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.

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Week 364 - Ethanol Producers

Situation: “Market research analysts at Technavio have predicted that the global bio-fuels market will grow steadily at a CAGR of almost 6% by 2020”. But arguments against blending ethanol with gasoline are building. In 2016, 15.2 billion gallons were produced at 214 plants, with Archer Daniels Midland (ADM), Valero Energy (VLO) and Green Plains Renewable Energy (GPRE) being the main publicly-traded producers. For example, those 3 companies operate 4 ethanol plants in Nebraska that together produced 2.2 billion gallons, representing 31% of the state’s crop. Not only is fuel a big business for the agriculture sector, but the by-product (“distillers grains”) is a rich source of animal feed. For every ton of ethanol produced, there are 0.24 tons of distillers grains. 

You need to think of ethanol plants as a permanent feature of the Corn Belt, i.e., the 11 states of the Upper Midwest. Government subsidies for ethanol plants in Europe and the United States aren’t going away, for two important reasons. Ethanol is a renewable fuel, and adding it to gasoline makes tailpipe emissions less damaging to the atmosphere. Furthermore, ethanol plants represent the only stable market for the dominant farm product of those 11 states (North Dakota, South Dakota, Nebraska, Kansas, Minnesota, Iowa, Missouri, Wisconsin, Illinois, Indiana, and Ohio). But, before you buy shares in one of the 6 companies we highlight here, you need to understand a number of factors that impact the feedstocks and ultimate markets served by those plants. Start by reading this summary prepared for Green Plains (GPRE) investors.

Mission: Analyze the 6 publicly-traded US companies in the ethanol business, using our Standard Spreadsheet.

Execution: see Table.

Administration: Ethanol plants have changed the lives of farmers in the Corn Belt from being a speculator to being a professional businessman. Iowa, the state that produces the most corn, almost exclusively grows #2 field corn  destined for ethanol plants. 20% of that corn becomes “distillers grains”, and dry distillers grains are shelf-stable and greatly valued as animal feed all over the world. So, that’s a stable and global market. And, ethanol is increasingly being shipped out of the US, either separately or blended with gasoline. For example, China recently adopted the same 10% ethanol content requirement for gasoline that the US has been using. That is seen as an export opportunity for US ethanol plants.

Bottom Line: Corn Belt = ethanol plants. That’s the equation you need to remember. It’s all based on #2 field corn. The #1 sweet corn that we like to eat is rarely grown in the Corn Belt. A state outside the Corn Belt (Washington) is the leading producer. But it’s only been 11 years since the Bush Administration pushed Congress to blend 10% ethanol with gasoline. Yes, hundreds of ethanol plants were built as a result but the economics of running those plants is only now being sorted out. If you invest in any those, you’re a speculator by definition. 

Addendum: Here’s the definition of a red line for “speculation” given in the May 28, 2018 Bloomberg Businessweek on page 8: “...a conservative threshold for volatility, typically lower than that of the broader market for relevant assets…” Column M in all of our tables lists the 16-year volatility of each company (with the required trading record) and highlights in red those that have a greater volatility than the Dow Jones Industrial Average (DIA). Of the 6 companies in this week’s Table, even Archer Daniels Midland (ADM), the longest-established (and highest rated by S&P) company, has a volatility well above that of DIA.

Risk Rating: 8 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10) 

Full Disclosure: I dollar-average into Archer Daniels Midland (ADM), which is a member of “The 2 and 8 Club” (Extended Version; see Week 362).

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

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Week 358 - Hedge the Crash With Low-Beta Dividend Achievers

Situation: It’s really tough to own stocks when the market crumps. Yes, you can follow Warren Buffett’s advice and tough it out with dollar-cost averaging. His other main idea, which is to buy great businesses at a fair price, may be useful someday down the road. He hasn’t been able to find any in this overpriced market, and neither will you. But after the market crashes, you’ll both be glad you kept a hefty dollop of cash in reserve to serve that very purpose. 

But what about hedging against the crash? That’s what hedge funds are supposed to do. Why can’t you and I do it? It’s not that simple. Hedging means that your portfolio pulls ahead in a Bear Market but lags on a Bull Market. Given that the market is historically up 3 years out of 4, you see the problem with hedging. But looking deeper, volatility is what you want to hedge against. You can do that year in and year out by adopting the “School Solution”: overweight low-beta stocks in your portfolio at all times. 

By hedging against volatility, your portfolio won’t necessarily fall behind in a Bull Market. Having less volatility only means that your gains will be less than those for the S&P 500 Index in a Bull Market, AND your losses will be less in a Bear Market. It doesn’t mean you’ll underperform that Index long-term. Why? Because trending stocks become overbought in a Bull Market. But you’re underweighting those high-beta Financial Services and Information Technology stocks! Half of the market capitalization in the S&P 500 Index is currently in those two industries, vs. the long-term average of 30%. Owning high-beta stocks will make you richer faster, but you’ll have to do daily research so that you know when to BUY and when to SELL. My approach to those two industries is to dollar-average into Microsoft (MSFT), International Business Machines (IBM) and JP Morgan Chase (JPM). And keep dollar-averaging no matter what.

Mission: Run our Standard Spreadsheet to identify low-beta stocks of high quality: 
   1. S&P Bond Ratings of A- or better (Column T in the Table);
   2. S&P Stock Ratings of B+/M or better (Column U in the Table);
   3. 5-Yr Beta of less than 0.7 (Column I in the Table);
   4. Lower statistical risk of loss than the S&P 500 Index (Column M in the Table);
   5. Higher Finance Value than the S&P 500 Index (Column E in the Table)
   6. Dividend Achiever status (Column AC in the Table).

Execution: see Table.

Bottom Line: Try not to be a momentum investor. The exciting stories that underlie every Bull Market create a crowded trade for stocks issued by Financial Services and Information Technology companies. To usefully deploy the cash that’s rolling into their coffers, those companies will try to innovate and deploy new services and equipment sooner than planned. Things will get messy, bordering on chaos. Parts of the “story” will collapse, or end in court. Current examples abound. So, we’re back to the Tortoise and Hare story because it will be trotted out at the end of every market cycle. Will you channel the Hare, or will you channel the Tortoise?

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

Full Disclosure: I dollar-average into NEE, PEP and NKE, and also own shares of KO and JNJ.

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

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Week 337 - Agriculture-related Companies in “The 2 and 8 Club” (Extended Version)

Situation: We’ve narrowed our “universe” to large & established US companies that reliably pay a good & growing dividend, and called it The 2 and 8 Club. Why? Because “good ” means 2% or better and “growing” means 8% or better. We use a wash/rinse/repeat method to find those companies. 

In the “wash” cycle, we collect companies that are listed at each of the 3 online spreadsheets we value: 1) The capitalization-weighted FTSE High Dividend Yield Index for US companies, which is simply the 400 companies in the Vanguard High Dividend Yield ETF. 2) The S&P 100 Index, which has the advantage of price discovery through the requirement that stocks in these large companies have active markets in Put and Call Options. 3) The BMW Method List of statistical data for stocks that have been traded on a public exchange for at least 16 years. 

In the “rinse” cycle, we look up information online about each stock that passed through the wash: 1) We make sure bonds issued by that company have an S&P Rating of A- or better. 2) We make sure stocks issued by that company have an S&P Rating of B+/M or better (go to your broker’s website). 3) We make sure the company’s annual dividend payout has been growing 8% or faster over the past 5 years, i.e., we get a list of payouts from the relevant Yahoo Finance page then put the most recent year’s payout and the payout for 5 years ago into a Compound Annual Growth Rate calculator. 

In the “repeat” cycle, we take the same steps 3 months later, then select stocks to add or delete by using a brokerage that charges you a flat fee of ~1% of Net Asset Value/yr. This allows you to trade without incurring transaction costs (including dividend reinvestment). 

If you’re a glutton for punishment, you can extend your oversight beyond S&P 100 stocks to include those on the Barron’s 500 List, published each year in May, which has the advantage of ranking companies by using 3 cash flow metrics. Then you’ll be running the Extended Version of The 2 and 8 Club, which currently has 32 companies (see Table for Week 329). This week’s blog drills down on the 10 companies in the Extended Version that ultimately depend on feedstocks provided by farmers, to ultimately market foods & beverages, motor engine fuels, animal feed, cigarettes, cotton shirts, and plastics made from corn. 

Mission: Set up a Standard Spreadsheet of those 10 companies.

Execution: see Table.

Administration: Farmers operate a capital-intensive business that requires large-scale production on ~1000 acres to justify the cost of chemicals and fertilizer plus the main cost, which is for the purchase and maintenance of equipment (e.g. combines, tractors, grain carts, center-pivot irrigation systems, sprayers, semi-tractors that haul 30 tons of grain, grain-drying bins, grain storage bins, and satellite navigation links needed for weather forecasting and precision agriculture). Their mobile powered equipment requires diesel fuel, and their grain-drying bins require natural gas or propane. 

Archer-Daniels-Midland is the only pure Ag company on the list. ADM collects crops at railheads for further shipment and initial processing, and distributes products worldwide. Much of that distribution begins by loading grain onto barges in the Mississippi River. 

Weather is the key variable. The software and hardware on weather satellites is IBM gear, and IBM owns The Weather Channel. GPS-based software is an important part of precision agriculture, and similarly depends on satellites running IBM equipment. Cummins (CMI) and Caterpillar (CAT) provide diesel engines, and ExxonMobil (XOM) is one of the largest sources of diesel fuel. CAT also makes skid-loaders and backhoe/end-loaders that some farmers use.

PepsiCo (PEP) and Coca-Cola (KO) process a variety of farm products (including milk, cheese, oranges, oats, coffee and tea) into dozens of branded foods and beverages that are found worldwide. Altria Group (MO) processes tobacco plants into cigarettes and smokeless tobacco for the US market. VF Corporation (VFC) is the largest company that fabricates clothing for a variety of markets, and depends on farmers to produce its main feedstock (cotton). Target (TGT) markets clothing, and Super Target stores offer a large variety of foods and beverages. 

Bottom Line: Farm incomes have fallen 20%/yr over the last 3 years, but appear to have stabilized with this year’s harvest. Cost-cutting and scaling-up are the main survival strategies. Farms that are large enough to sustain a family are multi-million dollar enterprises that cultivate more than a square mile of ground. When farmers are forced to cut costs, suppliers are forced into being acquired by (or merged with) other companies. To further complicate matters, efficient transportation networks now circle the planet. The supply of crop commodities outstrips demand enough that the effects of drought or war in one place are mitigated by bumper crops in another place. 

Risk Rating: 8 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).

Full Disclosure: I dollar-cost average into KO, XOM, and IBM, and also own shares of CAT and MO.

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

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Week 313 - High-quality Dividend Achievers That Beat The S&P 500 For 35 Years With Less Risk

Situation: Most investors don’t like to micromanage their stock holdings, preferring instead to “buy-and-hold.” But we occasionally lose money because we haven’t been paying adequate attention. Deciding when to sell is much harder than deciding when to buy. The basic rule is to buy stocks with an ROIC (Return On Invested Capital) that is more than twice their WACC (Weighted Average Cost of Capital), then sell when they no longer meet that standard. But that approach doesn’t work for technology stocks, where the ROIC is many times greater than the WACC, or for many stable and/or slowly growing companies. For example, Berkshire Hathaway (BRK-B) has had an ROIC that is only a little higher than its WACC for long periods.

If we are to “buy-and-hold” a stock, the underlying company needs to have a long record of stable price growth that outperforms the lowest-cost S&P 500 Index fund (VFINX). Otherwise, we would simply invest in VFINX and forget about picking stocks. We would also like those companies to have had less stock price volatility than VFINX over a long period of time . . . decades. The necessary statistical data is found at the BMW Method website.

Mission: For this week’s blog, we’ll look at how publicly-traded stocks have performed over 35 year holding periods. Next week, we’ll run the same spreadsheet for 25 year holding periods and the following week we’ll look at the 30 year period.

Execution: see Table.

Administration: We exclude companies that do not have high ratings from S&P on their stocks and bonds. We also exclude companies that S&P hasn’t designated as Dividend Achievers. “Less risk” is defined as a statistically lower risk of loss at 2 standard deviations below trendline than that for the S&P 500 Index (see Column M in the Table, where red highlights denote more risk).

Bottom Line: After analysis, we find that all 10 companies had better price returns than our benchmark (VBINX) over the two year correction in commodity prices from July of 2014 to July of 2016. Most of these companies showed unusually strong performance, meaning investors chose to shunt money away from commodity-related companies and into these companies. It is instructive to get an idea as to why these company’s products and services seemed more valuable to investors. Yes, it was a “risk-off” decision. This is because investors know that the best way to make money is to avoid losing money. Of the 10 stocks highlighted here, only 3 (MCD, MMM, APD) are in “growth” industries; the others are in “defensive” industries (healthcare, consumer staples, and utilities) where earnings tend to hold up better in a downturn. But why not build a portfolio of “risk-off” investments in the first place, given that those appear to outperform the S&P 500 Index over long periods? We’ll check that theory out at 25 and 30 year holding periods, to see how well it holds up. In the meantime, remember Warren Buffett’s Rule #1: “Never lose money.”

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

Full Disclosure: I own shares of GIS, MCD, MKC, and MMM.

Note: We use discounted cash flow from dividends and sale of the stock (after a 10-Yr holding period) to estimate Net Present Value; see Columns U-Y in the Table. The exponential growth rate in stock price over the next 10 years is estimated to be an extrapolation of the growth in stock price over the past 16 years. The Discount Rate is set at 9%, meaning that a stock with a positive NPV would return more over 10 years than a 10-Yr US Treasury Note paying 9%/Yr. Dividend Growth over the next 10 years is extrapolated from Dividend Growth over the past 4 years. Be aware that our NPV calculation is for comparative purposes only. Any rise in the rate of interest paid by 10-Yr Treasury Notes would diminish stock NPVs, provided that those Notes continue to carry a AAA credit rating from S&P.

Red highlights in the Table denote underperformance relative to our benchmark: Vanguard Balanced Index Fund (VBINX) at Line 18. Purple highlights denote metrics of concern.

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Week 243 - S&P 500 HealthCare Companies

Situation: Obamacare has been a boost for the healthcare industry, bringing 10 million new health insurance clients into the system. And, the Federal Reserve’s main monetary policy since the Lehman Panic, called “quantitative easing,” invested $4.2T (that’s Trillion) in government bonds to bring interest rates down to historic lows. That got people to stop investing in bonds and instead expand their businesses, build manufacturing plants, buy cars, refinance homes, advertise their services, or simply buy stocks. It worked, and investment dollars favored the HealthCare industry. The only “fly in the ointment” is that stocks have become overpriced because bonds are no longer able to compete on a total-return basis. The Federal Reserve is now trying to reverse its “easy money policy” because the economy no longer needs life support. However, this will sink the stock market for a while, including healthcare stocks. But those of you who are building a retirement portfolio can hardly avoid the obvious benefits of owning healthcare stocks, which are a growing client base and an aging population. And that’s just in the United States. Looking internationally, there are almost 20 million people emerging from poverty each year and now able to invest in their health! 

Mission: You’ll need to know which stocks you might want to drop and which you might eventually profit from owning (and should probably continue to dollar-average into). So we need to come up with a list of the highest quality HealthCare stocks. We’ll use our standard spreadsheet to highlight both the past rewards of ownership and the likely risks of continued ownership. We’ll start with the list of healthcare stocks in the S&P 500 Index, deleting any with insufficient revenues to appear on the 2015 Barron’s 500 List. We’ll also delete any stocks that haven’t been trading long enough to appear on the 16-yr BMW Method list. Finally, we’ll delete any companies that don’t have S&P bond ratings of at least BBB+ and S&P stock ratings of at least B+/M. 

Execution: The above exercise leaves us with 20 companies to consider, only 5 of which are S&P Dividend Achievers (denoting 10+ years of annual dividend increases). Those 4 companies are: Johnson & Johnson (JNJ), Abbott Laboratories (ABT), Becton Dickinson (BDX), Medtronic (MDT) and Stryker (SYK). The other 15 are speculative investments to varying degrees (see Columns D, I, J, K, and O in the Table). The benchmark mutual fund, Vanguard HealthCare Fund (VGHCX), shows stronger risk-adjusted performance than the aggregate of 20 stocks (compare Line 22 to Line 25 in the Table). Its outperformance has been remarkable for decades.

Bottom Line: HealthCare stocks have become a “crowded trade.” If you’ve held several of the 20 stocks on our list over the past decade, you’re likely happy with your choices. The HealthCare industry will likely continue to do well given the demographic trends in the US and internationally with bigger percentages of people becoming insured, entering their sunset years and emerging from poverty. Just keep in mind that the value of these stocks is technology-driven, and a price-appreciation graph for technology-driven stocks will continue to look like a roller-coaster (see Column O in the Table). Only 3 of these stocks have a steady and strong trend of price-appreciation: Johnson & Johnson (JNJ), Abbott Laboratories (ABT), and Becton Dickinson (BDX). If you want to venture beyond these safe havens, the safest and most rewarding move looks to be the mutual fund that represents this industry so well: Vanguard HealthCare Fund (VGHCX) at Line 24 in the Table.

Risk Rating: 6

Full Disclosure: I dollar-average into ABT and also own stock in JNJ, BDX, and MCK.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark at Line 27 in the Table. Total Returns in Column C of the Table date to 9/1/2000 because that marks the peak of the S&P 500 Index before the “dot.com” recession. There have been two peaks since, in 2007 and 2015, so we’re entering the third market cycle since 2000.

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Week 221 - Status of Commodity-Related Barron’s 500 Companies

Situation: Since 2009, China has contributed twice as much to world economic growth as the US. China has also purchased ~40% of all commodities sold worldwide. One commodity in particular, copper, is used as a measure of the health of commodity demand in emerging markets because it plays an important role in building electrical grids. Copper has recently reached new lows. China is slowing down its investment machine mainly because its total debt load has reached 300% of GDP. To put China’s woes in context for the US economy, the CEOs of several corporations have recently provided specific examples of how China’s economic decline impacts their businesses. 

What does this mean for investors? Basically, for the next one or two years, traders of all asset classes will be in a “risk-off” mode while governments, corporations, and individuals struggle to bring down their debt loads and develop ideas for growth. This cautionary stance will coincide with a bottoming of commodity prices as demand recovers while supplies moderate. The global “oil glut” is a special case, only marginally related to falling demand in China. Instead, it is due to a global “price war” triggered by an oversupply of oil related to improvements in technology, namely horizontal drilling into oil-rich shale deposits combined with hydraulic fracturing. And, oil prices may have further to fall.

Mission: Assess the effect on commodity-related companies of oversupply of commodities. Do this by evaluating all 56 such companies in the 2015 Barron’s 500 List that have at least 16 yrs of trading records.

Execution: This week’s spreadsheet (see Table) shows the carnage. Note the abundance of red highlights denoting underperformance relative to our key benchmark (VBINX at Line 73). Let’s start with a “thought experiment.” You’re looking for GARP (growth at a reasonable price), which will allow you to take advantage of sharply falling stock prices (see Column F in the Table). Let’s start by listing the companies that have moved up in rank compared to the 2014 Barron’s 500 List. Those are the ones with green highlights in Columns P and Q of the Table. Then pick those stocks that aren’t overpriced, i.e., the ones with an EV/EBITDA that is no greater than the EV/EBITDA for the S&P 500 Index (which is an EV/EBITDA of 11).

There are 10 candidates in the “oil & gas” group: HES, DVN, TSO, CAM, CHK, NOV, VLO, HAL, WFT, NBR. Two of those have been labelled “potentially underpriced” per the BMW Method (see Week 193): CHK and NOV (see Column O in the Table). There are 5 more candidates in the “basic materials” group: NUE, SCCO, CMC, X, AA and 6 candidates in the agriculture production group (ADM, POT, MOS, TSN, DOW, PPC). POT is another “potentially underpriced” stock. That totals 21 stocks. However, three of those failed to outperform the S&P 500 Index over the past 16 yrs (per the BMW Method: NBR, AA, PPC (see Column L in the Table). Eliminating those leaves 18 candidates. 

So far, so good. Most of the 18 have fallen hard in recent quarters and now have prices that are 1-2 Standard Deviations below trendline (see Column M in the Table). The BMW Method sorts out “risk” statistically by predicting the extent of loss below trendline that you can expect in a bear market (see Column N in the Table). The abundance of red highlights in that Column denotes stocks predicted to exhibit a greater loss below trendline than the S&P 500 Index faces, which is 32%. Every one of the 18 candidate stocks is highlighted in red, so they’re all unsuitable for a retirement portfolio. But what if you’re a speculator and willing to accept a loss of 40%? That’s a 25% greater loss than you’d suffer by owning an S&P 500 Index fund like VFINX. Even allowing for the added extra risk, only one of the 18 qualifies (ADM at Line 54 in the Table).

Given that commodity-related companies compose at least 10% of a balanced stock (or stock mutual fund) portfolio, we’ll need to dig deeper. For example, 23 of 56 such stocks listed in the Table are already in a bear market (see Column M), i.e., down 2 Standard Deviations (2SD) below their 16-yr trendline. Three of those companies have raised their dividend annually for at least the past 10 yrs (see a list of such Dividend Achievers in Column R of the Table) and have a statistical risk of loss in a bear market that is less than that for the S&P 500 Index (see Column N in the Table): CVX, XOM, PX. The odds that you’d lose money by starting to dollar-average into those stocks now are low.

Another approach is to dollar-average into low-cost mutual funds that reflect commodity investment, including emerging market index funds. There are 3 listed in the Benchmark section of the Table: 1) GSG, the exchange-traded fund for collateralized commodity futures; 2) PRNEX, the T Rowe Price New Era Fund that invests in natural resource stocks, and 3) VEIEX, the Vanguard index fund for emerging markets.

Bottom Line: The global economy faces a difficult period now that China’s fast growth phase has ended. Commodity-related assets are the first to crash, and that means commodity markets and commodity-related companies will be the first to recover. We’ve evaluated 56 commodity-related companies in the 2015 Barron’s 500 List to come up with 4 that are candidates for speculative investment: Archer Daniels Midland (ADM), Exxon Mobil (XOM), Chevron (CVX), and Praxair (PX).

Risk Rating: 8

Full Disclosure: Commodity-related stocks are “long-cycle” investments that I tend to favor, particularly those that are related to agricultural production. I dollar-average into XOM and also own shares of CVX, AA, HRL, ADM, DE, and DD.

Note: metrics highlighted in red denote underperformance relative to our key benchmark (VBINX); metrics are current as of the Sunday of publication.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Week 111 - Information Tech & Communication Services Stocks with Dividend Growth

Situation: When a country is digging itself out of recession, industries recover in a predictable pattern. Corporations start spending more on capital equipment upgrades (infrastructure, computers, software, ships, planes, locomotives, rail cars, pipelines) while avoiding new hires as long as possible. Then new hiring takes place followed almost immediately by an uptick in consumer discretionary spending (autos, housing, appliances, restaurants, etc.). Since the economic future appears brighter to the consumer (ie., workers), much of this spending is financed by credit, allowing interest rates to rise and banks to recover. The increased profits that start with “consumer discretionary spending” finally affect the financial, communication services, and information technology industries. Those industries suffered the most during the recession but now start to exhibit strong growth that eclipses defensive industries like healthcare, utilities, and consumer staples, including food.

Painful as it is, investors need to dollar-average some money into technology stocks throughout the recession and recovery periods. This is best done with a balanced index fund where 40% exposure to bonds hedges the volatility of such growth stocks (see VBINX in the Table). For you investors who want to try your stock-picking skills on growth companies, look for those that not only pay dividends but those whose managers try to hold onto long-term investors by growing dividends even during recessions. That’s a unique feature of American capitalism. (In other countries, dividends are paid in proportion to Free Cash Flow). There aren’t very many technology companies with such a record of relative stability, and a lot of those are small or medium-sized companies that have carved out a niche based on patents: only 9 of the 19 companies in the Table are in the S&P 500 Index.

For this week’s blog, we’ve looked at computer technology companies that have managed to increase their dividend annually for the last 10 or more yrs. Verizon Communications and Accenture have been added because those are large information technology companies that are within 3 yrs of being counted among such “Dividend Achievers.” That is Standard & Poor’s name for companies that have increased dividends annually for the past 10 or more yrs. There are 201 such companies; the full list can be found at the website for the Exchange-Traded Fund (PFM) that owns a capitalization-weighted amount of shares in all 201 stocks. For companies that perform less well than VBINX on a particular metric, we’ve highlighted that metric in red. Since we’re confining our attention to companies in the most competitive of industries, there are many red highlights. Nonetheless, we find 4 companies that are:

   a) large enough to be in the S&P 500 Index, and
   b) perform about as well or better than VBINX on a long-term, risk-adjusted basis (Column E).

Those 4 are: International Business Machines (IBM), Accenture (ACN), Automatic Data Processing (ADP), and Verizon Communications (VZ). To evaluate recent finance value, we look to the Barron’s 500 table published each year in May, where companies are ranked with respect to cash flow and sales trends over the most recent 1 & 3 yr periods. We’re particularly interested in companies that improved their 2012 rank over their 2011 rank (Columns J & K). Accenture (ACN) and Verizon Communications (VZ) are among those, and therefore have both long-term and recent Finance Value. You’ll need to dig deeper before deciding whether or not you’d like to start a dividend reinvestment plan (DRIP) in either company.

Bottom Line: Stock-picking is hardest for computer technology companies, but those companies are central to the Information Revolution that has eclipsed the Industrial Revolution. Trouble is, information technology changes so rapidly that even the strongest companies can fall by the wayside. But the biggest of them usually recover to some extent, since their core technologies are both patented and essential to industry-wide standards that underpin the Information Revolution. Nonetheless, their investors can become disappointed for long periods, and will often decide to sell at a loss rather than support a charity. The good news is that companies recognize these concerns and have developed dividend policies that are more shareholder friendly. Intel (INTC) and Microsoft (MSFT) are instructive examples; International Business Machines (IBM) also stumbled but then moved quickly to redirect its business plan to one that supports stable growth. 

Risk Rating: 8

Full Disclosure: I have stock in IBM, INTC, ACN, and MSFT.

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