Situation: Food is an “essential good.” The COVID-19 Pandemic has made us all acutely aware of this, now that we’re being told to shun restaurants and eat at home. But companies that process row crops into breakfast food have faced a topsy-turvy marketing climate in recent years. General Mills (GIS) and Kellogg (K) have had to endure an existential crisis because consumers chose to distance themselves from processed breakfast foods in favor of more nutritious, fresh, and “organic” offerings. This was partly because fewer families came together each day for a sit-down breakfast. People became concerned about sugars being added to so much of what we eat, as well as the preservatives and obscure ingredients (like dyes) listed on each box of cereal. Debates arose about nutritional value and safety for children. Now, several years after the fact, those former icons of the food industry have admitted their failures and are marketing foods that are demonstrably good for children and contain no obscure or unsafe ingredients. Cereals contain dried strawberries or blueberries, sliced almonds, and other fruits or nuts. Serious investors welcome this state of affairs because changes in consumer behavior create volatility in the market, which translates into opportunity. And who’s to argue against a wider choice of more healthy foods? But for the casual investor, who doesn’t devote hours a week to following the food industry, this is not a good thing. Now is a good time to look at the food and agriculture companies that are left standing.
Mission: Use our Standard Spreadsheet to analyze food and agriculture-related companies that have an A- or better S&P rating on their bonds, as well as B+/M or better S&P ratings on their stocks.
Execution: See Table.
Administration: Four of the 12 companies appear to offer exceptional value: Coca-Cola (KO), PepsiCo (PEP), Walmart (WMT) and Target (TGT). Those are all Dividend Achievers as well as being listed in the S&P 100 Index (OEF), the Vanguard High Dividend Yield Index (VYM), and the iShares Top 200 Value Index (IWX) (see Columns AL to AO of the Table).
Bottom Line: Companies close to the production of raw commodities have stock prices that tend to follow the commodity cycle, which is dominated by oil. Investors in Deere (DE) and Archer Daniels Midland (ADM) profit if the farmer profits. Investors in food processors and grocery stores face a fickle food consumer, whose only concern is to get the best taste and nutrition per dollar. The companies that have proven they can persevere in that arena are Hormel Foods (HRL), Costco Wholesale (COST), Coca-Cola (KO), Target (TGT), Hershey (HSY), Walmart (WMT), and PepsiCo (PEP). Those companies will still be doing well 10 years from now.
Risk Rating: 7 (10-yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into COST, UNP, KO, WMT and CAT, and also own shares of DE, BRK-B, TGT and PEP.
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 railroads. Show all posts
Showing posts with label railroads. Show all posts
Sunday, September 2
Week 374 - Bet With The House By Picking Companies In The 2 And 8 Club
Situation: In the U.S., capital-intensive industries with strategic importance are tightly regulated (see Week 230). Electric power grids and railroad networks are expensive to install, maintain and upgrade but those chores are absorbed by shareholders in private companies. Regulatory bodies grant these companies monopoly-like pricing power, oversee safety practices, and set rates high enough to pay for maintenance and upgrades.
Since the Great Recession, international Money Center banks have also come under intense regulation to meet Basel III requirements for sustainability and reduce systemic risks. A more specific definition now replaces Money Center Bank, which is Systemically Important Financial Institution (SIFI).
Looked at from the shareholder’s point of view, companies in these three industries have enough government regulation (and monopoly-like pricing power) that bankruptcy is no longer a material risk. One downside risk is that the US market for their goods and services is largely saturated. So, significant growth in the “bottom line” requires innovation and international outreach that will be overseen by government regulators.
Mission: Use our Standard Spreadsheet to highlight members of “The 2 and 8 Club” that are in the Electric Utilities, SIFI banking, and Railroad industries.
Execution: see Table.
Bottom Line: The safest tactic in gambling is to “bet with the house” whenever you can. Politicians are now in effective control of three industries: Electric utilities, railroads, and international Money Center banks (now called Systemically Important Financial Institutions or SIFIs). These industries are not in danger of being “nationalized” because politicians would much prefer that shareholders (as opposed to taxpayers) put up the large amounts of capital needed to keep these industries safe and effective.
Risk Rating: 6 (where US Treasury Notes = 1, S&P 500 Index =5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM.
"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
Since the Great Recession, international Money Center banks have also come under intense regulation to meet Basel III requirements for sustainability and reduce systemic risks. A more specific definition now replaces Money Center Bank, which is Systemically Important Financial Institution (SIFI).
Looked at from the shareholder’s point of view, companies in these three industries have enough government regulation (and monopoly-like pricing power) that bankruptcy is no longer a material risk. One downside risk is that the US market for their goods and services is largely saturated. So, significant growth in the “bottom line” requires innovation and international outreach that will be overseen by government regulators.
Mission: Use our Standard Spreadsheet to highlight members of “The 2 and 8 Club” that are in the Electric Utilities, SIFI banking, and Railroad industries.
Execution: see Table.
Bottom Line: The safest tactic in gambling is to “bet with the house” whenever you can. Politicians are now in effective control of three industries: Electric utilities, railroads, and international Money Center banks (now called Systemically Important Financial Institutions or SIFIs). These industries are not in danger of being “nationalized” because politicians would much prefer that shareholders (as opposed to taxpayers) put up the large amounts of capital needed to keep these industries safe and effective.
Risk Rating: 6 (where US Treasury Notes = 1, S&P 500 Index =5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 6
Week 357 - Dividend Achievers That Support Commodity Production
Situation: Commodities crashed in 2014 but the only S&P industries to be affected were Energy, Industrials (specifically railroads) and Basic Materials. A new Commodity Supercycle began to take hold in early 2017.
Which companies stand to benefit?
Mission: Under the best of circumstances, commodity-related investments are highly speculative. If you gamble at this casino long enough, you’ll lose big and win big. So, let’s confine our attention to “the best of circumstances,” i.e., set up our Standard Spreadsheet to look at companies meeting these requirements:
1) S&P credit rating for long-term bonds is BBB+ or better;
2) S&P stock rating is B+/M or better;
3) Long-term Debt doesn’t exceed 33% of Total Assets;
4) Tangible Book Value is a positive number;
5) the company is a Dividend Achiever.
Execution: see Table.
Administration: Seven companies meet our requirements. Only the two railroads (UNP, CSX) and Exxon Mobil (XOM) meet the key requirement Warren Buffett has for saying that a company enjoys a “Durable Competitive Advantage” (see Week 54), i.e., steady growth in Tangible Book Value exceeding 7%/yr (see Columns AD and AE in the Table). It is also important to note that all areas of commodity production (aside from aquaculture) employ equipment that digs in the dirt. That makes Caterpillar (CAT) a useful barometer, and its stock has done well since the Commodity Crash of 2014-2016.
Bottom Line: If you’ve held shares in any of these 7 companies (see Table) for more than a few years, I commend your perseverance. Stick it out awhile longer and you may be rewarded. A new Commodity Supercycle appears to be starting, and will likely take hold if China stays the course and becomes a Superpower.
Risk Rating: 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Union Pacific (UNP) and Exxon Mobil (XOM).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Which companies stand to benefit?
Mission: Under the best of circumstances, commodity-related investments are highly speculative. If you gamble at this casino long enough, you’ll lose big and win big. So, let’s confine our attention to “the best of circumstances,” i.e., set up our Standard Spreadsheet to look at companies meeting these requirements:
1) S&P credit rating for long-term bonds is BBB+ or better;
2) S&P stock rating is B+/M or better;
3) Long-term Debt doesn’t exceed 33% of Total Assets;
4) Tangible Book Value is a positive number;
5) the company is a Dividend Achiever.
Execution: see Table.
Administration: Seven companies meet our requirements. Only the two railroads (UNP, CSX) and Exxon Mobil (XOM) meet the key requirement Warren Buffett has for saying that a company enjoys a “Durable Competitive Advantage” (see Week 54), i.e., steady growth in Tangible Book Value exceeding 7%/yr (see Columns AD and AE in the Table). It is also important to note that all areas of commodity production (aside from aquaculture) employ equipment that digs in the dirt. That makes Caterpillar (CAT) a useful barometer, and its stock has done well since the Commodity Crash of 2014-2016.
Bottom Line: If you’ve held shares in any of these 7 companies (see Table) for more than a few years, I commend your perseverance. Stick it out awhile longer and you may be rewarded. A new Commodity Supercycle appears to be starting, and will likely take hold if China stays the course and becomes a Superpower.
Risk Rating: 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Union Pacific (UNP) and Exxon Mobil (XOM).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, 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, November 29
Week 230 - Bet with the House
Situation: Government regulation now limits pricing power in 3 sub-industries: electric utilities, long-distance railroad and truck transportation, and money-center banks. First it was electric utilities, then railroads and trucking. The purpose of this regulation was to ensure that these companies with high fixed costs would be able to maintain their networks. That meant customers had to be charged enough to keep Return on Equity at around 10%. Railroads and electric utilities are essentially monopolies, so regulators also prevent them from overcharging. Then the Great Recession came along, and the few investment banking firms that had existed prior to the Lehman Panic couldn’t remain solvent. To gain access to Federal protection, they applied to become commercial banks. That had the down-side of welcoming Federal auditors into their offices on a full-time basis. When the “other shoe dropped” (The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010), legislation imposed additional regulation on the riskier (and more lucrative) financial products that money center banks prefer to promote. The danger is that these interconnected megabanks would simultaneously lose a great deal of money, i.e., precipitate a global economic crisis. Dodd-Frank calls those banks “SIFIs” or “Systemically Important Financial Institutions." The point is that most of the levers controlling finance are no longer located near Wall Street. They’re in Washington. So, there may be more safety in investing with companies in those 3 sub-industries that fall under Federal protection. Think of them as government protected companies.
Mission: We take the gambler’s saying seriously, i.e., “when possible, bet with the house.” The House is now the US Treasury, which has controlled short-term interest rates through the Federal Open Market Committee since the Banking Act of 1933. That’s one key variable that controls stock prices. The other key variable is earnings growth, which is supposed to be a function of the private economy. But, pricing power of 3 sub-industries is now under oversight of the US Treasury or government agencies answerable to the US Treasury. To “bet with the house” we need to assess a sample of companies in those 3 sub-industries.
Execution: We look at the 65-stock Dow Jones Composite Index (^DJA) to find a representative sample of companies. This week’s Table has every company in those 3 sub-industries that is large enough to appear in the 2015 Barron’s 500 List, as long as it has an S&P bond rating of BBB+ or better and an S&P stock rating of B+/M.
Bottom Line: These 11 companies operate under close government regulation. As a group, they have done well compared to the lowest-cost S&P 500 Index fund (compare Lines 13, 22 and 26 under Columns C, E and N in the Table). This outperformance apparently comes with no additional risk (see the same Lines under Columns D, I and O in the Table), So, betting with the House looks like a good idea. Specifically, this 11-stock sample performs better than the 65-stock Dow Jones Composite Index (compare Lines 13, 20 and 25 in Columns C through F of the Table) which, in turn, performs better than VFINX (the lowest-cost S&P 500 Index fund at Line 22 of the Table).
Risk Rating: 6
Full Disclosure: I dollar-average into NEE, UNP and JPM.
Note: Metrics are current for the Sunday of publication; metrics in red denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: We take the gambler’s saying seriously, i.e., “when possible, bet with the house.” The House is now the US Treasury, which has controlled short-term interest rates through the Federal Open Market Committee since the Banking Act of 1933. That’s one key variable that controls stock prices. The other key variable is earnings growth, which is supposed to be a function of the private economy. But, pricing power of 3 sub-industries is now under oversight of the US Treasury or government agencies answerable to the US Treasury. To “bet with the house” we need to assess a sample of companies in those 3 sub-industries.
Execution: We look at the 65-stock Dow Jones Composite Index (^DJA) to find a representative sample of companies. This week’s Table has every company in those 3 sub-industries that is large enough to appear in the 2015 Barron’s 500 List, as long as it has an S&P bond rating of BBB+ or better and an S&P stock rating of B+/M.
Bottom Line: These 11 companies operate under close government regulation. As a group, they have done well compared to the lowest-cost S&P 500 Index fund (compare Lines 13, 22 and 26 under Columns C, E and N in the Table). This outperformance apparently comes with no additional risk (see the same Lines under Columns D, I and O in the Table), So, betting with the House looks like a good idea. Specifically, this 11-stock sample performs better than the 65-stock Dow Jones Composite Index (compare Lines 13, 20 and 25 in Columns C through F of the Table) which, in turn, performs better than VFINX (the lowest-cost S&P 500 Index fund at Line 22 of the Table).
Risk Rating: 6
Full Disclosure: I dollar-average into NEE, UNP and JPM.
Note: Metrics are current for the Sunday of publication; metrics in red denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 2
Week 213 - Barron’s 500 Companies with 16 years of Above-market Returns and Below-market Risk
Situation: It has been difficult for us to set objective standards for stock-picking this year. In an overheated market, there are few stocks that meet our standards for safety. And those that do often have issues that end up explaining why they’re attractively priced. So, we’ve emphasized long-term metrics (see Week 199 and Week 206). Our goal in those two blogs has been to uncover “unicorns” -- the few companies that achieve above-market long-term returns at below-market risk. In this week’s blog we continue the hunt, hoping that enough such companies are out there to allow us to categorize the sub-sectors of the economy where they might be found.
Mission: Develop an algorithm for identifying which Barron’s 500 stocks have risk metrics that do not exceed those of the S&P 500 Index while also having 16-yr returns that beat the S&P 500 Index.
Execution: Screen the 2015 list of Barron’s 500 companies by applying a set of short- and long-term risk measurements. For example, stocks with a 5-yr Beta over 1.00 are excluded, since those have a variance higher than the S&P 500 Index. Instead of using volatile P/E values as the other tool for assessing short-term risk, we use Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation and Amortization or "EV/EBITDA" and exclude stocks with a value higher than 11, which is the EV/EBITDA value for the S&P 500 Index. In other words, a company’s market capitalization (EV) is the current value of the bonds and stocks that it has issued; its earnings (EBITDA) exclude the complex and powerful effect that interest (paid on those bonds) has in lowering taxes. EV/EBITDA gives the kind of price/earnings information that investors need, one that eliminates distortions introduced by sources and sinks for cash.
To assess 16-yr returns, we primarily use the statistical (Standard Deviation of weekly prices) records found at the BMW Method website. That data set also generates estimates for the percent loss (or gain) in price that can be expected to occur at a variance of one or two Standard Deviations. For example, a drop of -2 SD is the loss that can be expected to occur in a future Bear Market. To supplement this “price only” data, we use the Buyupside website to calculate the added benefit that comes from dividends paid (i.e., Total return) from making a single stock purchase 16 yrs ago (see Column C in the Table). We also use that website to assess risk by calculating the Lehman Panic total return (10/07-4/09), which is recorded at Column D in the Table for each of our weekly blogs.
To help you gain perspective on these methods of analysis, we’ve made two additions to our list of BENCHMARKS: 1) Coca-Cola (KO), because it is the only specific stock recommendation that Warren Buffett has made for retail investors; 2) the Exchange-Traded Fund (ETF) for the Dow Jones Industrial Average (DIA or ^DJI), which has 10% better returns than the S&P 500 Index (VFINX or ^GSPC) over 3-4 market cycles with 5% less statistical risk of loss at -2SD: see 30-yr data for ^DJI vs. ^GSPC at the BMW Method website.
Bottom Line: We’ve found 10 companies that meet all of our standards for rewards vs. risk over the past 16 yrs relative to the S&P 500 Index. Five are monopolies in heavily regulated industries: Union Pacific (UNP), NextEra Energy (NEE), Eversource Energy (ES), AGL Resources (GAS), DTE Energy (DTE). Three derive the largest portion of their revenues from food: Wal-Mart Stores (WMT), Kimberly-Clark (KMB) and Sysco (SYY). It is unlikely that all 10 of these companies will continue to outperform the S&P 500 Index over the next 16 yrs, since that performance will attract more buyers and thereby elevate the short-term risk metrics (5-yr Beta, EV/EBITDA). But you get the idea: 1) “Bet with the house” which would be the government-regulated monopolies; 2) prioritize food-related investments.
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and NEE, and also own shares of ITW and UNP.
Note: Metrics are current as of the Sunday of publication; metrics highlighted in red denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Develop an algorithm for identifying which Barron’s 500 stocks have risk metrics that do not exceed those of the S&P 500 Index while also having 16-yr returns that beat the S&P 500 Index.
Execution: Screen the 2015 list of Barron’s 500 companies by applying a set of short- and long-term risk measurements. For example, stocks with a 5-yr Beta over 1.00 are excluded, since those have a variance higher than the S&P 500 Index. Instead of using volatile P/E values as the other tool for assessing short-term risk, we use Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation and Amortization or "EV/EBITDA" and exclude stocks with a value higher than 11, which is the EV/EBITDA value for the S&P 500 Index. In other words, a company’s market capitalization (EV) is the current value of the bonds and stocks that it has issued; its earnings (EBITDA) exclude the complex and powerful effect that interest (paid on those bonds) has in lowering taxes. EV/EBITDA gives the kind of price/earnings information that investors need, one that eliminates distortions introduced by sources and sinks for cash.
To assess 16-yr returns, we primarily use the statistical (Standard Deviation of weekly prices) records found at the BMW Method website. That data set also generates estimates for the percent loss (or gain) in price that can be expected to occur at a variance of one or two Standard Deviations. For example, a drop of -2 SD is the loss that can be expected to occur in a future Bear Market. To supplement this “price only” data, we use the Buyupside website to calculate the added benefit that comes from dividends paid (i.e., Total return) from making a single stock purchase 16 yrs ago (see Column C in the Table). We also use that website to assess risk by calculating the Lehman Panic total return (10/07-4/09), which is recorded at Column D in the Table for each of our weekly blogs.
To help you gain perspective on these methods of analysis, we’ve made two additions to our list of BENCHMARKS: 1) Coca-Cola (KO), because it is the only specific stock recommendation that Warren Buffett has made for retail investors; 2) the Exchange-Traded Fund (ETF) for the Dow Jones Industrial Average (DIA or ^DJI), which has 10% better returns than the S&P 500 Index (VFINX or ^GSPC) over 3-4 market cycles with 5% less statistical risk of loss at -2SD: see 30-yr data for ^DJI vs. ^GSPC at the BMW Method website.
Bottom Line: We’ve found 10 companies that meet all of our standards for rewards vs. risk over the past 16 yrs relative to the S&P 500 Index. Five are monopolies in heavily regulated industries: Union Pacific (UNP), NextEra Energy (NEE), Eversource Energy (ES), AGL Resources (GAS), DTE Energy (DTE). Three derive the largest portion of their revenues from food: Wal-Mart Stores (WMT), Kimberly-Clark (KMB) and Sysco (SYY). It is unlikely that all 10 of these companies will continue to outperform the S&P 500 Index over the next 16 yrs, since that performance will attract more buyers and thereby elevate the short-term risk metrics (5-yr Beta, EV/EBITDA). But you get the idea: 1) “Bet with the house” which would be the government-regulated monopolies; 2) prioritize food-related investments.
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and NEE, and also own shares of ITW and UNP.
Note: Metrics are current as of the Sunday of publication; metrics highlighted in red denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (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, April 5
Week 196 - Stockpicker's Secret Fishing Hole: 20-yr Returns
Situation: We started this blog 4 years ago because we saw an inconsistency in the way people plan for retirement. The same inconsistency affects the way most investors buy stocks. They’re looking for exotic investments, often in foreign and small-cap companies (or mutual funds that target such companies). Why? Because the S&P 500 Index has imploded twice on them since 2000. So, they choose to ignore the 800 pound gorilla in the room (large, well-established US companies), particularly the boring companies like utilities and transports. In other words, they ignore the very companies that make up the 65-stock Dow Jones Composite Average (DJCA). This makes no sense, given that the DJCA outperforms the S&P 500 Index long-term, and does so with less volatility. So, we started our blog with the Growing Perpetuity Index (stocks in the DJCA that are Dividend Achievers) and have highlighted the DJCA by calling it the Stockpicker’s Secret Fishing Hole (see Week 68).
But we’ve never made a comprehensive assessment of all 65 companies. This week’s blog tries to do that. Eight of the companies have been excluded because they are either too small to be in the Barron’s 500 List or don’t have total return records extending out to 20 yrs; 21 more were excluded because of being unsuitable for retirement portfolios (i.e., they had an S&P credit rating less than BBB+ and/or an S&P stock rating less than B+/M). Three of the remaining 36 were excluded because of having greater price volatility (variance) than the S&P 500 Index over the past 20 yrs.
Not surprisingly, the 33 companies in this week’s Table have outperformed the DJCA over the past 20 yrs (compare Line 35 to Line 44 in the Table under Column C). And, the DJCA had a 20-yr total return that beat the S&P 500 Index by more than 10% (compare Line 44 to Line 45). The problem is that you’ve heard of many of those 33 companies and often use their products. So, there’s nothing mysterious or exotic about investing in those companies; none are the “diamond in the rough” you can talk up at cocktail parties. Your stockbroker understands human nature, so she won’t be talking up those names either.
Let’s go down the list and see which stocks have outperformed the S&P 500 Index over both the past 5 and 20 yr periods. There’s JB Hunt Transport Services (the most commonly encountered trucks on the interstate), NextEra Energy (you know wind and solar power are growth industries but maybe you didn’t know NextEra is the leader), Nike (no one can be surprised by its continuing outperformance), and Travelers (any insurance company that knows how to price risk is a good investment). There’s 3M and the 3 railroads (Union Pacific, Norfolk Southern, and CSX), as well as Walt Disney and Home Depot. (You probably aren’t surprised to learn that all 6 of those are perennial money-makers.) UnitedHealth Group is the leading purveyor of health insurance (maybe you didn’t know that). Boeing and American Express round out the list of companies you already expected to continue raking in the cash. I had a stockbroker who didn’t mention any of those companies to me in over 30 years, although he did recommend others on the list: United Technologies, Cisco Systems, Intel, Caterpillar, ExxonMobil and Johnson & Johnson.
Bottom Line: You have little time to research stocks, so focus your attention on a shorter list than the S&P 500. Try the 65-stock Dow Jones Composite Average (DJCA), which also happens to outperform the S&P 500 over the long term. All 65 stocks are picked by a committee headed by the Managing Editor of the Wall Street Journal. We’ve trimmed the list down to 33 that can fit into a retirement portfolio. Take particular note of the 19 that are S&P Dividend Achievers (i.e., companies that have increased their dividends annually for at least the past 10 yrs). Eleven of those have a Finance Value (see Column E in the Table) that beats the Finance Value for our key benchmark, VBINX, which is the Vanguard Balanced Index Fund: WMT, MCD, ED, SO, NEE, NKE, IBM, JNJ, KO, XOM, CVX. Inflation has been 2.1%/yr over the past 20 years, and the average 20-yr dividend growth rate of those 11 stocks has been 11.6%/yr (see Column H in the Table). If your retirement portfolio were to contain equal dollar amounts in each of those 11 stocks, your dividend checks would be growing 9-10% faster than inflation, every year. Think about it.
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, XOM, MSFT, NEE, NKE, and JPM.
NOTE: Red highlights in the table denote underperformance vs. our key benchmark, VBINX. Values in the table are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
But we’ve never made a comprehensive assessment of all 65 companies. This week’s blog tries to do that. Eight of the companies have been excluded because they are either too small to be in the Barron’s 500 List or don’t have total return records extending out to 20 yrs; 21 more were excluded because of being unsuitable for retirement portfolios (i.e., they had an S&P credit rating less than BBB+ and/or an S&P stock rating less than B+/M). Three of the remaining 36 were excluded because of having greater price volatility (variance) than the S&P 500 Index over the past 20 yrs.
Not surprisingly, the 33 companies in this week’s Table have outperformed the DJCA over the past 20 yrs (compare Line 35 to Line 44 in the Table under Column C). And, the DJCA had a 20-yr total return that beat the S&P 500 Index by more than 10% (compare Line 44 to Line 45). The problem is that you’ve heard of many of those 33 companies and often use their products. So, there’s nothing mysterious or exotic about investing in those companies; none are the “diamond in the rough” you can talk up at cocktail parties. Your stockbroker understands human nature, so she won’t be talking up those names either.
Let’s go down the list and see which stocks have outperformed the S&P 500 Index over both the past 5 and 20 yr periods. There’s JB Hunt Transport Services (the most commonly encountered trucks on the interstate), NextEra Energy (you know wind and solar power are growth industries but maybe you didn’t know NextEra is the leader), Nike (no one can be surprised by its continuing outperformance), and Travelers (any insurance company that knows how to price risk is a good investment). There’s 3M and the 3 railroads (Union Pacific, Norfolk Southern, and CSX), as well as Walt Disney and Home Depot. (You probably aren’t surprised to learn that all 6 of those are perennial money-makers.) UnitedHealth Group is the leading purveyor of health insurance (maybe you didn’t know that). Boeing and American Express round out the list of companies you already expected to continue raking in the cash. I had a stockbroker who didn’t mention any of those companies to me in over 30 years, although he did recommend others on the list: United Technologies, Cisco Systems, Intel, Caterpillar, ExxonMobil and Johnson & Johnson.
Bottom Line: You have little time to research stocks, so focus your attention on a shorter list than the S&P 500. Try the 65-stock Dow Jones Composite Average (DJCA), which also happens to outperform the S&P 500 over the long term. All 65 stocks are picked by a committee headed by the Managing Editor of the Wall Street Journal. We’ve trimmed the list down to 33 that can fit into a retirement portfolio. Take particular note of the 19 that are S&P Dividend Achievers (i.e., companies that have increased their dividends annually for at least the past 10 yrs). Eleven of those have a Finance Value (see Column E in the Table) that beats the Finance Value for our key benchmark, VBINX, which is the Vanguard Balanced Index Fund: WMT, MCD, ED, SO, NEE, NKE, IBM, JNJ, KO, XOM, CVX. Inflation has been 2.1%/yr over the past 20 years, and the average 20-yr dividend growth rate of those 11 stocks has been 11.6%/yr (see Column H in the Table). If your retirement portfolio were to contain equal dollar amounts in each of those 11 stocks, your dividend checks would be growing 9-10% faster than inflation, every year. Think about it.
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, XOM, MSFT, NEE, NKE, and JPM.
NOTE: Red highlights in the table denote underperformance vs. our key benchmark, VBINX. Values in the table are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 25
Week 186 - Stock-pickers Secret Fishing Hole Revisited
Situation: Every so often we go back to our comfort zone, the Dow Jones Composite Average (DJCA) of 65 tried-and-true companies. We call it the Stock-pickers Secret Fishing Hole (see Week 29). Why? Because the DJCA tends to outperform the S&P 500 Index and it has lots of the “old” companies that Warren Buffett likes, i.e., boring but stable moneymakers. Fifteen of the companies are regulated electric utilities (Dow Jones Utility Average or DJUA) and 20 are transportation firms (Dow Jones Transportation Average or DJTA), i.e., railroads, trucking outfits, freight forwarders, airlines, and ocean shippers. The remaining 30 are the so-called “blue chip” companies that make up the Dow Jones Industrial Average (DJIA). We like to periodically revisit the 65 company list because it includes many steady performers that don’t generate much excitement and may even be underpriced. And that’s exactly the kind of company we love to feature.
The annual fixed costs of railroads and electric utilities are so high that they’re organized as “legal monopolies” and require government regulation, which allows them to attract investors but still protect customers from being overcharged. Return on Equity is generally in the 10-12% range, and the effect that price changes have on demand (elasticity) is minimal. Warren Buffett likes that combination, so Berkshire Hathaway’s most prominent moneymakers are Berkshire Hathaway Energy (the largest electric utility in the US), and Burlington Northern Santa Fe (the second-largest railroad). Berkshire Hathaway also owns large blocks of stock in 8 DJIA companies: American Express (AXP), Coca-Cola (KO), ExxonMobil (XOM), General Electric (GE), Goldman Sachs (GS), International Business Machines (IBM), Johnson & Johnson (JNJ), and Wal-Mart Stores (WMT).
To drill down to those companies with exceptional value (see Table), we start with the Barron’s 500 List because it a) contains information on revenues and ROIC (Return on Invested Capital), b) uses that information to rank-order the largest US and Canadian companies, and c) lists the year-over-year change in rank. We then eliminate companies that don’t have S&P bond ratings of at least BBB+ and S&P stock ratings of at least B+/M. Finally, the 37 companies that remain are winnowed down to 20 by excluding those with a Finance Value (Column E in the Table) that doesn’t beat VBINX (Vanguard Balanced Index Fund). In other words, the excluded companies had losses during the 18-month Lehman Panic that were not mitigated by long-term gains. That leaves us with 11 DJIA, 4 DJTA, and 5 DJUA companies (see Table). As a group, these are safe stocks to own because they had losses during the 18-month Lehman Panic of only 18.4% vs. 46.5% for the lowest-cost S&P 500 Index fund, VFINX, and their 5-yr Beta is ~0.65 vs. 1.00 for VFINX.
Bottom Line: Embrace Sutton’s Law (i.e., go where the money is). It’s easier to cull a list of 65 for winners than a list of 500, and even more rewarding if the shorter list outperforms the longer one. For the past 34 yrs, the 65-stock Dow Jones Composite Index has returned 8.7%/yr (without dividends reinvested) vs. 8.3%/yr for the S&P 500 Index. As a typical stock-picker, i.e., someone who has a day job and a family, you have little time to research stocks. We’re here to help, and that means highlighting stocks worth holding in a retirement account. This week there are 20 for you to consider and 5 happen to be Warren Buffett favorites: Wal-Mart Stores (WMT), Johnson & Johnson (JNJ), ExxonMobil (XOM), International Business Machines (IBM), and Coca-Cola (KO). Fourteen are Dividend Achievers (see Column P in the Table) with 10+ yrs of annual dividend increases. Start your hunt by taking a closer look at those but be aware that 4 of the 14 appear to be overpriced (see Column K in the Table): Procter & Gamble (PG), Coca-Cola (KO), Dominion Resources (D), and Nike (NKE).
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, NKE, XOM, and NEE, and also hold shares of MCD, D, IBM, JNJ, and CVX for dividend re-investment.
Note: metrics are current as of the Sunday of publication; red highlights denote underperformance vs. VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The annual fixed costs of railroads and electric utilities are so high that they’re organized as “legal monopolies” and require government regulation, which allows them to attract investors but still protect customers from being overcharged. Return on Equity is generally in the 10-12% range, and the effect that price changes have on demand (elasticity) is minimal. Warren Buffett likes that combination, so Berkshire Hathaway’s most prominent moneymakers are Berkshire Hathaway Energy (the largest electric utility in the US), and Burlington Northern Santa Fe (the second-largest railroad). Berkshire Hathaway also owns large blocks of stock in 8 DJIA companies: American Express (AXP), Coca-Cola (KO), ExxonMobil (XOM), General Electric (GE), Goldman Sachs (GS), International Business Machines (IBM), Johnson & Johnson (JNJ), and Wal-Mart Stores (WMT).
To drill down to those companies with exceptional value (see Table), we start with the Barron’s 500 List because it a) contains information on revenues and ROIC (Return on Invested Capital), b) uses that information to rank-order the largest US and Canadian companies, and c) lists the year-over-year change in rank. We then eliminate companies that don’t have S&P bond ratings of at least BBB+ and S&P stock ratings of at least B+/M. Finally, the 37 companies that remain are winnowed down to 20 by excluding those with a Finance Value (Column E in the Table) that doesn’t beat VBINX (Vanguard Balanced Index Fund). In other words, the excluded companies had losses during the 18-month Lehman Panic that were not mitigated by long-term gains. That leaves us with 11 DJIA, 4 DJTA, and 5 DJUA companies (see Table). As a group, these are safe stocks to own because they had losses during the 18-month Lehman Panic of only 18.4% vs. 46.5% for the lowest-cost S&P 500 Index fund, VFINX, and their 5-yr Beta is ~0.65 vs. 1.00 for VFINX.
Bottom Line: Embrace Sutton’s Law (i.e., go where the money is). It’s easier to cull a list of 65 for winners than a list of 500, and even more rewarding if the shorter list outperforms the longer one. For the past 34 yrs, the 65-stock Dow Jones Composite Index has returned 8.7%/yr (without dividends reinvested) vs. 8.3%/yr for the S&P 500 Index. As a typical stock-picker, i.e., someone who has a day job and a family, you have little time to research stocks. We’re here to help, and that means highlighting stocks worth holding in a retirement account. This week there are 20 for you to consider and 5 happen to be Warren Buffett favorites: Wal-Mart Stores (WMT), Johnson & Johnson (JNJ), ExxonMobil (XOM), International Business Machines (IBM), and Coca-Cola (KO). Fourteen are Dividend Achievers (see Column P in the Table) with 10+ yrs of annual dividend increases. Start your hunt by taking a closer look at those but be aware that 4 of the 14 appear to be overpriced (see Column K in the Table): Procter & Gamble (PG), Coca-Cola (KO), Dominion Resources (D), and Nike (NKE).
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, NKE, XOM, and NEE, and also hold shares of MCD, D, IBM, JNJ, and CVX for dividend re-investment.
Note: metrics are current as of the Sunday of publication; red highlights denote underperformance vs. VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 12
Week 171 - Thinking of Owning Farmland As An Investment?
Situation: Here on the Great Plains, owning farmland is the Great Game. Throughout the midwest, 60% of the land being farmed is rented. With corn prices down 50% from their 2012 peak, fixed rents are having to be renegotiated to reflect the falloff in farm incomes. “Custom financing” is becoming more prevalent, meaning that instead of a fixed rent the landlord gets half, 40% or 1/3rd of the revenue generated from crop sales at the end of the growing season. The tenant farmer pays all expenses other than property tax and insurance.
Over very long time periods, farmland appears to be a better asset class to own than stocks. For example, farmland in southwest Iowa (Audubon County) that sold for $266/acre in 1963 was worth $9466/acre in 2013 for a price return of 7.4%/yr. Compare that to 6.6%/yr for the S&P 500 Index. You also need to consider that both asset classes produce income (rents or dividends) and are hammered by inflation, which averaged 4.2%/yr across that 50-yr interval. Farmland rents stay close to 5% of land value, bringing total return to 12.4%/yr. Reinvesting dividends on the S&P 500 Index over the past 50 yrs brings total return to 9.9%/yr. Accounting for inflation, those numbers drop to 8.2%/yr and 5.7%/yr. Farmland prices also show less volatility than stock prices, so farmland looks to be the hands-down winner!
Prime farmland in Eastern Nebraska or Western Iowa currently costs ~$9600/ac and is sold in quarter section (160 acre) parcels. You’ll need a big mortgage for that $1,536,000 price tag, even if you can come up with the $307,200 down payment. But unless you are yourself a farmer, this is not as wise an investment as it appears to be. Why? Like investing in gold, it predates and is outside the built-in benefits of capitalism: There’s no accrual accounting or compounding of interest (see Week 157). More importantly, you'll lose money when crop prices collapse like they did in 2013 and have continued to do this year.
For both tenant and landlord, the Great Game is to bet on the weather cycle as opposed to the economic cycle. The farmer can always tune in to a local AM radio station that will provide instant pricing for “futures” on farm commodities. As he’s driving his tractor, he can trade futures on the Chicago Mercantile Exchange (CME) by using his smartphone. When prices spike upward, farmers (and their landlords) can reap windfall profits if they act quickly. When prices spike downwards, the crop insurance that is built into every US Farm Bill will likely prevent efficient farmers from having to “cash out.” Farmers also have the option of buying grain bins to store their crop until the market recovers. And, most farmers “hedge” 20-30% of their crop against the risk that prices will fall, agreeing to sell at a pre-set price when the growing season ends by entering into a futures contract on the CME.
Farmers are gamblers, as are those among their landlords who take a cut of crop sales in lieu of a fixed rent. More often than not, their gambles pay off. Why? Because planet-wide protein production can’t keep up with the demand created by population growth and rising incomes, and weather-related crises are out of sync with economic crises. Now you know why Omaha came through the Great Recession better than any other American city.
For our readers, we’d better stress that owning farmland is another way to gamble on a commodity (see Week 163). Yes, big profits can occur but they’re a hit-or-miss thing with long dry spells punctuated by some bad years, such as 2014. That being said, the prudent move is to take the time-proven route to commodity profits, which is to invest in companies that service the producer (e.g. farmer) rather than the commodity itself (e.g. farmland and crop futures). In this case, it means investing in stock issued by companies that provide inputs (and outputs such as railroads) to “production agriculture.” Then add a couple of food-processing companies. Why? Because those companies supply food to grocery stores and can pass commodity costs on to the consumer.
How then might you make a farmland investment that benefits from the insights of capitalism (accrual accounting and compound interest)? That would be through dollar-cost averaging your stock purchases then reinvesting your dividends. We find only 10 companies that meet our criteria for inclusion in a retirement portfolio (Table). Our benchmark is the Vanguard Balanced Index Fund (VBINX) at Line 17 in the Table; red highlights denote metrics that underperform VBINX. Our criteria are:
1) the company is an S&P Dividend Achiever, i.e., one that has raised its dividend annually for at least the past 10 yrs;
2) the company has an S&P bond rating of BBB+ or higher;
3) the company has an S&P stock rating of B+/M or higher;
4) the company’s stock has a dividend yield of 1.4% or higher.
Now let’s see how those 10 stocks have done over the past 14 yrs as opposed to returns on owning farmland in Audubon County, Iowa, the benchmark we used above. Farmland values have grown 12.4%/yr and inflation has been 2.4%/yr. Adding 5%/yr in rental income and subtracting 2.4%/yr inflation leaves 15%/yr. For our 10 stocks, total return is close to 15%/yr, which makes after-inflation return ~12.5%/yr.
Bottom Line: Farmland has been the most stable and rewarding asset class to own for many decades, if not centuries. But is that extra 2.5%/yr (compared to Ag-related stocks over the past 14 yrs or the S&P 500 Index over the past 50 yrs) worth all the trouble and disappointments of being a tenant farmer's landlord? Property taxes are high, and slow to reset; fixed rents leave you with insufficient funds (after paying interest on the mortgage) to pay property taxes. But, if you have the patience of Job, live near the land you'd be renting, and want to gamble a million dollars, it probably is worth the trouble and disappointments. But to come out ahead you’ll need to have your tenant farmer pay you a revenue-based “custom” rent instead of a fixed rent. That saves him from having to pay you any rent at all in bad years like this one, so try to get him to settle for a 50:50 split of revenues (from crop sales at the end of the growing season).
Risk Rating: 8
Full Disclosure: I own shares of MON, HRL, GIS, MKC, PEP, and DE.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Over very long time periods, farmland appears to be a better asset class to own than stocks. For example, farmland in southwest Iowa (Audubon County) that sold for $266/acre in 1963 was worth $9466/acre in 2013 for a price return of 7.4%/yr. Compare that to 6.6%/yr for the S&P 500 Index. You also need to consider that both asset classes produce income (rents or dividends) and are hammered by inflation, which averaged 4.2%/yr across that 50-yr interval. Farmland rents stay close to 5% of land value, bringing total return to 12.4%/yr. Reinvesting dividends on the S&P 500 Index over the past 50 yrs brings total return to 9.9%/yr. Accounting for inflation, those numbers drop to 8.2%/yr and 5.7%/yr. Farmland prices also show less volatility than stock prices, so farmland looks to be the hands-down winner!
Prime farmland in Eastern Nebraska or Western Iowa currently costs ~$9600/ac and is sold in quarter section (160 acre) parcels. You’ll need a big mortgage for that $1,536,000 price tag, even if you can come up with the $307,200 down payment. But unless you are yourself a farmer, this is not as wise an investment as it appears to be. Why? Like investing in gold, it predates and is outside the built-in benefits of capitalism: There’s no accrual accounting or compounding of interest (see Week 157). More importantly, you'll lose money when crop prices collapse like they did in 2013 and have continued to do this year.
For both tenant and landlord, the Great Game is to bet on the weather cycle as opposed to the economic cycle. The farmer can always tune in to a local AM radio station that will provide instant pricing for “futures” on farm commodities. As he’s driving his tractor, he can trade futures on the Chicago Mercantile Exchange (CME) by using his smartphone. When prices spike upward, farmers (and their landlords) can reap windfall profits if they act quickly. When prices spike downwards, the crop insurance that is built into every US Farm Bill will likely prevent efficient farmers from having to “cash out.” Farmers also have the option of buying grain bins to store their crop until the market recovers. And, most farmers “hedge” 20-30% of their crop against the risk that prices will fall, agreeing to sell at a pre-set price when the growing season ends by entering into a futures contract on the CME.
Farmers are gamblers, as are those among their landlords who take a cut of crop sales in lieu of a fixed rent. More often than not, their gambles pay off. Why? Because planet-wide protein production can’t keep up with the demand created by population growth and rising incomes, and weather-related crises are out of sync with economic crises. Now you know why Omaha came through the Great Recession better than any other American city.
For our readers, we’d better stress that owning farmland is another way to gamble on a commodity (see Week 163). Yes, big profits can occur but they’re a hit-or-miss thing with long dry spells punctuated by some bad years, such as 2014. That being said, the prudent move is to take the time-proven route to commodity profits, which is to invest in companies that service the producer (e.g. farmer) rather than the commodity itself (e.g. farmland and crop futures). In this case, it means investing in stock issued by companies that provide inputs (and outputs such as railroads) to “production agriculture.” Then add a couple of food-processing companies. Why? Because those companies supply food to grocery stores and can pass commodity costs on to the consumer.
How then might you make a farmland investment that benefits from the insights of capitalism (accrual accounting and compound interest)? That would be through dollar-cost averaging your stock purchases then reinvesting your dividends. We find only 10 companies that meet our criteria for inclusion in a retirement portfolio (Table). Our benchmark is the Vanguard Balanced Index Fund (VBINX) at Line 17 in the Table; red highlights denote metrics that underperform VBINX. Our criteria are:
1) the company is an S&P Dividend Achiever, i.e., one that has raised its dividend annually for at least the past 10 yrs;
2) the company has an S&P bond rating of BBB+ or higher;
3) the company has an S&P stock rating of B+/M or higher;
4) the company’s stock has a dividend yield of 1.4% or higher.
Now let’s see how those 10 stocks have done over the past 14 yrs as opposed to returns on owning farmland in Audubon County, Iowa, the benchmark we used above. Farmland values have grown 12.4%/yr and inflation has been 2.4%/yr. Adding 5%/yr in rental income and subtracting 2.4%/yr inflation leaves 15%/yr. For our 10 stocks, total return is close to 15%/yr, which makes after-inflation return ~12.5%/yr.
Bottom Line: Farmland has been the most stable and rewarding asset class to own for many decades, if not centuries. But is that extra 2.5%/yr (compared to Ag-related stocks over the past 14 yrs or the S&P 500 Index over the past 50 yrs) worth all the trouble and disappointments of being a tenant farmer's landlord? Property taxes are high, and slow to reset; fixed rents leave you with insufficient funds (after paying interest on the mortgage) to pay property taxes. But, if you have the patience of Job, live near the land you'd be renting, and want to gamble a million dollars, it probably is worth the trouble and disappointments. But to come out ahead you’ll need to have your tenant farmer pay you a revenue-based “custom” rent instead of a fixed rent. That saves him from having to pay you any rent at all in bad years like this one, so try to get him to settle for a 50:50 split of revenues (from crop sales at the end of the growing season).
Risk Rating: 8
Full Disclosure: I own shares of MON, HRL, GIS, MKC, PEP, and DE.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 5
Week 170 - Growing Perpetuity Index (UPDATED)
Situation: Our blog (Invest Tune Retire) grew from the idea that owning “buy-and-hold” stocks only makes sense if you a) plan on using dividends from those stocks to supplement your retirement income, and b) pick the right stocks. The goal is to receive dividend checks during retirement that grow faster than inflation (see Column H in our Table). We began writing our blog using an unchanging index of a dozen stocks that would bring this idea into focus. To have a catchy name for that index, we borrowed a finance term that is used to describe a rare type of bond that pays out more interest year after year, called a growing perpetuity.
To pick stocks for our Growing Perpetuity Index (see Week 4), we turned to the Dow Jones Composite Index of 65 stocks, which includes the 30-stock Dow Jones Industrial Average (DJIA), the 20-stock Dow Jones Transportation Average and the 15-stock Dow Jones Utility Average. To qualify, stocks were required to:
1) have a dividend yield no less than that for the exchange-traded fund (ETF) that mimics the S&P 500 Index (SPY);
2) be an S&P “Dividend Achiever” with 10+ years of annual dividend increases;
3) have an S&P stock rating of A- or better;
4) have an S&P bond rating of BBB+ or better.
We turned up 14 stocks but chose to limit our list to 12. Two utilities qualified, NextEra Energy (NEE) and Southern Company (SO), but we decided to include only one. We kept NEE because it is the dominant player in renewable energy (wind and solar). One transportation stock qualified, Norfolk Southern (NSC). There were 11 that qualified from the DJIA, so we needed to exclude one. Caterpillar (CAT) was excluded because the company had not raised the dividend for 24 months during the Great Recession, even though S&P still granted it Dividend Achiever status. After more than 3 yrs, the same 14 are the only companies that continue to qualify. Red highlights in the Table denote underperformance relative to our benchmark, Vanguard Balanced Index Fund (VBINX). For comparison purposes, the Table includes a section for stocks in the Barron’s 500 List that meet our criteria but aren’t in the Growing Perpetuity Index.
Bottom Line: It is not easy to identify high quality, buy-and-hold stocks that pay good and growing dividends. The 65-stock Dow Jones Composite Index has 14 such stocks by our criteria, the same number as in July of 2011 (see Week 4). We use 12 of those stocks to make up our Growing Perpetuity Index (see Table) but there are 28 more in the Barron’s 500 List that meet our criteria, including Microsoft which becomes a Dividend Achiever later this year. In both the list of 12 Growing Perpetuity Index stocks and the list of 28 similar stocks, the majority are S&P Dividend Aristocrats (see Column P in the Table), meaning that there has been a dividend increase approximately every year for at least the past 25 yrs. That’s the best sign that you’ve picked the right stock for your retirement portfolio (see Week 146).
Risk Rating for the Growing Perpetuity Index: 4
Full Disclosure: I dollar-average into XOM, WMT, JNJ, MSFT, ABT, PG, and NEE.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
To pick stocks for our Growing Perpetuity Index (see Week 4), we turned to the Dow Jones Composite Index of 65 stocks, which includes the 30-stock Dow Jones Industrial Average (DJIA), the 20-stock Dow Jones Transportation Average and the 15-stock Dow Jones Utility Average. To qualify, stocks were required to:
1) have a dividend yield no less than that for the exchange-traded fund (ETF) that mimics the S&P 500 Index (SPY);
2) be an S&P “Dividend Achiever” with 10+ years of annual dividend increases;
3) have an S&P stock rating of A- or better;
4) have an S&P bond rating of BBB+ or better.
We turned up 14 stocks but chose to limit our list to 12. Two utilities qualified, NextEra Energy (NEE) and Southern Company (SO), but we decided to include only one. We kept NEE because it is the dominant player in renewable energy (wind and solar). One transportation stock qualified, Norfolk Southern (NSC). There were 11 that qualified from the DJIA, so we needed to exclude one. Caterpillar (CAT) was excluded because the company had not raised the dividend for 24 months during the Great Recession, even though S&P still granted it Dividend Achiever status. After more than 3 yrs, the same 14 are the only companies that continue to qualify. Red highlights in the Table denote underperformance relative to our benchmark, Vanguard Balanced Index Fund (VBINX). For comparison purposes, the Table includes a section for stocks in the Barron’s 500 List that meet our criteria but aren’t in the Growing Perpetuity Index.
Bottom Line: It is not easy to identify high quality, buy-and-hold stocks that pay good and growing dividends. The 65-stock Dow Jones Composite Index has 14 such stocks by our criteria, the same number as in July of 2011 (see Week 4). We use 12 of those stocks to make up our Growing Perpetuity Index (see Table) but there are 28 more in the Barron’s 500 List that meet our criteria, including Microsoft which becomes a Dividend Achiever later this year. In both the list of 12 Growing Perpetuity Index stocks and the list of 28 similar stocks, the majority are S&P Dividend Aristocrats (see Column P in the Table), meaning that there has been a dividend increase approximately every year for at least the past 25 yrs. That’s the best sign that you’ve picked the right stock for your retirement portfolio (see Week 146).
Risk Rating for the Growing Perpetuity Index: 4
Full Disclosure: I dollar-average into XOM, WMT, JNJ, MSFT, ABT, PG, and NEE.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 28
Week 169 - Barron’s 500 “Industrials” That Are Dividend Achievers With Good Credit Ratings
Situation: There is increasing evidence that the US economy is moving away from the deflationary effects brought about by chronic trade deficits. This translates most directly into a recovery of the manufacturing sector, which we’re already starting to see. But emerging markets are the driver of industrial equipment sales, and those markets remain in a state of flux). Let’s take a closer look at what S&P classifies as “industrial” companies, since 11% of the S&P 500 Index consists of stocks issued by companies in that industry.
We’ve taken the Barron’s 500 List and pulled out the 16 “industrial” companies that are Dividend Achievers with good S&P bond ratings (Table). Of those 16 companies, 12 are manufacturers. Five are either defense companies, such as Lockheed-Martin (LMT), Northrop Grumman (NOC), and General Dynamics (GD), or they manufacture and service equipment for the aerospace industry, i.e., United Technologies (UTX) and Parker-Hannifin (PH). Two build agriculture, construction and mining equipment, Deere (DE) and Caterpillar (CAT). The 5 remaining companies are niche operators, Stanley Black & Decker (SWK), Illinois Tool Works (ITW), 3M (MMM), Dover (DOV) and Emerson Electric (EMR).
What about the other 4, the ones that don’t build stuff? Well, that’s the same story you’ve heard since the California Gold Rush days, namely that gold miners didn’t make nearly as much money as their suppliers, who made a lot. Industrial companies that supply and distribute parts (WW Grainger, GWW), transport manufactured goods (Norfolk Southern, NSC) or clean up messes (Waste Management, WM and Republic Services, RSC) do quite well.
Bottom Line: The US trade balance looks to be improving, which means our manufacturing sector is seeing an uptrend in exports. These “industrial” companies endured a hard decade to start the 21st century but are now in recovery mode, steady but slow.
Risk Rating: 6
Full Disclosure: I own shares of UTX, DE and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
We’ve taken the Barron’s 500 List and pulled out the 16 “industrial” companies that are Dividend Achievers with good S&P bond ratings (Table). Of those 16 companies, 12 are manufacturers. Five are either defense companies, such as Lockheed-Martin (LMT), Northrop Grumman (NOC), and General Dynamics (GD), or they manufacture and service equipment for the aerospace industry, i.e., United Technologies (UTX) and Parker-Hannifin (PH). Two build agriculture, construction and mining equipment, Deere (DE) and Caterpillar (CAT). The 5 remaining companies are niche operators, Stanley Black & Decker (SWK), Illinois Tool Works (ITW), 3M (MMM), Dover (DOV) and Emerson Electric (EMR).
What about the other 4, the ones that don’t build stuff? Well, that’s the same story you’ve heard since the California Gold Rush days, namely that gold miners didn’t make nearly as much money as their suppliers, who made a lot. Industrial companies that supply and distribute parts (WW Grainger, GWW), transport manufactured goods (Norfolk Southern, NSC) or clean up messes (Waste Management, WM and Republic Services, RSC) do quite well.
Bottom Line: The US trade balance looks to be improving, which means our manufacturing sector is seeing an uptrend in exports. These “industrial” companies endured a hard decade to start the 21st century but are now in recovery mode, steady but slow.
Risk Rating: 6
Full Disclosure: I own shares of UTX, DE and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 7
Week 166 - “Risk-On/Risk-Off” Investing in Response to Global Economic Patterns
Situation: Most of us take more risks with our investments when the world looks to be in good shape economically, and fewer risks when it doesn’t. For example, throughout 2008 investors were risk-averse and tended to sell their losing positions. It was a “Risk-Off” year by all accounts, and that selling did great damage to the retirement savings of roughly a billion people worldwide. The freed-up funds mostly went into US Treasury Bonds and German Bunds, lowering interest rates enough to leave investors in those bonds with no inflation-adjusted income for years. You see the problem, don’t you? Investors should have continued trading stocks in 2008 instead of holding a “fire sale.” The result of all this selling was that stocks became increasingly underpriced relative to their value, as assessed by time-tested methods of fundamental analysis. But where were the buyers? They showed up two years later.
We all need to take a deep breath and agree that our “animal spirits” sometimes lead us to take unreasonable risks when global economic patterns look rosey. I’ve done it, you’ve done it. The cure? Develop a consistent “Risk-Off” investment regimen, and stick with it through good times and bad. The only alternative is to panic when things look bad, and that means selling stocks at a loss. Remember, Warren Buffett's #1 Rule is to "never lose money."
What, exactly, is a consistent Risk-Off investment regimen? Warren Buffett has often said he looks for established companies in boring industries, companies that have built their brand through generations of managers. He likes Procter & Gamble, Coca-Cola, Wal-Mart Stores, Johnson & Johnson, IBM, Heinz, Mars, Wells Fargo, American Express, and Exxon Mobil. In 2008, he sold Johnson & Johnson stock only because he wanted to help out some floundering companies like General Electric and Goldman Sachs, but he otherwise continued to invest in a disciplined manner (e.g. moving to buy the Burlington Northern Santa Fe railroad). Once he buys a stock or company, he does so with the intention of never selling it. Exceptions are rare: 1) To free up money for younger associates to invest, he has done some selective selling; and, 2) he’s done some trading while learning to invest in the energy industry. The point is that he’s the quintessential “Risk Off” investor, and a model for us all to follow.
Where do we go to find a tidy list of old and mostly boring companies that stock analysts tend to yawn at (or just plain overlook)? Here at ITR, we go our “stockpickers secret fishing hole” (see Week 68 and Week 105), which is my name for the Dow Jones Composite Index of 65 companies (30 industrials, 15 utilities, and 20 transportation companies). Railroads and electrical utilities are highlighted there, for example, and have been among the best-performing sub-industries over the last few years (see Week 148). But few, if any, stock brokers are going to try and interest you in buying those. Why? Because they’re government-regulated “and regulators might get it wrong.” Regulation in these stocks is necessary for two reasons: 1) the companies are monopolies; 2) prices for their services need to be set high enough for the companies to afford massive fixed costs and still make a profit. In this week’s Table, you’ll find 11 electric utilities and 3 railroads because those companies prosper in good times and bad.
We’ve screened the 65 companies in the Dow Jones Composite Index, excluding those that a) don’t have long-term trading data, or b) have insufficient revenues to make it onto the Barron’s 500 List. We came up with 37 companies that either showed a higher rank by Barron’s criteria in 2014 than in 2013, or were ranked in the top 2/3rds for both years. The benchmark we use for “Risk Off” investing is the Vanguard Wellesley Income Fund (VWINX), which is 60% bonds/40% stocks. The benchmark we use for “Risk On” investing is the Vanguard Balanced Index Fund (VBINX), which is 40% bonds/60% stocks. VWINX has a low 5-yr Beta of 0.5, whereas, VBINX has a 5-yr Beta of 0.92, which is almost as high as the S&P 500 Index’s 5-yr Beta that is set at 1.0. This wide discrepancy is mainly because bonds have 70-80% less risk than stocks. Red highlights in the Table denote underperformance vs. VBINX.
NOTE: Our screening starts with the Barron’s 500 List of the largest companies (by revenue) on the New York and Toronto stock exchanges. That list is published each year in May and gives letter grades to each company in 3 areas: median three-year cash-flow-based return on investment (ROIC); the one-year change in that measure relative to the three-year median; and adjusted sales growth in the latest fiscal year. Those letter grades are equal-weighted and the combined grade determines the company’s rank for the year.
If you look at total returns for those 37 companies (Table), 20 outperformed VWINX in all 3 time periods (past 22, 10, and 5 yrs) but only 4 of those stocks lost less money for investors than VWINX did during the Lehman Panic: MCD, JBHT, SO, NEE. This was in spite of the fact that aggregate returns of the 37 companies not only beat VWINX at all 3 time periods but also beat the lowest-cost S&P 500 Index fund (VFINX) in all 3 time periods! So, picking safe stocks is trickier than picking a mutual fund that has built-in safety features. The only reason to pick stocks is to have a source of retirement income that outgrows inflation: Note that Dividend Growth values in Column I of the Table are typically 3-4 times greater than the rate of inflation. You have to “pick and track”. No mutual fund will do that for you.
When we look across the 3 market cycles since the 7/90-4/91 recession, we find that a bond-heavy balanced fund (VWINX) protects its investors from most of the stock market losses incurred during each recession. VWINX lost money in only 3 of the last 22 yrs: 1994 (-6.2%), 1999 (-3.6%), and 2008 (-9.1%), whereas, the S&P 500 Index lost money in 6 yrs, including a 33% loss in 2008. The protection that comes from high-quality bonds is what allows VWINX to grow from a point of preserved value at the beginning of recovery from each recession, instead of wasting months (or years) to make up for lost value.
Bottom Line: Stock-picking is the best way to have some retirement income that beats inflation (see Week 159), but it’s not the best way for a “retail investor” to accumulate wealth. We’ve found 37 stocks that (as a group) handily outperformed the S&P 500 Index after holding periods of 22, 10, and 5 yrs. But only 4 of those stocks could beat a bond-heavy balanced fund (VWINX) in all 3 time periods while losing less than the 16% that VWINX lost during the 18-month Lehman Panic. Two are regulated utilities (SO and NEE), the third is a trucking company (JBHT), and the fourth is a downscale restaurant chain (MCD) that thrives on recessions. So, if you didn’t start investing in those 4 companies 22 yrs ago, and kept adding money along the way, you’d have been better off investing in VWINX. Our standard stock-heavy benchmark, the Vanguard Balanced Index Fund (VBINX), only beat VWINX in the most recent 5-yr period because a severe recession has led to a strong bull market in stocks. Conclusion: We all need to learn how to become “Risk Off” investors by making a plan for investing a certain amount each month, then sticking to it through thick and thin.
Risk Ranking for the aggregate of 37 stocks: 6
Full Disclosure: I dollar-average each month into DRIPs for JNJ, NKE, PG, NEE, WMT, and MSFT, and also own shares of IBM, KO, UTX, MMM, MCD, and DD.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
We all need to take a deep breath and agree that our “animal spirits” sometimes lead us to take unreasonable risks when global economic patterns look rosey. I’ve done it, you’ve done it. The cure? Develop a consistent “Risk-Off” investment regimen, and stick with it through good times and bad. The only alternative is to panic when things look bad, and that means selling stocks at a loss. Remember, Warren Buffett's #1 Rule is to "never lose money."
What, exactly, is a consistent Risk-Off investment regimen? Warren Buffett has often said he looks for established companies in boring industries, companies that have built their brand through generations of managers. He likes Procter & Gamble, Coca-Cola, Wal-Mart Stores, Johnson & Johnson, IBM, Heinz, Mars, Wells Fargo, American Express, and Exxon Mobil. In 2008, he sold Johnson & Johnson stock only because he wanted to help out some floundering companies like General Electric and Goldman Sachs, but he otherwise continued to invest in a disciplined manner (e.g. moving to buy the Burlington Northern Santa Fe railroad). Once he buys a stock or company, he does so with the intention of never selling it. Exceptions are rare: 1) To free up money for younger associates to invest, he has done some selective selling; and, 2) he’s done some trading while learning to invest in the energy industry. The point is that he’s the quintessential “Risk Off” investor, and a model for us all to follow.
Where do we go to find a tidy list of old and mostly boring companies that stock analysts tend to yawn at (or just plain overlook)? Here at ITR, we go our “stockpickers secret fishing hole” (see Week 68 and Week 105), which is my name for the Dow Jones Composite Index of 65 companies (30 industrials, 15 utilities, and 20 transportation companies). Railroads and electrical utilities are highlighted there, for example, and have been among the best-performing sub-industries over the last few years (see Week 148). But few, if any, stock brokers are going to try and interest you in buying those. Why? Because they’re government-regulated “and regulators might get it wrong.” Regulation in these stocks is necessary for two reasons: 1) the companies are monopolies; 2) prices for their services need to be set high enough for the companies to afford massive fixed costs and still make a profit. In this week’s Table, you’ll find 11 electric utilities and 3 railroads because those companies prosper in good times and bad.
We’ve screened the 65 companies in the Dow Jones Composite Index, excluding those that a) don’t have long-term trading data, or b) have insufficient revenues to make it onto the Barron’s 500 List. We came up with 37 companies that either showed a higher rank by Barron’s criteria in 2014 than in 2013, or were ranked in the top 2/3rds for both years. The benchmark we use for “Risk Off” investing is the Vanguard Wellesley Income Fund (VWINX), which is 60% bonds/40% stocks. The benchmark we use for “Risk On” investing is the Vanguard Balanced Index Fund (VBINX), which is 40% bonds/60% stocks. VWINX has a low 5-yr Beta of 0.5, whereas, VBINX has a 5-yr Beta of 0.92, which is almost as high as the S&P 500 Index’s 5-yr Beta that is set at 1.0. This wide discrepancy is mainly because bonds have 70-80% less risk than stocks. Red highlights in the Table denote underperformance vs. VBINX.
NOTE: Our screening starts with the Barron’s 500 List of the largest companies (by revenue) on the New York and Toronto stock exchanges. That list is published each year in May and gives letter grades to each company in 3 areas: median three-year cash-flow-based return on investment (ROIC); the one-year change in that measure relative to the three-year median; and adjusted sales growth in the latest fiscal year. Those letter grades are equal-weighted and the combined grade determines the company’s rank for the year.
If you look at total returns for those 37 companies (Table), 20 outperformed VWINX in all 3 time periods (past 22, 10, and 5 yrs) but only 4 of those stocks lost less money for investors than VWINX did during the Lehman Panic: MCD, JBHT, SO, NEE. This was in spite of the fact that aggregate returns of the 37 companies not only beat VWINX at all 3 time periods but also beat the lowest-cost S&P 500 Index fund (VFINX) in all 3 time periods! So, picking safe stocks is trickier than picking a mutual fund that has built-in safety features. The only reason to pick stocks is to have a source of retirement income that outgrows inflation: Note that Dividend Growth values in Column I of the Table are typically 3-4 times greater than the rate of inflation. You have to “pick and track”. No mutual fund will do that for you.
When we look across the 3 market cycles since the 7/90-4/91 recession, we find that a bond-heavy balanced fund (VWINX) protects its investors from most of the stock market losses incurred during each recession. VWINX lost money in only 3 of the last 22 yrs: 1994 (-6.2%), 1999 (-3.6%), and 2008 (-9.1%), whereas, the S&P 500 Index lost money in 6 yrs, including a 33% loss in 2008. The protection that comes from high-quality bonds is what allows VWINX to grow from a point of preserved value at the beginning of recovery from each recession, instead of wasting months (or years) to make up for lost value.
Bottom Line: Stock-picking is the best way to have some retirement income that beats inflation (see Week 159), but it’s not the best way for a “retail investor” to accumulate wealth. We’ve found 37 stocks that (as a group) handily outperformed the S&P 500 Index after holding periods of 22, 10, and 5 yrs. But only 4 of those stocks could beat a bond-heavy balanced fund (VWINX) in all 3 time periods while losing less than the 16% that VWINX lost during the 18-month Lehman Panic. Two are regulated utilities (SO and NEE), the third is a trucking company (JBHT), and the fourth is a downscale restaurant chain (MCD) that thrives on recessions. So, if you didn’t start investing in those 4 companies 22 yrs ago, and kept adding money along the way, you’d have been better off investing in VWINX. Our standard stock-heavy benchmark, the Vanguard Balanced Index Fund (VBINX), only beat VWINX in the most recent 5-yr period because a severe recession has led to a strong bull market in stocks. Conclusion: We all need to learn how to become “Risk Off” investors by making a plan for investing a certain amount each month, then sticking to it through thick and thin.
Risk Ranking for the aggregate of 37 stocks: 6
Full Disclosure: I dollar-average each month into DRIPs for JNJ, NKE, PG, NEE, WMT, and MSFT, and also own shares of IBM, KO, UTX, MMM, MCD, and DD.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Subscribe to:
Comments (Atom)