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 oil. Show all posts
Showing posts with label oil. Show all posts
Sunday, September 9
Sunday, February 11
Week 345 - Natural Resource Companies in the Vanguard High Dividend Yield ETF
Situation: All natural resource companies have been affected by the 2014-2016 commodities crash. That event was largely driven by the rapid upgrade in commodities production and transportation that was needed to meet demand in China. That supply chain collapsed with the rapid defervescence in Chinese demand, and has only now returned to being in balance worldwide.
You have to look to the dominant commodity (oil) to understand why the crash was so sudden and deep. Just as Chinese demand was tapering off, new production (from unconventional sources like oil sands and shale) was coming online in North America. Those expensive projects had seemed worthwhile in a world where a barrel of oil was often worth over $100. Oil prices then collapsed when increased production met falling demand. The largest producer (Saudi Arabia) normally would have cut production to keep prices high. But this time the Saudis chose to increase production, hoping to force shale drillers in the United States to give up their costly projects. It didn’t work. American drillers adopted new technology (e.g. horizontal drilling), cut costs, and borrowed heavily to stay in business (even though the price of oil fell to $30/bbl).
Mission: Survey the damage done to strong commodity producers, equipment suppliers, and railroads (which often invest in their main shippers). Stick to companies listed in the US version of the FTSE High Dividend Yield Index, i.e., those in VYM (Vanguard High Dividend Yield ETF).
Execution: see Table.
Administration: We find only 3 Natural Resource-related companies in the Extended Version of “The 2 and 8 Club” (see Week 329): Caterpillar (CAT), Occidental Petroleum (OXY), and Archer Daniels Midland (ADM). We have added 3 more that are in the Vanguard High Dividend Yield Index (VYM) and meet all other requirements for membership in “The 2 and 8 Club” except the requirement that dividend growth be 8%/yr (see Column H in the Table): Norfolk Southern (NSC), Deere (DE), and Exxon Mobil (XOM).
Bottom Line: No matter how you choose to invest in commodities, you’ll be buying into a high-risk asset. You need to monitor positions daily, and have cash available to fund margin calls and attractive developments. Column D summarizes the risks you’ll face (see Table): Even the best companies lose a lot of capital in a commodities crash. And the crash always starts suddenly and goes to unanticipated extremes, leaving all players affected.
Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into XOM and own shares of CAT.
You have to look to the dominant commodity (oil) to understand why the crash was so sudden and deep. Just as Chinese demand was tapering off, new production (from unconventional sources like oil sands and shale) was coming online in North America. Those expensive projects had seemed worthwhile in a world where a barrel of oil was often worth over $100. Oil prices then collapsed when increased production met falling demand. The largest producer (Saudi Arabia) normally would have cut production to keep prices high. But this time the Saudis chose to increase production, hoping to force shale drillers in the United States to give up their costly projects. It didn’t work. American drillers adopted new technology (e.g. horizontal drilling), cut costs, and borrowed heavily to stay in business (even though the price of oil fell to $30/bbl).
Mission: Survey the damage done to strong commodity producers, equipment suppliers, and railroads (which often invest in their main shippers). Stick to companies listed in the US version of the FTSE High Dividend Yield Index, i.e., those in VYM (Vanguard High Dividend Yield ETF).
Execution: see Table.
Administration: We find only 3 Natural Resource-related companies in the Extended Version of “The 2 and 8 Club” (see Week 329): Caterpillar (CAT), Occidental Petroleum (OXY), and Archer Daniels Midland (ADM). We have added 3 more that are in the Vanguard High Dividend Yield Index (VYM) and meet all other requirements for membership in “The 2 and 8 Club” except the requirement that dividend growth be 8%/yr (see Column H in the Table): Norfolk Southern (NSC), Deere (DE), and Exxon Mobil (XOM).
Bottom Line: No matter how you choose to invest in commodities, you’ll be buying into a high-risk asset. You need to monitor positions daily, and have cash available to fund margin calls and attractive developments. Column D summarizes the risks you’ll face (see Table): Even the best companies lose a lot of capital in a commodities crash. And the crash always starts suddenly and goes to unanticipated extremes, leaving all players affected.
Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into XOM and own shares of 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
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 24
Week 338 - Alternative Investments (REITs, Pipelines, Copper, Silver and Gold)
Situation: You want to minimize losses from the next stock market crash. News Flash: The safe and effective way to do that is to have 50% of your assets in medium-term investment-grade bonds. Those will go up 10-25% whenever stocks swoon. But a plain vanilla form of protection won’t resonate with your neighbors after the crash hits. You’ll want to tell them about something cool that you did to protect yourself. And, while waiting for the next crash you don’t like the low interest income that you’d receive from a low-cost Vanguard intermediate-term investment-grade bond index fund like VBIIX or BIV. The exotic-seeming alternative is to bet on something related to land and its uses. Those bets carry valuations that track long supercycles, which overlap 3 or 4 economic cycles. But supercycles contain pitfalls for the unwary, and even for professional commodity traders.
Mission: Use our Standard Spreadsheet to examine Alternative Investments, and describe the pros and cons of owning those.
Execution: see Table.
Administration: The main bets are on real estate, oil/gas pipelines, copper, silver and gold. Traders mitigate losses during a recession by hoarding such assets until prices recover. Let’s look at the odds of success. The SEC (Securities and Exchange Commission) is responsible for guiding the average investor away from loss-making bets. For example, the SEC doesn’t allow a stock to be listed on a public exchange unless it has Tangible Book Value (TBV) and appears likely to continue having TBV after being listed. So, S&P identifies 10 Industries that have the structural profitability needed to maintain TBV and dividend payouts for retail investors.
Real Estate is not such an industry. However, S&P has started evaluating Real Estate Investment Trusts (REITs) with a view toward someday including those. However, the Financial Times of London does not include Real Estate companies in either its FTSE Global High Dividend Yield Index, or the US version of that index, which you can invest in at low cost through an ETF marketed by the Vanguard Group (VYM). Nonetheless, we’ll list what we think are the 7 best REITs in the accompanying Table.
Oil and gas pipelines offer a way to capture tax-advantaged dividend income that transcends the ups and downs of the economy, but typically requires you to buy into a Limited Partnership. To do so, the SEC requires you to be an Accredited Investor. “To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income.” You’re also liable for taxes levied by most states through which the pipelines run. As a retail investor, you aren’t going to buy shares of a Limited Partnership. So, none are listed in our Table. But a few “midstream” oil & gas companies issue common stock to help fund a large network of integrated pipelines. Those pay the same high dividends expected of Limited Partnerships, and two companies are listed in the FTSE High Dividend Yield Index for US companies (VYM): ONEOK (OKE) and Williams (WMB). This indicates that each company’s dividend policy is thought to be sustainable. ONEOK has the additional distinction of being an S&P Dividend Achiever because of 10+ years of annual dividend increases.
Gold is the traditional Alternative Investment, which also brings copper and silver into play given that all 3 are found in the same geological formations. Any copper mine that fails to process the small amounts of gold it unearths is a copper mine not worth owning. The same can be said of gold miners who ignore silver deposits. The problem for investors is that mines are costly to develop and have an unknown shelf life. So, owning common stocks issued by miners has fallen out of favor: Dividends are rare and fleeting, and long-term price appreciation is neither substantial nor steady. Nonetheless, we have listed 4 miners in the Table: Freeport McMoRan (FCX) and Southern Copper (SCCO) both focus on mining copper; Newmont Mining (NEM, focused on mining gold), and Pan American Silver (PAAS).
A better way to invest in precious metals is to buy stock in financial companies based on loaning money to miners on condition of being paid later either in royalties or ownership of a stream of product, should the mine become a successful enterprise. We have listed two such companies: Royal Gold (RGLD), which seeks royalties; Wheaton Precious Metals (WPM), which mainly seeks silver streaming contracts. See our Week 307 blog for a detailed discussion of silver.
Bottom Line: If you want to venture into Alternative Investments, and would like to take a relatively safe and effective approach, we suggest that you buy shares in the REIT ETF marketed by the Vanguard Group (VNQ at Line 19 in the Table). Better yet, stick to companies in “The 2 and 8 Club” that represent more reasonable bets in the Natural Resources space: ExxonMobil (XOM), Caterpillar (CAT), and Archer Daniels Midland (ADM). One pipeline company is also worth your consideration: ONEOK (OKE, see comments above).
Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into XOM, and also own shares of OKE, CAT and WPM.
"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
Mission: Use our Standard Spreadsheet to examine Alternative Investments, and describe the pros and cons of owning those.
Execution: see Table.
Administration: The main bets are on real estate, oil/gas pipelines, copper, silver and gold. Traders mitigate losses during a recession by hoarding such assets until prices recover. Let’s look at the odds of success. The SEC (Securities and Exchange Commission) is responsible for guiding the average investor away from loss-making bets. For example, the SEC doesn’t allow a stock to be listed on a public exchange unless it has Tangible Book Value (TBV) and appears likely to continue having TBV after being listed. So, S&P identifies 10 Industries that have the structural profitability needed to maintain TBV and dividend payouts for retail investors.
Real Estate is not such an industry. However, S&P has started evaluating Real Estate Investment Trusts (REITs) with a view toward someday including those. However, the Financial Times of London does not include Real Estate companies in either its FTSE Global High Dividend Yield Index, or the US version of that index, which you can invest in at low cost through an ETF marketed by the Vanguard Group (VYM). Nonetheless, we’ll list what we think are the 7 best REITs in the accompanying Table.
Oil and gas pipelines offer a way to capture tax-advantaged dividend income that transcends the ups and downs of the economy, but typically requires you to buy into a Limited Partnership. To do so, the SEC requires you to be an Accredited Investor. “To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income.” You’re also liable for taxes levied by most states through which the pipelines run. As a retail investor, you aren’t going to buy shares of a Limited Partnership. So, none are listed in our Table. But a few “midstream” oil & gas companies issue common stock to help fund a large network of integrated pipelines. Those pay the same high dividends expected of Limited Partnerships, and two companies are listed in the FTSE High Dividend Yield Index for US companies (VYM): ONEOK (OKE) and Williams (WMB). This indicates that each company’s dividend policy is thought to be sustainable. ONEOK has the additional distinction of being an S&P Dividend Achiever because of 10+ years of annual dividend increases.
Gold is the traditional Alternative Investment, which also brings copper and silver into play given that all 3 are found in the same geological formations. Any copper mine that fails to process the small amounts of gold it unearths is a copper mine not worth owning. The same can be said of gold miners who ignore silver deposits. The problem for investors is that mines are costly to develop and have an unknown shelf life. So, owning common stocks issued by miners has fallen out of favor: Dividends are rare and fleeting, and long-term price appreciation is neither substantial nor steady. Nonetheless, we have listed 4 miners in the Table: Freeport McMoRan (FCX) and Southern Copper (SCCO) both focus on mining copper; Newmont Mining (NEM, focused on mining gold), and Pan American Silver (PAAS).
A better way to invest in precious metals is to buy stock in financial companies based on loaning money to miners on condition of being paid later either in royalties or ownership of a stream of product, should the mine become a successful enterprise. We have listed two such companies: Royal Gold (RGLD), which seeks royalties; Wheaton Precious Metals (WPM), which mainly seeks silver streaming contracts. See our Week 307 blog for a detailed discussion of silver.
Bottom Line: If you want to venture into Alternative Investments, and would like to take a relatively safe and effective approach, we suggest that you buy shares in the REIT ETF marketed by the Vanguard Group (VNQ at Line 19 in the Table). Better yet, stick to companies in “The 2 and 8 Club” that represent more reasonable bets in the Natural Resources space: ExxonMobil (XOM), Caterpillar (CAT), and Archer Daniels Midland (ADM). One pipeline company is also worth your consideration: ONEOK (OKE, see comments above).
Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into XOM, and also own shares of OKE, CAT and WPM.
"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, October 25
Week 225 - How are the 20 Largest AgriBusiness Companies Doing?
Situation: Commodities have fallen steadily in value since the Lehman Panic. A recent further decline is related to a slowing in the pace of modernization in China, where 40% of commodity production had gone for the past 20 yrs. This has greatly compounded the problem because the rapid pace of modernization there had required remarkable growth in the production of all commodities. Now that China’s infrastructure buildout is largely complete, those upgraded mining and exploration assets in Australia, Brazil, Chile, and South Africa have been idled, and over a dozen billion dollar projects have been aborted. But those aren’t the only commodities out there. What about agricultural products? Demand for soybeans and cereal grains (e.g. barley, corn, oats, rice, rye, wheat, sorghum) is different because close to 20 million people emerge from poverty each year and are able to afford better food, which translates into a protein intake of at least 60 gm/d. The volumes of food involved in meeting that increased demand make it necessary to combine the “green revolution” with “factory farms.” That combination has come to be called “AgriBusiness.” AgriBusiness is focused on efficiently getting water to soil that has been prepared to support the germination of designer seeds through “agronomy.” Agronomy is shorthand for the scientific use of fertilizers, insecticides, and fungicides to optimize plant growth around weather patterns and irrigation systems that meet water needs.
Mission: Assemble data on stocks representing the 20 largest AgriBusiness companies, and compare their aggregate performance with broad commodity indices--as well as narrower indices that reflect the performance of farming, mining, and energy companies.
Execution: AgriBusiness companies are high risk investments, and each has only a small piece of the pie. In order to compete against one another, each has to maintain a market for its goods and services in dozens of countries. Only 4 of the 20 identified AgriBusinesses are stable enough to warrant inclusion in a retirement portfolio by even the most basic criteria (see Table). These criteria are 1) Dividend Achiever status, 2) an S&P bond rating of at least BBB+, and 3) an S&P stock rating of at least B+/M. The 4 companies that make the cut are: Monsanto (MON), Deere (DE), Hormel Foods (HRL), and Archer Daniels Midland (ADM).
Bottom Line: If you think your portfolio requires exposure to commodities, then you’re in for a rough ride. But “long cycle” investments such as commodities can be quite rewarding if held for two or more market cycles. The safest approach is to own stock in a few of the larger AgriBusiness companies, as opposed to owning stock in mining or energy companies (see Week 221). This week’s blog takes a closer look at those agricultural producers. Be aware, however, that overproduction to meet China’s needs over the past decade has expanded agricultural production capacity along with that for oil, natural gas, coal, iron ore, bauxite, and copper. This is being reversed now that China’s “buildout” has begun to plateau.
Risk Rating: 8
Full Disclosure: I own stock in CF, HRL, MON, DD, DE, and ADM.
Note: Metrics in the Table that are highlighted in red denote underperformance relative to our key benchmark (VBINX); metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Assemble data on stocks representing the 20 largest AgriBusiness companies, and compare their aggregate performance with broad commodity indices--as well as narrower indices that reflect the performance of farming, mining, and energy companies.
Execution: AgriBusiness companies are high risk investments, and each has only a small piece of the pie. In order to compete against one another, each has to maintain a market for its goods and services in dozens of countries. Only 4 of the 20 identified AgriBusinesses are stable enough to warrant inclusion in a retirement portfolio by even the most basic criteria (see Table). These criteria are 1) Dividend Achiever status, 2) an S&P bond rating of at least BBB+, and 3) an S&P stock rating of at least B+/M. The 4 companies that make the cut are: Monsanto (MON), Deere (DE), Hormel Foods (HRL), and Archer Daniels Midland (ADM).
Bottom Line: If you think your portfolio requires exposure to commodities, then you’re in for a rough ride. But “long cycle” investments such as commodities can be quite rewarding if held for two or more market cycles. The safest approach is to own stock in a few of the larger AgriBusiness companies, as opposed to owning stock in mining or energy companies (see Week 221). This week’s blog takes a closer look at those agricultural producers. Be aware, however, that overproduction to meet China’s needs over the past decade has expanded agricultural production capacity along with that for oil, natural gas, coal, iron ore, bauxite, and copper. This is being reversed now that China’s “buildout” has begun to plateau.
Risk Rating: 8
Full Disclosure: I own stock in CF, HRL, MON, DD, DE, and ADM.
Note: Metrics in the Table that are highlighted in red denote underperformance relative to our key benchmark (VBINX); metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 27
Week 221 - Status of Commodity-Related Barron’s 500 Companies
Situation: Since 2009, China has contributed twice as much to world economic growth as the US. China has also purchased ~40% of all commodities sold worldwide. One commodity in particular, copper, is used as a measure of the health of commodity demand in emerging markets because it plays an important role in building electrical grids. Copper has recently reached new lows. China is slowing down its investment machine mainly because its total debt load has reached 300% of GDP. To put China’s woes in context for the US economy, the CEOs of several corporations have recently provided specific examples of how China’s economic decline impacts their businesses.
What does this mean for investors? Basically, for the next one or two years, traders of all asset classes will be in a “risk-off” mode while governments, corporations, and individuals struggle to bring down their debt loads and develop ideas for growth. This cautionary stance will coincide with a bottoming of commodity prices as demand recovers while supplies moderate. The global “oil glut” is a special case, only marginally related to falling demand in China. Instead, it is due to a global “price war” triggered by an oversupply of oil related to improvements in technology, namely horizontal drilling into oil-rich shale deposits combined with hydraulic fracturing. And, oil prices may have further to fall.
Mission: Assess the effect on commodity-related companies of oversupply of commodities. Do this by evaluating all 56 such companies in the 2015 Barron’s 500 List that have at least 16 yrs of trading records.
Execution: This week’s spreadsheet (see Table) shows the carnage. Note the abundance of red highlights denoting underperformance relative to our key benchmark (VBINX at Line 73). Let’s start with a “thought experiment.” You’re looking for GARP (growth at a reasonable price), which will allow you to take advantage of sharply falling stock prices (see Column F in the Table). Let’s start by listing the companies that have moved up in rank compared to the 2014 Barron’s 500 List. Those are the ones with green highlights in Columns P and Q of the Table. Then pick those stocks that aren’t overpriced, i.e., the ones with an EV/EBITDA that is no greater than the EV/EBITDA for the S&P 500 Index (which is an EV/EBITDA of 11).
There are 10 candidates in the “oil & gas” group: HES, DVN, TSO, CAM, CHK, NOV, VLO, HAL, WFT, NBR. Two of those have been labelled “potentially underpriced” per the BMW Method (see Week 193): CHK and NOV (see Column O in the Table). There are 5 more candidates in the “basic materials” group: NUE, SCCO, CMC, X, AA and 6 candidates in the agriculture production group (ADM, POT, MOS, TSN, DOW, PPC). POT is another “potentially underpriced” stock. That totals 21 stocks. However, three of those failed to outperform the S&P 500 Index over the past 16 yrs (per the BMW Method: NBR, AA, PPC (see Column L in the Table). Eliminating those leaves 18 candidates.
So far, so good. Most of the 18 have fallen hard in recent quarters and now have prices that are 1-2 Standard Deviations below trendline (see Column M in the Table). The BMW Method sorts out “risk” statistically by predicting the extent of loss below trendline that you can expect in a bear market (see Column N in the Table). The abundance of red highlights in that Column denotes stocks predicted to exhibit a greater loss below trendline than the S&P 500 Index faces, which is 32%. Every one of the 18 candidate stocks is highlighted in red, so they’re all unsuitable for a retirement portfolio. But what if you’re a speculator and willing to accept a loss of 40%? That’s a 25% greater loss than you’d suffer by owning an S&P 500 Index fund like VFINX. Even allowing for the added extra risk, only one of the 18 qualifies (ADM at Line 54 in the Table).
Given that commodity-related companies compose at least 10% of a balanced stock (or stock mutual fund) portfolio, we’ll need to dig deeper. For example, 23 of 56 such stocks listed in the Table are already in a bear market (see Column M), i.e., down 2 Standard Deviations (2SD) below their 16-yr trendline. Three of those companies have raised their dividend annually for at least the past 10 yrs (see a list of such Dividend Achievers in Column R of the Table) and have a statistical risk of loss in a bear market that is less than that for the S&P 500 Index (see Column N in the Table): CVX, XOM, PX. The odds that you’d lose money by starting to dollar-average into those stocks now are low.
Another approach is to dollar-average into low-cost mutual funds that reflect commodity investment, including emerging market index funds. There are 3 listed in the Benchmark section of the Table: 1) GSG, the exchange-traded fund for collateralized commodity futures; 2) PRNEX, the T Rowe Price New Era Fund that invests in natural resource stocks, and 3) VEIEX, the Vanguard index fund for emerging markets.
Bottom Line: The global economy faces a difficult period now that China’s fast growth phase has ended. Commodity-related assets are the first to crash, and that means commodity markets and commodity-related companies will be the first to recover. We’ve evaluated 56 commodity-related companies in the 2015 Barron’s 500 List to come up with 4 that are candidates for speculative investment: Archer Daniels Midland (ADM), Exxon Mobil (XOM), Chevron (CVX), and Praxair (PX).
Risk Rating: 8
Full Disclosure: Commodity-related stocks are “long-cycle” investments that I tend to favor, particularly those that are related to agricultural production. I dollar-average into XOM and also own shares of CVX, AA, HRL, ADM, DE, and DD.
Note: metrics highlighted in red denote underperformance relative to our key benchmark (VBINX); metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
What does this mean for investors? Basically, for the next one or two years, traders of all asset classes will be in a “risk-off” mode while governments, corporations, and individuals struggle to bring down their debt loads and develop ideas for growth. This cautionary stance will coincide with a bottoming of commodity prices as demand recovers while supplies moderate. The global “oil glut” is a special case, only marginally related to falling demand in China. Instead, it is due to a global “price war” triggered by an oversupply of oil related to improvements in technology, namely horizontal drilling into oil-rich shale deposits combined with hydraulic fracturing. And, oil prices may have further to fall.
Mission: Assess the effect on commodity-related companies of oversupply of commodities. Do this by evaluating all 56 such companies in the 2015 Barron’s 500 List that have at least 16 yrs of trading records.
Execution: This week’s spreadsheet (see Table) shows the carnage. Note the abundance of red highlights denoting underperformance relative to our key benchmark (VBINX at Line 73). Let’s start with a “thought experiment.” You’re looking for GARP (growth at a reasonable price), which will allow you to take advantage of sharply falling stock prices (see Column F in the Table). Let’s start by listing the companies that have moved up in rank compared to the 2014 Barron’s 500 List. Those are the ones with green highlights in Columns P and Q of the Table. Then pick those stocks that aren’t overpriced, i.e., the ones with an EV/EBITDA that is no greater than the EV/EBITDA for the S&P 500 Index (which is an EV/EBITDA of 11).
There are 10 candidates in the “oil & gas” group: HES, DVN, TSO, CAM, CHK, NOV, VLO, HAL, WFT, NBR. Two of those have been labelled “potentially underpriced” per the BMW Method (see Week 193): CHK and NOV (see Column O in the Table). There are 5 more candidates in the “basic materials” group: NUE, SCCO, CMC, X, AA and 6 candidates in the agriculture production group (ADM, POT, MOS, TSN, DOW, PPC). POT is another “potentially underpriced” stock. That totals 21 stocks. However, three of those failed to outperform the S&P 500 Index over the past 16 yrs (per the BMW Method: NBR, AA, PPC (see Column L in the Table). Eliminating those leaves 18 candidates.
So far, so good. Most of the 18 have fallen hard in recent quarters and now have prices that are 1-2 Standard Deviations below trendline (see Column M in the Table). The BMW Method sorts out “risk” statistically by predicting the extent of loss below trendline that you can expect in a bear market (see Column N in the Table). The abundance of red highlights in that Column denotes stocks predicted to exhibit a greater loss below trendline than the S&P 500 Index faces, which is 32%. Every one of the 18 candidate stocks is highlighted in red, so they’re all unsuitable for a retirement portfolio. But what if you’re a speculator and willing to accept a loss of 40%? That’s a 25% greater loss than you’d suffer by owning an S&P 500 Index fund like VFINX. Even allowing for the added extra risk, only one of the 18 qualifies (ADM at Line 54 in the Table).
Given that commodity-related companies compose at least 10% of a balanced stock (or stock mutual fund) portfolio, we’ll need to dig deeper. For example, 23 of 56 such stocks listed in the Table are already in a bear market (see Column M), i.e., down 2 Standard Deviations (2SD) below their 16-yr trendline. Three of those companies have raised their dividend annually for at least the past 10 yrs (see a list of such Dividend Achievers in Column R of the Table) and have a statistical risk of loss in a bear market that is less than that for the S&P 500 Index (see Column N in the Table): CVX, XOM, PX. The odds that you’d lose money by starting to dollar-average into those stocks now are low.
Another approach is to dollar-average into low-cost mutual funds that reflect commodity investment, including emerging market index funds. There are 3 listed in the Benchmark section of the Table: 1) GSG, the exchange-traded fund for collateralized commodity futures; 2) PRNEX, the T Rowe Price New Era Fund that invests in natural resource stocks, and 3) VEIEX, the Vanguard index fund for emerging markets.
Bottom Line: The global economy faces a difficult period now that China’s fast growth phase has ended. Commodity-related assets are the first to crash, and that means commodity markets and commodity-related companies will be the first to recover. We’ve evaluated 56 commodity-related companies in the 2015 Barron’s 500 List to come up with 4 that are candidates for speculative investment: Archer Daniels Midland (ADM), Exxon Mobil (XOM), Chevron (CVX), and Praxair (PX).
Risk Rating: 8
Full Disclosure: Commodity-related stocks are “long-cycle” investments that I tend to favor, particularly those that are related to agricultural production. I dollar-average into XOM and also own shares of CVX, AA, HRL, ADM, DE, and DD.
Note: metrics highlighted in red denote underperformance relative to our key benchmark (VBINX); metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 13
Week 219 - Agricultural Production Equipment
Situation: Investing in commodities, or commodity-related companies, is a good way to lose money fast if you invest in the commodity when the commodity “supercycle” is ending. Agricultural commodity-related companies are the least risky way to invest in the commodity “supercycle.” Why? Because food is a necessity and, 10 million people a year emerge from poverty and will earn enough income to increase their dietary protein to the required 60 gm/d minimum. For example, investors in General Mills (GIS) and Deere (DE) have enjoyed a 30-yr total return that beat the S&P 500 Index while having a statistically lower risk of loss in a bear market. For all types of commodities (e.g. gold, oil, iron ore, cereal grains), suppliers of equipment typically make more money than those (e.g. farmers) who produce the raw commodity. In the United States, this phenomenon first became common knowledge during the California Gold Rush of 1849. So, this week’s blog is about companies that supply equipment to farmers.
Mission: Examine key metrics for all the agricultural equipment suppliers among the 1000 largest US companies by revenue, i.e., those in the 2015 Fortune 500 list with its supplemental material on the next largest 500.
Execution: The 2015 Fortune 500 list has 11 companies that make agricultural production equipment (see Table); 6 of those companies are also in the 2015 Barron’s 500 List of the largest companies by revenue that are listed on the New York or Toronto stock exchanges: Tractor Supply (TSCO), Cummins (CMI), Deere (DE), AGCO (AGCO), Caterpillar (CAT), Terex (TEX). For comparison purposes, the benchmarks at the bottom of this week’s Table include commodity-production companies involved in oil & gas exploration, gold & copper mining, metals production, and meat production, as well as indices for prices of 24 commodities (GSG) and gold/silver prices (^XAU).
The story, as you can see from the Table, is a depressing one. We’re near the end of the latest commodity “supercycle.” And, we won’t know if the supercycle has ended until developing nations can again afford to build out their infrastructure. There are some hints that the next supercycle is emerging, e.g., improved performance by several large companies in the metals and mining sector (see Week 217). But much depends on China, where 40% of the world’s appetite for commodities resides. Demand there continues to fall, and the government’s penchant for manipulating the stock market could forestall any recovery in confidence that would be sufficient to increase the demand for commodities.
But we should be advised of the prospects for each of the 11 companies identified in the Table. Perhaps there is one positioned to herald a new dawn. Five of the companies make, service and/or equip farm tractors, skid loaders, backhoes, end-loaders, and combines. Those five are: Deere (DE), AGCO Corp (AGCO), Tractor Supply (TSCO), Caterpillar (CAT), Terex (TEX). Trimble Navigation (TRMB) makes computerized equipment to outfit tractors for "precision agriculture" dependent on GPS, whether for planting seeds or guiding sprayers of fertilizer, insecticides, herbicides, and fungicides. Valmont (VAL) makes center-pivot irrigation systems that use well water pumped by electric or diesel motors. Flowserve (FLS) is a major supplier of pumps, and Cummins (CMI) is a major supplier of diesel motors. Fastenal (FAST) supplies building materials and has outlets throughout the Midwest and Great Plains. Toro (TTC) supplies the latest generation of plant watering systems, which is a metered drip irrigation that depends on a grid of buried "tapes"; Deere (DE) also provides a drip irrigation system.
As elsewhere, technology seems to be the game-changer. Drip irrigation systems use 40% less water than center-pivot systems which, in turn, use 40% less water than flood irrigation. Precision guidance of tractors from space (via GPS), combined with soil monitoring and interpretation via a wireless hookup to centers run by Monsanto (MON) and duPont (DE), means that the right amounts of water, fertilizer, insecticides, herbicides, and fungicides will be deployed to nurture the right kinds of seeds for each variety of soil in a farmer’s acreage--all combined with computerized weather analysis in real time (based on satellite interpretation of local rainfall patterns combined with meteorological prediction). This is called the Agronomy Revolution, and it’s where the future lies. The problem is that it has doubled the prices that farmers have to pay for new tractors with their attached gizmos. Typically, we would expect farmers to have trouble affording all of this “new paint” unless something had increased crop prices enough to give them a feeling of wealth. That happened with the drought of 2012, and conveniently during the Great Recession because Congress had mandated a surge in ethanol production.
The problem for you, as an investor, is that there is no company in the Table (including those named under Benchmarks) whose stock meets our requirements to be a candidate for inclusion in your retirement portfolio. Those requirements are a) the company is an S&P Dividend Achiever, having raised its dividend annually for at least the past 10 yrs; b) the company is large enough to appear on the 2015 Barron’s 500 List; c) the company’s stock has beat the S&P 500 Index for the past 16 yrs without incurring as great a risk of loss in a future bear market, per the BMW Method; d) the company’s bonds have an S&P rating no lower than BBB+ and its stock has an S&P rating no lower than B+/M, and e) the stock lost less money during the Lehman Panic than our key benchmark, the Vanguard Balanced Index Fund (VBINX). The only commodity-related companies we’re aware of that meet those requirements are Chevron (CVX) and Exxon Mobil (XOM). However, Chevron has gone 18 months without raising its dividend (because of negative cash flow related to a 60% drop in oil prices over the past year).
Bottom Line: Commodities, and commodity-related companies, are at a historic low point in valuation. Even the companies that supply farmers and ranchers with equipment are limping along. Deere (DE) has the best 30-yr record but remains a speculative investment, given that it’s stock lost more than the lowest-cost S&P 500 Index fund (VFINX) during the 18-month Lehman Panic period (see Column D in the Table). But Deere is also the company best positioned to benefit from the Agronomy Revolution that is bringing us the next big step up in agricultural productivity. The devil’s advocate will ask the obvious question: “If these stocks are all at historic lows, doesn’t that suggest that now is the time to buy?” That game has a name: Catch the Falling Knife. Which is fine, given that great rewards only go to those who take great risks. Professional investors often pass through a phase where they try their skill at catching the knife as it falls, after which they give up trying. From that point on, they studiously avoid buying any asset while it is falling in price.
Risk Rating: 7
Full Disclosure: I have FLS, CMI, and DE stock.
Note: Metrics in the Table are current for the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Mission: Examine key metrics for all the agricultural equipment suppliers among the 1000 largest US companies by revenue, i.e., those in the 2015 Fortune 500 list with its supplemental material on the next largest 500.
Execution: The 2015 Fortune 500 list has 11 companies that make agricultural production equipment (see Table); 6 of those companies are also in the 2015 Barron’s 500 List of the largest companies by revenue that are listed on the New York or Toronto stock exchanges: Tractor Supply (TSCO), Cummins (CMI), Deere (DE), AGCO (AGCO), Caterpillar (CAT), Terex (TEX). For comparison purposes, the benchmarks at the bottom of this week’s Table include commodity-production companies involved in oil & gas exploration, gold & copper mining, metals production, and meat production, as well as indices for prices of 24 commodities (GSG) and gold/silver prices (^XAU).
The story, as you can see from the Table, is a depressing one. We’re near the end of the latest commodity “supercycle.” And, we won’t know if the supercycle has ended until developing nations can again afford to build out their infrastructure. There are some hints that the next supercycle is emerging, e.g., improved performance by several large companies in the metals and mining sector (see Week 217). But much depends on China, where 40% of the world’s appetite for commodities resides. Demand there continues to fall, and the government’s penchant for manipulating the stock market could forestall any recovery in confidence that would be sufficient to increase the demand for commodities.
But we should be advised of the prospects for each of the 11 companies identified in the Table. Perhaps there is one positioned to herald a new dawn. Five of the companies make, service and/or equip farm tractors, skid loaders, backhoes, end-loaders, and combines. Those five are: Deere (DE), AGCO Corp (AGCO), Tractor Supply (TSCO), Caterpillar (CAT), Terex (TEX). Trimble Navigation (TRMB) makes computerized equipment to outfit tractors for "precision agriculture" dependent on GPS, whether for planting seeds or guiding sprayers of fertilizer, insecticides, herbicides, and fungicides. Valmont (VAL) makes center-pivot irrigation systems that use well water pumped by electric or diesel motors. Flowserve (FLS) is a major supplier of pumps, and Cummins (CMI) is a major supplier of diesel motors. Fastenal (FAST) supplies building materials and has outlets throughout the Midwest and Great Plains. Toro (TTC) supplies the latest generation of plant watering systems, which is a metered drip irrigation that depends on a grid of buried "tapes"; Deere (DE) also provides a drip irrigation system.
As elsewhere, technology seems to be the game-changer. Drip irrigation systems use 40% less water than center-pivot systems which, in turn, use 40% less water than flood irrigation. Precision guidance of tractors from space (via GPS), combined with soil monitoring and interpretation via a wireless hookup to centers run by Monsanto (MON) and duPont (DE), means that the right amounts of water, fertilizer, insecticides, herbicides, and fungicides will be deployed to nurture the right kinds of seeds for each variety of soil in a farmer’s acreage--all combined with computerized weather analysis in real time (based on satellite interpretation of local rainfall patterns combined with meteorological prediction). This is called the Agronomy Revolution, and it’s where the future lies. The problem is that it has doubled the prices that farmers have to pay for new tractors with their attached gizmos. Typically, we would expect farmers to have trouble affording all of this “new paint” unless something had increased crop prices enough to give them a feeling of wealth. That happened with the drought of 2012, and conveniently during the Great Recession because Congress had mandated a surge in ethanol production.
The problem for you, as an investor, is that there is no company in the Table (including those named under Benchmarks) whose stock meets our requirements to be a candidate for inclusion in your retirement portfolio. Those requirements are a) the company is an S&P Dividend Achiever, having raised its dividend annually for at least the past 10 yrs; b) the company is large enough to appear on the 2015 Barron’s 500 List; c) the company’s stock has beat the S&P 500 Index for the past 16 yrs without incurring as great a risk of loss in a future bear market, per the BMW Method; d) the company’s bonds have an S&P rating no lower than BBB+ and its stock has an S&P rating no lower than B+/M, and e) the stock lost less money during the Lehman Panic than our key benchmark, the Vanguard Balanced Index Fund (VBINX). The only commodity-related companies we’re aware of that meet those requirements are Chevron (CVX) and Exxon Mobil (XOM). However, Chevron has gone 18 months without raising its dividend (because of negative cash flow related to a 60% drop in oil prices over the past year).
Bottom Line: Commodities, and commodity-related companies, are at a historic low point in valuation. Even the companies that supply farmers and ranchers with equipment are limping along. Deere (DE) has the best 30-yr record but remains a speculative investment, given that it’s stock lost more than the lowest-cost S&P 500 Index fund (VFINX) during the 18-month Lehman Panic period (see Column D in the Table). But Deere is also the company best positioned to benefit from the Agronomy Revolution that is bringing us the next big step up in agricultural productivity. The devil’s advocate will ask the obvious question: “If these stocks are all at historic lows, doesn’t that suggest that now is the time to buy?” That game has a name: Catch the Falling Knife. Which is fine, given that great rewards only go to those who take great risks. Professional investors often pass through a phase where they try their skill at catching the knife as it falls, after which they give up trying. From that point on, they studiously avoid buying any asset while it is falling in price.
Risk Rating: 7
Full Disclosure: I have FLS, CMI, and DE stock.
Note: Metrics in the Table are current for the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 31
Week 204 - 2015 Barron’s 500 List: Commodity Producers with Improving Fundamentals
Situation: Commodities are priced in dollars but those prices reflect worldwide supply and demand, not US economic forces. To further complicate matters, agricultural commodities are priced to reflect regional climate events. The 2012 US drought was so severe that China decided to decrease its reliance on the US for corn and instead ramp up domestic production and source more corn from Argentina and Ukraine. This highlights how population growth is the main driver for commodity production, whether it is basic materials needed to expand infrastructure, energy for electricity production and transportation, or meat and grain for grocery stores. The problem for commodity producers is the necessity for a large up-front investment, whether for oil and gas exploration, mining operations, or the web of technology and infrastructure that brings the “green revolution” to farming. Such investments typically involve large expenditures for property, plant, equipment, powerplants, internet access, storage facilities, paved roads, pipelines, and railroads. In turn, those high initial costs drive research and development into innovations that promise to reduce up-front costs. The result is affordable food, construction methods, fuel, and electricity. Once in place, production efficiencies tend to overshoot; supplies exceed demand for a period, as we see happening now with oil and natural gas production.
Investors in commodity-related companies always face a roller-coaster ride, one that is often out-of-phase with regional economic cycles. As a result, commodity-linked investments tend to follow supercycles. Their “non-correlation” with GDP serves to benefit investors. This week’s blog is occasioned by the just-published Barron’s 500 List for 2015. That list gives a grade to the 500 largest companies in the US and Canada by using 3 equally-weighted metrics:
1) median 3-yr return on investment (ROIC),
2) change in the most recent year’s ROIC relative to the 3-yr median, and
3) revenue growth for the most recent fiscal year.
Each company’s 2015 rank is compared to its 2014 rank. There are 60 commodity producers; half were up in rank, half were down. We’re interested only in the companies that were up, since there’s no easy way to know why a company was down or when its rank will stop falling. And, since most of our readers are looking for retirement investments, we’re not interested in companies that have an S&P bond rating lower than BBB+ or an S&P stock rating lower than B+/M. Taken together, those restrictions remove all but 7 of the 60 companies from consideration (see Table).
These 7 stocks are different from those we usually think of as prudent for retirees. Notably, the average 5-yr Beta is high, and most are down one Standard Deviation from their 16-yr trendline in price appreciation (see Column M), whereas, recent pricing for the S&P 500 Index (^GSPC) is up two Standard Deviations. While we do like to invest in commodity-related stocks because of their out-of-sync behavior, extremes are a little un-nerving.
It gets worse. In Column N of the Table, the downside risk comes into sharp focus. That’s where the BMW Method (see Week 193, Week 199 and Week 201) is used to predict your loss by incorporating 16 yrs of weekly variance in price trends. For example, a 47% loss is predicted for our group of 7 stocks in the next Bear Market, whereas, the S&P 500 Index is predicted to sustain a 32% loss. You’ll find this information in the BMW Method Log Chart for each stock. Start by using the S&P 500 Index as an example. Find ^GSPC at the bottom of the 16-yr series, click on it, and look for “*2RMS” in the upper left-hand corner. Subtract that RF number (0.68) from 100 to get the predicted 32% loss at 2 Standard Deviations below the price trendline. That degree of price variance is projected to occur every 19-20 yrs.
This price variance is important to be aware of because a high degree of price variance over time means the party can end quickly. When a commodity-producing company’s Tangible Book Value for the past decade gives it a Durable Competitive Advantage (see Column R and Week 158), there’s little likelihood that its earnings will grow more than 7%/yr over the next decade (see Column S), which we estimate by using the Buffett Buy Analysis (see Week 189). Only one stock passed that test, National Oilwell Varco (NOV). In other words, the very impressive returns achieved by this select group of 7 stocks (see Columns C, F and L in the Table) come with a very impressive risk of loss.
Several academic studies have shown that the only way to legally “beat the market” is to take on a commensurately greater risk of loss. One example analyzed Jim Cramer’s success at picking stocks for CNBC’s “Mad Money” TV show. To make a long story short, you need to understand that over a 20-yr period you’ll probably be further ahead (on a risk-adjusted basis) by investing in a low-cost S&P 500 Index Fund (VFINX at Line 16 in the Table) than by investing in any combination of commodity-related companies.
Think about it. Commodity-related companies depend on the infrastructure and sustainability needs of fast growing countries like China, Brazil, India, Nigeria and Russia. Such a heavy reliance on commodities in countries with such large populations will be reflected in the success of mutual funds that focus on international stocks or natural resource stocks. The Vanguard Total International Stock Index fund (VGTSX at Line 18 in the Table) and T Rowe Price New Era Fund (PRNEX at Line 17 in the Table), respectively, are good low-cost examples. Are either of those mutual funds a better (i.e., risk-adjusted) place to put your retirement savings than VFINX? No. The reason is that investing in commodities is a hedging strategy. Any effort to smooth out (hedge) returns does exactly that. It protects you from Bear Market losses while reducing your Bull Market gains. Stocks go up 55% of the time, so over the long term a hedging strategy will underperform the market.
Bottom Line: Here at ITR, we like to call attention to investments that don’t track the S&P 500 Index. By having a few investments that are out-of-sync with the economic cycle, you may be able to limit the damage to your portfolio from a market crash. Our favorite non-correlated asset is the 10-yr US Treasury Note (when held to maturity), which you can obtain for zero cost. Our next favorite is stock in one or two commodity production companies, especially those where revenues reflect changes in the weather cycle. In particular, companies that supply farmers with tractors, center-pivot irrigation systems, diesel engines to power such equipment, fertilizer, herbicides, fungicides and ways to efficiently get crops and cattle to markets.
Risk Rating: 7
Full Disclosure: I own stock in CMI.
Note: metrics highlighted in red denote underperformance vs. 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
Investors in commodity-related companies always face a roller-coaster ride, one that is often out-of-phase with regional economic cycles. As a result, commodity-linked investments tend to follow supercycles. Their “non-correlation” with GDP serves to benefit investors. This week’s blog is occasioned by the just-published Barron’s 500 List for 2015. That list gives a grade to the 500 largest companies in the US and Canada by using 3 equally-weighted metrics:
1) median 3-yr return on investment (ROIC),
2) change in the most recent year’s ROIC relative to the 3-yr median, and
3) revenue growth for the most recent fiscal year.
Each company’s 2015 rank is compared to its 2014 rank. There are 60 commodity producers; half were up in rank, half were down. We’re interested only in the companies that were up, since there’s no easy way to know why a company was down or when its rank will stop falling. And, since most of our readers are looking for retirement investments, we’re not interested in companies that have an S&P bond rating lower than BBB+ or an S&P stock rating lower than B+/M. Taken together, those restrictions remove all but 7 of the 60 companies from consideration (see Table).
These 7 stocks are different from those we usually think of as prudent for retirees. Notably, the average 5-yr Beta is high, and most are down one Standard Deviation from their 16-yr trendline in price appreciation (see Column M), whereas, recent pricing for the S&P 500 Index (^GSPC) is up two Standard Deviations. While we do like to invest in commodity-related stocks because of their out-of-sync behavior, extremes are a little un-nerving.
It gets worse. In Column N of the Table, the downside risk comes into sharp focus. That’s where the BMW Method (see Week 193, Week 199 and Week 201) is used to predict your loss by incorporating 16 yrs of weekly variance in price trends. For example, a 47% loss is predicted for our group of 7 stocks in the next Bear Market, whereas, the S&P 500 Index is predicted to sustain a 32% loss. You’ll find this information in the BMW Method Log Chart for each stock. Start by using the S&P 500 Index as an example. Find ^GSPC at the bottom of the 16-yr series, click on it, and look for “*2RMS” in the upper left-hand corner. Subtract that RF number (0.68) from 100 to get the predicted 32% loss at 2 Standard Deviations below the price trendline. That degree of price variance is projected to occur every 19-20 yrs.
This price variance is important to be aware of because a high degree of price variance over time means the party can end quickly. When a commodity-producing company’s Tangible Book Value for the past decade gives it a Durable Competitive Advantage (see Column R and Week 158), there’s little likelihood that its earnings will grow more than 7%/yr over the next decade (see Column S), which we estimate by using the Buffett Buy Analysis (see Week 189). Only one stock passed that test, National Oilwell Varco (NOV). In other words, the very impressive returns achieved by this select group of 7 stocks (see Columns C, F and L in the Table) come with a very impressive risk of loss.
Several academic studies have shown that the only way to legally “beat the market” is to take on a commensurately greater risk of loss. One example analyzed Jim Cramer’s success at picking stocks for CNBC’s “Mad Money” TV show. To make a long story short, you need to understand that over a 20-yr period you’ll probably be further ahead (on a risk-adjusted basis) by investing in a low-cost S&P 500 Index Fund (VFINX at Line 16 in the Table) than by investing in any combination of commodity-related companies.
Think about it. Commodity-related companies depend on the infrastructure and sustainability needs of fast growing countries like China, Brazil, India, Nigeria and Russia. Such a heavy reliance on commodities in countries with such large populations will be reflected in the success of mutual funds that focus on international stocks or natural resource stocks. The Vanguard Total International Stock Index fund (VGTSX at Line 18 in the Table) and T Rowe Price New Era Fund (PRNEX at Line 17 in the Table), respectively, are good low-cost examples. Are either of those mutual funds a better (i.e., risk-adjusted) place to put your retirement savings than VFINX? No. The reason is that investing in commodities is a hedging strategy. Any effort to smooth out (hedge) returns does exactly that. It protects you from Bear Market losses while reducing your Bull Market gains. Stocks go up 55% of the time, so over the long term a hedging strategy will underperform the market.
Bottom Line: Here at ITR, we like to call attention to investments that don’t track the S&P 500 Index. By having a few investments that are out-of-sync with the economic cycle, you may be able to limit the damage to your portfolio from a market crash. Our favorite non-correlated asset is the 10-yr US Treasury Note (when held to maturity), which you can obtain for zero cost. Our next favorite is stock in one or two commodity production companies, especially those where revenues reflect changes in the weather cycle. In particular, companies that supply farmers with tractors, center-pivot irrigation systems, diesel engines to power such equipment, fertilizer, herbicides, fungicides and ways to efficiently get crops and cattle to markets.
Risk Rating: 7
Full Disclosure: I own stock in CMI.
Note: metrics highlighted in red denote underperformance vs. 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
Sunday, May 3
Week 200 - Agronomy Companies on the Barron’s 500 List
Situation: I know, you’re already bored. But we really have to talk about commodity-related stocks occasionally because those are the high-risk, high-reward, high-cost stocks that anchor the world economy. Their prices usually reflect a megacycle that lasts for decades, starting with supply shortages (relative to demand) and ending with overproduction that persistently exceeds demand for a time (e.g. today’s oil & gas markets). The pricing of such stocks correlates with global demand, not with the typical 5-7 yr economic cycle of individual countries or regions. Some commodities are so adept at reflecting the global economic cycle as to earn special respect, like “Doctor Copper”. You’ll want to own two or three of these “non-correlated” stocks that dampen the ups and downs of the economic cycle. In particular, consider production agriculture companies because those have special advantages: 1) Their profits are driven more by the weather cycle than the economic cycle; 2) ten million people per year enter the middle class in Asia and Africa who can finally afford to consume the 60 grams/day of protein that is required for good health and a long life.
Livestock has been the best-performing commodity sector over the past year. Let’s think about what goes into livestock production: grain, hay, and soybeans are the most important inputs. (Four pounds of feed is needed to make one pound of Grade A meat.) Production of those crops requires certain inputs: tractors and combines (see Week 197), irrigation equipment (see Week 129), and this week’s topic about the tools of an agronomist (seeds, fertilizer, insecticides, herbicides, and fungicides). Agronomists work “on call” for individual farmers (or a farmer's cooperative) to address issues of plant genetics & physiology, soil science, and meteorology. Think of them as general practitioners overseeing the crop. Increasingly, this role is played by “seed analysts” from one of the major seed production companies (Monsanto, Syngenta, Bayer or Dupont). Seed analysts also look for farmers who will allow part of their fields to be used for plant research.
This week’s Table has all of the large, publicly-held agronomy companies in the United States and Canada. Stocks in these companies are not suitable for inclusion in a retirement portfolio. But several are suitable for a portfolio of non-correlated assets, i.e., those where prices don’t follow the economic cycle. The pricing of agronomy companies is mainly driven by weather cycles, and the worldwide growth rate for workers who are paid enough to provide their families with an adequate protein intake.
Bottom Line: You need to have a few investments that don’t track the S&P 500 Index, so-called "non-correlated assets." Inflation-protected Savings Bonds epitomize this concept, and you should have a Rainy-Day Fund that is mainly invested in those or Treasury Bills (see Week 162). But there are other, more rewarding non-correlated investments. Most are commodity-related and come with a lot more risk. We like large companies that focus on the needs of farmers and ranchers. This week's Table has 8 of those.
Risk Rating: 7
Full Disclosure: I own stock in MON, CF, and DD.
NOTE: Data are current as of the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Livestock has been the best-performing commodity sector over the past year. Let’s think about what goes into livestock production: grain, hay, and soybeans are the most important inputs. (Four pounds of feed is needed to make one pound of Grade A meat.) Production of those crops requires certain inputs: tractors and combines (see Week 197), irrigation equipment (see Week 129), and this week’s topic about the tools of an agronomist (seeds, fertilizer, insecticides, herbicides, and fungicides). Agronomists work “on call” for individual farmers (or a farmer's cooperative) to address issues of plant genetics & physiology, soil science, and meteorology. Think of them as general practitioners overseeing the crop. Increasingly, this role is played by “seed analysts” from one of the major seed production companies (Monsanto, Syngenta, Bayer or Dupont). Seed analysts also look for farmers who will allow part of their fields to be used for plant research.
This week’s Table has all of the large, publicly-held agronomy companies in the United States and Canada. Stocks in these companies are not suitable for inclusion in a retirement portfolio. But several are suitable for a portfolio of non-correlated assets, i.e., those where prices don’t follow the economic cycle. The pricing of agronomy companies is mainly driven by weather cycles, and the worldwide growth rate for workers who are paid enough to provide their families with an adequate protein intake.
Bottom Line: You need to have a few investments that don’t track the S&P 500 Index, so-called "non-correlated assets." Inflation-protected Savings Bonds epitomize this concept, and you should have a Rainy-Day Fund that is mainly invested in those or Treasury Bills (see Week 162). But there are other, more rewarding non-correlated investments. Most are commodity-related and come with a lot more risk. We like large companies that focus on the needs of farmers and ranchers. This week's Table has 8 of those.
Risk Rating: 7
Full Disclosure: I own stock in MON, CF, and DD.
NOTE: Data are current as of the Sunday of publication; red highlights denote underperformance vs. our key benchmark (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, January 4
Week 183 - Buffett Buy Analysis of Oil and Natural Gas Companies
Situation: Oil and natural gas companies account for 8% of US GDP. Their stock prices mainly reflect 3 factors: 1) the pricing of front-month futures contracts, 2) the amount of proven and economically recoverable reserves in the ground, and 3) the expected rate of growth in the world’s appetite for oil. All of those numbers will fall if there is a recession in one of the world’s major economies. Europe is now on the brink of entering its third recession in 10 yrs (triggered by the crisis in Ukraine), which is one reason why the price of oil fell 40% between June and December. But there are two other reasons to consider.
The US is becoming the dominant oil and gas producing country by rapidly exploiting the twin technologies of hydrofracking and horizontal drilling. This is now causing a price war with the about-to-be-eclipsed countries (Russia and Saudi Arabia). Their strategy is to continue maximal production with traditional technology, which is cheaper than hydrofracking. That means their oil and gas has a lower price point (for making a profit) than US oil and gas. We’ll see who wins, but in the meantime the US consumer gets to have a better Christmas!
The remaining reason why the price of oil is falling is that vehicles are getting better fuel economy. And, $4.00/gal gasoline has changed people’s driving habits, e.g. fuel economy is now the most important consideration when buying a car. More importantly (for the long term), natural gas is starting to replace gasoline and diesel fuel in commercial and municipal vehicles, and even in locomotives and jet fighters. The revolution doesn’t end there, because electric motors will likely power most highway vehicles by 2050, given the current pace of research into battery development. Natural gas will remain an important feedstock for electrical power plants but there will be little need for oil other than as a lubricant and a source of asphalt.
Caveat Emptor: The “story” that supports the prices of energy stocks is always in flux, as well as being complex.
Given that oil and natural gas companies will increasingly emphasize natural gas production over oil production, is this a good time to invest in these suddenly cheap companies? By now, of course, you realize this would be more of a gamble than prudently investing for retirement. Normally, one makes this decision by estimating future earnings (or cash flows), then applying the growth rate for that industry to discount earnings back to the present. That gives an estimate for Present Value for the stock (i.e., what the current price should be). That Discounted Cash Flow (DCF) method has never worked very well for volatile (cyclical) stocks. Those are the ones that track the ups and downs of the economy too closely, such as oil and gas “exploration and production” stocks.
Instead, let’s use our old standby of the Buffett Buy Analysis (BBA). It simplifies the DCF method by projecting the trend-line for the past decade’s growth in core earnings (as calculated by S&P) to the end of the next decade (see Week 30, Week 94 and Week 135). That number is then multiplied by the worst P/E seen in the past decade. Mr. Buffett adds on the value of its current annual dividend multiplied by 10, since he doesn’t assume the company will be growing its dividend. Voila! He has a price prediction for 10 yrs from now and can calculate the BBA, which is total return/yr over the next 10 yrs (see Column T in the Table).
How has that worked out for him buying oil and natural gas stocks? He bought 18 million shares of ConocoPhillips (COP) early in 2006 for Berkshire Hathaway but soon thereafter decided he’d bet on the wrong horse. Now he’s down to 1.4 million shares of COP and 6.5 million shares of Phillips 66 (the recent spin-off of ConocoPhillips’ refinery operations). With the proceeds from those sales, he bought 41 million shares of ExxonMobil (XOM) and 7.3 million shares of National Oilwell Varco (NOV). In other words, he changed his mind when the Great Recession exposed the underlying value of specific energy companies (see Table).
The Buffett Buy Analysis starts by determining whether the company has a Durable Competitive Advantage (DCA). Mr. Buffett defines a DCA as a decade’s worth of steady growth in Tangible Book Value (TBV) at a rate of at least 9%/yr, with no more than two down years (see Column S in the Table). We’ve used his method to analyze the 40 oil and natural gas stocks in the Barrons 500 List of the largest US and Canadian companies. After excluding companies that don’t have the required DCA, plus an S&P investment-grade bond rating (i.e., BBB- or better) and an S&P stock rating of at least B+/M, we are left with the 9 companies in the Table.
Bottom Line: Only two of these 9 oil and natural gas companies had a Buffett Buy Analysis that projected returns higher than 7%/yr over the next decade, namely, Cameron International (CAM) and National Oilwell Varco (NOV). Both are too risky to include in a retirement portfolio. However, ExxonMobil (XOM) is worth considering because it has the largest investment in natural gas production and is projected to have a total return close to 5%/yr over the next 10 yrs. Most importantly for you, XOM does satisfy our requirements for inclusion in a retirement portfolio:
1) the stock has a Finance Value (Column E in the Table) that beats our key benchmark (Vanguard Balanced Index Fund - VBINX);
2) the stock is an S&P Dividend Achiever;
3) the company’s bonds have at least a BBB+ rating from S&P;
4) the stock has at least a B+/M rating from S&P;
5) the stock has had dividend growth of at least 5%/yr for the past 14 yrs, and
6) the company is large enough to be included in the Barron’s 500 List published each year in May. The Barron’s 500 List is particularly useful because it ranks companies by sales growth and cash flow-based ROIC (Return On Invested Capital) for each of the two most recent years.
Risk Rating: 6
Full Disclosure: I dollar-average into XOM and also own shares of CVX.
Note: metrics in the Table are current as of the Sunday of publication. Red highlights in the Table denote underperformance vs. VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The US is becoming the dominant oil and gas producing country by rapidly exploiting the twin technologies of hydrofracking and horizontal drilling. This is now causing a price war with the about-to-be-eclipsed countries (Russia and Saudi Arabia). Their strategy is to continue maximal production with traditional technology, which is cheaper than hydrofracking. That means their oil and gas has a lower price point (for making a profit) than US oil and gas. We’ll see who wins, but in the meantime the US consumer gets to have a better Christmas!
The remaining reason why the price of oil is falling is that vehicles are getting better fuel economy. And, $4.00/gal gasoline has changed people’s driving habits, e.g. fuel economy is now the most important consideration when buying a car. More importantly (for the long term), natural gas is starting to replace gasoline and diesel fuel in commercial and municipal vehicles, and even in locomotives and jet fighters. The revolution doesn’t end there, because electric motors will likely power most highway vehicles by 2050, given the current pace of research into battery development. Natural gas will remain an important feedstock for electrical power plants but there will be little need for oil other than as a lubricant and a source of asphalt.
Caveat Emptor: The “story” that supports the prices of energy stocks is always in flux, as well as being complex.
Given that oil and natural gas companies will increasingly emphasize natural gas production over oil production, is this a good time to invest in these suddenly cheap companies? By now, of course, you realize this would be more of a gamble than prudently investing for retirement. Normally, one makes this decision by estimating future earnings (or cash flows), then applying the growth rate for that industry to discount earnings back to the present. That gives an estimate for Present Value for the stock (i.e., what the current price should be). That Discounted Cash Flow (DCF) method has never worked very well for volatile (cyclical) stocks. Those are the ones that track the ups and downs of the economy too closely, such as oil and gas “exploration and production” stocks.
Instead, let’s use our old standby of the Buffett Buy Analysis (BBA). It simplifies the DCF method by projecting the trend-line for the past decade’s growth in core earnings (as calculated by S&P) to the end of the next decade (see Week 30, Week 94 and Week 135). That number is then multiplied by the worst P/E seen in the past decade. Mr. Buffett adds on the value of its current annual dividend multiplied by 10, since he doesn’t assume the company will be growing its dividend. Voila! He has a price prediction for 10 yrs from now and can calculate the BBA, which is total return/yr over the next 10 yrs (see Column T in the Table).
How has that worked out for him buying oil and natural gas stocks? He bought 18 million shares of ConocoPhillips (COP) early in 2006 for Berkshire Hathaway but soon thereafter decided he’d bet on the wrong horse. Now he’s down to 1.4 million shares of COP and 6.5 million shares of Phillips 66 (the recent spin-off of ConocoPhillips’ refinery operations). With the proceeds from those sales, he bought 41 million shares of ExxonMobil (XOM) and 7.3 million shares of National Oilwell Varco (NOV). In other words, he changed his mind when the Great Recession exposed the underlying value of specific energy companies (see Table).
The Buffett Buy Analysis starts by determining whether the company has a Durable Competitive Advantage (DCA). Mr. Buffett defines a DCA as a decade’s worth of steady growth in Tangible Book Value (TBV) at a rate of at least 9%/yr, with no more than two down years (see Column S in the Table). We’ve used his method to analyze the 40 oil and natural gas stocks in the Barrons 500 List of the largest US and Canadian companies. After excluding companies that don’t have the required DCA, plus an S&P investment-grade bond rating (i.e., BBB- or better) and an S&P stock rating of at least B+/M, we are left with the 9 companies in the Table.
Bottom Line: Only two of these 9 oil and natural gas companies had a Buffett Buy Analysis that projected returns higher than 7%/yr over the next decade, namely, Cameron International (CAM) and National Oilwell Varco (NOV). Both are too risky to include in a retirement portfolio. However, ExxonMobil (XOM) is worth considering because it has the largest investment in natural gas production and is projected to have a total return close to 5%/yr over the next 10 yrs. Most importantly for you, XOM does satisfy our requirements for inclusion in a retirement portfolio:
1) the stock has a Finance Value (Column E in the Table) that beats our key benchmark (Vanguard Balanced Index Fund - VBINX);
2) the stock is an S&P Dividend Achiever;
3) the company’s bonds have at least a BBB+ rating from S&P;
4) the stock has at least a B+/M rating from S&P;
5) the stock has had dividend growth of at least 5%/yr for the past 14 yrs, and
6) the company is large enough to be included in the Barron’s 500 List published each year in May. The Barron’s 500 List is particularly useful because it ranks companies by sales growth and cash flow-based ROIC (Return On Invested Capital) for each of the two most recent years.
Risk Rating: 6
Full Disclosure: I dollar-average into XOM and also own shares of CVX.
Note: metrics in the Table are current as of the Sunday of publication. Red highlights in the Table denote underperformance vs. VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 15
Week 115 - Capitalization-weighted Commodity Index (Updated)
Situation: Back in Week 49, we took a stab at creating a commodity index referencing stocks issued by key producers. It was intended to be a quick guide to the most volatile stocks in a favorable period, i.e., during rapid urbanization. To do that, the index needed to include companies that make the products most in demand and are marketed in all of the urbanizing regions. Our 8-company list came up short on both scores, so we’ve added 7 companies: duPont (DD), Occidental Petroleum (OXY), Potash (POT), Enbridge (ENB), Alcoa (AA), FMC (FMC), and BHP Billiton (BBL).
Mission: Create a capitalization-weighted index of 15 companies that have a primary focus on commodity extraction, production, packaging, or transportation. Demonstrate recent as well as long-term finance values, recent as well as long-term total returns, dividend information, debt, return on invested capital (ROIC), free cash flow per share (FCF/Sh), and multiple statistical presentations of recent and long-term volatility. In the Table showing these items, highlight any metric in red that fails to meet the standard of our recommended anchor investment: Vanguard Balanced Index Fund (VBINX). Include an appropriate benchmark, i.e., the lowest-cost no-load mutual fund that is most representative of natural resource stocks: T Rowe Price New Era Fund (PRNEX).
Execution: What does the Table tell us?
A) Since the end of the “dot.com recession” over 11 yrs ago, total returns are 14.3% vs. 6.9% for VBINX (Col C). But this has been at the expense of greater risk. Losses of 34.3% were accumulated during the Lehman Panic vs. overall market losses of 28% (Col D). Risk-adjusted returns (Col E) show that only 9 of the 15 companies have “Finance Value” vs. VBINX, i.e., are worth committing your funds over the long-term. But overall, our 15 companies had risk-adjusted returns on a par with VBINX.
B) How have those 9 better-performing companies been doing recently? There we look to the Barron’s 500 table for guidance, since it tells us recent trends in sales and cash flow. Only two of the 9 showed improvement in 2012 vs. 2011: Monsanto (MON) and Canadian National Railroad (CNI).
C) What about dividends (Columns I-K)? Dividend yield is 2.6% vs. 1.9% for VBINX, and dividend growth is 9.5% vs. 2.2%; 9 of the 15 companies have increased their dividends annually for at least the past 10 consecutive yrs.
D) Capitalization-weighted returns were a full 1.2% higher (Col N) than average returns (Col C), indicating that larger companies have an advantage over smaller companies. (The opposite holds true for almost all of the 10 S&P industries.) The companies with the most impact are BHP Billiton (BBL), Monsanto (MON), Occidental Petroleum (OXY), and Chevron (CVX).
E) Risk is a different story (Columns P-S): Only 4 companies lost less than the balanced index fund (VBINX): FMC, Enbridge (ENB), Chevron (CVX), and Exxon Mobil (XOM). Only one of those (XOM) had a tighter range of annual returns over the past 11 yrs and only two (XOM & ENB) had better 5-yr Beta values. However, Enbridge (ENB) is a pipeline company funded primarily with long-term debt (62.3% of capitalization). That presents a risk of default should the company have to rollover a large maturing loan during a credit crunch.
F) How efficient are these companies (Col T)? Using a standard of 12% return on invested capital (ROIC) we see that 10 of the 15 have efficient operations: MON, FMC, POT, CVX, XOM, CNI, BBL, SLB, CAT and DD. Exxon Mobil (XOM), as always, is the standout in this regard.
G) How does our Index stack up compared to a large natural resources mutual fund with ~100 companies (PRNEX)? On average, Index returns are greater and losses are less.
Bottom Line: Let’s start by recalling that on a risk-adjusted basis you can’t beat the S&P 500 Index. Yes, I know, two guys have done that. Peter Lynch ran the Magellan Fund in the 70s and 80s and beat the S&P 500 Index for 22 consecutive years but he did that by including ~1000 companies and doing superhuman research on those companies (helped by a large staff). Warren Buffett couldn’t do it consistently by stock-picking so he turned to company-picking and now owns over 100. Though he hasn’t beat the S&P 500 Index every year, he has beat it for every rolling 5-yr period over the past 40+ yrs while taking less risk (current 5 yr Beta =0.25). Your only chance of beating the S&P 500 Index is to take more risk or buy stock using insider knowledge (which is illegal in the US).
The world is urbanizing at a rapid rate, so this is the time to bet on infrastructure. That means betting on commodity producers, and here’s a terrific article about commodity cycles to help you decide if that’s something you’re willing to tackle. Five of our 15 companies are in the 30-stock Dow-Jones Industrial Average (DJIA): CVX, XOM, CAT, DD and AA. You might want to start your research there, since the DJIA outperforms the S&P 500 Index most years (DIA in the Table).
Risk Rating: 9
Full Disclosure: I have significant holdings (over 100 shares) in XOM, CVX, and OXY.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Subscribe to:
Comments (Atom)