Situation: We started this blog six years ago with the idea to create a Growing Perpetuity Index as a way to save for retirement, by selecting from a workable “watch list” of high-quality stocks (see Week 21). We chose to base the index on companies in the 65-stock Dow Jones Composite Average (^DJA), and ended up selecting 12 from the 14 that had earned S&P’s designation of Dividend Achiever, i.e., companies that had raised their dividend annually for the previous 10 years or longer:
Exxon Mobil
Wal-Mart Stores
Procter & Gamble
Johnson & Johnson
IBM
Chevron
Coca-Cola
McDonald’s
United Technologies
3M
Norfolk Southern
NextEra Energy
Our thought was that investors could select stocks from this index to safely dollar-cost average automatic online contributions into their Dividend Reinvestment Plan (DRIP). That would allow relatively safe and efficient growth in their retirement assets. Version 2.0 (see Week 224) added back the two companies that had been left out, Caterpillar (CAT) and Southern Company (SO), plus two newly qualified companies: Microsoft (MSFT) and CSX (CSX).
Now we’ll apply a lesson learned from running Net Present Value (NPV) calculations, namely that Discounted Cash Flows from good and growing dividends are more likely to predict rewards to the investor than Capital Gains from a history of price appreciation. Accordingly, Version 3.0 re-casts the index to include only those ^DJA companies that are in “The 2 and 8 Club” (see Week 329) of high-quality companies with a dividend yield of at least 2% and a dividend growth rate of at least 8% for the past 5 years. The result is a 13 company Watch List, not all of which are Dividend Achievers. Only 7 are holdovers from Growing Perpetuity Index, v2.0:
NextEra Energy
3M
Exxon Mobil
Coca-Cola
IBM
Microsoft
Caterpillar
Mission: Apply our standard spreadsheet (see Table) to the 13 companies in the 65-company Dow Jones Composite Index that are in “The 2 and 8 Club.”
Execution: see Table.
Bottom Line: The value of picking from among the highest-quality stocks in the Dow Jones Composite Index is not just that it’s the smallest and oldest index, but also that it is continuously vetted by the managing editor of The Wall Street Journal. Companies that don’t stand muster are replaced by companies that do. By adding the several requirements for inclusion in “The 2 and 8 Club” (e.g. S&P bond ratings cannot be lower than A-), you have a good chance of selecting half a dozen stocks that will beat the S&P 500 Index over a 10-Yr Holding Period (see Column Y in the Table). You’ll also be taking on more risk (see Columns D, I, and M in the Table), which you’ll ameliorate by trading new entrants to “The 2 and 8 Club” for those that are leaving.
Risk Rating: 6 (where 10-Yr Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into MSFT, XOM, NEE, KO, JPM and IBM, and also own shares of TRV, PFE, MMM, 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
Showing posts with label growing perpetuity index. Show all posts
Showing posts with label growing perpetuity index. Show all posts
Sunday, December 10
Sunday, August 13
Week 319 - A-rated Russell 1000 Companies With Tangible Book Value That Pay A "Good and Growing" Dividend
Last week, we surveyed A-rated companies in the 65-stock Dow Jones Composite Index with positive Tangible Book Value. It turned out there are 9 such companies for your Watch List. These 9 stocks constitute the latest version of our Growing Perpetuity Index (see Week 261 for background). This week, we survey all other companies in the Russell 1000 Index that pay a “good and growing” dividend and meet those requirements. There are 11 such companies, bringing the total number to 20.
Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 16 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers.
Bottom Line: Our blog is centered on the idea that stock-picking can be a safe and effective way to save for retirement. These 20 companies in the Russell 1000 Index (including the 9 from last week) represent our best effort to create a concise “Watch List” for stock-pickers. But be aware: A safer and more efficient approach is to invest in the Vanguard High Dividend Yield ETF (VYM). Then you won’t be forced (through painful experience) to learn about economics.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I own shares of HRL.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 16 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers.
Bottom Line: Our blog is centered on the idea that stock-picking can be a safe and effective way to save for retirement. These 20 companies in the Russell 1000 Index (including the 9 from last week) represent our best effort to create a concise “Watch List” for stock-pickers. But be aware: A safer and more efficient approach is to invest in the Vanguard High Dividend Yield ETF (VYM). Then you won’t be forced (through painful experience) to learn about economics.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I own shares of HRL.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 6
Week 318 - Growing Perpetuity Index: A-Rated Dow Jones Composite Companies With Tangible Book Value that pay a “Good and Growing” Dividend
Situation: You need a way to save for retirement that is safe and effective. We agree with Warren Buffett’s approach which is to use a low-cost S&P 500 Index fund combined with a low-cost short-intermediate term US Treasury fund. If you’re wealthy, make the stock:bond mix 90:10. If not, move toward a 50:50 mix.
If you’re a stock-picker but fully employed outside the financial services industry, find a formula that won’t require a lot of your time for oversight and maintenance. The S&P 500 Index has too many stocks, so stick to analyzing the Dow Jones Composite Index. Those stocks have been picked by the Managing Editor of the Wall Street Journal. Start with the 20 companies in that 65-stock index that pay at least a “market dividend” and are Dividend Achievers, i.e., have raised their dividend annually for at least the past 10 years. We call that shortened version The Growing Perpetuity Index (see Week 261). It also excludes companies with less than a BBB+ S&P Bond Rating or B+/M S&P Stock Rating. But companies with with ratings lower than A- tend to develop problems, as do companies with negative net Tangible Book Value. (The SEC requires that the sale of newly-issued shares on a US stock exchange not dilute a company’s net Tangible Book Value below zero.)
Mission: Revise “The Growing Perpetuity Index” to exclude companies with negative Tangible Book Value, as well as companies with an S&P Bond Rating less than A- or an S&P Stock Rating less than A-/M.
Execution: We’re down to 9 companies (see Table).
Administration: Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 14 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers.
In next week’s blog, we highlight the 11 companies in VYM that aren’t in the Dow Jones Composite Index. Then you’ll need to track only 20 companies on your adventure into stock-picking! But be aware: 30% of those 20 companies are boring utilities, meaning that clear-eyed stock-picking isn’t glamorous at all. It’s just making money by not losing money, which is Warren Buffett’s #1 Rule.
Bottom Line: Stock-picking becomes a problem for non-gamblers at the Go/No-Go point, i.e., after 5 years of trying, you need to think about giving up if you can’t beat the total return/yr for an S&P 500 Index fund (SPY or VFINX) by at least 2%/yr. This is because you need to cover your greater transaction costs and capital gains taxes that are being expensed out. We’re suggesting that you start with 9 “blue chip” stocks that have a reasonable likelihood of letting you stay in the game after a 5 year probation period. Of course, you’d be opening yourself up to selection bias because there is a greater risk of loss vs. investing in all 500 stocks. Academic studies have shown that you’d need to own shares in at least 50 companies to largely overcome that risk.
Risk Rating: 6 (10-Yr Treasury Note = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into NEE, MSFT, JNJ, KO, and UNP. I also own shares of MMM, TRV, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
If you’re a stock-picker but fully employed outside the financial services industry, find a formula that won’t require a lot of your time for oversight and maintenance. The S&P 500 Index has too many stocks, so stick to analyzing the Dow Jones Composite Index. Those stocks have been picked by the Managing Editor of the Wall Street Journal. Start with the 20 companies in that 65-stock index that pay at least a “market dividend” and are Dividend Achievers, i.e., have raised their dividend annually for at least the past 10 years. We call that shortened version The Growing Perpetuity Index (see Week 261). It also excludes companies with less than a BBB+ S&P Bond Rating or B+/M S&P Stock Rating. But companies with with ratings lower than A- tend to develop problems, as do companies with negative net Tangible Book Value. (The SEC requires that the sale of newly-issued shares on a US stock exchange not dilute a company’s net Tangible Book Value below zero.)
Mission: Revise “The Growing Perpetuity Index” to exclude companies with negative Tangible Book Value, as well as companies with an S&P Bond Rating less than A- or an S&P Stock Rating less than A-/M.
Execution: We’re down to 9 companies (see Table).
Administration: Our Benchmark for companies that pay a “good and growing” dividend is the Vanguard High Dividend Yield ETF (VYM at Line 14 in the Table). That fund represents a subset of the Russell 1000 Index of the largest publicly-traded US companies which pay at least as high a dividend yield as the average for the full set. As it happens, all of the companies in the subset that have A ratings from S&P on their bonds and stocks are Dividend Achievers.
In next week’s blog, we highlight the 11 companies in VYM that aren’t in the Dow Jones Composite Index. Then you’ll need to track only 20 companies on your adventure into stock-picking! But be aware: 30% of those 20 companies are boring utilities, meaning that clear-eyed stock-picking isn’t glamorous at all. It’s just making money by not losing money, which is Warren Buffett’s #1 Rule.
Bottom Line: Stock-picking becomes a problem for non-gamblers at the Go/No-Go point, i.e., after 5 years of trying, you need to think about giving up if you can’t beat the total return/yr for an S&P 500 Index fund (SPY or VFINX) by at least 2%/yr. This is because you need to cover your greater transaction costs and capital gains taxes that are being expensed out. We’re suggesting that you start with 9 “blue chip” stocks that have a reasonable likelihood of letting you stay in the game after a 5 year probation period. Of course, you’d be opening yourself up to selection bias because there is a greater risk of loss vs. investing in all 500 stocks. Academic studies have shown that you’d need to own shares in at least 50 companies to largely overcome that risk.
Risk Rating: 6 (10-Yr Treasury Note = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into NEE, MSFT, JNJ, KO, and UNP. I also own shares of MMM, TRV, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 3
Week 261 - Growing Perpetuity Index v2.1
Situation: Our blog started 5 years ago with the idea that saving for retirement could be more efficient if savers were to “dollar-average” $50-200 online each month into stocks. The purchases would be spread out over several companies in different sectors of the market, i.e., companies that pay a good and growing dividend. The saver’s accountants would declare to the IRS that those savings constitute an IRA. This week’s blog revisits our initial strategy, examines its performance, and looks for ways to enhance the way we measure performance.
By using the 65-stock Dow Jones Composite Average or ^DJA, we picked an initial 12 stocks and called those the Growing Perpetuity Index (see Week 4). ^DJA is not only a shorter list than the S&P 500 Index (^GSPC) but also outperforms ^GSPC over the long term (compare Lines 32 and 33 at Column C in the Table). Our strategy was to exclude stocks that don’t pay at least a market dividend (currently 2.0%/yr), and those issued by companies that don’t have S&P ratings of at least BBB+ for their bonds and B+/M for their common stock. Most importantly, the companies needed to have a record of increasing their dividend annually for 10 or more years. S&P calls those companies Dividend Achievers.
Mission: List all companies that currently qualify for inclusion in the Growing Perpetuity Index (see Table), and highlight important metrics for the investor to consider. Five years ago, we found 14 companies and eliminated two to reach our goal of having only a dozen. At Week 224 there were 16 qualifiers; we gave up the idea having a dozen favorites and called the 16-stock portfolio Growing Perpetuity Index v2.0. Now, 19 companies meet our criteria, and we’ve added one (Union Pacific) that will soon be designated a Dividend Achiever. You get to choose from the 20 stocks in Growing Perpetuity Index v2.1.
Execution: Highlighting “important metrics for the investor to consider” has become “the tail that wags the dog.” For example, we’ve come around to the idea that Net Present Value (NPV) needs to be calculated for every stock appearing in our tables. Explaining that math trick can start with pretending that you bought one of the stocks having a $0.00 transaction cost online, e.g. 50 shares of Exxon Mobil (XOM) at $100/Sh. If you’re looking for that $5000.00 investment to have a 9%/yr rate of price appreciation over a 10 year holding period, you’ll sell those 50 shares for $11835.00 ($236.72/Sh). The calculated Present Value of Expected Cash Flows on that price return works out to be $5000, meaning Net Present Value will be $0.00 because you spent $5000 of Present Value to buy it.
You get the point: The discount rate (9%/yr) is like the inflation rate but instead reduces your return because of the Time Value of Money. For example, the impact of that 9%/yr “discount” on each dollar of dividends paid out 10 yrs from now is to leave you with a NPV of 39 cents. The dividend growth you expect is also 9%/yr, which (if realized) would also generate an NPV of $0.00. (A detailed explanation of the inputs to the NPV calculation can be found at Week 256).
The amount of the dividend is important in the NPV calculation. Why? Because large dividend cash flows may be paid out in the early years, when the discount rate has less impact. XOM pays a high 3.3% dividend, which turns out to give it a positive NPV even though other factors work against its having a positive NPV. Those factors are 1) the NPV calculation includes transaction costs of 2.5% at both the front and back end, 2) the dividend growth rate is only 8.0%/yr, and 3) the price appreciation rate is only 7.9%/yr (see Columns G, H, M and Y at Line 16 in the Table). After buying XOM, almost 20% of its purchase price is returned to you as dividends within 5 yrs.
Administration: Market returns have but two sources: asset allocation and security selection. We recommend bond-like stocks for retirement planning, backed 2:1 with 10-yr US Treasury Notes that are purchased online to avoid transaction costs. Diversification to gain exposure to foreign markets or small-mid capitalization companies is not necessary because the average company in the Table gains 40% of revenues outside the US and several of the companies (JNJ, MSFT, IBM, PG, KO, XOM, UTX, MMM) buy up small companies almost every year.
That leaves “security selection” as the key source of returns. This is the hard part, since you aren’t going to buy all 20 stocks. But it’s really a 2-part problem, given that transaction costs may outweigh selection bias as a source of poor returns for the average investor. So, let’s look at those costs as a fraction of the asset’s purchase price, the so-called expense ratio. For automatic purchases of $100/mo online, the average expense ratio for the 20 stocks we highlight this week is 1.4% (see Column AB in the Table). Note: 8 of those 20 stocks carry zero or minimal transaction costs.
When buying stocks through a discount broker, the expense ratio is typically 2.5%. Index funds purchased through the Vanguard Group have expense ratios of 0.25% or less, which is the main reason Warren Buffett recommends that his friends and relatives buy the Vanguard 500 Index Fund (VFINX at Line 28 in the Table) instead of trying to pick stocks.
Selection bias is an important problem for investors holding fewer than 40 stocks. We try to help you by emphasizing the importance of diversification, e.g. having stocks in all 10 of the S&P industries (see Week 236). Mostly, you need to emphasize quality when picking stocks (see our rationale above for making this week’s selections). Then see how to get the most value from the stocks you like by running NPV calculations before you buy (c.f. Columns U through Y in the Table). Also, pay attention to the Graham Number in Column T and compare it to the Stock Price in Column U. The Graham Number is what the price of the stock would be at 15X earnings and 1.5X book value.
Bottom Line: We have refreshed our Growing Perpetuity Index. Now it is v2.1 and composed of 20 companies which, in the aggregate, handily outperform our benchmarks. We find that only 3 companies have a lower “finance value” than VFINX using our method of calculating performance: 16-yr total return minus the loss incurred in the 2011 market correction (see Column 5 of the Table). Those companies are 3M (MMM), CSX Railroad, and Caterpillar (CAT). In terms of NPV, all 20 companies outperformed the benchmarks (see Column Y in the Table). Those benchmarks include VFINX, Berkshire Hathaway (BRK-A), and the SPDR MidCap 400 ETF (MDY).
Risk Rating is 6, where Treasuries = 1 and gold = 10.
Full Disclosure: I dollar-average into XOM, JNJ, MSFT, NEE, PG, and UNP. I also own shares of MCD, MMM, IBM, KO, and WMT.
NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance vs. VBINX (Vanguard Balanced Index Fund at Line 26 in the Table), which is our key benchmark.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
By using the 65-stock Dow Jones Composite Average or ^DJA, we picked an initial 12 stocks and called those the Growing Perpetuity Index (see Week 4). ^DJA is not only a shorter list than the S&P 500 Index (^GSPC) but also outperforms ^GSPC over the long term (compare Lines 32 and 33 at Column C in the Table). Our strategy was to exclude stocks that don’t pay at least a market dividend (currently 2.0%/yr), and those issued by companies that don’t have S&P ratings of at least BBB+ for their bonds and B+/M for their common stock. Most importantly, the companies needed to have a record of increasing their dividend annually for 10 or more years. S&P calls those companies Dividend Achievers.
Mission: List all companies that currently qualify for inclusion in the Growing Perpetuity Index (see Table), and highlight important metrics for the investor to consider. Five years ago, we found 14 companies and eliminated two to reach our goal of having only a dozen. At Week 224 there were 16 qualifiers; we gave up the idea having a dozen favorites and called the 16-stock portfolio Growing Perpetuity Index v2.0. Now, 19 companies meet our criteria, and we’ve added one (Union Pacific) that will soon be designated a Dividend Achiever. You get to choose from the 20 stocks in Growing Perpetuity Index v2.1.
Execution: Highlighting “important metrics for the investor to consider” has become “the tail that wags the dog.” For example, we’ve come around to the idea that Net Present Value (NPV) needs to be calculated for every stock appearing in our tables. Explaining that math trick can start with pretending that you bought one of the stocks having a $0.00 transaction cost online, e.g. 50 shares of Exxon Mobil (XOM) at $100/Sh. If you’re looking for that $5000.00 investment to have a 9%/yr rate of price appreciation over a 10 year holding period, you’ll sell those 50 shares for $11835.00 ($236.72/Sh). The calculated Present Value of Expected Cash Flows on that price return works out to be $5000, meaning Net Present Value will be $0.00 because you spent $5000 of Present Value to buy it.
You get the point: The discount rate (9%/yr) is like the inflation rate but instead reduces your return because of the Time Value of Money. For example, the impact of that 9%/yr “discount” on each dollar of dividends paid out 10 yrs from now is to leave you with a NPV of 39 cents. The dividend growth you expect is also 9%/yr, which (if realized) would also generate an NPV of $0.00. (A detailed explanation of the inputs to the NPV calculation can be found at Week 256).
The amount of the dividend is important in the NPV calculation. Why? Because large dividend cash flows may be paid out in the early years, when the discount rate has less impact. XOM pays a high 3.3% dividend, which turns out to give it a positive NPV even though other factors work against its having a positive NPV. Those factors are 1) the NPV calculation includes transaction costs of 2.5% at both the front and back end, 2) the dividend growth rate is only 8.0%/yr, and 3) the price appreciation rate is only 7.9%/yr (see Columns G, H, M and Y at Line 16 in the Table). After buying XOM, almost 20% of its purchase price is returned to you as dividends within 5 yrs.
Administration: Market returns have but two sources: asset allocation and security selection. We recommend bond-like stocks for retirement planning, backed 2:1 with 10-yr US Treasury Notes that are purchased online to avoid transaction costs. Diversification to gain exposure to foreign markets or small-mid capitalization companies is not necessary because the average company in the Table gains 40% of revenues outside the US and several of the companies (JNJ, MSFT, IBM, PG, KO, XOM, UTX, MMM) buy up small companies almost every year.
That leaves “security selection” as the key source of returns. This is the hard part, since you aren’t going to buy all 20 stocks. But it’s really a 2-part problem, given that transaction costs may outweigh selection bias as a source of poor returns for the average investor. So, let’s look at those costs as a fraction of the asset’s purchase price, the so-called expense ratio. For automatic purchases of $100/mo online, the average expense ratio for the 20 stocks we highlight this week is 1.4% (see Column AB in the Table). Note: 8 of those 20 stocks carry zero or minimal transaction costs.
When buying stocks through a discount broker, the expense ratio is typically 2.5%. Index funds purchased through the Vanguard Group have expense ratios of 0.25% or less, which is the main reason Warren Buffett recommends that his friends and relatives buy the Vanguard 500 Index Fund (VFINX at Line 28 in the Table) instead of trying to pick stocks.
Selection bias is an important problem for investors holding fewer than 40 stocks. We try to help you by emphasizing the importance of diversification, e.g. having stocks in all 10 of the S&P industries (see Week 236). Mostly, you need to emphasize quality when picking stocks (see our rationale above for making this week’s selections). Then see how to get the most value from the stocks you like by running NPV calculations before you buy (c.f. Columns U through Y in the Table). Also, pay attention to the Graham Number in Column T and compare it to the Stock Price in Column U. The Graham Number is what the price of the stock would be at 15X earnings and 1.5X book value.
Bottom Line: We have refreshed our Growing Perpetuity Index. Now it is v2.1 and composed of 20 companies which, in the aggregate, handily outperform our benchmarks. We find that only 3 companies have a lower “finance value” than VFINX using our method of calculating performance: 16-yr total return minus the loss incurred in the 2011 market correction (see Column 5 of the Table). Those companies are 3M (MMM), CSX Railroad, and Caterpillar (CAT). In terms of NPV, all 20 companies outperformed the benchmarks (see Column Y in the Table). Those benchmarks include VFINX, Berkshire Hathaway (BRK-A), and the SPDR MidCap 400 ETF (MDY).
Risk Rating is 6, where Treasuries = 1 and gold = 10.
Full Disclosure: I dollar-average into XOM, JNJ, MSFT, NEE, PG, and UNP. I also own shares of MCD, MMM, IBM, KO, and WMT.
NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance vs. VBINX (Vanguard Balanced Index Fund at Line 26 in the Table), which is our key benchmark.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 18
Week 224 - Growing Perpetuity Index, v2.0
Situation: We started publishing this weekly blog over 4 years ago, believing that investors can safely profit by dollar-averaging online into stocks of strong companies. To simplify matters, we defined strong companies as those in the 65-stock Dow Jones Composite Average (^DJA) with a record of increasing their dividend each year for at least the past 10 yrs. S&P calls such companies Dividend Achievers, and there are 28 in the ^DJA. We call ^DJA the “Stockpicker’s Secret Fishing Hole” because it outperforms the S&P 500 Index (^GSPC) over two or more market cycles (compare Lines 30 and 32 in Column C of the Table) but contains only 1/8th as many stocks.
Mission: For v1.0 of the Growing Perpetuity Index, we set up 4 criteria to find the highest quality companies in the ^DJA (see Week 4). Each selected company had to fit the following criteria:
a) has a dividend yield that is no less than the yield for the S&P 500 Index (VFINX);
b) is a Dividend Achiever;
c) has an S&P stock rating of A-/M or better;
d) has an S&P bond rating of BBB+ or better.
There were 14 companies that met our criteria. We wanted a Growing Perpetuity Index of no more than 12 stocks, so Southern Company (SO) and Caterpillar (CAT) were excluded from v1.0 (see Week 4).
Execution: In the 4 years since that blog was published, two additional companies have come to meet our criteria: Microsoft (MSFT) and a railroad, CSX (CSX). Now we’re setting up version 2.0 of the Growing Perpetuity Index to include all 16 qualifying companies (see Table).
Bottom Line: A perpetuity is a bond that never matures (i.e., it pays interest indefinitely). A growing perpetuity is a bond that pays more interest each year. Our Growing Perpetuity Index does that. It is a unique reference tool for retirement planning, a safe and effective tactic to have a source of income (quarterly dividend checks) that will grow faster than inflation (see Column H in the Table). Inflation has grown 2.1%/yr since the S&P 500 Index peaked on 9/1/00 (see Column C in the Table), but dividends for v2.0 of the Growing Perpetuity Index have grown ~5 times faster (see Line 18 under Column H). Looking at price appreciation over the past 20 yrs using the BMW Method, the aggregate of 16 stocks (see Line 18 under Column L) has appreciated 3 times faster than the S&P 500 Index (see Line 32 in the Table). All 16 companies have outperformed the S&P 500 Index over the past 20 yrs (see Column L in the Table). However, outperformance always comes with greater risk: The BMW Method’s analysis of price performance over the past 20 yrs predicts that the extent of loss for those 16 companies in a future bear market will be 10% greater than for the S&P 500 Index (compare Lines 18 and 32 in Column N of the Table).
Risk Rating: 4
Full Disclosure: I dollar-average into JNJ, NEE, WMT, MSFT and XOM, and also own shares of MCD, IBM, KO, UTX, and MMM.
Note: Metrics highlighted in red indicate underperformance relative to our benchmark (VBINX); metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: For v1.0 of the Growing Perpetuity Index, we set up 4 criteria to find the highest quality companies in the ^DJA (see Week 4). Each selected company had to fit the following criteria:
a) has a dividend yield that is no less than the yield for the S&P 500 Index (VFINX);
b) is a Dividend Achiever;
c) has an S&P stock rating of A-/M or better;
d) has an S&P bond rating of BBB+ or better.
There were 14 companies that met our criteria. We wanted a Growing Perpetuity Index of no more than 12 stocks, so Southern Company (SO) and Caterpillar (CAT) were excluded from v1.0 (see Week 4).
Execution: In the 4 years since that blog was published, two additional companies have come to meet our criteria: Microsoft (MSFT) and a railroad, CSX (CSX). Now we’re setting up version 2.0 of the Growing Perpetuity Index to include all 16 qualifying companies (see Table).
Bottom Line: A perpetuity is a bond that never matures (i.e., it pays interest indefinitely). A growing perpetuity is a bond that pays more interest each year. Our Growing Perpetuity Index does that. It is a unique reference tool for retirement planning, a safe and effective tactic to have a source of income (quarterly dividend checks) that will grow faster than inflation (see Column H in the Table). Inflation has grown 2.1%/yr since the S&P 500 Index peaked on 9/1/00 (see Column C in the Table), but dividends for v2.0 of the Growing Perpetuity Index have grown ~5 times faster (see Line 18 under Column H). Looking at price appreciation over the past 20 yrs using the BMW Method, the aggregate of 16 stocks (see Line 18 under Column L) has appreciated 3 times faster than the S&P 500 Index (see Line 32 in the Table). All 16 companies have outperformed the S&P 500 Index over the past 20 yrs (see Column L in the Table). However, outperformance always comes with greater risk: The BMW Method’s analysis of price performance over the past 20 yrs predicts that the extent of loss for those 16 companies in a future bear market will be 10% greater than for the S&P 500 Index (compare Lines 18 and 32 in Column N of the Table).
Risk Rating: 4
Full Disclosure: I dollar-average into JNJ, NEE, WMT, MSFT and XOM, and also own shares of MCD, IBM, KO, UTX, and MMM.
Note: Metrics highlighted in red indicate underperformance relative to our benchmark (VBINX); metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 20
Week 220 - Diversification Among Core Assets
Situation: Individual stocks are not a core asset unless you’ve created your own diversified mutual fund (i.e., 40+ stocks covering all 10 S&P Industries). The reason why individual stocks are considered a liability and not a core asset is because competition (aided by unforeseen technological advancements) can doom the prospects of any one company. There are 5 Core Assets, and your investment portfolio will need representation from some of each:
1) diversified US stock mutual funds, especially index funds like VFINX and VEXMX (see the Table).
2) Bonds, mainly US Treasuries but also intermediate-term investment-grade bond index funds like VBIIX (see the Table).
3) Commodity-related investments. The relevant index fund is a “broad basket” collateralized futures ETF composed of iShares S&P GSCI Commodity Indexed Trust (GSG in the Table).
4) Real estate. Most of us already have too much invested in real estate (i.e., the equity in our homes). The relevant REIT index fund is VGSIX in the Table.
5) Cash-equivalents such as Savings Bonds, a Savings Account at an FDIC-insured bank, a short-term Treasury fund like VFISX (see the Table) or 3-6 month Treasury Bills purchased for zero cost at treasurydirect.
Mission: Set up a reasonable asset allocation, i.e., one that has worked well for me, using index funds as examples. This allocation needs to meet the standards of an acceptable personal retirement investment fund, and it does. However, opinions vary across a large spectrum. At one extreme, we have Warren Buffett who recommends that his relatives rely on a low-cost S&P 500 Index fund for 90% of their asset allocation, with the other 10% being invested in a short-term US Treasury fund. However, most investment advisors stress the importance of balancing among the 5 Core Assets listed above. In other words, hedge your bet on stocks even though the S&P 500 is well known to have outperformed all other asset classes over all rolling 20-yr periods on record. Warren Buffett takes a dim view of hedging strategies and continues to make bets that the S&P 500 Index will outperform international indexes as well as an esteemed group of hedge funds. The main reason for you to hedge your bets is that you’re not as rich as Warren Buffett’s relatives and could be financially devastated by a crash in the S&P 500 Index (if that’s where 90% of your retirement assets reside). So, hedging is a form of insurance and you’ll be glad you have it. (I never feel bad about dollar-averaging 30% of my new investment dollars into 10-yr Treasuries and Inflation-Protected Savings Bonds.)
What lies at the other end of the spectrum of advice being offered by investment advisors? Well, if you include accountants and business school professors as “advisors” you’ll find a sizeable minority who recommend that most of your retirement savings be in US Treasury Notes and Bonds having as average of ~5 yrs remaining until maturity. You can do that yourself simply by dollar-averaging into 10-yr Treasury Notes through the zero-cost Treasury website. When I was living in New York City (while going to medical school), I had a personal accountant who made that exact recommendation when I asked for his views on asset allocation. I had great respect for him as a wise and prudent man but thought his recommendation bordered on the absurd. Then, a few years ago, I went to business school and started hearing the same view again, first from an accountant in my study group and then from a professor of Banking and Finance. Finally, I read Henry Paulson’s book about his experiences as US Treasury Secretary, titled “On the Brink.” Prior to that posting, he’d been the CEO of Goldman Sachs. In the book he mentions that his personal savings are limited to bonds. In other words, the message you’re hearing at this end of the spectrum is that bonds are backed by the assets of the institution issuing them, whereas, stocks are backed by nothing other than a faith in future earnings.
Execution: We recommend that you balance stock and fixed-income investments 50:50. Real Estate Investment Trusts (REITs) are a hybrid between stocks and bonds but (when assembled into and REIT) they’re essentially a type of bond called a “growing perpetuity” and I allocate 15% there. Cash equivalents are also bonds and I allocate 5% to those. Then I allocate 15% to intermediate-term bond index funds and 15% to Treasury bonds and notes, which brings me up to 50% allocated to fixed-income. For stocks, I allocate 30% to S&P 500 stocks (which represent 75% of the US market) and 10% to smaller capitalization stock mutual funds. Commodity-related stocks represent 10% of my portfolio, though the recent underperformance of many “long cycle” investments has caused many advisors (including me) to cut back to 5%. In summary, you now have a formula for allocating 50% to stocks and 50% to bonds or bond hybrids (see Table).
Bottom Line: Core assets are vital to your financial well being. There are 5 categories, and this week’s Table gives index fund examples using an allocation that has worked well for me. By mixing 5 core assets you create your own hedge fund, the idea being to match returns of the S&P 500 Index over time while taking on less risk of a serious loss. Note: risk-adjusted returns for index funds in the commodity-linked and smaller capitalization stock categories typically underperform actively managed mutual funds.
Risk Rating: 5
Full Disclosure: I dollar-average into 10-yr Treasury Notes, and have VFINX-like and VEXMX-like investments in my 401(k).
Note: Metrics highlighted in red denote underperformance relative to VBINX. Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
1) diversified US stock mutual funds, especially index funds like VFINX and VEXMX (see the Table).
2) Bonds, mainly US Treasuries but also intermediate-term investment-grade bond index funds like VBIIX (see the Table).
3) Commodity-related investments. The relevant index fund is a “broad basket” collateralized futures ETF composed of iShares S&P GSCI Commodity Indexed Trust (GSG in the Table).
4) Real estate. Most of us already have too much invested in real estate (i.e., the equity in our homes). The relevant REIT index fund is VGSIX in the Table.
5) Cash-equivalents such as Savings Bonds, a Savings Account at an FDIC-insured bank, a short-term Treasury fund like VFISX (see the Table) or 3-6 month Treasury Bills purchased for zero cost at treasurydirect.
Mission: Set up a reasonable asset allocation, i.e., one that has worked well for me, using index funds as examples. This allocation needs to meet the standards of an acceptable personal retirement investment fund, and it does. However, opinions vary across a large spectrum. At one extreme, we have Warren Buffett who recommends that his relatives rely on a low-cost S&P 500 Index fund for 90% of their asset allocation, with the other 10% being invested in a short-term US Treasury fund. However, most investment advisors stress the importance of balancing among the 5 Core Assets listed above. In other words, hedge your bet on stocks even though the S&P 500 is well known to have outperformed all other asset classes over all rolling 20-yr periods on record. Warren Buffett takes a dim view of hedging strategies and continues to make bets that the S&P 500 Index will outperform international indexes as well as an esteemed group of hedge funds. The main reason for you to hedge your bets is that you’re not as rich as Warren Buffett’s relatives and could be financially devastated by a crash in the S&P 500 Index (if that’s where 90% of your retirement assets reside). So, hedging is a form of insurance and you’ll be glad you have it. (I never feel bad about dollar-averaging 30% of my new investment dollars into 10-yr Treasuries and Inflation-Protected Savings Bonds.)
What lies at the other end of the spectrum of advice being offered by investment advisors? Well, if you include accountants and business school professors as “advisors” you’ll find a sizeable minority who recommend that most of your retirement savings be in US Treasury Notes and Bonds having as average of ~5 yrs remaining until maturity. You can do that yourself simply by dollar-averaging into 10-yr Treasury Notes through the zero-cost Treasury website. When I was living in New York City (while going to medical school), I had a personal accountant who made that exact recommendation when I asked for his views on asset allocation. I had great respect for him as a wise and prudent man but thought his recommendation bordered on the absurd. Then, a few years ago, I went to business school and started hearing the same view again, first from an accountant in my study group and then from a professor of Banking and Finance. Finally, I read Henry Paulson’s book about his experiences as US Treasury Secretary, titled “On the Brink.” Prior to that posting, he’d been the CEO of Goldman Sachs. In the book he mentions that his personal savings are limited to bonds. In other words, the message you’re hearing at this end of the spectrum is that bonds are backed by the assets of the institution issuing them, whereas, stocks are backed by nothing other than a faith in future earnings.
Execution: We recommend that you balance stock and fixed-income investments 50:50. Real Estate Investment Trusts (REITs) are a hybrid between stocks and bonds but (when assembled into and REIT) they’re essentially a type of bond called a “growing perpetuity” and I allocate 15% there. Cash equivalents are also bonds and I allocate 5% to those. Then I allocate 15% to intermediate-term bond index funds and 15% to Treasury bonds and notes, which brings me up to 50% allocated to fixed-income. For stocks, I allocate 30% to S&P 500 stocks (which represent 75% of the US market) and 10% to smaller capitalization stock mutual funds. Commodity-related stocks represent 10% of my portfolio, though the recent underperformance of many “long cycle” investments has caused many advisors (including me) to cut back to 5%. In summary, you now have a formula for allocating 50% to stocks and 50% to bonds or bond hybrids (see Table).
Bottom Line: Core assets are vital to your financial well being. There are 5 categories, and this week’s Table gives index fund examples using an allocation that has worked well for me. By mixing 5 core assets you create your own hedge fund, the idea being to match returns of the S&P 500 Index over time while taking on less risk of a serious loss. Note: risk-adjusted returns for index funds in the commodity-linked and smaller capitalization stock categories typically underperform actively managed mutual funds.
Risk Rating: 5
Full Disclosure: I dollar-average into 10-yr Treasury Notes, and have VFINX-like and VEXMX-like investments in my 401(k).
Note: Metrics highlighted in red denote underperformance relative to VBINX. Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 5
Week 196 - Stockpicker's Secret Fishing Hole: 20-yr Returns
Situation: We started this blog 4 years ago because we saw an inconsistency in the way people plan for retirement. The same inconsistency affects the way most investors buy stocks. They’re looking for exotic investments, often in foreign and small-cap companies (or mutual funds that target such companies). Why? Because the S&P 500 Index has imploded twice on them since 2000. So, they choose to ignore the 800 pound gorilla in the room (large, well-established US companies), particularly the boring companies like utilities and transports. In other words, they ignore the very companies that make up the 65-stock Dow Jones Composite Average (DJCA). This makes no sense, given that the DJCA outperforms the S&P 500 Index long-term, and does so with less volatility. So, we started our blog with the Growing Perpetuity Index (stocks in the DJCA that are Dividend Achievers) and have highlighted the DJCA by calling it the Stockpicker’s Secret Fishing Hole (see Week 68).
But we’ve never made a comprehensive assessment of all 65 companies. This week’s blog tries to do that. Eight of the companies have been excluded because they are either too small to be in the Barron’s 500 List or don’t have total return records extending out to 20 yrs; 21 more were excluded because of being unsuitable for retirement portfolios (i.e., they had an S&P credit rating less than BBB+ and/or an S&P stock rating less than B+/M). Three of the remaining 36 were excluded because of having greater price volatility (variance) than the S&P 500 Index over the past 20 yrs.
Not surprisingly, the 33 companies in this week’s Table have outperformed the DJCA over the past 20 yrs (compare Line 35 to Line 44 in the Table under Column C). And, the DJCA had a 20-yr total return that beat the S&P 500 Index by more than 10% (compare Line 44 to Line 45). The problem is that you’ve heard of many of those 33 companies and often use their products. So, there’s nothing mysterious or exotic about investing in those companies; none are the “diamond in the rough” you can talk up at cocktail parties. Your stockbroker understands human nature, so she won’t be talking up those names either.
Let’s go down the list and see which stocks have outperformed the S&P 500 Index over both the past 5 and 20 yr periods. There’s JB Hunt Transport Services (the most commonly encountered trucks on the interstate), NextEra Energy (you know wind and solar power are growth industries but maybe you didn’t know NextEra is the leader), Nike (no one can be surprised by its continuing outperformance), and Travelers (any insurance company that knows how to price risk is a good investment). There’s 3M and the 3 railroads (Union Pacific, Norfolk Southern, and CSX), as well as Walt Disney and Home Depot. (You probably aren’t surprised to learn that all 6 of those are perennial money-makers.) UnitedHealth Group is the leading purveyor of health insurance (maybe you didn’t know that). Boeing and American Express round out the list of companies you already expected to continue raking in the cash. I had a stockbroker who didn’t mention any of those companies to me in over 30 years, although he did recommend others on the list: United Technologies, Cisco Systems, Intel, Caterpillar, ExxonMobil and Johnson & Johnson.
Bottom Line: You have little time to research stocks, so focus your attention on a shorter list than the S&P 500. Try the 65-stock Dow Jones Composite Average (DJCA), which also happens to outperform the S&P 500 over the long term. All 65 stocks are picked by a committee headed by the Managing Editor of the Wall Street Journal. We’ve trimmed the list down to 33 that can fit into a retirement portfolio. Take particular note of the 19 that are S&P Dividend Achievers (i.e., companies that have increased their dividends annually for at least the past 10 yrs). Eleven of those have a Finance Value (see Column E in the Table) that beats the Finance Value for our key benchmark, VBINX, which is the Vanguard Balanced Index Fund: WMT, MCD, ED, SO, NEE, NKE, IBM, JNJ, KO, XOM, CVX. Inflation has been 2.1%/yr over the past 20 years, and the average 20-yr dividend growth rate of those 11 stocks has been 11.6%/yr (see Column H in the Table). If your retirement portfolio were to contain equal dollar amounts in each of those 11 stocks, your dividend checks would be growing 9-10% faster than inflation, every year. Think about it.
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, XOM, MSFT, NEE, NKE, and JPM.
NOTE: Red highlights in the table denote underperformance vs. our key benchmark, VBINX. Values in the table are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
But we’ve never made a comprehensive assessment of all 65 companies. This week’s blog tries to do that. Eight of the companies have been excluded because they are either too small to be in the Barron’s 500 List or don’t have total return records extending out to 20 yrs; 21 more were excluded because of being unsuitable for retirement portfolios (i.e., they had an S&P credit rating less than BBB+ and/or an S&P stock rating less than B+/M). Three of the remaining 36 were excluded because of having greater price volatility (variance) than the S&P 500 Index over the past 20 yrs.
Not surprisingly, the 33 companies in this week’s Table have outperformed the DJCA over the past 20 yrs (compare Line 35 to Line 44 in the Table under Column C). And, the DJCA had a 20-yr total return that beat the S&P 500 Index by more than 10% (compare Line 44 to Line 45). The problem is that you’ve heard of many of those 33 companies and often use their products. So, there’s nothing mysterious or exotic about investing in those companies; none are the “diamond in the rough” you can talk up at cocktail parties. Your stockbroker understands human nature, so she won’t be talking up those names either.
Let’s go down the list and see which stocks have outperformed the S&P 500 Index over both the past 5 and 20 yr periods. There’s JB Hunt Transport Services (the most commonly encountered trucks on the interstate), NextEra Energy (you know wind and solar power are growth industries but maybe you didn’t know NextEra is the leader), Nike (no one can be surprised by its continuing outperformance), and Travelers (any insurance company that knows how to price risk is a good investment). There’s 3M and the 3 railroads (Union Pacific, Norfolk Southern, and CSX), as well as Walt Disney and Home Depot. (You probably aren’t surprised to learn that all 6 of those are perennial money-makers.) UnitedHealth Group is the leading purveyor of health insurance (maybe you didn’t know that). Boeing and American Express round out the list of companies you already expected to continue raking in the cash. I had a stockbroker who didn’t mention any of those companies to me in over 30 years, although he did recommend others on the list: United Technologies, Cisco Systems, Intel, Caterpillar, ExxonMobil and Johnson & Johnson.
Bottom Line: You have little time to research stocks, so focus your attention on a shorter list than the S&P 500. Try the 65-stock Dow Jones Composite Average (DJCA), which also happens to outperform the S&P 500 over the long term. All 65 stocks are picked by a committee headed by the Managing Editor of the Wall Street Journal. We’ve trimmed the list down to 33 that can fit into a retirement portfolio. Take particular note of the 19 that are S&P Dividend Achievers (i.e., companies that have increased their dividends annually for at least the past 10 yrs). Eleven of those have a Finance Value (see Column E in the Table) that beats the Finance Value for our key benchmark, VBINX, which is the Vanguard Balanced Index Fund: WMT, MCD, ED, SO, NEE, NKE, IBM, JNJ, KO, XOM, CVX. Inflation has been 2.1%/yr over the past 20 years, and the average 20-yr dividend growth rate of those 11 stocks has been 11.6%/yr (see Column H in the Table). If your retirement portfolio were to contain equal dollar amounts in each of those 11 stocks, your dividend checks would be growing 9-10% faster than inflation, every year. Think about it.
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, XOM, MSFT, NEE, NKE, and JPM.
NOTE: Red highlights in the table denote underperformance vs. our key benchmark, VBINX. Values in the table are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 5
Week 170 - Growing Perpetuity Index (UPDATED)
Situation: Our blog (Invest Tune Retire) grew from the idea that owning “buy-and-hold” stocks only makes sense if you a) plan on using dividends from those stocks to supplement your retirement income, and b) pick the right stocks. The goal is to receive dividend checks during retirement that grow faster than inflation (see Column H in our Table). We began writing our blog using an unchanging index of a dozen stocks that would bring this idea into focus. To have a catchy name for that index, we borrowed a finance term that is used to describe a rare type of bond that pays out more interest year after year, called a growing perpetuity.
To pick stocks for our Growing Perpetuity Index (see Week 4), we turned to the Dow Jones Composite Index of 65 stocks, which includes the 30-stock Dow Jones Industrial Average (DJIA), the 20-stock Dow Jones Transportation Average and the 15-stock Dow Jones Utility Average. To qualify, stocks were required to:
1) have a dividend yield no less than that for the exchange-traded fund (ETF) that mimics the S&P 500 Index (SPY);
2) be an S&P “Dividend Achiever” with 10+ years of annual dividend increases;
3) have an S&P stock rating of A- or better;
4) have an S&P bond rating of BBB+ or better.
We turned up 14 stocks but chose to limit our list to 12. Two utilities qualified, NextEra Energy (NEE) and Southern Company (SO), but we decided to include only one. We kept NEE because it is the dominant player in renewable energy (wind and solar). One transportation stock qualified, Norfolk Southern (NSC). There were 11 that qualified from the DJIA, so we needed to exclude one. Caterpillar (CAT) was excluded because the company had not raised the dividend for 24 months during the Great Recession, even though S&P still granted it Dividend Achiever status. After more than 3 yrs, the same 14 are the only companies that continue to qualify. Red highlights in the Table denote underperformance relative to our benchmark, Vanguard Balanced Index Fund (VBINX). For comparison purposes, the Table includes a section for stocks in the Barron’s 500 List that meet our criteria but aren’t in the Growing Perpetuity Index.
Bottom Line: It is not easy to identify high quality, buy-and-hold stocks that pay good and growing dividends. The 65-stock Dow Jones Composite Index has 14 such stocks by our criteria, the same number as in July of 2011 (see Week 4). We use 12 of those stocks to make up our Growing Perpetuity Index (see Table) but there are 28 more in the Barron’s 500 List that meet our criteria, including Microsoft which becomes a Dividend Achiever later this year. In both the list of 12 Growing Perpetuity Index stocks and the list of 28 similar stocks, the majority are S&P Dividend Aristocrats (see Column P in the Table), meaning that there has been a dividend increase approximately every year for at least the past 25 yrs. That’s the best sign that you’ve picked the right stock for your retirement portfolio (see Week 146).
Risk Rating for the Growing Perpetuity Index: 4
Full Disclosure: I dollar-average into XOM, WMT, JNJ, MSFT, ABT, PG, and NEE.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
To pick stocks for our Growing Perpetuity Index (see Week 4), we turned to the Dow Jones Composite Index of 65 stocks, which includes the 30-stock Dow Jones Industrial Average (DJIA), the 20-stock Dow Jones Transportation Average and the 15-stock Dow Jones Utility Average. To qualify, stocks were required to:
1) have a dividend yield no less than that for the exchange-traded fund (ETF) that mimics the S&P 500 Index (SPY);
2) be an S&P “Dividend Achiever” with 10+ years of annual dividend increases;
3) have an S&P stock rating of A- or better;
4) have an S&P bond rating of BBB+ or better.
We turned up 14 stocks but chose to limit our list to 12. Two utilities qualified, NextEra Energy (NEE) and Southern Company (SO), but we decided to include only one. We kept NEE because it is the dominant player in renewable energy (wind and solar). One transportation stock qualified, Norfolk Southern (NSC). There were 11 that qualified from the DJIA, so we needed to exclude one. Caterpillar (CAT) was excluded because the company had not raised the dividend for 24 months during the Great Recession, even though S&P still granted it Dividend Achiever status. After more than 3 yrs, the same 14 are the only companies that continue to qualify. Red highlights in the Table denote underperformance relative to our benchmark, Vanguard Balanced Index Fund (VBINX). For comparison purposes, the Table includes a section for stocks in the Barron’s 500 List that meet our criteria but aren’t in the Growing Perpetuity Index.
Bottom Line: It is not easy to identify high quality, buy-and-hold stocks that pay good and growing dividends. The 65-stock Dow Jones Composite Index has 14 such stocks by our criteria, the same number as in July of 2011 (see Week 4). We use 12 of those stocks to make up our Growing Perpetuity Index (see Table) but there are 28 more in the Barron’s 500 List that meet our criteria, including Microsoft which becomes a Dividend Achiever later this year. In both the list of 12 Growing Perpetuity Index stocks and the list of 28 similar stocks, the majority are S&P Dividend Aristocrats (see Column P in the Table), meaning that there has been a dividend increase approximately every year for at least the past 25 yrs. That’s the best sign that you’ve picked the right stock for your retirement portfolio (see Week 146).
Risk Rating for the Growing Perpetuity Index: 4
Full Disclosure: I dollar-average into XOM, WMT, JNJ, MSFT, ABT, PG, and NEE.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 9
Week 136 - How to Invest in the Growing Perpetuity Index
Situation: What is new that can we say about our Growing Perpetuity Index (see Week 118, Week 80, Week 66, Week 32, Week 4)? For one thing, we can explain those 12 companies came out of the Stockpicker’s Secret Fishing Hole (Week 68, Week 29), our name for the Dow Jones Composite Index of 65 stocks. Those are mainly “old line” companies that build things, move things, and provide electricity although some trendy companies (Nike, Visa, and Walt Disney) were recently added to better reflect the post-industrial economy. Still, Warren Buffett looks first to invest in old line companies that are well-established and have a wide moat to fend off copycats, e.g. his two largest purchases for Berkshire Hathaway in recent years were MidAmerican Energy Holdings and Burlington Northern Santa Fe. For another thing, we can explain how you might invest in the 12 stocks of the Growing Perpetuity Index while keeping costs under 1%.
When we started the ITR blog 3 years ago, we looked at the 65 companies in the Dow Jones Composite Index and cut that list down to those that were Dividend Achievers--Standard & Poor’s name for companies that have raised dividends for 10+ years in a row. Then we picked companies with a market capitalization greater than $10B that paid at least a 2% dividend and increased it at least 7%/yr. We called that list of 12 stocks our Growing Perpetuity Index because the companies posed no material risk of a) bankruptcy individually, or b) failing to raise dividends at least 9%/yr collectively. For a retired person who depends on quarterly dividend checks for much of her support, those are the main concerns.
Looking at the list (see Table), we see 6 hedge stocks (see Week 126): JNJ, WMT, PG, KO, MCD, NEE. Those carry so little risk of crashing during a recession that they don’t need to be backed 1:1 with 10-yr Treasury Notes. To have an investment plan for the Growing Perpetuity Index, 18 items need to be listed (bottom of Table): 6 hedge stocks, 6 risky stocks, and 6 T-Notes to back the risky stocks. There are dividend reinvestment plans (DRIPs) for all 12 stocks; 10 through computershare; NSC is purchased through American Stock Transfer & Trust Company and MMM is purchased through Wells Fargo. The ongoing cost for these 12 plans comes to $11/mo (Column N in the Table). Treasury Notes cannot be set up for automatic purchase or dividend (interest) reinvestment; you’ll need to enter the site treasurydirect.gov each month or quarter to buy your T-notes (either the inflation-protected or standard version) and reinvest accumulated interest into Savings Bonds (either the inflation-protected or standard version). The Table has an example of investing $1800/mo ($100 per item) that carries far less risk than our benchmark (VBINX): losses during the 18-month Lehman Panic came to 8.2% for our plan vs. 28% for VBINX; the 5-yr Beta for our plan is 0.47 vs. 0.93 for VBINX. Long-term total returns for our plan (Column C) are slightly greater than for VBINX after subtracting 0.6% for the transaction costs of our plan, i.e., the “expense ratio” of $11/mo in transaction costs divided by $1800/mo invested = 0.61%. If you cut the monthly investment for each item from $100 to $50, the expense ratio is doubled (1.2%) and VBINX would come out ahead.
Bottom Line: You can invest in the Growing Perpetuity Index online (using appropriate hedges) and get the same rewards as you would by investing in our benchmark (VBINX) while exposing yourself to much less risk of loss in a recession. Safety needs to be your watchword now that we all know how fast a 401(k) plan can turn into a “201(k)” plan.
Risk Rating: 3
Full Disclosure: I dollar-average monthly into DRIPs for WMT, KO, PG, JNJ, NEE, IBM, and XOM, and hedge expenditures for IBM and XOM with equal expenditures for 10-yr Treasury Notes.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
When we started the ITR blog 3 years ago, we looked at the 65 companies in the Dow Jones Composite Index and cut that list down to those that were Dividend Achievers--Standard & Poor’s name for companies that have raised dividends for 10+ years in a row. Then we picked companies with a market capitalization greater than $10B that paid at least a 2% dividend and increased it at least 7%/yr. We called that list of 12 stocks our Growing Perpetuity Index because the companies posed no material risk of a) bankruptcy individually, or b) failing to raise dividends at least 9%/yr collectively. For a retired person who depends on quarterly dividend checks for much of her support, those are the main concerns.
Looking at the list (see Table), we see 6 hedge stocks (see Week 126): JNJ, WMT, PG, KO, MCD, NEE. Those carry so little risk of crashing during a recession that they don’t need to be backed 1:1 with 10-yr Treasury Notes. To have an investment plan for the Growing Perpetuity Index, 18 items need to be listed (bottom of Table): 6 hedge stocks, 6 risky stocks, and 6 T-Notes to back the risky stocks. There are dividend reinvestment plans (DRIPs) for all 12 stocks; 10 through computershare; NSC is purchased through American Stock Transfer & Trust Company and MMM is purchased through Wells Fargo. The ongoing cost for these 12 plans comes to $11/mo (Column N in the Table). Treasury Notes cannot be set up for automatic purchase or dividend (interest) reinvestment; you’ll need to enter the site treasurydirect.gov each month or quarter to buy your T-notes (either the inflation-protected or standard version) and reinvest accumulated interest into Savings Bonds (either the inflation-protected or standard version). The Table has an example of investing $1800/mo ($100 per item) that carries far less risk than our benchmark (VBINX): losses during the 18-month Lehman Panic came to 8.2% for our plan vs. 28% for VBINX; the 5-yr Beta for our plan is 0.47 vs. 0.93 for VBINX. Long-term total returns for our plan (Column C) are slightly greater than for VBINX after subtracting 0.6% for the transaction costs of our plan, i.e., the “expense ratio” of $11/mo in transaction costs divided by $1800/mo invested = 0.61%. If you cut the monthly investment for each item from $100 to $50, the expense ratio is doubled (1.2%) and VBINX would come out ahead.
Bottom Line: You can invest in the Growing Perpetuity Index online (using appropriate hedges) and get the same rewards as you would by investing in our benchmark (VBINX) while exposing yourself to much less risk of loss in a recession. Safety needs to be your watchword now that we all know how fast a 401(k) plan can turn into a “201(k)” plan.
Risk Rating: 3
Full Disclosure: I dollar-average monthly into DRIPs for WMT, KO, PG, JNJ, NEE, IBM, and XOM, and hedge expenditures for IBM and XOM with equal expenditures for 10-yr Treasury Notes.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 6
Week 118 - Growing Perpetuity Index (Updated)
Situation: In one of our first blogs (see Week 4), we created the Growing Perpetuity Index (GPI). Our reason for doing so was because we needed a benchmark fund for comparison, one that embodies our investment theme. We have continued to follow the companies that were selected for the GPI and Total Returns were updated in Week 66. Since then, we have set a standard benchmark for use in comparison for all of the metrics used in our Tables, and that is the Vanguard Balanced Index Fund (VBINX) In the VBINX, 60% is allocated to a large-capitalization stock index and 40% to an investment-grade bond index. Its lowest value point occurred during the “dot.com” recession (10/9/02). For this week’s blog, we’ll use that date to calculate long-term total returns (Column C of the Table). Data are current through 10/4/13.
The Growing Perpetuity Index is composed of 12 companies that are listed in the 65-stock Dow Jones Composite Average (DJCA) and meet the following 4 criteria:
a) dividend yield no less than the yield on the lowest-cost mutual fund that mimics the S&P 500 Index--the Vanguard 500 Index Fund (VFINX);
b) 10 or more consecutive years of annual dividend increases;
c) S&P stock rating of A- or better;
d) S&P bond rating of BBB+ or better.
After analysis, we found there were 15 such companies, and we chose 12 for our Growing Perpetuity Index. Those 12 companies are listed at the top of the accompanying Table, ranked in order of Finance Value (long-term reward minus risk in Column E). That composition of companies will remain stable as a feature of our blog, even if one or more companies leave the DJCA. The 3 companies that we’ve left out (in order to limit the index to 12 companies) are Southern Company (SO), CH Robinson Worldwide (CHRW) and Caterpillar (CAT). Complete data for those companies is shown in the BENCHMARKS section at the bottom of the Table. We have also included data for Microsoft (MSFT) and Union Pacific (UNP) because these companies will soon meet GPI criteria.
Bottom Line: This 12 stock index has a remarkable history of outperformance, which was a key reason why we started this blog in the first place. Strong and stable companies that have multiple sources of income and clean balance sheets are simply in a better position to reward investors with annual dividend increases and stock buybacks.
Worried about your savings plan for retirement? History shows that you can set up 12 dividend reinvestment plans (DRIPs) to support equal and automatic monthly additions to each of these stocks then get on with your life. The chance that this portfolio won’t outperform the S&P 500 Index over rolling 5-yr periods is less than 50:50. AND it does so with less volatility (i.e., the index has a 5-yr Beta of 0.7 vs. the S&P 500 Index’s 1.00). AND it pays a higher dividend (2.5% vs. 1.9%).
Risk Rating: 4
Full Disclosure: I add to DRIPs in WMT, JNJ, KO, PG, NEE, IBM, and XOM each month.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The Growing Perpetuity Index is composed of 12 companies that are listed in the 65-stock Dow Jones Composite Average (DJCA) and meet the following 4 criteria:
a) dividend yield no less than the yield on the lowest-cost mutual fund that mimics the S&P 500 Index--the Vanguard 500 Index Fund (VFINX);
b) 10 or more consecutive years of annual dividend increases;
c) S&P stock rating of A- or better;
d) S&P bond rating of BBB+ or better.
After analysis, we found there were 15 such companies, and we chose 12 for our Growing Perpetuity Index. Those 12 companies are listed at the top of the accompanying Table, ranked in order of Finance Value (long-term reward minus risk in Column E). That composition of companies will remain stable as a feature of our blog, even if one or more companies leave the DJCA. The 3 companies that we’ve left out (in order to limit the index to 12 companies) are Southern Company (SO), CH Robinson Worldwide (CHRW) and Caterpillar (CAT). Complete data for those companies is shown in the BENCHMARKS section at the bottom of the Table. We have also included data for Microsoft (MSFT) and Union Pacific (UNP) because these companies will soon meet GPI criteria.
Bottom Line: This 12 stock index has a remarkable history of outperformance, which was a key reason why we started this blog in the first place. Strong and stable companies that have multiple sources of income and clean balance sheets are simply in a better position to reward investors with annual dividend increases and stock buybacks.
Worried about your savings plan for retirement? History shows that you can set up 12 dividend reinvestment plans (DRIPs) to support equal and automatic monthly additions to each of these stocks then get on with your life. The chance that this portfolio won’t outperform the S&P 500 Index over rolling 5-yr periods is less than 50:50. AND it does so with less volatility (i.e., the index has a 5-yr Beta of 0.7 vs. the S&P 500 Index’s 1.00). AND it pays a higher dividend (2.5% vs. 1.9%).
Risk Rating: 4
Full Disclosure: I add to DRIPs in WMT, JNJ, KO, PG, NEE, IBM, and XOM each month.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 13
Week 80 - 2012 Total Return for the Growing Perpetuity Index
Situation: The US economy has improved but only enough for job growth to keep up with population growth. The stock market, on the other hand, is pointing to the likelihood that the rate of economic expansion (GDP) will soon double to more than 3%/yr. We’re in a bull market, which we define as the S&P 500 Index outperforming the “blue-chip” 65-stock Dow Jones Composite Index. During 2012, there was a wide gap between the two with the S&P 500 Index gaining 13% vs. 5% for the Dow Jones Composite Index. Those are price-only indices so dividends, which are ~30% greater for the blue-chip index, aren’t counted. Therein lies the problem! Fear of going over the “fiscal cliff” had investors pulling money out of stocks that pay good dividends. Those dividends would have been taxed approximately twice as much had we gone over the cliff. We didn’t and are predicting that 2013 will see a renewed interest in dividend-paying stocks.
It’s time to update our previously published Growing Perpetuity Index (GPI, see Week 66). The 12 companies in our GPI are the bluest of blue-chips, and had an average Total Return of only 3.8% (Table). For 5 and 10 yr periods, the GPI handily outperformed the S&P 500 Index, as well as the Vanguard Dividend Growth Fund, a more appropriate benchmark for the GPI (Table). We have separated those 12 stocks into two groups, 7 that are low risk and 5 that are high risk.
Warren Buffett has stated on several occasions that stocks having a 5-yr Beta greater than 0.7 are best avoided. And the better hedge funds generally have 5-yr betas of less than 0.7. Indeed, at the May 2012 annual meeting of Berkshire Hathaway, Mr. Buffett indicated that a group of 5 above-average hedge funds lost 35% less than the S&P 500 Index during the Lehman Panic (Week 46). In other words, those hedge funds had a 5-yr Beta of less than 0.65. That is why we have recently started breaking our blog tables into two groups: an upper group that lost less than 65% as much as the S&P 500 Index during the Lehman Panic and had a 5-yr Beta less than 0.65, vs. a lower group that doesn’t meet that standard (see Week 78).
Our GPI has 7 such companies in the top group (Table): Wal*Mart (WMT), McDonald’s (MCD), NextEra Energy (NEE), IBM (IBM), Johnson & Johnson (JNJ), Coca-Cola (KO) and Procter & Gamble (PG). Those 7 had an average total return of 8% in 2012. More importantly, the aggregate data for those 7 stocks (line 9 of the Table) is impressive. Only two other A-rated dividend-paying stocks in the S&P 500 Index can come close to matching that data set, namely, Darden Restaurants (DRI) and General Mills (GIS). Darden Restaurants’ credit rating is too low to warrant inclusion in our Master List (Week 78) and General Mills has only raised its dividend for 6 consecutive yrs, instead of the 10 required for inclusion in the Master List. A recent hit movie (“Moneyball” based on the 2003 book of the same name by Michael Lewis) dwelt on this point by showing that a baseball team composed of players that individually had a low market value could outperform richer teams if those players collectively had a high on-base percentage. This concept came earlier to the investment world, in the early 1980s, when Michael Milken showed that “fallen angels” (corporate bonds that had slipped below an investment-grade rating) could give good results if, as a group, key ratios were at an investment grade level.
The point here is that every company’s competitive advantage is a work in progress. Some years the pieces fall together nicely but other years see a potent competitor taking market share. Only by holding a number of well-chosen stocks can you pull ahead of the pack.
Bottom Line: If you’re within 15 yrs of retirement, confine your stock-picking to tickers with a 5 yr Beta of less than 0.65 that lost less than 65% as much as the S&P 500 Index during the Lehman Panic.
Risk Rating: 3.
It’s time to update our previously published Growing Perpetuity Index (GPI, see Week 66). The 12 companies in our GPI are the bluest of blue-chips, and had an average Total Return of only 3.8% (Table). For 5 and 10 yr periods, the GPI handily outperformed the S&P 500 Index, as well as the Vanguard Dividend Growth Fund, a more appropriate benchmark for the GPI (Table). We have separated those 12 stocks into two groups, 7 that are low risk and 5 that are high risk.
Warren Buffett has stated on several occasions that stocks having a 5-yr Beta greater than 0.7 are best avoided. And the better hedge funds generally have 5-yr betas of less than 0.7. Indeed, at the May 2012 annual meeting of Berkshire Hathaway, Mr. Buffett indicated that a group of 5 above-average hedge funds lost 35% less than the S&P 500 Index during the Lehman Panic (Week 46). In other words, those hedge funds had a 5-yr Beta of less than 0.65. That is why we have recently started breaking our blog tables into two groups: an upper group that lost less than 65% as much as the S&P 500 Index during the Lehman Panic and had a 5-yr Beta less than 0.65, vs. a lower group that doesn’t meet that standard (see Week 78).
Our GPI has 7 such companies in the top group (Table): Wal*Mart (WMT), McDonald’s (MCD), NextEra Energy (NEE), IBM (IBM), Johnson & Johnson (JNJ), Coca-Cola (KO) and Procter & Gamble (PG). Those 7 had an average total return of 8% in 2012. More importantly, the aggregate data for those 7 stocks (line 9 of the Table) is impressive. Only two other A-rated dividend-paying stocks in the S&P 500 Index can come close to matching that data set, namely, Darden Restaurants (DRI) and General Mills (GIS). Darden Restaurants’ credit rating is too low to warrant inclusion in our Master List (Week 78) and General Mills has only raised its dividend for 6 consecutive yrs, instead of the 10 required for inclusion in the Master List. A recent hit movie (“Moneyball” based on the 2003 book of the same name by Michael Lewis) dwelt on this point by showing that a baseball team composed of players that individually had a low market value could outperform richer teams if those players collectively had a high on-base percentage. This concept came earlier to the investment world, in the early 1980s, when Michael Milken showed that “fallen angels” (corporate bonds that had slipped below an investment-grade rating) could give good results if, as a group, key ratios were at an investment grade level.
The point here is that every company’s competitive advantage is a work in progress. Some years the pieces fall together nicely but other years see a potent competitor taking market share. Only by holding a number of well-chosen stocks can you pull ahead of the pack.
Bottom Line: If you’re within 15 yrs of retirement, confine your stock-picking to tickers with a 5 yr Beta of less than 0.65 that lost less than 65% as much as the S&P 500 Index during the Lehman Panic.
Risk Rating: 3.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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