THIS IS THE LAST WEEKLY ISSUE. FUTURE ISSUES WILL APPEAR MONTHLY.
Situation: “The 2 and 8 Club” is based on the FTSE High Dividend Yield Index, which represents the ~400 companies in the FTSE Russell 1000 Index that reliably have a dividend yield higher than S&P 500 Index. Accordingly, a complete membership list for “The 2 and 8 Club” requires screening all ~400 companies in the FTSE High Dividend Yield Index periodically to capture new members and remove members that no longer qualify. This week’s blog is the first complete screen.
Mission: Use our Standard Spreadsheet to analyze all members of “The 2 and 8 Club.”
Execution: see Table
Administration: The requirements for membership in “The 2 and 8 Club” are:
1) membership in the FTSE High Dividend Yield Index;
2) a 5-Yr dividend growth rate of at least 8%;
3) a 16+ year trading record that has been quantitatively analyzed by the BMW Method;
4) a BBB+ or better rating from S&P on the company’s bond issues;
5) a B+/M or better rating from S&P on the company’s common stock issues.
In addition, the company cannot become or remain a member if Book Value for the most recent quarter (mrq) is negative or Earnings per Share for the trailing 12 months (TTM) are negative. Finally, there has to be a reference index that is a barometer of current market conditions, i.e., has a dividend yield that fluctuates around 2% and a 5-Yr dividend growth rate that fluctuates around 8%. The Dow Jones Industrial Average ETF (DIA) is that reference index. In the event that the 5-Yr dividend growth rate for that reference index moves down 50 basis points to 7.5% for example, we would use that cut-off point for membership instead of 8%.
Bottom Line: There are 40 current members. Only 9 are in “defensive” S&P Industries (Utilities, Consumer Staples, and Health Care). At the other end of the risk scale, there are 12 banks (or bank-like companies) and 5 Information Technology companies; 13 of the 40 have Balance Sheet issues that are cause for concern (see Columns N-P). While the rewards of “The 2 and 8 Club” are attractive (see Columns C, K, and W), such out-performance is not going to be seen in a rising interest rate environment (see Column F in the Table). Why? Because the high dividend payouts (see Column G in the Table) become less appealing to investors when compared to the high interest payouts of Treasury bonds).
NOTE: This week’s Table will be updated at the end of each quarter.
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 JPM, NEE and IBM, and also own shares of TRV, CSCO, BLK, MMM, CMI and R.
Caveat Emptor: If a capitalization-weighted Index of these 40 stocks were used to create a new ETF, it would be 5-10% more risky (see Columns D, I, J, and M in the Table) than an S&P 500 Index ETF like SPY. But the dividend yield and 5-Yr dividend growth rates would be ~50% higher, which means the investor’s money is being returned quite a bit more rapidly. That will have the effect of reducing opportunity cost.
"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
Showing posts with label utilities. Show all posts
Showing posts with label utilities. Show all posts
Sunday, December 30
Sunday, October 28
Week 382 - Steady Eddies
Situation: Some high-quality companies don’t pay good and growing dividends, don’t have high sustainability (ESG) scores, and aren’t blue chips, but do hold up well in bear markets. In theory, a hedge fund will take long positions in such companies (until retail investors take notice and the shares become overpriced). After reading this preamble, you’ll have figured out that we’re mostly talking about utilities. But that’s OK. You can still dollar-average into the non-utilities and do well, even though they’re often overpriced.
Mission: Run our Standard Spreadsheet on companies with A- or better S&P bond ratings and B+/L or better S&P stock ratings. Exclude companies in popular categories: “The 2 and 8 Club” (see Week 380), Blue Chips (see Week 379), the Dow Jones Industrial Average (see Week 378), and Sustainability Leaders (see Week 377). Also exclude companies that don’t do well in Bear Markets (see Column D in any of our Tables).
Execution: see Table.
Administration: This is a work in progress. The 7 examples in the Table are well-known to me; no doubt there are others in the S&P Index.
Bottom Line: A smart investor knows that a Bear Market in a particular S&P industry will usually begin with little or no warning. By the time she starts to think about selling shares, it’s too late. Some kind of insurance will have to be in place before that happens. Warren Buffett’s well-known recommendation is that you dollar-average your stock investments and back those up with a short-term investment-grade bond fund. (He also recommends that you avoid the two habits that in his experience are likely to derail investors: drinking alcohol and borrowing money.) Here we add a third option, which is to find stocks that “fly under the radar” and hold up well in a Bear Market.
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I own shares of HRL.
"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: Run our Standard Spreadsheet on companies with A- or better S&P bond ratings and B+/L or better S&P stock ratings. Exclude companies in popular categories: “The 2 and 8 Club” (see Week 380), Blue Chips (see Week 379), the Dow Jones Industrial Average (see Week 378), and Sustainability Leaders (see Week 377). Also exclude companies that don’t do well in Bear Markets (see Column D in any of our Tables).
Execution: see Table.
Administration: This is a work in progress. The 7 examples in the Table are well-known to me; no doubt there are others in the S&P Index.
Bottom Line: A smart investor knows that a Bear Market in a particular S&P industry will usually begin with little or no warning. By the time she starts to think about selling shares, it’s too late. Some kind of insurance will have to be in place before that happens. Warren Buffett’s well-known recommendation is that you dollar-average your stock investments and back those up with a short-term investment-grade bond fund. (He also recommends that you avoid the two habits that in his experience are likely to derail investors: drinking alcohol and borrowing money.) Here we add a third option, which is to find stocks that “fly under the radar” and hold up well in a Bear Market.
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I own shares of HRL.
"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, September 2
Week 374 - Bet With The House By Picking Companies In The 2 And 8 Club
Situation: In the U.S., capital-intensive industries with strategic importance are tightly regulated (see Week 230). Electric power grids and railroad networks are expensive to install, maintain and upgrade but those chores are absorbed by shareholders in private companies. Regulatory bodies grant these companies monopoly-like pricing power, oversee safety practices, and set rates high enough to pay for maintenance and upgrades.
Since the Great Recession, international Money Center banks have also come under intense regulation to meet Basel III requirements for sustainability and reduce systemic risks. A more specific definition now replaces Money Center Bank, which is Systemically Important Financial Institution (SIFI).
Looked at from the shareholder’s point of view, companies in these three industries have enough government regulation (and monopoly-like pricing power) that bankruptcy is no longer a material risk. One downside risk is that the US market for their goods and services is largely saturated. So, significant growth in the “bottom line” requires innovation and international outreach that will be overseen by government regulators.
Mission: Use our Standard Spreadsheet to highlight members of “The 2 and 8 Club” that are in the Electric Utilities, SIFI banking, and Railroad industries.
Execution: see Table.
Bottom Line: The safest tactic in gambling is to “bet with the house” whenever you can. Politicians are now in effective control of three industries: Electric utilities, railroads, and international Money Center banks (now called Systemically Important Financial Institutions or SIFIs). These industries are not in danger of being “nationalized” because politicians would much prefer that shareholders (as opposed to taxpayers) put up the large amounts of capital needed to keep these industries safe and effective.
Risk Rating: 6 (where US Treasury Notes = 1, S&P 500 Index =5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM.
"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
Since the Great Recession, international Money Center banks have also come under intense regulation to meet Basel III requirements for sustainability and reduce systemic risks. A more specific definition now replaces Money Center Bank, which is Systemically Important Financial Institution (SIFI).
Looked at from the shareholder’s point of view, companies in these three industries have enough government regulation (and monopoly-like pricing power) that bankruptcy is no longer a material risk. One downside risk is that the US market for their goods and services is largely saturated. So, significant growth in the “bottom line” requires innovation and international outreach that will be overseen by government regulators.
Mission: Use our Standard Spreadsheet to highlight members of “The 2 and 8 Club” that are in the Electric Utilities, SIFI banking, and Railroad industries.
Execution: see Table.
Bottom Line: The safest tactic in gambling is to “bet with the house” whenever you can. Politicians are now in effective control of three industries: Electric utilities, railroads, and international Money Center banks (now called Systemically Important Financial Institutions or SIFIs). These industries are not in danger of being “nationalized” because politicians would much prefer that shareholders (as opposed to taxpayers) put up the large amounts of capital needed to keep these industries safe and effective.
Risk Rating: 6 (where US Treasury Notes = 1, S&P 500 Index =5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE and JPM.
"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, August 26
Week 373 - 10 Dividend Achievers In Defensive Industries That Are Suitable For Long-term Dollar-cost Averaging
Situation: Which asset class do you favor? Stocks, bonds, real estate or commodities? On a risk-adjusted basis, none of those are likely to grow your savings faster than inflation over the near term. You might want to hold off making “risk-on” investments, unless you're a speculator, because markets are likely to fluctuate more than usual. If you think a “risk-off” approach is best, then you need to pick “defensive” stocks for monthly (or quarterly) investment of a fixed dollar amount (dollar-cost averaging). To minimize transaction costs, you’ll want to invest automatically in each stock through an online Dividend Re-Investment Plan (DRIP).
Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.
Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.
Execution: see Table.
Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.
Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M).
Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.
"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
Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.
Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.
Execution: see Table.
Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.
Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M).
Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.
"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, August 19
Week 372 - DJIA Companies in “The 2 and 8 Club”
Situation: The Dow Jones Industrial Average (DJIA) is generally thought to be the most stable reflection of the stock market. As it should be. Those 30 companies are picked by the Managing Editor of the Wall Street Journal to do exactly that. Here at ITR, we have our own, less subjective, measure of stability: companies that pay a good and growing dividend. In other words, companies with a dividend yield and dividend growth rate that are as good (or better than) the DJIA’s ~2% yield and ~8% growth rate. We propose that you pick such stocks out of the DJIA, thinking you’ll just have to do better than you would have done by investing in the Exchange Traded Fund (ETF) for the DJIA (DIA), which is called “Diamonds” for good reason.
Mission: Run our Standard Spreadsheet for the 8 companies in the DJIA that are members of “The 2 and 8 Club” (see Week 360).
Execution: see Table.
Administration: We have made two changes to “The 2 and 8 Club”: 1) Companies with a BBB+ S&P rating for their bonds are no longer accepted (see Column T in the Table); 2) all companies in the Russell 1000 Index that meet requirements (see Week 327) are included in “The 2 and 8 Club”(see Week 366). So, that phrase no longer refers specifically to companies in the S&P 100 Index.
Bottom Line: These 8 stocks have performed remarkably well vs. DIA. Total Returns over the past 11 years (see Column C) were 26% greater, Finance Values (see Column E) were 25% better, dividend yields were almost 30% better (see Column G), dividend growth was almost 80 faster (see Column H), and the rate of price appreciation over the past 16 years was more than 70% faster (see Column K). So far so good, but the devil is in the details. We also measure risk. The story there is a bit shocking, even though these very stable companies were able to shake off challenges posed by the recent crash in commodity markets (see Column D).
Five year price volatility was almost 25% greater (see Column I), P/E was twice as great (see Column J), and quantitative analysis of stock prices over the past 16 years predicts that losses will be almost 40% greater in the next Bear Market (see Column M). In other words, the risk-adjusted returns for these 8 companies are not significantly different than those for the DJIA. This conclusion is consistent with what we were taught in Business School, i.e., there are only two ways for a stock picker to “beat the market.” 1) use insider information (illegal), 2) take on more risk. Your best chance to beat the market without incurring more risk is to invest in the highest quality utilities, beverages, and pharmaceuticals (see Week 367).
Risk Rating: 6 (where US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).
Full Disclosure: I dollar-average into MSFT, JPM, CAT and IBM, and also own shares of TRV, MMM and CSCO.
"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: Run our Standard Spreadsheet for the 8 companies in the DJIA that are members of “The 2 and 8 Club” (see Week 360).
Execution: see Table.
Administration: We have made two changes to “The 2 and 8 Club”: 1) Companies with a BBB+ S&P rating for their bonds are no longer accepted (see Column T in the Table); 2) all companies in the Russell 1000 Index that meet requirements (see Week 327) are included in “The 2 and 8 Club”(see Week 366). So, that phrase no longer refers specifically to companies in the S&P 100 Index.
Bottom Line: These 8 stocks have performed remarkably well vs. DIA. Total Returns over the past 11 years (see Column C) were 26% greater, Finance Values (see Column E) were 25% better, dividend yields were almost 30% better (see Column G), dividend growth was almost 80 faster (see Column H), and the rate of price appreciation over the past 16 years was more than 70% faster (see Column K). So far so good, but the devil is in the details. We also measure risk. The story there is a bit shocking, even though these very stable companies were able to shake off challenges posed by the recent crash in commodity markets (see Column D).
Five year price volatility was almost 25% greater (see Column I), P/E was twice as great (see Column J), and quantitative analysis of stock prices over the past 16 years predicts that losses will be almost 40% greater in the next Bear Market (see Column M). In other words, the risk-adjusted returns for these 8 companies are not significantly different than those for the DJIA. This conclusion is consistent with what we were taught in Business School, i.e., there are only two ways for a stock picker to “beat the market.” 1) use insider information (illegal), 2) take on more risk. Your best chance to beat the market without incurring more risk is to invest in the highest quality utilities, beverages, and pharmaceuticals (see Week 367).
Risk Rating: 6 (where US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).
Full Disclosure: I dollar-average into MSFT, JPM, CAT and IBM, and also own shares of TRV, MMM and CSCO.
"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, 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, June 24
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 17
Week 363 - Big Pharma
Situation: There are 11 pharmaceutical companies in the S&P 100 Index, with an average market capitalization of ~$130 Billion. Stocks issued by healthcare companies (including hospital chains, pharmacy benefit managers, medical insurance vendors, and drugstores) are thought to be defensive “risk-off” bets, like stocks issued by utility, communication services, or consumer staples companies. But they’re not. Healthcare consumes almost 20% of GDP but it is a highly fragmented industry, rife with government interference seeking full control. Medical innovation for the entire planet has to take place in the United States because the healthcare industry is socialized elsewhere and large amounts of private capital are needed to conduct clinical trials. That innovation makes US healthcare into an ongoing research enterprise. For biotechnology companies, there is an ever-present risk of being eclipsed by another company’s research team. Stockpickers who have some appreciation for biochemistry can perhaps identify biotechnology groups that are onto a good thing. But Big Pharma companies survive by looking to buy those same startups. Can you really scope-out a “good thing” better than their scientists?
Mission: Run our Standard Spreadsheet for the 11 pharmaceutical companies in the S&P 100 Index.
Execution: see Table.
Bottom Line: This is not a game for the retail investor. All she can do is buy stock in one or two of the 11 “Big Pharma” companies, and hope that its CEO can find small biotechnology groups conducting breakthrough science, then buy at least one a year to throw money at. That’s an iffy business. Why? Because large-scale clinical studies (costing hundreds of million dollars) have to be conducted before the bet pays off. Usually it doesn’t. If you’re a stock-picker new to this industry, start by researching the old standbys that reliably pay good dividends: Johnson & Johnson (JNJ), Merck (MRK), Pfizer (PFE) and Eli Lilly (LLY).
Risk Rating: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into JNJ and also own shares of ABT.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Run our Standard Spreadsheet for the 11 pharmaceutical companies in the S&P 100 Index.
Execution: see Table.
Bottom Line: This is not a game for the retail investor. All she can do is buy stock in one or two of the 11 “Big Pharma” companies, and hope that its CEO can find small biotechnology groups conducting breakthrough science, then buy at least one a year to throw money at. That’s an iffy business. Why? Because large-scale clinical studies (costing hundreds of million dollars) have to be conducted before the bet pays off. Usually it doesn’t. If you’re a stock-picker new to this industry, start by researching the old standbys that reliably pay good dividends: Johnson & Johnson (JNJ), Merck (MRK), Pfizer (PFE) and Eli Lilly (LLY).
Risk Rating: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into JNJ and also own shares of ABT.
"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, April 29
Week 356 - Defensive Companies in “The 2 and 8 Club” (Extended Version)
Situation: You don’t want to lose money but you’re starting to. That comes with having your savings in an overbought stock market. It’s time for a cautionary warning light to click on in your head. That would mean moving some money into cash equivalents and making sure that at least a third of your stock portfolio is in defensive stocks, i.e., utility, healthcare, consumer staples, and telecommunication services companies. And, review the stocks you’re dollar-averaging into. Be comfortable with the prospect of building up your share-count in those stocks throughout a market crash.
Mission: Run our Standard Spreadsheet on defensive companies in “The 2 and 8 Club” (Extended Version).
Execution: see Table.
Administration: If their dividend growth rates continue to fall, Coca-Cola (KO) and Pfizer (PFE) will no longer be members of “The 2 and 8 Club.” Conversely, Hormel Foods (HRL at Line 13 in the Table) recently raised its dividend and now has a yield that is well above the yield for the S&P 500 Index. That means it will soon be included in the US version of the FTSE High Dividend Yield Index. HRL already meets the other requirements for membership in “The 2 and 8 Club.” So, it will become a member upon being listed in that Index. The ETF for that Index is VYM (the Vanguard High Dividend Yield ETF at Line 18 in the Table).
Bottom Line: There aren’t a lot of great defensive stocks, but the 8 included in “The 2 and 8 Club” are worth your close attention. Why? Because a set of trade policies are being promulgated by several countries that restrict the cross-border flow of goods and services. If those policies blossom into a tit-for-tat Trade War, Robert Shiller (Nobel Prize winning economist) thinks a recession would be triggered: “It’s just chaos,” he said on CNBC. “It will slow down development in the future if people think that this kind of thing is likely.”
Risk Rating: 5 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into NextEra Energy (NEE) and PepsiCo (PEP), and also own shares of Coca-Cola (KO) and Hormel Foods (HRL).
"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: Run our Standard Spreadsheet on defensive companies in “The 2 and 8 Club” (Extended Version).
Execution: see Table.
Administration: If their dividend growth rates continue to fall, Coca-Cola (KO) and Pfizer (PFE) will no longer be members of “The 2 and 8 Club.” Conversely, Hormel Foods (HRL at Line 13 in the Table) recently raised its dividend and now has a yield that is well above the yield for the S&P 500 Index. That means it will soon be included in the US version of the FTSE High Dividend Yield Index. HRL already meets the other requirements for membership in “The 2 and 8 Club.” So, it will become a member upon being listed in that Index. The ETF for that Index is VYM (the Vanguard High Dividend Yield ETF at Line 18 in the Table).
Bottom Line: There aren’t a lot of great defensive stocks, but the 8 included in “The 2 and 8 Club” are worth your close attention. Why? Because a set of trade policies are being promulgated by several countries that restrict the cross-border flow of goods and services. If those policies blossom into a tit-for-tat Trade War, Robert Shiller (Nobel Prize winning economist) thinks a recession would be triggered: “It’s just chaos,” he said on CNBC. “It will slow down development in the future if people think that this kind of thing is likely.”
Risk Rating: 5 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into NextEra Energy (NEE) and PepsiCo (PEP), and also own shares of Coca-Cola (KO) and Hormel Foods (HRL).
"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, November 12
Week 332 - Defensive Companies in “The 2 and 8 Club”
Situation: The Dow Jones Industrial Average keeps making new highs, “confirmed” by new highs in the Dow Jones Transportation Average. According to Dow Theory, we are in a “primary” Bull Market. That is a period when investors should be paying off their debts and/or building up cash reserves. It is also a period when stocks in “growth” companies become overpriced, and stocks in “defensive” companies become reasonably priced (after having been overpriced). It’s a good time to research high-quality companies in “defensive” industries: Consumer Staples, Health Care, Utilities, and Communication Services.
Mission: Develop our standard spreadsheet for companies in “The 2 and 8 Club” (see Week 327) that are in defensive industries (see Week 327), and add any companies that are close to qualifying.
Execution: (see Table)
Administration: We’ll use the Extended Version of “The 2 and 8 Club”, which simply matches companies on two lists: The Barron’s 500 List and the 400+ companies in the FTSE High Dividend Yield Index. The Barron’s 500 List is published annually in May, and ranks companies by their 1 & 3 year Cash Flows from Operations, as well as their past year’s Revenues. The FTSE High Dividend Yield Index lists US companies that pay more than a market yield (~2%) and are thought unlikely to reduce dividends during a Bear Market. Companies that appear on both lists but do not have a 5-Yr Compound Annual Growth Rate (CAGR) of at least 8% for their quarterly dividend payout are excluded, as are any companies that carry an S&P Rating lower than A- for their bonds or lower than B+/M for their stocks.
Note the inclusion of Costco Wholesale (COST) at Line 4 in the Table. Although it has an annual yield lower than the required 2% for its quarterly dividend, the company has also issued a supplementary dividend every other year for the past 5 years. In those years, the dividend yield exceeds 5%. In calculating Net Present Value (see Column Y in the Table), we have used adjusted values for Dividend Yield (5.4%) and 5-Yr Dividend Growth (2.1%) in an effort to present an assessment closer to reality. That boosts NPV 42% over what it would be had supplemental dividends been ignored.
Note the inclusion of Coca-Cola (KO) at Line 9 in the Table. Although it has a 5-year dividend CAGR of 7.7%, which is slightly lower than our 8% cut-off, KO is a “mega-capitalized” company that has a major influence on prospects for the Consumer Staples industry.
Bottom Line: Experienced stock-pickers can usually look forward to a decent night’s sleep, if experience has taught them to overweight their portfolio in high-quality “defensive” stocks that pay a good and growing dividend. By restricting our Watch List to companies in “The 2 and 8 Club”, we’ve found that there are only 10 defensive stocks you need to consider during this opportune time, i.e, when valuations are lower for “defensive” stocks because “growth” stocks become the overcrowded trade in a primary Bull Market.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-cost average into KO and NEE, and also own shares of COST, AMGN, MO, and HRL.
"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
Mission: Develop our standard spreadsheet for companies in “The 2 and 8 Club” (see Week 327) that are in defensive industries (see Week 327), and add any companies that are close to qualifying.
Execution: (see Table)
Administration: We’ll use the Extended Version of “The 2 and 8 Club”, which simply matches companies on two lists: The Barron’s 500 List and the 400+ companies in the FTSE High Dividend Yield Index. The Barron’s 500 List is published annually in May, and ranks companies by their 1 & 3 year Cash Flows from Operations, as well as their past year’s Revenues. The FTSE High Dividend Yield Index lists US companies that pay more than a market yield (~2%) and are thought unlikely to reduce dividends during a Bear Market. Companies that appear on both lists but do not have a 5-Yr Compound Annual Growth Rate (CAGR) of at least 8% for their quarterly dividend payout are excluded, as are any companies that carry an S&P Rating lower than A- for their bonds or lower than B+/M for their stocks.
Note the inclusion of Costco Wholesale (COST) at Line 4 in the Table. Although it has an annual yield lower than the required 2% for its quarterly dividend, the company has also issued a supplementary dividend every other year for the past 5 years. In those years, the dividend yield exceeds 5%. In calculating Net Present Value (see Column Y in the Table), we have used adjusted values for Dividend Yield (5.4%) and 5-Yr Dividend Growth (2.1%) in an effort to present an assessment closer to reality. That boosts NPV 42% over what it would be had supplemental dividends been ignored.
Note the inclusion of Coca-Cola (KO) at Line 9 in the Table. Although it has a 5-year dividend CAGR of 7.7%, which is slightly lower than our 8% cut-off, KO is a “mega-capitalized” company that has a major influence on prospects for the Consumer Staples industry.
Bottom Line: Experienced stock-pickers can usually look forward to a decent night’s sleep, if experience has taught them to overweight their portfolio in high-quality “defensive” stocks that pay a good and growing dividend. By restricting our Watch List to companies in “The 2 and 8 Club”, we’ve found that there are only 10 defensive stocks you need to consider during this opportune time, i.e, when valuations are lower for “defensive” stocks because “growth” stocks become the overcrowded trade in a primary Bull Market.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-cost average into KO and NEE, and also own shares of COST, AMGN, MO, and HRL.
"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, September 3
Week 322 - Global Buildout of Combined Heat & Power (CHP) Systems
Situation: Cogeneration of heat and power is a method that has long been used to capture waste energy remaining in the heat generated to produce electric power. That residual heat is used to generate steam--to heat nearby buildings. However, the Rural Electrification Act of 1936 subsidized the buildout of large, centrally located Regular Electric Generation Facilities (REGFs) to bring all homes onto the national power grid. That subsidy aborted the buildout CHP systems. Nonetheless, CHP systems accounted for 9% of US electric power generation in 2008. Worldwide, the growth of CHP systems is predicted to be 4.38%/yr from 2014 to 2024.
CHP systems are becoming more commonplace in urban areas, now that natural gas is replacing coal as the cheapest energy source. The idea is to add a heat exchanger that will generate steam from exhaust gases produced by newly installed electricity-generating gas turbines. This means that “energy wasted” is reduced to 20% from the 55% loss that is typical of REGFs. Unlike having a central station to generate electricity for wide use, CHP requires the station to be near heating and cooling application sites (https://energy.gov/eere/amo/combined-heat-and-power-basics). Most large applications are at industrial sites, typically oil refineries. But small applications used to heat or cool nearby buildings are also ideal. For example, the University of Cincinnati built a gas turbine powered CHP plant in 2004 with a capacity of 47,700 KW. The Department of Energy has identified a potential for over 290,000 sites in the US with more than 240GW of estimated output. That’s double the installed capacity of wind and solar power in the US.
Mission: Analyze 12 Electric Utilities that support electric grid connections to CHP power plants, including the 3 US companies highlighted in a recent study: “Some of the major players identified across the Global CHP system market for data centers include ENER-G, Korea Electric Power Corporation, National Grid plc, Exelon Corporation, NextEra Energy, Inc., Chubu Electric Power Company, American Electric Power Company, Inc. and others.
Execution: see Table.
Administration: Our best example of a CHP system is the one supporting the Phillips 66 (PSX) facility in Linden, NJ: “Linden Cogen Plant Gas Power Plant NJ USA” is owned by PSEG Power LLC, a division of Public Service Enterprise Group (PEG - see Table). The main purpose of this 1566 MW power plant is to provide Cogen-mode steam to the adjacent Bayway (Phillips 66) Refinery. It provides power to that refinery, and connects to the electrical grid operated by Consolidated Edison (ED) which provides power to the New York City and New Jersey markets.
Bottom Line: There are large up-front costs for building a cogeneration plant, but these pale in comparison to the long-term savings. But “the devil is in the details.” Plant engineers tend to focus on the avoided natural gas costs while assuming that the reliability benefit is approximately the same as for a Regular Electric Generation Facility. But it isn’t. Operating hours are lower and have a larger standard deviation. The key requirement for deciding to build a CHP plant is that it will provide steam for heating (and cooling) nearby buildings.
Risk Rating (for aggregate of 12 utilities): 4, where a 10-Yr T-Note = 1, S&P 500 Index = 5, and gold = 10.
Full Disclosure: I dollar-average into NextEra Energy (NEE).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
CHP systems are becoming more commonplace in urban areas, now that natural gas is replacing coal as the cheapest energy source. The idea is to add a heat exchanger that will generate steam from exhaust gases produced by newly installed electricity-generating gas turbines. This means that “energy wasted” is reduced to 20% from the 55% loss that is typical of REGFs. Unlike having a central station to generate electricity for wide use, CHP requires the station to be near heating and cooling application sites (https://energy.gov/eere/amo/combined-heat-and-power-basics). Most large applications are at industrial sites, typically oil refineries. But small applications used to heat or cool nearby buildings are also ideal. For example, the University of Cincinnati built a gas turbine powered CHP plant in 2004 with a capacity of 47,700 KW. The Department of Energy has identified a potential for over 290,000 sites in the US with more than 240GW of estimated output. That’s double the installed capacity of wind and solar power in the US.
Mission: Analyze 12 Electric Utilities that support electric grid connections to CHP power plants, including the 3 US companies highlighted in a recent study: “Some of the major players identified across the Global CHP system market for data centers include ENER-G, Korea Electric Power Corporation, National Grid plc, Exelon Corporation, NextEra Energy, Inc., Chubu Electric Power Company, American Electric Power Company, Inc. and others.
Execution: see Table.
Administration: Our best example of a CHP system is the one supporting the Phillips 66 (PSX) facility in Linden, NJ: “Linden Cogen Plant Gas Power Plant NJ USA” is owned by PSEG Power LLC, a division of Public Service Enterprise Group (PEG - see Table). The main purpose of this 1566 MW power plant is to provide Cogen-mode steam to the adjacent Bayway (Phillips 66) Refinery. It provides power to that refinery, and connects to the electrical grid operated by Consolidated Edison (ED) which provides power to the New York City and New Jersey markets.
Bottom Line: There are large up-front costs for building a cogeneration plant, but these pale in comparison to the long-term savings. But “the devil is in the details.” Plant engineers tend to focus on the avoided natural gas costs while assuming that the reliability benefit is approximately the same as for a Regular Electric Generation Facility. But it isn’t. Operating hours are lower and have a larger standard deviation. The key requirement for deciding to build a CHP plant is that it will provide steam for heating (and cooling) nearby buildings.
Risk Rating (for aggregate of 12 utilities): 4, where a 10-Yr T-Note = 1, S&P 500 Index = 5, and gold = 10.
Full Disclosure: I dollar-average into NextEra Energy (NEE).
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, July 16
Week 315 - High-quality Dividend Achievers That Beat The S&P 500 For 30 Years With Less Risk
Situation: The S&P 500 Index has risen faster than underlying earnings for the past 8 years. The main reason is that the Federal Reserve purchased over 3 Trillion dollars worth of government bonds and mortgages (including “non-conforming” private mortgages that carry no government guarantee). As intended, this flooded our economy with money that could be borrowed at historically low interest rates. Now the Federal Reserve is looking to start bringing that money back, by accepting the repayment of principal when loans mature instead of renewing (“rolling over”) the loans. This will result in a balance sheet “roll-off” that reduces the amount of money in circulation. Think of it as a “bail-in” to rebalance Treasury accounts, which will reverse the “bail-out” of Wall Street in 2008-9. Interest rates will slowly rise. Investors will once again have to consider the attractiveness of owning bonds in place of stocks. “Risk-on” investments, i.e., growth stocks and stocks issued by smaller companies, will be less sought after but “risk-off” investments (defensive stocks and corporate bonds) will be more sought after. Most of the stocks that have outperformed the S&P 500 over the past 25 years (see Week 314) and 35 years (see Week 313) have been issued by companies in “defensive” industries.
Mission: Look at 30 year statistics by using the BMW Method, to possibly find more stocks that outperform the S&P 500 Index while taking on less risk.
Execution: see Table.
Bottom Line: We have turned up 3 new companies: two from defensive industries (Archer Daniels Midland “ADM” and Kimberly-Clark “KMB”) and one from a growth industry (WW Grainger “GWW”). That makes a total of 11 companies from the 4 S&P “defensive” industries (Utilities, Healthcare, Consumer Staples, and Communication Services): CHD, MKC, BDX, WTR, ED, GIS, CVS, PEP, PG, ADM, KMB. And, 5 from the 6 S&P “growth” industries (Consumer Discretionary, Industrials, Information Technology, Materials, Energy, and Financial Services): APD, MMM, MCD, GPC, GWW.
In other words, the companies that make really good long-term investments are twice as likely to be from “risk-off” defensive industries than from “risk-on” growth industries. But think about what that implies, given that 2/3rds of the companies in the S&P 100 Index represent growth industries. If you want to beat the S&P 500 Index long-term, you’ll have to reverse that ratio and have 2/3rds of your money in defensive stocks.
Risk Rating: 5 (10-Yr Treasury Note = 1, S&P 500 Index = 5, Gold = 10)
Full Disclosure: I own shares of MCD, MMM, GIS, MKC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Look at 30 year statistics by using the BMW Method, to possibly find more stocks that outperform the S&P 500 Index while taking on less risk.
Execution: see Table.
Bottom Line: We have turned up 3 new companies: two from defensive industries (Archer Daniels Midland “ADM” and Kimberly-Clark “KMB”) and one from a growth industry (WW Grainger “GWW”). That makes a total of 11 companies from the 4 S&P “defensive” industries (Utilities, Healthcare, Consumer Staples, and Communication Services): CHD, MKC, BDX, WTR, ED, GIS, CVS, PEP, PG, ADM, KMB. And, 5 from the 6 S&P “growth” industries (Consumer Discretionary, Industrials, Information Technology, Materials, Energy, and Financial Services): APD, MMM, MCD, GPC, GWW.
In other words, the companies that make really good long-term investments are twice as likely to be from “risk-off” defensive industries than from “risk-on” growth industries. But think about what that implies, given that 2/3rds of the companies in the S&P 100 Index represent growth industries. If you want to beat the S&P 500 Index long-term, you’ll have to reverse that ratio and have 2/3rds of your money in defensive stocks.
Risk Rating: 5 (10-Yr Treasury Note = 1, S&P 500 Index = 5, Gold = 10)
Full Disclosure: I own shares of MCD, MMM, GIS, MKC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 9
Week 314 - High-quality Dividend Achievers That Beat The S&P 500 For 25 Years With Less Risk
Situation: See last week’s blog (Week 314 - High-quality Dividend Achievers That Beat The S&P 500 For 25 Years With Less Risk).
To “buy-and-hold” a stock, we want the underlying company 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. 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 25 year holding periods.
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 are not surprised to find that 5 of the 8 companies also starred in last week’s blog, where we used a 35 year holding period as opposed to this week’s 25 year period. The newcomers are Procter & Gamble (PG), Genuine Parts (GPC) and PepsiCo (PEP). Six of the 8 companies represent “defensive” industries, while in last week’s blog, 7 of the 10 companies were from those industries (consumer staples, utilities, healthcare, and communication services). Now we know why investors don’t overweight their portfolios with relatively safe (i.e., defensive) stocks, i.e., the ones that have a better chance of outperforming the S&P 500 Index simply because they rarely fall in price. Defensive stocks are boring! Yes, growth stocks are more likely to zip upward in price. But that comes with a statistically equal chance of zipping downward. Most of us pick stocks because we like to see that upward zip once in awhile, not because we hew closely to a disciplined approach for beating the S&P 500 long-term.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-average into PG and own shares of GIS and MKC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
To “buy-and-hold” a stock, we want the underlying company 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. 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 25 year holding periods.
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 are not surprised to find that 5 of the 8 companies also starred in last week’s blog, where we used a 35 year holding period as opposed to this week’s 25 year period. The newcomers are Procter & Gamble (PG), Genuine Parts (GPC) and PepsiCo (PEP). Six of the 8 companies represent “defensive” industries, while in last week’s blog, 7 of the 10 companies were from those industries (consumer staples, utilities, healthcare, and communication services). Now we know why investors don’t overweight their portfolios with relatively safe (i.e., defensive) stocks, i.e., the ones that have a better chance of outperforming the S&P 500 Index simply because they rarely fall in price. Defensive stocks are boring! Yes, growth stocks are more likely to zip upward in price. But that comes with a statistically equal chance of zipping downward. Most of us pick stocks because we like to see that upward zip once in awhile, not because we hew closely to a disciplined approach for beating the S&P 500 long-term.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)
Full Disclosure: I dollar-average into PG and own shares of GIS and MKC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, July 2
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Subscribe to:
Comments (Atom)