Month 111 - Nine A-rated non-Financial GARP Stocks in the S&P 100 Index - September 2020

Situation: “Growth at a reasonable price (GARP)" is an equity investment strategy that seeks to combine tenets of both growth investing and value investing to select individual stocks.” Different analysts use different metrics (and management assessments) to guesstimate favorable returns. Peter Lynch originated the concept and highlighted the usefulness of one ratio: Price/Earnings:Growth, commonly referred to as PEG. “Earnings” reference Earnings per Share (EPS) for the Trailing Twelve Month (TTM) period. “Growth” references an estimate of growth in EPS over the next 5 years. Yahoo Finance publishes the PEG ratio for each public company under Valuation Measures (see Column AH in the Table). The PEG ratio is kept up to date by Thomson Reuters. Peter Lynch is arguably the greatest stock-picker of all time. My interest in investing started through reading his books, which are practical down-to-earth primers. So, his reliance on PEG carries some gravitas. The basic idea is that a stock’s price ought to approximate the rate at which the company’s earnings grow (PEG = 1.0). That rarely happens in the real world but some companies come close (see Column AH in the Table).  

Mission: Look at the 23 A-rated non-financial high-yielding stocks in the S&P 100 Index and highlight the 9 that have 5-yr PEG numbers no higher than 2.5. 

Execution: see Table.

Administration: A-rated stocks are those that have:

            a) an above market dividend yield (see portfolio of Vanguard High Dividend Yield Index Fund ETF - VYM),

            b) positive Book Value, 

            c) positive earnings (TTM), 

            d) an S&P bond rating of A- or better, 

            e) an S&P stock rating of B+/M or better, and 

            f) a 20+ year trading history. 

Bottom Line: Merck (MRK), Target (TGT), Intel (INTC), Comcast (CMCSA), and Lockheed Martin (LMT) have the overall highest quality among stocks on this list (see Column AL in the Table). INTC and CMCSA are also Value Stocks, meaning that their price (50-day moving average) is less than twice their Graham Number (see Column AC) and their 7-year P/E is no higher than 25 (see Column AE). 

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 MRK, PFE and INTC, and also own shares of TGT and CMCSA. 

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

Month 110 - Buy Low! 12 A-rated Haven Stocks in the S&P 100 Index that aren’t overpriced - August 2020

Situation: There’s no mystery to saving for retirement. A good working game plan is to divert 15-20% of your monthly income to the purchase of stocks and government bonds, and then keep those assets in a 60:40 balance of stocks:bonds. You can also use any bond substitutes (e.g. gold, T-bills, and utility stock ETFs) that typically hold their value in a stock market crash. Mainly use stock index ETFs for your retirement savings but also buy stock in companies that tend to have an above-market dividend yield. Those “shareholder-friendly payouts” happen because the company has good collateral: Liabilities are protected by Tangible Book Value and a cushion of Cash Equivalents. In other words, avoid stocks issued by companies that have become over-indebted. 

Think of the bonds in your portfolio as the collateral that backs your stocks. So, a good way to start saving for retirement is to over-emphasize collateral-thinking: Dollar-average into the low-cost Vanguard Wellesley Income Fund (VWINX), which is 60% bonds and 40% stocks picked from the Vanguard High Dividend Yield Index Fund ETF (VYM). VWINX has lost money in only 7 of the past 50 years, those losses always being less than 10%. Since its inception on 7/1/1970, VWINX has returned 9.7%/yr vs. 10.8%/yr for the S&P 500 Index with dividends reinvested.

The harder task is to stop putting additional money into stocks that have become overpriced. To do that you have to know how to calculate the Graham Number. Benjamin Graham wrote the first edition of The Intelligent Investor almost 100 years ago. It is hard to read because he uses numbers to express almost every pearl of knowledge. The “Graham Number” is simply the rational market price for any stock at any given moment, calculated as the square root of: 15 times earnings for the Trailing Twelve Months (TTM) multiplied by 1.5 times Book Value for the most recent quarter (mrq) multiplied by 22.5 (i.e., 1.5 times 15). So, the Graham Number is nothing more than what the stock’s price would be if it were to reflect a P/E of 15 and a Book Value of 1.5.  The purpose of doing this calculation on your stocks is to know their underlying worth. Benjamin Graham also explained why the 7-year P/E should not exceed 25, assuming that a single year’s P/E (TTM) should not exceed 20, which is an earnings yield of 5%/yr: In a normal inflationary environment, a company’s earnings are likely to grow 3% to 3.5% per year. After 7 years, a CAGR (Compound Annual Growth Rate) of 3.2%/yr takes a P/E of 20 to 25.

My definition of an Overpriced Stock is one that a) has a market price (50-day Moving Average) that is more than 2.5 times the Graham Number and b) has a 7-year P/E that is more than 30. Looking at the 30-stock Dow Jones Industrial Average (DJIA), I see that 5 A-rated stocks are overpriced (see Column AC-AH in Comparisons section of Table):

     Microsoft (MSFT), 

     Apple (AAPL), 

     Nike (NKE), 

     Coca-Cola (KO) and 

     Procter & Gamble (PG). 

Stocks get overpriced because they become popular with investors, leading to a Crowded Trade. Assuming that your goal is to Buy Low, why would you continue to add money to any of these 5 stocks that you already own? You would only do so because you harbor a Positive Sentiment regarding their future prospects, In other words, you would be making a speculative investment (“gambling”). To avoid gambling and instead employ a “risk-off” approach to buying individual stocks, you’ll need clear definitions for A-rated stocks and for Haven stocks to supplement the numbers-based system used above to avoid Overpriced stocks. You’ll also want to favor stocks issued by large companies, since those typically have multiple product lines and unencumbered lines of credit.

Mission: Define “A-rated stocks” and “Haven stocks”. Analyze A-rated Haven stocks in the S&P 100 Index that aren’t overpriced by using our Standard Spreadsheet.

Execution: see Table.

Administration: A-rated stocks are those that have a) an above market dividend yield (see portfolio of Vanguard High Dividend Yield Index Fund ETF - VYM), b) positive Book Value, c) positive earnings (TTM), d) an S&P rating on the company’s bonds that is A- or better, e) an S&P rating on the company’s stock that is B+/M or better, and f) a 20+ year trading history. 

Haven Stocks are A-rated stocks issued by companies that aren’t encumbered with risk factors that are likely to threaten the company’s solvency during a recession. So, companies in the Real Estate Industry (i.e., REITs) and companies in the Financial Services Industry (i.e., banks) are excluded, as are companies with negative Tangible Book Value if Total Debt is more than 2.5 times EBITDA (TTM) or Total Debt is more than 2.0 times Shareholder Equity. 

Bottom Line: With the S&P 500 Index being priced at 29 times TTM earnings (see SPY at Line 28 and Column K in the Table), the stock market is overpriced relative to its long-term P/E of 15-16. But its 50-day Moving Average price is still less than 2.5 times its Graham Number (i.e., 2.1), and its 7-yr P/E is still less than 30 (i.e., 28), per Columns AC and AE at Line 28 in the Table. Using our example of the DJIA, the timely thing to do would be to avoid buying more shares of the overpriced A-rated stocks (MSFT, NKE, PG, KO, AAPL) but to continue buying more shares of SPY. This strategy allows you to retain exposure to volatility in stocks that are Overpriced (because of their future prospects) while using diversification to reduce your risk of serious loss.

Risk Rating: 5 (where 10-yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)

Full Disclosure: I dollar-average into NEE, INTC, WMT, JNJ, CAT, and also own shares of MRK, CSCO, TGT, DUK, SO, MMM. From late February through April 2020, I added shares of 6 new companies to my brokerage account--Comcast (CMCSA), Costco Wholesale (COST), Home Depot (HD), Merck (MRK), Disney (DIS) and Target (TGT), while selling shares of Norfolk Southern (NSC) and United Parcel Service (UPS). Regarding the 5 overpriced but A-rated stocks in the DJIA, I’ve stopped dollar-averaging into KO but continue to dollar-average into MSFT, NKE and PG because I expect those companies to continue to dominate their competitors. I have no plans to sell the shares of KO and AAPL that I already own.

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

Month 106 - A-rated Value Stocks in the S&P 100 Index - April 2020

Situation: Growth at a reasonable price (GARP) is often mentioned as an investing goal because value underlies the decision to buy. Warren Buffett is the king of value investing and has over $80 Billion in cash (his “elephant gun”) that he’d like to spend. We’re in a Bear Market fueled by the adverse economic consequences of the COVID-19 pandemic. So, he’ll soon spend that cash pile to buy a large company. Let’s look at his options, considering the ways he has prioritized purchases in the past. Firstly, he likes large and long-established companies. Why large companies? Because those have multiple product lines, one of which is usually designed to help the company maintain a stream of revenue during a recession. In addition, those companies are large enough to have the marketing power needed to maintain and grow their brands. 

Mission: Let’s see which choices look attractive among A-rated “haven stocks” in the S&P 100 Index (see Month 104). Remember: These companies reliably pay an above-market dividend, so they’re found in the Vanguard High Dividend Yield Index (VYM), and they’re also listed in the iShares Russell Top 200 Value ETF (IWX). Warren Buffett places high store in companies that don’t overuse debt and also retain Tangible Book Value, so we’ll exclude companies with negative Tangible Book Value that also have a total debt load greater than 2.5 times EBITDA (Earnings Before Interest, Tax, Depreciation & Amortization) or have sold long-term bonds to build more than 50% of their market capitalization. Finally, the company's stock price has to meet both of our two value criteria: 1) Share price isn't more than twice the Graham Number; 2) share price isn't more than 25 times average 7-yr earnings per share. 

Execution: (see Table).

Administration: These 9 companies include 4 from the two most deeply cyclical industries: banks and semiconductor manufacturers. Berkshire Hathaway’s portfolio already includes the 3 banks on the list, i.e., JPMorgan Chase (JPM), U.S. Bancorp (USB), and Wells Fargo (WFC) but doesn’t include the semiconductor manufacturer, Intel (INTC). Berkshire Hathaway is at heart an insurance company, so Warren Buffett always needs to diversify away from the Financial Services industry. There are only 4 non-financial companies on the list: Intel (INTC), Cisco Systems (CSCO), Pfizer (PFE), and Target (TGT), and only TGT is within the price range that Mr. Buffett is looking to spend ($80 to $100 Billion). 

Bottom Line: Target (TGT) appears to be the most attractive company to add to Berkshire’s stable, given that it is priced right and Mr. Buffett already has experience owning companies in the Consumer Discretionary industry.. 

Risk Rating: 7 (where 10-yr U.S. Treasury Notes = 1, S&P 500 Index = 5, and gold = 10).

Full Disclosure: I dollar-average into INTC and JPM, and also own shares of PFE, CSCO, TGT, USB, BLK and WFC.

The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Month 105 - A-rated Companies in the Dow Jones Industrial Average - March 2020

Situation: If you’ve been picking stocks for a retirement portfolio, and have more than 15 years of experience, you’ve learned enough about risk to appreciate last month’s blog about Haven Stocks (Month 104). You’re probably ready to take on more risk for more reward, assuming that you’ve learned how to ride out a market crash without selling. Warren Buffett, the reigning value investor, also stretches beyond investing in large-capitalization value stocks like those discussed in our Month 103 blog about Berkshire Hathaway’s portfolio.

In his most recent Annual Letter to the shareowners of Berkshire Hathaway, Warren explains how to do that by focusing on Retained Earnings (see the excerpt below in Appendix). Retained Earnings are what’s left over from Free Cash Flow after Dividends have been paid. Free Cash Flow is what’s left over from Operating Earnings (EBIT) after Capital Expenditures have been paid. Warren Buffett uses Return on Net Tangible Capital to estimate whether Retained Earnings are likely to be substantial. Return on Net Tangible Capital is the same as the familiar ROCE (Return on Capital Employed) except that Capital Employed is changed from Total Assets minus Current Liabilities to Total Assets minus Intangible Assets minus Current Liabilities. He thinks 20% is a good Return on Net Tangible Capital (see Column P in the Table).

The company’s CEO will eventually deploy Retained Earnings to build a better company faster. The cost for deploying that capital is zero. Going forward, the return on that investment is approximately the same as the return on Operating Earnings, which is EBIT (Earnings Before Interest and Taxes) divided by Market Capitalization. In a well-managed and well-positioned company, that return represents a high rate of Compound Interest over time--the 20%/yr Return on Net Tangible Capital that Warren Buffett is looking to achieve in most years on most of Berkshire Hathaway’s portfolio.

The trick, of course, is to find such companies. The Dow Jones Industrial Average (DJIA) is a good place to start, given that those companies have traditionally been picked (in part) because they expected to have a high Free Cash Flow Yield (see Column H in the Table).

Mission: Pick companies from the 30-stock DJIA that have S&P ratings on the bonds they’ve issued that are A- or higher, and insert a new column in our Standard Spreadsheet for Free Cash Flow Yield (Column K). Exclude any DJIA companies that do not have an S&P stock rating of at least B+/M, or do not have the 16 year trading record that is required for quantitative analysis by the BMW Method (https://invest.kleinnet.com/bmw1/). (We display at Columns L-M in the Table a summary of BMW Method findings for the most recent week.)

Administration: see Table.

Bottom Line: These 19 companies have an aggregate Return on Net Tangible Capital of 19.5%, which almost meets Warren Buffett’s requirement of 20%. Whether any of these stocks can be bought at a “sensible price” is not an easy question to answer. Here at ITR, we call a stock “sensibly priced” if the 50 day moving average in the price per share is no more than twice the Graham Number (see Columns AC & AD) and is no more than 25 times the 7-yr P/E (see Column AF). Five companies meet those criteria: PFE, INTC, JPM, TRV, IBM.

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, NKE, PFE, BA, KO, INTC, PG, JPM, WMT, JNJ, CAT and IBM, and also own shares of UNH, CSCO, AAPL, DIS, TRV and MMM.

Appendix: Excerpt from Warren Buffett’s February 2020 Letter to the shareowners of Berkshire Hathaway: “Charlie and I urge you to focus on operating earnings and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized...Over time, Charlie and I expect our equity holdings – as a group – to deliver major gains, albeit in an unpredictable and highly irregular manner. To see why we are optimistic, move on to the next discussion. The Power of Retained Earnings. In 1924, Edgar Lawrence Smith, an obscure economist and financial advisor, wrote Common Stocks as Long Term Investments, a slim book that changed the investment world. Indeed, writing the book changed Smith himself, forcing him to reassess his own investment beliefs. Going in, he planned to argue that stocks would perform better than bonds during inflationary periods and that bonds would deliver superior returns during deflationary times. That seemed sensible enough. But Smith was in for a shock. His book began, therefore, with a confession: “These studies are the record of a failure – the failure of facts to sustain a preconceived theory.” Luckily for investors, that failure led Smith to think more deeply about how stocks should be evaluated. For the crux of Smith’s insight, I will quote an early reviewer of his book, none other than John Maynard Keynes: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point. Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.” 

Warren concludes that history lesson on this note: “Charlie and I have long focused on using retained earnings advantageously. Reinvestment in productive operational assets will forever remain our top priority. In addition, we constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price.”


"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

Month 103 - Berkshire Hathaway's A-rated "Value" Stocks with High Dividend Yields - January 2020

Situation: In case your reason for buying stocks in your working years is to have growing income from dividends in your retirement years, we suggest that you prioritize “value stocks.” The bible of value investing is a book (The Intelligent Investor) written by Benjamin Graham, who was Warren Buffett’s instructor while Warren was earning his Master of Science in Economics degree at Columbia University. 

Why value investing, and what is a value stock? The main idea is to not overpay for either Earnings Per Share (EPS over the trailing twelve months, abbreviated ttm) or Book Value per share in the most recent quarter (abbreviated mrq). On page 349 of the Revised Edition (1973) of The Intelligent Investor, Benjamin Graham says “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings [per share] below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb, we suggest that the product of the [EPS] multiplier times the ratio of price to book value should not exceed 22.5.” That is, 1.5 x 15 = 22.5.

How do you calculate the “Graham Number” -- the “rational” stock price listed in Column AA of the Table? It is the square root of 22.5, times (Earnings Per Share for the ttm), times Book Value per share for the mrq. We suggest that you think of the share price of a value stock as being no greater than: a) twice the Graham Number, b) 25 times average 7-year Earnings Per Share (see page 159 of The Intelligent Investor), c) 3 times Book Value per share (ttm), and d) 3 times sales per share (mrq). If a company meets 3 out of 4 of those criteria, we call its stock a “value stock” in Column AF of the Table. 

Berkshire Hathaway’s stock portfolio contains 48 holdings worth $214,673,311,000 as of the last 13F SEC filing dated 11/14/19. The top 5 holdings (AAPL, BAC, KO, WFC, AXP) are worth ~$142B (66% of the total). We rate 8 of the 48 as being high-yielding “value” stocks (KO, PG, JPM, JNJ, TRV, USB, PNC, WFC), in that those companies meet an additional 4 criteria we like to use: 1) their bonds are rated A- or better by Standard & Poor’s (S&P), 2) their stocks are rated B+/M or better by S&P, 3) their stocks have the 16+ year trading record that is required for quantitative analysis using the BMW Method, and 4) their stocks are listed in both the iShares Russell 200 Value Index (IWX) and the Vanguard High Dividend Yield Index (VYM). You’ve probably figured out, by this point, that I’m encouraging you to think along these lines when building your own portfolio of retirement stocks. You can get a feel for the process by looking at 8 such stocks Warren Buffett has picked for Berkshire Hathaway’s portfolio.

Mission: Update our Month 98 blog, using our Standard Spreadsheet to analyze value stocks in Berkshire Hathaway’s stock portfolio.  

Execution: see Table.

Administration: The 10 largest positions in Berkshire Hathaway’s portfolio are:

Apple AAPL ($56B)
Bank of America BAC ($27B)
Coca-Cola KO ($22B)
Wells Fargo WFC ($19B)
American Express AXP ($18B)
Kraft Heinz KHC ($9B)
U.S. Bancorp USB ($7B)
JPMorgan Chase JPM ($7B)
Moody’s MCO ($5B)
Delta Air Lines DAL ($4B)

Six of those 10 are are either not high-yielding stocks or not “value” stocks (AAPL, BAC, AXP, KHC, MCO, DAL). Data for those 6 companies can be found in the BACKGROUND Section of the Table. 

A system for buying stocks can be boiled down and presented in a spreadsheet, as long as you realize that it omits assumptions used to estimate intrinsic value. But our Standard Spreadsheet won’t go far in helping you decide to sell a stock. All we have to go by is that Warren Buffett has told us he might sell for two reasons: 1) When a higher return is expected by trading to another asset (to include the loss incurred by capital gains tax); 2) When the company changes its fundamentals. He has also named two stocks he would never sell: Coca-Cola (KO) and American Express (AXP). American Express didn’t make our list for two reasons: 1) the S&P Rating for the company’s bonds is BBB+ as opposed to our minimum requirement of A-, and 2) the company is not in the Vanguard High Dividend Yield Index ETF VYM.

Bottom Line: The 8 A-rated high-yielding value stocks account for $57B (27%) of Berkshire’s stock portfolio. Five of those are in the Financial Services industry (Warren Buffett’s area of expertise). Take-home points include a) don’t overpay for a stock, b) buy what you know, and c) remember that the best bargains are to be found in the Financial Services industry. But note that all 4 of his bank stocks have above-market volatility in share prices (see Column I in the Table), which goes far toward explaining why they’re underpriced (average P/E = 13). Also note that while Coca-Cola (KO) and Procter & Gamble (PG) seem overpriced (see Columns AB-AH in the Table), you’d need to consider intrinsic value before coming to that conclusion.  

Risk Rating: 6 (where 1 = 10-yr US Treasury Notes, 5 = S&P 500 Index, and 10 = gold bullion) 

Full Disclosure: I dollar average into PG, JPM, JNJ and USB, and also own shares of KO, TRV and WFC.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Month 102 - A-rated Stocks in Vanguard’s Wellesley Income Fund (VWINX) - December 2019

Situation: For retiree savings accounts, most of the financial advisors that I follow prefer that half be allocated to bonds and the rest to stocks that reliably pay an above-market dividend. There is a convenient, low-cost way to anchor one’s portfolio in that direction, which is to invest in VWINX -- Vanguard’s Wellesley Income Fund. The managers allocate almost 60% to bonds and the rest to stocks that have been selected from the FTSE High Dividend Yield Index. Vanguard markets the U.S. version with the stock ticker of VYM. The ~400 stocks in VYM are selected from the Russell 1000 Index of large-capitalization companies (IWB). 

As a prospective retiree, you’ll want a balanced portfolio--one with approximately a 50:50 balance between stocks and bonds. The transaction costs for buying a corporate bond are high so you’ll want a mutual fund with a mix of government bonds and corporates. For stocks, you have the option of picking your own while keeping transaction costs (expense ratio) at ~2%/yr. But the expense ratio is much lower if you leave stock picking to professional managers (or computers) and opt for a mutual fund or Exchange-Traded Fund (ETF). The easy way to start is with VWINX, which has an expense ratio of 0.23%, and a 10-yr total return of 9.7%/yr. That’s 60% bonds, so supplement it with a stock mutual fund, stock ETF, or stocks of your own choosing. The Fidelity Balanced Fund (FBALX) is also weighted 60:40 in favor of bonds, also has a 10-yr total return of 9.7%/yr, but has a higher expense ratio of 0.53%. VWINX lost 9.8% in 2008 while FBALX lost 31.3%. That difference occurs because stock managers at VWINX are required to confine their selections to the ~400 companies in the FTSE High Dividend Yield Index while managers at FBLAX opted for a wide range of stocks typifying the S&P 500 Index. In other words, VWINX lost much less in the 2008 stock market crash because it held bond-like stocks. For a detailed analysis that compares VWINX to other balanced funds, read this Seeking Alpha article.

Mission: Use our Standard Spreadsheet to analyze companies in VWINX that have: 1) an S&P bond rating of A- or better, 2) a S&P stock rating of B+/M or better, 3) the 16+ year trading record needed for quantitative analysis by the BMW Method, and 4) are found in the current list of companies in the Vanguard High Dividend Yield Index. 

Execution: see the 26 companies in this week’s Table.

Administration: We have emphasized the safety features inherent in confining stock selections to companies in the S&P 100 Index. The managers of VWINX apparently agree, given that 17 of their 26 selections (see Column AK in the Table) are in that index. 

Bottom Line: We offer this view of stocks picked by managers at VWINX because that fund serves as a beacon for retirees. It has had only 5 down years in the past 40, and was down only 9.8% in the Great Recession of 2008. Since inception on 7/1/1970, it has returned 9.7%/yr. 

Risk Rating: 4, where 10-year US Treasury Notes = 1; S&P 500 Index = 5; gold bullion = 10.

Full Disclosure: I dollar-average into PFE, NEE, INTC, PG, JPM, JNJ and CAT, and also own shares of CSCO, DUK, KO, PEP, TRV, MMM, BLK and XOM.

"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

Month 98 - Berkshire Hathaway’s A-rated High Dividend Yield “Value” Stocks - August 2019

Situation: In case your reason for buying stocks in your working years is to have a growing income from dividends in your retirement years, this blog has emphasized “value stocks.” The bible of value investing is Benjamin Graham’s book: The Intelligent Investor. His most famous student is Warren Buffett, who graduated from Columbia University in 1951 with a Masters Degree in Economics. 

Why value investing, and what is a value stock? The central thought is to discipline yourself not to overpay for earnings and/or assets (“book value”). On page 349 of the Revised Edition (1973) of The Intelligent Investor, Benjamin Graham says “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb, we suggest that the product of the [earnings] multiplier times the ratio of price to book value should not exceed 22.5.” In other words, 1.5 times 15 equals 22.5.

How do you calculate the “Graham Number” or rational stock price? It is the square root of 22.5 times Earnings Per Share for the Trailing Twelve Months (TTM) times Book Value per share for the most recent quarter (mrq). We suggest that you think of the share price of a value stock as being no greater than: a) twice the Graham Number, b) 25 times the 7-year average for Earnings Per Share (see page 159 of The Intelligent Investor), and c) no more than 4 times Book Value per share. When you purchase a stock meeting those 3 requirements, it is demonstrably worth what you paid for it. The details are shown in Columns AA-AE of Tables accompanying our recent blogs. 

Berkshire Hathaway’s stock portfolio contains 46 holdings worth $201,828,368,888 as of the last 13F SEC filing dated 8/14/19. The top 5 holdings (AAPL, BAC, KO, AXP, WFC) are worth $133,600,000,000 (66% of the total). Eight of the 46 companies have issued A-rated value stocks, since the company meets the following 4 criteria: 1) its bonds are rated A- or better by Standard & Poor’s (S&P), 2) its stocks that are rated B+/M or better by S&P, 3) its stocks have the 16+ year trading record that is required for quantitative analysis using the BMW Method, and 4) its stocks are listed in both the iShares Russell 1000 Value Index (IWD) and the Vanguard High Dividend Yield Index (VYM). 

The top 10 stocks in Berkshire Hathaway’s portfolio, listed by valuation, are:

Apple AAPL ($51B)
Bank of America BAC ($25B)
Coca-Cola KO ($21B)
American Express AXP ($19B)
Wells Fargo WFC ($18B)
Kraft Heinz KHC ($8B)
U.S. Bancorp USB ($7B)
JPMorgan Chase JPM ($6B)
Moody’s MCO ($5B)
Delta Air Lines DAL ($4B)

Mission: Use our Standard Spreadsheet to analyze value stocks in the portfolio, based on the 4 criteria listed above.  

Execution: see Table.

Administration: Six of the top 10 stocks in the portfolio are not value stocks (AAPL, BAC, AXP, KHC, MCO, DAL). Data for those can be found in the BACKGROUND Section of the Table.

Bottom Line: The 8 A-rated value stocks account for $54 Billion (27%) of the portfolio’s value. These show that Warren Buffett’s area of expertise is not only value stocks generally but financial services stocks specifically, since 5 of the 8 companies are from that industry. The take-home points for retail investors are: a) don’t overpay for a stock, b) buy what you know, and c) remember that the best bargains are often in the Financial Services industry. But those stocks also tend to have the greatest volatility, which is a key reason why they are underpriced.

Risk Rating: 7 (where 1 = 10-year U.S. Treasuries, 5 = S&P 500 Index, and 10 = gold bullion) 

Full Disclosure: I dollar average into KO, PG, JPM and JNJ, and also own shares of AAPL 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

Month 97 - Members of "The 2 and 8 Club" in the Russell 1000 Index - July 2019

Situation: The idea here is to “beat the market” by making selective purchases of individual stocks. This is a delusion, given that the odds are less than 1 in 20 that a professional trader will (over any 10-year period) beat VOO--the ticker for the lowest cost S&P 500 Index Fund, which has an Expense Ratio of 0.03%. VOO is marketed by Vanguard. 

Since you have to actively trade stocks to even come close to beating VOO, trading costs will relentlessly keep you from beating the market. Those costs include brokerage fees, commissions, research time & expense, and capital gains taxes. So, this month’s blog is about an interesting game, like tennis or marriage: When you lose, you’re a fool if you take it personally.  

Mission: Run our Standard Spreadsheet for high-quality stocks in the Russell 1000 Index that have a good and growing dividend. High quality means an S&P bond rating of A- or better. A good dividend is one that gets the stock into the Vanguard High Dividend Yield Index Fund (VYM). A growing dividend is one that has been 8.0%/yr (or better) over the past 5 years.

Execution: see Table.

Bottom Line: You’re toast. It isn’t going to happen. But you’ll come close to beating the market if you avoid making abstract considerations and instead follow concrete markers, such as avoiding stocks with a dividend yield plus dividend growth rate of less than 10%. And, find a way to quickly decide whether a stock is overpriced. For example, you can ask your broker if Morningstar rates the stock as being “overvalued”. Or, you can calculate the Graham Number on your smartphone. The Graham Number is what the stock’s price would be at 15 times Earnings Per Share for the trailing 12 months (TTM), multiplied Book Value for the most recent quarter (mrq). This is a power function (15 times 1.5 equals 22.5). So, you have to multiply those numbers (for the stock in question) by 22.5 before taking the square root, which is the stock’s rational price. If the stock is selling for more than 2.5 times the Graham Number, it is overpriced (see the numbers highlighted in purple at Column AB of the Table). In other words, many investors want to own the stock but relatively few owners want to sell it. You should wait for this fever to break before buying shares.

Risk Rating: 6 (where a 10-year US Treasury Note = 1, S&P 500 Index = 5, and gold = 10)

Full Disclosure: I dollar-average into NEE, JPM, CAT and IBM, and also own shares of CSCO, AMGN, TRV, CMI, MMM and BLK.

"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

Week 391 - Members of “The 2 and 8 Club” in the FTSE Russell 1000 Index

THIS IS THE LAST WEEKLY ISSUE. FUTURE ISSUES WILL APPEAR MONTHLY.

Situation: “The 2 and 8 Club” is based on the FTSE High Dividend Yield Index, which represents the ~400 companies in the FTSE Russell 1000 Index that reliably have a dividend yield higher than S&P 500 Index. Accordingly, a complete membership list for “The 2 and 8 Club” requires screening all ~400 companies in the FTSE High Dividend Yield Index periodically to capture new members and remove members that no longer qualify. This week’s blog is the first complete screen.

Mission: Use our Standard Spreadsheet to analyze all members of “The 2 and 8 Club.”

Execution: see Table

Administration: The requirements for membership in “The 2 and 8 Club” are:
1) membership in the FTSE High Dividend Yield Index;
2) a 5-Yr dividend growth rate of at least 8%;
3) a 16+ year trading record that has been quantitatively analyzed by the BMW Method;
4) a BBB+ or better rating from S&P on the company’s bond issues;
5) a B+/M or better rating from S&P on the company’s common stock issues.

In addition, the company cannot become or remain a member if Book Value for the most recent quarter (mrq) is negative or Earnings per Share for the trailing 12 months (TTM) are negative. Finally, there has to be a reference index that is a barometer of current market conditions, i.e., has a dividend yield that fluctuates around 2% and a 5-Yr dividend growth rate that fluctuates around 8%. The Dow Jones Industrial Average ETF (DIA) is that reference index. In the event that the 5-Yr dividend growth rate for that reference index moves down 50 basis points to 7.5% for example, we would use that cut-off point for membership instead of 8%.   

Bottom Line: There are 40 current members. Only 9 are in “defensive” S&P Industries (Utilities, Consumer Staples, and Health Care). At the other end of the risk scale, there are 12 banks (or bank-like companies) and 5 Information Technology companies; 13 of the 40 have Balance Sheet issues that are cause for concern (see Columns N-P). While the rewards of “The 2 and 8 Club” are attractive (see Columns C, K, and W), such out-performance is not going to be seen in a rising interest rate environment (see Column F in the Table). Why? Because the high dividend payouts (see Column G in the Table) become less appealing to investors when compared to the high interest payouts of Treasury bonds).

NOTE: This week’s Table will be updated at the end of each quarter.

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 JPM, NEE and IBM, and also own shares of TRV, CSCO, BLK, MMM, CMI and R.

Caveat Emptor: If a capitalization-weighted Index of these 40 stocks were used to create a new ETF, it would be 5-10% more risky (see Columns D, I, J, and M in the Table) than an S&P 500 Index ETF like SPY. But the dividend yield and 5-Yr dividend growth rates would be ~50% higher, which means the investor’s money is being returned quite a bit more rapidly. That will have the effect of reducing opportunity cost.

"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

Week 387 - A-Rated Members of "The 2 and 8 Club" In The S&P 100 Index

Situation: If you’re a stock-picker, you’ll need a special watch list so you can work at home. Consider the fact that your spouse and children will want to know what you’re doing and why. Think of it as an opportunity. You’ll get to spend more time at home and convince them that you’re not a gambling their future away! 

Mission: Use our Standard Spreadsheet to illustrate members of “The 2 and 8 Club” in the S&P 100 Index that having S&P ratings of A- or better on their bonds stocks.

Execution: see Table.

Administration: Our least restrictive definition of “The 2 and 8 Club” is all companies in the Russell 1000 Index that reliably pay an above-market quarterly dividend (meaning a yield of ~2% or more) and have raised it at least 8%/yr over the past 5 years. So, we mine the FTSE High Dividend Yield Index because it is composed of the ~400 companies in the Russell 1000 Index that reliably pay an above-market dividend. We exclude any companies that have an S&P rating on their debt lower than BBB+ or an S&P rating on their common stock lower than B+/M. For this week’s blog, we’re listing the few companies in top tier of “The 2 and 8 Club”, which are those in the S&P 100 Index that are A-rated.

Bottom Line: Only 12 companies meet our criteria, half of which are in the highest risk S&P industries: Financial Services and Information Technology. Over the long term, investment in high quality companies drawn from those industries will bring greater rewards than investment in the S&P 500 Index or Dow Jones Industrial Average (as well as sharper losses during intervening Bear Markets). Boeing (BA) and Texas Instruments (TXN) appear overpriced, which we determine by using Graham Numbers and 7-Yr P/Es (see Columns W-Z in the Table). Accordingly, investment in these stocks is best conducted by using an automatic monthly dollar-cost averaging plan, e.g. Computershare.

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 JPM, NEE and IBM, and also own shares of MMM.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Week 386 - Retirement Savings Plan For The Self-Employed

Situation: Let’s follow the Kiss Rule (Keep It Simple, Stupid). There are many jobs that don’t offer a workplace retirement plan. For example, if you’re a long-haul truck driver and own your Class 8 tractor, i.e., you’re an “Owner/Operator”, you make over $100,000 per year but have high expenses. As an S corporation, you don’t pay taxes on the 15% of gross income that you try to set aside for retirement. 

How do you invest it? If you follow the KISS Rule, you’re best off putting all of it in Vanguard’s Wellesley Income Fund. That fund has an expense ratio of 0.22% and is half stocks and half bonds. The ~70 stocks are selected from the FTSE High Dividend Yield Index (i.e., the ~400 companies in the Russell 1000 Index that reliably pay an above-market dividend). You’ll recognize that Index as the same source we use to pick stocks for “The 2 and 8 Club”.

Mission: Run our Standard Spreadsheet using the 10 stocks that reliably pay good and growing dividends and are less likely to fall as much as the Dow Jones Industrial Average in a Bear Market. Compare that portfolio to the Vanguard Wellesley Income Fund (VWINX), the Vanguard High Dividend Yield Index ETF (VYM), and the SPDR S&P 500 Index ETF (SPY). 

Execution: see Table.

Bottom Line: If you’re self-employed (e.g. do seasonal work), you need a flexible retirement plan with low transaction costs. Safety is the main goal. Take no risks! If you want to pick your own stocks, all right. You can keep costs for that low by dollar-averaging but then your bonds have to be very low risk, i.e., US Savings Bonds.

Risk Rating: 4

Full Disclosure: I dollar-average into NEE, KO, T, JNJ and DIA, and also own shares of HRL.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

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

Week 379 - Are “Blue Chip” Stocks Overvalued?

Situation: There are two subjective issues that we need to quantify for “buy and hold” investors: 1) Define a “blue chip” stock. 2) Define an “overvalued” stock. 

Our previous effort to define a “blue chip” stock in quantitative terms (see Week 361) left room for subjective interpretation and was more complicated than necessary. Here’s the new and improved definition: Any US-based company in the S&P 100 Index whose stock has been tracked by modern quantitative methods for 30+ years, and enjoys an S&P rating of B+/M or better. The very important final requirement is that the company issues bonds carrying an S&P rating of A- or better. 

In last week’s blog, we introduced two different quantitative methods for deciding whether or not a stock is overvalued: 1) the Graham Number, which sets an optimal price by using Book Value for the most recent quarter (mrq) and Earnings Per Share for the trailing 12 months (TTM); 2) the 7-Yr P/E, which removes aberrations that are introduced by “blowout earnings” or the negative impact on earnings that is often introduced by “mergers and acquisitions” and “company restructurings.” Either metric can be misleading if used alone, but that problem is largely negated when both are used together. 

Mission: Set up our Standard Spreadsheet for the 40 companies that meet criteria. Show the Graham Number in Columns X and the 7-Yr P/E in Column Z.

Execution: see Table.

Administration: In our original blog about Blue Chip stocks (Week 361), we thought the definition needed to require that companies pay a good and growing dividend. However, there are no objective reasons why a company’s stock will be of more value if profits are paid out piecemeal to investors rather than entirely in the form of capital gains. That’s one of the things you learn in business school from professors of Banking and Finance. Accounting professors also point out that a dividend is a mini-liquidation, as well as a second round of taxation on the company’s profits. There are subjective reasons to prefer companies that pay a good and growing dividend, like building brand value (an intangible asset) and showing that the company is “shareholder friendly.” Dividends also reduce risk by returning some of the original investment quickly with inflation-protected dollars.

Bottom Line: In the aggregate, these company’s shares are overpriced but not to an unreasonable degree (see Columns X-Z in the Table). However, only 8 are bargain-priced: Altria Group (MO), Comcast (CMCSA), Berkshire Hathaway (BRK-B), JP Morgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFB), US Bancorp (USB), and Exxon Mobil (XOM). You’ll note that all 8 face challenges that will cause investors to pause before snapping up shares. 

Shares in 9 companies are overpriced by both metrics (Graham Number and 7-Yr P/E): Home Depot (HD), UnitedHealth (UNH), Lowe’s (LOW), Costco Wholesale (COST), Microsoft (MSFT), Texas Instruments (TXN), Raytheon (RTN), Honeywell International (HON), and Caterpillar (CAT). You’ll need to think about taking profits in those, if you’re a share-owner.

Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into MSFT, NEE, KO, JNJ, JPM, UNP, PG, WMT, CAT, XOM, and IBM. I also own shares of COST, MMM, BRK-B, and INTC.

"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

Week 378 - Which “Dow Jones Industrial Average” Stocks Are Not Overpriced?

Situation: Is the US stock market overpriced? We need to know because Warren Buffett keeps reminding us how important it is to avoid overpaying for a stock. Buffet says: “No matter how successful a company is, don’t overpay for its stock. Wait until Wall Street sours on a company you like and drives the price down into bargain territory. By making a watch list of interesting stocks, and waiting for their prices to drop, you increase the potential for future capital gains.”
The author of this link suggests that none of us “mere mortals” are as smart as Warren Buffett at getting the price right. It’s perhaps better to either dollar-average your investment, or leave it to professionals to do the stock-picking for you. We suggest that there is a third option, which is to use a couple of simple mathematical formulas to guide your stock-picking. Those formulas can be found in the book that Warren Buffett calls “by far the best book on investing every written.” The book is entitled: The Intelligent Investor by Benjamin Graham, Revised Edition, Harper, New York, 1973. There, you will find the value of calculating the 7-year P/E instead of the usual 12-month P/E, and also learn how to calculate the “Graham Number.” The Graham Number is what the stock would sell for if it were priced at 1.5 times Book Value and 15 times trailing 12-month (TTM) earnings. Calculating and using the Graham Number is important because it allows for variation in Book Value and earnings. Multiplying the two values just has to be ~22.5 (15 X 1.5) for the stock to be optimally priced.

Mission: To test both methods on stocks issued by the 30 companies in the Dow Jones Industrial Average (DJIA). See columns X, Y and Z on our Standard Spreadsheet (Table).

Execution: see Table.

Administration: Here’s how to calculate the Graham Number, as shown on p. 349 in the book cited above). [Clicking this link will take you to the Amazon website and the book).] Start by multiplying 1.5 (ideal ratio of Book Value/share) by 15 (ideal ratio of TTM Earnings/share) = 22.5. By multiplying two numbers you have created a Power Function. So, you’ll have to take the Square Root of the Final Number to arrive at the Graham Number. Final Number = 22.5 X actual Book Value/share for the most recent quarter (new) X actual TTM Earnings/share. To access Earnings/share, go to any company’s page at Yahoo Finance, e.g. Apple’s. In the right column find EPS (TTM) of $11.038. To access Book Value/share, click on “statistics” at the top of that page and scroll down the left column to “Balance Sheet.” Book Value/share for the most recent quarter (mrq) is the last entry: $23.74. Graham Number = square root of 22.5 X $11.038 X $23.74 = $76.79. This is the true value (Graham Number) for a single share of Apple stock. If it sells for less, that’s a bargain. Right now, it’s selling for almost 3 times as much. If you own some shares, either think about selling those or think about the company’s ability to scale-up the “Apple ecosystem”. Perhaps you’ll decide that those prospects make holding onto the shares for a while longer a worthwhile risk.

Calculating the 7-Yr P/E (p. 159 in the book cited above). You’ll need a website that provides the past 7 years of TTM earnings, or a library with S&P stock reports. Simply add the most recent 7 years’ earnings and divide by 7 to arrive at the denominator. Look up the current price of the stock (or its 50 Day Moving Average price found in the right column of the statistics page under “Stock Price History”) to arrive at the numerator. Divide numerator by denominator to calculate the 7-Yr P/E, which must be 25 or less to reflect “normative” earnings growth over 7 years for a stock with a 12-month P/E of ~20 during most years. By using the 7-yr P/E you avoid being mislead by a year of blowout earnings or negligible earnings.

Bottom Line: As a group, these 30 stocks are overpriced. Nonetheless, 12 companies have stocks that are priced within reason vs. their Graham Numbers and 7-Yr P/Es (see Columns X-Z in the Table): TRV, DIS, WBA, INTC, VZ, JPM, PFE, PG, GS, UTX, CVX, XOM. But only one company, Goldman Sachs (GS), can be called a bargain with respect to both values (those values being highlighted in green in the Table). Note that Berkshire Hathaway (BRK-B at Line 35 in the Table) is an even better bargain. Perhaps Warren Buffett noticed these markers of high intrinsic value when he recently spent part of Berkshire Hathaway’s cash hoard to buy back the stock. 

Risk Rating: 5 where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10

Full Disclosure: I dollar-average into 3 stocks on the “not overpriced list” -- JPM, PG and XOM, and also own shares in two others: INTC and TRV. Additionally, I dollar-average into MSFT, KO, JNJ, WMT, CAT and IBM, and own shares in MCD, MMM and CSCO. 

Comment: I focus on Dow Stocks because each is covered by dozens of analysts and business journalists, and its stock options are actively traded on the Chicago Board Options Exchange. The result of this microscopic attention is that price discovery is efficient, and surprise earnings are rare. In addition, all 30 companies have a long record of business experience, and are large enough to have multiple product lines that provide internal lines of support during a crisis. DJIA companies are famously able to weather almost any storm: Seven DJIA companies went through a near death experience during The Great Recession of 2008-2009 (General Electric, Citigroup, General Motors, Pfizer, Home Depot, Caterpillar, and American Express) but only 3 had to be removed in the aftermath of that “Lehman Panic” (General Electric, Citigroup, and General Motors).

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com.