Week 4 - Introducing the ITR Growing Perpetuity Index

Goal: To compose a value stock index that tracks the S&P 500 Index over two market cycles but with greater total returns and less risk. In the ITR Mission and Goals statement we define these companies as composing what we call the ITR Growing Perpetuity Index (GPI).

• Companies selected for the GPI must: 
• be members of the 65-stock Dow Jones Composite Index;
• have a dividend yield greater than or equal to the yield for SPY (the exchange-traded fund that mimics the S&P 500 index);
• have increased their dividend for 10+ years;
• issue stock that has an S&P Quality Rating of A- or higher;
• issue bonds that have an S&P Bond Rating of BBB+ or higher.
• Currently, we find there are 12 companies that meet our criteria and thereby make up ITR's GPI:
• ExxonMobil (XOM)
• WalMart (WMT)
• Procter & Gamble (PG)
• Chevron (CHV)
• Johnson & Johnson (JNJ)
• Coca-Cola (KO)
• McDonalds (MCD)
• IBM (IBM)
• United Technologies (UTX)
• 3M (MMM)
• NextEra Energy (NEE)
• Norfolk Southern (NSC)
• We used two benchmarks to test the validity of our selection method. One is the longest-running exchange-traded fund that mimics the S&P 500 Index (SPY). The other is the S&P 500 Index mutual fund that carries the lowest expense ratio (0.06%): Vanguard 500 Index Admiral (VFIAX). SPY is traded like any other stock on the New York Stock Exchange (NYSE), whereas, VFIAX is a no-load mutual fund that requires an initial investment of $100,000 and cannot be traded.
• We need two market cycles to show that stocks selected for the GPI really do outperform SPY. SPY started trading on January 29, 1993, and for the first time it became possible to make "apples to apples" comparisons, i.e., purchase the Index and simultaneously purchase a stock. SPY "went live" two years and 4 months after the (250-day moving average of the) S&P 500 Index hit bottom due to the 1990-92 recession. The next bottom occurred in June '03 and the last in October '09, completing two market cycles. January 31, 2012 will be the two market cycle anniversary for SPY since it began trading exactly 19 years earlier.
• To specifically compare the total return of a GPI stock to SPY, we calculate the total return from an investment of $200/month from 2/1/93 until the present day. Our virtual purchases follow the rules for a DRIP account using the ING website (ShareBuilder): namely, a $4 commission is charged for stock purchases but dividends are re-invested for free. For the 18 years from 1993 to 2011, we find that the total return for SPY was 5.1%/yr, whereas, the total return for each of the selected 12 stocks in the GPI was greater. For example, the total return for WalMart (WMT) was 7.3%/yr, for Coca-Cola (KO) was 5.4%/yr, and for NextEra Energy (NEE) was 7.6%/yr.
• We are developing a methodology for anticipating when a Dow Jones Composite Index company is soon going to meet all 5 criteria for membership in the GPI. For example, it became clear in 2007 that Wal*Mart’s Chief Financial Officer (CFO) intended to rapidly increase dividend payouts such that WMT would soon have a yield greater than that of the S&P 500 Index. Given that WMT already met the other 4 criteria for inclusion in the GPI, we could have predicted that WMT would be added to the GPI by 2010.
• Similarly, we are developing a methodology for anticipating when it will soon be necessary to remove a company from membership in the GPI. For example, the 2008 Panic negatively impacted 4 companies that already met all 5 criteria for the GPI – Caterpillar (CAT), Home Depot (HD), Pfizer (PFE), and General Electric (GE). Those companies were soon forced to withdraw plans to raise their dividend; PFE and GE eventually cut their dividend.
• One of our goals is to highlight companies outside the Dow Jones Composite Index that otherwise meet criteria for inclusion in the GPI. Approximately 20 such companies exist in the S&P 500 Index. Some of these strong performers will eventually replace companies now in the Dow Jones Composite Index, and thereby become members of the ITR GPI. In our blog next week, we will introduce you to the ITR Master List of those companies in the S&P 500 Index.

Bottom line: Here’s 12 stocks that can be comfortably added to a very long term DRIP investment portfolio.


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Week 3 - Goldilocks Allocations

Goal: To introduce asset allocation choices (the main drivers of investment returns) that minimize the risk of temporary loss while maintaining strong returns over two market cycles.


The internet makes it possible for investors to simply point and click their way to a balanced portfolio and cut out paying the middle man. This is important in the maintenance of a balanced portfolio for several reasons. First, it is less expensive—management fees are eliminated and commissions are reduced to less than a dollar a share. Second, use of an intermediary agent, such as a mutual fund portfolio manager, introduces what are called agency issues. Agents carry additional costs besides fund management fees: your investment can be allocated in ways that subject your funds to excessive risk of loss, and you will know nothing about it until it is too late. You own the cash you entrust to financial intermediaries but they are not required to act in your best interest. For example, the manager of a mutual fund may select risky stocks in an attempt to out-perform the relevant benchmark. This fund could achieve that during an “up market” but would surely underperform during a “down market” because stock market “risk” is what statisticians call “variance”: it cuts both ways. Risk, with respect to stocks, translates into the risk of bankruptcy for that company. For example, a stock that is unable to pay a dividend and is issued by a company that is deeply in debt is risky—its expenses exceed its earnings. The price of that stock will vary depending on whether the economy is strong enough for its products to be sold at a profit. Its price swings will be exaggerated because the chance it will have to declare bankruptcy is about the same as the chance it will earn enough to pay its debts. Another example is that of companies that are publicly owned but mainly operated by employees who are not shareholders (Berkshire Hathaway and Microsoft being notable exceptions). Those employees are being paid to act as the owner’s agents but they will probably act first to secure their own jobs and enhance their own remuneration.


An individual investor can best minimize the conflict between her needs and agency issues by eliminating this middleman, diversifying her holdings, and investing in companies that value shareholders by paying a reasonable dividend (25-50% of earnings) that increases every year. Direct ownership of stocks is done through Dividend Re-Investment Plans (DRIPs). Almost every S&P 500 company has a DRIP; some companies even waive all expenses. Computershare (computershare) services the largest number of DRIPs. The US Treasury issues the largest number of investment-grade bonds (treasurydirect) and also waives all commissions.


Changes in the macro economy (such as recession and inflation) are externalities that we try to anticipate through asset allocation decisions. For example, commodity-related stocks keep step with inflation and consumer-staples stocks retain value during a recession. Our ITR asset allocation plan is designed to weather these storms without sacrificing upside potential.


In future blogs, we will explore the ITR Investment Strategy:

• Use do-it-yourself point-and-click investment in assets that generate dividends or interest (computershare);
• Use a 50:50 balance of stocks and bonds;
• Select stocks that yield as much or more than the S&P 500 Index (SPY);
• Select stock in companies that have increased annual dividends for at least 10 years;
• Avoid derivatives (assets linked to other assets) except for a global allocation stock fund and two bond mutual funds;
• Stock allocations: 50% industrial & commodity-related, 33% defensive (consumer staples and health care related), and 17% in a global allocation mutual fund;
• Bond allocations: 17% in 10-year US Treasury notes (treasurydirect); 33% in an international bond mutual fund, and 50% in a diversified investment-grade bond mutual fund. A future blog will provide detailed information about purchasing no-load bond funds online.

Bottom Line: Conserve assets, minimize expenses, and maintain what you’ve obtained. Forget about the big kill but instead seek a portfolio similar to one which investors call a “Goldilocks Economy”— not too hot and not too cold.


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