Situation: You’re troubled by the dominance of the S&P 500 Index. After all, it is a derivative and you wonder whether it is really the safest and most effective way to build retirement savings. Your biggest concern is that it is a capitalization-weighted index, which is a design that favors momentum investing: Mid-Cap companies that garner investor enthusiasm become included in the S&P 500 Index because their stock is appreciating; Mid-Cap companies that have managed to be included in the S&P 500 Index investors are in danger of being excluded because investors have lost their enthusiasm and the stock’s price is falling. Many investors buy/sell shares in a company’s stock because of that trend in sentiment. Fundamental sources of value (revenue, earnings, and cash flow) often have little to do with their enthusiasm, or the fact that it has evaporated. Articles in the business press may carry greater weight, and those articles may be influenced by analyses introduced by short sellers, who are betting on a fall in price, or hedge fund traders with long positions, who are betting on a rise in price. In other words, most retail investors are paying attention to market sentiment when buying or selling shares, not due diligence that comes from a careful study of a company’s prospects and Balance Sheet.
Your second biggest concern is likely to be that few S&P 500 companies have a good credit rating backing their debts. In other words, they’re paying too high a rate of interest on the bonds they’ve issued, or the bank loans they’ve taken out. The company’s Net Tangible Book Value is therefore likely to be drifting deeper into negative territory because of interest expenses, part of which are no longer tax deductible due to changes in U.S. tax law.
Both of these problems fall by the wayside if you invest in the 30 companies that make up the Dow Jones Industrial Average, either separately or together in the price-weighted Dow Jones Industrial Average Index (DIA at Line 18 in the Table). Investing in the “Dow” may be a little smarter for retirement savers than investing in the S&P 500 Index (SPY at Line 16 in the Table) for two reasons: 1) DIA has a dividend yield that is ~10% greater; 2) DIA pays dividends monthly, whereas, SPY pays dividends quarterly. A higher dividend yield means that your original investment is returned to you more quickly, which translates as a higher net present value, if other factors (e.g. dividend growth and long-term price appreciation) are not materially different.
Mission: Use our Standard Spreadsheet to illustrate how I dollar-cost average into stocks issued by 10 DJIA companies.
Execution: see Table.
Administration: It has been necessary to use 3 separate Dividend Re-Investment Plans (DRIPs) to dollar-cost average into the 10 DJIA stocks I’ve chosen (see Column AE in the Table). Those DRIPs automatically extract $100 each month for each of the 10 stocks; transaction costs average $18.68/yr (see Column AD), which includes automatic reinvestment of dividends. The expense ratio is 1.56% for each year’s investments, but expenses relative to Net Asset Value fall to less than 0.01% after 10-20 years.
Bottom Line: This week’s blog compares my long-standing pick of 10 Dow stocks (for an automatic monthly investment of $100 each using an online DRIP) to investing $1500/qtr in the entire 30-stock index (DIA) using a regional broker-dealer, which is something I’ve just started doing to facilitate comparison going forward. (You’ll see each year’s total returns in future blogs published the first week of July.)
Risk Rating: 6 (where U.S. Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: If one of the 10 stocks I’ve chosen is dropped from the Dow Jones Industrial Average (DJIA), I’ll sell those shares and use those dollars to start a DRIP with shares issued by another DJIA company.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
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Showing posts with label mid cap. Show all posts
Showing posts with label mid cap. Show all posts
Sunday, August 5
Sunday, January 8
Week 288 - Don’t Leave Money On The Table
Situation: This phrase originated with poker players. It speaks volumes and quickly came to be adopted first by the financial community, and now the First Lady. It means that you need to become aware of all the available ways to meet your goals, then find a path forward that is most worthwhile and comes with the least risk of damaging your finances. Yes, that requires you to surf the web for hours and talk with experts. But if your daughter is college-bound, you’d better help her apply for available scholarships and teach her how to draw up a “term list” for available loans. Make an appointment with her high school guidance counselor, then visit colleges with her.
The risk:reward ratio for the stock market isn’t as good as the bond market’s, but the bond market is considerably more opaque to the retail investor, and can only teach you how to grow your money slowly. The transparency of publicly-traded corporate stocks, combined with their being the most rewarding asset class, means that stocks will have to dominate your retirement savings (if you start late). There is enough information available on the internet that you can try for a long-term return of 9% a year. How? By investing in A-rated stocks that have been appreciating that fast for the past 25 yrs. If you are afraid of owning stock in such companies, that’s understandable, given that most would lose more than an S&P 500 Index fund in a market crash (see Column N in the Table). You can likely achieve a 9%/yr return at less risk by doing something as simple as dollar-averaging into the S&P 400 MidCap Index ETF (MDY), or Berkshire Hathaway (BRK-B) which is an agglomeration of over 100 mostly Mid Cap companies.
Mission: Apply the 9% rule to the Dow Jones Composite Index (65 stocks) and the S&P 100 Index.
Execution: The companies we look at have a 9% trendline rate of price appreciation, meaning a Compound Annual Growth Rate (CAGR) calculated by the “least squares” method from weekly price points over the past 25 yrs. Stocks with a recent price trend that is two standard deviations above or below the trendline price are excluded, since there is no way to confidently predict that prices will return to the trendline. All companies are required to have at least an A- credit rating from S&P and at least an A-/M stock rating. The ratio of long-term debt to total assets cannot exceed 33% (see Column N in the Table). Tangible book value per share must be no less than -6%, which is the rate for Procter & Gamble (see Column O in the Table). Dividends over the past 6 months must have been paid from free cash flow (Div/FCF as noted in Column P of the Table).
Administration: The main competition that corporate stocks face comes from corporate bonds of similar risk, which are bonds rated at the lowest “investment grade” level, i.e., below Standard & Poor’s BBB+ rating or Moody’s Baa1 rating. But bonds (or bond funds) with that rating don’t pay even half the 9% you stand to gain from well-research stocks issued by the largest corporations. For example, the interest rate for the average Moody’s US Baa corporate bond on 11/15/16 was 4.36%. Paybacks to stock investors, in the form of dividends and/or share repurchases, tend to track that Baa rate. When you own such a bond, the interest payment is made every 6 months (i.e., 2.18% of the amount you invested) and that check will reliably show up in your mailbox until the bond matures.
Contrast that to the situation for high quality stocks in our Table, which have appreciated in price at least 9%/yr over the past 25 yrs (see Column K in the Table). Those had total returns of only 2.4%/yr during the 4.5 year Housing Crisis (see Column D in the Table), even though their total returns averaged ~10%/yr over the past 16 yrs, a period that included two severe recessions (see Column C in the Table). You get the picture, which is that you’ll have to own stocks and endure volatility if you waited until age 50 to start putting 15%/yr of your salary into a retirement plan. But if you had started saving that much at age 30, you could have taken a middle road, one where you would stand to double your money every 10 yrs (i.e., get a 7.2%/yr return), and do so with less risk, by investing in a low-cost bond-heavy mutual fund like the Vanguard Wellesley Income Fund (VWINX), which returned 4.9%/yr during the 4.5 year Housing Crisis (see Line 21 in the Table).
Bottom Line: Get out your pencil sharpener and green eyeshade, because making money from stocks is a lot of trouble. To simplify that task, stick with stocks issued by the largest corporations. Or, if you lack the time or interest to become a closet financier, invest in index funds that are composed of stocks issued by smaller corporations. Why a Mid Cap index fund? Because to get the 9%/yr price appreciation that is typical of Mid Cap growth stocks, without incurring their much greater risk of bankruptcy, you’ll need to hold positions in hundreds.
Risk Rating: 6 (where 10-yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into 6 stocks in the Table (UNP, NKE, JNJ, NEE, MSFT, PG), and own shares in 6 others (CAT, MMM, HON, GD, WMT, EMR).
NOTE: Net Present Value serves a valuable purpose, in that the calculation brings together the effects of dividend yield, dividend growth, and capital appreciation--while deducting 9%/yr from the dollars contributed by each of those cash flows. A positive NPV number means you’re not leaving money on the table--as long as you’re unable to find a safer investment that more reliably pays 10%/yr long-term. NPV is a retrospective analysis. If dividend growth were to fall below the trendline established over the past 10 years, NPV would go down. If price appreciation were to fall below the trendline established over the past 25 years, NPV would go down. But if increases were to develop in either, the Net Present Value of an investment made today would increase. The trick is to confine your attention to companies that have a clean Balance Sheet (see Columns N-P in the Table). But you also need to try balancing your stock picks across all 10 S&P Industries--to avoid the considerable risk that comes from selection bias.
Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 24 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 10-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr trendline (“least squares”) 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 29 in the Table. The ETF for that index is MDY at Line 23.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The risk:reward ratio for the stock market isn’t as good as the bond market’s, but the bond market is considerably more opaque to the retail investor, and can only teach you how to grow your money slowly. The transparency of publicly-traded corporate stocks, combined with their being the most rewarding asset class, means that stocks will have to dominate your retirement savings (if you start late). There is enough information available on the internet that you can try for a long-term return of 9% a year. How? By investing in A-rated stocks that have been appreciating that fast for the past 25 yrs. If you are afraid of owning stock in such companies, that’s understandable, given that most would lose more than an S&P 500 Index fund in a market crash (see Column N in the Table). You can likely achieve a 9%/yr return at less risk by doing something as simple as dollar-averaging into the S&P 400 MidCap Index ETF (MDY), or Berkshire Hathaway (BRK-B) which is an agglomeration of over 100 mostly Mid Cap companies.
Mission: Apply the 9% rule to the Dow Jones Composite Index (65 stocks) and the S&P 100 Index.
Execution: The companies we look at have a 9% trendline rate of price appreciation, meaning a Compound Annual Growth Rate (CAGR) calculated by the “least squares” method from weekly price points over the past 25 yrs. Stocks with a recent price trend that is two standard deviations above or below the trendline price are excluded, since there is no way to confidently predict that prices will return to the trendline. All companies are required to have at least an A- credit rating from S&P and at least an A-/M stock rating. The ratio of long-term debt to total assets cannot exceed 33% (see Column N in the Table). Tangible book value per share must be no less than -6%, which is the rate for Procter & Gamble (see Column O in the Table). Dividends over the past 6 months must have been paid from free cash flow (Div/FCF as noted in Column P of the Table).
Administration: The main competition that corporate stocks face comes from corporate bonds of similar risk, which are bonds rated at the lowest “investment grade” level, i.e., below Standard & Poor’s BBB+ rating or Moody’s Baa1 rating. But bonds (or bond funds) with that rating don’t pay even half the 9% you stand to gain from well-research stocks issued by the largest corporations. For example, the interest rate for the average Moody’s US Baa corporate bond on 11/15/16 was 4.36%. Paybacks to stock investors, in the form of dividends and/or share repurchases, tend to track that Baa rate. When you own such a bond, the interest payment is made every 6 months (i.e., 2.18% of the amount you invested) and that check will reliably show up in your mailbox until the bond matures.
Contrast that to the situation for high quality stocks in our Table, which have appreciated in price at least 9%/yr over the past 25 yrs (see Column K in the Table). Those had total returns of only 2.4%/yr during the 4.5 year Housing Crisis (see Column D in the Table), even though their total returns averaged ~10%/yr over the past 16 yrs, a period that included two severe recessions (see Column C in the Table). You get the picture, which is that you’ll have to own stocks and endure volatility if you waited until age 50 to start putting 15%/yr of your salary into a retirement plan. But if you had started saving that much at age 30, you could have taken a middle road, one where you would stand to double your money every 10 yrs (i.e., get a 7.2%/yr return), and do so with less risk, by investing in a low-cost bond-heavy mutual fund like the Vanguard Wellesley Income Fund (VWINX), which returned 4.9%/yr during the 4.5 year Housing Crisis (see Line 21 in the Table).
Bottom Line: Get out your pencil sharpener and green eyeshade, because making money from stocks is a lot of trouble. To simplify that task, stick with stocks issued by the largest corporations. Or, if you lack the time or interest to become a closet financier, invest in index funds that are composed of stocks issued by smaller corporations. Why a Mid Cap index fund? Because to get the 9%/yr price appreciation that is typical of Mid Cap growth stocks, without incurring their much greater risk of bankruptcy, you’ll need to hold positions in hundreds.
Risk Rating: 6 (where 10-yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into 6 stocks in the Table (UNP, NKE, JNJ, NEE, MSFT, PG), and own shares in 6 others (CAT, MMM, HON, GD, WMT, EMR).
NOTE: Net Present Value serves a valuable purpose, in that the calculation brings together the effects of dividend yield, dividend growth, and capital appreciation--while deducting 9%/yr from the dollars contributed by each of those cash flows. A positive NPV number means you’re not leaving money on the table--as long as you’re unable to find a safer investment that more reliably pays 10%/yr long-term. NPV is a retrospective analysis. If dividend growth were to fall below the trendline established over the past 10 years, NPV would go down. If price appreciation were to fall below the trendline established over the past 25 years, NPV would go down. But if increases were to develop in either, the Net Present Value of an investment made today would increase. The trick is to confine your attention to companies that have a clean Balance Sheet (see Columns N-P in the Table). But you also need to try balancing your stock picks across all 10 S&P Industries--to avoid the considerable risk that comes from selection bias.
Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 24 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 10-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr trendline (“least squares”) 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 29 in the Table. The ETF for that index is MDY at Line 23.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 1
Week 287 - Learn To Earn 9%/yr From Stocks Long-term
Situation: It is not difficult to pick 6 defensive stocks that will earn 6%/yr long-term (see Week 269). But try to pick 6 diversified stocks that will earn 9%/yr long-term without scaring you half to death. That is an order of magnitude more difficult but can be accomplished. Along the way, you’ll learn how not to “leave money on the table.”
Mission: Produce a spreadsheet that incorporates key tactics for picking stocks, limiting the sample to stocks in the S&P 100 Index that 1) had total returns/yr of at least 9% over the past 16 and 25 yr stretches; 2) had total returns/yr of at least 0% during the Housing Crisis (4/07-10/11); 3) have at least a market yield (currently 1.9%); 4) have had dividend growth of at least 9%/yr over the past 5 yrs; 5) have had trendline (“least squares” method) price growth of at least 9%/yr over the past 25 yrs; 6) have a clean Balance Sheet, meaning that long-term debt is no greater than 1/3rd of total assets, the company has Tangible Book Value (barring temporary short-term indebtedness to complete an acquisition), and the company is able to pay dividends from Free Cash Flow; 7) the S&P rating on the company’s long-term debt is no lower than A-; 8) the S&P rating on the company’s stock is no lower than B+/M.
Execution: We find 6 companies that satisfy all requirements (see Table).
Administration: For efficacy, the key tools we use are to 1) select from a pool of “mega-cap” companies, specifically those in the S&P 100 Index because it has an important safety feature: efficient “price discovery” based on the requirement that listed companies actively trade put and call options at the Chicago Board Options Exchange (CBOE); 2) demonstrate that Net Present Value is a positive number when using a 9% Discount Rate and 10-yr Holding Period. For safety, our key tools are to 1) calculate 3 ratios for determining whether or not the company has a clean balance sheet, and 2) select from companies that have a market yield or better.
Bottom Line: Stock-picking at this level requires research time, focus, money, and enough discipline to avoid the two great dangers that Warren Buffett has identified: “I’ve seen more people fail because of liquor and leverage — leverage being borrowed money.” Getting a 9%/yr return over time is mainly about amortizing risk through diversification, which can be accomplished more safely and efficiently by dollar-averaging into a “Mid Cap Blend” index fund, like the SPDR MidCap 400 Index ETF (MDY), or Berkshire Hathaway (BRK-B) which is an agglomeration of 100 mostly Mid Cap companies. During the Housing Crisis (4/07-10/11), MDY and BRK-B had total returns/yr of -0.7% and -0.3%, respectively (see Column D in the Table).
Caveat: By “shooting for the moon” like this, you will hone your stock-picking skills but also lose a lot of money from time to time (at least on paper). In other words, you would be fully committing to market risk. So, start by regularly investing small amounts in MDY and BRK-B. Then pause to reassess. Move on to Blue Chip companies (i.e., the 30 companies in the Dow Jones Industrial Index) that carry low risk and almost meet our criteria, such as Procter & Gamble (PG at Line 11 in the Table), which only grows dividends 5.0%/yr. PG clears our other hurdles and has a positive NPV at the 9% discount rate (see Column Y in the Table).
Risk Rating: 6 (where 10-yr Treasuries = 1, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, PG, and NEE, and also own shares of AAPL, HON, CAT, and MMM.
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 (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 25-Yr trendline (“least squares”) 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 23 in the Table. The ETF for that index is MDY at Line 16.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Produce a spreadsheet that incorporates key tactics for picking stocks, limiting the sample to stocks in the S&P 100 Index that 1) had total returns/yr of at least 9% over the past 16 and 25 yr stretches; 2) had total returns/yr of at least 0% during the Housing Crisis (4/07-10/11); 3) have at least a market yield (currently 1.9%); 4) have had dividend growth of at least 9%/yr over the past 5 yrs; 5) have had trendline (“least squares” method) price growth of at least 9%/yr over the past 25 yrs; 6) have a clean Balance Sheet, meaning that long-term debt is no greater than 1/3rd of total assets, the company has Tangible Book Value (barring temporary short-term indebtedness to complete an acquisition), and the company is able to pay dividends from Free Cash Flow; 7) the S&P rating on the company’s long-term debt is no lower than A-; 8) the S&P rating on the company’s stock is no lower than B+/M.
Execution: We find 6 companies that satisfy all requirements (see Table).
Administration: For efficacy, the key tools we use are to 1) select from a pool of “mega-cap” companies, specifically those in the S&P 100 Index because it has an important safety feature: efficient “price discovery” based on the requirement that listed companies actively trade put and call options at the Chicago Board Options Exchange (CBOE); 2) demonstrate that Net Present Value is a positive number when using a 9% Discount Rate and 10-yr Holding Period. For safety, our key tools are to 1) calculate 3 ratios for determining whether or not the company has a clean balance sheet, and 2) select from companies that have a market yield or better.
Bottom Line: Stock-picking at this level requires research time, focus, money, and enough discipline to avoid the two great dangers that Warren Buffett has identified: “I’ve seen more people fail because of liquor and leverage — leverage being borrowed money.” Getting a 9%/yr return over time is mainly about amortizing risk through diversification, which can be accomplished more safely and efficiently by dollar-averaging into a “Mid Cap Blend” index fund, like the SPDR MidCap 400 Index ETF (MDY), or Berkshire Hathaway (BRK-B) which is an agglomeration of 100 mostly Mid Cap companies. During the Housing Crisis (4/07-10/11), MDY and BRK-B had total returns/yr of -0.7% and -0.3%, respectively (see Column D in the Table).
Caveat: By “shooting for the moon” like this, you will hone your stock-picking skills but also lose a lot of money from time to time (at least on paper). In other words, you would be fully committing to market risk. So, start by regularly investing small amounts in MDY and BRK-B. Then pause to reassess. Move on to Blue Chip companies (i.e., the 30 companies in the Dow Jones Industrial Index) that carry low risk and almost meet our criteria, such as Procter & Gamble (PG at Line 11 in the Table), which only grows dividends 5.0%/yr. PG clears our other hurdles and has a positive NPV at the 9% discount rate (see Column Y in the Table).
Risk Rating: 6 (where 10-yr Treasuries = 1, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, PG, and NEE, and also own shares of AAPL, HON, CAT, and MMM.
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 (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 25-Yr trendline (“least squares”) 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 23 in the Table. The ETF for that index is MDY at Line 16.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 27
Week 282 - “Moneyball” Revisited: The Art of Investing in MidCap Stocks
Situation: The S&P 400 MidCap Index is a very good investment. So let’s dig deeper and ask whether there are MidCap stocks that might represent an even better investment? We’ve toyed with this idea in the past (see Week 263 - “Bond-like” Stocks That Fly Under The Radar). Now we undertake a systematic study.
Mission: Make a spreadsheet based on the 65 Dividend Achievers in the S&P MidCap 400 Index. Then remove companies that don’t have 16-yr trading records, or S&P stock ratings of at least B+/M. Remove companies where long-term debt accounts for more than 1/3rd of Total Assets, as well as companies that have been unable to make dividend payments over the past 2 quarters exclusively from Free Cash Flow, or have a Return on Invested Capital (ROIC) that is less than their Weighted Average Cost of Capital (WACC).
Execution: We find that only 8 companies meet our criteria (see Table).
Administration: Only one of those companies, Owens & Minor (OMI), pays a good and growing dividend. However, OMI had a total return of less than 6%/yr over the past 5 yrs, whereas, the other 7 companies returned at least 11%/yr. The good news is that 5 of those beat MDY (the S&P 400 Index ETF at Line 19 in the Table) and two (CHD and SON) are likely to lose less than the S&P 400 MidCap Index in the next Bear Market (see Column M in the Table).
Bottom Line: None of these stocks looks to be a good “stand alone” bet. MidCap companies rarely have more than one product line. So, you would need to own stock in several to take advantage of “MidCap growth”. You would also have to pick those stocks to achieve an overall result that minimizes areas of vulnerability but maximizes areas of strength. That statistical exercise is now called “moneyball,” after the book by Michael Lewis (and hit movie) that explains how a young economist brought success to a major league baseball team that could only afford “MidCap players”.
Risk Rating: 6 (for owning stock in all 8 companies)
Full Disclosure: I do not own stock in any of these companies, but do own shares of ARTMX (the “MidCap Blend” Mutual Fund at Line 18 in the Table) and a 401(k) clone of VEXMX (the “MidCap Blend” Index Fund at Line 21).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 20 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 the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (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% is designed to approximate Total Returns/yr from a stock index of similar risk (S&P 400 MidCap Index at Line 26) to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Make a spreadsheet based on the 65 Dividend Achievers in the S&P MidCap 400 Index. Then remove companies that don’t have 16-yr trading records, or S&P stock ratings of at least B+/M. Remove companies where long-term debt accounts for more than 1/3rd of Total Assets, as well as companies that have been unable to make dividend payments over the past 2 quarters exclusively from Free Cash Flow, or have a Return on Invested Capital (ROIC) that is less than their Weighted Average Cost of Capital (WACC).
Execution: We find that only 8 companies meet our criteria (see Table).
Administration: Only one of those companies, Owens & Minor (OMI), pays a good and growing dividend. However, OMI had a total return of less than 6%/yr over the past 5 yrs, whereas, the other 7 companies returned at least 11%/yr. The good news is that 5 of those beat MDY (the S&P 400 Index ETF at Line 19 in the Table) and two (CHD and SON) are likely to lose less than the S&P 400 MidCap Index in the next Bear Market (see Column M in the Table).
Bottom Line: None of these stocks looks to be a good “stand alone” bet. MidCap companies rarely have more than one product line. So, you would need to own stock in several to take advantage of “MidCap growth”. You would also have to pick those stocks to achieve an overall result that minimizes areas of vulnerability but maximizes areas of strength. That statistical exercise is now called “moneyball,” after the book by Michael Lewis (and hit movie) that explains how a young economist brought success to a major league baseball team that could only afford “MidCap players”.
Risk Rating: 6 (for owning stock in all 8 companies)
Full Disclosure: I do not own stock in any of these companies, but do own shares of ARTMX (the “MidCap Blend” Mutual Fund at Line 18 in the Table) and a 401(k) clone of VEXMX (the “MidCap Blend” Index Fund at Line 21).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 20 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 the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (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% is designed to approximate Total Returns/yr from a stock index of similar risk (S&P 400 MidCap Index at Line 26) to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount.
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Sunday, November 20
Week 281 - Investing for Capital Gains
Situation: Don’t leave money on the table. That means don’t accept a lower rate of return when you could get a higher rate of return by investing in the same asset class while taking the same risk.
This week we’ll focus on A-rated companies with over 9%/yr long-term growth in both Dividend and Price. Investing for Capital Gains starts with avoiding stocks that grow their dividends slower than 9%/yr. Why? Because you’ll soon find that 80% of the worthwhile companies are S&P Dividend Achievers, companies that have raised their dividend each year for at least the past 10+ years. Your benchmark is the S&P 400 MidCap Index, or its ETF (MDY). That index has a long-term growth rate of 9-10%/yr, which is higher than the growth rate for the S&P 500 Index while having a lower risk of loss (see Columns K & M at Lines 32 & 33 in the Table).
Mission: Make a spreadsheet of Dividend Achievers that have 1) grown their dividend at least 9%/yr over the past 10 yrs, and 2) have demonstrated price appreciation of at least 9%/yr over the past 25 yrs. We define price appreciation statistically, i.e., as the trendline derived from a “least squares” calculation of Standard Deviation for weekly price points . We exclude companies that have either an S&P stock rating lower than A-/M or an S&P bond rating lower than A-. We also exclude companies having a) Long-Term debt that amounts to more than 1/3rd of total assets (see Column N of the Table), b) insufficient revenue to be on the Barron’s 500 List published 4/30/16, c) insufficient Free Cash Flow in the most recent two quarters to fund their dividend (see Column O of the Table), and d) negative Tangible Book Value (see Column P in the Table). We also exclude any companies with a Weighted Average Cost of Capital (WACC) that exceeds their Return on Invested Capital (ROIC), as shown in Columns AB & AC of the Table. In other words, all of the companies listed have a clean Balance Sheet.
Execution: We find that 17 companies meet our requirements. Some have performed poorly under stress, i.e., during the 4.5 year Housing Crisis (e.g. the 5 stocks highlighted in red in Column D), or have a history of price volatility that predicts a greater loss in the next Bear Market than the S&P 500 Index (e.g. the 7 stocks highlighted in red in Column M not already highlighted in Column D). You might want to pay more attention to the 5 companies that had neither problem, namely, GWW, HRL, WEC, PH, APD.
Administration: Picking large-capitalization stocks for your retirement portfolio is fraught with risks, no matter how high you set the quality bar. Why? Because those companies typically have multiple product lines and strong brands, which allows them to borrow lots of money at low cost. Managers are incentivized to do this because their performance is often measured by Return on Equity (ROE). The more they use borrowed money, the higher ROE goes because returns go up while equity remains unchanged. Mid-Capitalization companies don’t yet have multiple product lines or strong brands, so their managers can’t borrow as much money. For those same reasons, it is rarely prudent to own stock in a Mid-Cap company, unless its Tangible Book Value is remarkably high. But a large aggregate of Mid-Cap companies (e.g. the S&P 400 MidCap Index) makes an excellent investment because there is little risk posed by long-term debt.
Owning individual stocks in a 401(k) through a mutual fund costs at least 1.59% more per year than owning index funds. Your costs, as an individual who likes to pick her own stocks, are at least 2%/yr more. Why would you do that? For starters, index funds are inefficient in ways that cost you almost 1%/yr. We all know another reason, which is that you can invest in Berkshire Hathaway (e.g. low-cost “B shares”) and beat the lowest-cost S&P 500 Index fund long-term while incurring less risk (compare Lines 23 & 28 in the Table). You can say the same about a few other companies, such as Johnson & Johnson at Line 22 in the Table. The cost of dollar-averaging $200/mo into JNJ stock online is 0.5%/yr.
I think the best reason to go with stock-picking is that a majority of companies in the S&P 500 Index have messy Balance Sheets and weak brands. If you confine your picks to companies with strong Balance Sheets and strong brands, as shown in Columns N through R in the Table, you will minimize losses in a downturn, as shown in Column D of the Table. Not losing money is the secret of making money. As Warren Buffett says, "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."
Bottom Line: Investing requires a disciplined approach to goals. When capital appreciation is the goal, you’ll want to use a benchmark that achieves that goal with the least risk. We think the S&P 400 MidCap Index is appropriate, given that it has 20% less risk of loss than the S&P 500 Index and 10% greater price appreciation. By using the S&P 400 MidCap Index as our benchmark, we arrive at a 9% discount rate for the Net Present Value (NPV) calculation (see Appendix to Week 256). If your growth stock selections generate a negative NPV, you’d be better off investing in MDY, the SPDR Exchange-Traded Fund that tracks the S&P 400 MidCap Index. This week’s Table has 17 Dividend Achievers with positive NPVs after being “handicapped” by the 9% discount rate. Those are worthwhile dividend-growing stocks for your retirement portfolio, as evidenced by how well their price held up during the Housing Crisis (see Column D in the Table).
Risk Rating: 6 (where 1 = 10-yr US Treasury Notes and 10 = gold bullion).
Full Disclosure: I dollar-average into MSFT, NKE, and UNP. I also own shares of ROST, TJX, HRL, WMT, and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
This week we’ll focus on A-rated companies with over 9%/yr long-term growth in both Dividend and Price. Investing for Capital Gains starts with avoiding stocks that grow their dividends slower than 9%/yr. Why? Because you’ll soon find that 80% of the worthwhile companies are S&P Dividend Achievers, companies that have raised their dividend each year for at least the past 10+ years. Your benchmark is the S&P 400 MidCap Index, or its ETF (MDY). That index has a long-term growth rate of 9-10%/yr, which is higher than the growth rate for the S&P 500 Index while having a lower risk of loss (see Columns K & M at Lines 32 & 33 in the Table).
Mission: Make a spreadsheet of Dividend Achievers that have 1) grown their dividend at least 9%/yr over the past 10 yrs, and 2) have demonstrated price appreciation of at least 9%/yr over the past 25 yrs. We define price appreciation statistically, i.e., as the trendline derived from a “least squares” calculation of Standard Deviation for weekly price points . We exclude companies that have either an S&P stock rating lower than A-/M or an S&P bond rating lower than A-. We also exclude companies having a) Long-Term debt that amounts to more than 1/3rd of total assets (see Column N of the Table), b) insufficient revenue to be on the Barron’s 500 List published 4/30/16, c) insufficient Free Cash Flow in the most recent two quarters to fund their dividend (see Column O of the Table), and d) negative Tangible Book Value (see Column P in the Table). We also exclude any companies with a Weighted Average Cost of Capital (WACC) that exceeds their Return on Invested Capital (ROIC), as shown in Columns AB & AC of the Table. In other words, all of the companies listed have a clean Balance Sheet.
Execution: We find that 17 companies meet our requirements. Some have performed poorly under stress, i.e., during the 4.5 year Housing Crisis (e.g. the 5 stocks highlighted in red in Column D), or have a history of price volatility that predicts a greater loss in the next Bear Market than the S&P 500 Index (e.g. the 7 stocks highlighted in red in Column M not already highlighted in Column D). You might want to pay more attention to the 5 companies that had neither problem, namely, GWW, HRL, WEC, PH, APD.
Administration: Picking large-capitalization stocks for your retirement portfolio is fraught with risks, no matter how high you set the quality bar. Why? Because those companies typically have multiple product lines and strong brands, which allows them to borrow lots of money at low cost. Managers are incentivized to do this because their performance is often measured by Return on Equity (ROE). The more they use borrowed money, the higher ROE goes because returns go up while equity remains unchanged. Mid-Capitalization companies don’t yet have multiple product lines or strong brands, so their managers can’t borrow as much money. For those same reasons, it is rarely prudent to own stock in a Mid-Cap company, unless its Tangible Book Value is remarkably high. But a large aggregate of Mid-Cap companies (e.g. the S&P 400 MidCap Index) makes an excellent investment because there is little risk posed by long-term debt.
Owning individual stocks in a 401(k) through a mutual fund costs at least 1.59% more per year than owning index funds. Your costs, as an individual who likes to pick her own stocks, are at least 2%/yr more. Why would you do that? For starters, index funds are inefficient in ways that cost you almost 1%/yr. We all know another reason, which is that you can invest in Berkshire Hathaway (e.g. low-cost “B shares”) and beat the lowest-cost S&P 500 Index fund long-term while incurring less risk (compare Lines 23 & 28 in the Table). You can say the same about a few other companies, such as Johnson & Johnson at Line 22 in the Table. The cost of dollar-averaging $200/mo into JNJ stock online is 0.5%/yr.
I think the best reason to go with stock-picking is that a majority of companies in the S&P 500 Index have messy Balance Sheets and weak brands. If you confine your picks to companies with strong Balance Sheets and strong brands, as shown in Columns N through R in the Table, you will minimize losses in a downturn, as shown in Column D of the Table. Not losing money is the secret of making money. As Warren Buffett says, "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."
Bottom Line: Investing requires a disciplined approach to goals. When capital appreciation is the goal, you’ll want to use a benchmark that achieves that goal with the least risk. We think the S&P 400 MidCap Index is appropriate, given that it has 20% less risk of loss than the S&P 500 Index and 10% greater price appreciation. By using the S&P 400 MidCap Index as our benchmark, we arrive at a 9% discount rate for the Net Present Value (NPV) calculation (see Appendix to Week 256). If your growth stock selections generate a negative NPV, you’d be better off investing in MDY, the SPDR Exchange-Traded Fund that tracks the S&P 400 MidCap Index. This week’s Table has 17 Dividend Achievers with positive NPVs after being “handicapped” by the 9% discount rate. Those are worthwhile dividend-growing stocks for your retirement portfolio, as evidenced by how well their price held up during the Housing Crisis (see Column D in the Table).
Risk Rating: 6 (where 1 = 10-yr US Treasury Notes and 10 = gold bullion).
Full Disclosure: I dollar-average into MSFT, NKE, and UNP. I also own shares of ROST, TJX, HRL, WMT, and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 22
Week 255 - “Buy and Hold” Mid Cap Dividend Achievers
Situation: Over long periods, Mid-Capitalization companies tend to outperform Large Capitalization companies. Mid Caps often have a more focused business plan and use less credit. Overshadowing these advantages, both the weighted average cost of capital (WACC) and the risk of bankruptcy are higher for Mid Caps. In addition, there are fewer product lines to offset poor performance, thus making these companies more difficult to analyze. Our favorite tool for following fundamental performance metrics, the Barron’s 500 List, doesn’t help us analyze Mid Caps because those don’t have sufficient revenue for inclusion. But the larger and more stable Mid Caps are easy to identify, since they’re S&P 500 companies that have been excluded from the Barron’s 500 List (a list that includes both Canadian and US companies). Mid Caps traditionally have a market capitalization of $2-10 Billion, whereas, the smaller S&P 500 companies that we reference have a market capitalization of $3-20 Billion. So, we’re stretching the Mid Cap definition.
Mission: Help investors decide which of these smaller S&P 500 companies are “Buy-and-Hold” candidates. We’ll exclude companies that haven’t outperformed the Vanguard 500 Index Fund (VFINX) over the past 16 yrs, haven’t increased their dividend annually for 10+ yrs to become Dividend Achievers, and/or haven’t obtained an S&P bond rating of at least BBB+ and an S&P stock rating of at least B+/M.
Execution: We’ll calculate the Net Present Value (NPV) of buying stock and holding it for 10 yrs. The tricky part of that calculation is picking the discount rate. We’ll use 9.0% because that is the sum of the CAGR for the S&P 400 Mid Cap Index at 7.6%/yr (see Column N at Line 22 in the Table), and the S&P 400 Mid Cap Index ETF dividend yield at 1.4% (MDY at Line 18 in the Table). The 16-yr dividend growth rate (Column H in the Table) and the 16-yr CAGR for price appreciation (Column N in the Table) are used to complete the NPV calculation on each stock. Transaction costs are 2.5% upon buying the stock and 2.5% upon selling the stock. Dividends are not re-invested.
The discount rate is supposed to be a “hurdle” rate for an investment under consideration. In other words, there needs to be a comparable investment “opportunity” with a readily determined growth rate that we’re trying to beat. That rate is then discounted or subtracted from the rate of growth of the investment under consideration. If we did beat it, the NPV is a positive number.
Bottom Line: We have found 8 Mid Cap Dividend Achievers in the S&P 500 Index. All 8 have positive Net Present Values (see Column W in the Table). NPV is important because it represents the profit you can expect (before subtracting inflation and taxes) over and above the rate at which your money would likely have grown were you to make the comparable “reference” investment. For these 8 stocks, we chose as our reference investment the Vanguard 400 MidCap Index ETF (MDY), currently growing at 9.0%/yr (the discount rate).
We have identified an interesting slice of the stock market, one where the reward/risk ratio is skewed in the direction of reward.
Risk Rating = 6 (where 1 = Treasuries and 10 = gold).
Full Disclosure: I own shares of MKC.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red reflect underperformance vs. VBINX, the Vanguard Balanced Index Fund.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Help investors decide which of these smaller S&P 500 companies are “Buy-and-Hold” candidates. We’ll exclude companies that haven’t outperformed the Vanguard 500 Index Fund (VFINX) over the past 16 yrs, haven’t increased their dividend annually for 10+ yrs to become Dividend Achievers, and/or haven’t obtained an S&P bond rating of at least BBB+ and an S&P stock rating of at least B+/M.
Execution: We’ll calculate the Net Present Value (NPV) of buying stock and holding it for 10 yrs. The tricky part of that calculation is picking the discount rate. We’ll use 9.0% because that is the sum of the CAGR for the S&P 400 Mid Cap Index at 7.6%/yr (see Column N at Line 22 in the Table), and the S&P 400 Mid Cap Index ETF dividend yield at 1.4% (MDY at Line 18 in the Table). The 16-yr dividend growth rate (Column H in the Table) and the 16-yr CAGR for price appreciation (Column N in the Table) are used to complete the NPV calculation on each stock. Transaction costs are 2.5% upon buying the stock and 2.5% upon selling the stock. Dividends are not re-invested.
The discount rate is supposed to be a “hurdle” rate for an investment under consideration. In other words, there needs to be a comparable investment “opportunity” with a readily determined growth rate that we’re trying to beat. That rate is then discounted or subtracted from the rate of growth of the investment under consideration. If we did beat it, the NPV is a positive number.
Bottom Line: We have found 8 Mid Cap Dividend Achievers in the S&P 500 Index. All 8 have positive Net Present Values (see Column W in the Table). NPV is important because it represents the profit you can expect (before subtracting inflation and taxes) over and above the rate at which your money would likely have grown were you to make the comparable “reference” investment. For these 8 stocks, we chose as our reference investment the Vanguard 400 MidCap Index ETF (MDY), currently growing at 9.0%/yr (the discount rate).
We have identified an interesting slice of the stock market, one where the reward/risk ratio is skewed in the direction of reward.
Risk Rating = 6 (where 1 = Treasuries and 10 = gold).
Full Disclosure: I own shares of MKC.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red reflect underperformance vs. VBINX, the Vanguard Balanced Index Fund.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 22
Week 229 - Stocks with 5-30 Years of Risk vs. Reward Data That Beat the S&P 500 Index
Situation: In last week’s blog (see Week 228), we turned up 6 “unicorns” (stocks with above-market returns and below market risk) over 5-16 yr holding periods. This week we’ve extended the holding period out to 30 yrs. Once again we turned up 6 unicorns (see Table) but 3 of those weren’t on last week’s list. In other words, only 3 companies in the 2015 Barron’s 500 List have outperformed the S&P 500 Index over 5, 16 and 30 yr periods while presenting the investor with a less risk than the S&P 500 Index. Those companies are Kimberly-Clark (KMB), NextEra Energy (NEE), and DTE Energy (DTE). Aside from investing in such minimally risky “defensive” stocks, you would do better by investing in the broad diversification of a low-cost S&P 500 Index fund like the Vanguard 500 Index Fund (VFINX). Or, you can seek higher returns by taking on more risk!
Mission: Develop a logical plan to have your stock portfolio outperform the S&P 500 Index by taking on more risk.
Execution: Academic studies of this problem have shown that you have two options:
1) pick stocks issued by 40+ large-capitalization companies that represent all 10 S&P industries, while avoiding those with long-term debt (see Week 158);
2) pick a low-cost stock index fund that represents the next most risky layer of the market, i.e., mid-capitalization companies covered by the S&P 400 Index. There is an exchange-traded fund that will do that for you, the SPDR MidCap 400 ETF Trust (MDY at Line 16 in the Table).
Bottom Line: If you want to beat the S&P 500 Index, you’ll have to take on more risk. Why? Because there are only 3 stocks that have had better risk-adjusted performance than the S&P 500 Index over the past 5, 16 and 30 yrs (KMB, NEE, DTE). That’s not enough! Academic studies have shown that you need to diversify your holdings across all 10 S&P industries in order to spread out risk that occurs in downturns. This means you need to hold upwards of 40 stocks in your portfolio to avoid “concentration” risk. Or, you can pick a mid-capitalization stock index fund (e.g. MDY) and save yourself a lot of trouble. Over the past 5-yr holding period, that choice would have given you better returns than the Vanguard S&P 500 Index fund (VFINX) but with a greater risk of loss (compare Lines 15 and 16 at Columns C, D and I of the Table). Over a 30-yr holding period (with regular additions through dollar-cost averaging), the returns are again greater for the Mid-Cap fund (see Lines 19 & 20 at Column M in the Table) but the risk of loss is significantly lower (see Column O at Lines 19 & 20 in the Table). This is a logical way to beat the S&P 500 Index without taking on more risk. Holding periods of 16, 20 and 25 yrs will also do that for you, per the BMW Method. Why does a Mid-Cap stock index carry less long-term risk than the S&P 500 Index? Because smaller companies have less access to long-term financing through bond sales. In other words, Mid-Cap companies have choppier earnings growth than S&P 500 companies, and are still establishing their brands. So, they are less able to attract a syndicate of banks that will back the issuance of a long-term bond with an interest rate that is lower than the company’s ROA (Return on Assets). Having no long-term debt means there is little chance of a company going bankrupt (or being acquired by another company for less than book value).
Risk Rating: 6 (because MDY will always have a higher 5-yr Beta than VFINX, which has a Risk Rating of 5, as will any broadly diversified collection of 40+ stocks).
Full Disclosure: I dollar-average into NEE.
Note: Metrics are brought current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Develop a logical plan to have your stock portfolio outperform the S&P 500 Index by taking on more risk.
Execution: Academic studies of this problem have shown that you have two options:
1) pick stocks issued by 40+ large-capitalization companies that represent all 10 S&P industries, while avoiding those with long-term debt (see Week 158);
2) pick a low-cost stock index fund that represents the next most risky layer of the market, i.e., mid-capitalization companies covered by the S&P 400 Index. There is an exchange-traded fund that will do that for you, the SPDR MidCap 400 ETF Trust (MDY at Line 16 in the Table).
Bottom Line: If you want to beat the S&P 500 Index, you’ll have to take on more risk. Why? Because there are only 3 stocks that have had better risk-adjusted performance than the S&P 500 Index over the past 5, 16 and 30 yrs (KMB, NEE, DTE). That’s not enough! Academic studies have shown that you need to diversify your holdings across all 10 S&P industries in order to spread out risk that occurs in downturns. This means you need to hold upwards of 40 stocks in your portfolio to avoid “concentration” risk. Or, you can pick a mid-capitalization stock index fund (e.g. MDY) and save yourself a lot of trouble. Over the past 5-yr holding period, that choice would have given you better returns than the Vanguard S&P 500 Index fund (VFINX) but with a greater risk of loss (compare Lines 15 and 16 at Columns C, D and I of the Table). Over a 30-yr holding period (with regular additions through dollar-cost averaging), the returns are again greater for the Mid-Cap fund (see Lines 19 & 20 at Column M in the Table) but the risk of loss is significantly lower (see Column O at Lines 19 & 20 in the Table). This is a logical way to beat the S&P 500 Index without taking on more risk. Holding periods of 16, 20 and 25 yrs will also do that for you, per the BMW Method. Why does a Mid-Cap stock index carry less long-term risk than the S&P 500 Index? Because smaller companies have less access to long-term financing through bond sales. In other words, Mid-Cap companies have choppier earnings growth than S&P 500 companies, and are still establishing their brands. So, they are less able to attract a syndicate of banks that will back the issuance of a long-term bond with an interest rate that is lower than the company’s ROA (Return on Assets). Having no long-term debt means there is little chance of a company going bankrupt (or being acquired by another company for less than book value).
Risk Rating: 6 (because MDY will always have a higher 5-yr Beta than VFINX, which has a Risk Rating of 5, as will any broadly diversified collection of 40+ stocks).
Full Disclosure: I dollar-average into NEE.
Note: Metrics are brought current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 10
Week 84 - Dividend Achievers that focus on International Sales
Situation: Last week we started a conversation about growth that is anchored around the concept of Opportunity Risk (see Week 83). The idea is that no one saving for retirement, no family saving for college, no company saving to build a broader competitive advantage, or government saving to build a broader comparative advantage can avoid RISK, since stagnation is the only alternative. They all have to consider Opportunity Risk, i.e., the risk that an expenditure will unnecessarily go toward supporting stagnation rather than growth.
Last week we talked about investing in the smaller (i.e., faster growing) companies that aren't in the S&P 500 Index. This week we’ll turn our attention to companies that capture most of their revenues from faster growing countries. Same as last week, we’ll confine our attention to Dividend Achievers--companies that have increased their dividend annually for at least 10 yrs. We’ve come up with 27 companies, all having an S&P “A” rating of both their stock and bond issues (see Table). The 17 companies in the upper part of the Table lost less than 65% as much as the S&P 500 Index during the Lehman Panic; companies that lost more are red-flagged with respect to Risk (Column D) and take their place in the lower part of the Table. Why less than 65%? Because a group of above-average hedge funds lost slightly less than 65% as much as the S&P 500 Index during the Lehman Panic (see Week 46).
Of those 17 companies in the upper part of the Table, 9 are “hedge" companies (see Week 82). In other words, they have a 5-yr Beta of less than 0.65 (indicating that even today they’d likely lose less than 65% as much as the S&P 500 Index in a bear market) AND beat the S&P 500 Index over the past 15 yrs:
McDonald’s (MCD)
Hormel Foods (HRL)
Abbott Laboratories (ABT)
International Business Machines (IBM)
Colgate-Palmolive (CL)
Johnson & Johnson (JNJ)
Kimberly-Clark (KMB)
PepsiCo (PEP)
Procter & Gamble (PG)
Investment in any of these 9 stocks doesn’t need to be backed 1:1 by a high-grade bond like an inflation-protected US Savings Bond. Do be careful to pick several rather than rely on just one because even the best stocks eventually become overpriced and have to "correct" (witness Apple’s fall from grace).
In the benchmarks at the bottom section of the Table we’ve included one of the best mutual funds focusing on international stocks (ARTIX). This table is a handy illustration of how stock selection can be used to beat mutual funds. Mutual fund managers drum up business by taking outsize risks. This results in good performance over the long haul but comes at the expense of terrible losses during bear markets. You don’t want that (or you wouldn’t be reading this blog).
Bottom Line: Companies that focus on sales from international markets are smart: they’ll grow earnings faster than the average S&P 500 company (which gets only 40% of its sales from outside the US). But it’s a hard row to hoe, so you will have to be very selective.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Last week we talked about investing in the smaller (i.e., faster growing) companies that aren't in the S&P 500 Index. This week we’ll turn our attention to companies that capture most of their revenues from faster growing countries. Same as last week, we’ll confine our attention to Dividend Achievers--companies that have increased their dividend annually for at least 10 yrs. We’ve come up with 27 companies, all having an S&P “A” rating of both their stock and bond issues (see Table). The 17 companies in the upper part of the Table lost less than 65% as much as the S&P 500 Index during the Lehman Panic; companies that lost more are red-flagged with respect to Risk (Column D) and take their place in the lower part of the Table. Why less than 65%? Because a group of above-average hedge funds lost slightly less than 65% as much as the S&P 500 Index during the Lehman Panic (see Week 46).
Of those 17 companies in the upper part of the Table, 9 are “hedge" companies (see Week 82). In other words, they have a 5-yr Beta of less than 0.65 (indicating that even today they’d likely lose less than 65% as much as the S&P 500 Index in a bear market) AND beat the S&P 500 Index over the past 15 yrs:
McDonald’s (MCD)
Hormel Foods (HRL)
Abbott Laboratories (ABT)
International Business Machines (IBM)
Colgate-Palmolive (CL)
Johnson & Johnson (JNJ)
Kimberly-Clark (KMB)
PepsiCo (PEP)
Procter & Gamble (PG)
Investment in any of these 9 stocks doesn’t need to be backed 1:1 by a high-grade bond like an inflation-protected US Savings Bond. Do be careful to pick several rather than rely on just one because even the best stocks eventually become overpriced and have to "correct" (witness Apple’s fall from grace).
In the benchmarks at the bottom section of the Table we’ve included one of the best mutual funds focusing on international stocks (ARTIX). This table is a handy illustration of how stock selection can be used to beat mutual funds. Mutual fund managers drum up business by taking outsize risks. This results in good performance over the long haul but comes at the expense of terrible losses during bear markets. You don’t want that (or you wouldn’t be reading this blog).
Bottom Line: Companies that focus on sales from international markets are smart: they’ll grow earnings faster than the average S&P 500 company (which gets only 40% of its sales from outside the US). But it’s a hard row to hoe, so you will have to be very selective.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 3
Week 83 - Low-Risk Small- and Mid-Cap Dividend Achievers
Situation: “Opportunity risk” is a phrase used by investors to denote the last consideration they check off their list before parting with hard-earned money. Spending on any investment means there will be less money available to support an even better opportunity. “Opportunity risk” is a reminder to all of us not to avoid making the chancy investments that eventually produce growth. We define these chancy investments as small & mid-cap stocks, emerging market stocks & bonds, oil & gas exploration and production companies, pipeline companies, diversified engineering companies that support infrastructure development, and food producers that support the growing world population. There is also opportunity risk for governments when they shy away from expensive but rewarding infrastructure projects that are so essential for GDP growth, like 10 gigabit/sec internet connectivity for every home and office.
Smaller companies can grow rapidly but usually have more cash flow problems and less resilience than large companies, often taking on too much debt. But even without troublesome debt and cash flow problems their stocks are often volatile. This is because investors hop on the bandwagon expecting that growth to get even more exciting but it inevitably slows. These “momentum investors” then sell at a loss, even though growth remains impressive. Apple stock (AAPL) is a current example of how the bandwagon works, and shows that even the largest companies can fall prey.
Companies that offer a good and growing dividend can usually avoid large price swings, so we have consulted the buyupside list of 199 Dividend Achievers (companies that have raised dividends annually for 10+ yrs), excluding those in the S&P 500 Index. We also require that stocks on our list meet our definition of a hedge stock (see Week 82):
a) a 15-yr annualized total return that beats the S&P 500 Index (VFINX);
b) a Lehman Panic (10/07-4/09) total return that is less than 65% as bad as the 45.6% loss in the S&P 500 Index;
c) a 5-yr Beta of less than 0.65.
Our survey has turned up 28 companies (see attached Table) but only 7 are free of red flags in metrics for efficiency (ROIC), debt (LT debt/total capitalization), and cash flow (FCF/div). Those 7 companies include two food producers (LANC & SAFM), two property & casualty insurers (HCC & WRB), one company that sells cleaning products (CHD), one that builds pipelines and collects tolls for oil & gas transportation (PAA), and one that provides conventional electricity (MGEE). Close study of the table will show that all 28 companies have remarkably strong and steady profitability.
Bottom Line: These days economic growth is constrained, so investors need to carefully take on more risk to adequately prepare for retirement. The “new normal” is a term you’ve seen by now, used to describe globally weak economic growth (due to vast amounts of debt that have to be serviced or repaid). The “new normal” clearly sums up present reality. What is less clear is that the financiers who came up with the term also think it sums up future reality. Why? Because the underlying reasons are long-term: a) governments, companies and families have borrowed too much in the expectation that the heady growth of the 1990s will come back and pay off those loans. b) But GDP growth at those 90s rates is unlikely to return because commodity prices (for oil, iron, copper, corn, soybeans, etc.) are likely to grow faster than “core inflation” when over a hundred million people/yr are emerging from poverty and wanting a better life.
Let’s take oil as an example. Think about the expense and risk of a) drilling in deep water, b) hydro-fracking for oil and gas that is locked in deeply buried shale deposits, c) bulldozing and boiling tar sands into bitumen, and d) drilling under the Arctic Ocean. Then remember that oil is the main up-front cost for running a modern economy. When energy is cheap, GDP growth is readily achieved: the growth rates for both GDP and the price of oil have been the same since 1960 at 3.1%/yr (adjusted for inflation). But oil was cheap for only the first half of that 52-yr stretch (its been tripling in price every 10 yrs for the last half). You can see the problem, and its not going to go away until cheaper and cleaner energy substitutes are developed. The only near-term solution is conservation (driven by heavy taxation of electricity, vehicles, and fuels), such as Denmark has been doing for decades.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Smaller companies can grow rapidly but usually have more cash flow problems and less resilience than large companies, often taking on too much debt. But even without troublesome debt and cash flow problems their stocks are often volatile. This is because investors hop on the bandwagon expecting that growth to get even more exciting but it inevitably slows. These “momentum investors” then sell at a loss, even though growth remains impressive. Apple stock (AAPL) is a current example of how the bandwagon works, and shows that even the largest companies can fall prey.
Companies that offer a good and growing dividend can usually avoid large price swings, so we have consulted the buyupside list of 199 Dividend Achievers (companies that have raised dividends annually for 10+ yrs), excluding those in the S&P 500 Index. We also require that stocks on our list meet our definition of a hedge stock (see Week 82):
a) a 15-yr annualized total return that beats the S&P 500 Index (VFINX);
b) a Lehman Panic (10/07-4/09) total return that is less than 65% as bad as the 45.6% loss in the S&P 500 Index;
c) a 5-yr Beta of less than 0.65.
Our survey has turned up 28 companies (see attached Table) but only 7 are free of red flags in metrics for efficiency (ROIC), debt (LT debt/total capitalization), and cash flow (FCF/div). Those 7 companies include two food producers (LANC & SAFM), two property & casualty insurers (HCC & WRB), one company that sells cleaning products (CHD), one that builds pipelines and collects tolls for oil & gas transportation (PAA), and one that provides conventional electricity (MGEE). Close study of the table will show that all 28 companies have remarkably strong and steady profitability.
Bottom Line: These days economic growth is constrained, so investors need to carefully take on more risk to adequately prepare for retirement. The “new normal” is a term you’ve seen by now, used to describe globally weak economic growth (due to vast amounts of debt that have to be serviced or repaid). The “new normal” clearly sums up present reality. What is less clear is that the financiers who came up with the term also think it sums up future reality. Why? Because the underlying reasons are long-term: a) governments, companies and families have borrowed too much in the expectation that the heady growth of the 1990s will come back and pay off those loans. b) But GDP growth at those 90s rates is unlikely to return because commodity prices (for oil, iron, copper, corn, soybeans, etc.) are likely to grow faster than “core inflation” when over a hundred million people/yr are emerging from poverty and wanting a better life.
Let’s take oil as an example. Think about the expense and risk of a) drilling in deep water, b) hydro-fracking for oil and gas that is locked in deeply buried shale deposits, c) bulldozing and boiling tar sands into bitumen, and d) drilling under the Arctic Ocean. Then remember that oil is the main up-front cost for running a modern economy. When energy is cheap, GDP growth is readily achieved: the growth rates for both GDP and the price of oil have been the same since 1960 at 3.1%/yr (adjusted for inflation). But oil was cheap for only the first half of that 52-yr stretch (its been tripling in price every 10 yrs for the last half). You can see the problem, and its not going to go away until cheaper and cleaner energy substitutes are developed. The only near-term solution is conservation (driven by heavy taxation of electricity, vehicles, and fuels), such as Denmark has been doing for decades.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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