Month 113 - BUY LOW: A-rated Non-financial Value stocks in the S&P 100 Index - November 2020

Situation: The reason to buy high-yielding “value” stocks is that their low price is temporary. A company has to be large enough to have multiple product lines (to make money from one line in order to fund repairs on a troubled line) and be well-followed by analysts and business media. Numbers will tell us which stocks are temporarily undervalued. In this month’s blog we will start using the 29 A-rated value stocks identified in last month’s WATCH LIST (see Month 112). Eight have both a price that is no higher than twice the rational price or Graham Number (see Column AD in the Table), and a 7-year P/E that is no higher than 25 (see Column AF in the Table).

Mission: Using our Standard Spreadsheet, analyze those 8 companies. 

Execution: see Table.

Administration: All 8 companies meet our requirements for A-rated value companies: 1) listed in portfolio of iShares Top 200 Value ETF (IWX), 2) listed in portfolio of Vanguard High Dividend Yield Index Fund ETF (VYM), 3) S&P bond rating of A- or higher, 4) S&P stock rating of B+/M or higher, 5) 20+ year trading history on a public US exchange, 6) positive Book Value for the most recent quarter (mrq), 7) positive earnings for the Trailing Twelve Months (TTM).

Key analytics include a) the main Growth At a Reasonable Price (GARP) metric or 5-yr PEG ratio (see Column AI in the Table), b) leverage or “gearing” (see LT-debt-to-equity in Column T in the Table), c) Return on Investment or EBIT/Assets (see Column AR  in the Table), d) Weighted Average Cost of Capital or WACC (see Column P in the Table), and e) S&P Insider Activity (see Column AS in the Table). 

Bottom Line: Because of COVID-19, only 5 of these companies currently have an ROI greater than their WACC: PFE, CSCO, INTC, GD, IBM. Of those, PFE, CSCO, INTC, and GD have a 5-yr PEG ratio that is under 3; none of those use excessive leverage (i.e., the ratio of LT-debt-to-equity is less than 1). S&P Insider Activity is neutral for GD and PFE but unfavorable for CSCO and INTC.

Risk Rating: 7 (where 1 = 10-yr US Treasury Notes, 5 = S&P 500 Index, and 10 = gold bullion)

Full Disclosure: I dollar-average into PFE and INTC and IBM, and also own shares of CSCO, DUK, CMCSA, SO and IBM.

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Month 111 - Nine A-rated non-Financial GARP Stocks in the S&P 100 Index - September 2020

Situation: “Growth at a reasonable price (GARP)" is an equity investment strategy that seeks to combine tenets of both growth investing and value investing to select individual stocks.” Different analysts use different metrics (and management assessments) to guesstimate favorable returns. Peter Lynch originated the concept and highlighted the usefulness of one ratio: Price/Earnings:Growth, commonly referred to as PEG. “Earnings” reference Earnings per Share (EPS) for the Trailing Twelve Month (TTM) period. “Growth” references an estimate of growth in EPS over the next 5 years. Yahoo Finance publishes the PEG ratio for each public company under Valuation Measures (see Column AH in the Table). The PEG ratio is kept up to date by Thomson Reuters. Peter Lynch is arguably the greatest stock-picker of all time. My interest in investing started through reading his books, which are practical down-to-earth primers. So, his reliance on PEG carries some gravitas. The basic idea is that a stock’s price ought to approximate the rate at which the company’s earnings grow (PEG = 1.0). That rarely happens in the real world but some companies come close (see Column AH in the Table).  

Mission: Look at the 23 A-rated non-financial high-yielding stocks in the S&P 100 Index and highlight the 9 that have 5-yr PEG numbers no higher than 2.5. 

Execution: see Table.

Administration: A-rated stocks are those that have:

            a) an above market dividend yield (see portfolio of Vanguard High Dividend Yield Index Fund ETF - VYM),

            b) positive Book Value, 

            c) positive earnings (TTM), 

            d) an S&P bond rating of A- or better, 

            e) an S&P stock rating of B+/M or better, and 

            f) a 20+ year trading history. 

Bottom Line: Merck (MRK), Target (TGT), Intel (INTC), Comcast (CMCSA), and Lockheed Martin (LMT) have the overall highest quality among stocks on this list (see Column AL in the Table). INTC and CMCSA are also Value Stocks, meaning that their price (50-day moving average) is less than twice their Graham Number (see Column AC) and their 7-year P/E is no higher than 25 (see Column AE). 

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 MRK, PFE and INTC, and also own shares of TGT and CMCSA. 

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Month 106 - A-rated Value Stocks in the S&P 100 Index - April 2020

Situation: Growth at a reasonable price (GARP) is often mentioned as an investing goal because value underlies the decision to buy. Warren Buffett is the king of value investing and has over $80 Billion in cash (his “elephant gun”) that he’d like to spend. We’re in a Bear Market fueled by the adverse economic consequences of the COVID-19 pandemic. So, he’ll soon spend that cash pile to buy a large company. Let’s look at his options, considering the ways he has prioritized purchases in the past. Firstly, he likes large and long-established companies. Why large companies? Because those have multiple product lines, one of which is usually designed to help the company maintain a stream of revenue during a recession. In addition, those companies are large enough to have the marketing power needed to maintain and grow their brands. 

Mission: Let’s see which choices look attractive among A-rated “haven stocks” in the S&P 100 Index (see Month 104). Remember: These companies reliably pay an above-market dividend, so they’re found in the Vanguard High Dividend Yield Index (VYM), and they’re also listed in the iShares Russell Top 200 Value ETF (IWX). Warren Buffett places high store in companies that don’t overuse debt and also retain Tangible Book Value, so we’ll exclude companies with negative Tangible Book Value that also have a total debt load greater than 2.5 times EBITDA (Earnings Before Interest, Tax, Depreciation & Amortization) or have sold long-term bonds to build more than 50% of their market capitalization. Finally, the company's stock price has to meet both of our two value criteria: 1) Share price isn't more than twice the Graham Number; 2) share price isn't more than 25 times average 7-yr earnings per share. 

Execution: (see Table).

Administration: These 9 companies include 4 from the two most deeply cyclical industries: banks and semiconductor manufacturers. Berkshire Hathaway’s portfolio already includes the 3 banks on the list, i.e., JPMorgan Chase (JPM), U.S. Bancorp (USB), and Wells Fargo (WFC) but doesn’t include the semiconductor manufacturer, Intel (INTC). Berkshire Hathaway is at heart an insurance company, so Warren Buffett always needs to diversify away from the Financial Services industry. There are only 4 non-financial companies on the list: Intel (INTC), Cisco Systems (CSCO), Pfizer (PFE), and Target (TGT), and only TGT is within the price range that Mr. Buffett is looking to spend ($80 to $100 Billion). 

Bottom Line: Target (TGT) appears to be the most attractive company to add to Berkshire’s stable, given that it is priced right and Mr. Buffett already has experience owning companies in the Consumer Discretionary industry.. 

Risk Rating: 7 (where 10-yr U.S. Treasury Notes = 1, S&P 500 Index = 5, and gold = 10).

Full Disclosure: I dollar-average into INTC and JPM, and also own shares of PFE, CSCO, TGT, USB, BLK and WFC.

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Month 105 - A-rated Companies in the Dow Jones Industrial Average - March 2020

Situation: If you’ve been picking stocks for a retirement portfolio, and have more than 15 years of experience, you’ve learned enough about risk to appreciate last month’s blog about Haven Stocks (Month 104). You’re probably ready to take on more risk for more reward, assuming that you’ve learned how to ride out a market crash without selling. Warren Buffett, the reigning value investor, also stretches beyond investing in large-capitalization value stocks like those discussed in our Month 103 blog about Berkshire Hathaway’s portfolio.

In his most recent Annual Letter to the shareowners of Berkshire Hathaway, Warren explains how to do that by focusing on Retained Earnings (see the excerpt below in Appendix). Retained Earnings are what’s left over from Free Cash Flow after Dividends have been paid. Free Cash Flow is what’s left over from Operating Earnings (EBIT) after Capital Expenditures have been paid. Warren Buffett uses Return on Net Tangible Capital to estimate whether Retained Earnings are likely to be substantial. Return on Net Tangible Capital is the same as the familiar ROCE (Return on Capital Employed) except that Capital Employed is changed from Total Assets minus Current Liabilities to Total Assets minus Intangible Assets minus Current Liabilities. He thinks 20% is a good Return on Net Tangible Capital (see Column P in the Table).

The company’s CEO will eventually deploy Retained Earnings to build a better company faster. The cost for deploying that capital is zero. Going forward, the return on that investment is approximately the same as the return on Operating Earnings, which is EBIT (Earnings Before Interest and Taxes) divided by Market Capitalization. In a well-managed and well-positioned company, that return represents a high rate of Compound Interest over time--the 20%/yr Return on Net Tangible Capital that Warren Buffett is looking to achieve in most years on most of Berkshire Hathaway’s portfolio.

The trick, of course, is to find such companies. The Dow Jones Industrial Average (DJIA) is a good place to start, given that those companies have traditionally been picked (in part) because they expected to have a high Free Cash Flow Yield (see Column H in the Table).

Mission: Pick companies from the 30-stock DJIA that have S&P ratings on the bonds they’ve issued that are A- or higher, and insert a new column in our Standard Spreadsheet for Free Cash Flow Yield (Column K). Exclude any DJIA companies that do not have an S&P stock rating of at least B+/M, or do not have the 16 year trading record that is required for quantitative analysis by the BMW Method (https://invest.kleinnet.com/bmw1/). (We display at Columns L-M in the Table a summary of BMW Method findings for the most recent week.)

Administration: see Table.

Bottom Line: These 19 companies have an aggregate Return on Net Tangible Capital of 19.5%, which almost meets Warren Buffett’s requirement of 20%. Whether any of these stocks can be bought at a “sensible price” is not an easy question to answer. Here at ITR, we call a stock “sensibly priced” if the 50 day moving average in the price per share is no more than twice the Graham Number (see Columns AC & AD) and is no more than 25 times the 7-yr P/E (see Column AF). Five companies meet those criteria: PFE, INTC, JPM, TRV, IBM.

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

Full Disclosure: I dollar-average into MSFT, NKE, PFE, BA, KO, INTC, PG, JPM, WMT, JNJ, CAT and IBM, and also own shares of UNH, CSCO, AAPL, DIS, TRV and MMM.

Appendix: Excerpt from Warren Buffett’s February 2020 Letter to the shareowners of Berkshire Hathaway: “Charlie and I urge you to focus on operating earnings and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized...Over time, Charlie and I expect our equity holdings – as a group – to deliver major gains, albeit in an unpredictable and highly irregular manner. To see why we are optimistic, move on to the next discussion. The Power of Retained Earnings. In 1924, Edgar Lawrence Smith, an obscure economist and financial advisor, wrote Common Stocks as Long Term Investments, a slim book that changed the investment world. Indeed, writing the book changed Smith himself, forcing him to reassess his own investment beliefs. Going in, he planned to argue that stocks would perform better than bonds during inflationary periods and that bonds would deliver superior returns during deflationary times. That seemed sensible enough. But Smith was in for a shock. His book began, therefore, with a confession: “These studies are the record of a failure – the failure of facts to sustain a preconceived theory.” Luckily for investors, that failure led Smith to think more deeply about how stocks should be evaluated. For the crux of Smith’s insight, I will quote an early reviewer of his book, none other than John Maynard Keynes: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point. Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.” 

Warren concludes that history lesson on this note: “Charlie and I have long focused on using retained earnings advantageously. Reinvestment in productive operational assets will forever remain our top priority. In addition, we constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price.”


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Month 103 - Berkshire Hathaway's A-rated "Value" Stocks with High Dividend Yields - January 2020

Situation: In case your reason for buying stocks in your working years is to have growing income from dividends in your retirement years, we suggest that you prioritize “value stocks.” The bible of value investing is a book (The Intelligent Investor) written by Benjamin Graham, who was Warren Buffett’s instructor while Warren was earning his Master of Science in Economics degree at Columbia University. 

Why value investing, and what is a value stock? The main idea is to not overpay for either Earnings Per Share (EPS over the trailing twelve months, abbreviated ttm) or Book Value per share in the most recent quarter (abbreviated mrq). On page 349 of the Revised Edition (1973) of The Intelligent Investor, Benjamin Graham says “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings [per share] below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb, we suggest that the product of the [EPS] multiplier times the ratio of price to book value should not exceed 22.5.” That is, 1.5 x 15 = 22.5.

How do you calculate the “Graham Number” -- the “rational” stock price listed in Column AA of the Table? It is the square root of 22.5, times (Earnings Per Share for the ttm), times Book Value per share for the mrq. We suggest that you think of the share price of a value stock as being no greater than: a) twice the Graham Number, b) 25 times average 7-year Earnings Per Share (see page 159 of The Intelligent Investor), c) 3 times Book Value per share (ttm), and d) 3 times sales per share (mrq). If a company meets 3 out of 4 of those criteria, we call its stock a “value stock” in Column AF of the Table. 

Berkshire Hathaway’s stock portfolio contains 48 holdings worth $214,673,311,000 as of the last 13F SEC filing dated 11/14/19. The top 5 holdings (AAPL, BAC, KO, WFC, AXP) are worth ~$142B (66% of the total). We rate 8 of the 48 as being high-yielding “value” stocks (KO, PG, JPM, JNJ, TRV, USB, PNC, WFC), in that those companies meet an additional 4 criteria we like to use: 1) their bonds are rated A- or better by Standard & Poor’s (S&P), 2) their stocks are rated B+/M or better by S&P, 3) their stocks have the 16+ year trading record that is required for quantitative analysis using the BMW Method, and 4) their stocks are listed in both the iShares Russell 200 Value Index (IWX) and the Vanguard High Dividend Yield Index (VYM). You’ve probably figured out, by this point, that I’m encouraging you to think along these lines when building your own portfolio of retirement stocks. You can get a feel for the process by looking at 8 such stocks Warren Buffett has picked for Berkshire Hathaway’s portfolio.

Mission: Update our Month 98 blog, using our Standard Spreadsheet to analyze value stocks in Berkshire Hathaway’s stock portfolio.  

Execution: see Table.

Administration: The 10 largest positions in Berkshire Hathaway’s portfolio are:

Apple AAPL ($56B)
Bank of America BAC ($27B)
Coca-Cola KO ($22B)
Wells Fargo WFC ($19B)
American Express AXP ($18B)
Kraft Heinz KHC ($9B)
U.S. Bancorp USB ($7B)
JPMorgan Chase JPM ($7B)
Moody’s MCO ($5B)
Delta Air Lines DAL ($4B)

Six of those 10 are are either not high-yielding stocks or not “value” stocks (AAPL, BAC, AXP, KHC, MCO, DAL). Data for those 6 companies can be found in the BACKGROUND Section of the Table. 

A system for buying stocks can be boiled down and presented in a spreadsheet, as long as you realize that it omits assumptions used to estimate intrinsic value. But our Standard Spreadsheet won’t go far in helping you decide to sell a stock. All we have to go by is that Warren Buffett has told us he might sell for two reasons: 1) When a higher return is expected by trading to another asset (to include the loss incurred by capital gains tax); 2) When the company changes its fundamentals. He has also named two stocks he would never sell: Coca-Cola (KO) and American Express (AXP). American Express didn’t make our list for two reasons: 1) the S&P Rating for the company’s bonds is BBB+ as opposed to our minimum requirement of A-, and 2) the company is not in the Vanguard High Dividend Yield Index ETF VYM.

Bottom Line: The 8 A-rated high-yielding value stocks account for $57B (27%) of Berkshire’s stock portfolio. Five of those are in the Financial Services industry (Warren Buffett’s area of expertise). Take-home points include a) don’t overpay for a stock, b) buy what you know, and c) remember that the best bargains are to be found in the Financial Services industry. But note that all 4 of his bank stocks have above-market volatility in share prices (see Column I in the Table), which goes far toward explaining why they’re underpriced (average P/E = 13). Also note that while Coca-Cola (KO) and Procter & Gamble (PG) seem overpriced (see Columns AB-AH in the Table), you’d need to consider intrinsic value before coming to that conclusion.  

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

Full Disclosure: I dollar average into PG, JPM, JNJ and USB, and also own shares of KO, TRV and WFC.

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Month 98 - Berkshire Hathaway’s A-rated High Dividend Yield “Value” Stocks - August 2019

Situation: In case your reason for buying stocks in your working years is to have a growing income from dividends in your retirement years, this blog has emphasized “value stocks.” The bible of value investing is Benjamin Graham’s book: The Intelligent Investor. His most famous student is Warren Buffett, who graduated from Columbia University in 1951 with a Masters Degree in Economics. 

Why value investing, and what is a value stock? The central thought is to discipline yourself not to overpay for earnings and/or assets (“book value”). On page 349 of the Revised Edition (1973) of The Intelligent Investor, Benjamin Graham says “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb, we suggest that the product of the [earnings] multiplier times the ratio of price to book value should not exceed 22.5.” In other words, 1.5 times 15 equals 22.5.

How do you calculate the “Graham Number” or rational stock price? It is the square root of 22.5 times Earnings Per Share for the Trailing Twelve Months (TTM) times Book Value per share for the most recent quarter (mrq). We suggest that you think of the share price of a value stock as being no greater than: a) twice the Graham Number, b) 25 times the 7-year average for Earnings Per Share (see page 159 of The Intelligent Investor), and c) no more than 4 times Book Value per share. When you purchase a stock meeting those 3 requirements, it is demonstrably worth what you paid for it. The details are shown in Columns AA-AE of Tables accompanying our recent blogs. 

Berkshire Hathaway’s stock portfolio contains 46 holdings worth $201,828,368,888 as of the last 13F SEC filing dated 8/14/19. The top 5 holdings (AAPL, BAC, KO, AXP, WFC) are worth $133,600,000,000 (66% of the total). Eight of the 46 companies have issued A-rated value stocks, since the company meets the following 4 criteria: 1) its bonds are rated A- or better by Standard & Poor’s (S&P), 2) its stocks that are rated B+/M or better by S&P, 3) its stocks have the 16+ year trading record that is required for quantitative analysis using the BMW Method, and 4) its stocks are listed in both the iShares Russell 1000 Value Index (IWD) and the Vanguard High Dividend Yield Index (VYM). 

The top 10 stocks in Berkshire Hathaway’s portfolio, listed by valuation, are:

Apple AAPL ($51B)
Bank of America BAC ($25B)
Coca-Cola KO ($21B)
American Express AXP ($19B)
Wells Fargo WFC ($18B)
Kraft Heinz KHC ($8B)
U.S. Bancorp USB ($7B)
JPMorgan Chase JPM ($6B)
Moody’s MCO ($5B)
Delta Air Lines DAL ($4B)

Mission: Use our Standard Spreadsheet to analyze value stocks in the portfolio, based on the 4 criteria listed above.  

Execution: see Table.

Administration: Six of the top 10 stocks in the portfolio are not value stocks (AAPL, BAC, AXP, KHC, MCO, DAL). Data for those can be found in the BACKGROUND Section of the Table.

Bottom Line: The 8 A-rated value stocks account for $54 Billion (27%) of the portfolio’s value. These show that Warren Buffett’s area of expertise is not only value stocks generally but financial services stocks specifically, since 5 of the 8 companies are from that industry. The take-home points for retail investors are: a) don’t overpay for a stock, b) buy what you know, and c) remember that the best bargains are often in the Financial Services industry. But those stocks also tend to have the greatest volatility, which is a key reason why they are underpriced.

Risk Rating: 7 (where 1 = 10-year U.S. Treasuries, 5 = S&P 500 Index, and 10 = gold bullion) 

Full Disclosure: I dollar average into KO, PG, JPM and JNJ, and also own shares of AAPL and TRV.

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Week 389 - Bond ETFs

Situation: You want to balance your stock portfolio with safe bonds. Right? Well, here’s a news flash: You need to start thinking about balancing your bond portfolio with safe stocks. Why? Because the world is gorging itself on debt--households, municipalities, states, nations, and corporations most of all. Yes, this is understandable because the Great Recession was so disabling that central banks everywhere dropped interest rates lower than the rate of inflation. It was free money, so people borrowed the stuff and invested it. Just as the central bankers had intended. Economic activity gradually returned to normal almost everywhere, now that 10 years have passed since Lehman Brothers declared bankruptcy on September 15, 2008. But the Federal Open Market Committee is removing the punch bowl from the party and raising short-term interest rates by a quarter percent 3-4 times a year. Bondholders are stocking up on Advil due to interest rate risk (duration), meaning that for each 1% rise in short-term interest rates there is a material reduction in the value of an existing bond that is worse for long-term than short-term bonds. 

If a company is struggling and has to refinance a maturing issue of long-term debt, it will have to pay a materially higher rate of interest vs. that paid to holders of the expiring bond. This may impact the credit rating of its existing bonds, driving it closer to insolvency. General Electric (GE) is an especially vivid example of how this works. A few short years ago, GE had an S&P rating of AAA for its bonds. That rating is now BBB+ and falling fast. Larry Culp, the CEO, is desperately selling off core divisions of the company in an attempt to avert bankruptcy. 

Mission: Use appropriate columns of our Standard Spreadsheet to evaluate the leading bond ETFs, and compare those to the S&P 500 Index ETF (SPY) as well as a stock with an S&P Bond Rating of AA or better.

Execution: see Table. 

Bottom Line: To offset the risks in your stock portfolio (bankruptcy, market crashes and sensitivity to fluctuation of interest rates), you need a bond portfolio. Why? Because high quality bonds rise in value during stock market crashes and/or recessions, have much less credit risk, and usually less interest rate risk. Stock prices are more sensitive to short-term interest rates than any but the longest-dated bonds, e.g. 30-Yr US Treasury Bonds. Stock indexes like the S&P 500 Index (SPY) have average S&P Bond Ratings of BBB to BBB+, compared to AA+ for 30-Yr Treasuries. To cover those risks, you’ll need a bond fund that has low-medium interest rate risk and high credit quality. BND and IEF are examples (see Table). BIV differs only in having medium credit quality per Morningstar. TLT has high credit quality but also has high interest rate sensitivity. TLT can be compared to a stock with high credit quality and high interest rate sensitivity, e.g. Pfizer (PFE; see Table). The main thing to remember is that stock market crashes are invariably accompanied by a booming bond market (flight to safety). That’s a good thing because governments will have to take on a lot more debt to finance social programs like unemployment insurance.

Risk Rating: 1 for BND and IEF (where 10-Yr Treasuries = 1, S&P 500 Index = 5, gold = 10)

Full Disclosure: I own bond funds that approximate BIV and TLT.

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Week 385 - Let’s Dollar-Average Into 10 Stocks From The Vanguard High Dividend Yield Index

Situation: The advantage of dollar-cost averaging into specific stocks vs. dollar-averaging into the reference index is that you can focus on high-quality companies. However, those companies are less dynamic than early-movers. By investing in an index fund you’ll capture the effect that “earnings surprises” have on prices for early-movers. So, let’s compare a portfolio of 10 high quality stocks to the relevant index. Dollar-averaging identical amounts each month into either the index or each of the 10 stocks is just a way to buy more shares whenever the market is down. That way, I can assume that your returns will approximate the published total returns/Yr.

Mission: Pick 10 stocks from the Vanguard High Dividend Yield Index. Then run our Standard Spreadsheet.

Execution: see Table.

Administration: The 10 stocks I’ve picked happen to be the 10 that I dollar-average into.

Bottom Line: From the spreadsheet, I cannot discern a material difference in long-term returns from dollar-averaging in an index fund, such as the SPDR S&P 500 ETF (SPY) or the Vanguard High Dividend Yield ETF (VYM), compared to dollar-averaging into the 10 stocks I’ve picked. However, there is a material difference with respect to transaction costs: VYM has an expense ratio of 0.08%, whereas, the expense ratio for dollar-averaging into my 10 stocks is ~1.2%.

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

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Week 384 - Which Dividend Achievers Are Likely To Be Safe & Effective Investments?

Situation: The US stock market is overpriced, as we have documented in recent blogs (see Week 378, Week 379, Week 380). So, the question becomes: Which companies will retain value (relatively speaking) during a correction, yet continue to reliably grow their earnings? We’re likely to find such companies in the 3 remaining Defensive Industries (Utilities, Consumer Staples, and HealthCare). S&P’s Defensive Sector used to include Telecommunication Services but that Industry has recently merged Media to become Communication Services. Newly added companies include Netflix (NFLX), Facebook (FB), Alphabet (GOOGL), Twitter (TWTR), Comcast (CMCSA), and Disney (DIS) -- all of which are Growth companies (as opposed to less risky companies in Defensive Industries).

Mission: Use our Standard Spreadsheet to analyze high-quality companies in Defensive Industries that have increased their dividend annually for at least the past 10 years (earning the S&P designation of Dividend Achiever).

Execution: see Table.

Administration: First, we need to define terms.

SAFE:
1) 16-Yr price volatility is less than that for the Dow Jones Industrial Average ETF (DIA -- see Column M in the Table); 
2) 3-Yr Beta is less than 0.7 (see Column I in the Table); 
3) 7-Yr P/E is less than 36 (see Column Z in the Table);
4) S&P Rating on bonds issued by the company is A- or better (see Column R in the Table). 

EFFECTIVE: 
1) 16-Yr price appreciation is at least 1/3rd as great as 16-Yr price volatility (compare Columns K and M in the Table);
2) S&P stock rating is at least A-/M and S&P Stars rating is at least 3 (see Column S in the Table).

Bottom Line: To be clear, there is no such thing as a “safe” stock. When confidence in the company’s future cash flow evaporates, the stock is quickly priced at Tangible Book Value (TBV) per share. That value is out of reach to stockholders in the event of bankruptcy, since it serves as collateral for the company’s bond issues. So, this week’s blog has 4 criteria for safety (plus S&P’s criteria for its Dividend Achiever designation). When those are added to criteria for relatively stable price performance over the past 16 years, we are left with only 9 stocks to consider. Ask Santa Claus to put a sampling of those in your stocking this Christmas.  

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

Full Disclosure: I dollar-average into NEE, JNJ, PG, WMT and DIA, and also own shares in PEP and HRL.

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

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Week 380 - Are Stocks in “The 2 and 8 Club” Overpriced?

Situation: There’s a lot of talk suggesting that an “overpriced” stock market is headed for a fall. And sure, stocks do have rich valuations because the Federal Reserve has kept money cheap for 10 years and bonds don’t pay enough interest to compete for investor’s money (because the Federal Reserve bought up long-dated bonds). Now the Federal Reserve is determined to reverse those policies and investors are having to get used to the idea that stocks will revert to true value. But we have to specify which metrics define “overpriced” and use at least two of those before concluding that a particular stock is overpriced (see our blogs for the past two weeks).

Mission: Run our Standard Spreadsheet, using colors in Columns Y and Z to highlight Graham Numbers and 7-Yr P/Es that are overpriced (purple) or underpriced (green).

Execution: see Table.

Bottom Line: In the aggregate, the 32 stocks in “The 2 and 8 Club” have Graham Numbers that are more than 200% of their current valuation. This leaves room for at least a 50% fall from present prices. However, our confirmation metric does not support such a dire prediction: The average 7-Yr P/E is a little under the upper limit of the normal range for valuations (25). 

Stocks issued by some companies appear to clearly be overpriced, in that the Graham Number is more than twice the stock’s price and the 7-Yr P/E is more than 30: TXN, ADP, UPS, HSY and CAT. Other companies appear to clearly be underpriced in that the Graham Number is less than the stock’s price and the 7-Yr P/E is less than 25: CMCSA, PNC, ADM, PFG and MET. The fact that 5/32 stocks are overpriced and 5/32 stocks are underpriced is indicative of normal distribution (Bell Curve). So, we’ll use this approach often in future blogs.

Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into NEE, JPM, CAT and IBM, and also own shares of TRV, MMM, CSCO and CMI.

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

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Week 371 - Know What You’re Buying: Graham Numbers for “The 2 and 8 Club”

Situation: Stock prices are a function of 3 variables: book value, earnings, and market sentiment. The first two numbers come from the company’s most recent quarterly report. Market sentiment drives the movement in buy and sell orders for a particular block of shares on a public exchange. In the days before electronic trading systems took over, traders would get together after work and make back-of-the-envelope calculations of future book values and earnings for stocks that interested them. This would give them an idea about the price at which the company’s stock would open the next morning. Benjamin Graham gave traders a starting point for those discussions on page 349, Chapter 14, of his book The Intelligent Investor (cf. the Revised Edition of 2003, annotated by Jason Zweig). There he makes clear that a rational price is the square root of 15 times earnings/share (EPS) and 1.5 times book value/share (BVPS), which is the square root of 22.5 X EPS x BVPS. For example, on June 18, 2018, JP Morgan Chase & Co. (JPM) closed at $108.17, with EPS of $6.35 and BVPS of $72.00. The Graham Number equals the square root of (22.5 X 6.35 X 72 = 10,287) or $101.42. Conclusion: JPM is 6.66% overvalued ($108.17/$101.42 = 1.0666).  

Mission: Run our Standard Spreadsheet for the 22 companies in “The 2 and 8 Club” to include Graham Numbers.

Execution: see Columns Z and AA in this week’s Table.

Bottom Line: The average company on this list is overvalued by a factor of three (see Column AA), reflecting the end-of-times for the second longest Bull Market since the Great Depression. You have to ask yourself why you still own shares of a stock that is priced more than 3 times its fundamental value. Those reasons will always reflect market sentiment unless you know of a specific reason why earnings and book value are going increase above trend, and you’re almost certain it will play out that way.

Risk Rating: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into MSFT, NEE, JPM, CAT and IBM and also own shares of TRV, MMM, CSCO and CMI.

"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

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 368 - Are You A Baby Boomer (54 to 72 years old) With Only $25,000 In Retirement Savings?

Situation: Here in the United States, a third of you have less than $25,000 in Retirement Savings.

Mission: Assess options for a healthy married couple with a household income of $59,000/yr, whose breadwinner will retire when he or she reaches age 66 and the household starts receiving an initial Social Security check of $2,123/mo . Assume that they have $25,000 in retirement savings in an IRA, with an initial payout of $75/mo.

Execution: see Table.

Administration: The options for the couple to receive an income from their $25,000 IRA are unattractive. They’ll need a relatively safe way to come up with an income of 3-4%/yr from that $25,000, a way that grows the principal at least as fast as inflation (historically 3.1%/yr). That growth rate can be predicted from the 5-yr growth rate for the quarterly dividend. To have enough confidence in that stream of income, their only option is to find half a dozen high-quality stocks with low price variance (5-yr Beta less than 0.7) and secure dividends. 

They should be able to live reasonably well on $2,198/mo, given that the poverty line for a household of two is $1,372/mo. But let’s break it down: They’ll pay at least $900/mo for housing (rent, tenant’s insurance, and utilities), so they’re left with $1,300/mo to cover the consumer price index categories of food and beverages, apparel, transportation, medical care, recreation, education and communication, and other goods and services. “Other goods and services” include restaurant meals, delivery services, and cigarettes. Food will cost at least $250/mo. Now they’re down to ~$1,050/mo to cover clothing, car expenses, Medicare premium plus deductibles and co-payments, smartphones, meals out, vacations, delivery services, and cigarettes. Owning, maintaining, and operating a used car for 5,000 miles/yr will cost ~$625/mo, which leaves $425/mo for clothing, healthcare, smartphones, meals out, vacations, delivery services, and cigarettes. To avoid selling the car, one of them will need to find a part-time job. New clothes, dining out, and travel will be hard to fund. Out-of-pocket healthcare costs will go up, so they’ll need to save money by avoiding alcohol, tobacco, caffeine, and sweets. 

Bottom Line: When a couple is facing a retirement that will be funded only by the average Social Security payout at full retirement age ($25,476/yr), they won’t be living much above the Federal Poverty Level for a household of two ($16,460/yr). It they own a home, they’ll no longer be able to afford to maintain it and pay property taxes. So, they’ll need to sell it and invest the residual equity. Maintaining their car will barely be affordable. Having $25,000 in an IRA will help, but a third of couples in their situation will retire with an even smaller cushion. In our Table for this week, we show how $75/mo is the expected income from an IRA of $25,000 value that has an average dividend yield of 3.6%/yr.

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

Full Disclosure: I dollar-average into NEE, KO, and JNJ.

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

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Week 365 - “Dogs of the Dow” (Mid-Year Review)

Situation: The 10 highest-yielding stocks in the Dow Jones Industrial Average are called The Dogs of the Dow (see Week 305 and Week 346). The only time-tested formula for beating an index fund (specifically the Dow Jones Industrial Average) is based on investing equal dollar amounts in each Dog at the start of the year. That would have worked in 6 of the past 8 years. Why? Because those are high quality stocks that have suffered a price decline and are likely to recover within ~2 years, which would lower their dividend yield and release them from the “Dog pen.” 

Mission: Predict which Dogs will emerge from the Dog pen by the end of 2018, using our Standard Spreadsheet.

Execution: see Table.

Administration: For various reasons, the 2018 Dogs are unlikely to post greater total returns this year than the Dow Jones Industrial Average (DIA). But we can still try to play the game by predicting which of this year’s Dogs will be missing from next year’s Dog pen. Those will probably come from those posting lower dividend yields at the mid-year point (see Column G in the Table): Coca-Cola (KO), Cisco Systems (CSCO), General Electric (GE), Merck (MRK) and Chevron (CVX).

Bottom Line: Given current trends, Cisco Systems (CSCO) and Chevron (CVX) are likely to be released from the Dog pen at the end of the year.

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

Full Disclosure: I dollar-average into KO, PG, XOM and IBM, and also own shares of CSCO.

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

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