Situation: Every so often we go back to our comfort zone, the Dow Jones Composite Average (DJCA) of 65 tried-and-true companies. We call it the Stock-pickers Secret Fishing Hole (see Week 29). Why? Because the DJCA tends to outperform the S&P 500 Index and it has lots of the “old” companies that Warren Buffett likes, i.e., boring but stable moneymakers. Fifteen of the companies are regulated electric utilities (Dow Jones Utility Average or DJUA) and 20 are transportation firms (Dow Jones Transportation Average or DJTA), i.e., railroads, trucking outfits, freight forwarders, airlines, and ocean shippers. The remaining 30 are the so-called “blue chip” companies that make up the Dow Jones Industrial Average (DJIA). We like to periodically revisit the 65 company list because it includes many steady performers that don’t generate much excitement and may even be underpriced. And that’s exactly the kind of company we love to feature.
The annual fixed costs of railroads and electric utilities are so high that they’re organized as “legal monopolies” and require government regulation, which allows them to attract investors but still protect customers from being overcharged. Return on Equity is generally in the 10-12% range, and the effect that price changes have on demand (elasticity) is minimal. Warren Buffett likes that combination, so Berkshire Hathaway’s most prominent moneymakers are Berkshire Hathaway Energy (the largest electric utility in the US), and Burlington Northern Santa Fe (the second-largest railroad). Berkshire Hathaway also owns large blocks of stock in 8 DJIA companies: American Express (AXP), Coca-Cola (KO), ExxonMobil (XOM), General Electric (GE), Goldman Sachs (GS), International Business Machines (IBM), Johnson & Johnson (JNJ), and Wal-Mart Stores (WMT).
To drill down to those companies with exceptional value (see Table), we start with the Barron’s 500 List because it a) contains information on revenues and ROIC (Return on Invested Capital), b) uses that information to rank-order the largest US and Canadian companies, and c) lists the year-over-year change in rank. We then eliminate companies that don’t have S&P bond ratings of at least BBB+ and S&P stock ratings of at least B+/M. Finally, the 37 companies that remain are winnowed down to 20 by excluding those with a Finance Value (Column E in the Table) that doesn’t beat VBINX (Vanguard Balanced Index Fund). In other words, the excluded companies had losses during the 18-month Lehman Panic that were not mitigated by long-term gains. That leaves us with 11 DJIA, 4 DJTA, and 5 DJUA companies (see Table). As a group, these are safe stocks to own because they had losses during the 18-month Lehman Panic of only 18.4% vs. 46.5% for the lowest-cost S&P 500 Index fund, VFINX, and their 5-yr Beta is ~0.65 vs. 1.00 for VFINX.
Bottom Line: Embrace Sutton’s Law (i.e., go where the money is). It’s easier to cull a list of 65 for winners than a list of 500, and even more rewarding if the shorter list outperforms the longer one. For the past 34 yrs, the 65-stock Dow Jones Composite Index has returned 8.7%/yr (without dividends reinvested) vs. 8.3%/yr for the S&P 500 Index. As a typical stock-picker, i.e., someone who has a day job and a family, you have little time to research stocks. We’re here to help, and that means highlighting stocks worth holding in a retirement account. This week there are 20 for you to consider and 5 happen to be Warren Buffett favorites: Wal-Mart Stores (WMT), Johnson & Johnson (JNJ), ExxonMobil (XOM), International Business Machines (IBM), and Coca-Cola (KO). Fourteen are Dividend Achievers (see Column P in the Table) with 10+ yrs of annual dividend increases. Start your hunt by taking a closer look at those but be aware that 4 of the 14 appear to be overpriced (see Column K in the Table): Procter & Gamble (PG), Coca-Cola (KO), Dominion Resources (D), and Nike (NKE).
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, NKE, XOM, and NEE, and also hold shares of MCD, D, IBM, JNJ, and CVX for dividend re-investment.
Note: metrics are current as of the Sunday of publication; red highlights denote underperformance vs. VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Situation: Dow Theory predicts that a bull market will continue if the primary trend is upward, i.e., both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) are making new highs. The idea is that the movement of goods to satisfy demand is every bit as important as producing the goods. As of this writing, the DJTA continues to “confirm” the bull market denoted by the DJIA’s current all-time highs. The problem is that very few companies in that important Transportation Average are investment-grade quality. Only 5 of the 20 companies have 1) a long-term S&P credit rating of BBB+ or better; 2) an S&P stock rating of B+/M or better; and 3) enough revenue to appear on the Barron’s 500 List of the largest public companies on the New York and Toronto Stock Exchanges.
Those 5 are:
CSX Railroad (CSX),
Norfolk Southern Railroad (NSC),
Union Pacific Railroad (UNP),
Expeditors International of Washington (EXPD), and
JB Hunt Transportation Services (JBHT),
We’ve come up with 9 more companies that meet all 3 requirements and derive much (but not all) of their revenue from transportation-related activities. Three of the 9 happen to be among the 30 companies on the DJIA list:
United Technologies (UTX),
Caterpillar (CAT), and
Boeing (BA).
The remaining 6 are:
Canadian National Railway (CNI),
Sysco (SYY),
Canadian Pacific Railway (CP),
PACCAR (PCAR),
Cummins (CMI), and
Honeywell (HON).
How does our newfangled list of these 14 companies help? For starters, the quality is there. You can invest in any of the stocks issued by those companies at any time, as long as you only invest a small and fixed amount over regular intervals (dollar-cost averaging). Second, fundamental information is readily available because all 14 appear on the Barron’s 500 List published annually (in May). There you can find the most recent year’s sales, and the cash-flow related ROIC (Return on Invested Capital) vs. its 3-yr average. Then you can see how those data rank each company and how that ranking compares to the previous year. Third, we show whether the company was a small loser or a big loser during the Lehman Panic (see Column D in all the Table), and whether the company’s long-term total return (Column C in the Table) mitigated that risk (see Column E in the Table). If the Finance Value in Column E beats our benchmark’s (VBINX), you’re likely to benefit from owning the company’s stock instead of shares in VBINX.
Bottom Line: These stocks are the pulse of the economy, meaning they're high-risk high-reward. Only 5 of the 14 are Dividend Achievers, and only one of those (NSC) has a Finance Value that beat’s our key benchmark, the Vanguard Balanced Index Fund (see Table). But there is one other reasonable approach to investing in this sector, and that is to gradually build a position in iShares Transportation Average (IYT), which is an exchange-traded fund (ETF) that tracks the performance of stocks in the Dow Jones Transportation Average. When the earnings of transportation company stocks are growing at a nice clip, you can be confident that the economy is doing well. And vice versa. So own a few of these stocks and learn from their price movements. Then you won’t be mystified by the next lurch upward or downward in the stock market, and you won’t panic (sell) when others do. Except for the railroads (which are government-regulated to protect both customers and investors), the stocks in this week’s Table are not the “buy-and-hold” variety.
Risk Rating: 7
Full Disclosure: I own shares of CNI, UTX, and CMI.
NOTE: Metrics in the Table are current as of the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
