Situation: Commodity producers have a dismal record. Spot prices fall whenever mining (or drilling or harvesting) becomes more efficient. To make matters worse, supply-chain management and investment has become increasingly global and professionalized. Nonetheless, copper sales remain the best barometer of fixed-asset investment, particularly the ongoing proliferation of industrial plants and equipment in China. Silver has a growing role, thanks to the buildout of solar power. And gold remains a check on the propensity of government leaders everywhere to finance their dreams with debt, as opposed to revenue from taxes.
Mission: Use our Standard Spreadsheet to highlight the largest companies producing gold, silver, and copper.
Execution: see Table.
Administration: Gold and silver prices remain stuck where they were 35 years ago but are characterized by high volatility. Commodity prices (in the aggregate) trace supercycles that last approximately 20 years. The most recent came from a 1999 low and fell back to that level in 2016; since then it has ever so slowly risen from that low.
Bottom Line: The basic rule for commodity producers is that 3 years out of 30 will be good years, and you’ll make a lot of money. But over any 20-30 year period, you’ll lose money (measured by inflation-adjusted dollars). Our Table for this week confirms these points but does show that copper (SCCO) is worth an investor’s attention. But beware! That company’s share price is falling because of a falloff in trade with China and could fall further if a trade war takes hold.
Risk Rating: 10 (where 10-Yr US Treasury Notes = 1, S&P 500 = 5, and gold bullion = 10).
Full Disclosure: I do not have positions in any commodity producers aside from Exxon Mobil (XOM), but do dollar-average into the main provider of mining equipment: Caterpillar (CAT).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Showing posts with label industrials. Show all posts
Showing posts with label industrials. Show all posts
Sunday, September 9
Sunday, May 6
Week 357 - Dividend Achievers That Support Commodity Production
Situation: Commodities crashed in 2014 but the only S&P industries to be affected were Energy, Industrials (specifically railroads) and Basic Materials. A new Commodity Supercycle began to take hold in early 2017.
Which companies stand to benefit?
Mission: Under the best of circumstances, commodity-related investments are highly speculative. If you gamble at this casino long enough, you’ll lose big and win big. So, let’s confine our attention to “the best of circumstances,” i.e., set up our Standard Spreadsheet to look at companies meeting these requirements:
1) S&P credit rating for long-term bonds is BBB+ or better;
2) S&P stock rating is B+/M or better;
3) Long-term Debt doesn’t exceed 33% of Total Assets;
4) Tangible Book Value is a positive number;
5) the company is a Dividend Achiever.
Execution: see Table.
Administration: Seven companies meet our requirements. Only the two railroads (UNP, CSX) and Exxon Mobil (XOM) meet the key requirement Warren Buffett has for saying that a company enjoys a “Durable Competitive Advantage” (see Week 54), i.e., steady growth in Tangible Book Value exceeding 7%/yr (see Columns AD and AE in the Table). It is also important to note that all areas of commodity production (aside from aquaculture) employ equipment that digs in the dirt. That makes Caterpillar (CAT) a useful barometer, and its stock has done well since the Commodity Crash of 2014-2016.
Bottom Line: If you’ve held shares in any of these 7 companies (see Table) for more than a few years, I commend your perseverance. Stick it out awhile longer and you may be rewarded. A new Commodity Supercycle appears to be starting, and will likely take hold if China stays the course and becomes a Superpower.
Risk Rating: 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Union Pacific (UNP) and Exxon Mobil (XOM).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Which companies stand to benefit?
Mission: Under the best of circumstances, commodity-related investments are highly speculative. If you gamble at this casino long enough, you’ll lose big and win big. So, let’s confine our attention to “the best of circumstances,” i.e., set up our Standard Spreadsheet to look at companies meeting these requirements:
1) S&P credit rating for long-term bonds is BBB+ or better;
2) S&P stock rating is B+/M or better;
3) Long-term Debt doesn’t exceed 33% of Total Assets;
4) Tangible Book Value is a positive number;
5) the company is a Dividend Achiever.
Execution: see Table.
Administration: Seven companies meet our requirements. Only the two railroads (UNP, CSX) and Exxon Mobil (XOM) meet the key requirement Warren Buffett has for saying that a company enjoys a “Durable Competitive Advantage” (see Week 54), i.e., steady growth in Tangible Book Value exceeding 7%/yr (see Columns AD and AE in the Table). It is also important to note that all areas of commodity production (aside from aquaculture) employ equipment that digs in the dirt. That makes Caterpillar (CAT) a useful barometer, and its stock has done well since the Commodity Crash of 2014-2016.
Bottom Line: If you’ve held shares in any of these 7 companies (see Table) for more than a few years, I commend your perseverance. Stick it out awhile longer and you may be rewarded. A new Commodity Supercycle appears to be starting, and will likely take hold if China stays the course and becomes a Superpower.
Risk Rating: 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Union Pacific (UNP) and Exxon Mobil (XOM).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 21
Week 342 - Industrial Companies in “The 2 and 8 Club” (Extended Version)
Situation: There are many industrial companies that enjoy good earnings over long time intervals. But these earnings are yoked to the economic cycle and tend to be volatile. This unsettles investors. Companies in the Financial Services, Consumer Discretionary, and Information Technology industries face the same problem. However, those 4 industries are also responsible for most of the growth in the US stock market. Stockpickers have to either stare at ugly “paper losses” from time to time, or behave like retail investors and “buy high, sell low.” For the former group, which has absorbed losses, studies show that they’ll spend 4% less money on consumer goods than customary. But when the stock market is up a lot, they’ll spend 4% more. The mechanics of maintaining what you’ve obtained may be difficult to explain to your life partner, but your heirs will understand. The harder part (for your life partner) is to understand why you allocate more money to the stock market when its down but less when its up!
The takeaway message from this is that money needs to be taken “off the table” when the market is frothy, and spent. With the current market, now would be a good time to start doing that. At every one of Berkshire Hathaway’s annual meetings that I’ve attended, Warren Buffett reprises his famous quote: “Be fearful when others are greedy and greedy when others are fearful”. In other words, allocate more of your income to the stock market when the economy is in a slump. Baron Rothschild put a fine point on it 202 years ago, when he profited mightily from the defeat of Napoleon at the Battle of Waterloo: “Buy when there’s blood in the streets, even if the blood is your own”. Caveat Emptor: The opposing argument, that “timing the market” never works, is widely respected.
Mission: If you want to at least keep up with the S&P 500 Index, you’ll have to focus much of your research on industrial stocks. So, here are 6 industrial stocks that 1) pay good & growing dividends, and 2) are highly rated by S&P and Morningstar. See our Week 329 blog for a detailed explanation of how we pick stocks from the Barron’s 500 List that have at least a 2% dividend yield and an 8%/yr dividend growth rate (over the previous 5 years).
Execution: see Table.
Bottom Line: Industrial companies take advantage of a growing economy. However, their stock prices fluctuate more widely than most investors can tolerate. You have to be a bit of a gambler to become an enthusiast. Over the long term, you’ll grow to be happy with the rewards. Just don’t expect your risk-adjusted total returns to be any better than you’d realize from owning shares in an S&P 500 Index fund, unless your hobby is to analyze industrial companies. To do so, it helps if you decide that only a few companies are likely to reward the time you spend on their study. We think the 6 industrial companies in “The 2 and 8 Club” are worth your time (see Table).
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into MMM, and also own shares of CMI and CAT.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The takeaway message from this is that money needs to be taken “off the table” when the market is frothy, and spent. With the current market, now would be a good time to start doing that. At every one of Berkshire Hathaway’s annual meetings that I’ve attended, Warren Buffett reprises his famous quote: “Be fearful when others are greedy and greedy when others are fearful”. In other words, allocate more of your income to the stock market when the economy is in a slump. Baron Rothschild put a fine point on it 202 years ago, when he profited mightily from the defeat of Napoleon at the Battle of Waterloo: “Buy when there’s blood in the streets, even if the blood is your own”. Caveat Emptor: The opposing argument, that “timing the market” never works, is widely respected.
Mission: If you want to at least keep up with the S&P 500 Index, you’ll have to focus much of your research on industrial stocks. So, here are 6 industrial stocks that 1) pay good & growing dividends, and 2) are highly rated by S&P and Morningstar. See our Week 329 blog for a detailed explanation of how we pick stocks from the Barron’s 500 List that have at least a 2% dividend yield and an 8%/yr dividend growth rate (over the previous 5 years).
Execution: see Table.
Bottom Line: Industrial companies take advantage of a growing economy. However, their stock prices fluctuate more widely than most investors can tolerate. You have to be a bit of a gambler to become an enthusiast. Over the long term, you’ll grow to be happy with the rewards. Just don’t expect your risk-adjusted total returns to be any better than you’d realize from owning shares in an S&P 500 Index fund, unless your hobby is to analyze industrial companies. To do so, it helps if you decide that only a few companies are likely to reward the time you spend on their study. We think the 6 industrial companies in “The 2 and 8 Club” are worth your time (see Table).
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into MMM, and also own shares of CMI and CAT.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 23
Week 316 - 2017 Barron’s 500 List: A-rated “Defensive” Companies That Moved Up In Rank During The Commodity Recession
Situation: A stock-picker can’t beat the market, given that transaction costs and tax inefficiencies reduce returns by 1-3%/yr compared to the lowest-cost S&P 500 Index fund (VFINX), which returns 7-8%/yr. To effectively compete with that, stock picks would need to return 9%/yr. That’s one of the reasons why we use a discount rate of 9% when calculating Net Present Value.
In business school, I was taught that there are only two ways to beat the market: Plan A is to trade on “insider information” (patently illegal); Plan B is to take outsize risks (i.e., run a portfolio where the capitalization-weighted 5-Yr Beta is greater than 1.0). Those of us who are employed full time in Financial Services may become good stock-pickers because we know a particular industry very well, the result being that we overweight our picks in that industry. In other words, we’re engaged in a legal form of insider trading. For example, doctors and dentists are often savvy traders of health-care stocks.
The stock-picker who had the longest run beating the S&P 500 Index was Peter Lynch, who managed Fidelity’s Magellan Fund from 1977 through 1990. He relied on diversification, running ~1000 stocks with the help of a dozen analysts, but focussed on retail stocks. He claimed that the insights his wife shared with him after a day of shopping were pivotal to his success. You get the point: Invest in what you know.
But what about Plan B (risk taking)? Like Plan A, that approach requires you to run a portfolio concentrated in particular industries. But unlike Plan A, those stocks have to be in boring “Defensive” industries, i.e., the ones where sales grow only as fast as the population grows (Consumer Staples, Healthcare, Communication Services, and Utilities). By overweighting defensive industries, you insulate your portfolio. When the market crashes, those industries tend to keep on growing their earnings. Than means you’re following Warren Buffett’s Rule #1: Never Lose Money.
Mission: Analyze the recent Commodity Recession (see Column D at Line 26 in the Table), which was almost severe enough to keep both GDP and the S&P 500 Index from growing.
Execution: see Table.
Administration: Commodities are a key driver of the economy, so the Commodity Recession gave us a rare opportunity to see which companies out-perform without that key driver. You’ll need some background information. Of the 22 commodity futures contracts that compose the Bloomberg Commodity Index, the 5 classified as “Energy” are strongest, with a combined weight of 30.57% (Natural Gas, Brent Crude Oil, West Texas Intermediate Crude Oil, Ultra-Low Sulfur Diesel, and Unleaded Gasoline). When those are down ~20%, the S&P 500 Index will barely rise even though GDP might keep going up. Whether we like it or not, the prices of petroleum products will be the best predictors of the stock market for the next 10+ yrs. To be successful, a stock-picker has to anticipate the ups and downs in prices for energy commodities, and be positioned to reap good returns from stocks of A-rated S&P 500 companies that maintain or improve their valuation metrics during a commodity recession.
Key metrics relate to cash-flow based ROIC, specifically the most recent year vs. the 3-Yr median, as well as sales growth for the most recent year. The Barron’s 500 List (published each May) ranks the largest 500 companies on the New York and Toronto stock exchanges in terms of those 3 metrics. We’re interested in knowing the names of ALL the A-ranked S&P 500 companies that moved up in rank. Most of those will be in “Defensive” industries. The few that are in “Growth” industries either have a business plan that allows them to be “hardy perennials,” or enjoy a special situation that allows them to take advantage of a Commodity Recession. This week we cover “Defensive” industries. Next week we’ll cover the few “Growth” industry out-performers.
Bottom Line: The costs associated with owning the Vanguard 500 Index Fund (VFINX) are nil, whereas, the costs of owning (and trading) stock in a few dozen companies are substantial. And, the capital gains taxes that you’ll pay each year for trading those stocks are erratic and immediate vs. what you’ll pay upon eventually selling your VFINX shares. Your stock portfolio has to outperform the S&P 500 Index by 2-3%/yr to equal the returns you’d realize from owning VFINX shares. Invest smart, by knowing that the market goes down eventually and doing something about it ahead of time. Either stick to industries you know, or hedge by overweighting the stocks of companies in “Defensive Industries.” The 14 shown in the Table are a good place to start your research. Pay close attention to Columns P-S because even these companies can swoon in a market crash if they have messy Balance Sheets (messiness is highlighted in purple).
Risk Rating: 6 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold)
Full Disclosure: I dollar-average into JNJ and KO, and also own shares of HRL and WMT.
In business school, I was taught that there are only two ways to beat the market: Plan A is to trade on “insider information” (patently illegal); Plan B is to take outsize risks (i.e., run a portfolio where the capitalization-weighted 5-Yr Beta is greater than 1.0). Those of us who are employed full time in Financial Services may become good stock-pickers because we know a particular industry very well, the result being that we overweight our picks in that industry. In other words, we’re engaged in a legal form of insider trading. For example, doctors and dentists are often savvy traders of health-care stocks.
The stock-picker who had the longest run beating the S&P 500 Index was Peter Lynch, who managed Fidelity’s Magellan Fund from 1977 through 1990. He relied on diversification, running ~1000 stocks with the help of a dozen analysts, but focussed on retail stocks. He claimed that the insights his wife shared with him after a day of shopping were pivotal to his success. You get the point: Invest in what you know.
But what about Plan B (risk taking)? Like Plan A, that approach requires you to run a portfolio concentrated in particular industries. But unlike Plan A, those stocks have to be in boring “Defensive” industries, i.e., the ones where sales grow only as fast as the population grows (Consumer Staples, Healthcare, Communication Services, and Utilities). By overweighting defensive industries, you insulate your portfolio. When the market crashes, those industries tend to keep on growing their earnings. Than means you’re following Warren Buffett’s Rule #1: Never Lose Money.
Mission: Analyze the recent Commodity Recession (see Column D at Line 26 in the Table), which was almost severe enough to keep both GDP and the S&P 500 Index from growing.
Execution: see Table.
Administration: Commodities are a key driver of the economy, so the Commodity Recession gave us a rare opportunity to see which companies out-perform without that key driver. You’ll need some background information. Of the 22 commodity futures contracts that compose the Bloomberg Commodity Index, the 5 classified as “Energy” are strongest, with a combined weight of 30.57% (Natural Gas, Brent Crude Oil, West Texas Intermediate Crude Oil, Ultra-Low Sulfur Diesel, and Unleaded Gasoline). When those are down ~20%, the S&P 500 Index will barely rise even though GDP might keep going up. Whether we like it or not, the prices of petroleum products will be the best predictors of the stock market for the next 10+ yrs. To be successful, a stock-picker has to anticipate the ups and downs in prices for energy commodities, and be positioned to reap good returns from stocks of A-rated S&P 500 companies that maintain or improve their valuation metrics during a commodity recession.
Key metrics relate to cash-flow based ROIC, specifically the most recent year vs. the 3-Yr median, as well as sales growth for the most recent year. The Barron’s 500 List (published each May) ranks the largest 500 companies on the New York and Toronto stock exchanges in terms of those 3 metrics. We’re interested in knowing the names of ALL the A-ranked S&P 500 companies that moved up in rank. Most of those will be in “Defensive” industries. The few that are in “Growth” industries either have a business plan that allows them to be “hardy perennials,” or enjoy a special situation that allows them to take advantage of a Commodity Recession. This week we cover “Defensive” industries. Next week we’ll cover the few “Growth” industry out-performers.
Bottom Line: The costs associated with owning the Vanguard 500 Index Fund (VFINX) are nil, whereas, the costs of owning (and trading) stock in a few dozen companies are substantial. And, the capital gains taxes that you’ll pay each year for trading those stocks are erratic and immediate vs. what you’ll pay upon eventually selling your VFINX shares. Your stock portfolio has to outperform the S&P 500 Index by 2-3%/yr to equal the returns you’d realize from owning VFINX shares. Invest smart, by knowing that the market goes down eventually and doing something about it ahead of time. Either stick to industries you know, or hedge by overweighting the stocks of companies in “Defensive Industries.” The 14 shown in the Table are a good place to start your research. Pay close attention to Columns P-S because even these companies can swoon in a market crash if they have messy Balance Sheets (messiness is highlighted in purple).
Risk Rating: 6 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold)
Full Disclosure: I dollar-average into JNJ and KO, and also own shares of HRL and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 16
Week 315 - High-quality Dividend Achievers That Beat The S&P 500 For 30 Years With Less Risk
Situation: The S&P 500 Index has risen faster than underlying earnings for the past 8 years. The main reason is that the Federal Reserve purchased over 3 Trillion dollars worth of government bonds and mortgages (including “non-conforming” private mortgages that carry no government guarantee). As intended, this flooded our economy with money that could be borrowed at historically low interest rates. Now the Federal Reserve is looking to start bringing that money back, by accepting the repayment of principal when loans mature instead of renewing (“rolling over”) the loans. This will result in a balance sheet “roll-off” that reduces the amount of money in circulation. Think of it as a “bail-in” to rebalance Treasury accounts, which will reverse the “bail-out” of Wall Street in 2008-9. Interest rates will slowly rise. Investors will once again have to consider the attractiveness of owning bonds in place of stocks. “Risk-on” investments, i.e., growth stocks and stocks issued by smaller companies, will be less sought after but “risk-off” investments (defensive stocks and corporate bonds) will be more sought after. Most of the stocks that have outperformed the S&P 500 over the past 25 years (see Week 314) and 35 years (see Week 313) have been issued by companies in “defensive” industries.
Mission: Look at 30 year statistics by using the BMW Method, to possibly find more stocks that outperform the S&P 500 Index while taking on less risk.
Execution: see Table.
Bottom Line: We have turned up 3 new companies: two from defensive industries (Archer Daniels Midland “ADM” and Kimberly-Clark “KMB”) and one from a growth industry (WW Grainger “GWW”). That makes a total of 11 companies from the 4 S&P “defensive” industries (Utilities, Healthcare, Consumer Staples, and Communication Services): CHD, MKC, BDX, WTR, ED, GIS, CVS, PEP, PG, ADM, KMB. And, 5 from the 6 S&P “growth” industries (Consumer Discretionary, Industrials, Information Technology, Materials, Energy, and Financial Services): APD, MMM, MCD, GPC, GWW.
In other words, the companies that make really good long-term investments are twice as likely to be from “risk-off” defensive industries than from “risk-on” growth industries. But think about what that implies, given that 2/3rds of the companies in the S&P 100 Index represent growth industries. If you want to beat the S&P 500 Index long-term, you’ll have to reverse that ratio and have 2/3rds of your money in defensive stocks.
Risk Rating: 5 (10-Yr Treasury Note = 1, S&P 500 Index = 5, Gold = 10)
Full Disclosure: I own shares of MCD, MMM, GIS, MKC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Look at 30 year statistics by using the BMW Method, to possibly find more stocks that outperform the S&P 500 Index while taking on less risk.
Execution: see Table.
Bottom Line: We have turned up 3 new companies: two from defensive industries (Archer Daniels Midland “ADM” and Kimberly-Clark “KMB”) and one from a growth industry (WW Grainger “GWW”). That makes a total of 11 companies from the 4 S&P “defensive” industries (Utilities, Healthcare, Consumer Staples, and Communication Services): CHD, MKC, BDX, WTR, ED, GIS, CVS, PEP, PG, ADM, KMB. And, 5 from the 6 S&P “growth” industries (Consumer Discretionary, Industrials, Information Technology, Materials, Energy, and Financial Services): APD, MMM, MCD, GPC, GWW.
In other words, the companies that make really good long-term investments are twice as likely to be from “risk-off” defensive industries than from “risk-on” growth industries. But think about what that implies, given that 2/3rds of the companies in the S&P 100 Index represent growth industries. If you want to beat the S&P 500 Index long-term, you’ll have to reverse that ratio and have 2/3rds of your money in defensive stocks.
Risk Rating: 5 (10-Yr Treasury Note = 1, S&P 500 Index = 5, Gold = 10)
Full Disclosure: I own shares of MCD, MMM, GIS, MKC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 23
Week 303 - A-rated Barron’s 500 Industrial Companies That Are Dividend Achievers
Situation: There are a number of large and well-established industrial companies. By taking a “buy and hold” approach to owning stock in a few of those, you’ll likely realize your best results as a stock-picker. Yes, they’re cyclical. But the level of reward found in purchasing these stocks is generally higher than their level of risk.
Mission: Focus on companies that 1) pay a good and growing dividend, 2) are big enough to be included in the Barron’s 500 List of US and Canadian companies with the highest revenues, 3) have been analyzed statistically over the past 20 yrs by the BMW Method, as shown in Columns K-M in the Table, 4) issue bonds and stocks that S&P rates as A- or better, and 5) have a clean Balance Sheet (see Columns P-R in the Table), which means that a) long-term debt constitutes no more than 1/3rd of total assets, b) Tangible Book Value is not a negative number, and c) dividends are consistently paid out of Free Cash Flow (FCF).
Execution: see Table.
Administration: We have applied our standard spreadsheet with one change. The compound annual growth rate (CAGR) of weekly prices is 20 yrs, instead of the customary 16 yrs (see Column K).
Bottom Line: To help you narrow your choices, we have focused on A-rated Dividend Achievers that have clean balance sheets. We have also calculated the Net Present Value (NPV) of owning a stock for the next 10 yrs then selling it (see Column Y in the Table). That statistic assembles income streams from the current dividend (Column G), maintenance of the dividend growth rate that has been established over the past 3 yrs (Column H), and maintenance of the price growth rate that has been established over the past 20 yrs (Column K). A positive number suggests a total return of 9%/yr or more, whereas a negative number projects a lower rate. Per NPV, the leading choice is Canadian National Railway (CNI).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, and also own shares of CNI, CAT, MMM, and GD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 20-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 22 in the Table. The ETF for that index is MDY at Line 15. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Focus on companies that 1) pay a good and growing dividend, 2) are big enough to be included in the Barron’s 500 List of US and Canadian companies with the highest revenues, 3) have been analyzed statistically over the past 20 yrs by the BMW Method, as shown in Columns K-M in the Table, 4) issue bonds and stocks that S&P rates as A- or better, and 5) have a clean Balance Sheet (see Columns P-R in the Table), which means that a) long-term debt constitutes no more than 1/3rd of total assets, b) Tangible Book Value is not a negative number, and c) dividends are consistently paid out of Free Cash Flow (FCF).
Execution: see Table.
Administration: We have applied our standard spreadsheet with one change. The compound annual growth rate (CAGR) of weekly prices is 20 yrs, instead of the customary 16 yrs (see Column K).
Bottom Line: To help you narrow your choices, we have focused on A-rated Dividend Achievers that have clean balance sheets. We have also calculated the Net Present Value (NPV) of owning a stock for the next 10 yrs then selling it (see Column Y in the Table). That statistic assembles income streams from the current dividend (Column G), maintenance of the dividend growth rate that has been established over the past 3 yrs (Column H), and maintenance of the price growth rate that has been established over the past 20 yrs (Column K). A positive number suggests a total return of 9%/yr or more, whereas a negative number projects a lower rate. Per NPV, the leading choice is Canadian National Railway (CNI).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, and also own shares of CNI, CAT, MMM, and GD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 20-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 22 in the Table. The ETF for that index is MDY at Line 15. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 5
Week 296 - Testing Our Stock-picking Algorithm
Situation: The “normal” way to invest in stocks is to play the Market as a whole. Typically, that means dollar-cost averaging into index funds such as those offered by Vanguard Group (VFINX, VEXMX, VTSMX, VGTSX) or SPDR State Street Global Advisors (SPY, MDY, DGT). That way, transaction costs are minimized and you can’t miss out on market moves. Or, you can try to beat the Market by building (and managing) a portfolio composed of many stocks representing all 10 S&P Industries. There’s no shortage of books on the subject but one will suffice: “The Four Pillars of Investing: Lessons for Building a Winning Portfolio” by William J. Bernstein, 2002, McGraw-Hill. There you’ll find a mathematical exercise proving that the only logical way to do well from investing in stocks is to focus on dividend growth.
Mission: Lay out an algorithm for stock selection.
Execution: Start with companies that have grown their dividend annually for 10 or more years, i.e., S&P Dividend Achievers. Select the ones that have grown their dividend faster than our benchmark S&P 500 index fund, VFINX, over the past 10 years, which is 6.8%/yr. Narrow that list down to those companies large enough to be on the Barron’s 500 List. Why? Because large companies a) have multiple product lines, and b) their stock has enough activity on the CBOE (Chicago Board Options Exchange) to facilitate price discovery. Remove any companies that don’t have an S&P Bond Rating of at least A- and an S&P Stock Rating of at least A-/M. Remove any companies that don’t have a 16-yr trading record that has been analyzed statistically by the BMW Method. Exclude companies that rely on long-term debt for more than 1/3rd of total capitalization, or couldn't meet dividend payments from free cash flow (FCF) in the two most recent quarters. Also exclude companies that are over-reliant on short-term debt, i.e., have more than 5% negative Tangible Book Value.
Administration: There are 27 companies that pass the above screen. By using the BMW Method, we have separated those into a group of 16 that has no greater chance of loss in a future Bear Market than the S&P 500 Index (see Column M of the Table under “Non-Gambling”), and a group of 11 that has a greater chance of loss (see red highlights in Column M under “Gambling”). If you do choose to invest in one of the Gambling companies, watch price-action because you’ll likely want to SELL at some point. In Columns N-P we provide data on 3 ratios that assess the overall health of Financial Statements.
Bottom Line: The purpose of stock-picking is to Beat the Market. It is very difficult, expensive, and time-consuming to do so over more than one Market Cycle. We have laid out a system for picking stocks, and back-tested it. It has a Failure Rate of 4%. In other words, 25 of the 26 stocks beat the S&P 500 Index over the past 16 years (see Column K in the Table). Just to be clear, we recommend that you dollar-average into index funds (see BENCHMARKS section of Table), and/or Berkshire Hathaway B-shares (where you would be building a position in over 100 large and mid-cap companies).
Of the 16 stocks we designate as non-gambling investments, most carry market multiples (or lower) for EV/EBITDA: GWW, UNP, CNI, WEC, APD, NEE, TRV, WMT, TGT. Those stocks are attractive for purchase if no issues arise from your further research, such as reading the Morningstar evaluation.
Risk Rating is 7 for the stock selection system outlined above. Why is that? Because of Selection Bias (https://en.wikipedia.org/wiki/Selection_bias) and Transaction Costs (http://www.investopedia.com/terms/t/transactioncosts.asp).
Full Disclosure: I dollar-average into UNP, NKE, JNJ, PG, NEE and MSFT, and also own shares of CNI, MMM, WMT, HRL, TRV, MKC, ROST, TJX, GD and CAT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 40 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends collected in 10th year), Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 45 in the Table. The ETF for that index is MDY at Line 39.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Lay out an algorithm for stock selection.
Execution: Start with companies that have grown their dividend annually for 10 or more years, i.e., S&P Dividend Achievers. Select the ones that have grown their dividend faster than our benchmark S&P 500 index fund, VFINX, over the past 10 years, which is 6.8%/yr. Narrow that list down to those companies large enough to be on the Barron’s 500 List. Why? Because large companies a) have multiple product lines, and b) their stock has enough activity on the CBOE (Chicago Board Options Exchange) to facilitate price discovery. Remove any companies that don’t have an S&P Bond Rating of at least A- and an S&P Stock Rating of at least A-/M. Remove any companies that don’t have a 16-yr trading record that has been analyzed statistically by the BMW Method. Exclude companies that rely on long-term debt for more than 1/3rd of total capitalization, or couldn't meet dividend payments from free cash flow (FCF) in the two most recent quarters. Also exclude companies that are over-reliant on short-term debt, i.e., have more than 5% negative Tangible Book Value.
Administration: There are 27 companies that pass the above screen. By using the BMW Method, we have separated those into a group of 16 that has no greater chance of loss in a future Bear Market than the S&P 500 Index (see Column M of the Table under “Non-Gambling”), and a group of 11 that has a greater chance of loss (see red highlights in Column M under “Gambling”). If you do choose to invest in one of the Gambling companies, watch price-action because you’ll likely want to SELL at some point. In Columns N-P we provide data on 3 ratios that assess the overall health of Financial Statements.
Bottom Line: The purpose of stock-picking is to Beat the Market. It is very difficult, expensive, and time-consuming to do so over more than one Market Cycle. We have laid out a system for picking stocks, and back-tested it. It has a Failure Rate of 4%. In other words, 25 of the 26 stocks beat the S&P 500 Index over the past 16 years (see Column K in the Table). Just to be clear, we recommend that you dollar-average into index funds (see BENCHMARKS section of Table), and/or Berkshire Hathaway B-shares (where you would be building a position in over 100 large and mid-cap companies).
Of the 16 stocks we designate as non-gambling investments, most carry market multiples (or lower) for EV/EBITDA: GWW, UNP, CNI, WEC, APD, NEE, TRV, WMT, TGT. Those stocks are attractive for purchase if no issues arise from your further research, such as reading the Morningstar evaluation.
Risk Rating is 7 for the stock selection system outlined above. Why is that? Because of Selection Bias (https://en.wikipedia.org/wiki/Selection_bias) and Transaction Costs (http://www.investopedia.com/terms/t/transactioncosts.asp).
Full Disclosure: I dollar-average into UNP, NKE, JNJ, PG, NEE and MSFT, and also own shares of CNI, MMM, WMT, HRL, TRV, MKC, ROST, TJX, GD and CAT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 40 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends collected in 10th year), Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 45 in the Table. The ETF for that index is MDY at Line 39.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 16
Week 276 - Barron’s 500 Companies With Clean Balance Sheets and Improving Fundamentals
Situation: Stock market valuations are still in nosebleed territory. The S&P 500 Index is 25 times trailing 12-mo earnings. The cyclically-adjusted PE ratio is 27 times trailing 10-yr earnings, i.e., just shy of the last peak reached in October of 2007. You get the point, so you’re in “risk-off” mode. But you’re not going to save for the future by hiding money under your mattress. How should a prudent investor continue adding money to the market, knowing that a precipice looms? With dollar-cost averaging, an investor can add small amounts each month to stocks from several different industries, i.e., more shares per dollar when the market swoons. But which stocks? When you’re in risk-off mode, those need to be A-rated, large-capitalization stocks with improving fundamentals, and at least a 25 yr trading record.
Mission: Screen the 2016 Barron’s 500 List for companies that have improved in rank and have 25 yrs of quantitative data at the BMW Method website. Eliminate companies that don’t have a clean Balance Sheet (as defined in the Appendix for Week 271). Assess growth prospects by calculating Net Present Value (NPV) for each stock. For companies with Top 500 Global Brands, provide 2016 and 2015 brand ranks.
Execution: see Table.
Bottom Line: We’ve used a tight screen to come up with 10 companies worth dollar-averaging through a Bear Market. Three represent the Consumer Staples industry: HRL, COST, WMT. Four represent the Consumer Discretionary industry: ROST, TJX, NKE, DIS. There’s also one Industrial company (PH), an Information Technology company (ADP) and a Basic Materials company (APD). All but the 3 companies with strong brands (NKE, COST, ADP) are likely to fall in value as much as the S&P 500 Index in the next Bear Market (see Columns AC and AD in the Table). NPV calculations (see Column V in the Table) suggest that buying shares in any of the 10 companies would result in a greater gain after 10 yrs than buying shares in the lowest cost S&P 500 Index fund (VFINX at Line 18 in the Table).
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, and gold = 10)
Full Disclosure: I dollar-average into NKE and also own shares of ROST, TJX, HRL and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate for this week is the25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/), done to emphasize “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Screen the 2016 Barron’s 500 List for companies that have improved in rank and have 25 yrs of quantitative data at the BMW Method website. Eliminate companies that don’t have a clean Balance Sheet (as defined in the Appendix for Week 271). Assess growth prospects by calculating Net Present Value (NPV) for each stock. For companies with Top 500 Global Brands, provide 2016 and 2015 brand ranks.
Execution: see Table.
Bottom Line: We’ve used a tight screen to come up with 10 companies worth dollar-averaging through a Bear Market. Three represent the Consumer Staples industry: HRL, COST, WMT. Four represent the Consumer Discretionary industry: ROST, TJX, NKE, DIS. There’s also one Industrial company (PH), an Information Technology company (ADP) and a Basic Materials company (APD). All but the 3 companies with strong brands (NKE, COST, ADP) are likely to fall in value as much as the S&P 500 Index in the next Bear Market (see Columns AC and AD in the Table). NPV calculations (see Column V in the Table) suggest that buying shares in any of the 10 companies would result in a greater gain after 10 yrs than buying shares in the lowest cost S&P 500 Index fund (VFINX at Line 18 in the Table).
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, and gold = 10)
Full Disclosure: I dollar-average into NKE and also own shares of ROST, TJX, HRL and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate for this week is the25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/), done to emphasize “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 21
Week 268 - "Buy and Hold" Barron’s 500 Growth Stocks
Situation: Every investor has to know when to leave the party. Or, as Warren Buffett says, “be fearful when others are greedy and greedy when others are fearful.”
Mission: Design a template for leaving the party.
Execution: You’ll need a Central Thought. Mine is to stay invested in growth stocks, the ones that do badly in a recession. That means continue to invest in companies from the following 6 S&P industries: Consumer Discretionary, Financial, Information Technology, Industrial, Basic Materials, and Energy. The trick is to dump stocks with problematic Balance Sheets and buy stocks with clean Balance Sheets.
Administration: Start by defining a clean Balance Sheet. Accountants do this by picking their favorite ratios. My favorite ratios are (see Columns Y thru AB in the Table):
1. Total Debt:Equity is under 200%. That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is under 30%. Long-term debt has to either be renewed upon maturity or returned to the lender. In a crisis, the rate of interest that bankers charge for a renewal loan (called a “rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling company assets at firesale prices or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies in the perceived value of their brand.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow.
There are other ways to know a company is likely to come through a Bear Market or recession unharmed. S&P stock and bond ratings are worth taking seriously: try to hold stock in A-rated companies (see Columns P and Q in the Table). Stick to companies with multiple product lines, i.e., those large enough to warrant inclusion in the Barron’s 500 List (see Columns N and O in the Table). That list ranks companies by cash flow and revenue. You can tell how a company is doing by comparing this year’s rank to last year’s.
You’ll also want to restrict your choices to companies that pay growing dividends, even if the dividend is low. An S&P Dividend Achiever is a company that has raised its dividend annually for the past 10 yrs. With one exception, all of the companies in this week’s Table are Dividend Achievers. Union Pacific is the exception but UNP will become a Dividend Achiever next February with a scheduled dividend increase.
Bottom Line: You can’t hope to keep up with the lowest-cost S&P 500 Index fund (VFINX at Line 21 in the Table) unless you stay invested in growth stocks. So, learn to pick growth stocks with clean Balance Sheets. Those are the ones likely to hold value in a Bear Market. Invest small amounts at a time by dollar-averaging your stock purchases automatically online. Then you’re certain to buy more shares per dollar invested when the market’s down.
Risk Rating: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into NKE, MSFT and UNP, and also own shares of ROST, TJX, MMM, and EMR.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days, corrected for transaction costs of 2.5% when buying ~$5000 worth of shares. Dividend Growth Rate is the dividend CAGR for the past 16 years. Price Growth Rate is mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/). Price Return from selling all shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Design a template for leaving the party.
Execution: You’ll need a Central Thought. Mine is to stay invested in growth stocks, the ones that do badly in a recession. That means continue to invest in companies from the following 6 S&P industries: Consumer Discretionary, Financial, Information Technology, Industrial, Basic Materials, and Energy. The trick is to dump stocks with problematic Balance Sheets and buy stocks with clean Balance Sheets.
Administration: Start by defining a clean Balance Sheet. Accountants do this by picking their favorite ratios. My favorite ratios are (see Columns Y thru AB in the Table):
1. Total Debt:Equity is under 200%. That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is under 30%. Long-term debt has to either be renewed upon maturity or returned to the lender. In a crisis, the rate of interest that bankers charge for a renewal loan (called a “rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling company assets at firesale prices or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies in the perceived value of their brand.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow.
There are other ways to know a company is likely to come through a Bear Market or recession unharmed. S&P stock and bond ratings are worth taking seriously: try to hold stock in A-rated companies (see Columns P and Q in the Table). Stick to companies with multiple product lines, i.e., those large enough to warrant inclusion in the Barron’s 500 List (see Columns N and O in the Table). That list ranks companies by cash flow and revenue. You can tell how a company is doing by comparing this year’s rank to last year’s.
You’ll also want to restrict your choices to companies that pay growing dividends, even if the dividend is low. An S&P Dividend Achiever is a company that has raised its dividend annually for the past 10 yrs. With one exception, all of the companies in this week’s Table are Dividend Achievers. Union Pacific is the exception but UNP will become a Dividend Achiever next February with a scheduled dividend increase.
Bottom Line: You can’t hope to keep up with the lowest-cost S&P 500 Index fund (VFINX at Line 21 in the Table) unless you stay invested in growth stocks. So, learn to pick growth stocks with clean Balance Sheets. Those are the ones likely to hold value in a Bear Market. Invest small amounts at a time by dollar-averaging your stock purchases automatically online. Then you’re certain to buy more shares per dollar invested when the market’s down.
Risk Rating: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into NKE, MSFT and UNP, and also own shares of ROST, TJX, MMM, and EMR.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days, corrected for transaction costs of 2.5% when buying ~$5000 worth of shares. Dividend Growth Rate is the dividend CAGR for the past 16 years. Price Growth Rate is mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/). Price Return from selling all shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 5
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 3
Week 248 - A-rated S&P 500 Growth Companies That Are Dividend Achievers And Have A Durable Competitive Advantage
Situation: Stocks are tricky investments to own, particularly “growth” stocks. How should you get started? You know by now that we believe the investor with less than a million dollars in net worth should focus on owning stock in S&P 500 companies. We particularly like those in the annual Barron’s 500 List of US and Canadian companies with the highest revenues. Stock prices reflect expected earnings growth. An easy way to find companies with steady earnings growth is to look for S&P’s Dividend Achievers, i.e., companies that have been increasing their dividend annually for at least the past 10 yrs. S&P also helps us by assigning each company in the S&P 500 Index to one of 10 industries, 6 of which are “growth” industries: Energy, Basic Materials, Financials, Industrials, Consumer Discretionary, and Information Technology.
It helps to know how a company is capitalized. Does it mainly depend on selling common stock to attract investors, or does it prefer to float bond issues and sell preferred stock? If the answer is bonds and preferred stock, then the company’s book value will mainly reflect its brand value. (Accountants call that an “intangible” asset.) But if the answer is common stock, “tangible” assets may have more value than all the company’s liabilities. In other words, the company has what accountants call Tangible Book Value (TBV). If its stock price is no more than ~15 times TBV, it is undeniably solvent.
Mission: Develop a spreadsheet of growth companies in the Barron’s 500 List that are both Dividend Achievers and undeniably solvent. Focus on those with at least a 15 year trading history, taking care to exclude any with an S&P Bond Rating lower than A- or an S&P Stock Rating lower than A-/M. Then check to be sure TBV growth has at least doubled over the past decade and there haven’t been any more than 3 down years for TBV. In other words, the company meets Warren Buffett’s requirements for having a Durable Competitive Advantage (see Week 238).
Execution: There are only 5 companies that meet our criteria (see Table). In the aggregate, they’re no riskier than our key benchmark, VBINX at Line 12 in the Table. VBINX is essentially an S&P 500 Index fund that is 40% hedged with high quality bonds. Note in Column C of the Table that Total Returns over the past 2+ market cycles have been more than 3 times higher than the benchmark’s.
Bottom Line: If you’re new to stock picking, you’ve probably been confining your attention to “defensive” stocks, which are those issued by companies in the HealthCare, Utilities, Consumer Staples, and Communication Services industries. Your next step is to think about owning shares in “growth” stocks issued by companies in the Information Technology, Financial Services, Industrial, Consumer Discretionary, Basic Materials, and Energy industries. Those are riskier but have greater long-term returns. You can get help deciding which to own by screening for companies that a) grow their dividend reliably, b) have large revenues, c) have a Tangible Book Value (TBV), and d) meet Warren Buffett’s requirements for having a Durable Competitive Advantage (DCA): steady TBV growth that has at least doubled TBV over the past decade (i.e., growth of more than 7.1%/yr). We’ve run that screen and find that only 5 companies meet our requirements (see Table).
Risk Rating: 6
Full Disclosure: I dollar-average into NKE, MSFT and XOM, and also own shares of ROST and TJX.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX. Total Returns in Column C date to 9/1/2000, a peak of the S&P 500 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
It helps to know how a company is capitalized. Does it mainly depend on selling common stock to attract investors, or does it prefer to float bond issues and sell preferred stock? If the answer is bonds and preferred stock, then the company’s book value will mainly reflect its brand value. (Accountants call that an “intangible” asset.) But if the answer is common stock, “tangible” assets may have more value than all the company’s liabilities. In other words, the company has what accountants call Tangible Book Value (TBV). If its stock price is no more than ~15 times TBV, it is undeniably solvent.
Mission: Develop a spreadsheet of growth companies in the Barron’s 500 List that are both Dividend Achievers and undeniably solvent. Focus on those with at least a 15 year trading history, taking care to exclude any with an S&P Bond Rating lower than A- or an S&P Stock Rating lower than A-/M. Then check to be sure TBV growth has at least doubled over the past decade and there haven’t been any more than 3 down years for TBV. In other words, the company meets Warren Buffett’s requirements for having a Durable Competitive Advantage (see Week 238).
Execution: There are only 5 companies that meet our criteria (see Table). In the aggregate, they’re no riskier than our key benchmark, VBINX at Line 12 in the Table. VBINX is essentially an S&P 500 Index fund that is 40% hedged with high quality bonds. Note in Column C of the Table that Total Returns over the past 2+ market cycles have been more than 3 times higher than the benchmark’s.
Bottom Line: If you’re new to stock picking, you’ve probably been confining your attention to “defensive” stocks, which are those issued by companies in the HealthCare, Utilities, Consumer Staples, and Communication Services industries. Your next step is to think about owning shares in “growth” stocks issued by companies in the Information Technology, Financial Services, Industrial, Consumer Discretionary, Basic Materials, and Energy industries. Those are riskier but have greater long-term returns. You can get help deciding which to own by screening for companies that a) grow their dividend reliably, b) have large revenues, c) have a Tangible Book Value (TBV), and d) meet Warren Buffett’s requirements for having a Durable Competitive Advantage (DCA): steady TBV growth that has at least doubled TBV over the past decade (i.e., growth of more than 7.1%/yr). We’ve run that screen and find that only 5 companies meet our requirements (see Table).
Risk Rating: 6
Full Disclosure: I dollar-average into NKE, MSFT and XOM, and also own shares of ROST and TJX.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX. Total Returns in Column C date to 9/1/2000, a peak of the S&P 500 Index.
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Sunday, January 10
Week 236 - A 10-Stock Retirement Portfolio (One Stock For Each S&P Industry)
Situation: If you don’t want to depend entirely on index funds to fund your retirement, you’ll need a plan for buying stocks. One approach is to only choose stocks from defensive industries, i.e., Consumer Staples, HealthCare, Utilities and Communication Services (see Week 231). Another strategy would be to have all 10 S&P industries represented, which would make your portfolio more diversified. (Academic studies show that returns are higher from owning stocks that are diversified across industries.)
Mission: Pick one stock from each of the 10 S&P industries, meaning the 4 defensive industries listed above, plus Industrials, Financial Services, Consumer Discretionary, Information Technology, Basic Materials, and Energy.
Execution: To avoid “cherry-picking” from a list of currently impressive stocks, I’ll simply present the 10 stocks in the S&P 100 list that I dollar-average into (see Table). To be complete, 9 alternates from the S&P 100 Index are listed.
Administration: Five of the stocks can be purchased online and without additional fees by making pre-programed monthly additions with automatic dividend reinvestment using computershare: Exxon Mobil (XOM), NextEra Energy (NEE), Abbott Laboratories (ABT), IBM (IBM) and Union Pacific (UNP). One exception is that IBM levies a 2% fee for reinvesting dividends. The remaining 5 stocks are available at reasonable cost, also from computershare: Monsanto (MON), JP Morgan (JPM), PepsiCo (PEP), AT&T (T), and Nike (NKE). 10-yr US Treasury Notes can be purchased at no cost at treasurydirect but automatic purchase is not available and you’ll need to point-and-click each purchase, as well as reinvest interest payments. Total transaction costs per year come to ~$137 if you invest $1200 (or $19,200/yr) in each of the 10 stocks and 6 Treasury bonds. This results in an expense ratio of 0.71% (see Column U in the Table).
Bottom Line: We’ve shown that you can dollar-average $100/mo into one stock for each S&P industry, and back that up with $600/mo in 10-yr US Treasury Notes, to achieve a total return/yr of ~7.0% dating back to the S&P 500 Index peak on 9/1/2000 (after subtracting transaction costs of 0.71%/yr). This beats our key benchmark (the Vanguard Balanced Index Fund, VBINX) by approximately 2.0%/yr without incurring additional volatility, according to standard measures (see Columns D, I, and O in the Table). However, you are responsible for the considerable risk of sampling bias, since you’ll be selecting only one stock to represent each of the 10 S&P industries.
Risk Rating: 6
Note: Metrics in the Table that are highlighted in red indicate underperformance relative to our key 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: Pick one stock from each of the 10 S&P industries, meaning the 4 defensive industries listed above, plus Industrials, Financial Services, Consumer Discretionary, Information Technology, Basic Materials, and Energy.
Execution: To avoid “cherry-picking” from a list of currently impressive stocks, I’ll simply present the 10 stocks in the S&P 100 list that I dollar-average into (see Table). To be complete, 9 alternates from the S&P 100 Index are listed.
Administration: Five of the stocks can be purchased online and without additional fees by making pre-programed monthly additions with automatic dividend reinvestment using computershare: Exxon Mobil (XOM), NextEra Energy (NEE), Abbott Laboratories (ABT), IBM (IBM) and Union Pacific (UNP). One exception is that IBM levies a 2% fee for reinvesting dividends. The remaining 5 stocks are available at reasonable cost, also from computershare: Monsanto (MON), JP Morgan (JPM), PepsiCo (PEP), AT&T (T), and Nike (NKE). 10-yr US Treasury Notes can be purchased at no cost at treasurydirect but automatic purchase is not available and you’ll need to point-and-click each purchase, as well as reinvest interest payments. Total transaction costs per year come to ~$137 if you invest $1200 (or $19,200/yr) in each of the 10 stocks and 6 Treasury bonds. This results in an expense ratio of 0.71% (see Column U in the Table).
Bottom Line: We’ve shown that you can dollar-average $100/mo into one stock for each S&P industry, and back that up with $600/mo in 10-yr US Treasury Notes, to achieve a total return/yr of ~7.0% dating back to the S&P 500 Index peak on 9/1/2000 (after subtracting transaction costs of 0.71%/yr). This beats our key benchmark (the Vanguard Balanced Index Fund, VBINX) by approximately 2.0%/yr without incurring additional volatility, according to standard measures (see Columns D, I, and O in the Table). However, you are responsible for the considerable risk of sampling bias, since you’ll be selecting only one stock to represent each of the 10 S&P industries.
Risk Rating: 6
Note: Metrics in the Table that are highlighted in red indicate underperformance relative to our key benchmark (VBINX). Metrics are current for the Sunday of publication.
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Sunday, December 20
Week 233 - Barron’s 500 “Industrials” That Are Dividend Achievers
Situation: The US dollar is outperforming all other major currencies, which decreases demand for goods shipped from the US to world markets. As a result, earnings for US industrial companies that gain most of their sales overseas have fallen 20-50%. This weighs on their stock prices but creates an opportunity for investors, provided the management of those companies is aggressively preparing for the day when other currencies recover.
Mission: Take a close look at large industrial companies and their performance over the past 3 yrs, as detailed in the 2015 Barron’s 500 List. Then determine which of those have a long history of relatively steady growth, as expressed by having a 10+ yr history of raising their dividend annually. S&P calls such companies Dividend Achievers.
Execution: All of the “industrials” that appear on both lists are found in the accompanying Table, except those that have an S&P bond rating lower than BBB+ or an S&P stock rating lower that B+/M. Information on price appreciation (over the past 25 yrs) and risk of loss, per the BMW Method, is found in Columns M through O of the Table. Four companies did not have 25-yr price appreciation data and are not included in the Table.
Bottom Line: Industrial companies, as a group, carry almost 10% higher risk of loss than the S&P 500 Index. That is offset by price appreciation that is almost twice as great. If you’re going to invest in this sector, you have to be in it for the long term and expect some rough years.
Risk Rating: 7
Full Disclosure: I own stock in UTX, ITW, MMM, and DE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Take a close look at large industrial companies and their performance over the past 3 yrs, as detailed in the 2015 Barron’s 500 List. Then determine which of those have a long history of relatively steady growth, as expressed by having a 10+ yr history of raising their dividend annually. S&P calls such companies Dividend Achievers.
Execution: All of the “industrials” that appear on both lists are found in the accompanying Table, except those that have an S&P bond rating lower than BBB+ or an S&P stock rating lower that B+/M. Information on price appreciation (over the past 25 yrs) and risk of loss, per the BMW Method, is found in Columns M through O of the Table. Four companies did not have 25-yr price appreciation data and are not included in the Table.
Bottom Line: Industrial companies, as a group, carry almost 10% higher risk of loss than the S&P 500 Index. That is offset by price appreciation that is almost twice as great. If you’re going to invest in this sector, you have to be in it for the long term and expect some rough years.
Risk Rating: 7
Full Disclosure: I own stock in UTX, ITW, MMM, and DE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 15
Week 189 - Buffett Buy Analysis of Barron’s 500 List
Situation: What factors underlie pricing for the S&P 500 Index? Is it the capital gains of the collective companies? Is it dividends? Is it stable and/or predictable interest rates? And how much do random fluctuations in the appetite of investors affect prices? With the appearance of big main-frame computers in the 1980s, academicians could start to model these questions. It turns out that only two things matter to S&P 500 Index pricing, earnings and short-term interest rates. That predicts the market may be headed for a fall, given the current expectation that the Federal Reserve will start raising short-term interest rates later this year.
In that event, you’ll want to know which stocks are best positioned to weather such a storm. I know of no other way to answer the question than to subject the 500 stocks in the Barron’s 500 List to the Buffett Buy Analysis (see Week 183 and Week 30 for details). The “BBA” is only useful if the company has been growing its wealth (Tangible Book Value) steadily over the previous decade. By “growing its wealth”, Mr. Buffett means TBV is rising at a rate over ~9%/yr. (We’ll settle for 7%.) By “steadily”, Mr. Buffett means that TBV fell no more than two yrs over the past decade. The BBA is simply an extension for 10 more yrs of the rate at which core earnings grew over the past 10 yrs. That estimates the company’s earnings for 2024, which are multiplied by the lowest P/E seen during the past decade to arrive at the expected stock price in 2024. But if the company pays a yearly dividend, that amount is multiplied by 10 and added. The expected price in 2024 is compared to the current price to give the average total return/yr over the next 10 yrs (BBA) by using a Compound Annual Growth Rate (CAGR) calculator. You’ll find the key numbers in Columns N through R of this week’s Table.
Sadly, there were only 16 companies with a BBA higher than ~7%/yr. For the most part, that is because prices have been driven up by short-term interest rates that have been under 1% for almost 6 yrs, thus making it cheap for investors to borrow money and invest it in stocks. Those currently elevated stock prices lower the CAGR that prices can achieve over the next 10 yrs.
What can we conclude from the 16 companies that passed the BBA test? For starters, two are railroads, Union Pacific (UNP) and CSX. Those industrial companies are joined by two more: Fluor (FLR) and Expeditors International of Washington (EXPD). Five additional companies are in the information technology sector: Apple (AAPL), Google (GOOGL), Oracle (ORCL), QUALCOMM (QCOM), and Cognizant Technology Solutions (CTSH). Three are Consumer Discretionary stocks: Ross Stores (ROST), Dick’s Sporting Goods (DKS), and Starbucks (SBUX). Two are oil exploration companies: Cameron International (CAM) and National Oilwell Varco (NOV). Two are financial services companies: JP Morgan Chase (JPM) and Travelers (TRV). In summary, 5 of the 10 S&P industry sectors failed to make an appearance (Consumer Staples, Healthcare, Utilities, Communication Services, and Materials), suggesting that those will be contributing little to growth.
Bottom Line: There are some bumps coming for the stock market. Prices have been inflated by cheap money and the lack of competition from bonds. Lifeboat Stocks (see Week 174) are particularly overpriced so you’ll need to maintain a program for investing in growth industries. In this week’s Table, there are 16 growth stocks that get passing grades from the Buffett Buy Analysis.
Risk Rating: 6
Full Disclosure: I dollar-average into JPM, and also own shares of QCOM.
NOTE: Metrics highlighted in red denote underperformance relative to our benchmark, VBINX; metrics are brought current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
In that event, you’ll want to know which stocks are best positioned to weather such a storm. I know of no other way to answer the question than to subject the 500 stocks in the Barron’s 500 List to the Buffett Buy Analysis (see Week 183 and Week 30 for details). The “BBA” is only useful if the company has been growing its wealth (Tangible Book Value) steadily over the previous decade. By “growing its wealth”, Mr. Buffett means TBV is rising at a rate over ~9%/yr. (We’ll settle for 7%.) By “steadily”, Mr. Buffett means that TBV fell no more than two yrs over the past decade. The BBA is simply an extension for 10 more yrs of the rate at which core earnings grew over the past 10 yrs. That estimates the company’s earnings for 2024, which are multiplied by the lowest P/E seen during the past decade to arrive at the expected stock price in 2024. But if the company pays a yearly dividend, that amount is multiplied by 10 and added. The expected price in 2024 is compared to the current price to give the average total return/yr over the next 10 yrs (BBA) by using a Compound Annual Growth Rate (CAGR) calculator. You’ll find the key numbers in Columns N through R of this week’s Table.
Sadly, there were only 16 companies with a BBA higher than ~7%/yr. For the most part, that is because prices have been driven up by short-term interest rates that have been under 1% for almost 6 yrs, thus making it cheap for investors to borrow money and invest it in stocks. Those currently elevated stock prices lower the CAGR that prices can achieve over the next 10 yrs.
What can we conclude from the 16 companies that passed the BBA test? For starters, two are railroads, Union Pacific (UNP) and CSX. Those industrial companies are joined by two more: Fluor (FLR) and Expeditors International of Washington (EXPD). Five additional companies are in the information technology sector: Apple (AAPL), Google (GOOGL), Oracle (ORCL), QUALCOMM (QCOM), and Cognizant Technology Solutions (CTSH). Three are Consumer Discretionary stocks: Ross Stores (ROST), Dick’s Sporting Goods (DKS), and Starbucks (SBUX). Two are oil exploration companies: Cameron International (CAM) and National Oilwell Varco (NOV). Two are financial services companies: JP Morgan Chase (JPM) and Travelers (TRV). In summary, 5 of the 10 S&P industry sectors failed to make an appearance (Consumer Staples, Healthcare, Utilities, Communication Services, and Materials), suggesting that those will be contributing little to growth.
Bottom Line: There are some bumps coming for the stock market. Prices have been inflated by cheap money and the lack of competition from bonds. Lifeboat Stocks (see Week 174) are particularly overpriced so you’ll need to maintain a program for investing in growth industries. In this week’s Table, there are 16 growth stocks that get passing grades from the Buffett Buy Analysis.
Risk Rating: 6
Full Disclosure: I dollar-average into JPM, and also own shares of QCOM.
NOTE: Metrics highlighted in red denote underperformance relative to our benchmark, VBINX; metrics are brought 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 19
Week 172 - Core Holdings for an Overpriced Market
Situation: The stock market is currently overpriced when assessed by several criteria. Economists, including the Nobel Laureate Robert J. Shiller, are trying to figure out why this is so. As a small investor, all you need to know is that the stocks in your portfolio that have a price/earnings (P/E) ratio higher than 20 are in a danger zone. In other words, your total return from that investment is less than 5% unless earnings improve. On a risk-adjusted basis, you’d do better parking any newly available funds in US Savings Bonds.
Even though stocks are overpriced, advantages remain for you to accumulate more for your portfolio. That is because you will receive growing dividends in retirement, however, to purchase more it is best to stick to dollar-cost averaging. Invest a little each month into an online Dividend Reinvestment Plan (DRIP). That way, you automatically smooth out the fluctuations in price. The bigger problem right now is that people prefer to cut back on investments in growth stocks when the market is overpriced. That’s not a good investment strategy, and we explain why below.
Bonds, and hard assets like gold and real estate, just don’t have the growth horizon that stocks currently have. Trouble will come for stocks from only 3 broad categories:
1. if interest rates and inflation spike upward (unlikely);
2. if companies stop growing earnings almost 10%/yr (unlikely);
3. if economic indicators herald a recession in a major economy (somewhat likely for the EuroZone and China).
Because stocks remain the asset of choice, they are becoming overpriced. In particular, the buyers of bond-like stocks (i.e., those that have historically had a good total return and increase their dividend ~10% year after year) are crowding out the sellers. Prices for strong and stable “defensive” stocks, like Abbott Laboratories (ABT) and Colgate-Palmolive (CL), drift higher than what their earnings can justify.
Does this really matter? Yes it does because timid investors see that price action and come off the sidelines to buy stock. Eventually, there’s almost no one left who wants to buy an overpriced stock and the market develops cracks. Buyers will only emerge when prices have fallen far enough for fundamental measures of value to justify the purchase. By that time, a lot of investors are underwater and are selling their Savings Bonds to fund cash-flow emergencies. The important point here is that a bear market can happen when the economy is doing just fine, as we saw on October 19, 1987. The Dow Jones Industrial Average fell 22.6% that day for no apparent reason other than “the big guys were selling their stock” because the market had gone up 44% in the previous 6 months.
For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A-/M or better. (That “M” in the denominator denotes medium risk, whereas, “L” denotes low risk.) To focus on growth companies we’ve excluded companies in the 4 “defensive” industries: healthcare, utilities, communication services, and consumer staples. The remaining 6 S&P industries are where we look for our “Core Holdings” (high-quality growth companies, see Week 102). Those industries represent 66% of the capitalization of the S&P 500 Index. Quite simply, your stock portfolio can’t capture market returns unless 2/3rds of it is in stocks issued by companies in those 6 industries: materials, energy, financial, industrial, consumer discretionary, and information technology. Even though those stocks will scare you when the market swoons, don’t sell unless the company’s “story” is broken.
Most of the stocks in the Table are fully valued at present, i.e., have elevated P/E ratios (Column J) because investors expect those companies to have strong earnings growth over the next year. You don’t know what the future will bring, so look for companies that don’t have a P/E over 20. Try to spend your research time on the few companies that have hardly any metrics highlighted in red, which denotes underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Note: Companies that don’t have a Finance Value (Column E in the Table) higher than that for VBINX were excluded, as were companies that pay a dividend that amounts to more than 55% of their earnings (the “payout ratio,” Column I Table). Finally, companies that had a lower Barron’s 500 rank in 2014 than in 2013 were excluded, unless they ranked in the top 2/3rds both years (see Columns L&M Table).
Bottom Line: There are still some bargains to be found among growth stocks. The 17 companies in the Table meet our criteria for Core Holdings, but most are overpriced (average P/E = 22). Their investors have already enjoyed a strong run (Column F Table), and many will be looking to take profits. But there are 6 companies on the list that still offer good value relative to risk: ROST, QCOM, CB, IBM, LMT, GPC.
Risk Rating: 6
Full Disclosure: I dollar-average into NKE and IBM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Even though stocks are overpriced, advantages remain for you to accumulate more for your portfolio. That is because you will receive growing dividends in retirement, however, to purchase more it is best to stick to dollar-cost averaging. Invest a little each month into an online Dividend Reinvestment Plan (DRIP). That way, you automatically smooth out the fluctuations in price. The bigger problem right now is that people prefer to cut back on investments in growth stocks when the market is overpriced. That’s not a good investment strategy, and we explain why below.
Bonds, and hard assets like gold and real estate, just don’t have the growth horizon that stocks currently have. Trouble will come for stocks from only 3 broad categories:
1. if interest rates and inflation spike upward (unlikely);
2. if companies stop growing earnings almost 10%/yr (unlikely);
3. if economic indicators herald a recession in a major economy (somewhat likely for the EuroZone and China).
Because stocks remain the asset of choice, they are becoming overpriced. In particular, the buyers of bond-like stocks (i.e., those that have historically had a good total return and increase their dividend ~10% year after year) are crowding out the sellers. Prices for strong and stable “defensive” stocks, like Abbott Laboratories (ABT) and Colgate-Palmolive (CL), drift higher than what their earnings can justify.
Does this really matter? Yes it does because timid investors see that price action and come off the sidelines to buy stock. Eventually, there’s almost no one left who wants to buy an overpriced stock and the market develops cracks. Buyers will only emerge when prices have fallen far enough for fundamental measures of value to justify the purchase. By that time, a lot of investors are underwater and are selling their Savings Bonds to fund cash-flow emergencies. The important point here is that a bear market can happen when the economy is doing just fine, as we saw on October 19, 1987. The Dow Jones Industrial Average fell 22.6% that day for no apparent reason other than “the big guys were selling their stock” because the market had gone up 44% in the previous 6 months.
For this week’s Table, we’ve listed all of the Dividend Achievers in the Barron’s 500 List that have an S&P bond rating of BBB+ or better and an S&P stock rating of A-/M or better. (That “M” in the denominator denotes medium risk, whereas, “L” denotes low risk.) To focus on growth companies we’ve excluded companies in the 4 “defensive” industries: healthcare, utilities, communication services, and consumer staples. The remaining 6 S&P industries are where we look for our “Core Holdings” (high-quality growth companies, see Week 102). Those industries represent 66% of the capitalization of the S&P 500 Index. Quite simply, your stock portfolio can’t capture market returns unless 2/3rds of it is in stocks issued by companies in those 6 industries: materials, energy, financial, industrial, consumer discretionary, and information technology. Even though those stocks will scare you when the market swoons, don’t sell unless the company’s “story” is broken.
Most of the stocks in the Table are fully valued at present, i.e., have elevated P/E ratios (Column J) because investors expect those companies to have strong earnings growth over the next year. You don’t know what the future will bring, so look for companies that don’t have a P/E over 20. Try to spend your research time on the few companies that have hardly any metrics highlighted in red, which denotes underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Note: Companies that don’t have a Finance Value (Column E in the Table) higher than that for VBINX were excluded, as were companies that pay a dividend that amounts to more than 55% of their earnings (the “payout ratio,” Column I Table). Finally, companies that had a lower Barron’s 500 rank in 2014 than in 2013 were excluded, unless they ranked in the top 2/3rds both years (see Columns L&M Table).
Bottom Line: There are still some bargains to be found among growth stocks. The 17 companies in the Table meet our criteria for Core Holdings, but most are overpriced (average P/E = 22). Their investors have already enjoyed a strong run (Column F Table), and many will be looking to take profits. But there are 6 companies on the list that still offer good value relative to risk: ROST, QCOM, CB, IBM, LMT, GPC.
Risk Rating: 6
Full Disclosure: I dollar-average into NKE and IBM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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