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

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

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

Execution: see Table.

Administration: A-rated stocks are those that have:

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

            b) positive Book Value, 

            c) positive earnings (TTM), 

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

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

            f) a 20+ year trading history. 

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

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

Full Disclosure: I dollar-average into MRK, PFE and INTC, and also own shares of TGT and CMCSA. 

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

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

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

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

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

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

     Microsoft (MSFT), 

     Apple (AAPL), 

     Nike (NKE), 

     Coca-Cola (KO) and 

     Procter & Gamble (PG). 

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

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

Execution: see Table.

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

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

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

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

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

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

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

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

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

Execution: (see Table).

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

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

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

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

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

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Week 332 - Defensive Companies in “The 2 and 8 Club”

Situation: The Dow Jones Industrial Average keeps making new highs, “confirmed” by new highs in the Dow Jones Transportation Average. According to Dow Theory, we are in a “primary” Bull Market. That is a period when investors should be paying off their debts and/or building up cash reserves. It is also a period when stocks in “growth” companies become overpriced, and stocks in “defensive” companies become reasonably priced (after having been overpriced). It’s a good time to research high-quality companies in “defensive” industries: Consumer Staples, Health Care, Utilities, and Communication Services. 

Mission: Develop our standard spreadsheet for companies in “The 2 and 8 Club” (see Week 327) that are in defensive industries (see Week 327), and add any companies that are close to qualifying.

Execution: (see Table)

Administration: We’ll use the Extended Version of “The 2 and 8 Club”, which simply matches companies on two lists: The Barron’s 500 List and the 400+ companies in the FTSE High Dividend Yield Index. The Barron’s 500 List is published annually in May, and ranks companies by their 1 & 3 year Cash Flows from Operations, as well as their past year’s Revenues. The FTSE High Dividend Yield Index lists US companies that pay more than a market yield (~2%) and are thought unlikely to reduce dividends during a Bear Market. Companies that appear on both lists but do not have a 5-Yr Compound Annual Growth Rate (CAGR) of at least 8% for their quarterly dividend payout are excluded, as are any companies that carry an S&P Rating lower than A- for their bonds or lower than B+/M for their stocks.

Note the inclusion of Costco Wholesale (COST) at Line 4 in the Table. Although it has an annual yield lower than the required 2% for its quarterly dividend, the company has also issued a supplementary dividend every other year for the past 5 years. In those years, the dividend yield exceeds 5%. In calculating Net Present Value (see Column Y in the Table), we have used adjusted values for Dividend Yield (5.4%) and 5-Yr Dividend Growth (2.1%) in an effort to present an assessment closer to reality. That boosts NPV 42% over what it would be had supplemental dividends been ignored.

Note the inclusion of Coca-Cola (KO) at Line 9 in the Table. Although it has a 5-year dividend CAGR of 7.7%, which is slightly lower than our 8% cut-off, KO is a “mega-capitalized” company that has a major influence on prospects for the Consumer Staples industry.  

Bottom Line: Experienced stock-pickers can usually look forward to a decent night’s sleep, if experience has taught them to overweight their portfolio in high-quality “defensive” stocks that pay a good and growing dividend. By restricting our Watch List to companies in “The 2 and 8 Club”, we’ve found that there are only 10 defensive stocks you need to consider during this opportune time, i.e, when valuations are lower for “defensive” stocks because “growth” stocks become the overcrowded trade in a primary Bull Market.

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

Full Disclosure: I dollar-cost average into KO and NEE, and also own shares of COST, AMGN, MO, and HRL.

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

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Week 326 - Investing for Income

Situation: Bonds or stocks? Which will give you a larger monthly check without disrupting your sleep? For stocks, the standard would be SPDR Dow Jones Industrial Average ETF (DIA), yielding 2.2%. For bonds, the standard would be iShares 20+ Year Treasury Bond ETF (TLT), yielding 2.5%. So far, so good. But what if you want more income than those “plain vanilla” options provide? For example, a bond index fund that wouldn’t be hit for a big loss if inflation were to spike upward? Then you would want to be an investment-grade intermediate-term index fund like the Vanguard Interm-Term Bond Fund (BIV). If you’re a stock-picker and want more yield, you’ll need to start with a close look at the 400+ stocks in the Russell 1000 Index that yield more than a market average 2%. There’s an exchange-traded index fund (ETF) that holds positions in all such stocks: The Vanguard High Dividend Yield ETF (VYM). Our Table for this week pulls out 8 Dividend Achievers that we think do the job. But remember, you’d have to hold positions in all 8 to minimize selection bias. Then, you’d have an investment that yields ~2.7% and is likely to grow those dividends ~9%/yr.

Mission: Find A-rated Dividend Achievers with a higher yield than DIA, a clean Balance Sheet, and less volatility over the past 20 years than the S&P 500 Index. 

Execution: We find 8 companies in the Russell 1000 Index that meet those criteria, except for minor Balance Sheet issues (see Table).

Bottom Line: Low-risk investments that yield more than 3% have almost disappeared. We find only two: WEC Energy Group (WEC) and Procter & Gamble (PG). Of course, there are some companies and government agencies that issue bonds paying a higher interest rate, but you’d have to invest $25,000 in each to avoid paying high up-front transaction costs. And, you’d need to have positions in several such bonds to minimize selection bias.  

Risk Rating: 3 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, gold = 10)

Full Disclosure: For equities, I dollar-average into NEE, PG and JNJ, and also own shares of TRV, WMT and MMM. For bonds, I own shares of BIV.

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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.

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Week 317 - 2017 Barron’s 500 List: A-rated “Growth” Companies That Moved Up In Rank During The Commodity Recession

Situation: If you’re a stock-picker, your job description and mission is to beat the lowest-cost S&P 500 Index ETF (SPY) by ~3%/yr over 5 years. Why? To overcome the frictional costs of do-it-yourself investing, mainly transaction costs and erratic capital gains taxes. In last week’s blog, we highlighted hedging, i.e., over-weighting “defensive” stocks. This week we highlight growth, i.e., picking stocks that grow fast enough to compensate for the drag created by defensive stocks. You should do fine most years, if you invest in 15-20 companies from each category, follow their quarterly reports, and track industry trends. You’ll have to trade often, so find a way to keep trading costs down (~1% of Net Asset Value). 

Commodities anchor the economy, so the recent Commodity Recession (7/14-7/16) made it easy to see which companies are efficient, i.e., their “cash-flow-based return on investment” grew during that period. The Barron’s 500 List ranks companies by tracking that growth over the most recent 3 years.

Mission: Identify companies that moved up in rank last year. 

Execution: Eliminate companies that do not have S&P bond ratings of A- (or better) and S&P stock ratings of A-/M (or better). In the Table, emphasize Balance Sheet metrics (see Columns P-S). In the evaluation of Net Present Value (Columns V-Z), use a Discount Rate of 9%/yr and a Holding Period of 10 years. Assume that the investor pays the average transaction cost when buying or selling stock (2.5%). Highlight potential money-losing issues in purple.

Administration: This is where you come into the picture. You need to assemble information and make a choice. The Table has only 27 Columns of metrics, but it’s a start. Column Z (NPV) is a convenient summary of the combined effects of the current dividend, its rate of growth (using the past 4 years), and the approximate capital gain that would be realized upon selling the stock ten years from now (which is arrived at by extrapolating the 16-Yr CAGR in Column K). That NPV estimate is only as good as management’s ability to build the company’s Brand while maintaining a clean Balance Sheet. 

Bottom Line: The list has the names of only 9 companies. You’ll need to invest in more than 50 growth companies (to avoid Selection Bias). But these 9 are about as problem-free as any you’ll find. Why is it so difficult to identify reliably growing companies? Because growth never lasts. It has a beginning, a middle, and an end--when sales grow only as fast as the population in the company’s “catchment area.” Competition and innovation are huge factors. One cancels out the other over time.

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

Full Disclosure: I own shares of TJX.

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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.

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Week 314 - High-quality Dividend Achievers That Beat The S&P 500 For 25 Years With Less Risk

Situation: See last week’s blog (Week 314 - High-quality Dividend Achievers That Beat The S&P 500 For 25 Years With Less Risk). 

To “buy-and-hold” a stock, we want the underlying company to have a long record of stable price growth that outperforms the lowest-cost S&P 500 Index fund (VFINX). Otherwise, we would simply invest in VFINX and forget about picking stocks. We would also like those companies to have had less stock price volatility than VFINX over a long period of time. The necessary statistical data is found at the BMW Method website. 

Mission: For this week’s blog, we’ll look at how publicly-traded stocks have performed over 25 year holding periods. 

Execution: see Table.

Administration: We exclude companies that do not have high ratings from S&P on their stocks and bonds. We also exclude companies that S&P hasn’t designated as Dividend Achievers. “Less risk” is defined as a statistically lower risk of loss at 2 standard deviations below trendline than that for the S&P 500 Index (see Column M in the Table, where red highlights denote more risk).

Bottom Line: After analysis, we are not surprised to find that 5 of the 8 companies also starred in last week’s blog, where we used a 35 year holding period as opposed to this week’s 25 year period. The newcomers are Procter & Gamble (PG), Genuine Parts (GPC) and PepsiCo (PEP). Six of the 8 companies represent “defensive” industries, while in last week’s blog, 7 of the 10 companies were from those industries (consumer staples, utilities, healthcare, and communication services). Now we know why investors don’t overweight their portfolios with relatively safe (i.e., defensive) stocks, i.e., the ones that have a better chance of outperforming the S&P 500 Index simply because they rarely fall in price. Defensive stocks are boring! Yes, growth stocks are more likely to zip upward in price. But that comes with a statistically equal chance of zipping downward. Most of us pick stocks because we like to see that upward zip once in awhile, not because we hew closely to a disciplined approach for beating the S&P 500 long-term. 

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

Full Disclosure: I dollar-average into PG and own shares of GIS and MKC.

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Week 313 - High-quality Dividend Achievers That Beat The S&P 500 For 35 Years With Less Risk

Situation: Most investors don’t like to micromanage their stock holdings, preferring instead to “buy-and-hold.” But we occasionally lose money because we haven’t been paying adequate attention. Deciding when to sell is much harder than deciding when to buy. The basic rule is to buy stocks with an ROIC (Return On Invested Capital) that is more than twice their WACC (Weighted Average Cost of Capital), then sell when they no longer meet that standard. But that approach doesn’t work for technology stocks, where the ROIC is many times greater than the WACC, or for many stable and/or slowly growing companies. For example, Berkshire Hathaway (BRK-B) has had an ROIC that is only a little higher than its WACC for long periods.

If we are to “buy-and-hold” a stock, the underlying company needs to have a long record of stable price growth that outperforms the lowest-cost S&P 500 Index fund (VFINX). Otherwise, we would simply invest in VFINX and forget about picking stocks. We would also like those companies to have had less stock price volatility than VFINX over a long period of time . . . decades. The necessary statistical data is found at the BMW Method website.

Mission: For this week’s blog, we’ll look at how publicly-traded stocks have performed over 35 year holding periods. Next week, we’ll run the same spreadsheet for 25 year holding periods and the following week we’ll look at the 30 year period.

Execution: see Table.

Administration: We exclude companies that do not have high ratings from S&P on their stocks and bonds. We also exclude companies that S&P hasn’t designated as Dividend Achievers. “Less risk” is defined as a statistically lower risk of loss at 2 standard deviations below trendline than that for the S&P 500 Index (see Column M in the Table, where red highlights denote more risk).

Bottom Line: After analysis, we find that all 10 companies had better price returns than our benchmark (VBINX) over the two year correction in commodity prices from July of 2014 to July of 2016. Most of these companies showed unusually strong performance, meaning investors chose to shunt money away from commodity-related companies and into these companies. It is instructive to get an idea as to why these company’s products and services seemed more valuable to investors. Yes, it was a “risk-off” decision. This is because investors know that the best way to make money is to avoid losing money. Of the 10 stocks highlighted here, only 3 (MCD, MMM, APD) are in “growth” industries; the others are in “defensive” industries (healthcare, consumer staples, and utilities) where earnings tend to hold up better in a downturn. But why not build a portfolio of “risk-off” investments in the first place, given that those appear to outperform the S&P 500 Index over long periods? We’ll check that theory out at 25 and 30 year holding periods, to see how well it holds up. In the meantime, remember Warren Buffett’s Rule #1: “Never lose money.”

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

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

Note: We use discounted cash flow from dividends and sale of the stock (after a 10-Yr holding period) to estimate Net Present Value; see Columns U-Y in the Table. The exponential growth rate in stock price over the next 10 years is estimated to be an extrapolation of the growth in stock price over the past 16 years. The Discount Rate is set at 9%, meaning that a stock with a positive NPV would return more over 10 years than a 10-Yr US Treasury Note paying 9%/Yr. Dividend Growth over the next 10 years is extrapolated from Dividend Growth over the past 4 years. Be aware that our NPV calculation is for comparative purposes only. Any rise in the rate of interest paid by 10-Yr Treasury Notes would diminish stock NPVs, provided that those Notes continue to carry a AAA credit rating from S&P.

Red highlights in the Table denote underperformance relative to our benchmark: Vanguard Balanced Index Fund (VBINX) at Line 18. Purple highlights denote metrics of concern.

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Week 257 - Barron’s 500 Defensive Stocks That Have Outperformed the S&P 500 for 16 Years

Situation: This is Blog #3 of a 3-blog series on S&P 500 Index stocks that have outperformed that Index for 16 yrs, i.e., up more and down less (see Week 255 and Week 256). For each blog, the companies we analyze are S&P Dividend Achievers and have high S&P ratings on their stocks and bonds. This week we cover companies in “defensive” S&P industries that have revenues sufficient for inclusion in the recently published 2016 Barron’s 500 List.

Mission: We select Dividend Achievers in defensive industries (Consumer Staples, HealthCare, Utilities, and Communication Services) that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks were up more and down less: 16-yr total returns/yr were greater and losses in the last market correction (April through September of 2011) were less. In addition, all companies must have an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher. Net Present Values are calculated; NPV data points are presented in U-Y of the Table. [A full explanation of inputs for NPV calculations is given in the Appendix of last week’s blog (Week 256).]

Execution: see Table.

Bottom Line: Five companies are outstanding. MO, COST, HRL, NEE and CVS have NPVs that are above the group average, as well as improving 3-yr trends in cash-flow based Return on Invested Capital (ROIC) and sales (which determine a company’s Barron’s 500 rank), and an ROIC that exceeds the company’s weighted average cost of capital (WACC). 

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

Full Disclosure: I dollar-average into JNJ, NEE and PG, and own shares of ABT, HRL, CVS, KO and PEP.

NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 26 in the Table). Metrics highlighted in green at Columns Q and R in the Table indicate improving performance trends for fundamental business parameters. Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC. Aside from NPV calculations for May 12, 2016, metrics are current for the Sunday of publication.

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Week 256 - Barron's 500 Growth Stocks That Have Outperformed the S&P 500 for 16 Years

Situation: You need a menu that limits your choices when looking for “buy-and-hold” growth stocks in the S&P 500 Index. This is the second blog in a 3-week series for building that menu. Part #1 (see Week 255) looked at S&P 500 stocks that do not have sufficient revenues for inclusion in the recently published 2016 Barron’s 500 List. Those are the largest US and Canadian companies by revenue. It is a valuable resource, which ranks companies by their 3-yr growth in sales and cash-flow based ROIC. This week we introduce a menu of larger S&P 500 growth companies found in the 2016 Barron’s 500 List. Next week, we’ll cover S&P 500 “defensive” companies. 

Mission: All 3 blogs use the same screening tools, starting with a requirement that companies be Dividend Achievers. From those company’s stocks, we select the ones that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks are up more and down less: 16-yr total returns/yr were greater and losses in the last market correction (April through September of 2011) were less. In addition, all companies must be of high quality, with an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher.

Execution: We have assembled a number of metrics for each company that you’ve seen before (see Table). In addition, we calculate the Net Present Value (NPV) for each company by using a standard flow chart. The NPV calculation has been explained briefly in last week’s blog (see Week 255). A detailed description of inputs to that flowchart, and the rationale for those inputs, is explained in the Appendix below. 

Bottom Line: We have screened for S&P 500 growth stocks that have been up more and down less than the S&P 500 Index over the past 16 yrs. The only companies that have been examined are a) Dividend Achievers, b) on the just-published 2016 Barron’s 500 List, and c) have high S&P bond & stock ratings. Net Present Value (NPV) calculations are for stock prices on May 28, 2016. We find that 17 companies meet our criteria (see Table). As a group, their stocks have no greater risk of loss than the S&P 500 Index by even the most severe statistical test per the BMW Method, found at Column P in the Table. Four of the companies offer outstanding long-term value to investors, in that they have NPVs higher than the average for the group, have improving fundamentals according to assessments by the Barron’s 500 editors, and have a Return on Invested Capital (ROIC) that exceeds their Weighted Average Cost of Capital (WACC) as indicated in Columns Z and AA of the Table. Note that 8 of the 17 appear overpriced in that EV/EBITDA is higher than the S&P 500 multiple of 12 (see Column K in the Table).

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

Full Disclosure: I dollar-average into NKE, MSFT and XOM, and own TJX, ROST and MCD shares.

NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 23 in the Table). Metrics highlighted in green at Columns Q and R 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. Aside from NPV calculations, metrics are current for the Sunday of publication. 

APPENDIX: Inputs to NPV Calculator:

Discount Rate = 9.0%. Why? Because that is the expected rate of return going forward using the reference index of our choice, the S&P MidCap 400 Index. This index fund has a dividend yield of ~1.5% and a 16-yr price CAGR of ~7.5% (1.5% + 7.5% = 9.0%). Standard practice is to select a Discount Rate that has comparable risk and reward features to the asset class being examined, which in our case are individual stocks in the S&P 500 Index. Therefore, our NPV calculation would yield an NPV of zero if the stock in question merely had a projected return of 9.0%/yr to the investor over the Life of the Project (10 years). A positive number for NPV is necessary to justify investment in a particular stock as opposed to simply choosing to invest in the reference index. 
Initial Cost is the price for ~$5,000 worth of an even number of shares, plus 2.5% in transaction costs. That means $5,128.21 becomes the Initial Cost for XX number of shares priced at exactly $5,000.00. $5,128.21 is entered in the flowchart with a minus sign in front of it. Why? Because the Present Value of Expected Cash Flows is the output of the flow chart, which represents cash received minus cash paid. 
Life of the Project is 10 years. So, the shares purchased at an Initial Cost of $5128.21 are sold in the 10th year for XX amount minus a 2.5% penalty for transaction costs. 
Cash Flow 1 is the annual dividend multiplied by the number of shares purchased. 
Cash Flow 2 is that amount multiplied by the rate of dividend growth over the past 16 yrs (Column H in the Table). For example, a dividend yield of 1% for a stock selling at $100.00 is $1.00; multiplying that by 40 shares gives Cash Flow 1 of $40.00. If the 16-yr Dividend Growth is 10.0%/yr, Cash Flow 2 is 1.1 times $40.00 = $44.00. 
Cash Flows 3-9 are handled the same way to generate estimated dividend payments. 
Cash Flow 10 is the sum of the estimated dividend payment for Year 10 plus the selling price for the shares originally purchased. That price is determined by using the 16-yr price CAGR for that stock in Column N in the Table, to project the original price 10 yrs ahead per the BMW Method. That price return is then decreased by 2.5% to account for transaction costs. Upon clicking Calculate, you arrive at the PV of Expected Cash Flows and NPV which is the PV of Expected Cash Flows left after subtracting 9.0%/yr for the Discount Rate.

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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.

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Week 246 - Corn Belt Prosperity: Is It Gone?

Situation: The farming counties of the Corn Belt are in a recession due to the collapse in corn price per bushel, but the US economy is still growing. “In the past 50 years, every recession has seen the number of jobs in the economy decline by at least 1%. And jobs have never declined by that much outside of a recession. Today, the number of jobs in the U.S. has been growing briskly—up 292,000 in December and up 2.7 million over the past year. This is why many economists remain confident the U.S. can avoid recession.” That quotation from the Wall Street Journal summarizes the way we measure growth vs. contraction in the economy but jobs are a “lagging” indicator. The country is already on the brink of recession because of the “knock-on” effects of slow growth and high indebtedness in emerging market countries, mainly China. Their plight is made worse by our Federal Reserve’s policy of raising interest rates. The “capital flight” that has been happening in emerging market countries simply gets accelerated as the dollar gets stronger and as interest rates move higher. In other words, investors are pulling money out of emerging markets but those are the very markets where real growth is happening. A third of the revenue for S&P 500 Index companies comes from those countries. Earnings for the S&P 500 Index will fall as those countries head into recessions, triggered in part by our strong dollar. News Flash: almost all of the 45 major stock markets around the world are currently in a Bear Market.

Mission: Drill down on the Corn Belt centered in Illinois, Iowa, southern Minnesota and the eastern half of Nebraska, where 57% of US production occurs. That’s also where almost half of US ethanol plants are located. Cropland in those states has been falling steadily in price/acre for 3 years, and 2015 showed no hint of relief. The average price per acre in those 4 states in 2015 was $6418, which is 2.9% lower than in 2014. For Iowa, where 2015 values were $8200 per acre, prices were down 6.3%. But farm incomes have fallen 55% in the past two years, so it is only a matter of time before cropland values start to reflect that loss in productivity. 

Execution: Let’s see how large AgriBusiness companies based in North America are doing, specifically those that meet our quality standards: Monsanto (MON), Potash (POT), DuPont (DD), Dow Chemical (DOW) and Deere (DE). Looking at this week’s Table, we see that they mirror what’s happening to commodity producers everywhere, namely, too much supply is being generated just when demand is collapsing for a variety of reasons. 

Administration: What you can do, as an investor, is to remember that this is a very rewarding group of 5 stocks to own over 2-3 market cycles (see Column C in the Table). Mostly, you need to avoid taking action. Don’t go out and buy cropland, don’t sell any of these stocks that you already hold, and keep dollar-averaging into those that you do own long-term. The thing about commodity markets is that during bear markets producers either fail or barely survive. Production eventually falls enough that remaining companies have to struggle to catch up with demand (demand that is no longer being satisfied). It will not be difficult to ramp up operations at that point because stocks (and bonds) issued by commodity producers will be snapped up by investors. However, these capital expenditures won’t take effect for a while because so much investment has to be directed at replacing fixed assets and skilled labor lost during the downturn. But production eventually catches up to (and then exceeds) demand. That is why these are called long-cycle investments. Boom-bust-boom turnarounds typically span two or three stock market cycles.

Bottom Line: This commodity supercycle is finished. Most estimates show that global commodity-related production is approximately 150% of demand. Farm commodities are no different. Those produced in the US have to be marketed at too high a price in foreign countries, because of the “strong” dollar. That means farmers in Brazil, Argentina, the Ukraine, Australia and Canada have a competitive advantage over US farmers. The US-based AgriBusiness companies that have worldwide operations will recover faster than US farmers but a difficult decade lies ahead. In rural counties of the Corn Belt, prosperity is unlikely to recover soon.

Risk Rating: 8 (on a scale where gold-related investments are 10 and inflation-protected US Savings Bonds are 1).

Full Disclosure: I dollar-average into MON, and own stock in DD, ADM, and DE.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark. Total Returns in Column C of the Table date to 9/1/2000 because that marks the peak of the S&P 500 Index before the “dot.com” recession. There have been two peaks since, in 2007 and 2015, so we’re entering the third market cycle since 2000.

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Week 243 - S&P 500 HealthCare Companies

Situation: Obamacare has been a boost for the healthcare industry, bringing 10 million new health insurance clients into the system. And, the Federal Reserve’s main monetary policy since the Lehman Panic, called “quantitative easing,” invested $4.2T (that’s Trillion) in government bonds to bring interest rates down to historic lows. That got people to stop investing in bonds and instead expand their businesses, build manufacturing plants, buy cars, refinance homes, advertise their services, or simply buy stocks. It worked, and investment dollars favored the HealthCare industry. The only “fly in the ointment” is that stocks have become overpriced because bonds are no longer able to compete on a total-return basis. The Federal Reserve is now trying to reverse its “easy money policy” because the economy no longer needs life support. However, this will sink the stock market for a while, including healthcare stocks. But those of you who are building a retirement portfolio can hardly avoid the obvious benefits of owning healthcare stocks, which are a growing client base and an aging population. And that’s just in the United States. Looking internationally, there are almost 20 million people emerging from poverty each year and now able to invest in their health! 

Mission: You’ll need to know which stocks you might want to drop and which you might eventually profit from owning (and should probably continue to dollar-average into). So we need to come up with a list of the highest quality HealthCare stocks. We’ll use our standard spreadsheet to highlight both the past rewards of ownership and the likely risks of continued ownership. We’ll start with the list of healthcare stocks in the S&P 500 Index, deleting any with insufficient revenues to appear on the 2015 Barron’s 500 List. We’ll also delete any stocks that haven’t been trading long enough to appear on the 16-yr BMW Method list. Finally, we’ll delete any companies that don’t have S&P bond ratings of at least BBB+ and S&P stock ratings of at least B+/M. 

Execution: The above exercise leaves us with 20 companies to consider, only 5 of which are S&P Dividend Achievers (denoting 10+ years of annual dividend increases). Those 4 companies are: Johnson & Johnson (JNJ), Abbott Laboratories (ABT), Becton Dickinson (BDX), Medtronic (MDT) and Stryker (SYK). The other 15 are speculative investments to varying degrees (see Columns D, I, J, K, and O in the Table). The benchmark mutual fund, Vanguard HealthCare Fund (VGHCX), shows stronger risk-adjusted performance than the aggregate of 20 stocks (compare Line 22 to Line 25 in the Table). Its outperformance has been remarkable for decades.

Bottom Line: HealthCare stocks have become a “crowded trade.” If you’ve held several of the 20 stocks on our list over the past decade, you’re likely happy with your choices. The HealthCare industry will likely continue to do well given the demographic trends in the US and internationally with bigger percentages of people becoming insured, entering their sunset years and emerging from poverty. Just keep in mind that the value of these stocks is technology-driven, and a price-appreciation graph for technology-driven stocks will continue to look like a roller-coaster (see Column O in the Table). Only 3 of these stocks have a steady and strong trend of price-appreciation: Johnson & Johnson (JNJ), Abbott Laboratories (ABT), and Becton Dickinson (BDX). If you want to venture beyond these safe havens, the safest and most rewarding move looks to be the mutual fund that represents this industry so well: Vanguard HealthCare Fund (VGHCX) at Line 24 in the Table.

Risk Rating: 6

Full Disclosure: I dollar-average into ABT and also own stock in JNJ, BDX, and MCK.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark at Line 27 in the Table. Total Returns in Column C of the Table date to 9/1/2000 because that marks the peak of the S&P 500 Index before the “dot.com” recession. There have been two peaks since, in 2007 and 2015, so we’re entering the third market cycle since 2000.

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