Situation: You’re bombarded with advice about how to save for retirement. But unless you’re already rich, the details are simple. Dollar-cost average 60% of your contribution into a stock index fund and 40% into a short or intermediate-term bond index fund. If you know you’ll never be in “the upper middle class”, opt for the short-term bond index fund. But maybe you have a workplace retirement plan, which makes saving for retirement a little more complicated. Either way, you’ll want to contribute the maximum amount each year to your IRA, which is currently $5500/yr until you reach age 50; then it’s $6500/yr.
Here’s our KISS (Keep It Simple, Stupid) suggestion: Make your IRA payments with Vanguard Group by using a Simple IRA (Vanguard terminology) composed only of the Vanguard High Dividend Yield Index ETF or VYM. Then, contribute 2/3rds of that amount into Inflation-protected US Savings Bonds. These are called ISBs and work just like an IRA. No tax is due from ISBs until you spend the money but there’s a penalty for spending the money early (you’ll lose one interest payment if you cash out before 5 years). The annual contribution limit is $10,000/yr. A convenient proxy for ISBs, with similar total returns, is the Vanguard Short-Term Bond Index ETF or BSV.
Mission: Create a Table showing a 60% allocation to VYM and 40% allocation to BSV. Include appropriate benchmarks, to allow the reader to create her own variation on that theme.
Execution: see Table.
Bottom Line: However you juggle the numbers, it looks like you’ll make ~7%/yr overall through your IRA + ISB retirement plan, with no taxes due until you spend the money. In other words, each year’s contribution will double in value every 10 years. The beauty of this plan is that transaction costs are almost zero, and the chance that it will give you headaches is almost zero.
Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Inflation-protected Savings Bonds and the Dow Jones Industrial Average ETF (DIA).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
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Showing posts with label taxes. Show all posts
Showing posts with label taxes. Show all posts
Sunday, September 16
Sunday, July 29
Week 369 - High Quality Producers & Transporters of Industrial Commodities in the 2017 Barron’s 500
Situation: Here in the U.S., debt/capita is growing at an alarming rate and is now greater than $60,000. U.S. Government debt is almost $20 Trillion and has been growing at a rate of 5.5%/yr (i.e., twice as fast as inflation) since 1990. By 2020, the Federal budget deficit will start to exceed $1 Trillion/Yr and the dollar’s status as the world’s reserve currency will be threatened. The gold reserves that stand behind the U.S. dollar (currently worth ~$185 Billion) would have to be increased on a regular basis, as would foreign currency reserves (currently worth ~$125 Billion)
The US economy is no longer capable of growing fast enough to balance the budget for even a single year, without introducing draconian measures. Nonetheless, it is worth noting that those can be effective given that Greece appears to have emerged from that process successfully. But the U.S. could not go through that process and still remain the “top dog” militarily. So, the trade-weighted value of the U.S. dollar will fall at some point, and we will no longer be able to afford imported goods and services. Before that happens, U.S. citizens will need to gradually move their retirement savings into commodity-related investments, as well as bonds and stocks issued in reserve currencies other than the U.S. dollar.
Mission: Use our Standard Spreadsheet to highlight large U.S. and Canadian companies that produce, refine and transport raw commodities, i.e., materials that are extracted from the ground. Select such companies from the 2017 Barron’s 500 list, but exclude any that issue bonds with an S&P rating lower than A- or stocks with an S&P rating lower than B+/M.
Execution: see Table.
Administration: The S&P Commodity Index has the following components and weightings:
Natural Gas (17.66%)
Unleaded Gas (12.16%)
Heating Oil (12.13%)
Crude Oil (11.41%)
Wheat (5.15%)
Live Cattle (4.87%)
Corn (4.48%)
Coffee (3.88%)
Soybeans (3.84%)
Sugar (3.80%)
Silver (3.67%)
Copper (3.39%)
Cotton (3.22%)
Soybean Oil (2.98%)
Cocoa (2.79%)
Soybean Meal (2.57%)
Lean Hogs (2.04%)
53.36% of the index represents petroleum products, 32.71% represents row crops, 7.06% represents industrial metals, and 6.91% represents live animals. Ground has to be mined, drilled, or planted & harvested with the help of heavy equipment to yield raw commodities. Those have to be transported by barge, rail, truck, or pipeline before being processed for market.
We find 8 companies that warrant inclusion in this week’s Table. Seven are obviously appropriate, but the presence of Berkshire Hathaway (BRK-B) needs some explanation (unless you already know it owns the Burlington Northern & Santa Fe railroad). Berkshire Hathaway is the largest shareholder of Phillips 66 (PSX), which has 13 oil refineries and supplies diesel for the largest marketing outlet of that fuel: Pilot Flying J Centers LLC. Berkshire Hathaway purchased 38.6% of that company’s stock on October 3, 2017, and plans to increase its stake in 2023 to 80%.
Bottom Line: Commodity futures haven’t been a good investment, given that their aggregate value is back to where it was 25 years ago, given that the most recent 20-year supercycle recently finished and another is just starting. Nonetheless, the companies that produce, process, and transport those commodities did well over those 25 years (see Column AB in Table). The problem is the volatility of their stocks (see Column M in the Table), and the extent to which their stocks get whacked when commodities become oversupplied relative to demand (see Column D in the Table). If you choose to own shares in these companies (aside from CNI, BRK-B and perhaps UNP), you’d be flat-out gambling.
Risk Rating: 7-9 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, ADM, CAT and XOM, and also own shares of CNI and BRK-B.
"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
The US economy is no longer capable of growing fast enough to balance the budget for even a single year, without introducing draconian measures. Nonetheless, it is worth noting that those can be effective given that Greece appears to have emerged from that process successfully. But the U.S. could not go through that process and still remain the “top dog” militarily. So, the trade-weighted value of the U.S. dollar will fall at some point, and we will no longer be able to afford imported goods and services. Before that happens, U.S. citizens will need to gradually move their retirement savings into commodity-related investments, as well as bonds and stocks issued in reserve currencies other than the U.S. dollar.
Mission: Use our Standard Spreadsheet to highlight large U.S. and Canadian companies that produce, refine and transport raw commodities, i.e., materials that are extracted from the ground. Select such companies from the 2017 Barron’s 500 list, but exclude any that issue bonds with an S&P rating lower than A- or stocks with an S&P rating lower than B+/M.
Execution: see Table.
Administration: The S&P Commodity Index has the following components and weightings:
Natural Gas (17.66%)
Unleaded Gas (12.16%)
Heating Oil (12.13%)
Crude Oil (11.41%)
Wheat (5.15%)
Live Cattle (4.87%)
Corn (4.48%)
Coffee (3.88%)
Soybeans (3.84%)
Sugar (3.80%)
Silver (3.67%)
Copper (3.39%)
Cotton (3.22%)
Soybean Oil (2.98%)
Cocoa (2.79%)
Soybean Meal (2.57%)
Lean Hogs (2.04%)
53.36% of the index represents petroleum products, 32.71% represents row crops, 7.06% represents industrial metals, and 6.91% represents live animals. Ground has to be mined, drilled, or planted & harvested with the help of heavy equipment to yield raw commodities. Those have to be transported by barge, rail, truck, or pipeline before being processed for market.
We find 8 companies that warrant inclusion in this week’s Table. Seven are obviously appropriate, but the presence of Berkshire Hathaway (BRK-B) needs some explanation (unless you already know it owns the Burlington Northern & Santa Fe railroad). Berkshire Hathaway is the largest shareholder of Phillips 66 (PSX), which has 13 oil refineries and supplies diesel for the largest marketing outlet of that fuel: Pilot Flying J Centers LLC. Berkshire Hathaway purchased 38.6% of that company’s stock on October 3, 2017, and plans to increase its stake in 2023 to 80%.
Bottom Line: Commodity futures haven’t been a good investment, given that their aggregate value is back to where it was 25 years ago, given that the most recent 20-year supercycle recently finished and another is just starting. Nonetheless, the companies that produce, process, and transport those commodities did well over those 25 years (see Column AB in Table). The problem is the volatility of their stocks (see Column M in the Table), and the extent to which their stocks get whacked when commodities become oversupplied relative to demand (see Column D in the Table). If you choose to own shares in these companies (aside from CNI, BRK-B and perhaps UNP), you’d be flat-out gambling.
Risk Rating: 7-9 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, ADM, CAT and XOM, and also own shares of CNI and BRK-B.
"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, July 22
Week 368 - Are You A Baby Boomer (54 to 72 years old) With Only $25,000 In Retirement Savings?
Situation: Here in the United States, a third of you have less than $25,000 in Retirement Savings.
Mission: Assess options for a healthy married couple with a household income of $59,000/yr, whose breadwinner will retire when he or she reaches age 66 and the household starts receiving an initial Social Security check of $2,123/mo . Assume that they have $25,000 in retirement savings in an IRA, with an initial payout of $75/mo.
Execution: see Table.
Administration: The options for the couple to receive an income from their $25,000 IRA are unattractive. They’ll need a relatively safe way to come up with an income of 3-4%/yr from that $25,000, a way that grows the principal at least as fast as inflation (historically 3.1%/yr). That growth rate can be predicted from the 5-yr growth rate for the quarterly dividend. To have enough confidence in that stream of income, their only option is to find half a dozen high-quality stocks with low price variance (5-yr Beta less than 0.7) and secure dividends.
They should be able to live reasonably well on $2,198/mo, given that the poverty line for a household of two is $1,372/mo. But let’s break it down: They’ll pay at least $900/mo for housing (rent, tenant’s insurance, and utilities), so they’re left with $1,300/mo to cover the consumer price index categories of food and beverages, apparel, transportation, medical care, recreation, education and communication, and other goods and services. “Other goods and services” include restaurant meals, delivery services, and cigarettes. Food will cost at least $250/mo. Now they’re down to ~$1,050/mo to cover clothing, car expenses, Medicare premium plus deductibles and co-payments, smartphones, meals out, vacations, delivery services, and cigarettes. Owning, maintaining, and operating a used car for 5,000 miles/yr will cost ~$625/mo, which leaves $425/mo for clothing, healthcare, smartphones, meals out, vacations, delivery services, and cigarettes. To avoid selling the car, one of them will need to find a part-time job. New clothes, dining out, and travel will be hard to fund. Out-of-pocket healthcare costs will go up, so they’ll need to save money by avoiding alcohol, tobacco, caffeine, and sweets.
Bottom Line: When a couple is facing a retirement that will be funded only by the average Social Security payout at full retirement age ($25,476/yr), they won’t be living much above the Federal Poverty Level for a household of two ($16,460/yr). It they own a home, they’ll no longer be able to afford to maintain it and pay property taxes. So, they’ll need to sell it and invest the residual equity. Maintaining their car will barely be affordable. Having $25,000 in an IRA will help, but a third of couples in their situation will retire with an even smaller cushion. In our Table for this week, we show how $75/mo is the expected income from an IRA of $25,000 value that has an average dividend yield of 3.6%/yr.
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) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Assess options for a healthy married couple with a household income of $59,000/yr, whose breadwinner will retire when he or she reaches age 66 and the household starts receiving an initial Social Security check of $2,123/mo . Assume that they have $25,000 in retirement savings in an IRA, with an initial payout of $75/mo.
Execution: see Table.
Administration: The options for the couple to receive an income from their $25,000 IRA are unattractive. They’ll need a relatively safe way to come up with an income of 3-4%/yr from that $25,000, a way that grows the principal at least as fast as inflation (historically 3.1%/yr). That growth rate can be predicted from the 5-yr growth rate for the quarterly dividend. To have enough confidence in that stream of income, their only option is to find half a dozen high-quality stocks with low price variance (5-yr Beta less than 0.7) and secure dividends.
They should be able to live reasonably well on $2,198/mo, given that the poverty line for a household of two is $1,372/mo. But let’s break it down: They’ll pay at least $900/mo for housing (rent, tenant’s insurance, and utilities), so they’re left with $1,300/mo to cover the consumer price index categories of food and beverages, apparel, transportation, medical care, recreation, education and communication, and other goods and services. “Other goods and services” include restaurant meals, delivery services, and cigarettes. Food will cost at least $250/mo. Now they’re down to ~$1,050/mo to cover clothing, car expenses, Medicare premium plus deductibles and co-payments, smartphones, meals out, vacations, delivery services, and cigarettes. Owning, maintaining, and operating a used car for 5,000 miles/yr will cost ~$625/mo, which leaves $425/mo for clothing, healthcare, smartphones, meals out, vacations, delivery services, and cigarettes. To avoid selling the car, one of them will need to find a part-time job. New clothes, dining out, and travel will be hard to fund. Out-of-pocket healthcare costs will go up, so they’ll need to save money by avoiding alcohol, tobacco, caffeine, and sweets.
Bottom Line: When a couple is facing a retirement that will be funded only by the average Social Security payout at full retirement age ($25,476/yr), they won’t be living much above the Federal Poverty Level for a household of two ($16,460/yr). It they own a home, they’ll no longer be able to afford to maintain it and pay property taxes. So, they’ll need to sell it and invest the residual equity. Maintaining their car will barely be affordable. Having $25,000 in an IRA will help, but a third of couples in their situation will retire with an even smaller cushion. In our Table for this week, we show how $75/mo is the expected income from an IRA of $25,000 value that has an average dividend yield of 3.6%/yr.
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) 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, March 11
Week 349 - Dividend Achievers with high Long-term Debt offset by a Strong Global Brand
Situation: Some highly indebted companies manage to pass through economic cycles with little difficulty, even though though they sometimes find it expensive to roll-over (refinance) their Long-Term Debt. This is a conundrum, given the impairment of their Balance Sheets (debt maturing in more than one year represents more than one third of their total assets). Think of having $200,000 left on your mortgage but your household assets (including equity in your home) are only worth $600,000.
I try to avoid investing in such companies. When I do, I look for an excuse to sell. But there has to be a rational explanation for why these companies prosper, given the cost of servicing long-term debt. Two explanations come to mind:
1) These companies have a lower cost of capital, since so much of their capitalization is in the form of debt, where interest payments have not been taxed until recently. (The new tax law levies a 21% tax on interest payments that consume more than 30% of earnings.)
2) These companies have a strong Global Brand, which is an Intangible Asset that increases their acquisition value. That is, a strong Global Brand would increase the purchase price at least 5% above Tangible Book Value.
3) These companies sell products that are remarkably “inelastic”, meaning that sales volumes are insensitive to price: “The price elasticity of supply measures how the amount of a good that a supplier wishes to supply changes in response to a change in price.[2] In a manner analogous to the price elasticity of demand, it captures the extent of horizontal movement along the supply curve relative to the extent of vertical movement [in price]. If the price elasticity of supply is zero the supply of a good supplied is ‘totally inelastic’ and the quantity supplied is fixed.”
Mission: Analyze high-yielding Dividend Achievers (companies that have increased their dividend annually for at least the past 10 years). Select companies that have long-term Debt amounting to more than 33% of Total Assets, as shown in Column P of the Table. Reject companies that do not have a strong Global Brand. Also reject companies that do not have A ratings from S&P for both the bonds and common stocks that they have issued (see Columns T and U in the Table). Brand rankings are shown in Columns AB-AC of the Table. Examine a comparison group of companies in the Benchmark Section of the Table.
Execution: see Table.
Bottom Line: The outperformance and low price volatility of these stocks, even during difficult market conditions (see Column D in the Table), cannot be explained by unique Tangible Assets such as strong Patent Protections or Tax Advantages. That leaves Brand Values (i.e., consumers prefer a brand they can trust) and Inelasticity (i.e., unit sales are not price sensitive) to account for the resiliency of their stock prices. That resiliency ultimately comes from pricing power.
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 Coca-Cola (KO), and also own shares of IBM and McDonald’s (MCD).
"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
I try to avoid investing in such companies. When I do, I look for an excuse to sell. But there has to be a rational explanation for why these companies prosper, given the cost of servicing long-term debt. Two explanations come to mind:
1) These companies have a lower cost of capital, since so much of their capitalization is in the form of debt, where interest payments have not been taxed until recently. (The new tax law levies a 21% tax on interest payments that consume more than 30% of earnings.)
2) These companies have a strong Global Brand, which is an Intangible Asset that increases their acquisition value. That is, a strong Global Brand would increase the purchase price at least 5% above Tangible Book Value.
3) These companies sell products that are remarkably “inelastic”, meaning that sales volumes are insensitive to price: “The price elasticity of supply measures how the amount of a good that a supplier wishes to supply changes in response to a change in price.[2] In a manner analogous to the price elasticity of demand, it captures the extent of horizontal movement along the supply curve relative to the extent of vertical movement [in price]. If the price elasticity of supply is zero the supply of a good supplied is ‘totally inelastic’ and the quantity supplied is fixed.”
Mission: Analyze high-yielding Dividend Achievers (companies that have increased their dividend annually for at least the past 10 years). Select companies that have long-term Debt amounting to more than 33% of Total Assets, as shown in Column P of the Table. Reject companies that do not have a strong Global Brand. Also reject companies that do not have A ratings from S&P for both the bonds and common stocks that they have issued (see Columns T and U in the Table). Brand rankings are shown in Columns AB-AC of the Table. Examine a comparison group of companies in the Benchmark Section of the Table.
Execution: see Table.
Bottom Line: The outperformance and low price volatility of these stocks, even during difficult market conditions (see Column D in the Table), cannot be explained by unique Tangible Assets such as strong Patent Protections or Tax Advantages. That leaves Brand Values (i.e., consumers prefer a brand they can trust) and Inelasticity (i.e., unit sales are not price sensitive) to account for the resiliency of their stock prices. That resiliency ultimately comes from pricing power.
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 Coca-Cola (KO), and also own shares of IBM and McDonald’s (MCD).
"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, October 8
Week 327 - The 2 and 8 Club: A Strategy To Beat The S&P 500
Situation: You enjoy learning about economics through investing in specific companies but then you learn that you are “leaving money on the table.” How does that happen? Because Warren Buffett has explained to us that the Vanguard S&P 500 Admiral Fund (VFIAX) will beat professional stock-pickers 90% of the time. Why? Because a) it has an expense ratio of only 0.04%, b) it reaches all sectors of the economy, and c) capital gains taxes are negligible because there’s no point selling VFIAX shares before you retire. Instead, you can continue to dollar-average into your VFIAX account until you retire, regardless of market fluctuations.
But we can suggest a strategy for picking stocks without losing much money vs. VFIAX. Firstly, you’d need a watch list positioned in all 11 S&P sectors. Secondly, you’d need a fee-based trading account at your brokerage, one costing ~1%/yr of net asset value that allows you to buy and sell shares as needed without paying transaction costs. Alternatively, you can employ a Dividend Re-Investment Plan when transaction costs are lower. For example, computershare’s DRIP for NextEra Energy (NEE) carries no transaction costs. Thirdly, you’d need to have plan for picking stocks from your watch list, and the discipline to stick with that plan.
Our blog for this week has a workable plan that we call “The 2 and 8 Club.” [Note: "The 2 and 8 Club" is copyrighted and reserved for use by Invest Tune Retire.com.] It sticks to a watch list of the largest and most frequently traded companies, i.e., those in the S&P 100 Index. It picks companies that pay more than a market yield (~2%) by using the S&P 100 companies listed in the FTSE High Dividend Yield Index, which most investors in the US know as VYM, the Vanguard High Dividend Yield ETF. Not all high-yielding companies in the S&P 100 Index are found there because companies have to meet international standards of dividend predictability.
Now you know the “2” part of The 2 and 8 Club, i.e., 2% market yield. The “8” part is a requirement that selected companies pay a dividend that has had a Compound Annual Growth Rate (CAGR) over the past 5 yrs of at least 8.0%/yr. Companies whose bonds are rated lower than A- by S&P are excluded, as are those whose stock is rated lower than B+/M.
Mission: List the current members of The 2 and 8 Club.
Execution: see Table.
Administration: To use this Plan, you simply keep track of the current members of The 2 and 8 Club, then dollar-average into half of those. Some will reach a point where they no longer qualify for membership. Chances are you will decide to stop investing in those companies but we suggest you consider replacing them with newly qualified companies. Each position is predicted to have at least a 10%/yr return (2+8=10), which is 3%/yr more than the long-term return for the S&P 500 Index. That 3% safety factor will likely be nibbled away by transaction costs of at least 1%/yr and capital gains taxes of at least 2%/yr.
Bottom Line: There are fewer than a dozen finance professionals in history with a record of beating the S&P 500 Index every year for more than 2 market cycles. So, a stock-picker like you or me is essentially a gambler. For example, 11 of the 16 companies in the Table that qualify for inclusion in The 2 and 8 Club have shown more extreme fluctuations in market price over the past 16 years than has the S&P 500 Index (see red highlights in Column M of the Table). As finance professors like to say, there are only two ways to beat the S&P 500 Index: 1) use insider information (which is illegal), or 2) have a portfolio that carries more risk of loss than the S&P 500 Index.
But you’re more than a gambler. You’re participating in an experiential school that teaches you (through trial and error) how the economy operates, and you’re learning more about the behavior of groups (sociology) and the governance of countries (politics).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into MSFT, IBM, MMM, CAT, JPM, AMGN, UNP and NEE.
NOTE: Candidates for The 2 and 8 Club are listed at the bottom of the Table. These are S&P 100 companies that have recently been paying an above-market (SPY) dividend yield and have grown that dividend faster than 8%/yr over the past 5 years, but are not yet included in the US version of the FTSE High Dividend Yield Index.
"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
But we can suggest a strategy for picking stocks without losing much money vs. VFIAX. Firstly, you’d need a watch list positioned in all 11 S&P sectors. Secondly, you’d need a fee-based trading account at your brokerage, one costing ~1%/yr of net asset value that allows you to buy and sell shares as needed without paying transaction costs. Alternatively, you can employ a Dividend Re-Investment Plan when transaction costs are lower. For example, computershare’s DRIP for NextEra Energy (NEE) carries no transaction costs. Thirdly, you’d need to have plan for picking stocks from your watch list, and the discipline to stick with that plan.
Our blog for this week has a workable plan that we call “The 2 and 8 Club.” [Note: "The 2 and 8 Club" is copyrighted and reserved for use by Invest Tune Retire.com.] It sticks to a watch list of the largest and most frequently traded companies, i.e., those in the S&P 100 Index. It picks companies that pay more than a market yield (~2%) by using the S&P 100 companies listed in the FTSE High Dividend Yield Index, which most investors in the US know as VYM, the Vanguard High Dividend Yield ETF. Not all high-yielding companies in the S&P 100 Index are found there because companies have to meet international standards of dividend predictability.
Now you know the “2” part of The 2 and 8 Club, i.e., 2% market yield. The “8” part is a requirement that selected companies pay a dividend that has had a Compound Annual Growth Rate (CAGR) over the past 5 yrs of at least 8.0%/yr. Companies whose bonds are rated lower than A- by S&P are excluded, as are those whose stock is rated lower than B+/M.
Mission: List the current members of The 2 and 8 Club.
Execution: see Table.
Administration: To use this Plan, you simply keep track of the current members of The 2 and 8 Club, then dollar-average into half of those. Some will reach a point where they no longer qualify for membership. Chances are you will decide to stop investing in those companies but we suggest you consider replacing them with newly qualified companies. Each position is predicted to have at least a 10%/yr return (2+8=10), which is 3%/yr more than the long-term return for the S&P 500 Index. That 3% safety factor will likely be nibbled away by transaction costs of at least 1%/yr and capital gains taxes of at least 2%/yr.
Bottom Line: There are fewer than a dozen finance professionals in history with a record of beating the S&P 500 Index every year for more than 2 market cycles. So, a stock-picker like you or me is essentially a gambler. For example, 11 of the 16 companies in the Table that qualify for inclusion in The 2 and 8 Club have shown more extreme fluctuations in market price over the past 16 years than has the S&P 500 Index (see red highlights in Column M of the Table). As finance professors like to say, there are only two ways to beat the S&P 500 Index: 1) use insider information (which is illegal), or 2) have a portfolio that carries more risk of loss than the S&P 500 Index.
But you’re more than a gambler. You’re participating in an experiential school that teaches you (through trial and error) how the economy operates, and you’re learning more about the behavior of groups (sociology) and the governance of countries (politics).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into MSFT, IBM, MMM, CAT, JPM, AMGN, UNP and NEE.
NOTE: Candidates for The 2 and 8 Club are listed at the bottom of the Table. These are S&P 100 companies that have recently been paying an above-market (SPY) dividend yield and have grown that dividend faster than 8%/yr over the past 5 years, but are not yet included in the US version of the FTSE High Dividend Yield Index.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 20
Week 320 - Key Players In The Food Chain That Have Tangible Book Value
Situation: As a stock-picker, you need to invest some of your assets in mature industries. Those are the industries where sales growth is a function of population growth. Companies in those industries typically retain value during recessions. Food & beverage companies are the prime example.
Mission: Set up a spreadsheet of key players in the food chain. Exclude any that do not have positive net Tangible Book Value. Why? Because the SEC requires that before a company can issue stock for sale on a public exchange. Include S&P stock and bond ratings, as well as key Balance Sheet debt ratios. Determine whether Free Cash Flow (FCF) covered company dividend payments for the last two quarters. Determine whether the company is an efficient deployer of capital by comparing Weighted Average Cost of Capital (WACC) to Return on Invested Capital (ROIC). The latter number should be at least twice the former.
Execution: see Table.
Administration: You’re a stock-picker because you think you have a strategy for beating a broad market index fund (e.g. SPY). You’re unlikely to succeed unless you avoid paying Capital Gains taxes until after you drop into a lower tax bracket (i.e., retire). Try to stick with companies that issue A-rated bonds and stocks, and practice other risk-reducing measures (e.g. deploy capital efficiently, have a clean Balance Sheet, and build a strong brand).
You’re also unlikely to succeed if you invest in a volatile stock, i.e., one where the price varies more widely than the price of the S&P 500 Index. We identify that 3 ways:
1) Stock price change vs. change in the S&P 500 Index is greater in response to withdrawal of a key market support, e.g. the cost of taking out a loan or buying a house goes up 20%, or spot prices for key commodities go down 20% (see Column D in any of our Tables);
2) 5-Yr Beta exceeds 1 (see Column I in any of our Tables);
3) 16-Yr stock price volatility is statistically greater than S&P 500 Index volatility per the BMW Method, which we highlight in red (see Column M of any of our Tables).
Bottom Line: We have uncovered only 2 “buy-and-hold” stocks: Costco Wholesale (COST) and Coca-Cola (KO). Consider investing in a sector fund, e.g. SPDR Consumer Staples Select Sector ETF (XLP).
Risk Rating: 7 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-average into KO and MON, and also own shares of HRL, COST, AGU, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Set up a spreadsheet of key players in the food chain. Exclude any that do not have positive net Tangible Book Value. Why? Because the SEC requires that before a company can issue stock for sale on a public exchange. Include S&P stock and bond ratings, as well as key Balance Sheet debt ratios. Determine whether Free Cash Flow (FCF) covered company dividend payments for the last two quarters. Determine whether the company is an efficient deployer of capital by comparing Weighted Average Cost of Capital (WACC) to Return on Invested Capital (ROIC). The latter number should be at least twice the former.
Execution: see Table.
Administration: You’re a stock-picker because you think you have a strategy for beating a broad market index fund (e.g. SPY). You’re unlikely to succeed unless you avoid paying Capital Gains taxes until after you drop into a lower tax bracket (i.e., retire). Try to stick with companies that issue A-rated bonds and stocks, and practice other risk-reducing measures (e.g. deploy capital efficiently, have a clean Balance Sheet, and build a strong brand).
You’re also unlikely to succeed if you invest in a volatile stock, i.e., one where the price varies more widely than the price of the S&P 500 Index. We identify that 3 ways:
1) Stock price change vs. change in the S&P 500 Index is greater in response to withdrawal of a key market support, e.g. the cost of taking out a loan or buying a house goes up 20%, or spot prices for key commodities go down 20% (see Column D in any of our Tables);
2) 5-Yr Beta exceeds 1 (see Column I in any of our Tables);
3) 16-Yr stock price volatility is statistically greater than S&P 500 Index volatility per the BMW Method, which we highlight in red (see Column M of any of our Tables).
Bottom Line: We have uncovered only 2 “buy-and-hold” stocks: Costco Wholesale (COST) and Coca-Cola (KO). Consider investing in a sector fund, e.g. SPDR Consumer Staples Select Sector ETF (XLP).
Risk Rating: 7 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-average into KO and MON, and also own shares of HRL, COST, AGU, and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 23
Week 316 - 2017 Barron’s 500 List: A-rated “Defensive” Companies That Moved Up In Rank During The Commodity Recession
Situation: A stock-picker can’t beat the market, given that transaction costs and tax inefficiencies reduce returns by 1-3%/yr compared to the lowest-cost S&P 500 Index fund (VFINX), which returns 7-8%/yr. To effectively compete with that, stock picks would need to return 9%/yr. That’s one of the reasons why we use a discount rate of 9% when calculating Net Present Value.
In business school, I was taught that there are only two ways to beat the market: Plan A is to trade on “insider information” (patently illegal); Plan B is to take outsize risks (i.e., run a portfolio where the capitalization-weighted 5-Yr Beta is greater than 1.0). Those of us who are employed full time in Financial Services may become good stock-pickers because we know a particular industry very well, the result being that we overweight our picks in that industry. In other words, we’re engaged in a legal form of insider trading. For example, doctors and dentists are often savvy traders of health-care stocks.
The stock-picker who had the longest run beating the S&P 500 Index was Peter Lynch, who managed Fidelity’s Magellan Fund from 1977 through 1990. He relied on diversification, running ~1000 stocks with the help of a dozen analysts, but focussed on retail stocks. He claimed that the insights his wife shared with him after a day of shopping were pivotal to his success. You get the point: Invest in what you know.
But what about Plan B (risk taking)? Like Plan A, that approach requires you to run a portfolio concentrated in particular industries. But unlike Plan A, those stocks have to be in boring “Defensive” industries, i.e., the ones where sales grow only as fast as the population grows (Consumer Staples, Healthcare, Communication Services, and Utilities). By overweighting defensive industries, you insulate your portfolio. When the market crashes, those industries tend to keep on growing their earnings. Than means you’re following Warren Buffett’s Rule #1: Never Lose Money.
Mission: Analyze the recent Commodity Recession (see Column D at Line 26 in the Table), which was almost severe enough to keep both GDP and the S&P 500 Index from growing.
Execution: see Table.
Administration: Commodities are a key driver of the economy, so the Commodity Recession gave us a rare opportunity to see which companies out-perform without that key driver. You’ll need some background information. Of the 22 commodity futures contracts that compose the Bloomberg Commodity Index, the 5 classified as “Energy” are strongest, with a combined weight of 30.57% (Natural Gas, Brent Crude Oil, West Texas Intermediate Crude Oil, Ultra-Low Sulfur Diesel, and Unleaded Gasoline). When those are down ~20%, the S&P 500 Index will barely rise even though GDP might keep going up. Whether we like it or not, the prices of petroleum products will be the best predictors of the stock market for the next 10+ yrs. To be successful, a stock-picker has to anticipate the ups and downs in prices for energy commodities, and be positioned to reap good returns from stocks of A-rated S&P 500 companies that maintain or improve their valuation metrics during a commodity recession.
Key metrics relate to cash-flow based ROIC, specifically the most recent year vs. the 3-Yr median, as well as sales growth for the most recent year. The Barron’s 500 List (published each May) ranks the largest 500 companies on the New York and Toronto stock exchanges in terms of those 3 metrics. We’re interested in knowing the names of ALL the A-ranked S&P 500 companies that moved up in rank. Most of those will be in “Defensive” industries. The few that are in “Growth” industries either have a business plan that allows them to be “hardy perennials,” or enjoy a special situation that allows them to take advantage of a Commodity Recession. This week we cover “Defensive” industries. Next week we’ll cover the few “Growth” industry out-performers.
Bottom Line: The costs associated with owning the Vanguard 500 Index Fund (VFINX) are nil, whereas, the costs of owning (and trading) stock in a few dozen companies are substantial. And, the capital gains taxes that you’ll pay each year for trading those stocks are erratic and immediate vs. what you’ll pay upon eventually selling your VFINX shares. Your stock portfolio has to outperform the S&P 500 Index by 2-3%/yr to equal the returns you’d realize from owning VFINX shares. Invest smart, by knowing that the market goes down eventually and doing something about it ahead of time. Either stick to industries you know, or hedge by overweighting the stocks of companies in “Defensive Industries.” The 14 shown in the Table are a good place to start your research. Pay close attention to Columns P-S because even these companies can swoon in a market crash if they have messy Balance Sheets (messiness is highlighted in purple).
Risk Rating: 6 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold)
Full Disclosure: I dollar-average into JNJ and KO, and also own shares of HRL and WMT.
In business school, I was taught that there are only two ways to beat the market: Plan A is to trade on “insider information” (patently illegal); Plan B is to take outsize risks (i.e., run a portfolio where the capitalization-weighted 5-Yr Beta is greater than 1.0). Those of us who are employed full time in Financial Services may become good stock-pickers because we know a particular industry very well, the result being that we overweight our picks in that industry. In other words, we’re engaged in a legal form of insider trading. For example, doctors and dentists are often savvy traders of health-care stocks.
The stock-picker who had the longest run beating the S&P 500 Index was Peter Lynch, who managed Fidelity’s Magellan Fund from 1977 through 1990. He relied on diversification, running ~1000 stocks with the help of a dozen analysts, but focussed on retail stocks. He claimed that the insights his wife shared with him after a day of shopping were pivotal to his success. You get the point: Invest in what you know.
But what about Plan B (risk taking)? Like Plan A, that approach requires you to run a portfolio concentrated in particular industries. But unlike Plan A, those stocks have to be in boring “Defensive” industries, i.e., the ones where sales grow only as fast as the population grows (Consumer Staples, Healthcare, Communication Services, and Utilities). By overweighting defensive industries, you insulate your portfolio. When the market crashes, those industries tend to keep on growing their earnings. Than means you’re following Warren Buffett’s Rule #1: Never Lose Money.
Mission: Analyze the recent Commodity Recession (see Column D at Line 26 in the Table), which was almost severe enough to keep both GDP and the S&P 500 Index from growing.
Execution: see Table.
Administration: Commodities are a key driver of the economy, so the Commodity Recession gave us a rare opportunity to see which companies out-perform without that key driver. You’ll need some background information. Of the 22 commodity futures contracts that compose the Bloomberg Commodity Index, the 5 classified as “Energy” are strongest, with a combined weight of 30.57% (Natural Gas, Brent Crude Oil, West Texas Intermediate Crude Oil, Ultra-Low Sulfur Diesel, and Unleaded Gasoline). When those are down ~20%, the S&P 500 Index will barely rise even though GDP might keep going up. Whether we like it or not, the prices of petroleum products will be the best predictors of the stock market for the next 10+ yrs. To be successful, a stock-picker has to anticipate the ups and downs in prices for energy commodities, and be positioned to reap good returns from stocks of A-rated S&P 500 companies that maintain or improve their valuation metrics during a commodity recession.
Key metrics relate to cash-flow based ROIC, specifically the most recent year vs. the 3-Yr median, as well as sales growth for the most recent year. The Barron’s 500 List (published each May) ranks the largest 500 companies on the New York and Toronto stock exchanges in terms of those 3 metrics. We’re interested in knowing the names of ALL the A-ranked S&P 500 companies that moved up in rank. Most of those will be in “Defensive” industries. The few that are in “Growth” industries either have a business plan that allows them to be “hardy perennials,” or enjoy a special situation that allows them to take advantage of a Commodity Recession. This week we cover “Defensive” industries. Next week we’ll cover the few “Growth” industry out-performers.
Bottom Line: The costs associated with owning the Vanguard 500 Index Fund (VFINX) are nil, whereas, the costs of owning (and trading) stock in a few dozen companies are substantial. And, the capital gains taxes that you’ll pay each year for trading those stocks are erratic and immediate vs. what you’ll pay upon eventually selling your VFINX shares. Your stock portfolio has to outperform the S&P 500 Index by 2-3%/yr to equal the returns you’d realize from owning VFINX shares. Invest smart, by knowing that the market goes down eventually and doing something about it ahead of time. Either stick to industries you know, or hedge by overweighting the stocks of companies in “Defensive Industries.” The 14 shown in the Table are a good place to start your research. Pay close attention to Columns P-S because even these companies can swoon in a market crash if they have messy Balance Sheets (messiness is highlighted in purple).
Risk Rating: 6 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold)
Full Disclosure: I dollar-average into JNJ and KO, and also own shares of HRL and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 2
Week 300 - $185/week For A Low-cost Online Retirement Fund
Situation: Let’s say you make $64,000/yr but don’t have a workplace Retirement Plan. You still need to put 15% of your income (or $9,600/yr or $185/week) into a Retirement Plan. You can’t expect Social Security checks to replace more than 40% of your salary.The lowest cost self-directed plan would be composed of an IRA for stocks and Inflation-protected US Savings Bonds (ISBs) for bonds. We define costs as a) transaction costs, b) taxes, and c) inflation. The annual IRA contribution limit is $5,500/yr ($6,500/yr if you’re over 50). That doesn’t cover the $9,600/yr you need to shield from taxes, which is where ISBs come in handy. Those have a $10,000/yr contribution limit, work like an IRA to defer taxes, and carry the added benefit of shielding you from inflation.
Mission: Set up our standard spreadsheet (see Table) for $6000/yr of online stock purchases which go into an IRA, and $3600/yr of online bond purchases, which go into ISBs.
Execution: see Table, where the Vanguard Interm-Term Bond Index Fund (VBIIX) is a proxy for ISBs to facilitate comparison with stocks, which are neither inflation-protected nor tax-advantaged.
Administration:
Plan A: You can put $100/mo into each of 5 stocks purchased online through computershare, then have your accountant declare that account at computershare to be your IRA. This assumes you’re over 50 years old when you start this plan.
Plan B: You can put $500/mo into a Total Stock Market Index Fund (VTSMX) IRA marketed by the Vanguard Group. VTSMX carries an expense ratio of only 0.16%/yr vs. 0.58%/yr for stocks purchased through computershare (see Column P in the Table). NOTE: Plan B is the smarter option. Why? a) The expense ratio is lower. b) An index fund eliminates the considerable risk of selection bias.
With either Plan, $300/mo is put into ISBs with automatic online withdrawals from your checking account. Less money is put into bonds than into stocks because Social Security payments are made from a US Treasury Bond Fund. The interest payments on ISBs are based off the interest payments for 10-yr Treasury Notes corrected for the value of the tax deferral benefit and inflation correction benefit. Also, remember that ISBs have zero transaction costs and zero inflation risk; interest accrues biannually and cannot be taxed until the bond is redeemed. To better understand why you should confine your bond investments to 10-yr US Treasury Notes, read the fine print:
Caveat emptor: “The hard part of setting up a Retirement Plan is understanding the role of bonds. Those go up in value when stocks go down, so bonds need to form half of the assets meant to sustain you in retirement. Why do bonds go up in value when stocks go down? Because bankruptcy drops bond prices to the liquidation value of collateral, say 70 cents on the dollar, whereas bankruptcy drops stock prices to zero. The easy part to understand is that the risk that a bond will end up in bankruptcy court is specified by the interest rate: no investor will buy a bond that doesn’t pay enough interest to compensate for the risk being assumed. The zero-risk set point for interest rates everywhere is the 10-yr US Treasury Note. A commercial bond has to pay sufficiently more interest to draw in a buyer. On a risk-adjusted basis, all publicly-traded bonds pay the same rate of interest. Given that Treasuries are obtained online at zero cost, there is no reason to own any other type of fixed-income investment (unless you’re a bond trader).”
Bottom Line: Investment-grade bond and total stock market indexes have approximately the same inflation-adjusted total returns over multi-decade periods of ~3%/yr (e.g. see Lines 21 and 22 in the Table). Those returns remain roughly equivalent, otherwise investors would accumulate less money in one in order to favor the other.
Instead of using stock & bond indexes, you can have professionals pick stocks and bonds for you. This is tempting, since most stock and bonds make unattractive investments (because most companies have Balance Sheet problems or a weak Brand). That’s why an actively managed & balanced mutual fund like Vanguard Wellesley Income Fund (VWINX) outperforms a 50:50 mix of stock and bond index funds (compare Line 13 to Line 23 in the Table).
Or you can pick conservative bonds and stocks for yourself and keep transaction costs low by investing online (compare Line 10 to Lines 13 and 23 in the Table). NOTE: transaction costs in Column AB, which come to 0.58%/yr ($56/$9600).
Risk Rating: 4 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, KO, IBM, JNJ, NEE, and ISBs.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Set up our standard spreadsheet (see Table) for $6000/yr of online stock purchases which go into an IRA, and $3600/yr of online bond purchases, which go into ISBs.
Execution: see Table, where the Vanguard Interm-Term Bond Index Fund (VBIIX) is a proxy for ISBs to facilitate comparison with stocks, which are neither inflation-protected nor tax-advantaged.
Administration:
Plan A: You can put $100/mo into each of 5 stocks purchased online through computershare, then have your accountant declare that account at computershare to be your IRA. This assumes you’re over 50 years old when you start this plan.
Plan B: You can put $500/mo into a Total Stock Market Index Fund (VTSMX) IRA marketed by the Vanguard Group. VTSMX carries an expense ratio of only 0.16%/yr vs. 0.58%/yr for stocks purchased through computershare (see Column P in the Table). NOTE: Plan B is the smarter option. Why? a) The expense ratio is lower. b) An index fund eliminates the considerable risk of selection bias.
With either Plan, $300/mo is put into ISBs with automatic online withdrawals from your checking account. Less money is put into bonds than into stocks because Social Security payments are made from a US Treasury Bond Fund. The interest payments on ISBs are based off the interest payments for 10-yr Treasury Notes corrected for the value of the tax deferral benefit and inflation correction benefit. Also, remember that ISBs have zero transaction costs and zero inflation risk; interest accrues biannually and cannot be taxed until the bond is redeemed. To better understand why you should confine your bond investments to 10-yr US Treasury Notes, read the fine print:
Caveat emptor: “The hard part of setting up a Retirement Plan is understanding the role of bonds. Those go up in value when stocks go down, so bonds need to form half of the assets meant to sustain you in retirement. Why do bonds go up in value when stocks go down? Because bankruptcy drops bond prices to the liquidation value of collateral, say 70 cents on the dollar, whereas bankruptcy drops stock prices to zero. The easy part to understand is that the risk that a bond will end up in bankruptcy court is specified by the interest rate: no investor will buy a bond that doesn’t pay enough interest to compensate for the risk being assumed. The zero-risk set point for interest rates everywhere is the 10-yr US Treasury Note. A commercial bond has to pay sufficiently more interest to draw in a buyer. On a risk-adjusted basis, all publicly-traded bonds pay the same rate of interest. Given that Treasuries are obtained online at zero cost, there is no reason to own any other type of fixed-income investment (unless you’re a bond trader).”
Bottom Line: Investment-grade bond and total stock market indexes have approximately the same inflation-adjusted total returns over multi-decade periods of ~3%/yr (e.g. see Lines 21 and 22 in the Table). Those returns remain roughly equivalent, otherwise investors would accumulate less money in one in order to favor the other.
Instead of using stock & bond indexes, you can have professionals pick stocks and bonds for you. This is tempting, since most stock and bonds make unattractive investments (because most companies have Balance Sheet problems or a weak Brand). That’s why an actively managed & balanced mutual fund like Vanguard Wellesley Income Fund (VWINX) outperforms a 50:50 mix of stock and bond index funds (compare Line 13 to Line 23 in the Table).
Or you can pick conservative bonds and stocks for yourself and keep transaction costs low by investing online (compare Line 10 to Lines 13 and 23 in the Table). NOTE: transaction costs in Column AB, which come to 0.58%/yr ($56/$9600).
Risk Rating: 4 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, KO, IBM, JNJ, NEE, and ISBs.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 19
Week 294 - Don’t Leave Money On Table: Invest Online
Situation: Let’s use a hypothetical situation to make our case. You’ve retired and sold your house to pay off debts. For many people that would mean that you are now living in a rental that fits your needs and income. In addition, you may have a lot of money left over from the sale of your home and would like to invest it in a prudent manner. But cash is fungible. It can disappear into anything that someone thinks has an equivalent value. (Your minister might think tithing is equivalent, even though you’ve already paid tithing on the income that created your retirement plan.)
As a retiree, you need to develop a budget that will cut your living costs and execute on that plan. Aside from spending money, as directed by your budget, what kind of expenses are going to deplete your nest egg? The main factors to consider are inflation, taxes and transaction costs. There’s little you can do about inflation, other than to stay 50% invested in stocks and 50% in inflation-protected bonds, e.g. inflation-protected 10-Yr Treasury Notes, ISB Savings Bonds and inflation-protected bond funds like Vanguard Inflation-Protected Securities (VIPSX). There’s little you can do about taxes, other than own Treasury Bonds and Savings Bonds (because those pay interest that cannot be taxed by the state where you live). Also, you can avoid both Federal and state taxes by owning municipal bonds issued in the state where you live. But that is risky unless you happen to live in one of the 7 states that offer a AAA bond with investor-friendly covenants. You might also consider a low-cost, state-specific municipal bond fund if you live in a populous state that is in good fiscal condition and has a AAA credit rating, but Florida is the only state that fits that description.
Now we’re left to talk about transaction costs. You’ll like doing business with the US Treasury over the internet because there are no transaction costs. But with stocks, it gets more complicated. To reduce transaction costs, there are two routes you can take: 1) Invest in low-cost mutual funds. Vanguard Group has the best deals. Avoid Exchange-Traded Funds unless you want to throw a little business to your stock-broker in return for the research materials she’s been providing. 2) Make low-cost investments online, monthly and automatically. You can do this with any of the Vanguard mutual funds but also with individual stocks. There are 3 main websites: Computershare, Wells Fargo, and American Stock Transfer & Trust.
Mission: Set up a spreadsheet (see Table) with metrics for a sample of stocks that are available for dollar-cost averaging (monthly and online using automatic withdrawals from your checking account). Pick examples from a single source (Computershare) and list the annual transaction cost for investing $100/mo. Balance stocks with 10-Yr Treasury Notes obtained through TreasuryDirect. Inflation-protected versions of those Notes are available, as are IRA-like versions called ISBs (Inflation-Protected Savings Bonds). Those fixed-income assets need to represent 1/3rd of your monthly investment, stocks from each of the 4 S&P Defensive Industries 1/3rd, and stocks from each of the 4 S&P Growth Industries 1/3rd.
In the BENCHMARKS section, include low-cost mutual funds referencing a Standard Retirement Plan. NOTE: The 4 S&P Defensive Industries are Utilities, HealthCare, Communication Services and Consumer Staples. The 4 S&P Growth Industries are Financials, Information Technology, Industrials and Consumer Discretionary. The two commodity-related Industries (Basic Materials and Energy) are omitted. Why? Because even the few A-rated stocks have excess volatility. As a retiree, investing in those Industries would amount to gambling with your “nest egg.”
Execution: see Table.
Bottom Line: Transaction costs consume 2.5%/yr of most investor’s savings. But the internet allows you to reduce transaction costs to less than 1%/yr. Over a 10 yr holding period, that 1.5% difference would increase your return on a $10,000 investment by $1,600. In Column U of this week’s Table, we show that if you pick a dozen high-quality stocks and bonds from the main internet sources, and automatically invest $100/mo in each, your annual expenses would come to ~$135 for that investment of $12,000 (0.94%). But read the fine print first:
Caveat emptor: Owning individual stocks is a gamble unless a) you own at least 30 stocks, and b) your picks reflect the impact of each S&P Industry on the economy. Otherwise, you’ll lose money at some point because of selection bias. To avoid that risk altogether, invest in stock index funds that cover the entire economy, e.g. the Vanguard 500 Index Fund (VFINX), the Vanguard Total Stock Market Index Fund (VTSMX), and the SPDR S&P MidCap 400 ETF (MDY).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: In dollar-average into UNP, JNJ, T, NKE and KO, as well as ISBs (Inflation-Protected Savings Bonds).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 20.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
As a retiree, you need to develop a budget that will cut your living costs and execute on that plan. Aside from spending money, as directed by your budget, what kind of expenses are going to deplete your nest egg? The main factors to consider are inflation, taxes and transaction costs. There’s little you can do about inflation, other than to stay 50% invested in stocks and 50% in inflation-protected bonds, e.g. inflation-protected 10-Yr Treasury Notes, ISB Savings Bonds and inflation-protected bond funds like Vanguard Inflation-Protected Securities (VIPSX). There’s little you can do about taxes, other than own Treasury Bonds and Savings Bonds (because those pay interest that cannot be taxed by the state where you live). Also, you can avoid both Federal and state taxes by owning municipal bonds issued in the state where you live. But that is risky unless you happen to live in one of the 7 states that offer a AAA bond with investor-friendly covenants. You might also consider a low-cost, state-specific municipal bond fund if you live in a populous state that is in good fiscal condition and has a AAA credit rating, but Florida is the only state that fits that description.
Now we’re left to talk about transaction costs. You’ll like doing business with the US Treasury over the internet because there are no transaction costs. But with stocks, it gets more complicated. To reduce transaction costs, there are two routes you can take: 1) Invest in low-cost mutual funds. Vanguard Group has the best deals. Avoid Exchange-Traded Funds unless you want to throw a little business to your stock-broker in return for the research materials she’s been providing. 2) Make low-cost investments online, monthly and automatically. You can do this with any of the Vanguard mutual funds but also with individual stocks. There are 3 main websites: Computershare, Wells Fargo, and American Stock Transfer & Trust.
Mission: Set up a spreadsheet (see Table) with metrics for a sample of stocks that are available for dollar-cost averaging (monthly and online using automatic withdrawals from your checking account). Pick examples from a single source (Computershare) and list the annual transaction cost for investing $100/mo. Balance stocks with 10-Yr Treasury Notes obtained through TreasuryDirect. Inflation-protected versions of those Notes are available, as are IRA-like versions called ISBs (Inflation-Protected Savings Bonds). Those fixed-income assets need to represent 1/3rd of your monthly investment, stocks from each of the 4 S&P Defensive Industries 1/3rd, and stocks from each of the 4 S&P Growth Industries 1/3rd.
In the BENCHMARKS section, include low-cost mutual funds referencing a Standard Retirement Plan. NOTE: The 4 S&P Defensive Industries are Utilities, HealthCare, Communication Services and Consumer Staples. The 4 S&P Growth Industries are Financials, Information Technology, Industrials and Consumer Discretionary. The two commodity-related Industries (Basic Materials and Energy) are omitted. Why? Because even the few A-rated stocks have excess volatility. As a retiree, investing in those Industries would amount to gambling with your “nest egg.”
Execution: see Table.
Bottom Line: Transaction costs consume 2.5%/yr of most investor’s savings. But the internet allows you to reduce transaction costs to less than 1%/yr. Over a 10 yr holding period, that 1.5% difference would increase your return on a $10,000 investment by $1,600. In Column U of this week’s Table, we show that if you pick a dozen high-quality stocks and bonds from the main internet sources, and automatically invest $100/mo in each, your annual expenses would come to ~$135 for that investment of $12,000 (0.94%). But read the fine print first:
Caveat emptor: Owning individual stocks is a gamble unless a) you own at least 30 stocks, and b) your picks reflect the impact of each S&P Industry on the economy. Otherwise, you’ll lose money at some point because of selection bias. To avoid that risk altogether, invest in stock index funds that cover the entire economy, e.g. the Vanguard 500 Index Fund (VFINX), the Vanguard Total Stock Market Index Fund (VTSMX), and the SPDR S&P MidCap 400 ETF (MDY).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: In dollar-average into UNP, JNJ, T, NKE and KO, as well as ISBs (Inflation-Protected Savings Bonds).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 20.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 6
Week 244 - Will You Profit From Owning Stocks?
Situation: People used to say “yes” whenever asked that question. Now, the answer is more problematic. Let’s assume that “the past is prologue” and calculate how much you’d profit from the “best-case scenario.” If on August 9, 1999, you purchased 25 shares of the lowest cost S&P 500 Index fund online, the Vanguard 500 Index Fund (VFINX), for $120.07/Sh ($3001.75), and spent dividends along the way, then sold your 25 shares 16 yrs later on 8/7/2015 for $192.03/Sh ($4800.75), you would have averaged a 3.0%/yr price return. According to the Buyupside website, your total return averaged 4.9%/yr, which included price appreciation of 3.0%/yr, plus an average dividend yield of 1.9%/yr.
Your initial $3001.75 investment has grown to $6400.00. Of that growth, $1599.25 is due to dividends and $4800.75 is due to capital appreciation, as noted above. But the annual 15% tax on dividends has reduced the value of those payouts to $1359.36, and the 20% capital gains tax has reduced your gain from selling 25 shares to $4440.95. That leaves you with $5800.31, for an after-tax return of 4.2%/yr. Now let’s account for the 2.2%/yr average rate of inflation over those 16 years, which brings your gain down to 2.0%/yr. Transaction costs of 0.2%/yr are folded into the share price, so you’re left with an average profit from your initial investment of 2.0%/yr net of costs. So far, so good. But consider this: The average retail investor spends 2.2%/yr on transaction costs vs. the 0.2%/yr that you’ve spent. Your entire 2.0%/yr profit came from choosing an investment run by computers.
There was no one at Vanguard Group to call on the phone when the S&P 500 Index crashed twice. You flew solo. That’s the best-case scenario, disintermediation. But no one you’ll ever meet invests that way. Why? Because the ups and downs of the S&P 500 Index cannot be looked upon with equanimity by anyone other than a professional trader. Another reason is human nature. People can’t seem to make a plain vanilla investment that all available evidence says is the best investment on the planet. Instead, they’ll entertain themselves by trying to beat the S&P 500 Index.
Then there’s the 4% rule to consider. That’s the maximum amount you can sell each year from a balanced retirement portfolio (50% bond, 50% stock), after adding a percentage to account for recent inflation, without running the risk that you’ll out-live your money. VFINX is 100% large-capitalization stocks and pays only a 2% dividend. You’d have to sell some shares every year to collect the other 2%. The market might be down a lot when you sell those shares, so it might be preferable to find a way to live off dividends and preserve your principal.
Our benchmarks for retirement savings are the Vanguard Balanced Index Fund and the Vanguard Wellesley Income Fund at Lines 27 & 28 in this week’s Table. Both have payouts less than 3%/yr, and payouts over the past 16 yrs have fallen because interest rates have fallen and those funds are hedged with bonds. The only way to reach 4%/yr in dividend payouts is to own stock in companies that grow dividends faster than inflation.
Mission: Find a source of retirement income that reliably grows at least twice as fast as inflation and gives you a chance to live off dividends without eroding principal. That means you’re looking to own stock in companies that S&P calls Dividend Aristocrats (because they’ve increased their dividend annually for at least the past 25 yrs).
Execution: Which of the 51 Dividend Aristocrats meet our quality criteria for inclusion in a retirement portfolio, and have grown their dividend more than three times as fast as inflation over the past 16 yrs, i.e., at least 6.0%/yr? And which of those have revenues high enough to be in the 2015 Barron’s 500 List, and S&P ratings of BBB+ or better for bonds and B+/M or better for stocks. Of the 30 stocks that emerge from that screen, which fluctuate in price more than the S&P 500 Index? During the most recent market correction (4/1/11 through 9/30/11), 8 were more volatile so we’ve excluded those. Four others have a dividend yield that is lower than VFINX, so we’ve excluded those. That leaves 18 companies that meet all criteria; those grew their dividends more than 11%/yr over the past 16 yrs (see Column H in the Table).
Bottom Line: Yes, you can profit from owning shares in the lowest-cost S&P 500 Index fund (VFINX) over two market cycles. But you can do better by owning a basket of stocks issued by companies that have increased their dividend annually for at least the past 25 yrs. These are companies that S&P calls Dividend Aristocrats. We’ve found 18 such companies that meet our quality criteria, and all but 2 (Coca-Cola and Wal-Mart Stores) have outperformed the lowest-cost S&P 500 Index fund (VFINX) over the past 23 yrs. As a group, they have a dividend yield of ~3.0% and grew their dividends 5 times faster than inflation. They all meet the 4% rule for annual withdrawals from a retirement fund. In other words, dividend growth is so rapid that you’re getting at least a 4% dividend yield on your original investment within a few years, and dividend yield is likely to grow more than twice as fast as inflation.
Risk Rating: 4
Full Disclosure: I dollar-average monthly into ABT and XOM (neither have transaction costs at www.computershare.com), and also own shares of MCD, JNJ, KO, PEP, and WMT.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark. Total Returns in Column C of the Table date to 9/28/1992 because that marks the onset of trading in VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Your initial $3001.75 investment has grown to $6400.00. Of that growth, $1599.25 is due to dividends and $4800.75 is due to capital appreciation, as noted above. But the annual 15% tax on dividends has reduced the value of those payouts to $1359.36, and the 20% capital gains tax has reduced your gain from selling 25 shares to $4440.95. That leaves you with $5800.31, for an after-tax return of 4.2%/yr. Now let’s account for the 2.2%/yr average rate of inflation over those 16 years, which brings your gain down to 2.0%/yr. Transaction costs of 0.2%/yr are folded into the share price, so you’re left with an average profit from your initial investment of 2.0%/yr net of costs. So far, so good. But consider this: The average retail investor spends 2.2%/yr on transaction costs vs. the 0.2%/yr that you’ve spent. Your entire 2.0%/yr profit came from choosing an investment run by computers.
There was no one at Vanguard Group to call on the phone when the S&P 500 Index crashed twice. You flew solo. That’s the best-case scenario, disintermediation. But no one you’ll ever meet invests that way. Why? Because the ups and downs of the S&P 500 Index cannot be looked upon with equanimity by anyone other than a professional trader. Another reason is human nature. People can’t seem to make a plain vanilla investment that all available evidence says is the best investment on the planet. Instead, they’ll entertain themselves by trying to beat the S&P 500 Index.
Then there’s the 4% rule to consider. That’s the maximum amount you can sell each year from a balanced retirement portfolio (50% bond, 50% stock), after adding a percentage to account for recent inflation, without running the risk that you’ll out-live your money. VFINX is 100% large-capitalization stocks and pays only a 2% dividend. You’d have to sell some shares every year to collect the other 2%. The market might be down a lot when you sell those shares, so it might be preferable to find a way to live off dividends and preserve your principal.
Our benchmarks for retirement savings are the Vanguard Balanced Index Fund and the Vanguard Wellesley Income Fund at Lines 27 & 28 in this week’s Table. Both have payouts less than 3%/yr, and payouts over the past 16 yrs have fallen because interest rates have fallen and those funds are hedged with bonds. The only way to reach 4%/yr in dividend payouts is to own stock in companies that grow dividends faster than inflation.
Mission: Find a source of retirement income that reliably grows at least twice as fast as inflation and gives you a chance to live off dividends without eroding principal. That means you’re looking to own stock in companies that S&P calls Dividend Aristocrats (because they’ve increased their dividend annually for at least the past 25 yrs).
Execution: Which of the 51 Dividend Aristocrats meet our quality criteria for inclusion in a retirement portfolio, and have grown their dividend more than three times as fast as inflation over the past 16 yrs, i.e., at least 6.0%/yr? And which of those have revenues high enough to be in the 2015 Barron’s 500 List, and S&P ratings of BBB+ or better for bonds and B+/M or better for stocks. Of the 30 stocks that emerge from that screen, which fluctuate in price more than the S&P 500 Index? During the most recent market correction (4/1/11 through 9/30/11), 8 were more volatile so we’ve excluded those. Four others have a dividend yield that is lower than VFINX, so we’ve excluded those. That leaves 18 companies that meet all criteria; those grew their dividends more than 11%/yr over the past 16 yrs (see Column H in the Table).
Bottom Line: Yes, you can profit from owning shares in the lowest-cost S&P 500 Index fund (VFINX) over two market cycles. But you can do better by owning a basket of stocks issued by companies that have increased their dividend annually for at least the past 25 yrs. These are companies that S&P calls Dividend Aristocrats. We’ve found 18 such companies that meet our quality criteria, and all but 2 (Coca-Cola and Wal-Mart Stores) have outperformed the lowest-cost S&P 500 Index fund (VFINX) over the past 23 yrs. As a group, they have a dividend yield of ~3.0% and grew their dividends 5 times faster than inflation. They all meet the 4% rule for annual withdrawals from a retirement fund. In other words, dividend growth is so rapid that you’re getting at least a 4% dividend yield on your original investment within a few years, and dividend yield is likely to grow more than twice as fast as inflation.
Risk Rating: 4
Full Disclosure: I dollar-average monthly into ABT and XOM (neither have transaction costs at www.computershare.com), and also own shares of MCD, JNJ, KO, PEP, and WMT.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark. Total Returns in Column C of the Table date to 9/28/1992 because that marks the onset of trading in VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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 26
Week 60 - The “Fiscal Cliff”
Situation: "The Fiscal Cliff": Political candidates on the stump, special interest groups, reporters and “talking heads” in the media love to bandy the term about. Hand-wringing and doomsday prophecies abound. How much of this should we (as long-term investors) be paying attention to? The fiscal cliff is supposed to occur because of legislative bills that have already been signed into law by Congress but which have not yet taken effect. The idea is that our present trajectory (under these pending bills) has the adult US population and the country’s economy bolting over a financial cliff en masse come January. “But wait,” you say, “it’s an election year and this smells suspiciously like Vote Getting Behavior!” Our view is that beyond its usefulness as a classical media scare, the fiscal cliff’s effect on investors will probably depend on their investing strategy, i.e., whether you’re investing for the short term or the long term.
Short term investor: The Fiscal Cliff isn’t good because it cuts the US 2013 GDP by 0.5-0.6%. That may not sound like much of a cut but the expected GDP is only 1.2% and would, therefore, be cut in half. Economists predict that this will be enough to stall the economic recovery and perhaps create a recession.
Long term investor: The Fiscal Cliff is good. You’ll feel skippy because government spending goes down and taxes go up. As a result, the government will spend only a little more than what it collects in taxes and fees instead of its current behavior of spending a lot more. In real terms, that means the US Treasury won’t be pushing so many dollars away from the private economy by continually floating larger and larger government bond issues to support the public economy.
So just what is the Fiscal Cliff then in real terms?
a) Taxes on dividends and capital gains will revert to Clinton-era rates. That means capital gains are taxed at a 20% rate instead of at 15%. For middle income households, dividends are taxed at 28% instead of 15%.
b) And then there’s the Alternative Minimum Tax (AMT) which will revert to its original form. Remember that? It forces everyone to pay some tax even if they’ve been successful in using “tax shelters” to prevent that. The AMT has to be corrected for inflation annually by separate legislation. If it’s not, many middle income households will be taxed at upper-middle income rates, meaning that dividends would then be taxed at a 31% rate.
c) Take-home pay will fall because the special reduction of Social Security taxes (from 6.5% down to 4.5%) is going to expire.
d) State unemployment benefits will no longer receive Federal extensions.
e) The August 2, 2011, legislation that extended the Federal Debt Limit kicks in. Remember how that one came about? Congress couldn’t agree on how to limit spending so automatic cuts of $1.2 Trillion (apportioned 50% to defense spending and 50% to discretionary spending) over 10 yrs will kick in. That means Federal spending will be $120 Billion less in 2013.
Bottom Line: No politician wants to be the one who cuts government spending and raises taxes. They know they’ll have a tough time getting re-elected because opponents will promise voters more. That means they are careful to inflict pain during the first year of a President’s term and then hope you’ll forget how it felt. By letting Bush-era tax cuts on dividends and capital gains expire as promised, and by having across-the-board cuts in defense and discretionary spending occur automatically and equally in every Government bureau, no politician can be personally blamed: Nobody’s fingerprints are on the legislation.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Short term investor: The Fiscal Cliff isn’t good because it cuts the US 2013 GDP by 0.5-0.6%. That may not sound like much of a cut but the expected GDP is only 1.2% and would, therefore, be cut in half. Economists predict that this will be enough to stall the economic recovery and perhaps create a recession.
Long term investor: The Fiscal Cliff is good. You’ll feel skippy because government spending goes down and taxes go up. As a result, the government will spend only a little more than what it collects in taxes and fees instead of its current behavior of spending a lot more. In real terms, that means the US Treasury won’t be pushing so many dollars away from the private economy by continually floating larger and larger government bond issues to support the public economy.
So just what is the Fiscal Cliff then in real terms?
a) Taxes on dividends and capital gains will revert to Clinton-era rates. That means capital gains are taxed at a 20% rate instead of at 15%. For middle income households, dividends are taxed at 28% instead of 15%.
b) And then there’s the Alternative Minimum Tax (AMT) which will revert to its original form. Remember that? It forces everyone to pay some tax even if they’ve been successful in using “tax shelters” to prevent that. The AMT has to be corrected for inflation annually by separate legislation. If it’s not, many middle income households will be taxed at upper-middle income rates, meaning that dividends would then be taxed at a 31% rate.
c) Take-home pay will fall because the special reduction of Social Security taxes (from 6.5% down to 4.5%) is going to expire.
d) State unemployment benefits will no longer receive Federal extensions.
e) The August 2, 2011, legislation that extended the Federal Debt Limit kicks in. Remember how that one came about? Congress couldn’t agree on how to limit spending so automatic cuts of $1.2 Trillion (apportioned 50% to defense spending and 50% to discretionary spending) over 10 yrs will kick in. That means Federal spending will be $120 Billion less in 2013.
Bottom Line: No politician wants to be the one who cuts government spending and raises taxes. They know they’ll have a tough time getting re-elected because opponents will promise voters more. That means they are careful to inflict pain during the first year of a President’s term and then hope you’ll forget how it felt. By letting Bush-era tax cuts on dividends and capital gains expire as promised, and by having across-the-board cuts in defense and discretionary spending occur automatically and equally in every Government bureau, no politician can be personally blamed: Nobody’s fingerprints are on the legislation.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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