Situation: Stock-pickers know what they want, which is to own stock in a company that grows its cash flows ~10%/yr. To convert that growth into retirement income, they'll gravitate to stocks with a dividend yield of ~2%/yr plus a dividend growth rate of ~8%/yr – what I call “The 2 and 8 Club.” But there aren't many companies that will commit to such a generous policy, given that Free Cash Flow has to grow ~10% every year to sustain the policy without borrowing money.
Mission: Find and analyze A-rated companies (with at least $10B in market capitalization) that are members of The 2 and 8 Club. Only analyze Dividend Achievers that are listed in VIG (the Vanguard ETF that excludes the 25% of Dividend Achievers that have unsustainably high dividend yields). Also exclude companies in the Financial Services industry, since those have above-market price volatility.
Execution: see Table.
Administration: Our new requirements (changes italicized) for an A-rating are that a company 1) be listed in the US version of the FTSE All-World High Dividend Yield Index, which we know as the Vanguard High Dividend Yield ETF VYM; 2) be listed in the 20-year BMW Method Screen; 3) issue bonds rated A- or better by S&P; 4) issue stock rated B/M or better by S&P; 5) have a positive number for trailing 12-month earnings (TTM); 6) have a positive number for Book Value in the most recent quarter (mrq); 7) have long-term Debt that is no greater than 2.5 times Equity.
Analysis: Warren Buffett’s favorite metric is addressed in Column R of the Table: Return on Net Tangible Capital Employed. He thinks anything over 20% for the last fiscal year (lfy) is a good number and 6 companies meet that standard: FAST, SNA, TXN, LMT, UPS, ITW. His second point -- that the company is being “run by able and honest managers” -- is addressed in Morningstar reports (see Column AL) and is negatively impacted by the degree to which managers capitalize their company by issuing long-term bonds rather than common stock (see Column U). Two companies (APD and CMCSA) have a BUY rating from Morningstar, and 7 companies have Long-Term Debt:Equity ratios that are less than 1.0 (ADP, FAST, SNA, TXN, APD, CMCSA, GD). Mr. Buffett has also stated that a high Free Cash Flow Yield (Column I) reflects good management because Retained Earnings allow the company to expand (or pay down debt) at zero cost. Ten companies (ADP, WM, SNA, TGT, TXN, LMT, CMCSA, UPS, ITW, GD) have Free Cash Flow remaining after dividends have been paid. His third point -- that the stock be available “at a sensible price” -- is addressed by the 1-yr and 5-yr Forward PEG ratios (see Columns M and N): 5 companies have PEGs under 2.0 at both time points (SNA, TGT, CMCSA, UPS, ITW). Two companies are cited 4 times (SNA, CMCSA).
Bottom Line: The 2 and 8 Club is a plan to invest for reliable growth. Seven of the 13 companies are in IWY (the iShares Russell Top 200 Growth ETF): ADP, WM, TGT, TXN, LMT, UPS, ITW. It is also a belt and suspenders plan, given the risk of loss that growth stocks carry. But you’re being paid up front for taking that risk by confining your attention to large companies with an above-market dividend yield. The hard part is finding reliable growth, which is why you’ll need to further confine your attention to Dividend Achievers.
Risk Rating: 7 (where 10-yr US Treasury Note = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE, TXN, LMT and UPS, and also own shares of APD, CMCSA and GD.
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