Situation: You’d like information about the durability of your investments. Sustainability is the jargon term that investment professionals have assigned to this topic. The problem is to quantify it by rating the 3 main components: Environment, Social, and Governance (ESG). The Yahoo Finance website now has a heading for sustainability that attempts to do exactly that. The editors of Barron’s also have a recent article looking more closely at the “100 Most Sustainable Companies”, with date suggesting that these may outperform the S&P 500 Index. We’d like to know which of those have also been examined by S&P. Specifically, which of those 100 Most Sustainable Companies have issued bonds that S&P has rated A or better?
Mission: Use our Standard Spreadsheet to analyze all of the Barron’s “100 Most Sustainable Companies” that are on the Russell 1000 List, selecting only the non-financial companies that have an S&P bond rating of A or better, and an S&P stock rating of B+/M or better. To identify stocks that are possibly overpriced, include columns for “Graham Numbers” and “7-Yr P/E”.
Execution: see Table.
Bottom Line: 18 companies meet criteria, 14 of which already appear on our two major lists: “The 2 and 8 Club” (see Week 360); “Blue Chips” (see Week 361). The new companies are Stanley Black & Decker (SWK), WW Grainger (GWW), Colgate-Palmolive (CL) and Deere (DE).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MSFT and PG, and also own shares of CSCO and CMI.
"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 durable competitive advantage. Show all posts
Showing posts with label durable competitive advantage. Show all posts
Sunday, September 23
Sunday, April 22
Week 355 - Companies in “The 2 and 8 Club” with a Durable Competitive Advantage
Situation: It is now 10 years since The Great Recession began with the collapse of Bear Stearns. Trust in markets was broken and has barely begun to recover. The Securities and Exchange Commission (SEC) grew out of The Great Depression because investors lost trust in markets. One of the ways it tried to rebuild trust was to require private companies to still have a strong balance sheet after a successful Initial Public Offering (IPO). If the SEC wasn’t convinced this would happen at the proposed price for the IPO, then the IPO wouldn’t be permitted.
Before the Great Recession of 2008, fewer than a third of companies in the S&P 500 Index had steadily growing Tangible Book Value (TBV), i.e., property, plant, equipment, and software priced at original cost (see Week 54, Week 94, Week 158, Week 241, Week 251, Week 271). After 2008, Balance Sheets were in need of repair, and that was facilitated by low interest rates. Now, perhaps a quarter of S&P 500 companies again have steady TBV growth.
Mission: Apply our Standard Spreadsheet to companies in the Extended Version of “The 2 and 8 Club” that have shown steady TBV growth (with no more than 3 down years) since 2008. Warren Buffett suggests that such companies have a Durable Competitive Advantage (see blogs listed above), as long as TBV meets the Business Case of doubling after 10 years (i.e., a growth rate of at least 7%/yr).
Execution: see Table.
Administration: Risk works both ways for stock investors, i.e., you’ll either lose or gain +20% every few years. Our investing behavior isn’t governed by numbers, so we don’t act appropriately when warning signs of a market crash emerge. Why? Because we can’t know for certain when and whether a market crash will indeed happen. Many of us will remain sitting at the table even after it has clearly become a gambling table. You know when that occurs because the risk-off investors have already cashed out. Those of us who remain are governed by a desire to have. After a few market cycles, we come to realize that having more is going to be either boring or exciting, based on one’s appetite for risk. To have more, and have it be exciting, involves good study habits and an ability to live with chronic anxiety. Simply being human will matter less and less.
The trick is to maintain discipline 24/7/365, by using a system for monitoring and researching your investments. This has to be combined with a weird ability to stick with your system through good times and bad. Numbers won’t save you when the market is turning. Instead, you have to know whether or not the “story” that underpins the reason for each of your holdings has retained its agency. Truth be told, the moves you make (or don’t make) at turning points will come down to a gut feeling as to whether your holdings are overbought or oversold. Any decision you make at a turning point is a risk-on decision. Caveat emptor: This is not a formula for marital bliss. (Warren Buffett was mystified when his wife left to become an artist in San Francisco.)
Bottom Line: Now is a good time to have a boring investment posture, which means choosing to dollar-average into companies that have bullet-proof Balance Sheets and strong Global Brands. This week we look at the bedrock of strong Balance Sheets, which is steady growth in Tangible Book Value. Five of these 9 companies are part of S&P’s Finance Industry. Their strong Balance Sheets reflect the regulatory requirements of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. If Dodd-Frank becomes eroded by a Risk-on Congress, you’ll have to dig deeper into Annual Reports when investing in a Financial Services company. REMEMBER: common stocks issued by Financial Services and Real Estate companies are the most risky places to park your money, aside from commodity futures.
Risk Rating: 7 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM, and also own shares of CSCO and TRV.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Before the Great Recession of 2008, fewer than a third of companies in the S&P 500 Index had steadily growing Tangible Book Value (TBV), i.e., property, plant, equipment, and software priced at original cost (see Week 54, Week 94, Week 158, Week 241, Week 251, Week 271). After 2008, Balance Sheets were in need of repair, and that was facilitated by low interest rates. Now, perhaps a quarter of S&P 500 companies again have steady TBV growth.
Mission: Apply our Standard Spreadsheet to companies in the Extended Version of “The 2 and 8 Club” that have shown steady TBV growth (with no more than 3 down years) since 2008. Warren Buffett suggests that such companies have a Durable Competitive Advantage (see blogs listed above), as long as TBV meets the Business Case of doubling after 10 years (i.e., a growth rate of at least 7%/yr).
Execution: see Table.
Administration: Risk works both ways for stock investors, i.e., you’ll either lose or gain +20% every few years. Our investing behavior isn’t governed by numbers, so we don’t act appropriately when warning signs of a market crash emerge. Why? Because we can’t know for certain when and whether a market crash will indeed happen. Many of us will remain sitting at the table even after it has clearly become a gambling table. You know when that occurs because the risk-off investors have already cashed out. Those of us who remain are governed by a desire to have. After a few market cycles, we come to realize that having more is going to be either boring or exciting, based on one’s appetite for risk. To have more, and have it be exciting, involves good study habits and an ability to live with chronic anxiety. Simply being human will matter less and less.
The trick is to maintain discipline 24/7/365, by using a system for monitoring and researching your investments. This has to be combined with a weird ability to stick with your system through good times and bad. Numbers won’t save you when the market is turning. Instead, you have to know whether or not the “story” that underpins the reason for each of your holdings has retained its agency. Truth be told, the moves you make (or don’t make) at turning points will come down to a gut feeling as to whether your holdings are overbought or oversold. Any decision you make at a turning point is a risk-on decision. Caveat emptor: This is not a formula for marital bliss. (Warren Buffett was mystified when his wife left to become an artist in San Francisco.)
Bottom Line: Now is a good time to have a boring investment posture, which means choosing to dollar-average into companies that have bullet-proof Balance Sheets and strong Global Brands. This week we look at the bedrock of strong Balance Sheets, which is steady growth in Tangible Book Value. Five of these 9 companies are part of S&P’s Finance Industry. Their strong Balance Sheets reflect the regulatory requirements of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. If Dodd-Frank becomes eroded by a Risk-on Congress, you’ll have to dig deeper into Annual Reports when investing in a Financial Services company. REMEMBER: common stocks issued by Financial Services and Real Estate companies are the most risky places to park your money, aside from commodity futures.
Risk Rating: 7 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM, and also own shares of CSCO and TRV.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 18
Week 350 - Non “S&P 100 Index” Companies in the Extended Version of “The 2 and 8 Club”
Situation: “The 2 and 8 Club” has 23 members that we have selected from the S&P 100 Index because those have a dividend yield greater than ~2%/yr, and have had a dividend growth rate of at least ~8%/yr over the past 5 years (see Week 344). By using a larger starting list than the S&P 100 Index, i.e., the Barron’s 500 List, we can add 11 companies to create the Extended Version of “The 2 and 8 Club.”
Mission: Apply our Standard Spreadsheet to those additional 11 companies.
Execution: see Table.
Administration: All 11 companies meet requirements for membership in “The 2 and 8 Club”: 1) an S&P bond rating of BBB+ or better; 2) an S&P stock rating of B+/M or better, 3) are listed in the Vanguard High Dividend Yield Index and 4) have the 16+ years of trading records that are needed for quantitative metrics using the BMW Method.
Bottom Line: These additional 11 companies help us meet a requirement that academic studies have imposed on stock-pickers who seek to avoid Selection Bias. That requirement is to be actively trading ~40 stocks to have a good chance of beating risk-adjusted returns for “the population intended to be analyzed”, which in this case is the S&P 500 Index.
Risk Rating for the cohort of 34 companies in the Extended Version: 6 (where 1 = 10-Yr US Treasury Notes, 5 = S&P 500 Index, and 10 = gold bullion).
Caveat Emptor: The risk of loss in a Bear Market (from investing equal amounts in all 34 stocks) is ~12% greater vs. investing in SPY, per Column M of this Week’s Blog and the Week 348 Blog. But price performance over the past 16 years is ~75% better, per Column K of those Blogs. Total Returns since the highest S&P 500 Index peak just prior to the Great Recession have been ~35% greater, per Column C in both Blogs.
Full Disclosure: I own shares of TRV, WEC and CMI.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Apply our Standard Spreadsheet to those additional 11 companies.
Execution: see Table.
Administration: All 11 companies meet requirements for membership in “The 2 and 8 Club”: 1) an S&P bond rating of BBB+ or better; 2) an S&P stock rating of B+/M or better, 3) are listed in the Vanguard High Dividend Yield Index and 4) have the 16+ years of trading records that are needed for quantitative metrics using the BMW Method.
Bottom Line: These additional 11 companies help us meet a requirement that academic studies have imposed on stock-pickers who seek to avoid Selection Bias. That requirement is to be actively trading ~40 stocks to have a good chance of beating risk-adjusted returns for “the population intended to be analyzed”, which in this case is the S&P 500 Index.
Risk Rating for the cohort of 34 companies in the Extended Version: 6 (where 1 = 10-Yr US Treasury Notes, 5 = S&P 500 Index, and 10 = gold bullion).
Caveat Emptor: The risk of loss in a Bear Market (from investing equal amounts in all 34 stocks) is ~12% greater vs. investing in SPY, per Column M of this Week’s Blog and the Week 348 Blog. But price performance over the past 16 years is ~75% better, per Column K of those Blogs. Total Returns since the highest S&P 500 Index peak just prior to the Great Recession have been ~35% greater, per Column C in both Blogs.
Full Disclosure: I own shares of TRV, WEC and CMI.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 25
Week 347 - The Gretzky Rule Applied to Dividend Achievers in the Food Sector
Situation: Business people seeking to predict outcomes often quote Wayne Gretzky quote: “I skate to where the puck is going to be, not where it has been.” This highlights a problem: All of the metrics and technical charts that we use are retrospective. We’re driving forward by looking in the rear view mirror! Warren Buffett has tried to estimate outcomes by making calculations of the growth in “core earnings’ in companies that have a “Durable Competitive Advantage”. DCA companies have had a growth rate for Tangible Book Value over the most recent 10 years that exceeds 7%/yr, with no more than three down years. (c.f. The Warren Buffett Stock Portfolio, Scribner, NY, 2011 by Mary Buffett and David Clark) You can read more about such estimates of “true” Shareholder Equity by Googling Net Tangible Asset Investing.
We agree with Mr. Buffett, and have learned to envision the future prospects of a company by first assessing its ability to grow Tangible Book Value. But since the Great Recession, few S&P 500 companies have even a dollar of Net Tangible Assets. Why? Because the Federal Reserve’s policy (to accelerate recovery from the Great Recession) has been to make money more freely available than ever before. Accordingly, companies favor debt financing over equity financing. Debt becomes a larger dollar amount on the Balance Sheet than equity. (Equity for most companies represents the initial cost of property, plant and equipment, which equals Tangible Book Value.)
Mission: Use our Standard Spreadsheet to arrive at an estimate of a company’s position in its sector of the economy 10 years from now. Start by analyzing S&P 500 companies in the Food, Beverage and Restaurant sector that are Dividend Achievers, i.e., have increased their dividend annually for at least the past 10 years.
Execution: see Table.
Administration: For almost any business, the name of the game for making money is not losing money. If a stock falls 50% in price, that price must rise 200% just to get back to where it started. So, let’s start our analysis by excluding Dividend Achievers that have a 16 year record of price appreciation showing volatility which exceeds that for the S&P 500 Index (see Column M in the Table). Then, we’ll look for companies having a clean Balance Sheet (Columns P-S in the Table) and a strong Global Brand (Columns AC-AD in the Table). None of the 11 companies have a clean Balance Sheet, but Coca-Cola (KO), Costco Wholesale (COST), Target (TGT), and Walmart (WMT) come close. Those four are also the only companies that have any Tangible Book Value (see Column R in the Table) but none have grown TBV fast enough to meet Warren Buffett’s requirements for DCA (see Column AF in the Table), although Walmart (WMT) comes close. Those 4 companies are also among the 7 that have a strong Global Brand.
Bottom Line: Walmart (WMT) is the winner of this contest.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10). As a group, these 11 companies had remarkably buoyant total returns during the recent commodity recession (see Column D in the Table), which saw a 24.2%/yr drop in commodity prices (see Line 21 in the Table). Of course, raw food commodities were less expensive during that period but the outperformance of the food sector is strong enough to suggest that investors tend to move money there in deflationary times.
Full Disclosure: I dollar-cost average into Coca-Cola (KO), and also own shares of Costco Wholesale (COST), Target (TGT), Walmart (WMT), McCormick (MKC) and McDonald’s (MCD).
"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
We agree with Mr. Buffett, and have learned to envision the future prospects of a company by first assessing its ability to grow Tangible Book Value. But since the Great Recession, few S&P 500 companies have even a dollar of Net Tangible Assets. Why? Because the Federal Reserve’s policy (to accelerate recovery from the Great Recession) has been to make money more freely available than ever before. Accordingly, companies favor debt financing over equity financing. Debt becomes a larger dollar amount on the Balance Sheet than equity. (Equity for most companies represents the initial cost of property, plant and equipment, which equals Tangible Book Value.)
Mission: Use our Standard Spreadsheet to arrive at an estimate of a company’s position in its sector of the economy 10 years from now. Start by analyzing S&P 500 companies in the Food, Beverage and Restaurant sector that are Dividend Achievers, i.e., have increased their dividend annually for at least the past 10 years.
Execution: see Table.
Administration: For almost any business, the name of the game for making money is not losing money. If a stock falls 50% in price, that price must rise 200% just to get back to where it started. So, let’s start our analysis by excluding Dividend Achievers that have a 16 year record of price appreciation showing volatility which exceeds that for the S&P 500 Index (see Column M in the Table). Then, we’ll look for companies having a clean Balance Sheet (Columns P-S in the Table) and a strong Global Brand (Columns AC-AD in the Table). None of the 11 companies have a clean Balance Sheet, but Coca-Cola (KO), Costco Wholesale (COST), Target (TGT), and Walmart (WMT) come close. Those four are also the only companies that have any Tangible Book Value (see Column R in the Table) but none have grown TBV fast enough to meet Warren Buffett’s requirements for DCA (see Column AF in the Table), although Walmart (WMT) comes close. Those 4 companies are also among the 7 that have a strong Global Brand.
Bottom Line: Walmart (WMT) is the winner of this contest.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10). As a group, these 11 companies had remarkably buoyant total returns during the recent commodity recession (see Column D in the Table), which saw a 24.2%/yr drop in commodity prices (see Line 21 in the Table). Of course, raw food commodities were less expensive during that period but the outperformance of the food sector is strong enough to suggest that investors tend to move money there in deflationary times.
Full Disclosure: I dollar-cost average into Coca-Cola (KO), and also own shares of Costco Wholesale (COST), Target (TGT), Walmart (WMT), McCormick (MKC) and McDonald’s (MCD).
"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, September 10
Week 323 - “Toto, I’ve A Feeling We’re Not In Kansas Any More.”
Situation: A storm has hit international relations. It’s not as though we haven’t been warned. In his 2014 book, “World Order,” Henry Kissinger mentions dark trends could undermine the principles of international governance, which were established by (and adhered to since) the Peace of Westphalia ended the Thirty Years War in 1648. Those principles are 1) the inviolability of national sovereignty, and 2) the self-determination of peoples free from religious intolerance. But Russia has recently annexed Crimea, and Great Britain’s vote to leave the European Union reflects growing religious intolerance. Here in America, we have echoed Brexit by electing Donald J. Trump to be our President.
Investors abhor uncertainty and wonder whether they’ll continue to prosper in the absence of International Order. The issue is one of governance. Picture a tent with many people of various nationalities inside, debating ideas about how best to get along together. This metaphor worked for hundreds of years, even though a camel would occasionally stick its nose under a tent. Now countries and economic unions are having to grapple with anarchists seeking Jihad.
What does it all mean? Investors need a mental picture, one where cause and effect assume a pattern that allows us to anticipate how events on the world stage are likely to play out. Artists often arrive at formulations before events unfold. The disruption of Victorian Order that culminated in World War One is one example. The writings of Franz Kafka and paintings of Picasso spring to mind as heralds of Modernism. Similarly, Existentialists like Albert Camus and Jean Paul Sartre anticipated the Second World War and gave us The Theatre of the Absurd. The effect reached music with the 12-tone scale, choreography with ballets no longer anchored in stories, paintings lacking both content and message, and the “deconstruction” of classical poetry.
The art world has evolved beyond Modernism to become Post-Modern, but more recently that has been replaced by Contemporary Art, which anticipates the crumbling of World Order we’re now seeing. Formerly, art was about feelings, music, and imagery; reasoned discourse was left out. In Contemporary Art, the intellect is finally engaged but still without reasoned discourse. The tent ropes have come loose. We are left to manage without Cliff’s Notes, religious precepts, party politics, or judicial constraint; mood-altering drugs are used to let light in as often as to keep it out. A piece of Contemporary Art (if we are open to it at all) might lead any one of us to see, hear, read, imagine, or think along a unique trajectory, then use that as a basis for free association.
There are no guideposts, and the unhinging has been accelerated by the ready availability of computing power and networking via one’s cell phone. The artist typically has no interest in channeling the viewer or listener’s thoughts, feelings, or mental images. Why presume, given that each of us is unique? A poet might apply the words levitation, unmooring, kaleidoscopic, or ricochet to characterize the mental effects that the artist ignites in some people. If people join together, it might become participatory theater. Think of stadium performances by iconic figures like The Grateful Dead, Janis Joplin, or even Donald J. Trump. The traditional format used by the music industry is also “going down the tubes.” Few artists make an “album” any longer with a recording studio contract. It’s all small entrepreneurs selling a single song via the internet, using social media as advertising.
Prepare your portfolio. Think about limiting key retirement investments to US Treasury bonds and well-capitalized A-rated stocks that have a Durable Competitive Advantage (see Table). VYM is the Benchmark Index for Russell 1000 companies that pay at least a market dividend. “Durable Competitive Advantage” (see Column O in the Table) is a term that Warren Buffett coined to denote a 7% (or higher) rate of growth in a company’s Tangible Book Value (TBV) over the past 10 yrs, provided that TBV is down no more than 3 years (see Week 158 and Week 241).
Administration: The sky is not falling. Civilization won’t end, and neither will Westphalian Principles of Governance. Be patient but don’t take risks. Some good is bound to come from abandoning “received wisdom” or “group think.” Why? Because “received wisdom” gives rise to dogma, and dogma prevents innovation. Don’t worry about nuclear war. Sure, it could happen. Maybe there’s even a “material” risk (odds higher than one in twenty). That would amount to an existential crisis for many survivors. We’d all become more focussed on survival, so behavior would become more collegial.
Bottom Line: Uncertainty is on the move. So, this is not a good time to speculate in financial assets. Hard assets like farmland are another matter (see next week’s blog).
Risk Rating: 6 (where 10-Yr T-Notes = 1, S&P 500 Index = 5, gold = 10)
Full Disclosure: I dollar-average into MSFT and NEE, and own shares of NKE, TJX, ACN, JPM, and TRV.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Investors abhor uncertainty and wonder whether they’ll continue to prosper in the absence of International Order. The issue is one of governance. Picture a tent with many people of various nationalities inside, debating ideas about how best to get along together. This metaphor worked for hundreds of years, even though a camel would occasionally stick its nose under a tent. Now countries and economic unions are having to grapple with anarchists seeking Jihad.
What does it all mean? Investors need a mental picture, one where cause and effect assume a pattern that allows us to anticipate how events on the world stage are likely to play out. Artists often arrive at formulations before events unfold. The disruption of Victorian Order that culminated in World War One is one example. The writings of Franz Kafka and paintings of Picasso spring to mind as heralds of Modernism. Similarly, Existentialists like Albert Camus and Jean Paul Sartre anticipated the Second World War and gave us The Theatre of the Absurd. The effect reached music with the 12-tone scale, choreography with ballets no longer anchored in stories, paintings lacking both content and message, and the “deconstruction” of classical poetry.
The art world has evolved beyond Modernism to become Post-Modern, but more recently that has been replaced by Contemporary Art, which anticipates the crumbling of World Order we’re now seeing. Formerly, art was about feelings, music, and imagery; reasoned discourse was left out. In Contemporary Art, the intellect is finally engaged but still without reasoned discourse. The tent ropes have come loose. We are left to manage without Cliff’s Notes, religious precepts, party politics, or judicial constraint; mood-altering drugs are used to let light in as often as to keep it out. A piece of Contemporary Art (if we are open to it at all) might lead any one of us to see, hear, read, imagine, or think along a unique trajectory, then use that as a basis for free association.
There are no guideposts, and the unhinging has been accelerated by the ready availability of computing power and networking via one’s cell phone. The artist typically has no interest in channeling the viewer or listener’s thoughts, feelings, or mental images. Why presume, given that each of us is unique? A poet might apply the words levitation, unmooring, kaleidoscopic, or ricochet to characterize the mental effects that the artist ignites in some people. If people join together, it might become participatory theater. Think of stadium performances by iconic figures like The Grateful Dead, Janis Joplin, or even Donald J. Trump. The traditional format used by the music industry is also “going down the tubes.” Few artists make an “album” any longer with a recording studio contract. It’s all small entrepreneurs selling a single song via the internet, using social media as advertising.
Prepare your portfolio. Think about limiting key retirement investments to US Treasury bonds and well-capitalized A-rated stocks that have a Durable Competitive Advantage (see Table). VYM is the Benchmark Index for Russell 1000 companies that pay at least a market dividend. “Durable Competitive Advantage” (see Column O in the Table) is a term that Warren Buffett coined to denote a 7% (or higher) rate of growth in a company’s Tangible Book Value (TBV) over the past 10 yrs, provided that TBV is down no more than 3 years (see Week 158 and Week 241).
Administration: The sky is not falling. Civilization won’t end, and neither will Westphalian Principles of Governance. Be patient but don’t take risks. Some good is bound to come from abandoning “received wisdom” or “group think.” Why? Because “received wisdom” gives rise to dogma, and dogma prevents innovation. Don’t worry about nuclear war. Sure, it could happen. Maybe there’s even a “material” risk (odds higher than one in twenty). That would amount to an existential crisis for many survivors. We’d all become more focussed on survival, so behavior would become more collegial.
Bottom Line: Uncertainty is on the move. So, this is not a good time to speculate in financial assets. Hard assets like farmland are another matter (see next week’s blog).
Risk Rating: 6 (where 10-Yr T-Notes = 1, S&P 500 Index = 5, gold = 10)
Full Disclosure: I dollar-average into MSFT and NEE, and own shares of NKE, TJX, ACN, JPM, and TRV.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 4
Week 309 - Barron’s 500 Food Processing Companies
Situation: The food processing sector can be quite rewarding for stock-pickers, relative to risk, even though profit margins are thin. This “competitive advantage” occurs because food is an “essential good.” Consumers tend to purchase the same food items in the same quantities, month after month, regardless of price. Demand is relatively insensitive to price, so prices are said to be inelastic. This is fortunate for the food processor because input costs can change on short notice (typically due to weather events or transportation bottlenecks).
Mission: Identify and analyze all of the large and well-established US food processing companies that are publicly traded.
Execution: Provide a spreadsheet analysis (see Table) of those companies large enough to be on the Barron’s 500 List (http://online.wsj.com/public/resources/documents/500TopCompanies2016.pdf) and well-established enough to have had 16 years of trading records analyzed by the BMW Method. Exclude companies that issue “junk bonds” (those rated lower than BBB- by S&P).
Bottom Line: We’ve come up with 18 companies (see Table). In the aggregate, their stocks make a very good investment, having returned over 11%/yr since the S&P 500 peak on 9/1/2000 vs. less than 5%/yr for VFINX (the lowest-cost S&P 500 Index fund at Line 28 in the Table). Risk measures also look good. For example, the average stock gained 3.7%/yr during the 4.5 year Housing Crisis vs. a loss of 3%/yr for VFINX (see Column D in the Table), and has less than half the price volatility (as measured by the 5-Yr Beta statistic, see Column I in the Table).
What’s not to like? Well, a lot. Try picking just 3 of the 18 for your portfolio. Maybe you want to confine your research to A-rated stocks (see Columns U and V)? Only 6 qualify: HRL, COST, HSY, KO, PEP and WMT. Maybe you want stocks with a clean Balance Sheet (see Columns R through T in the Table)? Only 8 qualify: HRL, COST, WFM, INGR, KO, WMT, ADM and KR. Maybe you don’t want to gamble, so you’ll avoid the red-highlighted stocks in Column M of the Table. There are 9 of those: SJM, COST, GIS, KO, K, PEP, WMT, CPB and SYY. You get the point. Very few are “safe,” meaning that the stock is able to clear all 3 of those hurdles. There are 3 of those: Costco Wholesale (COST), Coca-Cola (KO) and Wal-Mart Stores (WMT). Not surprisingly, both are strong global brands, as shown in Columns P and Q. Only COST and KO have a projected rate of return over the next decade of at least 9%/yr, i.e., a positive NPV number in Column AA of the Table.
Risk Rating: 6 (where 10-Yr Treasury Note = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into KO, and also own shares of HRL, WMT, and COST.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 27 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 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning 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 32 in the Table. The ETF for that index is MDY at Line 26. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Identify and analyze all of the large and well-established US food processing companies that are publicly traded.
Execution: Provide a spreadsheet analysis (see Table) of those companies large enough to be on the Barron’s 500 List (http://online.wsj.com/public/resources/documents/500TopCompanies2016.pdf) and well-established enough to have had 16 years of trading records analyzed by the BMW Method. Exclude companies that issue “junk bonds” (those rated lower than BBB- by S&P).
Bottom Line: We’ve come up with 18 companies (see Table). In the aggregate, their stocks make a very good investment, having returned over 11%/yr since the S&P 500 peak on 9/1/2000 vs. less than 5%/yr for VFINX (the lowest-cost S&P 500 Index fund at Line 28 in the Table). Risk measures also look good. For example, the average stock gained 3.7%/yr during the 4.5 year Housing Crisis vs. a loss of 3%/yr for VFINX (see Column D in the Table), and has less than half the price volatility (as measured by the 5-Yr Beta statistic, see Column I in the Table).
What’s not to like? Well, a lot. Try picking just 3 of the 18 for your portfolio. Maybe you want to confine your research to A-rated stocks (see Columns U and V)? Only 6 qualify: HRL, COST, HSY, KO, PEP and WMT. Maybe you want stocks with a clean Balance Sheet (see Columns R through T in the Table)? Only 8 qualify: HRL, COST, WFM, INGR, KO, WMT, ADM and KR. Maybe you don’t want to gamble, so you’ll avoid the red-highlighted stocks in Column M of the Table. There are 9 of those: SJM, COST, GIS, KO, K, PEP, WMT, CPB and SYY. You get the point. Very few are “safe,” meaning that the stock is able to clear all 3 of those hurdles. There are 3 of those: Costco Wholesale (COST), Coca-Cola (KO) and Wal-Mart Stores (WMT). Not surprisingly, both are strong global brands, as shown in Columns P and Q. Only COST and KO have a projected rate of return over the next decade of at least 9%/yr, i.e., a positive NPV number in Column AA of the Table.
Risk Rating: 6 (where 10-Yr Treasury Note = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into KO, and also own shares of HRL, WMT, and COST.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 27 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 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning 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 32 in the Table. The ETF for that index is MDY at Line 26. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 11
Week 271 - Barron’s 500 Dividend Achievers with a Durable Competitive Advantage
Situation: Warren Buffett likes to know a company’s Tangible Book Value (TBV) before digging deeper to see if the stock price is attractive. TBV represents physical assets that can be sold. Intangibles include patents, and the dollars above book value that were paid for strategic acquisitions that enhanced the company’s brand value. TBV is the company’s brand value, and estimates can vary widely on what that’s worth. Mr. Buffett looks for steady growth of TBV (at least 8% a year) with no more than two down years in the prior decade. Such companies have what he calls a Durable Competitive Advantage (see “The Warren Buffett Stock Portfolio” by Mary Buffett and David Clark, Scribner, New York, 2011). Remember: TBV is stuff that has real value, not patents, not brand names, and not the difference between the original cost (for property, plant, and equipment) and the estimated replacement cost.
The problem is that most large companies have negative TBV. Why? Because their managers think it is preferable to borrow money for expansion and advertising, using TBV as collateral. But some companies hold out for the old way and maintain a strong Balance Sheet. Investors gravitate toward buying stock in those companies, which often results in those stocks becoming overpriced. That means stockpickers need to dig deeper into Balance Sheets, and look at each company’s prospects for growth, to find the few remaining bargains.
Mission: Find the few Dividend Achievers that have a Durable Competitive Advantage.
Execution: Compare 2016 & 2015 Barron’s 500 rankings using the buyupside website to determine Total Return/yr since our key benchmark (VBINX) was introduced on 9/28/1992, and the BMW Method website for the 25-yr CAGR in each stock’s mean price. Include our Balance Sheet package (see Appendix below), and calculate the Net Present Value for buying $5000 worth of each stock.
Administration: see Table.
Bottom Line: We’ve come up with 8 Dividend Achievers that have a Durable Competitive Advantage. Five look to be good long-term bets for dollar-cost averaging. Exxon Mobil (XOM) cannot pay its dividend from Free Cash Flow (FCF) because the price of oil has collapsed, and its Weighted Average Cost of Capital (WACC) still exceeds its Return On Invested Capital (ROIC) even though the price of oil has retraced 20% of its 70% loss. The two financial companies, Travelers (TRV) and Franklin Resources (BEN), are still recovering from the Lehman Panic, which pulls their 2016 Barron’s rank lower than their 2015 Barron’s rank and produces volatility in their stock prices (see Column I in the Table).
Risk Rating: 6 (where Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into NKE and XOM, and own shares of ROST, TJX, and CMI.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Purple highlights denote Balance Sheet issues and shortfalls in TBV growth. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found here.
APPENDIX: These are our criteria for a clean Balance Sheet.
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 patents, property, plant, and equipment. TBV may be negative for a short period after a company restructures by selling non-strategic assets to pay down LT debt. Procter & Gamble (at Line 16 in the Table) is a current example.
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).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The problem is that most large companies have negative TBV. Why? Because their managers think it is preferable to borrow money for expansion and advertising, using TBV as collateral. But some companies hold out for the old way and maintain a strong Balance Sheet. Investors gravitate toward buying stock in those companies, which often results in those stocks becoming overpriced. That means stockpickers need to dig deeper into Balance Sheets, and look at each company’s prospects for growth, to find the few remaining bargains.
Mission: Find the few Dividend Achievers that have a Durable Competitive Advantage.
Execution: Compare 2016 & 2015 Barron’s 500 rankings using the buyupside website to determine Total Return/yr since our key benchmark (VBINX) was introduced on 9/28/1992, and the BMW Method website for the 25-yr CAGR in each stock’s mean price. Include our Balance Sheet package (see Appendix below), and calculate the Net Present Value for buying $5000 worth of each stock.
Administration: see Table.
Bottom Line: We’ve come up with 8 Dividend Achievers that have a Durable Competitive Advantage. Five look to be good long-term bets for dollar-cost averaging. Exxon Mobil (XOM) cannot pay its dividend from Free Cash Flow (FCF) because the price of oil has collapsed, and its Weighted Average Cost of Capital (WACC) still exceeds its Return On Invested Capital (ROIC) even though the price of oil has retraced 20% of its 70% loss. The two financial companies, Travelers (TRV) and Franklin Resources (BEN), are still recovering from the Lehman Panic, which pulls their 2016 Barron’s rank lower than their 2015 Barron’s rank and produces volatility in their stock prices (see Column I in the Table).
Risk Rating: 6 (where Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into NKE and XOM, and own shares of ROST, TJX, and CMI.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Purple highlights denote Balance Sheet issues and shortfalls in TBV growth. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found here.
APPENDIX: These are our criteria for a clean Balance Sheet.
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 patents, property, plant, and equipment. TBV may be negative for a short period after a company restructures by selling non-strategic assets to pay down LT debt. Procter & Gamble (at Line 16 in the Table) is a current example.
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).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 24
Week 251 - A-rated S&P 500 Dividend Achievers with a Durable Competitive Advantage
Situation: Stock markets are more fragile than most people realize. For example, the S&P 500 Index has a Return on Assets or ROA of ~3% while its Weighted Average Cost of Capital or WACC is ~8%. Although the deficiency in ROA vs. WACC is unsustainable, that’s thought to be OK because the economy is still recovering from the Great Recession, i.e., the return on assets will reach parity with the cost of assets. As long as that doesn’t happen, company managers will hesitate before investing yet more capital in property, plant, equipment, and labor. Instead, they’ll be more likely to return money to investors via a buy back of stock or by raising the dividend. That has been common practice since the Great Recession, and is one reason why the stock market has a P/E ratio that is higher than its historical average.
Stock markets have only one fuel, and that is peoples’ savings, including the savings of corporations now that the US Supreme Court has decided that a corporation is essentially “a person” with the same First Amendment rights. Savings are more constrained than ever because the level of indebtedness of countries, corporations, states, cities, and small businesses has not decreased since the Great Recession. Only household debt has managed to recover somewhat. The “great unwind” has yet to occur. Deleveraging is not a priority for governments or corporations because interest rates are so low that it seems foolish not to borrow money. Until deleveraging happens, the ROA for the most important asset (educated citizens) will not be much greater than the cost of creating that asset. Why? Because the cost of servicing debt eats into savings needed for investment.
Given the above warning, you need to look for stock in companies that are responsibly managed and clearly profitable. These would be firms that have high operating margins most of the time (e.g. Nike), or moderate but stable operating margins all of the time (e.g. Wal-Mart Stores). What is an “operating margin” (see Column M in the Table)? It is an unambiguous measure of profitability, expressed as a ratio: EBIT/Total Revenue, where EBIT = Earnings Before Interest and Taxes. “Total Revenue” is the first line of an Income Statement and “Earnings Before Interest And Taxes” is usually at line 13. See this Income Statement of 3M Corporation as an example.
Mission: Screen the S&P 500 Index for companies that have the following quality markers: 1) high S&P bond ratings (A- or higher) and stock ratings (A-/M or higher); 2) are designated as a Dividend Achiever by S&P, indicating annual dividend increases for at least the past 10 yrs; 3) have a Durable Competitive Advantage or DCA (see Columns P through T in the Table), as defined by Warren Buffett (see Week 241).
Execution: Given the turbulent nature of the stock market over the past decade, there are only 9 companies that meet our requirements (see Table). All of those companies have an Operating Margin greater than the WACC (see Column N of the Table). But some of the companies have a current problem selling their goods and services that pushes their ROA lower than their WACC (compare Column O to Column N in the Table). Exxon Mobil (XOM) at Line 10 in the Table is a prime example.
Bottom Line: It is particularly difficult to save for retirement when Central Banks are busy lowering the interest rate on bonds, a move that is meant to entice people to invest in stocks, start a new business, build a factory, create an app, buy a home or get a better education. For retirement planning, you need to put ~50% of your savings into dividend-paying stocks and the remainder into US Treasuries. To get adequate diversification, your stocks need to represent all 10 S&P industries. To get adequate quality, you need to have stringent criteria like those above. Only 6 S&P industries have contributed the 9 stocks that meet our stringent criteria: Consumer Staples (WMT), HealthCare (JNJ and ABT), Utilities (NEE), Consumer Discretionary (TJX, ROST, NKE), Information Technology (MSFT) and Energy (XOM). You can check out our recent blogs on defensive industries (Week 247) and growth industries (Week 248) for help picking stocks to cover the other 4 S&P industries (Basic Materials, Communication Services, Industrials, and Financials).
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, JNJ, NEE, NKE, MSFT and XOM, and also own shares of ABT, TJX and ROST.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, VBINX at Line 16 in the Table. Total returns/Yr in Column C, and the CAGR for stock prices in Column U, are for performance over the past 20 years. That period is chosen because it covers approximately 3 market cycles, i.e., there have been 15 recessions in the past 90 years for an average of 6 years between each.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Stock markets have only one fuel, and that is peoples’ savings, including the savings of corporations now that the US Supreme Court has decided that a corporation is essentially “a person” with the same First Amendment rights. Savings are more constrained than ever because the level of indebtedness of countries, corporations, states, cities, and small businesses has not decreased since the Great Recession. Only household debt has managed to recover somewhat. The “great unwind” has yet to occur. Deleveraging is not a priority for governments or corporations because interest rates are so low that it seems foolish not to borrow money. Until deleveraging happens, the ROA for the most important asset (educated citizens) will not be much greater than the cost of creating that asset. Why? Because the cost of servicing debt eats into savings needed for investment.
Given the above warning, you need to look for stock in companies that are responsibly managed and clearly profitable. These would be firms that have high operating margins most of the time (e.g. Nike), or moderate but stable operating margins all of the time (e.g. Wal-Mart Stores). What is an “operating margin” (see Column M in the Table)? It is an unambiguous measure of profitability, expressed as a ratio: EBIT/Total Revenue, where EBIT = Earnings Before Interest and Taxes. “Total Revenue” is the first line of an Income Statement and “Earnings Before Interest And Taxes” is usually at line 13. See this Income Statement of 3M Corporation as an example.
Mission: Screen the S&P 500 Index for companies that have the following quality markers: 1) high S&P bond ratings (A- or higher) and stock ratings (A-/M or higher); 2) are designated as a Dividend Achiever by S&P, indicating annual dividend increases for at least the past 10 yrs; 3) have a Durable Competitive Advantage or DCA (see Columns P through T in the Table), as defined by Warren Buffett (see Week 241).
Execution: Given the turbulent nature of the stock market over the past decade, there are only 9 companies that meet our requirements (see Table). All of those companies have an Operating Margin greater than the WACC (see Column N of the Table). But some of the companies have a current problem selling their goods and services that pushes their ROA lower than their WACC (compare Column O to Column N in the Table). Exxon Mobil (XOM) at Line 10 in the Table is a prime example.
Bottom Line: It is particularly difficult to save for retirement when Central Banks are busy lowering the interest rate on bonds, a move that is meant to entice people to invest in stocks, start a new business, build a factory, create an app, buy a home or get a better education. For retirement planning, you need to put ~50% of your savings into dividend-paying stocks and the remainder into US Treasuries. To get adequate diversification, your stocks need to represent all 10 S&P industries. To get adequate quality, you need to have stringent criteria like those above. Only 6 S&P industries have contributed the 9 stocks that meet our stringent criteria: Consumer Staples (WMT), HealthCare (JNJ and ABT), Utilities (NEE), Consumer Discretionary (TJX, ROST, NKE), Information Technology (MSFT) and Energy (XOM). You can check out our recent blogs on defensive industries (Week 247) and growth industries (Week 248) for help picking stocks to cover the other 4 S&P industries (Basic Materials, Communication Services, Industrials, and Financials).
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, JNJ, NEE, NKE, MSFT and XOM, and also own shares of ABT, TJX and ROST.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, VBINX at Line 16 in the Table. Total returns/Yr in Column C, and the CAGR for stock prices in Column U, are for performance over the past 20 years. That period is chosen because it covers approximately 3 market cycles, i.e., there have been 15 recessions in the past 90 years for an average of 6 years between each.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 3
Week 248 - A-rated S&P 500 Growth Companies That Are Dividend Achievers And Have A Durable Competitive Advantage
Situation: Stocks are tricky investments to own, particularly “growth” stocks. How should you get started? You know by now that we believe the investor with less than a million dollars in net worth should focus on owning stock in S&P 500 companies. We particularly like those in the annual Barron’s 500 List of US and Canadian companies with the highest revenues. Stock prices reflect expected earnings growth. An easy way to find companies with steady earnings growth is to look for S&P’s Dividend Achievers, i.e., companies that have been increasing their dividend annually for at least the past 10 yrs. S&P also helps us by assigning each company in the S&P 500 Index to one of 10 industries, 6 of which are “growth” industries: Energy, Basic Materials, Financials, Industrials, Consumer Discretionary, and Information Technology.
It helps to know how a company is capitalized. Does it mainly depend on selling common stock to attract investors, or does it prefer to float bond issues and sell preferred stock? If the answer is bonds and preferred stock, then the company’s book value will mainly reflect its brand value. (Accountants call that an “intangible” asset.) But if the answer is common stock, “tangible” assets may have more value than all the company’s liabilities. In other words, the company has what accountants call Tangible Book Value (TBV). If its stock price is no more than ~15 times TBV, it is undeniably solvent.
Mission: Develop a spreadsheet of growth companies in the Barron’s 500 List that are both Dividend Achievers and undeniably solvent. Focus on those with at least a 15 year trading history, taking care to exclude any with an S&P Bond Rating lower than A- or an S&P Stock Rating lower than A-/M. Then check to be sure TBV growth has at least doubled over the past decade and there haven’t been any more than 3 down years for TBV. In other words, the company meets Warren Buffett’s requirements for having a Durable Competitive Advantage (see Week 238).
Execution: There are only 5 companies that meet our criteria (see Table). In the aggregate, they’re no riskier than our key benchmark, VBINX at Line 12 in the Table. VBINX is essentially an S&P 500 Index fund that is 40% hedged with high quality bonds. Note in Column C of the Table that Total Returns over the past 2+ market cycles have been more than 3 times higher than the benchmark’s.
Bottom Line: If you’re new to stock picking, you’ve probably been confining your attention to “defensive” stocks, which are those issued by companies in the HealthCare, Utilities, Consumer Staples, and Communication Services industries. Your next step is to think about owning shares in “growth” stocks issued by companies in the Information Technology, Financial Services, Industrial, Consumer Discretionary, Basic Materials, and Energy industries. Those are riskier but have greater long-term returns. You can get help deciding which to own by screening for companies that a) grow their dividend reliably, b) have large revenues, c) have a Tangible Book Value (TBV), and d) meet Warren Buffett’s requirements for having a Durable Competitive Advantage (DCA): steady TBV growth that has at least doubled TBV over the past decade (i.e., growth of more than 7.1%/yr). We’ve run that screen and find that only 5 companies meet our requirements (see Table).
Risk Rating: 6
Full Disclosure: I dollar-average into NKE, MSFT and XOM, and also own shares of ROST and TJX.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX. Total Returns in Column C 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
It helps to know how a company is capitalized. Does it mainly depend on selling common stock to attract investors, or does it prefer to float bond issues and sell preferred stock? If the answer is bonds and preferred stock, then the company’s book value will mainly reflect its brand value. (Accountants call that an “intangible” asset.) But if the answer is common stock, “tangible” assets may have more value than all the company’s liabilities. In other words, the company has what accountants call Tangible Book Value (TBV). If its stock price is no more than ~15 times TBV, it is undeniably solvent.
Mission: Develop a spreadsheet of growth companies in the Barron’s 500 List that are both Dividend Achievers and undeniably solvent. Focus on those with at least a 15 year trading history, taking care to exclude any with an S&P Bond Rating lower than A- or an S&P Stock Rating lower than A-/M. Then check to be sure TBV growth has at least doubled over the past decade and there haven’t been any more than 3 down years for TBV. In other words, the company meets Warren Buffett’s requirements for having a Durable Competitive Advantage (see Week 238).
Execution: There are only 5 companies that meet our criteria (see Table). In the aggregate, they’re no riskier than our key benchmark, VBINX at Line 12 in the Table. VBINX is essentially an S&P 500 Index fund that is 40% hedged with high quality bonds. Note in Column C of the Table that Total Returns over the past 2+ market cycles have been more than 3 times higher than the benchmark’s.
Bottom Line: If you’re new to stock picking, you’ve probably been confining your attention to “defensive” stocks, which are those issued by companies in the HealthCare, Utilities, Consumer Staples, and Communication Services industries. Your next step is to think about owning shares in “growth” stocks issued by companies in the Information Technology, Financial Services, Industrial, Consumer Discretionary, Basic Materials, and Energy industries. Those are riskier but have greater long-term returns. You can get help deciding which to own by screening for companies that a) grow their dividend reliably, b) have large revenues, c) have a Tangible Book Value (TBV), and d) meet Warren Buffett’s requirements for having a Durable Competitive Advantage (DCA): steady TBV growth that has at least doubled TBV over the past decade (i.e., growth of more than 7.1%/yr). We’ve run that screen and find that only 5 companies meet our requirements (see Table).
Risk Rating: 6
Full Disclosure: I dollar-average into NKE, MSFT and XOM, and also own shares of ROST and TJX.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX. Total Returns in Column C 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, February 14
Week 241 - S&P 100 Companies With a Durable Competitive Advantage
Situation: The Federal Reserve has committed to gradually raising interest rates, which will depress the prices of bond-like stocks as well as legacy bonds. There is a 50:50 chance that the Federal Reserve will have to backtrack at some point, given that the global financial system remains in recovery mode following the Lehman Panic of 2008. The European Central Bank, for example, continues to gradually lower interest rates below zero at its Deposit Facility. This leaves us investors to focus on owning stocks issued by the largest and most credit-worthy companies. Why? Because we’ll want to minimize the risk of owning stocks (bankruptcy) until interest rate fluctuations stabilize at a plateau where bond ownership has approximately the same risk-adjusted returns as stock ownership.
Mission: Develop a spreadsheet of “mega-cap” companies (i.e., those in the S&P 100 Index) whose stock appreciation is anchored by steady appreciation in Tangible Book Value (TBV). That means meeting Warren Buffett’s criteria for having a Durable Competitive Advantage (see Week 238). Eliminate any company that does not pay a dividend or have high S&P quality ratings, i.e., an A- or better rating for its bonds and B+/M or better rating for its common stock.
Execution: We have come up with 11 stocks that meet those criteria (see Table). Returns for the aggregate have been more than twice the returns for the lowest-cost S&P 500 Index Fund (VFINX) over the past two market cycles (see Columns C and L in the Table), but that result has come with a materially greater risk of loss in a future bear market (see Column N in the Table).
Bottom Line: Over the foreseeable future, you should think about owning stocks in mega-cap companies with strong credit, especially those that steadily grow their Tangible Book Value by 7%/yr or more (and have had no more than down 3 yrs in the past decade). In other words, look for companies that have what Warren Buffett calls a Durable Competitive Advantage. However, by using this strategy long-term you probably won’t beat a low-cost S&P 500 Index fund like VFINX (on either a risk- or cost-adjusted basis) unless you’re very good at picking from among the 11 stocks in the Table and keep studying those companies closely.
Risk Rating: 5
Full Disclosure: I dollar-average into 6 of these stocks online (NKE, MSFT, WMT, XOM and JPM).
Note: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Total returns in Column C of the Table date to 9/1/2000, because that was the last S&P 500 Index peak before the peak on 10/9/2007. The past 15+ year time span provides returns over more than two market cycles (given that a even more recent peak occurred on 7/20/2015).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Develop a spreadsheet of “mega-cap” companies (i.e., those in the S&P 100 Index) whose stock appreciation is anchored by steady appreciation in Tangible Book Value (TBV). That means meeting Warren Buffett’s criteria for having a Durable Competitive Advantage (see Week 238). Eliminate any company that does not pay a dividend or have high S&P quality ratings, i.e., an A- or better rating for its bonds and B+/M or better rating for its common stock.
Execution: We have come up with 11 stocks that meet those criteria (see Table). Returns for the aggregate have been more than twice the returns for the lowest-cost S&P 500 Index Fund (VFINX) over the past two market cycles (see Columns C and L in the Table), but that result has come with a materially greater risk of loss in a future bear market (see Column N in the Table).
Bottom Line: Over the foreseeable future, you should think about owning stocks in mega-cap companies with strong credit, especially those that steadily grow their Tangible Book Value by 7%/yr or more (and have had no more than down 3 yrs in the past decade). In other words, look for companies that have what Warren Buffett calls a Durable Competitive Advantage. However, by using this strategy long-term you probably won’t beat a low-cost S&P 500 Index fund like VFINX (on either a risk- or cost-adjusted basis) unless you’re very good at picking from among the 11 stocks in the Table and keep studying those companies closely.
Risk Rating: 5
Full Disclosure: I dollar-average into 6 of these stocks online (NKE, MSFT, WMT, XOM and JPM).
Note: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Total returns in Column C of the Table date to 9/1/2000, because that was the last S&P 500 Index peak before the peak on 10/9/2007. The past 15+ year time span provides returns over more than two market cycles (given that a even more recent peak occurred on 7/20/2015).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 24
Week 238 - Let’s Revisit The “Stockpicker’s Secret Fishing Hole”
Situation: Stock-picking is a good way to build a retirement portfolio, if you have enough time and enthusiasm. It requires that you delve into fundamental company practices far enough to select and follow a dozen or more stocks. But how do you start, and where should you focus your efforts? For sure, you’re not going to analyze all 500 stocks in the S&P 500 Index (^GSPC). But you can become familiar with the 65 stocks in the Dow Jones Composite Index (^DJA). We call it the Stockpicker’s Secret Fishing Hole because it often outperforms the S&P 500 Index. For example, price appreciation over the past two market cycles for ^DJA has been twice as great as for ^GSPC (see Column C at Lines 52 & 54 in the Table). ^DJA also benefits from being a “managed” index: its stocks are picked by a Wall Street Journal committee chaired by the Managing Editor.
Mission: Produce our standard spreadsheet for all ^DJA stocks that have revenues high enough to warrant inclusion in the Barron’s 500 List. Exclude any that have an S&P stock rating lower than B+/M, or an S&P bond rating lower than BBB+, and determine which of the remainder have a Durable Competitive Advantage (DCA).
Execution: Of the 38 companies that meet mission criteria, 18 are suitable for long-term investment because much of their book value is in real (“tangible”) assets that track earnings growth. Warren Buffett says this confers a “Durable Competitive Advantage” if tangible assets have been growing at least 9% per year over the most recent decade, and if there have been no more than two down years (see The Warren Buffett Stock Portfolio by Mary Buffett and David Clark, Scribner, New York, 2011). Given that the Great Recession sharply reduced economic growth over the past decade, I’ve loosened that standard to 7%/yr with no more than 3 down years.
The 18 companies listed below meet our requirements. All have a Price/Tangible Book Value ratio that is less than 10. In other words, real assets (as opposed to brand value or “goodwill”) represent at least 10% of the share price (see Columns T-V in the Table). I use this system, and dollar-average into the 7 stocks with bold typeface:
Apple
Nike
NiSource
Public Service Enterprise Group
NextEra Energy
Microsoft
JB Hunt Transport Services
Wal-Mart Stores
American Express
Union Pacific
Chevron
ExxonMobil
Travelers
Expeditors International of Washington
CSX
Cisco Systems
JP Morgan Chase
Goldman Sachs
Bottom Line: “High quality megacaps are the name of the game.” You’ll need a system for recognizing value and sustainability among those large capitalization companies. S&P charts for individual companies list the Tangible Book Value (TBV) for each of the past 10 yrs and are available through most brokerages, as well as S&P. By using a calculator for Compound Annual Growth Rate, you can arrive at each company’s Durable Competitive Advantage (growth in TBV). If the company has no TBV, its liabilities exceed the value of its real assets; you’ll need to delve into its Balance Sheet before deciding to assume that much risk. We’ve filtered through the 65-stock Dow Jones Composite Index and come up with 18 companies that look worthwhile, using our standard spreadsheet supplemented with calculations of their Durable Competitive Advantage.
Risk rating: 5
Full Disclosure: In addition to the 7 stocks above that I dollar-average into, I own shares of UTX, DD, MMM, INTC, KO, IBM, JNJ and MCD.
Note: Metrics in the Table are current for the Sunday of publication; those highlighted in red denote underperformance vs. our key benchmark (VBINX at Line 45 in the Table). Total returns/yr (in Column C of the Table) date to the penultimate S&P 500 Index peak that occurred on 9/1/2000.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Produce our standard spreadsheet for all ^DJA stocks that have revenues high enough to warrant inclusion in the Barron’s 500 List. Exclude any that have an S&P stock rating lower than B+/M, or an S&P bond rating lower than BBB+, and determine which of the remainder have a Durable Competitive Advantage (DCA).
Execution: Of the 38 companies that meet mission criteria, 18 are suitable for long-term investment because much of their book value is in real (“tangible”) assets that track earnings growth. Warren Buffett says this confers a “Durable Competitive Advantage” if tangible assets have been growing at least 9% per year over the most recent decade, and if there have been no more than two down years (see The Warren Buffett Stock Portfolio by Mary Buffett and David Clark, Scribner, New York, 2011). Given that the Great Recession sharply reduced economic growth over the past decade, I’ve loosened that standard to 7%/yr with no more than 3 down years.
The 18 companies listed below meet our requirements. All have a Price/Tangible Book Value ratio that is less than 10. In other words, real assets (as opposed to brand value or “goodwill”) represent at least 10% of the share price (see Columns T-V in the Table). I use this system, and dollar-average into the 7 stocks with bold typeface:
Apple
Nike
NiSource
Public Service Enterprise Group
NextEra Energy
Microsoft
JB Hunt Transport Services
Wal-Mart Stores
American Express
Union Pacific
Chevron
ExxonMobil
Travelers
Expeditors International of Washington
CSX
Cisco Systems
JP Morgan Chase
Goldman Sachs
Bottom Line: “High quality megacaps are the name of the game.” You’ll need a system for recognizing value and sustainability among those large capitalization companies. S&P charts for individual companies list the Tangible Book Value (TBV) for each of the past 10 yrs and are available through most brokerages, as well as S&P. By using a calculator for Compound Annual Growth Rate, you can arrive at each company’s Durable Competitive Advantage (growth in TBV). If the company has no TBV, its liabilities exceed the value of its real assets; you’ll need to delve into its Balance Sheet before deciding to assume that much risk. We’ve filtered through the 65-stock Dow Jones Composite Index and come up with 18 companies that look worthwhile, using our standard spreadsheet supplemented with calculations of their Durable Competitive Advantage.
Risk rating: 5
Full Disclosure: In addition to the 7 stocks above that I dollar-average into, I own shares of UTX, DD, MMM, INTC, KO, IBM, JNJ and MCD.
Note: Metrics in the Table are current for the Sunday of publication; those highlighted in red denote underperformance vs. our key benchmark (VBINX at Line 45 in the Table). Total returns/yr (in Column C of the Table) date to the penultimate S&P 500 Index peak that occurred on 9/1/2000.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 13
Week 232 - Safe and Effective Stocks for Trying to Beat the S&P 500 Index Long-Term
Situation: As a general rule, you should use index funds to build a retirement portfolio. Why? Because you can’t beat the market on a risk-adjusted basis (after allowing for transaction costs) unless you apply the art of buying low and selling high. A reasonable alternative to index funds is to “buy and hold” high quality stocks. The growth in their dividend payouts often beats inflation by a wider margin than payouts from a low-cost S&P 500 Index fund like the Vanguard 500 Index Fund (VFINX) or its bond-hedged version--the Vanguard Balanced Index Fund (VBINX) which we use as our benchmark. You’ll want to look for companies that have a Durable Competitive Advantage, i.e., those that have doubled their Tangible Book Value over the past decade. Nonetheless, you’ll need to have rules that give you a chance to beat the S&P 500 Index on a total return basis long-term. Otherwise, you’d be better off investing in VFINX or VBINX.
Mission: Set up rules that allow an investor to take calculated risks in order to buy high quality stocks that have a reasonable chance of beating the S&P 500 Index long-term.
Execution: Rule #1 is to buy stocks that have demonstrated improving fundamentals over the most recent 3 yrs, as determined by the stock’s Barron’s 500 Rank this year compared to last year. Rule #2 is to buy stocks that have a Durable Competitive Advantage (see Week 227 for further elaboration on Rules #1 and #2). Rule #3 is to find out which of those stocks have a price appreciation history that beats the S&P 500 Index over the past 2-3 market cycles while having less risk of loss, as determined by the BMW Method. Rule #4 is to not overpay for the stock, i.e., EV/EBITDA needs to be no greater than that for the S&P 500 Index, which is rarely higher than 11. Finally, you don’t want to buy stock in companies that have sustainability issues, meaning the S&P stock rating is lower than B+/M or the S&P bond rating is lower than BBB+ (see Table).
By adhering to this algorithm, you’re focus will be on building a position in companies that are out-of-favor, companies that are preparing to outperform when current headwinds lose their strength. Warren Buffett has often addressed this point: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.“ The trick is to see through the headwinds that are holding down a company’s stock. No one knows when that will occur, but it is not hard to find out if a company’s management is preparing for that day.
Bottom Line: Given that the US stock market is currently overpriced, we are able to come up with only 6 candidate stocks for purchase. Four of those 6 are electric utilities. Utilities pay high dividends. So, utility stocks are expected to fall in price as the Federal Reserve raises interest rates. In other words, that fall in price compensates for the eroded value of their dividends compared interest payouts on newly-issued bonds.
Risk Rating: 6
Full Disclosure: I dollar-average into NEE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Set up rules that allow an investor to take calculated risks in order to buy high quality stocks that have a reasonable chance of beating the S&P 500 Index long-term.
Execution: Rule #1 is to buy stocks that have demonstrated improving fundamentals over the most recent 3 yrs, as determined by the stock’s Barron’s 500 Rank this year compared to last year. Rule #2 is to buy stocks that have a Durable Competitive Advantage (see Week 227 for further elaboration on Rules #1 and #2). Rule #3 is to find out which of those stocks have a price appreciation history that beats the S&P 500 Index over the past 2-3 market cycles while having less risk of loss, as determined by the BMW Method. Rule #4 is to not overpay for the stock, i.e., EV/EBITDA needs to be no greater than that for the S&P 500 Index, which is rarely higher than 11. Finally, you don’t want to buy stock in companies that have sustainability issues, meaning the S&P stock rating is lower than B+/M or the S&P bond rating is lower than BBB+ (see Table).
By adhering to this algorithm, you’re focus will be on building a position in companies that are out-of-favor, companies that are preparing to outperform when current headwinds lose their strength. Warren Buffett has often addressed this point: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.“ The trick is to see through the headwinds that are holding down a company’s stock. No one knows when that will occur, but it is not hard to find out if a company’s management is preparing for that day.
Bottom Line: Given that the US stock market is currently overpriced, we are able to come up with only 6 candidate stocks for purchase. Four of those 6 are electric utilities. Utilities pay high dividends. So, utility stocks are expected to fall in price as the Federal Reserve raises interest rates. In other words, that fall in price compensates for the eroded value of their dividends compared interest payouts on newly-issued bonds.
Risk Rating: 6
Full Disclosure: I dollar-average into NEE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 8
Week 227 - Established Companies with a Durable Competitive Advantage and Improving Fundamentals
Situation: Government and corporate credit woes are building up around the world, instead of receding. We’ve pointed out in several blogs that the root cause of the Great Recession was overuse of credit. We’ve also pointed out that the world had apparently learned its lesson and was gradually deleveraging. That trend stopped in 2014 and a reversal is now underway. Why did deleveraging stop? Because the Federal Reserve maintained its “free money” policy too long. How should we respond? Stocks are widely understood to have been inflated in value as a result of that Federal Reserve policy, since low interest rates made bonds an unattractive alternative. Until the Federal Reserve actually raises rates to traditional levels relative to inflation, that leaves you with the same two investment choices you’ve had for the past 5 years: risky stocks vs. “bond-like” stocks. Bond-like stocks are issued by established companies, have an above-market dividend yield, and have a history of growing dividends twice as fast as inflation. To pick the best bond-like stocks during this period of global economic uncertainty, focus on companies that have what Warren Buffett calls a “Durable Competitive Advantage”, particularly those with improving fundamentals.
Mission: Make a list of Barron’s 500 companies that have trading records extending back at least 16 yrs and have a Barron’s rank this year that is higher than last year’s rank, i.e., companies with improving fundamentals. Determine which have a Durable Competitive Advantage (see Week 30). That means Tangible Book Value (TBV) has grown at least 7-10% a year for the past 10 yrs, and there have been no more than two down years. If TBV is positive in any given year, that means tangible assets exceed liabilities. Most companies have a negative TBV because of being capitalized mainly by loans. That exposes the company to the risk of insolvency during periods when loans are difficult to renew, unless the company agrees to pay an interest rate that exceeds the company’s rate of return on assets. By focusing on TBV, we bypass such companies. Next, we eliminate companies with below-market dividend yields, or dividend growth that is less than twice the inflation rate. Finally, we calculate the Buffett Buy Analysis for each company that remains.
Execution: This week’s Table lays out metrics that fit the mission. Calculation of the Buffett Buy Analysis (see Columns S thru Z in the Table) requires some explanation. It is a “discounted cash flow” method wherein earnings growth over the past 10 yrs (Column T) is projected 10 yrs into the future (Column U), then multiplied by the lowest P/E seen over the past 10 yrs (Column V). That gives a conservative estimate of the stock’s price 10 yrs from now, unless a dividend is paid. If a dividend is paid, there is a conservative assumption that the dividend won’t be increased any time in the next 10 yrs. The current annual dividend is multiplied by 10 (Column W) and added to the price estimate dictated by the projected growth in earnings (Column X). To conduct a Buffett Buy Analysis, we start with the current price (see Column Y) and calculate the Compound Annual Growth Rate (CAGR) over the next 10 yrs that would be needed to arrive at the predicted price (see Column X) 10 yrs from now. The result is given in Column Z. That CAGR is the Buffett Buy Analysis (BBA). That rate of stock price appreciation should be in line with the rate of TBV appreciation rate over the past 10 yrs (see Column R). It will be lower if the stock is currently overpriced, since the “runway” to reach the projected price 10 yrs from now is shorter.
Bottom Line: By taking an objective approach to stock-picking, we’ve managed to eliminate 99% of the companies on the Barron’s 500 List (see Table). Partly that’s because the market has become overpriced, since the Federal Reserve’s easy money policy takes attention away from owning bonds, and partly because those same policies have made money so cheap that most companies have come to rely more heavily on debt financing than they normally would. Debt financing is also cheaper because interest payments are tax-deductible. The 5 companies in this week’s Table offer objective value: 1) growing TBV; 2) improving fundamentals. They all have returns that have far exceeded S&P 500 Index’s returns since that index peaked on 9/1/00 (see Columns C and L in the Table), and none are currently overpriced (see Column K). The main caveat for owning such bond-like stocks is that their price is likely to drop for a period after the Federal Reserve starts raising interest rates, because new bonds pay more interest than old bonds.
Risk Rating: 5
Full Disclosure: I dollar-average into NEE, and also own shares of CMI and ADM.
Note: Metrics in the Table that are highlighted in red denote underperformance relative to our main benchmark, the Vanguard Balanced Index Fund (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: Make a list of Barron’s 500 companies that have trading records extending back at least 16 yrs and have a Barron’s rank this year that is higher than last year’s rank, i.e., companies with improving fundamentals. Determine which have a Durable Competitive Advantage (see Week 30). That means Tangible Book Value (TBV) has grown at least 7-10% a year for the past 10 yrs, and there have been no more than two down years. If TBV is positive in any given year, that means tangible assets exceed liabilities. Most companies have a negative TBV because of being capitalized mainly by loans. That exposes the company to the risk of insolvency during periods when loans are difficult to renew, unless the company agrees to pay an interest rate that exceeds the company’s rate of return on assets. By focusing on TBV, we bypass such companies. Next, we eliminate companies with below-market dividend yields, or dividend growth that is less than twice the inflation rate. Finally, we calculate the Buffett Buy Analysis for each company that remains.
Execution: This week’s Table lays out metrics that fit the mission. Calculation of the Buffett Buy Analysis (see Columns S thru Z in the Table) requires some explanation. It is a “discounted cash flow” method wherein earnings growth over the past 10 yrs (Column T) is projected 10 yrs into the future (Column U), then multiplied by the lowest P/E seen over the past 10 yrs (Column V). That gives a conservative estimate of the stock’s price 10 yrs from now, unless a dividend is paid. If a dividend is paid, there is a conservative assumption that the dividend won’t be increased any time in the next 10 yrs. The current annual dividend is multiplied by 10 (Column W) and added to the price estimate dictated by the projected growth in earnings (Column X). To conduct a Buffett Buy Analysis, we start with the current price (see Column Y) and calculate the Compound Annual Growth Rate (CAGR) over the next 10 yrs that would be needed to arrive at the predicted price (see Column X) 10 yrs from now. The result is given in Column Z. That CAGR is the Buffett Buy Analysis (BBA). That rate of stock price appreciation should be in line with the rate of TBV appreciation rate over the past 10 yrs (see Column R). It will be lower if the stock is currently overpriced, since the “runway” to reach the projected price 10 yrs from now is shorter.
Bottom Line: By taking an objective approach to stock-picking, we’ve managed to eliminate 99% of the companies on the Barron’s 500 List (see Table). Partly that’s because the market has become overpriced, since the Federal Reserve’s easy money policy takes attention away from owning bonds, and partly because those same policies have made money so cheap that most companies have come to rely more heavily on debt financing than they normally would. Debt financing is also cheaper because interest payments are tax-deductible. The 5 companies in this week’s Table offer objective value: 1) growing TBV; 2) improving fundamentals. They all have returns that have far exceeded S&P 500 Index’s returns since that index peaked on 9/1/00 (see Columns C and L in the Table), and none are currently overpriced (see Column K). The main caveat for owning such bond-like stocks is that their price is likely to drop for a period after the Federal Reserve starts raising interest rates, because new bonds pay more interest than old bonds.
Risk Rating: 5
Full Disclosure: I dollar-average into NEE, and also own shares of CMI and ADM.
Note: Metrics in the Table that are highlighted in red denote underperformance relative to our main benchmark, the Vanguard Balanced Index Fund (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
Subscribe to:
Comments (Atom)