Week 6 - Summary

Situation: Investors have many options, whether they are savers or gamblers, but few of these options are simple, straightforward, and cheap. Our blog meets these objectives by ignoring the ups and downs of stock, bond, commodity, and real estate markets: we identify very long term investments of high quality and low risk, then show the investor how to put a regular investment plan on “autopilot.”

Goal: Once a month, our weekly ITR blog will be a review of the previous 4 or 5 weekly installments. While we are not personal investment counselors, our summaries are an attempt to condense ideas – and thereby provide a degree of guidance to investors who are getting started.

In our Mission and Goals statement, we introduced the ITR Growing Perpetuity Index of 12 stocks. In our Week 4 blog, we provided further details of this index. In Week 5 we provided an ITR Master List of all stocks in the S&P 500 Index that meet our investment criteria, and we introduced a new feature, “The Incubator,” where we are creating a sample investment platform. Now (Week 6) we compare the total returns since 2/1/93 for 8 Growing Perpetuity Index stocks to the total return for SPY. We make 3 assumptions: 1) quarterly dividends are reinvested; 2) $200 is added on the first trading day of each month; and 3) a 2% commission is paid (leaving $196/month for investment). By reinvesting dividends, we capture the power of compound interest. By purchasing a fixed dollar amount of shares each month, we capture the power of dollar cost averaging.

For example, the effect of dividend reinvestment on an investment made in SPY can be illustrated by using the 10 yrs from 12/29/00 (when SPY closed at $131.19/share) to 12/31/10 (when SPY closed at $125.75/share). Although each share of SPY lost 0.42%/yr in value over this period, dividend reinvestment resulted in a total return of 1.3%/yr (moneychimp). Dollar cost averaging (adding $200/month) increased SPY’s total return to 1.9%/yr (because stocks were “on sale” for much of that decade).

In Week 4, we explained why these12 stocks were selected for inclusion in our Growing Perpetuity Index:

• ExxonMobil (XOM)
• Wal*Mart (WMT)
• Procter & Gamble (PG)
• Chevron (CVX)
• IBM (IBM)
• Johnson & Johnson (JNJ)
• Coca-Cola (KO)
• McDonalds (MCD)
• United Technologies (UTX)
• 3M (MMM)
• Norfolk Southern (NSC)
• NextEra Energy (NEE)

DRIPs are available for all 12 stocks but 8 happen to be available at computershare with minimal or no commissions (XOM, WMT, IBM, JNJ, KO, MCD, UTX, NEE). Not only does the “point and click” investor benefit from one-stop shopping but these 8 companies happen to represent all 7 S&P industries that contribute companies to our Growing Perpetuity Index, namely:

• consumer staples (WMT, KO)
• consumer discretionary (MCD)
• health care (JNJ)
• energy (XOM)
• utilities (NEE)
• information technology (IBM)
• industrials (UTX)

This helps to provide diversification for your portfolio. Regular investment in only one company from each of these 7 categories does carry some risk, namely the risk that the chosen company will not be a stellar performer for that sector. However, companies meeting the ITR criteria are “blue chips” that minimize such risk. By undertaking regular, very long term DRIP investment in a company from each of the 7 industries, a newbie investor would achieve total returns in excess of the S&P 500 Index and do so with less risk. Why is there less risk? Two reasons: Firstly, all 3 “defensive” sectors of the stock market are represented: consumer staples, health care, and utilities. Consumers continue to spend on those sectors during a recession and stock prices hold up better. Secondly, the 34 companies (in Week 5) that meet our criteria carry less than half as much debt as the S&P 500 Index as a whole (Debt/Equity = 0.60 vs. 1.25): When revenues fall off in a recession, companies lose value because of the need to service their debt by paying interest and returning principle on bonds that come due. Revenues may not be sufficient to cover those legal obligations so bankruptcy looms in the immediate future.

This week we provide a Total Returns Table where we compare the Total Return (i.e., dividend reinvestment gains + gains from monthly $200 purchases) for each of these 8 stocks over 18.5 yrs (2/1/93 to 8/1/11) to the total return for SPY. This Table shows that stocks chosen because of their high quality and low risk far outperform the S&P 500 Index as a whole. Why is that? It is because most of the companies in the S&P 500 combine low quality with high risk. The 34 exceptions are in our Week 5 ITR Master List.

Bottom line: There is a simple, cheap, and straightforward way to invest in stocks. It requires patience, attention to detail, and the ability to ignore market gyrations.


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