Situation: A new business cycle started on Oct 1, 2009 (when the S&P 500 Index 250-day moving average started moving up). We’re 8.5 quarters into the new cycle, long enough to assess total returns for the 12 companies in our Growing Perpetuity Index (Week 4).
We’ll examine the outcome from investing $100 at the start of each quarter to buy XOM, WMT, PG, CVX, IBM, JNJ, KO, MCD, UTX, MMM, NSC, NEE and re-invest dividends received from each. We’ll also assume those investments are cost-free, to allow us to compare our investment with the essentially cost-free Vanguard Admiral S&P 500 Index Fund (VFIAX) that is used by Warren Buffett as the benchmark for all asset classes. We will assess raw returns, unadjusted for management expenses, trading commissions, inflation, or taxes. The Vanguard fund has an expense ratio of merely 0.06%/yr because it requires a large initial investment of $10,000. We will also compare those returns with two balanced funds we have assessed previously, i.e., the Blackrock Global Allocation A (MDLOX) and Vanguard Wellesley Fund (VWINX).
Calculating our results as of 11/15/11, the attached <spreadsheet> is a summary of returns. Only 4 stocks under-performed the S&P 500 Index (PG, JNJ, MMM, and NEE) but all 4 showed positive returns for the ~2 yr period we examined. A total of $10,800 was invested ($900 in each of the 12 stocks), which grew to $12,797 representing a total return of 16.0%/yr (vs. 9.32%/yr for VFIAX and 2.73%/yr for the Consumer Price Index). That out-performance is not surprising given that the Growing Perpetuity Index includes iconic brands that are long-term dividend growers and typically yield more than the S&P 500 Index. Moving forward, we have no way of knowing which of the 12 will disappoint but we do know from back-testing that it is unlikely to be these same 4 stocks. For example, during the decade prior to the recent recession the under-performers were Coca-Cola (KO), Norfolk Southern (NSC), and 3M (MMM). After the recession ended, KO and NSC became strong performers. The performance of MMM is likely to improve if more international markets, like Japan’s, emerge from recession. Therefore, the ITR investment recommendation we will make is that you should regularly invest the same amount in every stock of the Growing Perpetuity Index, even if it only happens once a year. If that’s not practical, we encourage you to research the companies in the ITR Master List and purchase at least 4 DRIPs. Keep in mind that new companies will move onto the list (while others may be removed) on a quarterly basis, whereas the 65 companies in the Dow Jones Combined Average (from which the Growing Perpetuity Index companies are selected) rarely change. If your first 4 DRIPs are XOM, WMT, MCD, and IBM, you will have a solid investment.
Of the funds we mentioned earlier, one (MDLOX) under-performed the S&P 500 Index while the other (VWINX) more than kept up. Treasury notes (VFIUX) also did well.
Bottom Line: Investing regularly in as many of the Growing Perpetuity Index stocks as possible is almost certainly a way to “beat the market”. But a low-cost, bond-centric balanced fund like VWINX will also allow you keep up with the market without all the fuss and worry.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 27
Sunday, November 20
Week 20 - Mining & Drilling for Key Commodities: Oil & Gas
Situation: The key commodities extracted from the ground (oil, natural gas, copper and gold) are heavily traded on regulated futures exchanges. Open interest amounts to almost $100 billion but many more contracts trade “over the counter”, i.e., removed from the prying eyes of competitors and regulatory agencies. Some of the companies that find and extract commodities also refine, transport, and/or sell their product. Other companies provide additional services and equipment.
Goal: Orient the ITR investor to dividend-paying companies that produce (or support the production of) key commodities.
This week’s blog takes the ITR investor beyond the Master List into cyclical companies that take more chances with more up-front money. Why? Because these companies supply us with essential commodities. High fixed costs characterize every company that extracts materials from the earth by mining or drilling. When commodity prices are high, new companies are tempted to enter the fray, which then drives prices down. The companies that survive the melee can’t afford to continue innovating and expanding; production remains flat or declines until the economy re-expands enough for the survivors to “pick up the slack”. Most companies that dig commodities out of the ground are dependent on investors who are willing to lose everything in the hope of a big return. If it’s a young company that hasn’t had a chance to expand into safer sidelines (refining, transporting, merchandising), it will likely fail. However, these “junior miners” have enormous upside potential and therefore attract investors who want to gamble.
To analyze companies that mine gold & copper, or drill for oil & gas, it is helpful to focus on a particular geological province that attracts a typical grouping of companies. The Western United States is rich in such provinces with the current favorite being the shale formations that mainly yield natural gas. The recoverable oil & gas in these formations is 3 times that known to be present in Saudi Arabia.
To take a closer look, we will focus our attention first on natural gas plays west of the continental divide. Drilling activities there have expanded rapidly for two reasons: new discoveries and technological breakthroughs that allow formerly marginal geology to be drilled anew. Drilling has increased dramatically since the advent of horizontal drilling and hydraulic fracturing (“fracking”). The Piceance Basin in NW Colorado is the most active recent find but production is rapidly expanding in the well-mapped Green River Basin in SW Wyoming and NE Utah.
The accompanying spreadsheet <click here to open> provides information about 9 companies active in exploration and production (E&P), plus 4 others that provide services and equipment (CAT, NOV, BHI, and SLB). The 6 pure E&P companies are riskiest (APC, NBL, EOG, DVN, ECA, COG) but the 3 companies with refineries (XOM, CVX, and RDS-B) do well through thick and thin, with significant fluctuations in share price because of being tightly tied to the economic cycle. The 4 servicing companies show the fastest earnings growth in each business cycle but with even more marked fluctuations in share price. This pattern (of mining & drilling suppliers reaping the most profit) has held true since as far back as the 1849 California Gold Rush.
All 13 companies pay dividends and are followed by S&P. XOM, ECA, CVX, and NBL are active in Piceance Basin; DVN, RDS, COG, EOG, APC, APC, and CVX are active in Green River Basin. The drilling activity is hard to miss if you’re driving along I-70 in Colorado between the towns of Rifle and Grand Junction. You’ll see many oil service trucks plus the roadside buildup of servicing depots (e.g. near DeBeque). Driving I-80 west of Rawlins, Wyoming, is even more revealing because there is little else to see. An entire city (Wamsutter) has been built for oil workers where only a single gas station existed 15 years ago. Driving through that barren stretch at night is otherworldly because of lights and mists around drilling rigs that are hard to see by daylight.
The big problem with investing in E&P companies is that there always seems to be a wide variation in the quality of management and a shortage of skilled workers. These problems are related because good workers tend to follow good managers. If you’re investing in Exxon (XOM), Chevron (CVX), Shell (RDS-A) or Schlumberger (SLB), that problem has likely been solved. Here at ITR, we’ve been trying to get a handle on the others. We’ll keep you informed of our progress looking at shale plays.
Bottom Line: Drillers have to make a large up-front investment in order to make a lot of money several years down the road (living with a big “maybe”). Most drilling companies are small and don’t last long but do start strong by using money from impatient investors who are attracted to the potential for great rewards. The drillers that do succeed typically look for sidelines with more stable revenues, i.e., lay pipelines, refine petroleum & develop commodity chemicals, transport those products, and open service stations to fuel planes, ships, trucks, and cars.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Goal: Orient the ITR investor to dividend-paying companies that produce (or support the production of) key commodities.
This week’s blog takes the ITR investor beyond the Master List into cyclical companies that take more chances with more up-front money. Why? Because these companies supply us with essential commodities. High fixed costs characterize every company that extracts materials from the earth by mining or drilling. When commodity prices are high, new companies are tempted to enter the fray, which then drives prices down. The companies that survive the melee can’t afford to continue innovating and expanding; production remains flat or declines until the economy re-expands enough for the survivors to “pick up the slack”. Most companies that dig commodities out of the ground are dependent on investors who are willing to lose everything in the hope of a big return. If it’s a young company that hasn’t had a chance to expand into safer sidelines (refining, transporting, merchandising), it will likely fail. However, these “junior miners” have enormous upside potential and therefore attract investors who want to gamble.
To analyze companies that mine gold & copper, or drill for oil & gas, it is helpful to focus on a particular geological province that attracts a typical grouping of companies. The Western United States is rich in such provinces with the current favorite being the shale formations that mainly yield natural gas. The recoverable oil & gas in these formations is 3 times that known to be present in Saudi Arabia.
To take a closer look, we will focus our attention first on natural gas plays west of the continental divide. Drilling activities there have expanded rapidly for two reasons: new discoveries and technological breakthroughs that allow formerly marginal geology to be drilled anew. Drilling has increased dramatically since the advent of horizontal drilling and hydraulic fracturing (“fracking”). The Piceance Basin in NW Colorado is the most active recent find but production is rapidly expanding in the well-mapped Green River Basin in SW Wyoming and NE Utah.
The accompanying spreadsheet <click here to open> provides information about 9 companies active in exploration and production (E&P), plus 4 others that provide services and equipment (CAT, NOV, BHI, and SLB). The 6 pure E&P companies are riskiest (APC, NBL, EOG, DVN, ECA, COG) but the 3 companies with refineries (XOM, CVX, and RDS-B) do well through thick and thin, with significant fluctuations in share price because of being tightly tied to the economic cycle. The 4 servicing companies show the fastest earnings growth in each business cycle but with even more marked fluctuations in share price. This pattern (of mining & drilling suppliers reaping the most profit) has held true since as far back as the 1849 California Gold Rush.
All 13 companies pay dividends and are followed by S&P. XOM, ECA, CVX, and NBL are active in Piceance Basin; DVN, RDS, COG, EOG, APC, APC, and CVX are active in Green River Basin. The drilling activity is hard to miss if you’re driving along I-70 in Colorado between the towns of Rifle and Grand Junction. You’ll see many oil service trucks plus the roadside buildup of servicing depots (e.g. near DeBeque). Driving I-80 west of Rawlins, Wyoming, is even more revealing because there is little else to see. An entire city (Wamsutter) has been built for oil workers where only a single gas station existed 15 years ago. Driving through that barren stretch at night is otherworldly because of lights and mists around drilling rigs that are hard to see by daylight.
The big problem with investing in E&P companies is that there always seems to be a wide variation in the quality of management and a shortage of skilled workers. These problems are related because good workers tend to follow good managers. If you’re investing in Exxon (XOM), Chevron (CVX), Shell (RDS-A) or Schlumberger (SLB), that problem has likely been solved. Here at ITR, we’ve been trying to get a handle on the others. We’ll keep you informed of our progress looking at shale plays.
Bottom Line: Drillers have to make a large up-front investment in order to make a lot of money several years down the road (living with a big “maybe”). Most drilling companies are small and don’t last long but do start strong by using money from impatient investors who are attracted to the potential for great rewards. The drillers that do succeed typically look for sidelines with more stable revenues, i.e., lay pipelines, refine petroleum & develop commodity chemicals, transport those products, and open service stations to fuel planes, ships, trucks, and cars.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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