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

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

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

Execution: see Table.

Administration: A-rated stocks are those that have:

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

            b) positive Book Value, 

            c) positive earnings (TTM), 

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

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

            f) a 20+ year trading history. 

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

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

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

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Month 105 - A-rated Companies in the Dow Jones Industrial Average - March 2020

Situation: If you’ve been picking stocks for a retirement portfolio, and have more than 15 years of experience, you’ve learned enough about risk to appreciate last month’s blog about Haven Stocks (Month 104). You’re probably ready to take on more risk for more reward, assuming that you’ve learned how to ride out a market crash without selling. Warren Buffett, the reigning value investor, also stretches beyond investing in large-capitalization value stocks like those discussed in our Month 103 blog about Berkshire Hathaway’s portfolio.

In his most recent Annual Letter to the shareowners of Berkshire Hathaway, Warren explains how to do that by focusing on Retained Earnings (see the excerpt below in Appendix). Retained Earnings are what’s left over from Free Cash Flow after Dividends have been paid. Free Cash Flow is what’s left over from Operating Earnings (EBIT) after Capital Expenditures have been paid. Warren Buffett uses Return on Net Tangible Capital to estimate whether Retained Earnings are likely to be substantial. Return on Net Tangible Capital is the same as the familiar ROCE (Return on Capital Employed) except that Capital Employed is changed from Total Assets minus Current Liabilities to Total Assets minus Intangible Assets minus Current Liabilities. He thinks 20% is a good Return on Net Tangible Capital (see Column P in the Table).

The company’s CEO will eventually deploy Retained Earnings to build a better company faster. The cost for deploying that capital is zero. Going forward, the return on that investment is approximately the same as the return on Operating Earnings, which is EBIT (Earnings Before Interest and Taxes) divided by Market Capitalization. In a well-managed and well-positioned company, that return represents a high rate of Compound Interest over time--the 20%/yr Return on Net Tangible Capital that Warren Buffett is looking to achieve in most years on most of Berkshire Hathaway’s portfolio.

The trick, of course, is to find such companies. The Dow Jones Industrial Average (DJIA) is a good place to start, given that those companies have traditionally been picked (in part) because they expected to have a high Free Cash Flow Yield (see Column H in the Table).

Mission: Pick companies from the 30-stock DJIA that have S&P ratings on the bonds they’ve issued that are A- or higher, and insert a new column in our Standard Spreadsheet for Free Cash Flow Yield (Column K). Exclude any DJIA companies that do not have an S&P stock rating of at least B+/M, or do not have the 16 year trading record that is required for quantitative analysis by the BMW Method (https://invest.kleinnet.com/bmw1/). (We display at Columns L-M in the Table a summary of BMW Method findings for the most recent week.)

Administration: see Table.

Bottom Line: These 19 companies have an aggregate Return on Net Tangible Capital of 19.5%, which almost meets Warren Buffett’s requirement of 20%. Whether any of these stocks can be bought at a “sensible price” is not an easy question to answer. Here at ITR, we call a stock “sensibly priced” if the 50 day moving average in the price per share is no more than twice the Graham Number (see Columns AC & AD) and is no more than 25 times the 7-yr P/E (see Column AF). Five companies meet those criteria: PFE, INTC, JPM, TRV, IBM.

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

Full Disclosure: I dollar-average into MSFT, NKE, PFE, BA, KO, INTC, PG, JPM, WMT, JNJ, CAT and IBM, and also own shares of UNH, CSCO, AAPL, DIS, TRV and MMM.

Appendix: Excerpt from Warren Buffett’s February 2020 Letter to the shareowners of Berkshire Hathaway: “Charlie and I urge you to focus on operating earnings and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized...Over time, Charlie and I expect our equity holdings – as a group – to deliver major gains, albeit in an unpredictable and highly irregular manner. To see why we are optimistic, move on to the next discussion. The Power of Retained Earnings. In 1924, Edgar Lawrence Smith, an obscure economist and financial advisor, wrote Common Stocks as Long Term Investments, a slim book that changed the investment world. Indeed, writing the book changed Smith himself, forcing him to reassess his own investment beliefs. Going in, he planned to argue that stocks would perform better than bonds during inflationary periods and that bonds would deliver superior returns during deflationary times. That seemed sensible enough. But Smith was in for a shock. His book began, therefore, with a confession: “These studies are the record of a failure – the failure of facts to sustain a preconceived theory.” Luckily for investors, that failure led Smith to think more deeply about how stocks should be evaluated. For the crux of Smith’s insight, I will quote an early reviewer of his book, none other than John Maynard Keynes: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point. Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.” 

Warren concludes that history lesson on this note: “Charlie and I have long focused on using retained earnings advantageously. Reinvestment in productive operational assets will forever remain our top priority. In addition, we constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price.”


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Month 101 - Moving the Needle: A-rated S&P 100 Companies in “The 2 and 8 Club” - November 2019

Situation: You’re now in your 50s. The “sunset years” loom ahead. While you have the advantage of being a more experienced investor, you’re losing time and may retire short of where you need to be. Even now, you need to have a “nest egg” at least 6 times your current salary. Your retirement account is likely to be 60% in stocks but that allocation falls to 50% by the time you retire. You’ll need to hold safer but more effective stocks. “The 2 and 8 Club” is one way to do that: buy stocks that carry both a higher dividend yield and a faster rate of dividend growth compared to the S&P 500 Index (SPY), i.e., stocks that yield at least 2%/yr and grow dividends at least 8%/yr. For safety, confine your picks to stocks issued by “mega-cap” companies in the S&P 100 Index. Why those? Because they’re large enough to have multiple product lines, i.e., they’re more able to respond to diverse market conditions. And, they’re required to have active hedging positions at the Chicago Board Options Exchange. Those “put and call” stock options are side-bets made by professional traders, which makes “price discovery” for the underlying stocks more rational. 

Mission: Use our standard spreadsheet to analyze companies in the S&P 100 Index that a) issue debt rated at least A- by S&P, b) issue stock rated B+/M or better by S&P,  c) are listed in the U.S. version of the FTSE High Dividend Yield Index--marketed by Vanguard Group as VYM, d) have the 16+ year trading record that is needed for quantitative analysis by the BMW Method, and e) have grown their dividend at least 8%/yr for the past 5 years. 

Execution: see the 13 companies at the top of this week’s Table.

Administration: Let’s explain the Basic Quality Screen (see Column AH in the Table). The idea is to give readers a quick take on which stocks are worthwhile to consider as a new BUY. The maximum score is 4. Overpriced stocks (see Column AF) are penalized half a point. Reading from left to right across the spreadsheet, the first opportunity to score a point is found in Column K. Stocks that have a 16-yr price appreciation that is more than 1/3rd the risk of ownership (Column M) score one point. A negative value in Column S for Tangible Book Value (highlighted in purple) results in a loss of one point if the debt load is either greater than 2.5 times EBITDA (Column R) or LT-debt represents more than 50% of the company’s total capitalization (Column Q). In Columns U and V, all 13 companies earn 2 points because their S&P ratings meet the requirement of being at least A- for the company’s debt and B+/M for the company’s stock. In Column Z, one point is earned if the stock appears likely to meet our Required Rate of Return over the next 10 years, which is 10%/yr, i.e., the dollar value is not highlighted in purple.

Bottom Line: As you approach retirement, look more closely at the stocks and ETFs in your portfolio. Those equities will need to be half your retirement savings. Where possible, choose stocks issued by large companies that offer higher dividend yields and faster dividend growth than the S&P 500 Index. Five of this week’s stocks are worth researching for possible purchase because of being rated 3 or 4 on our Basic Quality Screen (see Column AH): CSCO, JPM, USB, CAT and BLK.   

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

Full Disclosure: I dollar-average into NEE, JPM, USB, CAT and IBM, and also own shares of AMGN, CSCO, PEP, BLK and MMM.

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Month 100 - The Clubhouse Turn: A-rated Companies in the 65-Stock Dow Jones Composite Index - October 2019

Situation: Last month, we came up with 10 stocks that are “safe and effective” bets for the neophyte stock-picker. Our starting point was the S&P 100 Index of the largest publicly-traded companies that benefit from price discovery through a robust market in stock options. Very large companies have the built-in safety feature of multiple product lines, which provide management with internal options for responding to an economic crisis. I excluded companies with less-than-stellar S&P ratings on the stocks and bonds they have issued, as well as companies trading for fewer than 16 years. I have also excluded companies with volatile stocks--those with a 3-yr Beta that is higher than 0.75--as well as companies that are not listed in both of the “value” sub-indices (VYM and IWD) for the Russell 1000 Index. 

This month I’ve dialed back on those safety requirements by including stocks that likely carry more reward at the expense of greater risk. My assumption is that the stock-picker has accumulated 10+ years of experience and now needs to face up to the responsibility of carefully investing for retirement. The “savings race” has reached The Clubhouse Turn but she still needs guideposts for selecting safe and effective stocks.

Mission: Run our Standard Spreadsheet on only the companies in the 65-stock Dow Jones Composite Average that have either issued bonds rated at least  A- by S&P or carry no long-term debt on their balance sheet. (Those 65 companies are picked by a committee chaired by the Managing Editor of the Wall Street Journal.)

Execution: see Table.  

Administration: Five companies that met the above criteria had to be excluded because they lack information we need for analysis: a full 16+ years of trading records (V, AWK) or an S&P stock rating of at least B+/M (CVX, DD, MRK). One company, PepsiCo (PEP) has been added to the BACKGROUND section because it is the only company among last month’s list of 10 Starter Stocks that isn’t in the Dow Jones Composite Index.

Bottom Line: A mid-career stock-picker who doesn’t have a degree in accounting or business administration is at a disadvantage. It would be in her best interest to narrow her choices to the gold standard of stock-picker lists, which is the 65-stock Dow Jones Composite Index, then further narrow her choices to companies that issue bonds rated A- or better by S&P and have at least a 16 year trading record for their stock. That leaves 28 companies to research. The goal, of course, is to find stocks that have outperformed the S&P 500 Index over the past 5 and 10 years while losing less value than the Index did in its worst year of the past 10. In other words, I’m suggesting that she should focus her research on the 9 companies that have no red highlights in Columns C through F of the Table: Microsoft (MSFT), UnitedHealth (UNH), Nike (NKE), Boeing (BA), Intel (INTC), Union Pacific (UNP), Disney (DIS), NextEra Energy (NEE), and American Electric Power (AEP).   

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

Full Disclosure: I dollar-average into MSFT, NKE, BA, UNP, NEE, JPM, INTC, KO, WMT, JNJ, PG, CAT and IBM, and also own shares of AAPL, CSCO, PFE, TRV, DUK, UPS, SO, MMM and XOM. So, I am invested in 22 of the 28 companies. It is difficult to follow that many companies, but it is nonetheless essential: Academic studies suggest that a stock-picker needs to be invested in at least 30 companies to have a good chance of matching market returns (see Columns C, F, and K in the Table) while enjoying less risk that the portfolio will lose value (see Columns D, I, and M of the Table).

APPENDIX: “Investment” is a nice word for the deployment of capital. As with any other capital expenditure, its effectiveness (profit margin) is what accountants call Operating Margin, which is Operating Income divided by Sales Revenue. Sales Revenue comes to the stock investor from dividends and the liquidation of shares. Operating Income is Earnings Before Interest and Taxes (EBIT) “after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax.” 

As an investor who buys stocks, your variable costs of production are transaction costs (fees and commissions paid for purchase and sale of shares) plus rent/utilities/supplies for your “home office” and the cost of your business services (e.g. subscriptions to business magazines, newspapers, and websites). For money used to purchase stocks, EBIT is Gross Income (Sales Revenue after subtracting the variable costs of production) minus Depreciation (which is inflation).

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Month 96 - Watch List for S&P 100 Companies in the Vanguard High Dividend Yield Index - June 2019

Situation: All investors have an objective as well as a plan to reach that objective. I started with the objective of getting my children through college, then moved on to having a comfortable retirement. Direct stock ownership has been a key part of both plans. Why stocks? Because mutual funds are sold on the basis of long-term performance records, not safety from market crashes. But a small group of stocks are relatively safe because of being issued by a large company that reliably pays a good and growing dividend. The trick is to have a Watch List of 20-30 such companies and know “the story” behind each company.

Mission: Use our Standard Spreadsheet to evaluate companies in the S&P 100 Index that also appear in the FTSE High Dividend Yield Index, i.e., the ~400 companies in the FTSE Russell 1000 Index that reliably pay an above-market dividend. Our source document is the list of companies in VYM (the capitalization-weighted Vanguard High Dividend Yield ETF,
which is the US version of the FTSE High Dividend Yield Index.

Execution: see Table showing a spreadsheet with 36 columns of information for commons stocks issued by 27 US companies.

Administration: 54 companies are common to both indexes but 27 have been  excluded from our Watch List because an item of information needed to populate a cell in the spreadsheet is missing and/or the company's S&P ratings are too low to denote above-average safety. We require an A- bond rating or better and a B+/M stock rating or better.

A key requirement is to avoid overpaying for a stock. I’m a numbers guy, so I use two numbers to decide if a stock is overpriced (where “price” or P is defined as the 50-day moving average):
   1) the 7-yr P/E is greater than 30 (see Column AD in the Table. 
   2) the stock’s Graham Number, which is the square root of 22.5 times EPS (Earnings Per Share) multiplied by BV/Sh (Book Value Per Share), is greater than 250% of its price (see Column AB in the Table). 

If only one of those two numbers is over the limit, the stock is still overpriced if the other number is close to the limit (more than 25 or 200%, respectively).

Another key requirement is to know whether a company's stock is a worthwhile investment, given its current price. As a starting place, I’ve devised a Basic Quality Screen that has only 6 elements and a maximum score of 4 (see Table):
   1) If price appreciation over the past 16 years has been greater than 1/3rd the risk of short-term loss as determined by the BMW method, one point is added. In other words, 16-Yr price appreciation in Column K is greater than 1/3rd the risk in Column M.
   2) If Tangible Book Value in Column S is negative and either LT-debt represents more than 50% of Total Capital (Column O), or Total Debt is more than 250% of EBITDA (Column P), one point is subtracted. 
   3) If the S&P Bond Rating in Column U is A- or better, one point is added. 
   4) If the S&P Stock Rating in Column V is B+/M or better, one point is added. 
   5) If Net Present Value of dividend growth (based on trailing 5-Yr dividend growth in Column H) and cash-out value after a 10 year Holding Period (determined by extrapolation of trailing 16-Yr price appreciation in Column K) is a positive number when applying a Discount Rate of 10% (see Column Z), one point is added. 
   6) If the two markers of an overpriced stock noted above (see Columns AB and AD) indicate that the stock is indeed overpriced, half a point is subtracted.

The final SCORE is found in Column AJ.

Bottom Line: As expected, these 27 companies have not performed as well as SPY, the S&P 500 Index ETF (see Line 29 to Line 35 at Columns C through F in the Table). But these 27 companies pay a higher dividend (Column G) and have lower price volatility (see Columns I & M) than SPY. Estimates for Net Present Value after a 10 year holding period (assuming a continuation of the trailing 5 year dividend growth rate and the trailing 16 year price growth rate and trading costs of 2.5% at the time of purchase and sale) were higher than SPY (see Column Z).  

Conclusion: These 9 stocks appear to be over-priced (see Columns AB and AD): CSCO, KO, TXN, PEP, JNJ, LMT, MMM, CL and UPS. These 12 appear to be bargain-priced “value stocks” based on Book Value, Graham Number and average 7 year P/E (see Columns AA-AE): PFE, NEE, DUK, INTC, TGT, SO, JPM, CMCSA, USB, BLK, XOM and WFC. These 10 appear to be worthwhile investments because of having a score of either 3 or 4 on our Basic Quality Screen (see Column AJ): PFE, NEE, DUK, INTC, PG, SO, JPM, WMT, CAT, BLK.

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

Full Disclosure: I dollar-average into NEE, KO, INTC, PG, JNJ, JPM, WMT, CAT and IBM. I also own shares of PFE, CSCO, DUK, SO, PEP, MMM, BLK, UPS and XOM. Note that all but two (BLK and PEP) of those 18 are in the 65-stock Dow Jones Composite Average.

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Month 94 - Food and Agriculture Companies - Spring 2019 Update

Situation: Investors should pay attention to asset classes that fluctuate in value out-of-sync with the S&P 500 Index. Such asset classes are said to have minimal or negative “correlation” with large-capitalization US stocks. Emerging markets and raw commodities are important examples. Those are a natural pair, given that most countries in the emerging markets group have an economy that is based on the production of one or more raw commodities. 

The idea that you can find a safe haven for your savings, one which will allow you to ride out a crash in the US stock market, is a pleasant fiction. Articles in support of that idea are published almost daily. But unless you are a trader who can afford to rent or buy a $500,000 seat on the Chicago Mercantile Exchange, you probably aren’t deft enough to arbitrage the various risks accurately enough before they develop (and at low enough transaction costs) to avoid losing money in a crash. 

If you really want to ride out most crashes, invest in a bond-heavy balanced mutual fund that is managed by real humans. The Vanguard Group offers one best, and it comes with very low transaction fees (Vanguard Wellesley Income Fund or VWINX). To refresh yourself on the competitive advantages of investing in food and agriculture companies, see our most recent blog on the subject (see Month 91). To refresh yourself on the competitive disadvantages, study this month’s Table and Bottom Line carefully.

The essential fact is that economies require money for spending and investment. That comes down to having consumers who are confident enough about their employment prospects and entrepreneurs who are confident enough about their ability to invest. Those consumers and entrepreneurs can be relied upon to transfer their successes to the larger economy by saving money, taking out loans, and paying taxes. National economies are interlinked. Because of the size and innovation of its marketplace, the US economy is the main enabler for most of the other national economies. Logic would suggest that the valuation for any asset class will roughly track the ups and downs of the S&P 500 Index, either as a first derivative or second derivative. 

Mission: Use our Standard Spreadsheet to analyze US and Canadian food and agriculture companies that carry at least a BBB rating on their bonds (see Column R).

Execution: see Table.

Administration: Of the 25 companies listed in the Table, only one meets Warren Buffett’s criteria of low beta (see Column I), low volatility (Column M), high quality (Column S), strong balance sheet (Columns N-R), and TTM (Trailing Twelve Month) earnings plus mrq (most recent quarter) Book Values that yield a Graham Number which is not far from the stock’s current Price (Column Y). That company is Berkshire Hathaway. We use a Basic Quality Screen that is less stringent as his: 1) an S&P stock rating of B+/M or better (Column S), 2) an S&P bond rating of BBB+ or better (Column R), 3) 16-Yr price volatility (Column M) that is less than 3 times the rate of price appreciation (Column K), and 4) a positive dollar amount for net present value (Column W) when using a 10-Yr holding period in combination with a 10% discount rate (to reflect a 10% Required Rate of Return).

Bottom Line: Only 8 companies on the list pass our Basic Quality Screen (see Administration above): HRL, COST, PEP, KO, DE, FAST, CNI, UNP. At the opposite end of the spectrum, 9 companies have a below-market S&P bond rating of BBB. So, those stocks represent outright gambles. 

Aside from Berkshire Hathaway, none of the 25 companies can be said to issue a reasonably priced “value” stock. We’re dealing with 24 “growth” stocks, only a third of which are of high quality. Three of the 9 with BBB bond ratings have high total debt levels relative to EBITDA (see Column O in the Table) that are unprotected by Tangible Book Value (Column P): SJM, MKC, GIS. The good news is that only one of the 9 appears to be overpriced, and that company (MKC) is a quasi-monopoly that has little risk of bankruptcy because it has “cornered” the US spice market. 

In summary, you can do well by investing in this space as long as you understand that you’re dealing with a fragmented food industry, one that is flush with companies of dubious quality. You might like to be well-informed about these companies because food, like fuel, is an essential good, and the food industry enjoys steady growth. Why? Because the number of people in Asia & Africa who can afford to consume 50 grams of protein per day grows by tens of millions per year.

Risk Rating: ranges from 6 to 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion =10).

Full Disclosure: I dollar-average into TSN, KO and UNP, and also own shares of AMZN, HRL, MO, MKC, BRK-B, CAT and WMT.

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Week 385 - Let’s Dollar-Average Into 10 Stocks From The Vanguard High Dividend Yield Index

Situation: The advantage of dollar-cost averaging into specific stocks vs. dollar-averaging into the reference index is that you can focus on high-quality companies. However, those companies are less dynamic than early-movers. By investing in an index fund you’ll capture the effect that “earnings surprises” have on prices for early-movers. So, let’s compare a portfolio of 10 high quality stocks to the relevant index. Dollar-averaging identical amounts each month into either the index or each of the 10 stocks is just a way to buy more shares whenever the market is down. That way, I can assume that your returns will approximate the published total returns/Yr.

Mission: Pick 10 stocks from the Vanguard High Dividend Yield Index. Then run our Standard Spreadsheet.

Execution: see Table.

Administration: The 10 stocks I’ve picked happen to be the 10 that I dollar-average into.

Bottom Line: From the spreadsheet, I cannot discern a material difference in long-term returns from dollar-averaging in an index fund, such as the SPDR S&P 500 ETF (SPY) or the Vanguard High Dividend Yield ETF (VYM), compared to dollar-averaging into the 10 stocks I’ve picked. However, there is a material difference with respect to transaction costs: VYM has an expense ratio of 0.08%, whereas, the expense ratio for dollar-averaging into my 10 stocks is ~1.2%.

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

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Week 384 - Which Dividend Achievers Are Likely To Be Safe & Effective Investments?

Situation: The US stock market is overpriced, as we have documented in recent blogs (see Week 378, Week 379, Week 380). So, the question becomes: Which companies will retain value (relatively speaking) during a correction, yet continue to reliably grow their earnings? We’re likely to find such companies in the 3 remaining Defensive Industries (Utilities, Consumer Staples, and HealthCare). S&P’s Defensive Sector used to include Telecommunication Services but that Industry has recently merged Media to become Communication Services. Newly added companies include Netflix (NFLX), Facebook (FB), Alphabet (GOOGL), Twitter (TWTR), Comcast (CMCSA), and Disney (DIS) -- all of which are Growth companies (as opposed to less risky companies in Defensive Industries).

Mission: Use our Standard Spreadsheet to analyze high-quality companies in Defensive Industries that have increased their dividend annually for at least the past 10 years (earning the S&P designation of Dividend Achiever).

Execution: see Table.

Administration: First, we need to define terms.

SAFE:
1) 16-Yr price volatility is less than that for the Dow Jones Industrial Average ETF (DIA -- see Column M in the Table); 
2) 3-Yr Beta is less than 0.7 (see Column I in the Table); 
3) 7-Yr P/E is less than 36 (see Column Z in the Table);
4) S&P Rating on bonds issued by the company is A- or better (see Column R in the Table). 

EFFECTIVE: 
1) 16-Yr price appreciation is at least 1/3rd as great as 16-Yr price volatility (compare Columns K and M in the Table);
2) S&P stock rating is at least A-/M and S&P Stars rating is at least 3 (see Column S in the Table).

Bottom Line: To be clear, there is no such thing as a “safe” stock. When confidence in the company’s future cash flow evaporates, the stock is quickly priced at Tangible Book Value (TBV) per share. That value is out of reach to stockholders in the event of bankruptcy, since it serves as collateral for the company’s bond issues. So, this week’s blog has 4 criteria for safety (plus S&P’s criteria for its Dividend Achiever designation). When those are added to criteria for relatively stable price performance over the past 16 years, we are left with only 9 stocks to consider. Ask Santa Claus to put a sampling of those in your stocking this Christmas.  

Risk Rating: 4 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into NEE, JNJ, PG, WMT and DIA, and also own shares in PEP and HRL.

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Week 383 - Dow Theory: A Primary Uptrend Resumed on 9/20/2018

Situation: The Dow Jones Industrial Average (DJIA) fell 9% from the end of January to the end of March because of a developing trade war. The Dow Jones Transportation Average (DJTA) confirmed this move, suggesting that a new primary downtrend was developing. However, neither the DJIA nor the DJTA reached previous lows. By 9/20/2018, the DJIA reached a new high confirming the new high reached a month earlier by the DJTA. So, the decade-long primary uptrend had resumed after an 8-month hiccup. Why? Because trade war fears had abated. 

Both the DJIA (DIA) and DJTA (ITY) have out-performed Berkshire Hathaway (BRK-B) over the past 5 years, which is unusual. This leads stock-pickers to pay more attention to the stocks that are most heavily weighted in constructing those price-weighted indices. 

Mission: Take a close look at the top 10 companies in each index by applying our Standard Spreadsheet.

Execution: see Table.

Bottom Line: Eleven of the 20 companies issue bonds that carry an S&P rating of A- or better, and 6 of those 11 carry an S&P stock rating of A-/M or better: Home Depot (HD), UnitedHealth (UNH), 3M (MMM), Boeing (BA), International Business Machines (IBM), and Union Pacific (UNP). In that group, only IBM has failed to outperform BRK-B over the past 5 and 10 year periods.

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

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

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Week 370 - Ways To Win At Stock-picking #1: Dollar-cost Average Into 10 Of The 30 DJIA Companies

Situation: You’re troubled by the dominance of the S&P 500 Index. After all, it is a derivative and you wonder whether it is really the safest and most effective way to build retirement savings. Your biggest concern is that it is a capitalization-weighted index, which is a design that favors momentum investing: Mid-Cap companies that garner investor enthusiasm become included in the S&P 500 Index because their stock is appreciating; Mid-Cap companies that have managed to be included in the S&P 500 Index investors are in danger of being excluded because investors have lost their enthusiasm and the stock’s price is falling. Many investors buy/sell shares in a company’s stock because of that trend in sentiment. Fundamental sources of value (revenue, earnings, and cash flow) often have little to do with their enthusiasm, or the fact that it has evaporated. Articles in the business press may carry greater weight, and those articles may be influenced by analyses introduced by short sellers, who are betting on a fall in price, or hedge fund traders with long positions, who are betting on a rise in price. In other words, most retail investors are paying attention to market sentiment when buying or selling shares, not due diligence that comes from a careful study of a company’s prospects and Balance Sheet. 

Your second biggest concern is likely to be that few S&P 500 companies have a good credit rating backing their debts. In other words, they’re paying too high a rate of interest on the bonds they’ve issued, or the bank loans they’ve taken out. The company’s Net Tangible Book Value is therefore likely to be drifting deeper into negative territory because of interest expenses, part of which are no longer tax deductible due to changes in U.S. tax law.

Both of these problems fall by the wayside if you invest in the 30 companies that make up the Dow Jones Industrial Average, either separately or together in the price-weighted Dow Jones Industrial Average Index (DIA at Line 18 in the Table). Investing in the “Dow” may be a little smarter for retirement savers than investing in the S&P 500 Index (SPY at Line 16 in the Table) for two reasons: 1) DIA has a dividend yield that is ~10% greater; 2) DIA pays dividends monthly, whereas, SPY pays dividends quarterly. A higher dividend yield means that your original investment is returned to you more quickly, which translates as a higher net present value, if other factors (e.g. dividend growth and long-term price appreciation) are not materially different.

Mission: Use our Standard Spreadsheet to illustrate how I dollar-cost average into stocks issued by 10 DJIA companies.

Execution: see Table.

Administration: It has been necessary to use 3 separate Dividend Re-Investment Plans (DRIPs) to dollar-cost average into the 10 DJIA stocks I’ve chosen (see Column AE in the Table). Those DRIPs automatically extract $100 each month for each of the 10 stocks; transaction costs average $18.68/yr (see Column AD), which includes automatic reinvestment of dividends. The expense ratio is 1.56% for each year’s investments, but expenses relative to Net Asset Value fall to less than 0.01% after 10-20 years.

Bottom Line: This week’s blog compares my long-standing pick of 10 Dow stocks (for an automatic monthly investment of $100 each using an online DRIP) to investing $1500/qtr in the entire 30-stock index (DIA) using a regional broker-dealer, which is something I’ve just started doing to facilitate comparison going forward. (You’ll see each year’s total returns in future blogs published the first week of July.)  

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

Full Disclosure: If one of the 10 stocks I’ve chosen is dropped from the Dow Jones Industrial Average (DJIA), I’ll sell those shares and use those dollars to start a DRIP with shares issued by another DJIA company.

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

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Week 367 - Safe and Effective Stocks

Situation: The stock market is becalmed, waiting for wind to fill its sails. "Risk-On" investors seem to be out of ideas, except for a renewal of interest in the energy sector. The bond market is experiencing hard-to-predict volatility. Safe stocks that will grow your money effectively are hard to find. The formula for Net Present Value tells us that more value is found when your original investment is returned to you quickly. Therefore, an “effective” stock is one that pays a good and growing dividend. 

Mission: “Safe stocks” = an oxymoron. Basically, we’re looking for a group of high-quality stocks issued by companies in “defensive” industries (Utilities, HealthCare, Consumer Staples, and Communication Services). “Effective stocks” are those that a) pay an above-market dividend, b) grow that dividend at an above-market rate, and c) have an above-market 16-Yr CAGR. Our reference for the “market” is the Dow Jones Industrial Average ETF (DIA). 

Execution: see Table.

Administration: What are “high-quality” stocks? Those are either “Blue Chips” (see Week 361) or members of “The 2 and 8 Club” (see Week 327 and Week 348) plus its Extended Version (see Week 362). “Safe and effective” stocks are those that have no red highlights in Columns D, E, G, I, K, and M of the reference Tables. (Red highlights indicate underperformance vs. DIA.) In addition, we require that the company be a Dividend Achiever, and that its long-term bonds have an S&P rating of A- or better (see Column T).   

Bottom Line: We find that only 5 companies issue “safe and effective” stocks (see Table). Were you to own shares of similar value in all 5, you wouldn’t be gambling. In other words, your risk-adjusted returns would likely “beat the market” by 1-2%/yr over a market cycle. But your transaction costs would also be 1-2% higher vs. owning shares in the leading S&P 500 Index Fund (SPY).  

Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into NEE, KO, and JNJ.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Week 366 - A Capitalization-weighted Watch List for Russell 1000 Companies

Situation: Every stock-picker needs to confine her attention to a manageable list of companies, called a “Watch List.” Here at ITR, the focus is on investing for retirement. So, our interest is in companies that have a higher dividend yield than the S&P 500 Index. Why? Because your original investment will be returned to you faster, which automatically gives your portfolio a higher “net present value” than a portfolio composed of companies that pay either no dividend or a small dividend. Once you’ve retired, you’ll switch from reinvesting dividends to spending dividends.

Mission: Assemble a Watch List composed of companies that are “Blue Chips” (see Week 361), companies that are in “The 2 and 8 Club” (see Week 344), and companies that are in the Extended Version of “The 2 and 8 Club” (see Week 362). 

Execution: see Table.

Bottom Line: If you’re saving for retirement and would like to pick some individual stocks to supplement your index funds, here is an effective and reasonably safe Watch List. However, the mutual funds that pick individual stocks haven’t done very well compared to benchmark index funds. So, your chances of doing well as a stock-picker also aren’t good. But index funds like the SPDR S&P 500 (SPY) expose you to significant downside risk. There is one conservatively managed mutual fund that we think is an excellent retirement investment, the Vanguard Wellesley Income Fund, which is mostly composed of bonds. Your risk of loss from owning VWINX is less than half that from owning SPY; the 10-Yr Total Return is 7.0%/yr vs. 9.0%/yr for SPY.

Risk Rating for our Watch List: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).

Full Disclosure: I dollar-average into MSFT, JPM, XOM, WMT, PG, KO, IBM, CAT and NEE, and also own shares of GOOGL, CSCO, MCD, MMM, TRV, CMI and ADM.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Week 365 - “Dogs of the Dow” (Mid-Year Review)

Situation: The 10 highest-yielding stocks in the Dow Jones Industrial Average are called The Dogs of the Dow (see Week 305 and Week 346). The only time-tested formula for beating an index fund (specifically the Dow Jones Industrial Average) is based on investing equal dollar amounts in each Dog at the start of the year. That would have worked in 6 of the past 8 years. Why? Because those are high quality stocks that have suffered a price decline and are likely to recover within ~2 years, which would lower their dividend yield and release them from the “Dog pen.” 

Mission: Predict which Dogs will emerge from the Dog pen by the end of 2018, using our Standard Spreadsheet.

Execution: see Table.

Administration: For various reasons, the 2018 Dogs are unlikely to post greater total returns this year than the Dow Jones Industrial Average (DIA). But we can still try to play the game by predicting which of this year’s Dogs will be missing from next year’s Dog pen. Those will probably come from those posting lower dividend yields at the mid-year point (see Column G in the Table): Coca-Cola (KO), Cisco Systems (CSCO), General Electric (GE), Merck (MRK) and Chevron (CVX).

Bottom Line: Given current trends, Cisco Systems (CSCO) and Chevron (CVX) are likely to be released from the Dog pen at the end of the year.

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

Full Disclosure: I dollar-average into KO, PG, XOM and IBM, and also own shares of CSCO.

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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Week 362 - “The 2 and 8 Club” (Extended Version) = Non-S&P 100 Companies In The Russell 1000 Index

Situation: The risk of loss from owning small-capitalization stocks vs. large-capitalization stocks is material, i.e., greater than 5%. Stocks in the S&P 100 Index are safest to own, given that those are required to have actively-traded Put and Call options on the CBOE (Chicago Board Option Exchange), and are usually followed by at least a dozen analysts. Large companies also have the advantage of multiple product lines, one of which is likely to do well in a recession. This same lack of uncertainty makes their stocks boring to own, even though a number of S&P 100 stocks are statistically more likely to weather a Bear Market than the S&P 500 Index (see Column M in any of our Tables). Index investing is even more boring and predictable. 

You’re left trying to find a winner among the other 900 companies of The Russell 1000 Index. A sign that you’ve selected well for your investment occurs when you find that company highlighted in a Wall Street Journal article. Our blog for this week tries to help you do exactly that. We’ve already found a handy way to identify trendy S&P 500 companies, which we call “The 2 and 8 Club” (see Week 348). And, we published an Extended Version (see Week 350) that takes you through promising companies in The Barron’s 500 List. 

Caveat Emptor: “The 2 and 8 Club” focuses exclusively on companies in The Russell 1000 Index that have historically paid an above-market dividend and are judged (by The Financial Times) likely to continue doing so. That means they’re bond-like, and attract investors because of the near-certainty that they will continue to pay a good and growing dividend. The downside of this benefit is that price appreciation will flatten and decline in a rising interest rate environment, just as bond prices do. Why? Because of competition from newly-issued bonds that pay a higher rate of interest and have less risk of default. 

Mission: This week we double-down and identify putative winners in The Russell 1000 Index.

Execution: see Table.

Administration: Rules for membership in “The 2 and 8 Club”: 
   1) The company is listed on the FTSE High Dividend Yield Index (US), which contains the ~400 highest-yielding companies in the Russell 1000 Index. Those are companies that have historically paid an above-market dividend (usually ~2%) without reducing that payout in periods of market stress.
   2) The company has raised its regular quarterly dividend at least 8%/yr over the past 5 years.
   3) The company’s bonds carry an S&P Rating of at least BBB+.
   4) The company’s stock carries an S&P Rating of at least B+/M.
   5) The company’s end-of-week stock price has been analyzed quantitatively by using the BMW Method for the past 16 years.
   6) The company is graded annually as to cash flow trends and revenue growth by the editors of Barron’s.
   7) The company is required to be a Dividend Achiever, to offset the risk of loss of carried by these companies because of being less well capitalized than those in the S&P 100 Index.

Bottom Line: Of the 7 companies in this week’s Table, only two are reasonably safe bets: The Travelers (TRV) and WEC Energy (WEC). In other words, their risk of loss in the next Bear Market is lower than that for investors in the Dow Jones Industrial Average ETF (DIA) (see Column M of the Table). So, why not simply buy shares of DIA instead of gambling on one of the other 5 companies? After all, DIA has an ~2% dividend yield and grows its dividend ~8%/yr. Answer: You’re a speculator and think you can do better than settle for the 7-8% long-term Total Return/Yr you’d realize from owning shares of DIA.

Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I own shares of The Travelers (TRV) and Cummins (CMI).

"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.

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