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

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Week 331 - Barron’s 500 Stocks in Berkshire Hathaway’s Portfolio

Situation: There are 43 publicly-traded companies in Berkshire Hathaway’s $180B stock portfolio, 29 of which are in the 2017 Barron’s 500 List. The 10 largest holdings are Kraft-Heinz (KHC - $28B), Wells Fargo (WFC - $23B), Apple (AAPL - $19B), American Express (AXP - $12B), Coca-Cola (KO -$17B), Bank of America (BAC - $17B), IBM - $14B), Phillips 66 (PSX - $7B), US Bancorp (USB - $4B), and Wal-Mart Stores (WMT - $4B). Warren Buffett often speaks of the importance of investing in large and well-established companies, particularly those at the top of their peer group that have long trading records. We’d like to know more about those stocks he’s picked for Berkshire Hathaway’s portfolio.

Mission: Run our standard spreadsheet on the 29 companies in the 2017 Barron’s 500 List, taking care to exclude any that do not have the 16+ year trading history that is required for quantitative analysis per the BMW Method.

Execution: 20 companies fit the bill (see Table).

Administration: The list is dominated by 9 companies in the two highest-risk industries among the 10 standard S&P industries. He has picked 7 companies from Financial Services (AXP, WFC, BAC, USB, MTB, BK, GS) and two from Information Technology (AAPL, IBM). Taken together, the 20 companies have risk parameters that are higher than those for the S&P 500 Index. For example, returns during the recent two-year Bear Market for commodities were 3.8%/yr vs. 6.6%/yr for the S&P 500 Index (see Column D in the Table). The extent of loss (at -2 standard deviations from trendline) in the next Bear Market is predicted to average 38% vs. 30% for the S&P 500 Index (see Column M in the Table). 

Bottom Line: Warren Buffett is “all-in” on his long-standing bet that the US economy will do well going forward. Financial Services stand to gain the most in that event, and 7 of the 20 companies in the Table are in that industry, where he is the unchallenged expert when it comes to pricing their brands and analyzing their black-box financial reports. If you’re like me and hold stock in Berkshire Hathaway, you should be happy that he is sticking to basics, i.e., invest in what you know. The downside is that Warren Buffett is one of a kind. We’re left to hope that he will indeed leave the company in good hands. 

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

Full Disclosure: I dollar-cost average into KO, JNJ, MON, and IBM. I also own shares of AAPL, COST, and WMT.

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