Week 29 - Stockpicker’s Secret Fishing Hole

Situation: The S&P 500 Index represents the largest public companies in the US and uses a “scientific weighting”, where the greater the value of a company’s stock the higher the degree of representation for that company in the Index. We have watched the S&P 500 decline 14% in value over the 12 yr period from 1/3/2000 through 12/30/2011 meanwhile the “unscientific” Dow Jones indexes have increased in value:
   the DJIA (30 industrial stocks) increased 6.2%,
   the DJTA (15 transportation stocks) increased 69%,
   the DJUA (20 utility stocks) increased 64%, and
   the DJA (composite of those 65 stocks) increased 32%.
Ask any fisherman. The place to fish a river is the hole with the biggest fish. The place to fish for stocks is the smallest index that has the most valuable companies: the 65-stock DJA.

To find stocks in the DJA that are close to meeting our 6 criteria (discussed in Week 27) but aren’t quite there yet, we’ve tightened our risk screen to exclude stocks with a 2yr Bollinger Band variance exceeding 3 standard deviations and/or a 5yr Beta exceeding 0.95. That leads us into this week’s blog discussion and a spreadsheet of 9 stock picks. Six of these picks are on the 2012 Master List (see Week 27): KO, XOM, JNJ, NEE, PG, and WMT. The new “fish” are AT&T (T), Intel (INTC), and Travelers Insurance (TRV). You will recall that when we defined the ITR Growing Perpetuity Index (Week 4), we said it is composed of companies in the DJA that meet ITR’s investment criteria. The 3 new companies we identify this week (T, INTC and TRV) are all likely to be added to the GPI over the next 3 years.

Among non-DJA stocks on the 2012 Master List, only Abbott Laboratories (ABT), PepsiCo (PEP), Automatic Data Processing (ADP), and Becton-Dickinson (BDX) meet the low-risk standards that we have used to develop this week’s spreadsheet. In a very difficult 12-year period for stock owners, even these 13 low-risk stocks had tough sledding. Seven beat the 32% price increase for the DJA over that period: XOM (113%), NEE (187%), JNJ (41%), ABT (60%), PEP (88%), BDX (186%) and TRV (78%) but two stocks turned in an even worse performance than the gut-wrenching 14% loss posted by the S&P 500 Index: T (-38%) and INTC (-71%). The 4 “Steady Eddies” were PG (24%), WMT (-13%), KO (21%), and ADP (1%).

It’s worth noting that while the DJA was increasing at a rate of 2.4%/yr over that 12 year period, the Consumer Price Index increased 2.6% and inflation-protected ISB Savings Bonds increased 6.0% (doubling in value). This further illustrates why we recommend that you hedge stocks with an equal investment in bonds. Our point of balancing stock and bond investments 50:50 was emphasized to perfection in a recent Wall Street Journal article titled The Rally That Wouldn’t Die! (1/14/2012): “Since 1981, long-term Treasury bonds (average maturity of 20 yrs) have returned 11.03% annually, 0.05 percentage points better than the Standard & Poor’s 500-stock index.”

Bottom Line: Large, established companies are the best place to look for stocks that have lasting value and lower risk. We’ll continue fishing the Dow Jones Indexes for quality and dependability.

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