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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Showing posts with label stock rating. Show all posts
Showing posts with label stock rating. Show all posts
Sunday, June 30
Sunday, November 4
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)
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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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Sunday, October 14
Week 380 - Are Stocks in “The 2 and 8 Club” Overpriced?
Situation: There’s a lot of talk suggesting that an “overpriced” stock market is headed for a fall. And sure, stocks do have rich valuations because the Federal Reserve has kept money cheap for 10 years and bonds don’t pay enough interest to compete for investor’s money (because the Federal Reserve bought up long-dated bonds). Now the Federal Reserve is determined to reverse those policies and investors are having to get used to the idea that stocks will revert to true value. But we have to specify which metrics define “overpriced” and use at least two of those before concluding that a particular stock is overpriced (see our blogs for the past two weeks).
Mission: Run our Standard Spreadsheet, using colors in Columns Y and Z to highlight Graham Numbers and 7-Yr P/Es that are overpriced (purple) or underpriced (green).
Execution: see Table.
Bottom Line: In the aggregate, the 32 stocks in “The 2 and 8 Club” have Graham Numbers that are more than 200% of their current valuation. This leaves room for at least a 50% fall from present prices. However, our confirmation metric does not support such a dire prediction: The average 7-Yr P/E is a little under the upper limit of the normal range for valuations (25).
Stocks issued by some companies appear to clearly be overpriced, in that the Graham Number is more than twice the stock’s price and the 7-Yr P/E is more than 30: TXN, ADP, UPS, HSY and CAT. Other companies appear to clearly be underpriced in that the Graham Number is less than the stock’s price and the 7-Yr P/E is less than 25: CMCSA, PNC, ADM, PFG and MET. The fact that 5/32 stocks are overpriced and 5/32 stocks are underpriced is indicative of normal distribution (Bell Curve). So, we’ll use this approach often in future blogs.
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE, JPM, CAT and IBM, and also own shares of TRV, MMM, CSCO and CMI.
Mission: Run our Standard Spreadsheet, using colors in Columns Y and Z to highlight Graham Numbers and 7-Yr P/Es that are overpriced (purple) or underpriced (green).
Execution: see Table.
Bottom Line: In the aggregate, the 32 stocks in “The 2 and 8 Club” have Graham Numbers that are more than 200% of their current valuation. This leaves room for at least a 50% fall from present prices. However, our confirmation metric does not support such a dire prediction: The average 7-Yr P/E is a little under the upper limit of the normal range for valuations (25).
Stocks issued by some companies appear to clearly be overpriced, in that the Graham Number is more than twice the stock’s price and the 7-Yr P/E is more than 30: TXN, ADP, UPS, HSY and CAT. Other companies appear to clearly be underpriced in that the Graham Number is less than the stock’s price and the 7-Yr P/E is less than 25: CMCSA, PNC, ADM, PFG and MET. The fact that 5/32 stocks are overpriced and 5/32 stocks are underpriced is indicative of normal distribution (Bell Curve). So, we’ll use this approach often in future blogs.
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE, JPM, CAT and IBM, and also own shares of TRV, MMM, CSCO and CMI.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
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, October 7
Week 379 - Are “Blue Chip” Stocks Overvalued?
Situation: There are two subjective issues that we need to quantify for “buy and hold” investors: 1) Define a “blue chip” stock. 2) Define an “overvalued” stock.
Our previous effort to define a “blue chip” stock in quantitative terms (see Week 361) left room for subjective interpretation and was more complicated than necessary. Here’s the new and improved definition: Any US-based company in the S&P 100 Index whose stock has been tracked by modern quantitative methods for 30+ years, and enjoys an S&P rating of B+/M or better. The very important final requirement is that the company issues bonds carrying an S&P rating of A- or better.
In last week’s blog, we introduced two different quantitative methods for deciding whether or not a stock is overvalued: 1) the Graham Number, which sets an optimal price by using Book Value for the most recent quarter (mrq) and Earnings Per Share for the trailing 12 months (TTM); 2) the 7-Yr P/E, which removes aberrations that are introduced by “blowout earnings” or the negative impact on earnings that is often introduced by “mergers and acquisitions” and “company restructurings.” Either metric can be misleading if used alone, but that problem is largely negated when both are used together.
Mission: Set up our Standard Spreadsheet for the 40 companies that meet criteria. Show the Graham Number in Columns X and the 7-Yr P/E in Column Z.
Execution: see Table.
Administration: In our original blog about Blue Chip stocks (Week 361), we thought the definition needed to require that companies pay a good and growing dividend. However, there are no objective reasons why a company’s stock will be of more value if profits are paid out piecemeal to investors rather than entirely in the form of capital gains. That’s one of the things you learn in business school from professors of Banking and Finance. Accounting professors also point out that a dividend is a mini-liquidation, as well as a second round of taxation on the company’s profits. There are subjective reasons to prefer companies that pay a good and growing dividend, like building brand value (an intangible asset) and showing that the company is “shareholder friendly.” Dividends also reduce risk by returning some of the original investment quickly with inflation-protected dollars.
Bottom Line: In the aggregate, these company’s shares are overpriced but not to an unreasonable degree (see Columns X-Z in the Table). However, only 8 are bargain-priced: Altria Group (MO), Comcast (CMCSA), Berkshire Hathaway (BRK-B), JP Morgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFB), US Bancorp (USB), and Exxon Mobil (XOM). You’ll note that all 8 face challenges that will cause investors to pause before snapping up shares.
Shares in 9 companies are overpriced by both metrics (Graham Number and 7-Yr P/E): Home Depot (HD), UnitedHealth (UNH), Lowe’s (LOW), Costco Wholesale (COST), Microsoft (MSFT), Texas Instruments (TXN), Raytheon (RTN), Honeywell International (HON), and Caterpillar (CAT). You’ll need to think about taking profits in those, if you’re a share-owner.
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, NEE, KO, JNJ, JPM, UNP, PG, WMT, CAT, XOM, and IBM. I also own shares of COST, MMM, BRK-B, and INTC.
Our previous effort to define a “blue chip” stock in quantitative terms (see Week 361) left room for subjective interpretation and was more complicated than necessary. Here’s the new and improved definition: Any US-based company in the S&P 100 Index whose stock has been tracked by modern quantitative methods for 30+ years, and enjoys an S&P rating of B+/M or better. The very important final requirement is that the company issues bonds carrying an S&P rating of A- or better.
In last week’s blog, we introduced two different quantitative methods for deciding whether or not a stock is overvalued: 1) the Graham Number, which sets an optimal price by using Book Value for the most recent quarter (mrq) and Earnings Per Share for the trailing 12 months (TTM); 2) the 7-Yr P/E, which removes aberrations that are introduced by “blowout earnings” or the negative impact on earnings that is often introduced by “mergers and acquisitions” and “company restructurings.” Either metric can be misleading if used alone, but that problem is largely negated when both are used together.
Mission: Set up our Standard Spreadsheet for the 40 companies that meet criteria. Show the Graham Number in Columns X and the 7-Yr P/E in Column Z.
Execution: see Table.
Administration: In our original blog about Blue Chip stocks (Week 361), we thought the definition needed to require that companies pay a good and growing dividend. However, there are no objective reasons why a company’s stock will be of more value if profits are paid out piecemeal to investors rather than entirely in the form of capital gains. That’s one of the things you learn in business school from professors of Banking and Finance. Accounting professors also point out that a dividend is a mini-liquidation, as well as a second round of taxation on the company’s profits. There are subjective reasons to prefer companies that pay a good and growing dividend, like building brand value (an intangible asset) and showing that the company is “shareholder friendly.” Dividends also reduce risk by returning some of the original investment quickly with inflation-protected dollars.
Bottom Line: In the aggregate, these company’s shares are overpriced but not to an unreasonable degree (see Columns X-Z in the Table). However, only 8 are bargain-priced: Altria Group (MO), Comcast (CMCSA), Berkshire Hathaway (BRK-B), JP Morgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFB), US Bancorp (USB), and Exxon Mobil (XOM). You’ll note that all 8 face challenges that will cause investors to pause before snapping up shares.
Shares in 9 companies are overpriced by both metrics (Graham Number and 7-Yr P/E): Home Depot (HD), UnitedHealth (UNH), Lowe’s (LOW), Costco Wholesale (COST), Microsoft (MSFT), Texas Instruments (TXN), Raytheon (RTN), Honeywell International (HON), and Caterpillar (CAT). You’ll need to think about taking profits in those, if you’re a share-owner.
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, NEE, KO, JNJ, JPM, UNP, PG, WMT, CAT, XOM, and IBM. I also own shares of COST, MMM, BRK-B, and INTC.
"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
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Sunday, September 23
Week 377 - Russell 1000 Non-financial Companies With High Sustainability and S&P Ratings
Situation: You’d like information about the durability of your investments. Sustainability is the jargon term that investment professionals have assigned to this topic. The problem is to quantify it by rating the 3 main components: Environment, Social, and Governance (ESG). The Yahoo Finance website now has a heading for sustainability that attempts to do exactly that. The editors of Barron’s also have a recent article looking more closely at the “100 Most Sustainable Companies”, with date suggesting that these may outperform the S&P 500 Index. We’d like to know which of those have also been examined by S&P. Specifically, which of those 100 Most Sustainable Companies have issued bonds that S&P has rated A or better?
Mission: Use our Standard Spreadsheet to analyze all of the Barron’s “100 Most Sustainable Companies” that are on the Russell 1000 List, selecting only the non-financial companies that have an S&P bond rating of A or better, and an S&P stock rating of B+/M or better. To identify stocks that are possibly overpriced, include columns for “Graham Numbers” and “7-Yr P/E”.
Execution: see Table.
Bottom Line: 18 companies meet criteria, 14 of which already appear on our two major lists: “The 2 and 8 Club” (see Week 360); “Blue Chips” (see Week 361). The new companies are Stanley Black & Decker (SWK), WW Grainger (GWW), Colgate-Palmolive (CL) and Deere (DE).
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 and PG, and also own shares of CSCO and CMI.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Use our Standard Spreadsheet to analyze all of the Barron’s “100 Most Sustainable Companies” that are on the Russell 1000 List, selecting only the non-financial companies that have an S&P bond rating of A or better, and an S&P stock rating of B+/M or better. To identify stocks that are possibly overpriced, include columns for “Graham Numbers” and “7-Yr P/E”.
Execution: see Table.
Bottom Line: 18 companies meet criteria, 14 of which already appear on our two major lists: “The 2 and 8 Club” (see Week 360); “Blue Chips” (see Week 361). The new companies are Stanley Black & Decker (SWK), WW Grainger (GWW), Colgate-Palmolive (CL) and Deere (DE).
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 and PG, and also own shares of CSCO and CMI.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 4
Week 348 - Capitalization-weighted Index of “The 2 and 8 Club”
Situation: Whatever your stock-picking method, you need to decide how to manage large vs. small company stocks. If most of your stocks are issued by S&P 500 companies, your benchmark is the S&P 500 Index. It’s the greyhound you’re trying to catch. You won’t be able to keep up unless you invest more in mega-cap stocks than in the remaining companies of the S&P 500 Index. (I’ll bet you wish you’d owned Boeing stock going into 2017.)
Our stock-picking method is to invest in mega-caps, specifically the S&P 100 Index companies that represent 63% of the market capitalization of the S&P 500. Membership in that Index requires their stocks to have active “exchange-listed options” on the CBOE (Chicago Board Options Exchange). That’s important because a strong market in Put and Call Options means that there will be accurate and prompt price discovery, which is the best way to protect investors from a sudden collapse in price.
Mission: Use our Standard Spreadsheet to list the 22 S&P 100 companies that are in “The 2 and 8 Club” (see Week 327).
Execution: see Table listing those 22 stocks by market capitalization.
Administration: We confine our attention to S&P 100 companies among the ~400 companies in the Russell 1000 Index that pay a stable above-market dividend, one that is usually above 2%/yr. The Vanguard High Dividend Yield ETF (VYM) is a capitalization-weighted Index of those 400 companies, and is updated monthly. We reject companies that have not grown their dividend ~8%/yr (or faster) over the most recent 5-Yr period.
There are currently 22 members of “The 2 and 8 Club”. All 22 companies have BBB+ or better S&P Bond Ratings, and B+/M or better S&P Stock Ratings. Additionally, all 22 have at least the 16-yr trading record that is required for quantitative analysis by the BMW Method, which is based on stock prices that are updated every Sunday.
Bottom Line: These 22 stocks collectively have greater volatility (see Column M in the Table) but higher long-term total returns (see Column C in the Table), than the S&P 500 Index (see the ETF SPY at Line 32 in the Table). Only 7 of the 22 have less price volatility than the S&P 500 Index (see Column M): KO, PEP, IBM, MO, UPS, NEE, TGT. If you’re not a gambler, stick to investing in those and the benchmark ETFs (SPY and VYM).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).
Full Disclosure: I dollar-cost average into MSFT, JPM, KO and NEE, and also own shares of PFE, CSCO, PEP, IBM, MMM, MO, AMGN, TXN, CAT and TGT.
"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
Our stock-picking method is to invest in mega-caps, specifically the S&P 100 Index companies that represent 63% of the market capitalization of the S&P 500. Membership in that Index requires their stocks to have active “exchange-listed options” on the CBOE (Chicago Board Options Exchange). That’s important because a strong market in Put and Call Options means that there will be accurate and prompt price discovery, which is the best way to protect investors from a sudden collapse in price.
Mission: Use our Standard Spreadsheet to list the 22 S&P 100 companies that are in “The 2 and 8 Club” (see Week 327).
Execution: see Table listing those 22 stocks by market capitalization.
Administration: We confine our attention to S&P 100 companies among the ~400 companies in the Russell 1000 Index that pay a stable above-market dividend, one that is usually above 2%/yr. The Vanguard High Dividend Yield ETF (VYM) is a capitalization-weighted Index of those 400 companies, and is updated monthly. We reject companies that have not grown their dividend ~8%/yr (or faster) over the most recent 5-Yr period.
There are currently 22 members of “The 2 and 8 Club”. All 22 companies have BBB+ or better S&P Bond Ratings, and B+/M or better S&P Stock Ratings. Additionally, all 22 have at least the 16-yr trading record that is required for quantitative analysis by the BMW Method, which is based on stock prices that are updated every Sunday.
Bottom Line: These 22 stocks collectively have greater volatility (see Column M in the Table) but higher long-term total returns (see Column C in the Table), than the S&P 500 Index (see the ETF SPY at Line 32 in the Table). Only 7 of the 22 have less price volatility than the S&P 500 Index (see Column M): KO, PEP, IBM, MO, UPS, NEE, TGT. If you’re not a gambler, stick to investing in those and the benchmark ETFs (SPY and VYM).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).
Full Disclosure: I dollar-cost average into MSFT, JPM, KO and NEE, and also own shares of PFE, CSCO, PEP, IBM, MMM, MO, AMGN, TXN, CAT and TGT.
"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 25
Week 347 - The Gretzky Rule Applied to Dividend Achievers in the Food Sector
Situation: Business people seeking to predict outcomes often quote Wayne Gretzky quote: “I skate to where the puck is going to be, not where it has been.” This highlights a problem: All of the metrics and technical charts that we use are retrospective. We’re driving forward by looking in the rear view mirror! Warren Buffett has tried to estimate outcomes by making calculations of the growth in “core earnings’ in companies that have a “Durable Competitive Advantage”. DCA companies have had a growth rate for Tangible Book Value over the most recent 10 years that exceeds 7%/yr, with no more than three down years. (c.f. The Warren Buffett Stock Portfolio, Scribner, NY, 2011 by Mary Buffett and David Clark) You can read more about such estimates of “true” Shareholder Equity by Googling Net Tangible Asset Investing.
We agree with Mr. Buffett, and have learned to envision the future prospects of a company by first assessing its ability to grow Tangible Book Value. But since the Great Recession, few S&P 500 companies have even a dollar of Net Tangible Assets. Why? Because the Federal Reserve’s policy (to accelerate recovery from the Great Recession) has been to make money more freely available than ever before. Accordingly, companies favor debt financing over equity financing. Debt becomes a larger dollar amount on the Balance Sheet than equity. (Equity for most companies represents the initial cost of property, plant and equipment, which equals Tangible Book Value.)
Mission: Use our Standard Spreadsheet to arrive at an estimate of a company’s position in its sector of the economy 10 years from now. Start by analyzing S&P 500 companies in the Food, Beverage and Restaurant sector that are Dividend Achievers, i.e., have increased their dividend annually for at least the past 10 years.
Execution: see Table.
Administration: For almost any business, the name of the game for making money is not losing money. If a stock falls 50% in price, that price must rise 200% just to get back to where it started. So, let’s start our analysis by excluding Dividend Achievers that have a 16 year record of price appreciation showing volatility which exceeds that for the S&P 500 Index (see Column M in the Table). Then, we’ll look for companies having a clean Balance Sheet (Columns P-S in the Table) and a strong Global Brand (Columns AC-AD in the Table). None of the 11 companies have a clean Balance Sheet, but Coca-Cola (KO), Costco Wholesale (COST), Target (TGT), and Walmart (WMT) come close. Those four are also the only companies that have any Tangible Book Value (see Column R in the Table) but none have grown TBV fast enough to meet Warren Buffett’s requirements for DCA (see Column AF in the Table), although Walmart (WMT) comes close. Those 4 companies are also among the 7 that have a strong Global Brand.
Bottom Line: Walmart (WMT) is the winner of this contest.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10). As a group, these 11 companies had remarkably buoyant total returns during the recent commodity recession (see Column D in the Table), which saw a 24.2%/yr drop in commodity prices (see Line 21 in the Table). Of course, raw food commodities were less expensive during that period but the outperformance of the food sector is strong enough to suggest that investors tend to move money there in deflationary times.
Full Disclosure: I dollar-cost average into Coca-Cola (KO), and also own shares of Costco Wholesale (COST), Target (TGT), Walmart (WMT), McCormick (MKC) and McDonald’s (MCD).
"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
We agree with Mr. Buffett, and have learned to envision the future prospects of a company by first assessing its ability to grow Tangible Book Value. But since the Great Recession, few S&P 500 companies have even a dollar of Net Tangible Assets. Why? Because the Federal Reserve’s policy (to accelerate recovery from the Great Recession) has been to make money more freely available than ever before. Accordingly, companies favor debt financing over equity financing. Debt becomes a larger dollar amount on the Balance Sheet than equity. (Equity for most companies represents the initial cost of property, plant and equipment, which equals Tangible Book Value.)
Mission: Use our Standard Spreadsheet to arrive at an estimate of a company’s position in its sector of the economy 10 years from now. Start by analyzing S&P 500 companies in the Food, Beverage and Restaurant sector that are Dividend Achievers, i.e., have increased their dividend annually for at least the past 10 years.
Execution: see Table.
Administration: For almost any business, the name of the game for making money is not losing money. If a stock falls 50% in price, that price must rise 200% just to get back to where it started. So, let’s start our analysis by excluding Dividend Achievers that have a 16 year record of price appreciation showing volatility which exceeds that for the S&P 500 Index (see Column M in the Table). Then, we’ll look for companies having a clean Balance Sheet (Columns P-S in the Table) and a strong Global Brand (Columns AC-AD in the Table). None of the 11 companies have a clean Balance Sheet, but Coca-Cola (KO), Costco Wholesale (COST), Target (TGT), and Walmart (WMT) come close. Those four are also the only companies that have any Tangible Book Value (see Column R in the Table) but none have grown TBV fast enough to meet Warren Buffett’s requirements for DCA (see Column AF in the Table), although Walmart (WMT) comes close. Those 4 companies are also among the 7 that have a strong Global Brand.
Bottom Line: Walmart (WMT) is the winner of this contest.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10). As a group, these 11 companies had remarkably buoyant total returns during the recent commodity recession (see Column D in the Table), which saw a 24.2%/yr drop in commodity prices (see Line 21 in the Table). Of course, raw food commodities were less expensive during that period but the outperformance of the food sector is strong enough to suggest that investors tend to move money there in deflationary times.
Full Disclosure: I dollar-cost average into Coca-Cola (KO), and also own shares of Costco Wholesale (COST), Target (TGT), Walmart (WMT), McCormick (MKC) and McDonald’s (MCD).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
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Sunday, July 17
Week 263 - “Bond-like” Stocks That Fly Under The Radar
Situation: The stock market is overpriced, which is the obvious outcome of “quantitative easing” and ultra-low interest rates. US Treasury bonds and notes carry an interest rate that is close to the projected inflation rate over their holding period. Stocks, in spite of their added risk, are the only path to portfolio growth. For that reason, the business news increasingly talks up “bond-like” stocks.
Mission: In last week’s blog, we set up criteria for defining “bond-like” stocks, starting with the requirement that they be Dividend Achievers, i.e., the dividend has been increased annually for at least the past 10 yrs. Now we’ll use those same criteria to highlight “below the radar” stocks, e.g. those issued by companies that don’t have sufficient revenue to be included in the 2016 Barron’s 500 List.
Execution: We exclude any Dividend Achiever from consideration if one or more of the following conditions apply:
1. Revenues are insufficient to warrant inclusion in the 2016 Barron’s 500 List;
2. S&P bond rating is less than BBB+ or (in the absence of a rating) debt/equity is less than or equal to one;
3. S&P stock rating is less than B+/M or S&P assigns a denominator of “H” to the rating (indicating high risk of loss);
4. WACC exceeds ROIC;
5. Finance Value (Column E in our Tables) falls more than for the Vanguard 500 Index Fund (VFINX);
6. Dividend yield is less than for VFINX;
7. 16-yr CAGR is less than for the S&P 500 Index (^GSPC);
8. Dividend yield + 16-yr CAGR is less than 11.4%. NOTE: This metric has predictive value for Net Present Value (NPV) and is highlighted in yellow at Column Q in the Table.
9. Predicted loss to the investor at 2 standard deviations below 16-yr price CAGR is more than 36% (see Column P in the Table).
Bottom Line: We’ve found a dozen Dividend Achievers that appear attractive for long-term investment, even though most reside in the S&P 400 MidCap Index. Not surprisingly, 7 of the 12 are utility stocks. But the strongest stock of the group is Tanger Factory Outlet Centers (SKT), a real estate investment trust.
Risk Rating: 5 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I own shares of Lincoln Electric (LECO).
Note: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance relative to our key benchmark (VBINX at Line 25 in the Table). NPV inputs are listed and justified in the Appendix for Week 256.
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Mission: In last week’s blog, we set up criteria for defining “bond-like” stocks, starting with the requirement that they be Dividend Achievers, i.e., the dividend has been increased annually for at least the past 10 yrs. Now we’ll use those same criteria to highlight “below the radar” stocks, e.g. those issued by companies that don’t have sufficient revenue to be included in the 2016 Barron’s 500 List.
Execution: We exclude any Dividend Achiever from consideration if one or more of the following conditions apply:
1. Revenues are insufficient to warrant inclusion in the 2016 Barron’s 500 List;
2. S&P bond rating is less than BBB+ or (in the absence of a rating) debt/equity is less than or equal to one;
3. S&P stock rating is less than B+/M or S&P assigns a denominator of “H” to the rating (indicating high risk of loss);
4. WACC exceeds ROIC;
5. Finance Value (Column E in our Tables) falls more than for the Vanguard 500 Index Fund (VFINX);
6. Dividend yield is less than for VFINX;
7. 16-yr CAGR is less than for the S&P 500 Index (^GSPC);
8. Dividend yield + 16-yr CAGR is less than 11.4%. NOTE: This metric has predictive value for Net Present Value (NPV) and is highlighted in yellow at Column Q in the Table.
9. Predicted loss to the investor at 2 standard deviations below 16-yr price CAGR is more than 36% (see Column P in the Table).
Bottom Line: We’ve found a dozen Dividend Achievers that appear attractive for long-term investment, even though most reside in the S&P 400 MidCap Index. Not surprisingly, 7 of the 12 are utility stocks. But the strongest stock of the group is Tanger Factory Outlet Centers (SKT), a real estate investment trust.
Risk Rating: 5 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I own shares of Lincoln Electric (LECO).
Note: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance relative to our key benchmark (VBINX at Line 25 in the Table). NPV inputs are listed and justified in the Appendix for Week 256.
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Sunday, July 10
Week 262 - The Master List for 2016
Situation: You’d like not to outlive your retirement savings. And you probably want to find a path toward that goal that doesn’t involve gambling. For that reason, non-gamblers who work on Wall Street have traditionally invested in bonds because bond pricing is stable unless the borrower faces bankruptcy. Even then, the creditor gets back most of the money owed, after the court liquidates and distributes the borrower’s assets. High quality bonds also come with fairy dust. They go up in price during recessions. Stock pricing depends on the perceived value of future cash flows discounted to the present. High quality stocks mostly go down in price during recessions because cash flows depend on demand for the company’s goods and services.
Bonds now pay only enough interest to cover inflation. You have little choice but to invest in “bond-like” stocks that don’t fall much in value during recessions, and maybe even go up. Examples include Wal-Mart and McDonald’s, both of which went up during the Lehman Panic. We’ve constructed the 2016 Master List around that idea. It starts of course with companies that pay a good and growing dividend, the ones S&P calls Dividend Achievers because they’ve raised their dividend annually for at least the past 10 yrs. Those companies have a captive audience of some sort, people who will keep shelling out cash for a product or service, even during recessions.
Mission: Identify Dividend Achievers likely to hold their value during recessions.
Execution: You’ll know them by how little their total return to investors fell during the most recent “bear market” in an important asset class. That would be the middle two quarters of 2011, when the S&P 400 MidCap Index ETF (MDY) fell 21%. We exclude any Dividend Achiever from consideration if one or more of the following conditions apply:
1. Revenues are insufficient to warrant inclusion in the 2016 Barron’s 500 List;
2. S&P bond rating is less than BBB+ or (in the absence of a rating) debt/equity is less than or equal to one;
3. S&P stock rating is less than B+/M (or S&P assigns a denominator of “H” to the rating, denoting high risk of loss to the investor);
4. WACC exceeds ROIC;
5. Finance Value (Column E in our Tables) falls more than for the Vanguard 500 Index Fund (VFINX);
6. Dividend yield is less than for VFINX;
7. 16-yr CAGR is less than for the S&P 500 Index (^GSPC);
8. Dividend yield + 16-yr CAGR is less than 11.4%. NOTE: this metric has predictive value for Net Present Value (NPV) and is highlighted in yellow at Column Q in the Table;
9. Predicted loss to the investor at 2 standard deviations below 16-yr price CAGR is more than 36% (see Column P in the Table).
Bottom Line: We’ve found 24 Dividend Achievers in the 2016 Barron’s 500 List that defy gravity. All 24 have outgrown the Vanguard S&P 500 Index Fund (VFINX) over the past 16 yrs AND dropped no more in Finance Value during the 2011 bear market than did MDY, the S&P 400 MidCap Index ETF (see Column E in the Table). More importantly, the first 10 companies in the Table beat out 10-Yr Treasury Notes in Finance Value. Thirteen of the 24 improved their cash flow and sales numbers in 2015 compared to 2014 (highlighted in green in Columns R & S of the Table). All 24 continue to more than repay their cost of capital (see Columns AB and AC in the Table). The discounted cash flow (NPV) over the next 10 yrs, projected from 16-yr dividend and price appreciation rates by using a 9%/yr discount rate, shows that all 24 are likely to beat out Berkshire Hathaway (BRK-A), MDY, Microsoft (MSFT), and VFINX (see Columns W-AA in the Table).
Risk Rating: 4 (where 1 = Treasury Notes and 10 = gold).
Full Disclosure: I dollar-average into JNJ and NEE, and own shares of GIS, KO and MCD.
Note: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance relative to our key benchmark (VBINX at Line 37 in the Table). NPV inputs are listed and justified in the Appendix for Week 256.
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Bonds now pay only enough interest to cover inflation. You have little choice but to invest in “bond-like” stocks that don’t fall much in value during recessions, and maybe even go up. Examples include Wal-Mart and McDonald’s, both of which went up during the Lehman Panic. We’ve constructed the 2016 Master List around that idea. It starts of course with companies that pay a good and growing dividend, the ones S&P calls Dividend Achievers because they’ve raised their dividend annually for at least the past 10 yrs. Those companies have a captive audience of some sort, people who will keep shelling out cash for a product or service, even during recessions.
Mission: Identify Dividend Achievers likely to hold their value during recessions.
Execution: You’ll know them by how little their total return to investors fell during the most recent “bear market” in an important asset class. That would be the middle two quarters of 2011, when the S&P 400 MidCap Index ETF (MDY) fell 21%. We exclude any Dividend Achiever from consideration if one or more of the following conditions apply:
1. Revenues are insufficient to warrant inclusion in the 2016 Barron’s 500 List;
2. S&P bond rating is less than BBB+ or (in the absence of a rating) debt/equity is less than or equal to one;
3. S&P stock rating is less than B+/M (or S&P assigns a denominator of “H” to the rating, denoting high risk of loss to the investor);
4. WACC exceeds ROIC;
5. Finance Value (Column E in our Tables) falls more than for the Vanguard 500 Index Fund (VFINX);
6. Dividend yield is less than for VFINX;
7. 16-yr CAGR is less than for the S&P 500 Index (^GSPC);
8. Dividend yield + 16-yr CAGR is less than 11.4%. NOTE: this metric has predictive value for Net Present Value (NPV) and is highlighted in yellow at Column Q in the Table;
9. Predicted loss to the investor at 2 standard deviations below 16-yr price CAGR is more than 36% (see Column P in the Table).
Bottom Line: We’ve found 24 Dividend Achievers in the 2016 Barron’s 500 List that defy gravity. All 24 have outgrown the Vanguard S&P 500 Index Fund (VFINX) over the past 16 yrs AND dropped no more in Finance Value during the 2011 bear market than did MDY, the S&P 400 MidCap Index ETF (see Column E in the Table). More importantly, the first 10 companies in the Table beat out 10-Yr Treasury Notes in Finance Value. Thirteen of the 24 improved their cash flow and sales numbers in 2015 compared to 2014 (highlighted in green in Columns R & S of the Table). All 24 continue to more than repay their cost of capital (see Columns AB and AC in the Table). The discounted cash flow (NPV) over the next 10 yrs, projected from 16-yr dividend and price appreciation rates by using a 9%/yr discount rate, shows that all 24 are likely to beat out Berkshire Hathaway (BRK-A), MDY, Microsoft (MSFT), and VFINX (see Columns W-AA in the Table).
Risk Rating: 4 (where 1 = Treasury Notes and 10 = gold).
Full Disclosure: I dollar-average into JNJ and NEE, and own shares of GIS, KO and MCD.
Note: Metrics are current for the Sunday of publication. Metrics highlighted in red denote underperformance relative to our key benchmark (VBINX at Line 37 in the Table). NPV inputs are listed and justified in the Appendix for Week 256.
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Sunday, December 27
Week 234 - Barron’s 500 "Utilities" That Are Dividend Achievers
Situation: Utilities, including communication services companies like AT&T, have such high fixed costs that they’re mainly capitalized by loans. Their stock investors are compensated for this impairment by being awarded high dividend payouts. That places share prices in direct competition with corporate bonds, meaning that newly issued bonds will have higher interest rates than legacy bonds. The price paid for legacy bonds will fall, putting downward pressure on the price paid for utility stocks. Now that the Federal Reserve is determined to raise short-term interest rates we can expect this to occur. The highest quality utility stocks will see only a temporary effect, since earnings growth will continue unabated.
Mission: Identify the highest quality utility stocks in the Barron’s 500 List by picking out the Dividend Achievers, i.e., those that have paid a larger dividend every year for at least the past 10 yrs. Exclude any companies that have an S&P bond rating less than BBB+ and/or an S&P stock rating lower than B+/M. Assess the long-term value of owning these stocks by collecting 25-yr data on price appreciation and risk of loss at the BMW Method website.
Execution: Eight companies are identified as meeting our criteria (see Table).
Bottom Line: Over the long term, this group of 8 companies shows a materially higher total return/yr than the S&P 500 Index, along with a materially lower risk of loss. Over the past 3 yrs, their performance with respect to key metrics of cash flow and revenue has improved, as demonstrated by the data collected for Barron’s 500 rankings in 2015.
Risk Rating: 4
Full Disclosure: I dollar average into NEE and own shares of T.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
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Mission: Identify the highest quality utility stocks in the Barron’s 500 List by picking out the Dividend Achievers, i.e., those that have paid a larger dividend every year for at least the past 10 yrs. Exclude any companies that have an S&P bond rating less than BBB+ and/or an S&P stock rating lower than B+/M. Assess the long-term value of owning these stocks by collecting 25-yr data on price appreciation and risk of loss at the BMW Method website.
Execution: Eight companies are identified as meeting our criteria (see Table).
Bottom Line: Over the long term, this group of 8 companies shows a materially higher total return/yr than the S&P 500 Index, along with a materially lower risk of loss. Over the past 3 yrs, their performance with respect to key metrics of cash flow and revenue has improved, as demonstrated by the data collected for Barron’s 500 rankings in 2015.
Risk Rating: 4
Full Disclosure: I dollar average into NEE and own shares of T.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
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Sunday, December 20
Week 233 - Barron’s 500 “Industrials” That Are Dividend Achievers
Situation: The US dollar is outperforming all other major currencies, which decreases demand for goods shipped from the US to world markets. As a result, earnings for US industrial companies that gain most of their sales overseas have fallen 20-50%. This weighs on their stock prices but creates an opportunity for investors, provided the management of those companies is aggressively preparing for the day when other currencies recover.
Mission: Take a close look at large industrial companies and their performance over the past 3 yrs, as detailed in the 2015 Barron’s 500 List. Then determine which of those have a long history of relatively steady growth, as expressed by having a 10+ yr history of raising their dividend annually. S&P calls such companies Dividend Achievers.
Execution: All of the “industrials” that appear on both lists are found in the accompanying Table, except those that have an S&P bond rating lower than BBB+ or an S&P stock rating lower that B+/M. Information on price appreciation (over the past 25 yrs) and risk of loss, per the BMW Method, is found in Columns M through O of the Table. Four companies did not have 25-yr price appreciation data and are not included in the Table.
Bottom Line: Industrial companies, as a group, carry almost 10% higher risk of loss than the S&P 500 Index. That is offset by price appreciation that is almost twice as great. If you’re going to invest in this sector, you have to be in it for the long term and expect some rough years.
Risk Rating: 7
Full Disclosure: I own stock in UTX, ITW, MMM, and DE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
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Mission: Take a close look at large industrial companies and their performance over the past 3 yrs, as detailed in the 2015 Barron’s 500 List. Then determine which of those have a long history of relatively steady growth, as expressed by having a 10+ yr history of raising their dividend annually. S&P calls such companies Dividend Achievers.
Execution: All of the “industrials” that appear on both lists are found in the accompanying Table, except those that have an S&P bond rating lower than BBB+ or an S&P stock rating lower that B+/M. Information on price appreciation (over the past 25 yrs) and risk of loss, per the BMW Method, is found in Columns M through O of the Table. Four companies did not have 25-yr price appreciation data and are not included in the Table.
Bottom Line: Industrial companies, as a group, carry almost 10% higher risk of loss than the S&P 500 Index. That is offset by price appreciation that is almost twice as great. If you’re going to invest in this sector, you have to be in it for the long term and expect some rough years.
Risk Rating: 7
Full Disclosure: I own stock in UTX, ITW, MMM, and DE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
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Sunday, March 16
Week 141 - An Update on Berkshire Hathaway
Situation: In a past blog (see Week 125), we characterized Berkshire Hathaway’s B shares (BRK-B, priced around $120/sh) as a “hedge fund for the masses” and we’re sticking to it. The reason we could make this designation is because there are two parts to the company that act to counterbalance each other in a way that maximizes returns and minimizes risks. Almost 2/3rds of the company is made up of more than 80 wholly-owned subsidiaries that are, for the most part, “low risk” enterprises. These include electric utilities, a railroad, a car insurer, a restaurant chain, and a trucking company. The remainder of Berkshire Hathaway is an investment portfolio holding stock in 42 companies that are, for the most part, “high risk” enterprises.
Many investors like to have the latest information on what Warren Buffett is up to, so we have summarized the major current holdings of Berkshire’s investment portfolio for you in the Table. Red highlights denote higher risk or lower performance vs. the benchmark we like to use, VBINX, which is a low-cost hedged S&P 500 Index fund.
How are the two parts of Berkshire Hathaway performing? For 2013, Berkshire Hathaway as a whole was up 27.4% in value vs. 28.9% for the lowest-cost S&P 500 Index fund, VFINX (see Column G in the Table), whereas, the average stock in the Berkshire Hathaway’s investment portfolio was up 31.7%. These results are as expected, given the overall robust performance of the stock market and the relative risk of Berkshire’s wholly-owned subsidiaries vs. its investment portfolio.
As of Dec 31, 2013, the value for all of Berkshire Hathaway was $294 Billion, with the investment portfolio representing $105 Billion. In other words, 36% of the company’s value is in marketable common stocks. Berkshire Hathaway is in the financial services industry, so it is not surprising that stock in such companies represents 43% of its investment portfolio. Wells Fargo (WFC) alone accounts for 20% of that portfolio and American Express (AXP) 13%. Every quarter, the Securities and Exchange Commission (SEC) requires large companies to submit an update of their investment holdings. We’ve perused Berkshire’s recently issued “13-F filing” for the 4th quarter of 2013, and summarized the results for company holdings that are larger than $0.5 Billion (in Table). Two companies were excluded because their stock was issued only recently: General Motors (GM) holdings worth $1.6 Billion, and Liberty Media (LMCA) holdings worth $0.78 Billion. When this filing is compared with the previous quarter’s, we see that Berkshire Hathaway has exited from positions in Dish Network and GlaxoSmithKline plc but has added a position in Liberty Global plc valued at $0.26 Billion. Warrants that Berkshire had been holding in Goldman Sachs (GS) have been converted to shares worth $2.2 Billion.
Taking a closer look at the investment portfolio (Table), we see only 3 financial services companies (WFC, AXP, USB) among the largest 10 holdings (denoted in the Table with green stock tickers in Column B). Not surprisingly, given Warren Buffett’s prowess as a stock picker, all 7 non-financial companies have finance values (Column E) higher than our benchmark’s (VBINX). Costco Wholesale (COST) is the only one in that high value group that isn’t in the Top 10 holdings, so it stands to reason that COST is a candidate for further accumulation.
BRK-B shares are priced around $120/Share, making those easy to accumulate by using a low-cost online brokerage such as TD-Ameritrade. And, it is a hedge stock by our definition (i.e., a stock that a hedge fund trader would be unlikely to bet against). Why? Because of characteristics that minimize its volatility enough to temper a hedge fund trader’s enthusiasm: a) it has outperformed the hedged S&P 500 Index (VBINX) since the market peak on 9/1/00 and over the most recent 5 yrs, as well as the past year; b) its losses during the Lehman Panic were limited (28.8%) while the S&P 500 Index fund lost 46.5% (see Column D in the Table); c) it has a 5-yr Beta of 0.29 (Column J) that is much less than the hedge fund industry average ranging from 0.6 to 0.7; d) it has a trailing P/E much less than the market’s (Column K); e) it has an AA S&P bond rating. Berkshire Hathaway falls down on only one criterion for discouraging a hedge fund trader. It doesn’t pay a dividend. Remember, traders bet against a stock by entering into a “short sale.” That involves borrowing and immediately selling a stock in the hope that it will fall in value, at which point it is bought back cheap and the shares returned to the original owner, pocketing the difference between what was earned on the sale and the cost for re-purchase. However, when the stock pays a dividend the trader (or the boss) has to reimburse the original owner in an amount equal to the value of each quarterly dividend over the holding period. That’s a nuisance, and a significant expense. Berkshire Hathaway doesn’t pay a dividend so its shares can be shorted without incurring that expense.
To summarize, it is very unlikely that the price of Berkshire Hathaway’s stock would ever be driven down more than 5% because of “short” sales. And, because it is so well managed, Berkshire doesn’t need to pay a dividend in order to gain the investors trust. That means all of its Free Cash Flow is being used to grow the company instead of some being diverted to pay dividends. There is also a tax advantage to waiving dividends: Shareholders are already being taxed at the 35% “corporate” rate, so why would they be happy being taxed again at the 15-20% “individual” rate on the same earnings in the form of dividends?
Bottom Line: The reader should feel comfortable buying BRK-B shares, knowing that her investment will have unusually low volatility while being representative of a broad swath of the market.
Risk Rating for BRK-B: 4
Full disclosure: I have stock in Berkshire Hathaway, and make monthly additions to dividend reinvestment plans for WMT, IBM, KO, XOM, and PG.
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Many investors like to have the latest information on what Warren Buffett is up to, so we have summarized the major current holdings of Berkshire’s investment portfolio for you in the Table. Red highlights denote higher risk or lower performance vs. the benchmark we like to use, VBINX, which is a low-cost hedged S&P 500 Index fund.
How are the two parts of Berkshire Hathaway performing? For 2013, Berkshire Hathaway as a whole was up 27.4% in value vs. 28.9% for the lowest-cost S&P 500 Index fund, VFINX (see Column G in the Table), whereas, the average stock in the Berkshire Hathaway’s investment portfolio was up 31.7%. These results are as expected, given the overall robust performance of the stock market and the relative risk of Berkshire’s wholly-owned subsidiaries vs. its investment portfolio.
As of Dec 31, 2013, the value for all of Berkshire Hathaway was $294 Billion, with the investment portfolio representing $105 Billion. In other words, 36% of the company’s value is in marketable common stocks. Berkshire Hathaway is in the financial services industry, so it is not surprising that stock in such companies represents 43% of its investment portfolio. Wells Fargo (WFC) alone accounts for 20% of that portfolio and American Express (AXP) 13%. Every quarter, the Securities and Exchange Commission (SEC) requires large companies to submit an update of their investment holdings. We’ve perused Berkshire’s recently issued “13-F filing” for the 4th quarter of 2013, and summarized the results for company holdings that are larger than $0.5 Billion (in Table). Two companies were excluded because their stock was issued only recently: General Motors (GM) holdings worth $1.6 Billion, and Liberty Media (LMCA) holdings worth $0.78 Billion. When this filing is compared with the previous quarter’s, we see that Berkshire Hathaway has exited from positions in Dish Network and GlaxoSmithKline plc but has added a position in Liberty Global plc valued at $0.26 Billion. Warrants that Berkshire had been holding in Goldman Sachs (GS) have been converted to shares worth $2.2 Billion.
Taking a closer look at the investment portfolio (Table), we see only 3 financial services companies (WFC, AXP, USB) among the largest 10 holdings (denoted in the Table with green stock tickers in Column B). Not surprisingly, given Warren Buffett’s prowess as a stock picker, all 7 non-financial companies have finance values (Column E) higher than our benchmark’s (VBINX). Costco Wholesale (COST) is the only one in that high value group that isn’t in the Top 10 holdings, so it stands to reason that COST is a candidate for further accumulation.
BRK-B shares are priced around $120/Share, making those easy to accumulate by using a low-cost online brokerage such as TD-Ameritrade. And, it is a hedge stock by our definition (i.e., a stock that a hedge fund trader would be unlikely to bet against). Why? Because of characteristics that minimize its volatility enough to temper a hedge fund trader’s enthusiasm: a) it has outperformed the hedged S&P 500 Index (VBINX) since the market peak on 9/1/00 and over the most recent 5 yrs, as well as the past year; b) its losses during the Lehman Panic were limited (28.8%) while the S&P 500 Index fund lost 46.5% (see Column D in the Table); c) it has a 5-yr Beta of 0.29 (Column J) that is much less than the hedge fund industry average ranging from 0.6 to 0.7; d) it has a trailing P/E much less than the market’s (Column K); e) it has an AA S&P bond rating. Berkshire Hathaway falls down on only one criterion for discouraging a hedge fund trader. It doesn’t pay a dividend. Remember, traders bet against a stock by entering into a “short sale.” That involves borrowing and immediately selling a stock in the hope that it will fall in value, at which point it is bought back cheap and the shares returned to the original owner, pocketing the difference between what was earned on the sale and the cost for re-purchase. However, when the stock pays a dividend the trader (or the boss) has to reimburse the original owner in an amount equal to the value of each quarterly dividend over the holding period. That’s a nuisance, and a significant expense. Berkshire Hathaway doesn’t pay a dividend so its shares can be shorted without incurring that expense.
To summarize, it is very unlikely that the price of Berkshire Hathaway’s stock would ever be driven down more than 5% because of “short” sales. And, because it is so well managed, Berkshire doesn’t need to pay a dividend in order to gain the investors trust. That means all of its Free Cash Flow is being used to grow the company instead of some being diverted to pay dividends. There is also a tax advantage to waiving dividends: Shareholders are already being taxed at the 35% “corporate” rate, so why would they be happy being taxed again at the 15-20% “individual” rate on the same earnings in the form of dividends?
Bottom Line: The reader should feel comfortable buying BRK-B shares, knowing that her investment will have unusually low volatility while being representative of a broad swath of the market.
Risk Rating for BRK-B: 4
Full disclosure: I have stock in Berkshire Hathaway, and make monthly additions to dividend reinvestment plans for WMT, IBM, KO, XOM, and PG.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 7
Week 5 - Master List of Companies Meeting the ITR Criteria
Goal: To pin down which companies in the S&P 500 Index conform to the ITR selection criteria and detail the benefits and risks of owning stock in each over the past decade.
click here to open the Master List Spreadsheet
Legend for the ITR Master List:
click here to open the Master List Spreadsheet
Legend for the ITR Master List:
Large S&P 500 Companies (n = 19): Stocks selected from the S&P 100 Index. Most of these are multinationals that derive 40-70% of sales from foreign countries.
Smaller S&P 500 Companies (n = 15): Stocks selected from the 400 smaller companies in the S&P 500 Index. Such companies typically have a focused business plan and a less hierarchical management style. These companies have fewer institutional impediments to innovation and can be more nimble in responding to market stresses caused by competition, obsolescence, and recession.
Ticker: Company symbol used for stock trading purposes. (Click on the ticker to view the "Investor Relations" page at the company's website.)
2000-10 TR: Annualized gross Total Return (reinvestment of dividends plus price appreciation) for a stock purchased at close of business (COB) 12/29/00 then sold at COB 12/31/10 (see discussion in Week 4 blog). Our benchmark, SPY, had an annualized gross total return of 1.3% for that 10 yr period. Returns are even lower when costs are subtracted - to calculate net total returns: trading commissions and fees amount to ~2% for each BUY or SELL order placed through a stock broker; inflation averaged 2.4%/yr over that 10 yr period (Inflation_Calculator); and tax rates on dividends and capital gains are set at 15%. To reiterate: fees, capital gains taxes, taxes on dividends, and inflation are not accounted for in calculating the gross Total Return (in Column 3).
Dividend: Current quarterly pay-out per share multiplied by 4 and divided by the recent stock price (expressed as %).
Ann Div Incr: consecutive annual dividend increases.
Stk Rating: "A" is S&P's highest stock rating, with relative benefit sometimes qualified with a "+" or "–" sign; L, M, and H denote a separate assessment of risk: low, medium, or high. Risk in this case represents the extent to which the stock’s value is likely to be impaired or improved during a bear or bull market, respectively.
Bnd Rating: Most companies are financed by both bonds and stocks. Bond ratings denote the risk of bankruptcy. AAA is S&P's highest bond rating, currently held by only 4 companies (ExxonMobil, Johnson & Johnson, Microsoft, and Automatic Data Processing). BBB- is the lowest “investment-grade” rating. BB+ and lower ratings are reserved for “junk status” bonds (also termed "high yield" bonds), which have odds of default greater than 1 in 20.
S&P Industries: S&P has 10 industry categories. Only the telecommunications industry is not represented on our Master List. It is obviously difficult to pigeonhole the major revenue source for a multinational company. Nonetheless, S&P analysts make an effort to do so because the fluctuation of stock prices and dividend payouts depend somewhat on the company's key industry, it is either moving into a new industry or has become an outlier in its historic industry.5 yr Beta: The variance of a stock’s price relative to the S&P 500 Index (Beta = 1.00) calculated each trading day over a 5 yr period and then averaged. For example, a Beta of 0.83 for 3M means that the price of 3M went up or down 83% as much as the S&P 500 Index over the 5 yrs before the current month. Barron’s Dictionary of Finance and Investment Terms (1998, Fifth Edition, Barron’s Educational Series, Inc.) ends its definition with this sentence: “A conservative investor whose main concern is preservation of capital should focus on stocks with low betas, whereas, one willing to take high risks in an effort to earn high rewards should look for high-beta.
Debt/Equity: Total debt divided by shareholder’s equity (total assets minus total liabilities). The Debt/Equity ratio for the S&P 500 Index is ~1.25. “Blue Chip” companies normally top out at 0.85 but may temporarily go higher to expand in support of strong revenues.
Bottom Line: 34 companies meet the ITR criteria for profitable long-term investment with acceptable risk. Of those 34, five (XOM, PG, MKC, NEE, UTX) stand out for providing steady returns (Mean Gross Total Return = 8.8%/yr) and good payouts (Mean Dividend = 2.8%) while maintaining a low S&P Risk Rating. Those 5 companies also issue bonds that carry an S&P rating of "A" (or better), and have very low price variance vs. S&P 500 Index (Average Beta of 0.53 vs. 1.00). For comparison, the annualized Total Return of the S&P 500 Index clunked along at 1.3% over the past decade, and it currently pays a dividend of 1.9%.
click here to continue to Week 6
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