Situation: You should invest in the lowest-cost S&P 500 Index fund (VFINX) unless your stock picks have a history of doing better while taking on less risk. Why? Because stock-picking takes up a lot of your time and costs more money than buying shares in an index fund. For investing in smaller capitalization stocks or foreign stocks, don’t even consider any option other than low-cost index funds. Those are the rules so what are the exceptions? There’s really only one, and that is to pick from large capitalization stocks have a history of granting annual dividend increases that more than compensate for inflation. The trick is to find a low-cost dividend reinvestment plan (DRIP) to dollar-average your monthly purchases. After you retire, have those dividends sent to your mailbox and enjoy the one source of retirement income that grows faster than inflation.
Mission: Identify large-capitalization stocks that have below-market variance and above-market returns while paying a dividend that grows more than twice as fast as inflation.
Execution: In our Week 193 and Week 199 blogs, we have presented a system for assessing price variance at multiple points over 25 yrs. The BMW Method provides monthly updates of 16-yr, 20-yr, 25-yr, 30-yr, 35-yr and 40-yr variance, which are “least squares” calculations based on the logarithm of weekly prices for over 500 stocks (fewer at 30, 35 and 40yr intervals). The graphs give a trendline (CAGR at Column S in the Table) with adjacent lines at one and two Standard Deviations from the trendline. The spread between the base trendline and the -2SD trendline is the percent loss you can expect once every 20 yrs (see Column U in the Table). In constructing the Table, a stock that follows a track one Standard Deviation away from the S&P 500 Index (^GSPC) over recent months is at variance with ^GSPC and has therefore been excluded (see Column T in the Table). To further assess variance exceeding that for the S&P 500 Index, we look at Total Return during the Lehman Panic (see Column D in the Table), and at the 5-yr Beta (see Column I in the Table). S&P ratings are used to exclude companies that issue bonds with a rating lower than BBB+ and stocks with a rating lower than B+/M.
Using this information, we’ve come up with 14 companies, all but one of which is a Dividend Achiever (see Column R in the Table). You’ll remember that "Dividend Achiever" is S&P’s term for a company that increases its dividend annually for at least the past 10 yrs. That one exception on our list is Campbell Soup (CPB), and S&P will soon designate it a Dividend Achiever. Several columns in the Table point to the outperformance of these 14 stocks, as well as documenting less volatility than the S&P 500 Index. What is their key to success? Column L (estimated 5-yr earnings growth/yr) offers the key: 3/4ths of these companies are expected to grow earnings slower than the average company in the S&P 500 Index. By itself, that speaks volumes about why these companies outperform with less risk. Their earnings growth is relentless, with only minor hiccoughs. When earnings balk, a stock’s price will usually fall and it may take years to recover (certainly many months). IBM is a case in point. It recently sold off a couple of slow-growth divisions and re-tasked a couple of others, taking an earnings hit. The stock price fell 20% as soon as these moves were announced, and it has stayed at that level for more than 6 months. Is the company worse off or better off as a result of those structural adjustments? Warren Buffett decided that it is better off and bought more shares of IBM for Berkshire Hathaway.
Bottom Line: Companies that rarely disappoint on earnings enjoy steady growth in their stock price. Mature companies with stable earnings growth can outperform the S&P 500 Index, even with earnings growth that is predictably less than for the average S&P 500 company. We’ve only found 14 companies that have better growth with less risk, but those “diamonds in the rough” are worth close examination as prospective investments for your retirement portfolio.
Risk Rating: 4
Full Disclosure: I dollar-average into WMT, NKE, NEE and JNJ, and also own shares of GIS, PEP and ITW.
NOTE: Metrics in the Table that underperform our key benchmark (VBINX) are highlighted in red. All metrics are brought current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Showing posts with label small cap. Show all posts
Showing posts with label small cap. Show all posts
Sunday, May 10
Sunday, February 10
Week 84 - Dividend Achievers that focus on International Sales
Situation: Last week we started a conversation about growth that is anchored around the concept of Opportunity Risk (see Week 83). The idea is that no one saving for retirement, no family saving for college, no company saving to build a broader competitive advantage, or government saving to build a broader comparative advantage can avoid RISK, since stagnation is the only alternative. They all have to consider Opportunity Risk, i.e., the risk that an expenditure will unnecessarily go toward supporting stagnation rather than growth.
Last week we talked about investing in the smaller (i.e., faster growing) companies that aren't in the S&P 500 Index. This week we’ll turn our attention to companies that capture most of their revenues from faster growing countries. Same as last week, we’ll confine our attention to Dividend Achievers--companies that have increased their dividend annually for at least 10 yrs. We’ve come up with 27 companies, all having an S&P “A” rating of both their stock and bond issues (see Table). The 17 companies in the upper part of the Table lost less than 65% as much as the S&P 500 Index during the Lehman Panic; companies that lost more are red-flagged with respect to Risk (Column D) and take their place in the lower part of the Table. Why less than 65%? Because a group of above-average hedge funds lost slightly less than 65% as much as the S&P 500 Index during the Lehman Panic (see Week 46).
Of those 17 companies in the upper part of the Table, 9 are “hedge" companies (see Week 82). In other words, they have a 5-yr Beta of less than 0.65 (indicating that even today they’d likely lose less than 65% as much as the S&P 500 Index in a bear market) AND beat the S&P 500 Index over the past 15 yrs:
McDonald’s (MCD)
Hormel Foods (HRL)
Abbott Laboratories (ABT)
International Business Machines (IBM)
Colgate-Palmolive (CL)
Johnson & Johnson (JNJ)
Kimberly-Clark (KMB)
PepsiCo (PEP)
Procter & Gamble (PG)
Investment in any of these 9 stocks doesn’t need to be backed 1:1 by a high-grade bond like an inflation-protected US Savings Bond. Do be careful to pick several rather than rely on just one because even the best stocks eventually become overpriced and have to "correct" (witness Apple’s fall from grace).
In the benchmarks at the bottom section of the Table we’ve included one of the best mutual funds focusing on international stocks (ARTIX). This table is a handy illustration of how stock selection can be used to beat mutual funds. Mutual fund managers drum up business by taking outsize risks. This results in good performance over the long haul but comes at the expense of terrible losses during bear markets. You don’t want that (or you wouldn’t be reading this blog).
Bottom Line: Companies that focus on sales from international markets are smart: they’ll grow earnings faster than the average S&P 500 company (which gets only 40% of its sales from outside the US). But it’s a hard row to hoe, so you will have to be very selective.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Last week we talked about investing in the smaller (i.e., faster growing) companies that aren't in the S&P 500 Index. This week we’ll turn our attention to companies that capture most of their revenues from faster growing countries. Same as last week, we’ll confine our attention to Dividend Achievers--companies that have increased their dividend annually for at least 10 yrs. We’ve come up with 27 companies, all having an S&P “A” rating of both their stock and bond issues (see Table). The 17 companies in the upper part of the Table lost less than 65% as much as the S&P 500 Index during the Lehman Panic; companies that lost more are red-flagged with respect to Risk (Column D) and take their place in the lower part of the Table. Why less than 65%? Because a group of above-average hedge funds lost slightly less than 65% as much as the S&P 500 Index during the Lehman Panic (see Week 46).
Of those 17 companies in the upper part of the Table, 9 are “hedge" companies (see Week 82). In other words, they have a 5-yr Beta of less than 0.65 (indicating that even today they’d likely lose less than 65% as much as the S&P 500 Index in a bear market) AND beat the S&P 500 Index over the past 15 yrs:
McDonald’s (MCD)
Hormel Foods (HRL)
Abbott Laboratories (ABT)
International Business Machines (IBM)
Colgate-Palmolive (CL)
Johnson & Johnson (JNJ)
Kimberly-Clark (KMB)
PepsiCo (PEP)
Procter & Gamble (PG)
Investment in any of these 9 stocks doesn’t need to be backed 1:1 by a high-grade bond like an inflation-protected US Savings Bond. Do be careful to pick several rather than rely on just one because even the best stocks eventually become overpriced and have to "correct" (witness Apple’s fall from grace).
In the benchmarks at the bottom section of the Table we’ve included one of the best mutual funds focusing on international stocks (ARTIX). This table is a handy illustration of how stock selection can be used to beat mutual funds. Mutual fund managers drum up business by taking outsize risks. This results in good performance over the long haul but comes at the expense of terrible losses during bear markets. You don’t want that (or you wouldn’t be reading this blog).
Bottom Line: Companies that focus on sales from international markets are smart: they’ll grow earnings faster than the average S&P 500 company (which gets only 40% of its sales from outside the US). But it’s a hard row to hoe, so you will have to be very selective.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 3
Week 83 - Low-Risk Small- and Mid-Cap Dividend Achievers
Situation: “Opportunity risk” is a phrase used by investors to denote the last consideration they check off their list before parting with hard-earned money. Spending on any investment means there will be less money available to support an even better opportunity. “Opportunity risk” is a reminder to all of us not to avoid making the chancy investments that eventually produce growth. We define these chancy investments as small & mid-cap stocks, emerging market stocks & bonds, oil & gas exploration and production companies, pipeline companies, diversified engineering companies that support infrastructure development, and food producers that support the growing world population. There is also opportunity risk for governments when they shy away from expensive but rewarding infrastructure projects that are so essential for GDP growth, like 10 gigabit/sec internet connectivity for every home and office.
Smaller companies can grow rapidly but usually have more cash flow problems and less resilience than large companies, often taking on too much debt. But even without troublesome debt and cash flow problems their stocks are often volatile. This is because investors hop on the bandwagon expecting that growth to get even more exciting but it inevitably slows. These “momentum investors” then sell at a loss, even though growth remains impressive. Apple stock (AAPL) is a current example of how the bandwagon works, and shows that even the largest companies can fall prey.
Companies that offer a good and growing dividend can usually avoid large price swings, so we have consulted the buyupside list of 199 Dividend Achievers (companies that have raised dividends annually for 10+ yrs), excluding those in the S&P 500 Index. We also require that stocks on our list meet our definition of a hedge stock (see Week 82):
a) a 15-yr annualized total return that beats the S&P 500 Index (VFINX);
b) a Lehman Panic (10/07-4/09) total return that is less than 65% as bad as the 45.6% loss in the S&P 500 Index;
c) a 5-yr Beta of less than 0.65.
Our survey has turned up 28 companies (see attached Table) but only 7 are free of red flags in metrics for efficiency (ROIC), debt (LT debt/total capitalization), and cash flow (FCF/div). Those 7 companies include two food producers (LANC & SAFM), two property & casualty insurers (HCC & WRB), one company that sells cleaning products (CHD), one that builds pipelines and collects tolls for oil & gas transportation (PAA), and one that provides conventional electricity (MGEE). Close study of the table will show that all 28 companies have remarkably strong and steady profitability.
Bottom Line: These days economic growth is constrained, so investors need to carefully take on more risk to adequately prepare for retirement. The “new normal” is a term you’ve seen by now, used to describe globally weak economic growth (due to vast amounts of debt that have to be serviced or repaid). The “new normal” clearly sums up present reality. What is less clear is that the financiers who came up with the term also think it sums up future reality. Why? Because the underlying reasons are long-term: a) governments, companies and families have borrowed too much in the expectation that the heady growth of the 1990s will come back and pay off those loans. b) But GDP growth at those 90s rates is unlikely to return because commodity prices (for oil, iron, copper, corn, soybeans, etc.) are likely to grow faster than “core inflation” when over a hundred million people/yr are emerging from poverty and wanting a better life.
Let’s take oil as an example. Think about the expense and risk of a) drilling in deep water, b) hydro-fracking for oil and gas that is locked in deeply buried shale deposits, c) bulldozing and boiling tar sands into bitumen, and d) drilling under the Arctic Ocean. Then remember that oil is the main up-front cost for running a modern economy. When energy is cheap, GDP growth is readily achieved: the growth rates for both GDP and the price of oil have been the same since 1960 at 3.1%/yr (adjusted for inflation). But oil was cheap for only the first half of that 52-yr stretch (its been tripling in price every 10 yrs for the last half). You can see the problem, and its not going to go away until cheaper and cleaner energy substitutes are developed. The only near-term solution is conservation (driven by heavy taxation of electricity, vehicles, and fuels), such as Denmark has been doing for decades.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Smaller companies can grow rapidly but usually have more cash flow problems and less resilience than large companies, often taking on too much debt. But even without troublesome debt and cash flow problems their stocks are often volatile. This is because investors hop on the bandwagon expecting that growth to get even more exciting but it inevitably slows. These “momentum investors” then sell at a loss, even though growth remains impressive. Apple stock (AAPL) is a current example of how the bandwagon works, and shows that even the largest companies can fall prey.
Companies that offer a good and growing dividend can usually avoid large price swings, so we have consulted the buyupside list of 199 Dividend Achievers (companies that have raised dividends annually for 10+ yrs), excluding those in the S&P 500 Index. We also require that stocks on our list meet our definition of a hedge stock (see Week 82):
a) a 15-yr annualized total return that beats the S&P 500 Index (VFINX);
b) a Lehman Panic (10/07-4/09) total return that is less than 65% as bad as the 45.6% loss in the S&P 500 Index;
c) a 5-yr Beta of less than 0.65.
Our survey has turned up 28 companies (see attached Table) but only 7 are free of red flags in metrics for efficiency (ROIC), debt (LT debt/total capitalization), and cash flow (FCF/div). Those 7 companies include two food producers (LANC & SAFM), two property & casualty insurers (HCC & WRB), one company that sells cleaning products (CHD), one that builds pipelines and collects tolls for oil & gas transportation (PAA), and one that provides conventional electricity (MGEE). Close study of the table will show that all 28 companies have remarkably strong and steady profitability.
Bottom Line: These days economic growth is constrained, so investors need to carefully take on more risk to adequately prepare for retirement. The “new normal” is a term you’ve seen by now, used to describe globally weak economic growth (due to vast amounts of debt that have to be serviced or repaid). The “new normal” clearly sums up present reality. What is less clear is that the financiers who came up with the term also think it sums up future reality. Why? Because the underlying reasons are long-term: a) governments, companies and families have borrowed too much in the expectation that the heady growth of the 1990s will come back and pay off those loans. b) But GDP growth at those 90s rates is unlikely to return because commodity prices (for oil, iron, copper, corn, soybeans, etc.) are likely to grow faster than “core inflation” when over a hundred million people/yr are emerging from poverty and wanting a better life.
Let’s take oil as an example. Think about the expense and risk of a) drilling in deep water, b) hydro-fracking for oil and gas that is locked in deeply buried shale deposits, c) bulldozing and boiling tar sands into bitumen, and d) drilling under the Arctic Ocean. Then remember that oil is the main up-front cost for running a modern economy. When energy is cheap, GDP growth is readily achieved: the growth rates for both GDP and the price of oil have been the same since 1960 at 3.1%/yr (adjusted for inflation). But oil was cheap for only the first half of that 52-yr stretch (its been tripling in price every 10 yrs for the last half). You can see the problem, and its not going to go away until cheaper and cleaner energy substitutes are developed. The only near-term solution is conservation (driven by heavy taxation of electricity, vehicles, and fuels), such as Denmark has been doing for decades.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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