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 374 - Bet With The House By Picking Companies In The 2 And 8 Club

Situation: In the U.S., capital-intensive industries with strategic importance are tightly regulated (see Week 230). Electric power grids and railroad networks are expensive to install, maintain and upgrade but those chores are absorbed by shareholders in private companies. Regulatory bodies grant these companies monopoly-like pricing power, oversee safety practices, and set rates high enough to pay for maintenance and upgrades. 

Since the Great Recession, international Money Center banks have also come under intense regulation to meet Basel III requirements for sustainability and reduce systemic risks. A more specific definition now replaces Money Center Bank, which is Systemically Important Financial Institution (SIFI). 

Looked at from the shareholder’s point of view, companies in these three industries have enough government regulation (and monopoly-like pricing power) that bankruptcy is no longer a material risk. One downside risk is that the US market for their goods and services is largely saturated. So, significant growth in the “bottom line” requires innovation and international outreach that will be overseen by government regulators. 

Mission: Use our Standard Spreadsheet to highlight members of “The 2 and 8 Club” that are in the Electric Utilities, SIFI banking, and Railroad industries.  

Execution: see Table.

Bottom Line: The safest tactic in gambling is to “bet with the house” whenever you can. Politicians are now in effective control of three industries: Electric utilities, railroads, and international Money Center banks (now called Systemically Important Financial Institutions or SIFIs). These industries are not in danger of being “nationalized” because politicians would much prefer that shareholders (as opposed to taxpayers) put up the large amounts of capital needed to keep these industries safe and effective. 

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

Full Disclosure: I dollar-average into NEE and JPM.

"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 358 - Hedge the Crash With Low-Beta Dividend Achievers

Situation: It’s really tough to own stocks when the market crumps. Yes, you can follow Warren Buffett’s advice and tough it out with dollar-cost averaging. His other main idea, which is to buy great businesses at a fair price, may be useful someday down the road. He hasn’t been able to find any in this overpriced market, and neither will you. But after the market crashes, you’ll both be glad you kept a hefty dollop of cash in reserve to serve that very purpose. 

But what about hedging against the crash? That’s what hedge funds are supposed to do. Why can’t you and I do it? It’s not that simple. Hedging means that your portfolio pulls ahead in a Bear Market but lags on a Bull Market. Given that the market is historically up 3 years out of 4, you see the problem with hedging. But looking deeper, volatility is what you want to hedge against. You can do that year in and year out by adopting the “School Solution”: overweight low-beta stocks in your portfolio at all times. 

By hedging against volatility, your portfolio won’t necessarily fall behind in a Bull Market. Having less volatility only means that your gains will be less than those for the S&P 500 Index in a Bull Market, AND your losses will be less in a Bear Market. It doesn’t mean you’ll underperform that Index long-term. Why? Because trending stocks become overbought in a Bull Market. But you’re underweighting those high-beta Financial Services and Information Technology stocks! Half of the market capitalization in the S&P 500 Index is currently in those two industries, vs. the long-term average of 30%. Owning high-beta stocks will make you richer faster, but you’ll have to do daily research so that you know when to BUY and when to SELL. My approach to those two industries is to dollar-average into Microsoft (MSFT), International Business Machines (IBM) and JP Morgan Chase (JPM). And keep dollar-averaging no matter what.

Mission: Run our Standard Spreadsheet to identify low-beta stocks of high quality: 
   1. S&P Bond Ratings of A- or better (Column T in the Table);
   2. S&P Stock Ratings of B+/M or better (Column U in the Table);
   3. 5-Yr Beta of less than 0.7 (Column I in the Table);
   4. Lower statistical risk of loss than the S&P 500 Index (Column M in the Table);
   5. Higher Finance Value than the S&P 500 Index (Column E in the Table)
   6. Dividend Achiever status (Column AC in the Table).

Execution: see Table.

Bottom Line: Try not to be a momentum investor. The exciting stories that underlie every Bull Market create a crowded trade for stocks issued by Financial Services and Information Technology companies. To usefully deploy the cash that’s rolling into their coffers, those companies will try to innovate and deploy new services and equipment sooner than planned. Things will get messy, bordering on chaos. Parts of the “story” will collapse, or end in court. Current examples abound. So, we’re back to the Tortoise and Hare story because it will be trotted out at the end of every market cycle. Will you channel the Hare, or will you channel the Tortoise?

Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)

Full Disclosure: I dollar-average into NEE, PEP and NKE, and also own shares of KO and JNJ.

"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 343 - Raise Cash For The Crash

Situation: By now, you know that many are predicting that we are in the late stages of a bull market. Euphoria is the last stage, and in the present climate, one would expect that euphoria will begin happening as the new tax bill takes effect. Two or 3 years later, the stock market will over-correct to the downside and recession will likely soon follow. Now would be a good time for small investors to begin to protect themselves. One way to do that would be to “bulk up” on cash equivalents and Treasuries. The money you still have in equities will need to move in the direction of high-yielding Dividend Achiever type stocks. 

Why should we start making these changes now? Because the yield curve is flattening (see Appendix below), which is the best indicator that Financial Services professionals have to predict a market crash.

Mission: Draw up a portfolio of stocks and bonds that will carry you through a market crash relatively unscathed.

Execution: see Table.

Administration: There are 4 ways to raise cash for a crash.
   1) Have a Rainy Day Fund that covers 6 months of expenses and is inflation-protected. All of us resist maintaining this “Dead Money Account.” Why? Because it keeps taking money away from spending as our income increases. The trick is to make it painless by a) eliminating transaction costs, tax payments, and inflation risk, and b) paying into the Account automatically. Sounds great, but how? By going to the US Treasury website and directing that a transfer of $25+/mo be made from your checking account into an Inflation-Protected Savings Bond (ISB). Follow a First In/First Out (FIFO) policy when cashing-out your Rainy Day Fund, since you’ll lose an interest payment if you cash-out sooner than 5 years. Taxes are only due after you’ve drawn down the Account.

   2) Increase your Cash-Equivalents Allocation: dollar-average into 2-Yr Treasury Notes. Normally, this allocation is whatever cash cushion you like to maintain in your Savings, Checking, and Brokerage Accounts. But now isn’t a normal time. You need to plus-up those cash holdings and build a “backstop.” Why? Because there’s a material risk that your household will soon be living on less income (that is, a reduction upwards of 5%/yr). The easiest way to build a temporary backstop is to go back into www.treasurydirect.com and invest $1000 every 2 months in a 2-Yr Treasury Note. After 2 years, you’re done. You’ve allocated $12,000 that will start paying $1000 into your Checking Account every 2 months. Meantime, you can track the value of this investment through the ticker SHY (iShares 1-3 Year Treasury Bond ETF -- see Line 20 in the Table),  

   3) Reduce your Equity Allocation but retain Dividend Achievers with above-market yields. This week’s Table has suggestions that may assist you. Those stocks were chosen largely on the basis of a) high ratings from S&P, b) above-market yields, c) the likelihood of payouts continuing to increase in a recession, d) P/E ratios at or below market, and e) predicted losses in a bear market (see Column M in the Table) that are less than or equal to those predicted for the S&P 500 Index (at Line 20). When the crash hits, you will be tempted to sell these (your most crash-resistant stocks) because you’re afraid they’ll fall further. Don’t. Instead of reinvesting dividends, just have the dividend checks sent to your mailbox. If you aren’t a stock picker, simply invest in VYM (Vanguard High Dividend Yield ETF at Line 17 in Table) and XLU (SPDR Utilities Select Sector ETF at Line 14).

   4) Increase your Fixed-Income Allocation: dollar-average into 20+ Yr Treasury Bonds. In a Bear Market, you may need to raise cash by selling assets. You might want to sell assets that have temporarily spiked upward in value because stocks are crashing. Only one asset that will predictably do that for you: 20+ Year Treasury Bonds, which are already being bought up and flattening the yield curve (see Appendix below). These are the Treasuries you’ll be buying, and later turning around to sell. So, you’ll need to have a brokerage account that is fee-based (that is, you’re charged ~1% of Net Asset Value/yr in return for transaction costs being waived). Then dollar-average into TLT (iShares 20+ Year Treasury Bond ETF at Line 15 in the Table). Sell those when you think the stock market has bottomed, and spend the proceeds on stocks in that Fire Sale. 

Bottom Line: To avoid sleepless nights and migraine headaches, pull in your horns now. Stop gambling (but restart after the market collapses). Build up your Rainy Day Fund, and invest in cash equivalents, high-yielding high-quality stocks, and long-term Treasuries. When the crash hits, people will tell you to stop buying stocks altogether. Why do they say that? Because nobody can say for sure how long the market will keep going down. But Walmart (WMT) and McDonald’s (MCD) will be booming, even while layoffs in the Industrial Sector continue to make headlines. The End of the World isn’t happening. Get over it. Read the Wall Street Journal. When the Bear looks to be getting tired, call your stock broker and buy.  

Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into NEE and TGT, and also own shares of PEP, PFE, HRL, and MO. I am executing on the 4 suggestions above for raising cash.

APPENDIX: The yield curve is Flattening. What does that jargon term mean? Savvy investors are moving money out of growth stocks and into Long-Term Treasuries, even while the Federal Reserve is raising Short-Term interest rates. It doesn’t make sense. Long-Term rates would typically move up in tandem with Short-Term rates, provided the economy is truly gaining strength. 

You can follow that increase in Long-Term Treasury Bond prices (which move in the opposite direction of interest rates) by going to Yahoo Finance and entering TLT (for iShares 20+ Yr Treasury Bond ETF). Click on “chart” and select the 2 Year chart. Then on “indicator” and choose a 200-day moving average. That will show the steady upward movement in the price of those bonds—because buyers outnumber sellers. That results in a steady downward movement in the rate of interest being earned by new buyers, which flattens the yield curve. 

There are several explanations why Long-Term interest rates might fall even as Short-Term rates are rising: “the likeliest...is the simplest: markets are losing confidence in the Fed’s ability to raise [Short-Term] rates without inflation sagging.” You might want to learn more about the falling yield curve, so read on.

"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

Week 342 - Industrial Companies in “The 2 and 8 Club” (Extended Version)

Situation: There are many industrial companies that enjoy good earnings over long time intervals. But these earnings are yoked to the economic cycle and tend to be volatile. This unsettles investors. Companies in the Financial Services, Consumer Discretionary, and Information Technology industries face the same problem. However, those 4 industries are also responsible for most of the growth in the US stock market. Stockpickers have to either stare at ugly “paper losses” from time to time, or behave like retail investors and “buy high, sell low.” For the former group, which has absorbed losses, studies show that they’ll spend 4% less money on consumer goods than customary. But when the stock market is up a lot, they’ll spend 4% more. The mechanics of maintaining what you’ve obtained may be difficult to explain to your life partner, but your heirs will understand. The harder part (for your life partner) is to understand why you allocate more money to the stock market when its down but less when its up!  

The takeaway message from this is that money needs to be taken “off the table” when the market is frothy, and spent. With the current market, now would be a good time to start doing that. At every one of Berkshire Hathaway’s annual meetings that I’ve attended, Warren Buffett reprises his famous quote: “Be fearful when others are greedy and greedy when others are fearful”. In other words, allocate more of your income to the stock market when the economy is in a slump. Baron Rothschild put a fine point on it 202 years ago, when he profited mightily from the defeat of Napoleon at the Battle of Waterloo: “Buy when there’s blood in the streets, even if the blood is your own”. Caveat Emptor: The opposing argument, that “timing the market” never works, is widely respected.

Mission: If you want to at least keep up with the S&P 500 Index, you’ll have to focus much of your research on industrial stocks. So, here are 6 industrial stocks that 1) pay good & growing dividends, and 2) are highly rated by S&P and Morningstar. See our Week 329 blog for a detailed explanation of how we pick stocks from the Barron’s 500 List that have at least a 2% dividend yield and an 8%/yr dividend growth rate (over the previous 5 years). 

Execution: see Table.

Bottom Line: Industrial companies take advantage of a growing economy. However, their stock prices fluctuate more widely than most investors can tolerate. You have to be a bit of a gambler to become an enthusiast. Over the long term, you’ll grow to be happy with the rewards. Just don’t expect your risk-adjusted total returns to be any better than you’d realize from owning shares in an S&P 500 Index fund, unless your hobby is to analyze industrial companies. To do so, it helps if you decide that only a few companies are likely to reward the time you spend on their study. We think the 6 industrial companies in “The 2 and 8 Club” are worth your time (see Table).

Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into MMM, and also own shares of CMI and CAT.

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

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

Week 340 - Financial Services Companies in “The 2 and 8 Club”

Situation: Ten years ago, you were probably burned in the recession by owning stocks (or bonds) served up by the Financial Services industry. OK, I’ll give you that. But now the industry is back on its feet and paying good dividends, and your job is to invest. “Once bitten, twice shy” can’t be your approach. Instead, you need to know a little about when to get in and when to get out. Why? Because it’s one of the two industries where you stand to make a lot of money--the other being Information Technology. You can’t be a stockpicker and keep up with the S&P 500 Index unless you invest ~15% of your stock portfolio in each of those.

The leading company in this space is Berkshire Hathaway, which is an insurance company that makes side bets by using income from premiums (while waiting for claims to be filed). This sounds easy but it all depends on the quality of those side bets and the amount of cash set aside to pay claims. Greed will doom that project, which is why Berkshire’s CEO (Warren Buffett) says “be fearful when others are greedy and greedy when others are fearful.” These days, he must think that others are being very greedy because he has set aside over $100 Billion in cash. But, with Berkshire Hathaway being an insurance company, recent hurricanes have already shrunk that pile of cash by $3 Billion.

Mission: Run our standard spreadsheet for Financial Services companies in “The 2 and 8 Club” (see Week 329). 

Execution: see Table. 

Administration: Let me use an example to explain why banks can be so profitable. Banks set a price on your use of their money. That interest rate has to appear attractive or you won’t sign up for a repayment plan. If the counterparty (loan officer) thinks the project is too risky, she can still make the loan at an attractive rate, provided that the collateral (e.g. your home) becomes bank property if you default on the loan and is worth enough to cover the bank’s risk. 

Let’s say you need money to dig a gold mine. Chances are, that won’t “pan out” and the bank will have to claim collateral, i.e., all or part of the tangible assets (land, equipment, and structures that you purchased with their money). But sometimes the mine “proves up” and you’ll want to expand it. The loan officer is happy to extend credit because now there is new collateral (gold). The bank will accept a royalty in lieu of repayment. If you are a stockholder in a bank that specializes in loaning money to gold (or silver) mining companies (see Week 307), your payoff is much greater than it would be from owning a mutual fund of gold mines, e.g. VanEck Vectors Gold Miners ETF (GDX). Go to Lines 19-21 in the Table and compare Royal Gold (RGLD, a company that finances gold mines through royalty agreements) with the total returns from owning a gold bullion ETF (GLD) or stock in GDX. You’ll see that RGLD is a reasonably good investment (indeed, it’s a Dividend Achiever), whereas, GLD and GDX are anything but.  

Bottom Line: The reality is that the hopes and dreams of people who are “cash short” can be fulfilled by borrowing money, and their risk of a crippling loss from various enterprises can be reduced by taking out insurance. The bank (or insurance company) wins, even if the borrower defaults on the loan (or is wiped out by a natural disaster). In fact, it often prefers that outcome. Over time, the bank’s Return on Equity (ROE) can be amazing, say 15-20%. But the bank may be funding those loans with too much borrowed money (e.g. more than 20-25 times the amount of cash equivalents and stock that is backing those loans). On the other hand, when ROE grows because the bank is able to sell the assets it acquires at a nice profit (or the insurance company is able to double its premiums on new contracts because recent disasters proved that premiums had been too low), the risk-adjusted returns for stockholders are very good.

Risk Rating: 7 (where US 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)

Full Disclosure: I dollar-cost average into J. P. Morgan Chase (JPM), and also own shares of The Travelers Companies (TRV) and Berkshire Hathaway (BRK-B).

"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

Week 331 - Barron’s 500 Stocks in Berkshire Hathaway’s Portfolio

Situation: There are 43 publicly-traded companies in Berkshire Hathaway’s $180B stock portfolio, 29 of which are in the 2017 Barron’s 500 List. The 10 largest holdings are Kraft-Heinz (KHC - $28B), Wells Fargo (WFC - $23B), Apple (AAPL - $19B), American Express (AXP - $12B), Coca-Cola (KO -$17B), Bank of America (BAC - $17B), IBM - $14B), Phillips 66 (PSX - $7B), US Bancorp (USB - $4B), and Wal-Mart Stores (WMT - $4B). Warren Buffett often speaks of the importance of investing in large and well-established companies, particularly those at the top of their peer group that have long trading records. We’d like to know more about those stocks he’s picked for Berkshire Hathaway’s portfolio.

Mission: Run our standard spreadsheet on the 29 companies in the 2017 Barron’s 500 List, taking care to exclude any that do not have the 16+ year trading history that is required for quantitative analysis per the BMW Method.

Execution: 20 companies fit the bill (see Table).

Administration: The list is dominated by 9 companies in the two highest-risk industries among the 10 standard S&P industries. He has picked 7 companies from Financial Services (AXP, WFC, BAC, USB, MTB, BK, GS) and two from Information Technology (AAPL, IBM). Taken together, the 20 companies have risk parameters that are higher than those for the S&P 500 Index. For example, returns during the recent two-year Bear Market for commodities were 3.8%/yr vs. 6.6%/yr for the S&P 500 Index (see Column D in the Table). The extent of loss (at -2 standard deviations from trendline) in the next Bear Market is predicted to average 38% vs. 30% for the S&P 500 Index (see Column M in the Table). 

Bottom Line: Warren Buffett is “all-in” on his long-standing bet that the US economy will do well going forward. Financial Services stand to gain the most in that event, and 7 of the 20 companies in the Table are in that industry, where he is the unchallenged expert when it comes to pricing their brands and analyzing their black-box financial reports. If you’re like me and hold stock in Berkshire Hathaway, you should be happy that he is sticking to basics, i.e., invest in what you know. The downside is that Warren Buffett is one of a kind. We’re left to hope that he will indeed leave the company in good hands. 

Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into KO, JNJ, MON, and IBM. I also own shares of AAPL, COST, and WMT.

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

Week 315 - High-quality Dividend Achievers That Beat The S&P 500 For 30 Years With Less Risk

Situation: The S&P 500 Index has risen faster than underlying earnings for the past 8 years. The main reason is that the Federal Reserve purchased over 3 Trillion dollars worth of government bonds and mortgages (including “non-conforming” private mortgages that carry no government guarantee). As intended, this flooded our economy with money that could be borrowed at historically low interest rates. Now the Federal Reserve is looking to start bringing that money back, by accepting the repayment of principal when loans mature instead of renewing (“rolling over”) the loans. This will result in a balance sheet “roll-off” that reduces the amount of money in circulation. Think of it as a “bail-in” to rebalance Treasury accounts, which will reverse the “bail-out” of Wall Street in 2008-9. Interest rates will slowly rise. Investors will once again have to consider the attractiveness of owning bonds in place of stocks. “Risk-on” investments, i.e., growth stocks and stocks issued by smaller companies, will be less sought after but “risk-off” investments (defensive stocks and corporate bonds) will be more sought after. Most of the stocks that have outperformed the S&P 500 over the past 25 years (see Week 314) and 35 years (see Week 313) have been issued by companies in “defensive” industries. 

Mission: Look at 30 year statistics by using the BMW Method, to possibly find more stocks that outperform the S&P 500 Index while taking on less risk.  

Execution: see Table. 

Bottom Line: We have turned up 3 new companies: two from defensive industries (Archer Daniels Midland “ADM” and Kimberly-Clark “KMB”) and one from a growth industry (WW Grainger “GWW”). That makes a total of 11 companies from the 4 S&P “defensive” industries (Utilities, Healthcare, Consumer Staples, and Communication Services): CHD, MKC, BDX, WTR, ED, GIS, CVS, PEP, PG, ADM, KMB. And, 5 from the 6 S&P “growth” industries (Consumer Discretionary, Industrials, Information Technology, Materials, Energy, and Financial Services): APD, MMM, MCD, GPC, GWW. 

In other words, the companies that make really good long-term investments are twice as likely to be from “risk-off” defensive industries than from “risk-on” growth industries. But think about what that implies, given that 2/3rds of the companies in the S&P 100 Index represent growth industries. If you want to beat the S&P 500 Index long-term, you’ll have to reverse that ratio and have 2/3rds of your money in defensive stocks. 

Risk Rating: 5 (10-Yr Treasury Note = 1, S&P 500 Index = 5, Gold = 10)

Full Disclosure: I own shares of MCD, MMM, GIS, MKC.

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

Week 298 - Barron’s 500 “Financial Services” Companies That Are Dividend Achievers

Situation: Even a Retirement Portfolio needs some exposure to Financial Services companies. Yes, I know. During the 4.5 year Housing Crisis (from April 2007 to October 2011), stocks in the Financial Services index fund (XLF) lost 20%/yr vs. 3%/yr for the S&P 500 Index (see Column D in the Table). So, let’s confine our attention to companies that kept increasing their dividend throughout that crisis, i.e., companies S&P calls Dividend Achievers.

Mission: Apply our standard spreadsheet analysis to financial services Dividend Achievers on the 2016 Barron’s 500 List, specifically those that have traded their stock long enough for it to appear on the 16-Yr BMW Method List, and have an investment-grade bond rating from Standard & Poor's. Only 5 companies meet our requirements, but all of those have clean balance sheets (see Columns P-R).

Execution: see Table.

Administration: During the 4.5 year Housing Crisis, 3 of the 5 companies outperformed the lowest-cost S&P 500 Index Fund, VFINX at Column D in the Table. But read the fine print:

Caveat emptor: You’ll want to know exactly why it’s a good idea to add Financial Services companies to your retirement portfolio. Relatively safe stocks, i.e., dividend-growing stocks issued by companies in one of the 4 “defensive” S&P Industries (Utilities, HealthCare, Consumer Staples, Communication Services), are what you buy to reduce Risk. Unfortunately, there are so many “savers” who seek to reduce risk that those stocks are almost always overvalued. You can’t get them at a fair price, so you have to break a key Warren Buffett rule to build a sizable position over time. You can only make real money if you sell those stocks when savers are desperate to buy them. But there’s another side to that coin: growth stocks. Those are issued by companies in the Financial Services, Information Technology, Industrial, and Consumer Discretionary industries. Buy them when they have a bad smell due to the powerful aversion training (think Pavlov’s dog) that we all experience from untoward events like the Housing Crisis. That calamity had such a negative effect on the value of Financial Services companies that their Return on Invested Capital (ROIC) didn’t rise above their Weighted Average Cost of Capital (WACC) until last year. You had a 7-yr opportunity to buy stock in fundamentally sound companies at absurdly low prices. Now, it’s too late to make real money on that trade. Almost any flavor of Financial Services stock is speculative: you need to know when to buy and when to sell. You sell when ROICs  are twice as high as WACCs, and stock brokers start recommending Financial Services stocks to financially naive people. I’m afraid we’ve already reached that point, with respect to Money Center banks (see Columns AB and AC at Line 16).

Bottom Line: These companies represent high-risk/high-reward investments (see Columns D, I, and M in the Table). Four of the 5 sell insurance products. The exception is Franklin Resources (BEN), which sells mutual funds to institutions and wealthy individuals. Standard & Poor’s has A-ratings for stocks and bonds issued by Travelers (TRV) and Aflac (AFL), so consider buying one of those through an online dollar-averaging program. The Net Present Value calculation is higher for TRV (see Column Y in the Table).

Risk Rating: 8 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)

Full Disclosure: I own shares in TRV.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 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 (no dividends accrue in 10th year), Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/Yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 21 in the Table. The ETF for that index is MDY at Line 12.

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

Week 268 - "Buy and Hold" Barron’s 500 Growth Stocks

Situation: Every investor has to know when to leave the party. Or, as Warren Buffett says, “be fearful when others are greedy and greedy when others are fearful.”

Mission: Design a template for leaving the party.

Execution: You’ll need a Central Thought. Mine is to stay invested in growth stocks, the ones that do badly in a recession. That means continue to invest in companies from the following 6 S&P industries: Consumer Discretionary, Financial, Information Technology, Industrial, Basic Materials, and Energy. The trick is to dump stocks with problematic Balance Sheets and buy stocks with clean Balance Sheets. 

Administration: Start by defining a clean Balance Sheet. Accountants do this by picking their favorite ratios. My favorite ratios are (see Columns Y thru AB in the Table):

1. Total Debt:Equity is under 200%. That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is under 30%. Long-term debt has to either be renewed upon maturity or returned to the lender. In a crisis, the rate of interest that bankers charge for a renewal loan (called a “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 company assets at firesale prices 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 in the perceived value of their brand.
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. 

There are other ways to know a company is likely to come through a Bear Market or recession unharmed. S&P stock and bond ratings are worth taking seriously: try to hold stock in A-rated companies (see Columns P and Q in the Table). Stick to companies with multiple product lines, i.e., those large enough to warrant inclusion in the Barron’s 500 List (see Columns N and O in the Table). That list ranks companies by cash flow and revenue. You can tell how a company is doing by comparing this year’s rank to last year’s. 

You’ll also want to restrict your choices to companies that pay growing dividends, even if the dividend is low. An S&P Dividend Achiever is a company that has raised its dividend annually for the past 10 yrs. With one exception, all of the companies in this week’s Table are Dividend Achievers. Union Pacific is the exception but UNP will become a Dividend Achiever next February with a scheduled dividend increase. 

Bottom Line: You can’t hope to keep up with the lowest-cost S&P 500 Index fund (VFINX at Line 21 in the Table) unless you stay invested in growth stocks. So, learn to pick growth stocks with clean Balance Sheets. Those are the ones likely to hold value in a Bear Market. Invest small amounts at a time by dollar-averaging your stock purchases automatically online. Then you’re certain to buy more shares per dollar invested when the market’s down.

Risk Rating: 6 (Treasuries = 1 and gold = 10)

Full Disclosure: I dollar-average into NKE, MSFT and UNP, and also own shares of ROST, TJX, MMM, and EMR.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for 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 dividend CAGR for the past 16 years. Price Growth Rate is mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/). Price Return from selling all shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).

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

Week 260 - Barron’s 500 Global “Systemically Important Financial Institutions”

Situation: Unless you just returned from 10 yrs on another planet, you know that financial innovation almost crashed this planet’s largest economies in 2008. The financial services industry in the US had earlier been given free reign to “innovate” by the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999. Prior to that Act, any one financial services institution had been prohibited “from acting as any combination of an investment bank, a commercial bank, and an insurance company.” Not only did such combinations become legal but the Securities and Exchange Commission was denied authority to regulate the “large investment bank holding companies” enabled by the Act: The fox would be running the henhouse. 

Once the consequences of that became clear in 2008, the US Congress was moved to pass the Dodd-Frank Wall Street Reform and Consumer Protection Act; President Obama signed it into law on July 21, 2010. Most of the reforms enabled by that Act will be extended worldwide when the Third Basel Accord (Basel III) takes effect on March 31, 2019. However, we note that Mervyn King, the former Bank of England Governor, doubts whether Basel III will prevent another financial calamity. 

Now that the status quo ante has largely been restored, we can take a fresh look at financial services institutions, beginning with the remaining Bank Holding Companies. Those 33 money center banks are now called Global SIFIs (Systemically Important Financial Institutions) or G-SIBs. To remain Bank Holding Companies, each is required to carry large amounts of reserve capital and publish a “living will” that has been approved by its central bank. So, if a financial calamity were to consume all of a holding company’s reserve capital, there is a plan in place to resolve the difficulty in an orderly manner. To prepare for that day, each G-SIB has to lock away tens of billion dollars. Those funds are unavailable for making loans or serving as collateral. The idea is to have G-SIBs gradually go away, since restrictions on their ability to provide loans or collateral make it difficult for them to sustain competition against investment banks, commercial banks and insurance companies. Three of the original 33 G-SIBs have already been broken up.

Mission: Given that G-SIB CEOs believe there is a competitive advantage to providing a complete range of financial services for their customers, we’ll look at a variety of metrics and decide whether or not they’re on a quixotic mission. Why should we care? Because the severity of regulation being applied by central bankers almost guarantees that G-SIBs won’t collapse. If you own stock in one, you’ll almost certainly make money. We’ll limit our attention to the 8 G-SIBs in North America, i.e., those that appear in the recently published 2016 Barron’s 500 List.

Execution: We’ll deploy our recently expanded spreadsheet (see Table). There you’ll find performance data and new metrics designed to scope out future prospects for success. Column L in the Table shows the consensus of analyst’s estimates for the trend in each company’s earnings over the next 5 yrs. The green highlights in Columns P and Q indicate that cash-flow based ROIC and sales have been improving at each of the 8 companies for the past 3 yrs. Column T gives the Graham Number and Column U gives the stock price. The Graham Number is where the stock price would be if it were to reflect 15 times earnings per share and 1.5 times book value per share. Benjamin Graham is the “father of value investing” and was the Professor of Economics at Columbia Business School who had such a large effect on Warren Buffett (MSc Economics, 1951).

Bottom Line: Wall Street banks have become a thicket of thorns. Financial engineering has not paid off for them, and the various routes they have discovered for creative finance are now blocked. Workarounds have been forged, and may yet pay off. For the retail investor, these are not promising stocks. The only exception is Wells Fargo (WFC), which has long avoided the kind of creative finance that brought us the Lehman Panic.

Risk Rating = 9 (Treasuries = 1 and gold = 10).

Full Disclosure: I dollar-average into JPM.

NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 14 in the Table). Metrics highlighted in green at Columns P and Q in the Table indicate improving performance trends for fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC.

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

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

Week 207 - Starter Stocks

Situation: The stock market is pricey and the bond market is becoming less pricey. This suggests that stock prices are going to plateau for a while because bonds will be paying higher interest. Dividends will no longer be the best way for you to get an income from your investments.

Mission: Find stocks that are suitable for a newcomer to stock-picking. 

Execution: We can’t change our stripes, so we’ll fall back on the two most important considerations for a newcomer to stock-picking: (1) start with large companies and (2) confine your attention to those that are Dividend Achievers, which is S&P’s name for companies with 10 or more yrs of annual dividend increases. Risky stocks need to be excluded from the newcomer’s portfolio, so we eliminate any companies that either have a S&P bond rating lower than A- or an S&P stock rating lower than A+/M (see the Table). And, we exclude companies with a 3-yr history of declining operational metrics according to research done to produce the annual Barron’s 500 List with one exception. Any company that ranked in the top 250 on both the 2015 and 2014 lists is acceptable. Metrics from the BMW Method are also used to exclude companies with price trends that don’t track the market and companies that are predicted to lose 40% or more in the next Bear Market. Companies that lost more than the hedged S&P 500 Index (i.e., Vanguard’s Balanced Index Fund, VBINX) during the 18-month Lehman Panic are also excluded, as are companies in the most cyclical industries: Energy, Basic Materials, Finance, and Information Technology.

Bottom Line: We were able to come up with only 4 “starter stocks”: Nike (NKE), NextEra Energy (NEE), Johnson & Johnson (JNJ) and PepsiCo (PEP). You would need to dollar-average equal amounts of money into each stock every month online to achieve the best gain during bull markets and the least loss during bear markets. In other words, diversify your bets and make small bets often rather than big bets occasionally.

Risk Rating: 4

Full Disclosure: I dollar-average into all 4 of these stocks.

NOTE: metrics highlighted in red indicate underperformance vs. our key benchmark, which is the Vanguard Balanced Index Fund (VBINX). Metrics are brought current for the Sunday of publication.

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