Z, one point is earned if the stock appears likely to meet our Required Rate of Return over the next 10 years, which is 10%/yr, i.e., the dollar value is not highlighted in purple.
Bottom Line: As you approach retirement, look more closely at the stocks and ETFs in your portfolio. Those equities will need to be half your retirement savings. Where possible, choose stocks issued by large companies that offer higher dividend yields and faster dividend growth than the S&P 500 Index. Five of this week’s stocks are worth researching for possible purchase because of being rated 3 or 4 on our Basic Quality Screen (see Column AH): CSCO, JPM, USB, CAT and BLK.
Risk Rating: 6 (where 10-yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE, JPM, USB, CAT and IBM, and also own shares of AMGN, CSCO, PEP, BLK and MMM.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
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Showing posts with label core holdings. Show all posts
Showing posts with label core holdings. Show all posts
Monday, November 25
Sunday, November 4
Week 383 - Dow Theory: A Primary Uptrend Resumed on 9/20/2018
Situation: The Dow Jones Industrial Average (DJIA) fell 9% from the end of January to the end of March because of a developing trade war. The Dow Jones Transportation Average (DJTA) confirmed this move, suggesting that a new primary downtrend was developing. However, neither the DJIA nor the DJTA reached previous lows. By 9/20/2018, the DJIA reached a new high confirming the new high reached a month earlier by the DJTA. So, the decade-long primary uptrend had resumed after an 8-month hiccup. Why? Because trade war fears had abated.
Both the DJIA (DIA) and DJTA (ITY) have out-performed Berkshire Hathaway (BRK-B) over the past 5 years, which is unusual. This leads stock-pickers to pay more attention to the stocks that are most heavily weighted in constructing those price-weighted indices.
Mission: Take a close look at the top 10 companies in each index by applying our Standard Spreadsheet.
Execution: see Table.
Bottom Line: Eleven of the 20 companies issue bonds that carry an S&P rating of A- or better, and 6 of those 11 carry an S&P stock rating of A-/M or better: Home Depot (HD), UnitedHealth (UNH), 3M (MMM), Boeing (BA), International Business Machines (IBM), and Union Pacific (UNP). In that group, only IBM has failed to outperform BRK-B over the past 5 and 10 year periods.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
"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
Both the DJIA (DIA) and DJTA (ITY) have out-performed Berkshire Hathaway (BRK-B) over the past 5 years, which is unusual. This leads stock-pickers to pay more attention to the stocks that are most heavily weighted in constructing those price-weighted indices.
Mission: Take a close look at the top 10 companies in each index by applying our Standard Spreadsheet.
Execution: see Table.
Bottom Line: Eleven of the 20 companies issue bonds that carry an S&P rating of A- or better, and 6 of those 11 carry an S&P stock rating of A-/M or better: Home Depot (HD), UnitedHealth (UNH), 3M (MMM), Boeing (BA), International Business Machines (IBM), and Union Pacific (UNP). In that group, only IBM has failed to outperform BRK-B over the past 5 and 10 year periods.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
"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, July 8
Week 366 - A Capitalization-weighted Watch List for Russell 1000 Companies
Situation: Every stock-picker needs to confine her attention to a manageable list of companies, called a “Watch List.” Here at ITR, the focus is on investing for retirement. So, our interest is in companies that have a higher dividend yield than the S&P 500 Index. Why? Because your original investment will be returned to you faster, which automatically gives your portfolio a higher “net present value” than a portfolio composed of companies that pay either no dividend or a small dividend. Once you’ve retired, you’ll switch from reinvesting dividends to spending dividends.
Mission: Assemble a Watch List composed of companies that are “Blue Chips” (see Week 361), companies that are in “The 2 and 8 Club” (see Week 344), and companies that are in the Extended Version of “The 2 and 8 Club” (see Week 362).
Execution: see Table.
Bottom Line: If you’re saving for retirement and would like to pick some individual stocks to supplement your index funds, here is an effective and reasonably safe Watch List. However, the mutual funds that pick individual stocks haven’t done very well compared to benchmark index funds. So, your chances of doing well as a stock-picker also aren’t good. But index funds like the SPDR S&P 500 (SPY) expose you to significant downside risk. There is one conservatively managed mutual fund that we think is an excellent retirement investment, the Vanguard Wellesley Income Fund, which is mostly composed of bonds. Your risk of loss from owning VWINX is less than half that from owning SPY; the 10-Yr Total Return is 7.0%/yr vs. 9.0%/yr for SPY.
Risk Rating for our Watch List: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into MSFT, JPM, XOM, WMT, PG, KO, IBM, CAT and NEE, and also own shares of GOOGL, CSCO, MCD, MMM, TRV, CMI and ADM.
"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: Assemble a Watch List composed of companies that are “Blue Chips” (see Week 361), companies that are in “The 2 and 8 Club” (see Week 344), and companies that are in the Extended Version of “The 2 and 8 Club” (see Week 362).
Execution: see Table.
Bottom Line: If you’re saving for retirement and would like to pick some individual stocks to supplement your index funds, here is an effective and reasonably safe Watch List. However, the mutual funds that pick individual stocks haven’t done very well compared to benchmark index funds. So, your chances of doing well as a stock-picker also aren’t good. But index funds like the SPDR S&P 500 (SPY) expose you to significant downside risk. There is one conservatively managed mutual fund that we think is an excellent retirement investment, the Vanguard Wellesley Income Fund, which is mostly composed of bonds. Your risk of loss from owning VWINX is less than half that from owning SPY; the 10-Yr Total Return is 7.0%/yr vs. 9.0%/yr for SPY.
Risk Rating for our Watch List: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into MSFT, JPM, XOM, WMT, PG, KO, IBM, CAT and NEE, and also own shares of GOOGL, CSCO, MCD, MMM, TRV, CMI and ADM.
"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, February 5
Week 293 - Berkshire Hathaway’s “Core Holdings”: Stock in 7 A-rated Barron’s 500 Companies
Situation: We can all agree that Warren Buffett is a good stock-picker. So, why does he favor the same “plain vanilla” stocks that get talked-up by your cab driver and the shoe shine guy at the airport?
Mission: Find out which stocks he’s purchased for Berkshire Hathaway, then put those through the wringer (our standard spreadsheet).
Execution: Scan Berkshire Hathaway’s latest 13F quarterly filing of 46 common stock holdings for companies have a) revenues large enough to be on the 2016 Barron’s 500 List, b) at least 16 yrs of trading records, and c) Standard & Poor’s credit ratings of at least A- and stock ratings of at least A-/M.
Administration: Berkshire Hathaway holds 7 A-rated stocks, which are worth ~$56 Billion (see Columns AB and AC in the Table) and represent ~43% of the portfolio’s value. All 7 are “high quality” companies with household names: Costco Wholesale, IBM, Coca-Cola, Johnson & Johnson, Procter & Gamble, Wal-Mart Stores, and Wells Fargo.
Bottom Line: If someone new to investing had asked you to name some good stocks, most of you would have mentioned stocks on our list. Is that because we like to read about Warren Buffett’s stock picks? Or is it because Warren Buffett likes to read about companies that have products and services that are consistently praised by consumers and businesses? Either way, you need (and want) to mimic his best stock picks, no matter how boring and obvious. How do we know they’re his best stock picks? Because he calls Berkshire Hathaway’s stock portfolio a “float”, meaning the place where insurance premiums are stored until they’re needed to pay for some catastrophe. These 7 high-quality stocks account for 43% of the 46-stock portfolio he uses for safe-keeping. They’re the anchor that will keep the company “afloat” through storms.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into IBM, PG and JNJ, and own shares in KO and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is chosen to approximate Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 22 in the Table. The ETF for that index is MDY at Line 15.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Find out which stocks he’s purchased for Berkshire Hathaway, then put those through the wringer (our standard spreadsheet).
Execution: Scan Berkshire Hathaway’s latest 13F quarterly filing of 46 common stock holdings for companies have a) revenues large enough to be on the 2016 Barron’s 500 List, b) at least 16 yrs of trading records, and c) Standard & Poor’s credit ratings of at least A- and stock ratings of at least A-/M.
Administration: Berkshire Hathaway holds 7 A-rated stocks, which are worth ~$56 Billion (see Columns AB and AC in the Table) and represent ~43% of the portfolio’s value. All 7 are “high quality” companies with household names: Costco Wholesale, IBM, Coca-Cola, Johnson & Johnson, Procter & Gamble, Wal-Mart Stores, and Wells Fargo.
Bottom Line: If someone new to investing had asked you to name some good stocks, most of you would have mentioned stocks on our list. Is that because we like to read about Warren Buffett’s stock picks? Or is it because Warren Buffett likes to read about companies that have products and services that are consistently praised by consumers and businesses? Either way, you need (and want) to mimic his best stock picks, no matter how boring and obvious. How do we know they’re his best stock picks? Because he calls Berkshire Hathaway’s stock portfolio a “float”, meaning the place where insurance premiums are stored until they’re needed to pay for some catastrophe. These 7 high-quality stocks account for 43% of the 46-stock portfolio he uses for safe-keeping. They’re the anchor that will keep the company “afloat” through storms.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into IBM, PG and JNJ, and own shares in KO and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is chosen to approximate Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 22 in the Table. The ETF for that index is MDY at Line 15.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 17
Week 237 - Respect The KISS Rule
Situation: How do we save for retirement? After all, a typical adult is disinclined to reduce discretionary spending by the needed ~50% to plan for her future (and that’s assuming that a series of favorable events will transpire). To effectively save for retirement, most people have to make a game out of it. We substitute the discretionary entertainment value that comes from immediate consumption by instead watching our nest egg grow. The entertainment value we receive can be amplified by trying to be more clever than our neighbors and co-workers. With the help of a financial advisor, we play around with our retirement portfolios. But it doesn’t have to be that way. You can forget about entertainment and one-upping your friends. Just pick mutual funds that balance stocks and bonds. Or pick only one, such as the Vanguard Balanced Index Fund (VBINX), which serves as Jack Bogle’s only personal investment during most years. He’s the originator of index fund investing and founder of Vanguard Group. Jack Bogle respects the KISS rule: “Keep it simple, stupid.” But he has many critics in the community of investment advisors (as the above link makes clear). Their main criticism is that VBINX minimizes international investing and overlooks “core” assets like real estate investment trusts (REITs), small-cap stocks, and commodities.
Mission: Test a balanced portfolio of “core assets” consisting of US stocks, international stocks, US bonds, international bonds, REITs, and Commodities. In other words, combine the most diversified mutual funds for US stocks (VTSMX), US bonds (VBMFX), real estate investment trusts (VGSIX), commodity futures (QRAAX), international bonds (RPIBX), and international stocks (VGTSX).
Execution: Since the S&P 500 Index peaked on 9/1/00 (see Table), total return/yr for these 6 core assets has come in at 3.6%/yr, matching the lowest-cost S&P 500 Index fund (VFINX). Broad diversification among core assets is meant to reduce the risk of an S&P 500 index fund without reducing returns. The 6 core assets we selected did achieve our objective. Risk measures were lower for this asset group (see Columns D and I in the Table). However, these core assets under-performed VFINX by a wide margin during the bull market of the past 5 years (see Column F in the Table). More importantly, their average expense ratio is 3 times higher at 0.52% (vs. 0.17% for VFINX). And, QRAAX has to be purchased through a broker.
As a “rule of thumb” you want some assurance that your investment will meet the “business case” and double in value over the next 10 years, i.e., total return will increase by at least 7%/yr. If the dividend yield plus the dividend growth rate is at least 7%, that is likely to be the case (see Columns G and H in the Table where those instances are highlighted in green). Core assets, except for the real estate fund (VGSIX), do not meet that criterion.
Administration: Mutual funds also have “tail risks,” a term used to describe unlikely yet destabilizing events. Managed funds are sold on the basis of performance, which means managers tend to choose small- and mid-cap stocks that often perform remarkably well (meaning they have a high return on equity or ROE), due in part to being overcapitalized by loans and bonds that are “less than investment grade.” Of course, that indebtedness is ignored when calculating ROE. Index funds are also sold on the basis of performance and overly dependent on their smallest (i.e., riskiest) companies for that performance. Finally, mutual funds maintain minimal cash balances which can force them to sell their bonds or stocks at a loss during a bear market (i.e., conduct a “fire sale”). In other words, they have to immediately honor every investor’s request to have her money returned. None of these problems exist if you’re a shareowner. You get to decide how much risk you want to assume and whether or not to “ride out” a bear market, or even continue dollar-averaging into your favorite positions, so as to “vacuum up” shares that mutual funds are unloading at a loss.
By now you’re getting the point: part of your retirement portfolio has to be devoted to owning shares in a diversified group of strong companies that you’ve selected, so as to avoid the “buy high, sell low” roller coaster that mutual funds can’t avoid. They’re constrained by market forces and the inflows/outflows of investor’s cash. They’ll engage in “momentum investing” as they ride bull markets up, and “fire sales” as they ride bear markets down. By owning individual stocks, you choose whether to play along or not. Individual stocks also have their place in a retirement portfolio for another reason we often highlight. Many companies issue dividends that have increased 2-5 times faster than inflation for more than 10 years, whereas, distributions from stock mutual funds rarely keep up with inflation (see Column H in any of our Tables). That means you don’t have to cash out shares during retirement but instead can simply live off your income. For example, you can do quite well by investing in 5 stocks (that represent half the S&P industries) combined with owning 10-yr Treasury Notes in a 60% stock/40% Treasury Note ratio (see Line 14 in the Table).
Bottom Line: Broad diversification among “core assets” will allow you to match the performance of the lowest-cost S&P 500 Index fund (VFINX) while incurring less risk, as long as you ignore transaction costs, advisory fees, and front-end brokerage charges. But professional money managers prefer to get you into “core assets” for the very reason that they live off advisory fees (as well as often gaining a piece of the income from transaction costs and brokerage relationships). Warren Buffett is right. You will beat 90% of professional investors by investing online through Vanguard Group--placing 90% of your savings in the lowest-cost S&P 500 Index fund (VFINX) and 10% in the lowest cost US government short-term bond index fund (VSBSX), as shown in Line 23 of the Table. The key benchmark we recommend to our readers is the Vanguard Balanced Index Fund (VBINX) at line 21 in the Table, which does even better than the Buffett Plan while incurring less risk.
Risk Rating: 5
Full Disclosure: I own shares of MCD, JNJ, and KO, as well as dollar-average into T, NEE and Treasury Notes.
Note: Metrics highlighted in red denote 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: Test a balanced portfolio of “core assets” consisting of US stocks, international stocks, US bonds, international bonds, REITs, and Commodities. In other words, combine the most diversified mutual funds for US stocks (VTSMX), US bonds (VBMFX), real estate investment trusts (VGSIX), commodity futures (QRAAX), international bonds (RPIBX), and international stocks (VGTSX).
Execution: Since the S&P 500 Index peaked on 9/1/00 (see Table), total return/yr for these 6 core assets has come in at 3.6%/yr, matching the lowest-cost S&P 500 Index fund (VFINX). Broad diversification among core assets is meant to reduce the risk of an S&P 500 index fund without reducing returns. The 6 core assets we selected did achieve our objective. Risk measures were lower for this asset group (see Columns D and I in the Table). However, these core assets under-performed VFINX by a wide margin during the bull market of the past 5 years (see Column F in the Table). More importantly, their average expense ratio is 3 times higher at 0.52% (vs. 0.17% for VFINX). And, QRAAX has to be purchased through a broker.
As a “rule of thumb” you want some assurance that your investment will meet the “business case” and double in value over the next 10 years, i.e., total return will increase by at least 7%/yr. If the dividend yield plus the dividend growth rate is at least 7%, that is likely to be the case (see Columns G and H in the Table where those instances are highlighted in green). Core assets, except for the real estate fund (VGSIX), do not meet that criterion.
Administration: Mutual funds also have “tail risks,” a term used to describe unlikely yet destabilizing events. Managed funds are sold on the basis of performance, which means managers tend to choose small- and mid-cap stocks that often perform remarkably well (meaning they have a high return on equity or ROE), due in part to being overcapitalized by loans and bonds that are “less than investment grade.” Of course, that indebtedness is ignored when calculating ROE. Index funds are also sold on the basis of performance and overly dependent on their smallest (i.e., riskiest) companies for that performance. Finally, mutual funds maintain minimal cash balances which can force them to sell their bonds or stocks at a loss during a bear market (i.e., conduct a “fire sale”). In other words, they have to immediately honor every investor’s request to have her money returned. None of these problems exist if you’re a shareowner. You get to decide how much risk you want to assume and whether or not to “ride out” a bear market, or even continue dollar-averaging into your favorite positions, so as to “vacuum up” shares that mutual funds are unloading at a loss.
By now you’re getting the point: part of your retirement portfolio has to be devoted to owning shares in a diversified group of strong companies that you’ve selected, so as to avoid the “buy high, sell low” roller coaster that mutual funds can’t avoid. They’re constrained by market forces and the inflows/outflows of investor’s cash. They’ll engage in “momentum investing” as they ride bull markets up, and “fire sales” as they ride bear markets down. By owning individual stocks, you choose whether to play along or not. Individual stocks also have their place in a retirement portfolio for another reason we often highlight. Many companies issue dividends that have increased 2-5 times faster than inflation for more than 10 years, whereas, distributions from stock mutual funds rarely keep up with inflation (see Column H in any of our Tables). That means you don’t have to cash out shares during retirement but instead can simply live off your income. For example, you can do quite well by investing in 5 stocks (that represent half the S&P industries) combined with owning 10-yr Treasury Notes in a 60% stock/40% Treasury Note ratio (see Line 14 in the Table).
Bottom Line: Broad diversification among “core assets” will allow you to match the performance of the lowest-cost S&P 500 Index fund (VFINX) while incurring less risk, as long as you ignore transaction costs, advisory fees, and front-end brokerage charges. But professional money managers prefer to get you into “core assets” for the very reason that they live off advisory fees (as well as often gaining a piece of the income from transaction costs and brokerage relationships). Warren Buffett is right. You will beat 90% of professional investors by investing online through Vanguard Group--placing 90% of your savings in the lowest-cost S&P 500 Index fund (VFINX) and 10% in the lowest cost US government short-term bond index fund (VSBSX), as shown in Line 23 of the Table. The key benchmark we recommend to our readers is the Vanguard Balanced Index Fund (VBINX) at line 21 in the Table, which does even better than the Buffett Plan while incurring less risk.
Risk Rating: 5
Full Disclosure: I own shares of MCD, JNJ, and KO, as well as dollar-average into T, NEE and Treasury Notes.
Note: Metrics highlighted in red denote 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 7
Week 179 - The ITR “Master List” for Fall 2014
Situation: Twice a year, we try to look into the future using the lens of the past. Currently, the US stock market has reached a plateau due to overvaluation. Alan Greenspan, in his recent book “The Map and the Territory” (The Penguin Press, New York, 2013), explains overvaluation by saying that "demand to acquire the stock of a company is sated as the company becomes adequately funded [and such companies] will yield low prospective rates of profit until the excess capital is withdrawn and presumably reinvested in more promising ventures." In other words, there is no such thing as a stock that looks like a good bet year in and year out. That’s why you need to pick stocks wisely and then dollar-cost average your choices.
You’ve no doubt noticed that our Master List keep getting shorter as the risk of a Bear Market increases. We began with 34 (large and small) companies (see Week 5) and now we’re down to 10 large companies (see Table). Those 10 are chosen from our 9 Lifeboat Stocks (see Week 174) and 17 Core Holdings (see Week 172). We eliminate any that aren’t "Dividend Aristocrats" (25+ yrs of dividend growth) or lost more during the Lehman Panic than the 28% that our “risk-on” benchmark (VBINX) lost.
This week, for the first time, we ask whether you’d be better off investing in all 10 of those companies, or would you be better off investing in Vanguard Wellesley Income Fund (VWINX), which is the “risk-off” benchmark that we recommend for retirement portfolios. It is not too difficult to build a portfolio of stocks with a higher dividend yield and/or faster dividend growth rate than the S&P 500 Index, particularly if you stick to companies have grown their dividend annually for at least 25 yrs. Those companies have a long and stable history of rewarding their investors through good times and bad. By owning shares in a few such companies you can look forward to receiving dividend checks in retirement that grow faster than inflation. But will you end up with more retirement assets by doing that? This week’s blog tries to answer that question.
Long term, VWINX has been the most stable and rewarding mutual fund. It is balanced roughly 40:60 between high quality stocks and investment-grade bonds, respectively. VWINX has returned 10.6%/yr over the past 35 yrs, which is identical to the return for the lowest-cost S&P 500 Index fund, the Vanguard 500 Index Fund (VFINX). Bonds in VWINX go up in value whenever stocks go down. That means VWINX has had only 4 down years in 35 (average loss of 6.3%) vs. 8 for VFINX (average loss of 11%). The lesson here is to hedge your stocks with high quality bonds. We suggest that you use inflation-protected US Savings Bonds because those never lose money and carry all the tax advantages of an IRA.
We’ve blogged often about the risk of owning individual stocks, and use several metrics like 5-yr Beta (Column I in our Tables) to highlight that risk. But there’s only one sure-fire metric: How much did investors lose during the last Bear Market (Column D in our Tables)? Warren Buffett likes to make analogies about core principles, and his analogy for this one is “You can only tell who’s swimming naked when the tide goes out.” With bonds, risk is easier to gauge because the interest that a corporate bond pays vs. the interest that a US Treasury bond (with the same maturity) pays is a direct measure of credit risk. The difference between those two interest rates is called “the spread” and the higher the spread, the riskier the bond. In other words, you’re paid more interest because you’re willing to take on more of the risk of bankruptcy. US Savings Bonds purchased online at treasurydirect are a zero-cost, tax-advantaged way to invest in 10-yr US Treasury Notes, the safest investment on the planet (according to Warren Buffett). You’ll appreciate having those Savings Bonds available to fund the non-recurring capital expenditures that are bound to appear during the next market calamity. (You certainly won’t want to sell stocks at a loss.)
The 10 “buy and hold” stocks in this week’s Table include 4 Hedge Stocks (see Week 150): WMT, CB, JNJ, PEP. Those stocks don’t need to be backed with inflation-protected Savings Bonds (ISBs). To answer our question (Is it better to invest in those 10 stocks or in VWINX?), we’ll make a virtual investment of $50/mo in each of the 10 stocks ($500/mo) backed by another virtual investment of $300/mo in ISBs. (Thus, you see 6 entries for ISBs in the Table). We’ve made stock purchases online at a dividend reinvestment sites like computershare or shareowneronline wherever transaction costs can be less than ~2%/yr. If the costs are higher, we’ve resorted to using a discount brokerage like Edward Jones (one of several that are available). For our virtual portfolio, we found it necessary to do that for 3 stocks (GWW, CB, PEP), buying one a year in that order. Our virtual investment then totaled $1800 once a year for 3 yrs with reinvested dividends, which accomplishes the same goal as investing $50/mo for 3 yrs at a dividend reinvestment site online.
Bottom Line: You can construct a 10-stock portfolio and be ahead of VWINX while maintaining the same risk profile (e.g. a 5-yr Beta of ~0.45). Over the past 14 yrs, our virtual portfolio returned ~9.5%/yr vs. ~7.3%/yr for VWINX. However, that ~2.2%/yr advantage is reduced to ~1.8%/yr after you subtract transaction costs of ~0.4%/yr: $321.65 spent during the first 3 yrs (Column R in the Table) divided by an investment of $28,800 = 1.12%, which is ~0.4%/yr. Dividend yield plus dividend growth is also better with 10 stocks than with VWINX (8.6% vs. 2.2%, see Columns G and H in the Table). During retirement, you’ll probably be able to cash those quarterly dividend checks without needing to sell the underlying shares, as opposed to having to sell shares of VWINX to come up with the same amount of cash. Of course, there is greater selection bias in picking 10 stocks than in owning shares of a managed stock/bond mutual fund like VWINX. Getting an extra ~1.8%/yr might justify the additional time and energy you’ll spend managing your portfolio but always consider opportunity costs. For example, a better choice for building retirement wealth might be to invest in VWINX, then use the time and energy you’ve saved to further your education and get a better day job.
Risk Rating: 3
Full Disclosure: I dollar-average into ISBs, WMT, ABT, and PEP. I also own shares of HRL, JNJ, and BDX.
NOTE: Metrics in the Table are current as of the Sunday of publication.
Post comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
You’ve no doubt noticed that our Master List keep getting shorter as the risk of a Bear Market increases. We began with 34 (large and small) companies (see Week 5) and now we’re down to 10 large companies (see Table). Those 10 are chosen from our 9 Lifeboat Stocks (see Week 174) and 17 Core Holdings (see Week 172). We eliminate any that aren’t "Dividend Aristocrats" (25+ yrs of dividend growth) or lost more during the Lehman Panic than the 28% that our “risk-on” benchmark (VBINX) lost.
This week, for the first time, we ask whether you’d be better off investing in all 10 of those companies, or would you be better off investing in Vanguard Wellesley Income Fund (VWINX), which is the “risk-off” benchmark that we recommend for retirement portfolios. It is not too difficult to build a portfolio of stocks with a higher dividend yield and/or faster dividend growth rate than the S&P 500 Index, particularly if you stick to companies have grown their dividend annually for at least 25 yrs. Those companies have a long and stable history of rewarding their investors through good times and bad. By owning shares in a few such companies you can look forward to receiving dividend checks in retirement that grow faster than inflation. But will you end up with more retirement assets by doing that? This week’s blog tries to answer that question.
Long term, VWINX has been the most stable and rewarding mutual fund. It is balanced roughly 40:60 between high quality stocks and investment-grade bonds, respectively. VWINX has returned 10.6%/yr over the past 35 yrs, which is identical to the return for the lowest-cost S&P 500 Index fund, the Vanguard 500 Index Fund (VFINX). Bonds in VWINX go up in value whenever stocks go down. That means VWINX has had only 4 down years in 35 (average loss of 6.3%) vs. 8 for VFINX (average loss of 11%). The lesson here is to hedge your stocks with high quality bonds. We suggest that you use inflation-protected US Savings Bonds because those never lose money and carry all the tax advantages of an IRA.
We’ve blogged often about the risk of owning individual stocks, and use several metrics like 5-yr Beta (Column I in our Tables) to highlight that risk. But there’s only one sure-fire metric: How much did investors lose during the last Bear Market (Column D in our Tables)? Warren Buffett likes to make analogies about core principles, and his analogy for this one is “You can only tell who’s swimming naked when the tide goes out.” With bonds, risk is easier to gauge because the interest that a corporate bond pays vs. the interest that a US Treasury bond (with the same maturity) pays is a direct measure of credit risk. The difference between those two interest rates is called “the spread” and the higher the spread, the riskier the bond. In other words, you’re paid more interest because you’re willing to take on more of the risk of bankruptcy. US Savings Bonds purchased online at treasurydirect are a zero-cost, tax-advantaged way to invest in 10-yr US Treasury Notes, the safest investment on the planet (according to Warren Buffett). You’ll appreciate having those Savings Bonds available to fund the non-recurring capital expenditures that are bound to appear during the next market calamity. (You certainly won’t want to sell stocks at a loss.)
The 10 “buy and hold” stocks in this week’s Table include 4 Hedge Stocks (see Week 150): WMT, CB, JNJ, PEP. Those stocks don’t need to be backed with inflation-protected Savings Bonds (ISBs). To answer our question (Is it better to invest in those 10 stocks or in VWINX?), we’ll make a virtual investment of $50/mo in each of the 10 stocks ($500/mo) backed by another virtual investment of $300/mo in ISBs. (Thus, you see 6 entries for ISBs in the Table). We’ve made stock purchases online at a dividend reinvestment sites like computershare or shareowneronline wherever transaction costs can be less than ~2%/yr. If the costs are higher, we’ve resorted to using a discount brokerage like Edward Jones (one of several that are available). For our virtual portfolio, we found it necessary to do that for 3 stocks (GWW, CB, PEP), buying one a year in that order. Our virtual investment then totaled $1800 once a year for 3 yrs with reinvested dividends, which accomplishes the same goal as investing $50/mo for 3 yrs at a dividend reinvestment site online.
Bottom Line: You can construct a 10-stock portfolio and be ahead of VWINX while maintaining the same risk profile (e.g. a 5-yr Beta of ~0.45). Over the past 14 yrs, our virtual portfolio returned ~9.5%/yr vs. ~7.3%/yr for VWINX. However, that ~2.2%/yr advantage is reduced to ~1.8%/yr after you subtract transaction costs of ~0.4%/yr: $321.65 spent during the first 3 yrs (Column R in the Table) divided by an investment of $28,800 = 1.12%, which is ~0.4%/yr. Dividend yield plus dividend growth is also better with 10 stocks than with VWINX (8.6% vs. 2.2%, see Columns G and H in the Table). During retirement, you’ll probably be able to cash those quarterly dividend checks without needing to sell the underlying shares, as opposed to having to sell shares of VWINX to come up with the same amount of cash. Of course, there is greater selection bias in picking 10 stocks than in owning shares of a managed stock/bond mutual fund like VWINX. Getting an extra ~1.8%/yr might justify the additional time and energy you’ll spend managing your portfolio but always consider opportunity costs. For example, a better choice for building retirement wealth might be to invest in VWINX, then use the time and energy you’ve saved to further your education and get a better day job.
Risk Rating: 3
Full Disclosure: I dollar-average into ISBs, WMT, ABT, and PEP. I also own shares of HRL, JNJ, and BDX.
NOTE: Metrics in the Table are current as of the Sunday of publication.
Post comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 19
Week 172 - Core Holdings for an Overpriced Market
Situation: The stock market is currently overpriced when assessed by several criteria. Economists, including the Nobel Laureate Robert J. Shiller, are trying to figure out why this is so. As a small investor, all you need to know is that the stocks in your portfolio that have a price/earnings (P/E) ratio higher than 20 are in a danger zone. In other words, your total return from that investment is less than 5% unless earnings improve. On a risk-adjusted basis, you’d do better parking any newly available funds in US Savings Bonds.
Even though stocks are overpriced, advantages remain for you to accumulate more for your portfolio. That is because you will receive growing dividends in retirement, however, to purchase more it is best to stick to dollar-cost averaging. Invest a little each month into an online Dividend Reinvestment Plan (DRIP). That way, you automatically smooth out the fluctuations in price. The bigger problem right now is that people prefer to cut back on investments in growth stocks when the market is overpriced. That’s not a good investment strategy, and we explain why below.
Bonds, and hard assets like gold and real estate, just don’t have the growth horizon that stocks currently have. Trouble will come for stocks from only 3 broad categories:
1. if interest rates and inflation spike upward (unlikely);
2. if companies stop growing earnings almost 10%/yr (unlikely);
3. if economic indicators herald a recession in a major economy (somewhat likely for the EuroZone and China).
Because stocks remain the asset of choice, they are becoming overpriced. In particular, the buyers of bond-like stocks (i.e., those that have historically had a good total return and increase their dividend ~10% year after year) are crowding out the sellers. Prices for strong and stable “defensive” stocks, like Abbott Laboratories (ABT) and Colgate-Palmolive (CL), drift higher than what their earnings can justify.
Does this really matter? Yes it does because timid investors see that price action and come off the sidelines to buy stock. Eventually, there’s almost no one left who wants to buy an overpriced stock and the market develops cracks. Buyers will only emerge when prices have fallen far enough for fundamental measures of value to justify the purchase. By that time, a lot of investors are underwater and are selling their Savings Bonds to fund cash-flow emergencies. The important point here is that a bear market can happen when the economy is doing just fine, as we saw on October 19, 1987. The Dow Jones Industrial Average fell 22.6% that day for no apparent reason other than “the big guys were selling their stock” because the market had gone up 44% in the previous 6 months.
For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A-/M or better. (That “M” in the denominator denotes medium risk, whereas, “L” denotes low risk.) To focus on growth companies we’ve excluded companies in the 4 “defensive” industries: healthcare, utilities, communication services, and consumer staples. The remaining 6 S&P industries are where we look for our “Core Holdings” (high-quality growth companies, see Week 102). Those industries represent 66% of the capitalization of the S&P 500 Index. Quite simply, your stock portfolio can’t capture market returns unless 2/3rds of it is in stocks issued by companies in those 6 industries: materials, energy, financial, industrial, consumer discretionary, and information technology. Even though those stocks will scare you when the market swoons, don’t sell unless the company’s “story” is broken.
Most of the stocks in the Table are fully valued at present, i.e., have elevated P/E ratios (Column J) because investors expect those companies to have strong earnings growth over the next year. You don’t know what the future will bring, so look for companies that don’t have a P/E over 20. Try to spend your research time on the few companies that have hardly any metrics highlighted in red, which denotes underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Note: Companies that don’t have a Finance Value (Column E in the Table) higher than that for VBINX were excluded, as were companies that pay a dividend that amounts to more than 55% of their earnings (the “payout ratio,” Column I Table). Finally, companies that had a lower Barron’s 500 rank in 2014 than in 2013 were excluded, unless they ranked in the top 2/3rds both years (see Columns L&M Table).
Bottom Line: There are still some bargains to be found among growth stocks. The 17 companies in the Table meet our criteria for Core Holdings, but most are overpriced (average P/E = 22). Their investors have already enjoyed a strong run (Column F Table), and many will be looking to take profits. But there are 6 companies on the list that still offer good value relative to risk: ROST, QCOM, CB, IBM, LMT, GPC.
Risk Rating: 6
Full Disclosure: I dollar-average into NKE and IBM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Even though stocks are overpriced, advantages remain for you to accumulate more for your portfolio. That is because you will receive growing dividends in retirement, however, to purchase more it is best to stick to dollar-cost averaging. Invest a little each month into an online Dividend Reinvestment Plan (DRIP). That way, you automatically smooth out the fluctuations in price. The bigger problem right now is that people prefer to cut back on investments in growth stocks when the market is overpriced. That’s not a good investment strategy, and we explain why below.
Bonds, and hard assets like gold and real estate, just don’t have the growth horizon that stocks currently have. Trouble will come for stocks from only 3 broad categories:
1. if interest rates and inflation spike upward (unlikely);
2. if companies stop growing earnings almost 10%/yr (unlikely);
3. if economic indicators herald a recession in a major economy (somewhat likely for the EuroZone and China).
Because stocks remain the asset of choice, they are becoming overpriced. In particular, the buyers of bond-like stocks (i.e., those that have historically had a good total return and increase their dividend ~10% year after year) are crowding out the sellers. Prices for strong and stable “defensive” stocks, like Abbott Laboratories (ABT) and Colgate-Palmolive (CL), drift higher than what their earnings can justify.
Does this really matter? Yes it does because timid investors see that price action and come off the sidelines to buy stock. Eventually, there’s almost no one left who wants to buy an overpriced stock and the market develops cracks. Buyers will only emerge when prices have fallen far enough for fundamental measures of value to justify the purchase. By that time, a lot of investors are underwater and are selling their Savings Bonds to fund cash-flow emergencies. The important point here is that a bear market can happen when the economy is doing just fine, as we saw on October 19, 1987. The Dow Jones Industrial Average fell 22.6% that day for no apparent reason other than “the big guys were selling their stock” because the market had gone up 44% in the previous 6 months.
For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A-/M or better. (That “M” in the denominator denotes medium risk, whereas, “L” denotes low risk.) To focus on growth companies we’ve excluded companies in the 4 “defensive” industries: healthcare, utilities, communication services, and consumer staples. The remaining 6 S&P industries are where we look for our “Core Holdings” (high-quality growth companies, see Week 102). Those industries represent 66% of the capitalization of the S&P 500 Index. Quite simply, your stock portfolio can’t capture market returns unless 2/3rds of it is in stocks issued by companies in those 6 industries: materials, energy, financial, industrial, consumer discretionary, and information technology. Even though those stocks will scare you when the market swoons, don’t sell unless the company’s “story” is broken.
Most of the stocks in the Table are fully valued at present, i.e., have elevated P/E ratios (Column J) because investors expect those companies to have strong earnings growth over the next year. You don’t know what the future will bring, so look for companies that don’t have a P/E over 20. Try to spend your research time on the few companies that have hardly any metrics highlighted in red, which denotes underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Note: Companies that don’t have a Finance Value (Column E in the Table) higher than that for VBINX were excluded, as were companies that pay a dividend that amounts to more than 55% of their earnings (the “payout ratio,” Column I Table). Finally, companies that had a lower Barron’s 500 rank in 2014 than in 2013 were excluded, unless they ranked in the top 2/3rds both years (see Columns L&M Table).
Bottom Line: There are still some bargains to be found among growth stocks. The 17 companies in the Table meet our criteria for Core Holdings, but most are overpriced (average P/E = 22). Their investors have already enjoyed a strong run (Column F Table), and many will be looking to take profits. But there are 6 companies on the list that still offer good value relative to risk: ROST, QCOM, CB, IBM, LMT, GPC.
Risk Rating: 6
Full Disclosure: I dollar-average into NKE and IBM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 1
Week 126 - There are 7 “Hedge Stocks” in the S&P 100 Index
Situation: Here at ITR, we like to focus your attention on stocks issued by really big companies. That’s because those companies have the resources and flexibility needed to ride out a bear market. You don’t get as much bang for the buck as you do with small or mid-cap stocks (e.g. those found in the S&P 400 Index) but the risk of damage to your retirement nest egg just when you need it the most (at the beginning of retirement) is much less. Our latest list of “hedge stocks” (see Week 117) had only 16 companies but 7 of those are found in the S&P 100 Index of companies with market capitalizations over ~$35B.
We’ll look at the long and short term Finance Values of those seven. In addition, we’ll look at 3 more companies that are on the border for inclusion that august group: General Mills (GIS) and NextEra Energy (NEE) have ~$35B of market capitalization and are in our list of 16 hedge stocks; Procter & Gamble (PG) is already in the S&P 100 Index but fell just short of being a hedge stock. Why? Because during the Lehman Panic it lost slightly more than our benchmark, the Vanguard Balanced Index Fund (VBINX -- Column D in the Table). But PG is already used by investors around the world to hedge against the risk of their other investments, so we’ll sneak it into our list of S&P 100 hedge stocks.
These 10 stocks have superior long-term Finance Value (Column E in the Table), meaning that after subtracting losses during the Lehman Panic from long-term gains investors came out ahead of our benchmark (VBINX). We assess short-term Finance Value by referencing the Barron’s 500 list for 2013 vs. the 2012 list, to determine whether there has been recent growth in sales and cash flow (Columns L & M in the Table). Of the 3 companies that were in the top 200 in 2012 (ABT, MCD, GIS), only McDonald’s (MCD) slipped out of that group in 2013. Of the remaining 7 companies, only PepsiCo (PEP) had a significantly lower rank in 2013 than in 2012. That leaves us with 8 hedge stocks that have both long and short term Finance Value. Those are the ones you need to study closely. Then think about setting up a DRIP through computershare (which offers DRIPs for all 10).
What’s not to like? Let’s start with the fact that nobody really likes the idea of investing in a hedge fund or hedge stock, since those mainly make money for you by falling less during a bear market at the expense of rising less during a bull market like the one we’ve seen over the past 5 yrs (Column G). Half of those 10 companies failed to make as much money as our VBINX benchmark, which is itself hedged (40% invested in bonds). Returns for those laggards are highlighted in red, as are any other numbers in the Table denoting underperformance vs. VBINX. The S&P 500 Index (VFINX) did even better than VBINX, as you would expect in a bull market.
Now you see what’s not to like. Taken together, the 10 stocks underperformed VBINX over the past 5 yrs (Line 14 at Column G in the Table) and did even worse vs. the S&P 500 Index fund (VFINX): Lines 25 & 26 at Column G in the Table. Think of hedge stocks as ballast, deep in the hold of the ship taking you to retirement. The ship goes slower because the ballast is heavy, but the ship will rock less in a big storm instead of foundering. To give that ship some zip faster after the storm, put a large dollop of our retirement savings in Core Holdings (see Week 102). Those are growth companies that have to be hedged with bonds, but they’ll outperform the S&P 500 Index in a bull market. Note that our list of 10 hedge stocks in the S&P 100 Index has only one Core Holding (MCD). The other 9 are Lifeboat Stocks (see Week 106). No surprise there!
Bottom Line: Hedge stocks don’t need to be backed up with bonds. They’ll carry you through a bear market by losing ~40% less than the S&P 500 Index. Some, like Wal-Mart (WMT) and McDonald’s (MCD), will even gain in value. Why? Because people shop for the cheapest food they can find after they’ve lost their job. Over the past 100+ yrs, market cycles have lasted about 5 yrs and bear markets have accounted for a third of that; bull markets account for 2/3rds. However, the first half of a bull market only serves to get the S&P 500 Index back where it was at the beginning of the bear market. Since the market only makes new highs a third of the time, it is possible for a company’s stock to beat the market by losing less the other 2/3rds of the time. That’s the whole premise behind a hedge fund or hedge stock.
Large companies have a better chance of doing that than small companies, given that they have more product lines, pay lower interest on their loans, and maintain larger cash hoards relative to earnings. The 10 large capitalization stocks in the Table won’t, as a group, do as well as the S&P 500 Index in a bull market but they’ll serve you much better in a bear market. And we’ve had two of those since 3/24/00, when the market peaked just before the “dot.com recession.” Over the 13.5 yrs since then, those 10 stocks have kept more than 7% ahead of inflation (Column C) while the S&P 500 Index still struggles to beat inflation by 1%. You get the point.
Risk Rating: 3
Full Disclosure: I regularly add to DRIPs in 6 of these companies (WMT, PG, KO, JNJ, ABT, NEE), and also own stock in MCD and GIS.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
We’ll look at the long and short term Finance Values of those seven. In addition, we’ll look at 3 more companies that are on the border for inclusion that august group: General Mills (GIS) and NextEra Energy (NEE) have ~$35B of market capitalization and are in our list of 16 hedge stocks; Procter & Gamble (PG) is already in the S&P 100 Index but fell just short of being a hedge stock. Why? Because during the Lehman Panic it lost slightly more than our benchmark, the Vanguard Balanced Index Fund (VBINX -- Column D in the Table). But PG is already used by investors around the world to hedge against the risk of their other investments, so we’ll sneak it into our list of S&P 100 hedge stocks.
These 10 stocks have superior long-term Finance Value (Column E in the Table), meaning that after subtracting losses during the Lehman Panic from long-term gains investors came out ahead of our benchmark (VBINX). We assess short-term Finance Value by referencing the Barron’s 500 list for 2013 vs. the 2012 list, to determine whether there has been recent growth in sales and cash flow (Columns L & M in the Table). Of the 3 companies that were in the top 200 in 2012 (ABT, MCD, GIS), only McDonald’s (MCD) slipped out of that group in 2013. Of the remaining 7 companies, only PepsiCo (PEP) had a significantly lower rank in 2013 than in 2012. That leaves us with 8 hedge stocks that have both long and short term Finance Value. Those are the ones you need to study closely. Then think about setting up a DRIP through computershare (which offers DRIPs for all 10).
What’s not to like? Let’s start with the fact that nobody really likes the idea of investing in a hedge fund or hedge stock, since those mainly make money for you by falling less during a bear market at the expense of rising less during a bull market like the one we’ve seen over the past 5 yrs (Column G). Half of those 10 companies failed to make as much money as our VBINX benchmark, which is itself hedged (40% invested in bonds). Returns for those laggards are highlighted in red, as are any other numbers in the Table denoting underperformance vs. VBINX. The S&P 500 Index (VFINX) did even better than VBINX, as you would expect in a bull market.
Now you see what’s not to like. Taken together, the 10 stocks underperformed VBINX over the past 5 yrs (Line 14 at Column G in the Table) and did even worse vs. the S&P 500 Index fund (VFINX): Lines 25 & 26 at Column G in the Table. Think of hedge stocks as ballast, deep in the hold of the ship taking you to retirement. The ship goes slower because the ballast is heavy, but the ship will rock less in a big storm instead of foundering. To give that ship some zip faster after the storm, put a large dollop of our retirement savings in Core Holdings (see Week 102). Those are growth companies that have to be hedged with bonds, but they’ll outperform the S&P 500 Index in a bull market. Note that our list of 10 hedge stocks in the S&P 100 Index has only one Core Holding (MCD). The other 9 are Lifeboat Stocks (see Week 106). No surprise there!
Bottom Line: Hedge stocks don’t need to be backed up with bonds. They’ll carry you through a bear market by losing ~40% less than the S&P 500 Index. Some, like Wal-Mart (WMT) and McDonald’s (MCD), will even gain in value. Why? Because people shop for the cheapest food they can find after they’ve lost their job. Over the past 100+ yrs, market cycles have lasted about 5 yrs and bear markets have accounted for a third of that; bull markets account for 2/3rds. However, the first half of a bull market only serves to get the S&P 500 Index back where it was at the beginning of the bear market. Since the market only makes new highs a third of the time, it is possible for a company’s stock to beat the market by losing less the other 2/3rds of the time. That’s the whole premise behind a hedge fund or hedge stock.
Large companies have a better chance of doing that than small companies, given that they have more product lines, pay lower interest on their loans, and maintain larger cash hoards relative to earnings. The 10 large capitalization stocks in the Table won’t, as a group, do as well as the S&P 500 Index in a bull market but they’ll serve you much better in a bear market. And we’ve had two of those since 3/24/00, when the market peaked just before the “dot.com recession.” Over the 13.5 yrs since then, those 10 stocks have kept more than 7% ahead of inflation (Column C) while the S&P 500 Index still struggles to beat inflation by 1%. You get the point.
Risk Rating: 3
Full Disclosure: I regularly add to DRIPs in 6 of these companies (WMT, PG, KO, JNJ, ABT, NEE), and also own stock in MCD and GIS.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 3
Week 122 - Our Universe of 51 Companies
Situation: Stock selection comes down to assessing safety vs. efficacy. “Safety” means the company has effective defenses against having short sales consume more than 10% of its publicly-traded stock in a bear market, and effective defenses against bankruptcy. “Efficacy” means the company has a time-proven business plan that generates earnings growth over time. The problem is that many metrics are used to capture these values (safety & efficacy), and they only look backwards, amounting what the military calls “fighting the last war.” Our blog has carried on this tradition, be-laboring our readers with numbers that capture important information about safety & efficacy in the past. Simplification is needed, along with metrics that point to the future.
Safety is about having a stable return that grows over time with few hiccups. The main "hiccup" we want to avert is a serious drop in stock price because management then has to take measures (such as selling assets) to avert bankruptcy. To alleviate concerns like that, we won't consider any companies in this blog that have an S&P bond rating less than -A (Column N in the Table). When we invest for retirement we’re ultimately looking for retirement income that grows enough to beat inflation handily, i.e., dividend checks that arrive each quarter and get bigger each year. Remember: annuities and pensions don’t grow. Social Security is the only cost-effective exception to that rule. (At present, it more than keeps up with inflation but there is talk of having it merely keep up with inflation.) Going forward, stock ownership is likely to be the only way for investors to have a steady stream of income that more than keeps up with inflation. So what is the best way to find such stocks? You need start with the list of 200+ Dividend Achievers. Why? Because those are the only companies that will keep paying you more, year after year, and have done so for at least the past 10 yrs. Companies with a long record of increasing dividends irrespective of recessions are safe for retirement investment. You’re only looking at two metrics after you retire: a) dividend yield of the stocks you own (Column G in the Table), and b) dividend growth of the stocks you own (Column H in the Table). Adding those together approximates your future total return. What’s the catch? You need to be a little choosy in picking from the Dividend Achiever list because 1-2% of the names on that list will disappear each year. In other words, the company has discontinued annual dividend increases. This happened to Pfizer, General Electric, and Home Depot during the Lehman Panic. So you’ll need to pay particular attention to the next paragraph.
Efficacy means growth, and growth ultimately comes down to increasing sales and cash flow over time. The editors of Barron’s provide an important service to investors by publishing a 500-stock list each May that ranks companies by performance in those two key areas during the most recent 3 yrs, along with noting the previous year’s rank. Any company listed there has superior growth prospects, given that it has been chosen from the more than 6500 that are listed on US exchanges, plus those listed on the Toronto Stock Exchange.
Now we can define a “universe” of worthwhile companies for our blog to follow, by listing all of the Dividend Achievers that appear in the 2013 Barron’s 500 list. It turns out that there are 51 (see Table). At the top, you’ll see 12 Lifeboat Stocks (Week 106). Those are the companies from defensive industries (utilities, consumer staples, healthcare, and communication services) that have a Finance Value (Reward minus Risk; see Column E of the Table) superior to that of our benchmark--the Vanguard Balanced Index Fund (VBINX, which is 60% stock index and 40% bond index). Next are 7 additional defensive companies that have a Finance Value less than VBINX. The third group is most important: those are companies in non-defensive industries (energy, materials, industrials, financials, consumer discretionary, and information technology) that have a superior Finance Value compared to VBINX (see Column E in the Table). Companies in those industries do particularly well in a growing economy so you can think of them as “growth” companies. That’s where 2/3rds of your stock assets need to be. We call the best such companies Core Holdings (Week 102). The fourth group is for growth companies that didn’t have a Finance Value superior to VBINX. Benchmarks are at the bottom. Metrics are current as of close of business on October 30, 2013.
Bottom Line: Stock-picking is cumbersome but for future retirees it has a uniquely worthwhile feature. You’ll get substantial annual pay raises during your retirement (Column H of the Table). Over the past 20 yrs, dividend growth rates have far exceeded inflation for companies that have committed to annual dividend increases. All 51 of the companies in the Table have been growing dividends annually for over 10 yrs; S&P calls such companies “Dividend Achievers.” Those 51 include 34 companies that have been growing dividends annually for over 25 yrs; S&P calls such companies “Dividend Aristocrats” and there are only 54 names in that group. The Barron’s 500 List has given us a way to winnow down that list of safe companies for retirement investment (Dividend Achievers), so as to include only those that have demonstrated increasing sales and cash flow growth in recent years.
Risk Rating: 4
Full Disclosure: I make automatic monthly additions to DRIPs in ABT, JNJ, WMT, PG, KO, NEE, NKE, XOM, and IBM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Safety is about having a stable return that grows over time with few hiccups. The main "hiccup" we want to avert is a serious drop in stock price because management then has to take measures (such as selling assets) to avert bankruptcy. To alleviate concerns like that, we won't consider any companies in this blog that have an S&P bond rating less than -A (Column N in the Table). When we invest for retirement we’re ultimately looking for retirement income that grows enough to beat inflation handily, i.e., dividend checks that arrive each quarter and get bigger each year. Remember: annuities and pensions don’t grow. Social Security is the only cost-effective exception to that rule. (At present, it more than keeps up with inflation but there is talk of having it merely keep up with inflation.) Going forward, stock ownership is likely to be the only way for investors to have a steady stream of income that more than keeps up with inflation. So what is the best way to find such stocks? You need start with the list of 200+ Dividend Achievers. Why? Because those are the only companies that will keep paying you more, year after year, and have done so for at least the past 10 yrs. Companies with a long record of increasing dividends irrespective of recessions are safe for retirement investment. You’re only looking at two metrics after you retire: a) dividend yield of the stocks you own (Column G in the Table), and b) dividend growth of the stocks you own (Column H in the Table). Adding those together approximates your future total return. What’s the catch? You need to be a little choosy in picking from the Dividend Achiever list because 1-2% of the names on that list will disappear each year. In other words, the company has discontinued annual dividend increases. This happened to Pfizer, General Electric, and Home Depot during the Lehman Panic. So you’ll need to pay particular attention to the next paragraph.
Efficacy means growth, and growth ultimately comes down to increasing sales and cash flow over time. The editors of Barron’s provide an important service to investors by publishing a 500-stock list each May that ranks companies by performance in those two key areas during the most recent 3 yrs, along with noting the previous year’s rank. Any company listed there has superior growth prospects, given that it has been chosen from the more than 6500 that are listed on US exchanges, plus those listed on the Toronto Stock Exchange.
Now we can define a “universe” of worthwhile companies for our blog to follow, by listing all of the Dividend Achievers that appear in the 2013 Barron’s 500 list. It turns out that there are 51 (see Table). At the top, you’ll see 12 Lifeboat Stocks (Week 106). Those are the companies from defensive industries (utilities, consumer staples, healthcare, and communication services) that have a Finance Value (Reward minus Risk; see Column E of the Table) superior to that of our benchmark--the Vanguard Balanced Index Fund (VBINX, which is 60% stock index and 40% bond index). Next are 7 additional defensive companies that have a Finance Value less than VBINX. The third group is most important: those are companies in non-defensive industries (energy, materials, industrials, financials, consumer discretionary, and information technology) that have a superior Finance Value compared to VBINX (see Column E in the Table). Companies in those industries do particularly well in a growing economy so you can think of them as “growth” companies. That’s where 2/3rds of your stock assets need to be. We call the best such companies Core Holdings (Week 102). The fourth group is for growth companies that didn’t have a Finance Value superior to VBINX. Benchmarks are at the bottom. Metrics are current as of close of business on October 30, 2013.
Bottom Line: Stock-picking is cumbersome but for future retirees it has a uniquely worthwhile feature. You’ll get substantial annual pay raises during your retirement (Column H of the Table). Over the past 20 yrs, dividend growth rates have far exceeded inflation for companies that have committed to annual dividend increases. All 51 of the companies in the Table have been growing dividends annually for over 10 yrs; S&P calls such companies “Dividend Achievers.” Those 51 include 34 companies that have been growing dividends annually for over 25 yrs; S&P calls such companies “Dividend Aristocrats” and there are only 54 names in that group. The Barron’s 500 List has given us a way to winnow down that list of safe companies for retirement investment (Dividend Achievers), so as to include only those that have demonstrated increasing sales and cash flow growth in recent years.
Risk Rating: 4
Full Disclosure: I make automatic monthly additions to DRIPs in ABT, JNJ, WMT, PG, KO, NEE, NKE, XOM, and IBM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 20
Week 120 - $150/wk for a Retirement Fund
Situation: You’ve heard a lot about saving for retirement, and you’ve probably heard that Social Security plus your workplace retirement plan probably won’t get you to a comfortable retirement any more. Why? Because people only reduce their spending by 15% after they retire, which means you will need a private savings plan to make up for the lost income. This savings plan can take the form of an IRA, payments into a low-cost annuity, proceeds from the sale of your home (if you move to smaller quarters), or perhaps even gold you’ve hidden away, and other choices. But when retirement is more than 5 years in the future, stocks remain your best bet.
We recommend that you minimize costs by using a stock index fund backed by a bond index fund. The Vanguard Balanced Index Fund (VBINX) provides both in one package, allocated 60% to stocks and 40% to bonds (see Table). It is rebalanced daily, so you won’t get burned if a stock market bubble bursts. (Most of those stock gains would already have been converted to bonds as part of daily rebalancing, and bonds typically increase in value when stocks crash.) Or, you can choose a low-cost managed fund that uses an excess of bonds to balance both the inherent risk of stocks and the difficulty managers have of knowing when to move away from stocks and into bonds. The Vanguard Wellesley Income Fund (VWINX) has the best record. It is bond-heavy and therefore has less volatility than VBINX but performs about as well. The third low-cost option is to study the markets yourself and invest in stocks online at computershare, and in bonds at treasurydirect. This third option allows you to pick only the most stable stocks and bonds. That hedging strategy will serve you well, even though it has less exposure to growth themes.
Why do we harp on buying and selling costs? Aside from “impulse buying”, the main reason retail investors make only half as much as they should (based on whatever asset allocations they’ve chosen) is their failure to control costs. (Company CEOs are no different.) It’s a human failing to like toys and spend too much for those. But retirement is dead serious. You won’t like it if you haven’t prepared your body, mind, and pocketbook ahead of time.
Our blog this week details one example of a personal retirement fund (mine). I dollar-average into 6 stocks and one bond (see Table). There are two Lifeboat Stocks (Week 106): Procter & Gamble (PG) and NextEra Energy (NEE), and two Core Holdings (Week 102): International Business Machines (IBM) and Nike (NKE). The remaining two stocks are Exxon Mobil (XOM) and Microsoft (MSFT), both of which have AAA credit ratings to make up for the fact that they don’t quite meet our standards for designation as Core Holdings.
In our Week 117 blog on hedge stocks, we identified 16 such stocks out of the 900 in the S&P 500 and S&P 400 mid-cap indexes. NextEra Energy (NEE) was one of those, meaning that an investment in NEE stock doesn’t need to be backed up with investment in a Treasury Note or a bond index fund. The “bonds” that I use to back up the $250 that I invest each month in the other 5 stocks are inflation-protected 10-yr US Treasury Notes ($750/qtr).
In the Table, we use red highlights to denote values that are lower than benchmark values (VBINX). All values are current through 10/18/13.
Bottom Line: Dividend Reinvestment Plans (DRIPs) take time to set up and sell but are on automatic pilot the rest of the time. Savings Bonds and Treasury Notes are even easier to manage (through treasurydirect), except that you have to remember to buy them. The key difficulty is deciding exactly which stocks you’d like to own for an extended period. If you want to eliminate that chore without incurring additional expense, it is best to take Warren Buffett’s advice and invest in low cost index funds.
This week’s blog shows one example of how you can build retirement savings with DRIPs for stocks issued by 6 highly rated and stable companies, balanced with inflation-protected 10-yr Treasury Notes. You can have your accountant designate up to $6500/yr as a standard IRA or Roth IRA.
Risk Rating: 4
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
We recommend that you minimize costs by using a stock index fund backed by a bond index fund. The Vanguard Balanced Index Fund (VBINX) provides both in one package, allocated 60% to stocks and 40% to bonds (see Table). It is rebalanced daily, so you won’t get burned if a stock market bubble bursts. (Most of those stock gains would already have been converted to bonds as part of daily rebalancing, and bonds typically increase in value when stocks crash.) Or, you can choose a low-cost managed fund that uses an excess of bonds to balance both the inherent risk of stocks and the difficulty managers have of knowing when to move away from stocks and into bonds. The Vanguard Wellesley Income Fund (VWINX) has the best record. It is bond-heavy and therefore has less volatility than VBINX but performs about as well. The third low-cost option is to study the markets yourself and invest in stocks online at computershare, and in bonds at treasurydirect. This third option allows you to pick only the most stable stocks and bonds. That hedging strategy will serve you well, even though it has less exposure to growth themes.
Why do we harp on buying and selling costs? Aside from “impulse buying”, the main reason retail investors make only half as much as they should (based on whatever asset allocations they’ve chosen) is their failure to control costs. (Company CEOs are no different.) It’s a human failing to like toys and spend too much for those. But retirement is dead serious. You won’t like it if you haven’t prepared your body, mind, and pocketbook ahead of time.
Our blog this week details one example of a personal retirement fund (mine). I dollar-average into 6 stocks and one bond (see Table). There are two Lifeboat Stocks (Week 106): Procter & Gamble (PG) and NextEra Energy (NEE), and two Core Holdings (Week 102): International Business Machines (IBM) and Nike (NKE). The remaining two stocks are Exxon Mobil (XOM) and Microsoft (MSFT), both of which have AAA credit ratings to make up for the fact that they don’t quite meet our standards for designation as Core Holdings.
In our Week 117 blog on hedge stocks, we identified 16 such stocks out of the 900 in the S&P 500 and S&P 400 mid-cap indexes. NextEra Energy (NEE) was one of those, meaning that an investment in NEE stock doesn’t need to be backed up with investment in a Treasury Note or a bond index fund. The “bonds” that I use to back up the $250 that I invest each month in the other 5 stocks are inflation-protected 10-yr US Treasury Notes ($750/qtr).
In the Table, we use red highlights to denote values that are lower than benchmark values (VBINX). All values are current through 10/18/13.
Bottom Line: Dividend Reinvestment Plans (DRIPs) take time to set up and sell but are on automatic pilot the rest of the time. Savings Bonds and Treasury Notes are even easier to manage (through treasurydirect), except that you have to remember to buy them. The key difficulty is deciding exactly which stocks you’d like to own for an extended period. If you want to eliminate that chore without incurring additional expense, it is best to take Warren Buffett’s advice and invest in low cost index funds.
This week’s blog shows one example of how you can build retirement savings with DRIPs for stocks issued by 6 highly rated and stable companies, balanced with inflation-protected 10-yr Treasury Notes. You can have your accountant designate up to $6500/yr as a standard IRA or Roth IRA.
Risk Rating: 4
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 29
Week 117 - Hedge Stocks Revisited
Situation: Hedge Fund managers often bet against (short) shaky or overpriced stocks. That means borrowing thousands of shares of that stock and immediately selling those. While waiting for the shares to fall far enough in price to provide a profit to the hedge fund (after being bought back and returned to the owner), the hedge fund has to pay that owner interest on the loan and the value of any dividends that she would have received. There are over 10,000 hedge funds, so other hedge fund managers often see the same opportunity and “pile on.” That creates a self-fulfilling prophecy because the stock price will certainly fall from the selling pressure--presumably enough to “discover” the real value of the firm. That means prices for many stocks will crash in the early months of a recession, particularly stock in companies financed primarily by debt (which is most of the S&P 500 companies, since interest on that debt is tax-deductible). You and I, however, would like to avoid that downdraft in our portfolios by investing in stocks that are less likely to be shorted. Here at ITR, we call those “hedge stocks” (see Week 46, Week 76, Week 95 and Week 101).
By definition then, a hedge stock has few (if any) of the characteristics that would tempt a hedge fund manager to short the stock. That’s a long list but the main problems that attract “shorts” are:
1) more long-term debt than equity (because debt can’t always be refinanced cheap);
2) apparent overvaluation (price/earnings ratio higher than 20);
3) 5-yr Beta higher than ~0.65 (i.e., volatility is necessary to make a short sale work);
4) ROIC less than ~10% (suggesting managerial incompetence);
5) negative free cash flow (suggesting excessive or untimely capital expenditures);
6) little or no dividend payout (since dividends add costs to a short sale).
This week’s screen looks at all 900 stocks in both the large-cap S&P 500 Index and the medium-cap S&P 400 Index. We exclude any stocks that have:
a) a P/E greater than 21;
b) a dividend yield less than 1.5%;
c) a 5-yr Beta greater than 0.65;
d) a total return/yr (since the S&P 500 Index’s inflation-adjusted peak on 3/24/00) less than that for the Vanguard 500 Index Fund (VFINX);
e) a loss in total return over the 18-month “Lehman Panic” period greater than 30.2%, which is 65% as much as the 46.5% that VFINX lost.
We also exclude companies (aside from utilities) that had problems in 2012 with free cash flow (FCF), long-term debt, and return on invested capital (ROIC).
This screen yields only 16 companies (see Table). Not surprisingly, 12 of those 16 are from “defensive” S&P industries (consumer staples, healthcare, utilities, and communication services). In other words, those 12 are “Lifeboat Stocks” (see Week 106). Aside from the 4 Utilities companies (WEC, SO, NEE, WTR), there are 2 Healthcare companies (JNJ and ABT) and 6 Consumer Staples companies, all food-related (KO, PEP, GIS, SJM, LANC, WMT). The remaining 4 companies (CB, HCC, MCD, CHRW) are all we could find to represent the 6 “non-defensive” S&P industries (Energy, Materials, Industrial, Financials, Information Technology, and Consumer Discretionary). In other words, those 4 are “Core Holdings” (see Week 102): 2 Financial companies (CB and HCC), one Industrial company (CHRW), and one Consumer Discretionary company (MCD). Red highlights in the Table indicate inferior performance vs. our reference benchmark: the Vanguard Balanced Index Fund (VBINX). Data are current through 9/27/13.
While your investment in any of these 16 hedge stocks need not be backed up 1:1 with an investment in US Treasuries, the very brevity of the list (1.8% of the 900 companies) shows why we suggest that you insulate your stocks from market crashes by owning an equivalent amount of Treasuries or A-grade bond funds. (We think that inflation-protected US Savings Bonds, if held for more than 5 yrs, are the best option. Interest accrues automatically, and isn’t taxed until the bond is redeemed.) Much of the downdraft in stock prices that occurs during a market crash is due to hedge funds shorting stocks. Should you happen to retire just before one of those downdrafts occurs, you’ll be pleased to hold some stocks that didn’t get shorted. An interesting sidebar here is that Hedge Fund Research recently published its findings for the average total return of stock-related hedge funds in the first 6 months of 2013, which was 7.7%. Our 16 hedge stocks returned almost twice as much, 14.6% (Column F in the Table).
Bottom Line: “Price Discovery” is important and hedge funds do a fine job of this by shorting overpriced or shaky stocks before they get too overpriced. Our analysis this week shows that all but 16 of the S&P 500 and S&P 400 stocks have one or more characteristic that might trigger a short sale. When short sales include more than a few percent of a company’s outstanding shares, the downside volatility becomes exaggerated. You can either a) accept this volatility, or b) weight your portfolio toward stocks that are relatively immune. We’ve found 16 relatively immune stocks for you to consider.
Risk Rating: 3
Full Disclosure: I dollar-average into DRIPs for WMT, ABT, JNJ, KO, and NEE each month, and also own some stock in MCD, PEP, and GIS.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
By definition then, a hedge stock has few (if any) of the characteristics that would tempt a hedge fund manager to short the stock. That’s a long list but the main problems that attract “shorts” are:
1) more long-term debt than equity (because debt can’t always be refinanced cheap);
2) apparent overvaluation (price/earnings ratio higher than 20);
3) 5-yr Beta higher than ~0.65 (i.e., volatility is necessary to make a short sale work);
4) ROIC less than ~10% (suggesting managerial incompetence);
5) negative free cash flow (suggesting excessive or untimely capital expenditures);
6) little or no dividend payout (since dividends add costs to a short sale).
This week’s screen looks at all 900 stocks in both the large-cap S&P 500 Index and the medium-cap S&P 400 Index. We exclude any stocks that have:
a) a P/E greater than 21;
b) a dividend yield less than 1.5%;
c) a 5-yr Beta greater than 0.65;
d) a total return/yr (since the S&P 500 Index’s inflation-adjusted peak on 3/24/00) less than that for the Vanguard 500 Index Fund (VFINX);
e) a loss in total return over the 18-month “Lehman Panic” period greater than 30.2%, which is 65% as much as the 46.5% that VFINX lost.
We also exclude companies (aside from utilities) that had problems in 2012 with free cash flow (FCF), long-term debt, and return on invested capital (ROIC).
This screen yields only 16 companies (see Table). Not surprisingly, 12 of those 16 are from “defensive” S&P industries (consumer staples, healthcare, utilities, and communication services). In other words, those 12 are “Lifeboat Stocks” (see Week 106). Aside from the 4 Utilities companies (WEC, SO, NEE, WTR), there are 2 Healthcare companies (JNJ and ABT) and 6 Consumer Staples companies, all food-related (KO, PEP, GIS, SJM, LANC, WMT). The remaining 4 companies (CB, HCC, MCD, CHRW) are all we could find to represent the 6 “non-defensive” S&P industries (Energy, Materials, Industrial, Financials, Information Technology, and Consumer Discretionary). In other words, those 4 are “Core Holdings” (see Week 102): 2 Financial companies (CB and HCC), one Industrial company (CHRW), and one Consumer Discretionary company (MCD). Red highlights in the Table indicate inferior performance vs. our reference benchmark: the Vanguard Balanced Index Fund (VBINX). Data are current through 9/27/13.
While your investment in any of these 16 hedge stocks need not be backed up 1:1 with an investment in US Treasuries, the very brevity of the list (1.8% of the 900 companies) shows why we suggest that you insulate your stocks from market crashes by owning an equivalent amount of Treasuries or A-grade bond funds. (We think that inflation-protected US Savings Bonds, if held for more than 5 yrs, are the best option. Interest accrues automatically, and isn’t taxed until the bond is redeemed.) Much of the downdraft in stock prices that occurs during a market crash is due to hedge funds shorting stocks. Should you happen to retire just before one of those downdrafts occurs, you’ll be pleased to hold some stocks that didn’t get shorted. An interesting sidebar here is that Hedge Fund Research recently published its findings for the average total return of stock-related hedge funds in the first 6 months of 2013, which was 7.7%. Our 16 hedge stocks returned almost twice as much, 14.6% (Column F in the Table).
Bottom Line: “Price Discovery” is important and hedge funds do a fine job of this by shorting overpriced or shaky stocks before they get too overpriced. Our analysis this week shows that all but 16 of the S&P 500 and S&P 400 stocks have one or more characteristic that might trigger a short sale. When short sales include more than a few percent of a company’s outstanding shares, the downside volatility becomes exaggerated. You can either a) accept this volatility, or b) weight your portfolio toward stocks that are relatively immune. We’ve found 16 relatively immune stocks for you to consider.
Risk Rating: 3
Full Disclosure: I dollar-average into DRIPs for WMT, ABT, JNJ, KO, and NEE each month, and also own some stock in MCD, PEP, and GIS.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 22
Week 116 - Is there an “Optimum Portfolio” for the retail investor?
Situation: There has always been this myth of the “optimum portfolio” but exactly whose interests are best served by such a portfolio? We’re all different, after all, and of many minds. You may know that the left brain rationalizes everything to make us look better than we are and the right brain spouts poetry, solves math problems, and creates art, music, novels, architecture (along with gambling and other addictions). Ah, did I just mention gambling? There’s our clue to the optimum portfoliio. Pretty much any investor will take a risk once in awhile but she also wants most of her money to be in a safe place. So there’s the dichotomy.
Here at ITR, we keep gambling corralled in a small corner, writing only occasional pieces about commodity-related investments. The idea there is that (with enough basic information) the average investor can look at how commodities are used and make an investment where future benefits are more than likely to offset the not inconsiderable risks.
In Week 3, we set out our ideas on asset allocation, namely by proposing a recipe that calls for 3 helpings of bonds, two helpings of Core Holdings (Week 102), and one helping of Lifeboat Stocks (Week 106). The accompanying Table breaks out our current choices in each category.
Starting with bonds, US Treasuries are the place to be because all other bonds go down in value during a financial crisis but Treasuries go up, a lot. Some companies that make or market essential products also shine: People will pay the price dictated by supply and demand rather than go without heat, light, water, baby formula, Band-Aids, Tylenol, pizza, trips to the nearest McDonald’s, clothes, shoes and cleaning materials. Previous necessities, like a new car every 3 years, cable TV, soda pop, beer, quick stops at Starbucks, an evening out for dinner and a movie, and holiday travel soon become “out of reach” for the unemployed.
All 27 companies in the Table are A-rated by S&P, and none are rated high risk. This means that the second letter in the S&P stock rating is either an “L” for low risk, or an “M” for medium risk.
14 are in defensive industries (healthcare, consumer staples, utilities).
The remaining 13 stocks represent Core Holdings:
5 of those are in S&P’s “consumer discretionary” industry (ROST, FDO, MCD, TJX, NKE)
2 are in the “materials” industry (SHW and SIAL)
2 are in the “information technology” industry (IBM and ADP)
2 are in the “financial” industry (CB and TRV)
1 is in the “industrial” industry (JBHT) and
1 is in the “energy” industry (CVX).
The Table has red highlights for metrics that underperform the Vanguard Balanced Index Fund (VBINX), which is weighted 40% in a bond index and 60% in a stock index.
Bottom Line: Every portfolio is a form of personal expression. In providing a "guide" to help you construct an optimum portfolio, our first concern is to guide you away from foundering on the shoals in a storm.
Risk Rating: 5
Full disclosure: my trading positions on companies in the Table consist of monthly automatic electronic additions to DRIPs in WMT, NKE, ABT, JNJ, IBM, and NEE.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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