Situation: Want to bet on agriculture? Then pay attention to fertilizer stocks. That’s where returns outweigh risk (whereas, risk outweighs returns from commodity futures in grain and soybeans because futures incorporate borrowed money). But realize that net farm income has fallen 46% over the past 3 yrs here in the US. A decline that large and lasting that long hasn’t happened since the Great Depression. The reasons for that decline relate to improvements worldwide in technology (e.g. GMO seeds), infrastructure (e.g. paved roads), and logistics (e.g. free trade agreements), resulting in an overproduction of crops. The USDA Foreign Agricultural Service website is a good starting place, if you want to learn more about how this happened.
US farmland has grown 7%/yr in value since 2002, going from an average price of $1,590/acre to $4,090/acre, partly because 8% of the acreage disappeared due to urbanization and the conversion of farmland to parks and pasture. Farmers increasingly overuse their land to justify its cost, which leads to a greater dependence on improvements in technology, infrastructure and logistics. But at the most basic level, “overuse” means that more fertilizer will be applied to counteract the depletion of nitrogen, potassium and phosphate from the soil.
Mission: Apply our standard spreadsheet analysis to large fertilizer companies in the US and Canada, namely those that have appeared on the annual Barron’s 500 List in recent years. Exclude companies that haven’t had their stock traded long enough to appear on the 16-yr BMW Method List. Include 5-yr returns on key commodity contracts (corn, soybeans, wheat, cattle and copper). In making this analysis, we find that only 5 companies meet our requirements, and none are Dividend Achievers.
Execution: see Table.
Administration: Commodity-related investments are speculative. With farming, there are additional variables to consider, namely, dependence on soil, sunshine and water. Soil has to supply 5 of the 7 elements essential for life: nitrogen, phosphorus, and potassium being the most important. In addition, soil provides sodium and chlorine ions that come from the life cycle of small organisms living within the soil. Finally, sunshine and water allow healthy plants to synthesize the other two essential elements by combining carbon dioxide in the atmosphere with water: oxygen, and useful forms of carbon -- sugar and cellulose.
Farmers have traditionally tried to reverse soil depletion by 1) rotating crops, 2) leaving fields fallow every 3 yrs, and 3) pasturing cows on the field in the off-season, to distribute natural fertilizer (manure). But the costs for farm implements and land have risen so much that farmers reach for the maximum yield of whatever crop will give them the greatest return on investment. Therefore, they will over-plant every field every year. This over-planting leads to the purchase of more fertilizer, which is distributed using bigger sprayers. As millions of farmers around the world are adopting this approach, the supply of grain and soybeans has come to exceed demand. The result has been that the prices farmers receive for their grain and soybeans collapsed 3 yrs ago, and has yet to recover. Farmers have tried to stop buying new machinery and the most expensive seeds, i.e., the seeds that have been genetically engineered to carry yield-maximizing traits. And, farmers have tried to spend less on fertilizer, water, insecticides, fungicides and herbicides. In other words, the vendors that serve farmers are merging operations in a desperate attempt to stave off bankruptcy.
Bottom Line: You can make a lot of money on volatile commodity investments like fertilizer stocks but if you don’t know when to sell, you’ll incur large losses. To allay that risk, it is necessary to study the trends in a) crop prices, b) weather cycles (El Nino and La Nina), and c) inventories of foodstuffs and agronomy chemicals, particularly fertilizer. Or, you can follow a Warren Buffett recommendation: dollar-cost average your investment, and continue spending a fixed-dollar amount each quarter on that (now) cheapened stock. You’ll have bought many shares at absurdly low prices, so you’ll be ahead nicely on your investment when prices recover. But beware: Shares in Potash Corporation of Saskatchewan (the largest fertilizer company) went for $61.60 in 2/1/11 and $18.55 on 2/1/17. That’s a 70% loss over 6 yrs. When it comes to commodity-related stocks, dollar-averaging is a fool’s errand. You have to sell quickly whenever you conclude that earnings are likely to stop growing.
Which fertilizer stock of the five in the Table looks the most promising? Not surprisingly, the two largest players (by market capitalization) are merging with one another: Agrium (AGU) and Potash Corporation of Saskatchewan (POT). Why? Because the multi-year collapse in grain and soybean prices has pulled the rug out from under fertilizer sales (see Column F in the Table under “commodity futures”). If you buy stock in either POT or AGU you’ll eventually be rewarded because 1) population growth increases the demand for food, and 2) urban sprawl (combined with droughts due to global warming) reduces the availability of arable land.
Risk level: 9 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and Gold Bullion = 10)
Full disclosure: I own shares of AGU.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends accrue in 10th year), Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-5 Yr CAGR found at Column H. Price Growth Rate is the 20-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/Yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 14.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 9
Sunday, April 2
Week 300 - $185/week For A Low-cost Online Retirement Fund
Situation: Let’s say you make $64,000/yr but don’t have a workplace Retirement Plan. You still need to put 15% of your income (or $9,600/yr or $185/week) into a Retirement Plan. You can’t expect Social Security checks to replace more than 40% of your salary.The lowest cost self-directed plan would be composed of an IRA for stocks and Inflation-protected US Savings Bonds (ISBs) for bonds. We define costs as a) transaction costs, b) taxes, and c) inflation. The annual IRA contribution limit is $5,500/yr ($6,500/yr if you’re over 50). That doesn’t cover the $9,600/yr you need to shield from taxes, which is where ISBs come in handy. Those have a $10,000/yr contribution limit, work like an IRA to defer taxes, and carry the added benefit of shielding you from inflation.
Mission: Set up our standard spreadsheet (see Table) for $6000/yr of online stock purchases which go into an IRA, and $3600/yr of online bond purchases, which go into ISBs.
Execution: see Table, where the Vanguard Interm-Term Bond Index Fund (VBIIX) is a proxy for ISBs to facilitate comparison with stocks, which are neither inflation-protected nor tax-advantaged.
Administration:
Plan A: You can put $100/mo into each of 5 stocks purchased online through computershare, then have your accountant declare that account at computershare to be your IRA. This assumes you’re over 50 years old when you start this plan.
Plan B: You can put $500/mo into a Total Stock Market Index Fund (VTSMX) IRA marketed by the Vanguard Group. VTSMX carries an expense ratio of only 0.16%/yr vs. 0.58%/yr for stocks purchased through computershare (see Column P in the Table). NOTE: Plan B is the smarter option. Why? a) The expense ratio is lower. b) An index fund eliminates the considerable risk of selection bias.
With either Plan, $300/mo is put into ISBs with automatic online withdrawals from your checking account. Less money is put into bonds than into stocks because Social Security payments are made from a US Treasury Bond Fund. The interest payments on ISBs are based off the interest payments for 10-yr Treasury Notes corrected for the value of the tax deferral benefit and inflation correction benefit. Also, remember that ISBs have zero transaction costs and zero inflation risk; interest accrues biannually and cannot be taxed until the bond is redeemed. To better understand why you should confine your bond investments to 10-yr US Treasury Notes, read the fine print:
Caveat emptor: “The hard part of setting up a Retirement Plan is understanding the role of bonds. Those go up in value when stocks go down, so bonds need to form half of the assets meant to sustain you in retirement. Why do bonds go up in value when stocks go down? Because bankruptcy drops bond prices to the liquidation value of collateral, say 70 cents on the dollar, whereas bankruptcy drops stock prices to zero. The easy part to understand is that the risk that a bond will end up in bankruptcy court is specified by the interest rate: no investor will buy a bond that doesn’t pay enough interest to compensate for the risk being assumed. The zero-risk set point for interest rates everywhere is the 10-yr US Treasury Note. A commercial bond has to pay sufficiently more interest to draw in a buyer. On a risk-adjusted basis, all publicly-traded bonds pay the same rate of interest. Given that Treasuries are obtained online at zero cost, there is no reason to own any other type of fixed-income investment (unless you’re a bond trader).”
Bottom Line: Investment-grade bond and total stock market indexes have approximately the same inflation-adjusted total returns over multi-decade periods of ~3%/yr (e.g. see Lines 21 and 22 in the Table). Those returns remain roughly equivalent, otherwise investors would accumulate less money in one in order to favor the other.
Instead of using stock & bond indexes, you can have professionals pick stocks and bonds for you. This is tempting, since most stock and bonds make unattractive investments (because most companies have Balance Sheet problems or a weak Brand). That’s why an actively managed & balanced mutual fund like Vanguard Wellesley Income Fund (VWINX) outperforms a 50:50 mix of stock and bond index funds (compare Line 13 to Line 23 in the Table).
Or you can pick conservative bonds and stocks for yourself and keep transaction costs low by investing online (compare Line 10 to Lines 13 and 23 in the Table). NOTE: transaction costs in Column AB, which come to 0.58%/yr ($56/$9600).
Risk Rating: 4 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, KO, IBM, JNJ, NEE, and ISBs.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Set up our standard spreadsheet (see Table) for $6000/yr of online stock purchases which go into an IRA, and $3600/yr of online bond purchases, which go into ISBs.
Execution: see Table, where the Vanguard Interm-Term Bond Index Fund (VBIIX) is a proxy for ISBs to facilitate comparison with stocks, which are neither inflation-protected nor tax-advantaged.
Administration:
Plan A: You can put $100/mo into each of 5 stocks purchased online through computershare, then have your accountant declare that account at computershare to be your IRA. This assumes you’re over 50 years old when you start this plan.
Plan B: You can put $500/mo into a Total Stock Market Index Fund (VTSMX) IRA marketed by the Vanguard Group. VTSMX carries an expense ratio of only 0.16%/yr vs. 0.58%/yr for stocks purchased through computershare (see Column P in the Table). NOTE: Plan B is the smarter option. Why? a) The expense ratio is lower. b) An index fund eliminates the considerable risk of selection bias.
With either Plan, $300/mo is put into ISBs with automatic online withdrawals from your checking account. Less money is put into bonds than into stocks because Social Security payments are made from a US Treasury Bond Fund. The interest payments on ISBs are based off the interest payments for 10-yr Treasury Notes corrected for the value of the tax deferral benefit and inflation correction benefit. Also, remember that ISBs have zero transaction costs and zero inflation risk; interest accrues biannually and cannot be taxed until the bond is redeemed. To better understand why you should confine your bond investments to 10-yr US Treasury Notes, read the fine print:
Caveat emptor: “The hard part of setting up a Retirement Plan is understanding the role of bonds. Those go up in value when stocks go down, so bonds need to form half of the assets meant to sustain you in retirement. Why do bonds go up in value when stocks go down? Because bankruptcy drops bond prices to the liquidation value of collateral, say 70 cents on the dollar, whereas bankruptcy drops stock prices to zero. The easy part to understand is that the risk that a bond will end up in bankruptcy court is specified by the interest rate: no investor will buy a bond that doesn’t pay enough interest to compensate for the risk being assumed. The zero-risk set point for interest rates everywhere is the 10-yr US Treasury Note. A commercial bond has to pay sufficiently more interest to draw in a buyer. On a risk-adjusted basis, all publicly-traded bonds pay the same rate of interest. Given that Treasuries are obtained online at zero cost, there is no reason to own any other type of fixed-income investment (unless you’re a bond trader).”
Bottom Line: Investment-grade bond and total stock market indexes have approximately the same inflation-adjusted total returns over multi-decade periods of ~3%/yr (e.g. see Lines 21 and 22 in the Table). Those returns remain roughly equivalent, otherwise investors would accumulate less money in one in order to favor the other.
Instead of using stock & bond indexes, you can have professionals pick stocks and bonds for you. This is tempting, since most stock and bonds make unattractive investments (because most companies have Balance Sheet problems or a weak Brand). That’s why an actively managed & balanced mutual fund like Vanguard Wellesley Income Fund (VWINX) outperforms a 50:50 mix of stock and bond index funds (compare Line 13 to Line 23 in the Table).
Or you can pick conservative bonds and stocks for yourself and keep transaction costs low by investing online (compare Line 10 to Lines 13 and 23 in the Table). NOTE: transaction costs in Column AB, which come to 0.58%/yr ($56/$9600).
Risk Rating: 4 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, KO, IBM, JNJ, NEE, and ISBs.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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