Week 73 - "Food is the New Oil and Land the New Gold"

Situation: Today's title is a quote from Lester R. Brown’s new book (“Full Planet Empty Plates,” ISBN-10: 0393344150) and puts a fine point on why the ITR blog is now being written from Hastings, Nebraska. Planet Earth's reality is that ~220,000 people are born each day. There are also ~3 Billion people who have acquired upward mobility and expectations of a better life. The problem is how will we double food production to feed the planet as it sprints to a population of 7.5 Billion with a growth rate of 3%/yr. Meanwhile, droughts will probably be more frequent, and energy sources and concerns will continue to grow. In the world’s biggest breadbasket, the Great Plains of the US, almost a third of its corn crop is currently being diverted to make ethanol-blended gasoline.

In our breakdown of companies, we have classified “food-related companies” as what we have called defensive or “Lifeboat Stock” type investments (see Week 50). However, food-producing companies are dicey investments because weather plays such a large and unpredictable role in month-to-month pricing of food commodities (wheat, rice, corn, soybeans, oats) and animal feed. Where does that leave an investor who wants to put her hard-earned money toward solving the food problem? Which stocks should she consider buying as a responsible investment? Let’s start by looking at the 18 food-related companies (Table) as presented in The World-Herald 150, a stock index published in the Omaha World-Herald newspaper. That list is a good place to start because of Omaha’s central location on the Great Plains, and because the University of Nebraska is the focal point of agricultural research and policy in the US.

Looking at the Table, it is clear that food-related stocks as a group consistently outperform. In terms of Finance Value (Reward minus Risk in Col E, Table), all but one of the 18 companies outperformed the S&P 500 Index (VFIAX). But there’s a lot of variability. We’ve red-flagged items of concern and only one company is free of those concerns, Hormel Foods (HRL). But 6 more performed almost as well (i.e., beat VFIAX over the past 5 and 10 yrs while falling less than 2/3rds as much during the Lehman Panic). Those companies are PepsiCo (PEP), Aqua America (WTR), Kellogg (K), Smucker (SJM), Hershey (HSY), and Coca-Cola (KO).

Bottom Line: Food-related companies are going to become more compelling for investors as food shortages become more common due to population growth, affluence growth, urban sprawl, increasing energy costs and drought. Food production is a risky endeavor, so stock prices will fluctuate even more as production costs rise. This can be turned to the investor’s advantage by dollar-cost averaging (investing a little each month), owning several such stocks, and avoiding stocks issued by companies that carry significant debt (e.g. LT-debt that exceeds a third of Total Capitalization). As with any commodity, the investor is better off holding stock in a company that buys the raw commodity and turns it into something consumers want to buy than she would be investing directly in the raw commodity. However, the introduction 10 yrs ago of an Exchange Traded Fund (ETF) that buys gold bars (GLD) has shown that investors will buy a raw commodity and have someone store it for later sale. Result: now you can buy an ETF for corn futures (CORN). Its price is volatile but has grown 29% over the past 2 yrs vs. 13% for the S&P 500 Index.

The ITR Risk Rating: The risk rating for this blog is 8 on a scale that sets maximum performance orientation at 10 and maximum safety orientation at 1. [For example, a blog about oil & gas exploration and production companies like Apache (APA) and Suncor (SU) would have a risk rating of 10 and a blog about inflation-protected US Savings Bonds (ISB) would have a risk rating of 1.]

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

Week 72 - So You Want a Small Portfolio of Only 6 Stocks?

Situation: Stocks are risky, 4-5 times riskier than bonds. To capture the value of owning stocks directly vs. owning a stock mutual fund, you need to distribute the risk by owning stock in a number of companies. Academic studies recommend positions in at least 20 companies representing at least 5 industries. But if you’re just starting out, you’ll want to own only a few stocks. Well, there’s a way to do that: pick stocks to overemphasize safety and underemphasize performance. Instead of buying the 1/3rd Lifeboat Stocks and 2/3rds Core Holdings that we recommended (see Week 3), reverse that ratio for a small portfolio of 6 picks and go with companies that have the best credit ratings.

We first identify those that have a AAA credit rating (which is better than US Treasury Bonds with have a AA- credit rating). That AAA credit rating means the risk of bankruptcy is negligible: S&P can identify no concerns or issues that might herald a risk of bankruptcy. We’ve found there are only 4 such companies: Exxon Mobil (XOM), Automatic Data Processing (ADP), Johnson & Johnson (JNJ) and Microsoft (MSFT). To get you to our goal of 6 stocks, we’ll add the next safest company (in our opinion): Wal*Mart (WMT), with a AA credit rating. Then we’ll add the safest utility (in our opinion) that has its bonds guaranteed by a state government: NextEra Energy (NEE), with an A- credit rating.

Given the size of your portfolio, you can’t afford to be concerned about performance. Nonetheless, the 6 companies we’ve identified have performed as well (in the aggregate) as the least costly S&P 500 Index Fund (VFIAX, in the attached Table). More importantly, this “safe” portfolio of 6 stocks was harmed much less than VFIAX by the Lehman Panic.

But now you’ll want to know how these 6 stocks have performed compared to bonds, which we’ve recommended you own in a 1:1 ratio with stocks (Week 3). Bonds did better, as represented in the table by the T Rowe Price New Income Fund (PRCIX). You’d have also done better by avoiding those 6 stocks and holding the lowest cost balanced fund that has at least 50% of its asset value in bonds: the Vanguard Wellesley Income Fund (VWINX, in the Table).

Bottom Line: Owning individual stocks is a time-consuming hobby because you’ll soon realize that you need a baker’s dozen of dividend growers before you’ll sleep well. But there is a way to start with a portfolio of only 6 stocks where the gains are likely to be about as good as the S&P 500 Index and the pains are much less. But a more economical use of your resources would be to hold a low-cost bond-heavy balanced fund like VWINX, and you’ll probably make at least as much money going forward.

In future weekly posts, we’ll distinguish between blogs that feature ideas for investment performance vs. those that feature ideas for safety. In our closing statements, we’ll include a ratings scale of 0 to 10. An number between 7 to 10 will be for discussions that emphasize performance, while 1 to 3 will be for those that emphasize safety. Bear in mind that out-performance cannot be achieved without sacrificing safety but out-performance yields a bigger nest egg for retirement.

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