Situation: More than just a technical term in statistics, “alpha” has come to have Unicorn-like significance for traders. Indeed, some investors think of alpha as the Holy Grail of investing. The non-mathematical definition of alpha carries little cachet. It refers to Annualized Total Return from an investment that is in excess of what can be accounted for by fluctuations in the mean value for that asset class, i.e., market-beating returns. It seems that alpha should be simple to achieve since, by definition, half of investments do better than average. For stocks issued by well-established companies, half would have superior returns. The problem is that many such beknighted companies fall out of that category with remarkable frequency, only to be replaced by others that also fall out with remarkable frequency. The result? You should follow Warren Buffett’s advice to retail investors, which is that you’re best off sticking to a low-cost S&P 500 Index fund like the Vanguard 500 Index Fund (VFINX).
But the myth survives in the lay press that you and I can “beat the market” if we but pay a fee to the investment guru, brokerage, or hedge fund of the hour. Here at ITR, we say forget the fee and do-it-yourself online with dividend reinvestment plans (DRIPs). More importantly, we encourage you to forget the myth. It isn’t achievable anyway, for periods longer than 20 yrs, unless you are Warren Buffett, John Templeton, or Peter Lynch. But there are kernels of wisdom in the writings and quotations of those three luminaries, which you and I can use to our advantage: Don’t buy stock in good companies that make money rapidly in a bull market. Instead, look for good companies that lose money slowly in a bear market. That’s why every one of our tables has a Column D that states how much each company’s stock lost during the Lehman Panic. We don’t think companies that lost more than 28% over that 18 month period are worth your attention, since that is how much the hedged S&P 500 Index lost as measured by the Vanguard Balanced Index Fund (VBINX), vs. the 46.5% lost by the lowest cost S&P 500 Index fund (VFINX). Hedging is necessary. So, the idea is to stick to an index fund and seek your own alpha. To do that, you will need to pick DRIP stocks that have made more than VFINX while losing less than VBINX in the Lehman Panic.
Let’s look for companies that beat VFINX for both the past 21 yrs (two and a half market cycles) and the past 5 yrs. We’ll pick those from our universe of 55 companies that have beaten that index since 2002 (see Week 122) and eliminate any company that lost more than the 28% loss sustained by VBINX during the Lehman Panic. Surprisingly, we find 10 companies that have pulled off the alpha feat (see Table). Half of those companies have names that are familiar to anyone who shops: Nike (NKE), TJX, Sherwin-Williams (SHW), Hormel Foods (HRL) and Colgate-Palmolive (CL). They are what they are, namely, unexciting but also able to post good profits year in and year out. Who doesn’t need the stuff they sell? Try going a year without toothpaste, meat, shoes, marked-down new clothes, and paint. In short, most of these companies don’t have great performance because they grow earnings rapidly in a bull market. Instead, it’s because their earnings hold up well in a bear market. Remember: when one of your stocks drops 50% in a recession it has to go up 100% just to get back where it was. In the meantime, 3 to 5 yrs have passed while you’ve had that “dead money” sitting in your brokerage account.
Bottom Line: It is possible to “beat the market” over a long period of time by owning stock in companies that have a strong, recession-proof brand.
Risk Rating: 4
Full Disclosure: I have stock in IBM, Nike (NKE), and Hormel Foods (HRL).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 29
Sunday, December 22
Week 129 - Crop irrigation equipment
Situation: The “Green Revolution” of the 1970s grew out of innovations in farm equipment, augmented by improvements in tillage techniques, fertilizers, insecticides, herbicides, and seeds (see Week 124). Possibly the most important innovation came soon afterward, when groundwater irrigation (from wells) began to replace surface water irrigation (from canals). That transition grew from the innovation of “center-pivot” sprinklers in the 1950s and 60s. Those sprinklers can water 136 acres (of the 160 acres in a quarter section of land) in a single rotation around the center pivot. That cuts the water requirement for growing corn by over 40%. Now another innovation is gaining acceptance, and that is buried drip irrigation systems which selectively irrigate the root zone and cut water requirements by another 40%.
At present, there are a billion acres of irrigated land worldwide. Nine million of those acres are in Nebraska, which is arguably the most productive region for agriculture on the planet. Nearly 8.5 million of those 9 million acres are irrigated by groundwater pumped to center pivots. This doubles productivity in a state that gets only 22 inches of rain a year. Dryland farming depends on rainfall and rainfall of less than 20 inches produces only 110 to 140 bushels of corn per acre, whereas, the yield with center-pivot irrigation is roughly doubled.
Historically, dams have been the most important piece of irrigation equipment. The technology of storing water during the rainy season, for use during the dry season when crops are maturing, has until recently been the only way farmers could “ride out” a multi-year drought. Dams also protect fields and towns from flooding, recharge the aquifer, and provide recreation opportunities that bring in tourist dollars. The unfortunate aspect of the Green Revolution is that farmland has increased 10-fold in value, making it too expensive to buy up and flood with a new dam. (Eminent Domain cannot be used to seize land for the apparent purpose of enriching farmers.) Here in the US, the Army Corps of Engineers worked in the 1970s and 80s to map out all the best locations for placing dams but few have been built. That forces greater use of groundwater wells but also removes the best way to recharge the aquifers that support those wells, which is the reservoir behind a dam--combined with drainage canals that divert excess water (produced by floods) into holding basins. For further information on crop irrigation strategies visit the University of Nebraska at Lincoln website (http://water.unl.edu/web/cropswater/).
As an investor, we think you’ll want to know which listed companies provide irrigation equipment. There are two companies that make center-pivot sprinkler systems, Valmont Industries (VMI), which holds the original patent, and Lindsay Corporation (LNN). You’ll also want to know which listed companies make and install subsurface drip irrigation (SDI) systems. Again, there are two: John Deere (DE) and Toro (TTC). For groundwater irrigation systems, you’ll want to know which companies make the pumps and plumbing that bring well water to the surface and distribute it. Here there are 3 leaders: Xylem (XYL), a company that only recently started issuing stock, Flowserve (FLS), and Marmon Water, a subsidiary of Berkshire Hathaway (BRK-A). Diesel and propane powered generators supply power to groundwater pumps; Cummins (CMI) and Caterpillar (CAT) are the most prominent suppliers.
The future of irrigation will be driven by data collected on crop moisture levels when tractors make a pass through a field. Trimble Navigation (TRMB) has software that uses satellite weather information to produce virtual data on rainfall at any GPS location specified by the farmer. Modern tractors have global positioning systems (GPS) that link to an onboard computer containing data from previous passes through the field. Software packages take over the chores of seeding the field, deciding how much and what kind of fertilizer to place where, and doing the same for insecticides, herbicides, and fungicides. In a new program called Field360, the data collected on John Deere (DE) tractors will be wirelessly downloaded to a local DuPont Pioneer (DD) field office for analysis. Information on crop moisture levels in different parts of the field will be made available to the farmer to use in programming sprinkler (or drip) irrigation systems. A similar system is being rolled out by Monsanto (MON) and another is available through Raven Industries (RAVN) that links to AGCO tractors.
For this week’s Table, we have populated our basic spreadsheet with data for the companies cited above; total returns are impressive. There is, however, a problem for investors: the spreadsheet looks like it has the measles because red highlights are everywhere. Those indicate substandard performance vs. our benchmark (the bond-hedged S&P 500 Index - VBINX). This means that while the potential rewards from investing in irrigation equipment are high the risk is even higher.
Bottom Line: Modern farming is increasingly about automation, and programmed with the help of GPS. This system is gradually reducing the overuse or underuse of inputs like fertilizer, insecticides, herbicides, fungicides, and now water. That automation is based in tractors and combines, standard pieces of farm equipment for generations, that now cost several hundred thousand dollars apiece. For example, at a cost of less than a thousand dollars a year that information can be transferred wirelessly in real time from Deere (DE) tractors to a DuPont Pioneer (DD) field office for analysis. In many parts of the world, water scarcity is the key factor limiting production farming. The new era of micromanagement via GPS promises to optimize water use by responding to known crop moisture levels and rainfall in different parts of a field. Further progress in optimizing water use will depend on large-scale financing for projects that collect and store rain and flood waters by using dams, diversion canals and holding basins. In agricultural areas afflicted with creeping desertification, such projects are the only known way to recharge the depleted aquifers that support groundwater irrigation.
The only stocks mentioned here that currently have good long- and short-term Finance Value, along with high S&P bond ratings, are Berkshire Hathaway (BRK-A) and Monsanto (MON).
Risk Rating: 7
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Full disclosure: I have stock in Deere, Flowserve, DuPont, Cummins, Caterpillar, and Berkshire Hathaway.
At present, there are a billion acres of irrigated land worldwide. Nine million of those acres are in Nebraska, which is arguably the most productive region for agriculture on the planet. Nearly 8.5 million of those 9 million acres are irrigated by groundwater pumped to center pivots. This doubles productivity in a state that gets only 22 inches of rain a year. Dryland farming depends on rainfall and rainfall of less than 20 inches produces only 110 to 140 bushels of corn per acre, whereas, the yield with center-pivot irrigation is roughly doubled.
Historically, dams have been the most important piece of irrigation equipment. The technology of storing water during the rainy season, for use during the dry season when crops are maturing, has until recently been the only way farmers could “ride out” a multi-year drought. Dams also protect fields and towns from flooding, recharge the aquifer, and provide recreation opportunities that bring in tourist dollars. The unfortunate aspect of the Green Revolution is that farmland has increased 10-fold in value, making it too expensive to buy up and flood with a new dam. (Eminent Domain cannot be used to seize land for the apparent purpose of enriching farmers.) Here in the US, the Army Corps of Engineers worked in the 1970s and 80s to map out all the best locations for placing dams but few have been built. That forces greater use of groundwater wells but also removes the best way to recharge the aquifers that support those wells, which is the reservoir behind a dam--combined with drainage canals that divert excess water (produced by floods) into holding basins. For further information on crop irrigation strategies visit the University of Nebraska at Lincoln website (http://water.unl.edu/web/cropswater/).
As an investor, we think you’ll want to know which listed companies provide irrigation equipment. There are two companies that make center-pivot sprinkler systems, Valmont Industries (VMI), which holds the original patent, and Lindsay Corporation (LNN). You’ll also want to know which listed companies make and install subsurface drip irrigation (SDI) systems. Again, there are two: John Deere (DE) and Toro (TTC). For groundwater irrigation systems, you’ll want to know which companies make the pumps and plumbing that bring well water to the surface and distribute it. Here there are 3 leaders: Xylem (XYL), a company that only recently started issuing stock, Flowserve (FLS), and Marmon Water, a subsidiary of Berkshire Hathaway (BRK-A). Diesel and propane powered generators supply power to groundwater pumps; Cummins (CMI) and Caterpillar (CAT) are the most prominent suppliers.
The future of irrigation will be driven by data collected on crop moisture levels when tractors make a pass through a field. Trimble Navigation (TRMB) has software that uses satellite weather information to produce virtual data on rainfall at any GPS location specified by the farmer. Modern tractors have global positioning systems (GPS) that link to an onboard computer containing data from previous passes through the field. Software packages take over the chores of seeding the field, deciding how much and what kind of fertilizer to place where, and doing the same for insecticides, herbicides, and fungicides. In a new program called Field360, the data collected on John Deere (DE) tractors will be wirelessly downloaded to a local DuPont Pioneer (DD) field office for analysis. Information on crop moisture levels in different parts of the field will be made available to the farmer to use in programming sprinkler (or drip) irrigation systems. A similar system is being rolled out by Monsanto (MON) and another is available through Raven Industries (RAVN) that links to AGCO tractors.
For this week’s Table, we have populated our basic spreadsheet with data for the companies cited above; total returns are impressive. There is, however, a problem for investors: the spreadsheet looks like it has the measles because red highlights are everywhere. Those indicate substandard performance vs. our benchmark (the bond-hedged S&P 500 Index - VBINX). This means that while the potential rewards from investing in irrigation equipment are high the risk is even higher.
Bottom Line: Modern farming is increasingly about automation, and programmed with the help of GPS. This system is gradually reducing the overuse or underuse of inputs like fertilizer, insecticides, herbicides, fungicides, and now water. That automation is based in tractors and combines, standard pieces of farm equipment for generations, that now cost several hundred thousand dollars apiece. For example, at a cost of less than a thousand dollars a year that information can be transferred wirelessly in real time from Deere (DE) tractors to a DuPont Pioneer (DD) field office for analysis. In many parts of the world, water scarcity is the key factor limiting production farming. The new era of micromanagement via GPS promises to optimize water use by responding to known crop moisture levels and rainfall in different parts of a field. Further progress in optimizing water use will depend on large-scale financing for projects that collect and store rain and flood waters by using dams, diversion canals and holding basins. In agricultural areas afflicted with creeping desertification, such projects are the only known way to recharge the depleted aquifers that support groundwater irrigation.
The only stocks mentioned here that currently have good long- and short-term Finance Value, along with high S&P bond ratings, are Berkshire Hathaway (BRK-A) and Monsanto (MON).
Risk Rating: 7
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Full disclosure: I have stock in Deere, Flowserve, DuPont, Cummins, Caterpillar, and Berkshire Hathaway.
Sunday, December 15
Week 128 - Disintermediation Is Our Investment Philosophy
Situation: Every project needs a Central Thought or Point of Main Interest. Forty years of investing have taught me to take personal responsibility for controlling my costs, i.e., inflation, taxes, research, and commissions. At first, those seemed to be largely unavoidable. So, I didn't keep track of them. Finally, I realized I was losing money after subtracting what accountants call CGS (Cost of Goods Sold) from my gains, whether paper or actual. That brought me to DIY (Do It Yourself), using DRIPs for stock investing and treasurydirect for bond investing. I could cut out the middleman. There is a fancy name for doing that: disintermediation. My first small step was to dollar-average Savings Bond purchases through automatic withdrawals from my salary, starting in 1992. Two years later, I set up a DRIP for Exxon Mobil (XOM) and soon moved on DRIPs for McDonald's (MCD) and Procter & Gamble (PG). All 4 of those investments have beat inflation and implied taxes over the past two decades, and all but MCD remain free of transaction costs.
Let's break down the benefits of disintermediation. First, you regulate safety. Second, you decide how much to diversify your holdings. Third, you decide whether to emphasize income or growth. Fourth, you decide when to sell. We have suggestions for how you might manage those control levers:
#1 Safety: Start with 40% of your savings in 10-yr Treasury Notes (or Savings Bonds), 20% in hedge stocks (see Week 117), and 40% in other stocks chosen from our universe of 51 (see Week 122).
#2 Diversification: Bonds are priced around the world on the basis of their risk of default compared to the US 10-yr Treasury Note. That makes T-Notes the most obvious hedge for stocks, given that T-Note prices go up in any recession whereas stock prices fall. With stocks, you need to have a portfolio where all 10 S&P industries are represented. You'll need at least 12 different DRIPs; 4 of those need to represent the 4 defensive S&P industries (healthcare, consumer staples, utilities, and telecommunication services) and 4 need to be hedge stocks (see Week 117). For this week’s Table, we’ve picked the highest ranked stock in terms of long-term Finance Value (Column E in the Table) for each of the 10 S&P industries. That leaves non-defensive industries underrepresented so we’ve added the two highest capitalization stocks that remain: Nike (NKE) and Chevron (CVX).
#3 Income vs. Growth: A growing dividend is money in the bank, but a growing stock price is fungible. So look to own stock in growth companies that pay a growing dividend. Many growth companies, i.e., those in the 6 non-defensive S&P industries (energy, materials, information technology, consumer discretionary, industrials and financials), provide substantial and growing dividends even if their fortunes ebb during recessions.
#4 When to sell: If you're dollar-averaging into a DRIP, never sell as long as the dividend is being increased every year. When you retire, start spending (instead of reinvesting) that dividend.
Results of this plan: If you go to the Table and add two parts 10-yr T-Note returns to 3 parts 10-yr returns for our 12-stock list, then divide by 5, you’ll see that the total return/yr is approximately 35% better than the total return/yr for the S&P 500 Index (VFINX) but the risk measures (columns D and L) indicate greater safety.
Bottom Line: What’s not to like about point-and-click investing? Well, your choices have to be well-researched because selling a DRIP comes with tax headaches. You’ll also need to have nerves of steel in order to maintain fixed regular allocations into each DRIP during a bear market. Even though you’re getting more shares for each dollar allocated, you’ll really wish you weren’t shovelling more money into a falling market. I had to learn that lesson the hard way during the dot.com recession but shovelled on during the Great Recession.
Risk Rating: 3
Full Disclosure: I make monthly additions to DRIPs in WMT, NKE, ABT, and IBM. I also have stock in MCD, CVX, MON, and OXY.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Let's break down the benefits of disintermediation. First, you regulate safety. Second, you decide how much to diversify your holdings. Third, you decide whether to emphasize income or growth. Fourth, you decide when to sell. We have suggestions for how you might manage those control levers:
#1 Safety: Start with 40% of your savings in 10-yr Treasury Notes (or Savings Bonds), 20% in hedge stocks (see Week 117), and 40% in other stocks chosen from our universe of 51 (see Week 122).
#2 Diversification: Bonds are priced around the world on the basis of their risk of default compared to the US 10-yr Treasury Note. That makes T-Notes the most obvious hedge for stocks, given that T-Note prices go up in any recession whereas stock prices fall. With stocks, you need to have a portfolio where all 10 S&P industries are represented. You'll need at least 12 different DRIPs; 4 of those need to represent the 4 defensive S&P industries (healthcare, consumer staples, utilities, and telecommunication services) and 4 need to be hedge stocks (see Week 117). For this week’s Table, we’ve picked the highest ranked stock in terms of long-term Finance Value (Column E in the Table) for each of the 10 S&P industries. That leaves non-defensive industries underrepresented so we’ve added the two highest capitalization stocks that remain: Nike (NKE) and Chevron (CVX).
#3 Income vs. Growth: A growing dividend is money in the bank, but a growing stock price is fungible. So look to own stock in growth companies that pay a growing dividend. Many growth companies, i.e., those in the 6 non-defensive S&P industries (energy, materials, information technology, consumer discretionary, industrials and financials), provide substantial and growing dividends even if their fortunes ebb during recessions.
#4 When to sell: If you're dollar-averaging into a DRIP, never sell as long as the dividend is being increased every year. When you retire, start spending (instead of reinvesting) that dividend.
Results of this plan: If you go to the Table and add two parts 10-yr T-Note returns to 3 parts 10-yr returns for our 12-stock list, then divide by 5, you’ll see that the total return/yr is approximately 35% better than the total return/yr for the S&P 500 Index (VFINX) but the risk measures (columns D and L) indicate greater safety.
Bottom Line: What’s not to like about point-and-click investing? Well, your choices have to be well-researched because selling a DRIP comes with tax headaches. You’ll also need to have nerves of steel in order to maintain fixed regular allocations into each DRIP during a bear market. Even though you’re getting more shares for each dollar allocated, you’ll really wish you weren’t shovelling more money into a falling market. I had to learn that lesson the hard way during the dot.com recession but shovelled on during the Great Recession.
Risk Rating: 3
Full Disclosure: I make monthly additions to DRIPs in WMT, NKE, ABT, and IBM. I also have stock in MCD, CVX, MON, and OXY.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 8
Week 127 - Barron’s 500 Industrial Companies That Are Also Dividend Achievers
Situation: The resumption of strong earnings growth in the industrial sector is a hallmark of recovery from a recession. Those companies do so poorly during a recession that their recovery is well publicized by the press. Retail investors take that to be a sign that they’d better “get on the bandwagon.” Professional investors view the resulting inflow of dollars as just one more worry in an already overheated market. They’re afraid that the additional rise in stock prices won’t be justified by the expected rise in corporate earnings. Message? Nobody wants to see another bubble but you need to prepare for one anyway--by hedging your bets.
Is it a good time to buy stock in one or two of the leading industrial companies? No, you’re too late. But there is never a bad time to start putting ~$60/mo into the stock of any well-researched company by using a Dividend Re-Investment Plan (DRIP). To research industrial companies, first try to understand why they’re doing so well. In a nutshell it is for two basic reasons, “on-shoring” and “fracking.” U.S. exports account for well over 40% of world trade, and those exports are growing. But a lot of the parts for those “widgets” are now being built in Asia. Most manufacturers started doing that 10 yrs ago out of sheer necessity. They had to compete on labor costs or go bankrupt. The downside is the cost (and delay) in moving those parts back to the US for final assembly: Think about moving a Boeing 777 wing from where it is made (Japan) to where the plane is assembled (Seattle).
Now that wages have more than tripled in China but fallen here in the U.S., there is no longer an overwhelming labor cost advantage to globalization. In addition, one of the main inputs for manufacturing in general and chemicals in particular is natural gas, which has fallen 50% in price here at home but costs 4 times that much in Asia. Result? Companies are bringing production back home in a process called “on-shoring.” There has also been a new-found appreciation for the infrastructure that the U.S. already has in place, as opposed to the almost non-existent infrastructure in Asian locales where wages are still low (Myanmar and inland China). Paved roads, seaports, railroads, electrical wiring, and airports are essential tools of commerce.
The icing on the cake is that wage growth here in the U.S. has either reversed or stagnated while productivity has kept growing through investment in communication services and information technology. U.S. workers were already the best at interacting with growing automation in the workplace. Then the Great Recession came along and forced companies to double down on robots and automation, producing a dramatic increase in worker productivity. Result? US manufacturing jobs have grown steadily since the third quarter of 2010. This has been the first sustained growth that has occurred since the third quarter of 1998 (U.S. Bureau of Labor Statistics). Message? Build it here. When all is said and done, no other country has a workforce with the talent, creativity, and productivity that is found here in the US.
This week’s Table has all 15 “industrials” found in the Barron’s 500 list of companies with the best records of recent cash flow and sales growth that have also increased dividends annually for at least the past 10 yrs. (Companies with an S&P credit rating of BBB+ or lower were excluded.) All 15 took a hit on earnings during the Lehman Panic but kept growing dividends anyway--out of confidence in the future. Twelve of the 15 showed growth or stability in their cash flow and sales, or maintained their rank in the top 200 on the Barron’s 500 list (see Columns F and G of the Table). Three of those 12 also have good long-term Finance Value (see Column E of the Table): CH Robinson Worldwide (CHRW), Grainger (GWW) and Canadian National Railroad (CNI).
Under BENCHMARKS in the Table, we have added two new features. First, we have included the Vanguard Dividend Growth stock mutual fund (VDIGX) because it prioritizes dividend growth ahead of dividend yield. It also differs from our preference for companies that have 10 or more years of dividend growth by accepting companies with only two years of dividend growth. Second, we have included the sector ETF for industrial stocks (XLI). Red highlights in the Table denote underperformance vs. our benchmark: We use the Vanguard Balanced Index fund (VBINX) that is composed 40% of an investment-grade bond index and 60% of a large-capitalization stock index. That fund lost only 28% during the Lehman Panic vs. 46.5% lost by the S&P 500 index fund (VFINX). We think that hedging against the inevitable bear market for stocks is a fundamental aspect of investing. That is why we have chosen a benchmark (VBINX) that fully hedges the S&P 500 Index fund (VFINX).
The Table also includes 4 columns (O, P, Q, and R) for the Buffett Buy Analysis (see Week 30 & Week 94). That analysis uses for its starting point the 9-yr growth rate for Tangible Book Value (TBV). If that is greater than the nominal rate of GDP growth (5-6%/yr), then the company is said to have a Durable Competitive Advantage (DCA) provided there were no more than 3 yrs in the past 10 when TBV fell. If the stock navigates past those hurdles, its total return over the next 10 yrs is calculated--giving the Buffett Buy Analysis (BBA). That calculation is based on extrapolating core earnings growth over the past 8 or 9 yrs and multiplying that by the worst P/E seen in the past 10 yrs. The current dividend X 10 is added on the assumption that economic conditions won’t allow the company to raise its dividend over the next 10 yrs. The resulting number is the predicted stock price 10 yrs from now; it is compared to the current stock price to arrive at the projected total return/yr over the next decade. If the stock is overpriced now, its BBA will be underwhelming compared to its record of growth in TBV.
Bottom Line: An industrial stock is risky to own because earnings either diminish greatly or disappear in a recession, which is reflected by the stock’s price. But that company is well-positioned to show robust earnings growth when the economy recovers. We find 3 companies that have both long and short term Finance Value (CHRW, GWW and CNI). Grainger (GWW) is too overpriced (P/E = 24) to expect high returns to continue but you might want to see a fuller explanation from Morningstar (www.morningstar.com). CH Robinson Worldwide (CHRW) has had problems acquiring a competitor in the truck-brokerage business, which has depressed its stock price. Apparently that problem has now been resolved, leading Morningstar to upgrade its recommendation to Buy. The third leader on our list, Canadian National (CNI), is thought to be overpriced by Morningstar but the P/E of 18 doesn’t seem that high to us--given that CNI is generally regarded as “the highest margin railroad by far,” to quote the Morningstar analyst.
This week’s Table carries more data than usual because its always a nail-biting experience to commit money to stock in an industrial company.
Risk Rating: 8
Full Disclosure: I own stock in UTX, MMM, CNI, and CAT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Is it a good time to buy stock in one or two of the leading industrial companies? No, you’re too late. But there is never a bad time to start putting ~$60/mo into the stock of any well-researched company by using a Dividend Re-Investment Plan (DRIP). To research industrial companies, first try to understand why they’re doing so well. In a nutshell it is for two basic reasons, “on-shoring” and “fracking.” U.S. exports account for well over 40% of world trade, and those exports are growing. But a lot of the parts for those “widgets” are now being built in Asia. Most manufacturers started doing that 10 yrs ago out of sheer necessity. They had to compete on labor costs or go bankrupt. The downside is the cost (and delay) in moving those parts back to the US for final assembly: Think about moving a Boeing 777 wing from where it is made (Japan) to where the plane is assembled (Seattle).
Now that wages have more than tripled in China but fallen here in the U.S., there is no longer an overwhelming labor cost advantage to globalization. In addition, one of the main inputs for manufacturing in general and chemicals in particular is natural gas, which has fallen 50% in price here at home but costs 4 times that much in Asia. Result? Companies are bringing production back home in a process called “on-shoring.” There has also been a new-found appreciation for the infrastructure that the U.S. already has in place, as opposed to the almost non-existent infrastructure in Asian locales where wages are still low (Myanmar and inland China). Paved roads, seaports, railroads, electrical wiring, and airports are essential tools of commerce.
The icing on the cake is that wage growth here in the U.S. has either reversed or stagnated while productivity has kept growing through investment in communication services and information technology. U.S. workers were already the best at interacting with growing automation in the workplace. Then the Great Recession came along and forced companies to double down on robots and automation, producing a dramatic increase in worker productivity. Result? US manufacturing jobs have grown steadily since the third quarter of 2010. This has been the first sustained growth that has occurred since the third quarter of 1998 (U.S. Bureau of Labor Statistics). Message? Build it here. When all is said and done, no other country has a workforce with the talent, creativity, and productivity that is found here in the US.
This week’s Table has all 15 “industrials” found in the Barron’s 500 list of companies with the best records of recent cash flow and sales growth that have also increased dividends annually for at least the past 10 yrs. (Companies with an S&P credit rating of BBB+ or lower were excluded.) All 15 took a hit on earnings during the Lehman Panic but kept growing dividends anyway--out of confidence in the future. Twelve of the 15 showed growth or stability in their cash flow and sales, or maintained their rank in the top 200 on the Barron’s 500 list (see Columns F and G of the Table). Three of those 12 also have good long-term Finance Value (see Column E of the Table): CH Robinson Worldwide (CHRW), Grainger (GWW) and Canadian National Railroad (CNI).
Under BENCHMARKS in the Table, we have added two new features. First, we have included the Vanguard Dividend Growth stock mutual fund (VDIGX) because it prioritizes dividend growth ahead of dividend yield. It also differs from our preference for companies that have 10 or more years of dividend growth by accepting companies with only two years of dividend growth. Second, we have included the sector ETF for industrial stocks (XLI). Red highlights in the Table denote underperformance vs. our benchmark: We use the Vanguard Balanced Index fund (VBINX) that is composed 40% of an investment-grade bond index and 60% of a large-capitalization stock index. That fund lost only 28% during the Lehman Panic vs. 46.5% lost by the S&P 500 index fund (VFINX). We think that hedging against the inevitable bear market for stocks is a fundamental aspect of investing. That is why we have chosen a benchmark (VBINX) that fully hedges the S&P 500 Index fund (VFINX).
The Table also includes 4 columns (O, P, Q, and R) for the Buffett Buy Analysis (see Week 30 & Week 94). That analysis uses for its starting point the 9-yr growth rate for Tangible Book Value (TBV). If that is greater than the nominal rate of GDP growth (5-6%/yr), then the company is said to have a Durable Competitive Advantage (DCA) provided there were no more than 3 yrs in the past 10 when TBV fell. If the stock navigates past those hurdles, its total return over the next 10 yrs is calculated--giving the Buffett Buy Analysis (BBA). That calculation is based on extrapolating core earnings growth over the past 8 or 9 yrs and multiplying that by the worst P/E seen in the past 10 yrs. The current dividend X 10 is added on the assumption that economic conditions won’t allow the company to raise its dividend over the next 10 yrs. The resulting number is the predicted stock price 10 yrs from now; it is compared to the current stock price to arrive at the projected total return/yr over the next decade. If the stock is overpriced now, its BBA will be underwhelming compared to its record of growth in TBV.
Bottom Line: An industrial stock is risky to own because earnings either diminish greatly or disappear in a recession, which is reflected by the stock’s price. But that company is well-positioned to show robust earnings growth when the economy recovers. We find 3 companies that have both long and short term Finance Value (CHRW, GWW and CNI). Grainger (GWW) is too overpriced (P/E = 24) to expect high returns to continue but you might want to see a fuller explanation from Morningstar (www.morningstar.com). CH Robinson Worldwide (CHRW) has had problems acquiring a competitor in the truck-brokerage business, which has depressed its stock price. Apparently that problem has now been resolved, leading Morningstar to upgrade its recommendation to Buy. The third leader on our list, Canadian National (CNI), is thought to be overpriced by Morningstar but the P/E of 18 doesn’t seem that high to us--given that CNI is generally regarded as “the highest margin railroad by far,” to quote the Morningstar analyst.
This week’s Table carries more data than usual because its always a nail-biting experience to commit money to stock in an industrial company.
Risk Rating: 8
Full Disclosure: I own stock in UTX, MMM, CNI, and CAT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 1
Week 126 - There are 7 “Hedge Stocks” in the S&P 100 Index
Situation: Here at ITR, we like to focus your attention on stocks issued by really big companies. That’s because those companies have the resources and flexibility needed to ride out a bear market. You don’t get as much bang for the buck as you do with small or mid-cap stocks (e.g. those found in the S&P 400 Index) but the risk of damage to your retirement nest egg just when you need it the most (at the beginning of retirement) is much less. Our latest list of “hedge stocks” (see Week 117) had only 16 companies but 7 of those are found in the S&P 100 Index of companies with market capitalizations over ~$35B.
We’ll look at the long and short term Finance Values of those seven. In addition, we’ll look at 3 more companies that are on the border for inclusion that august group: General Mills (GIS) and NextEra Energy (NEE) have ~$35B of market capitalization and are in our list of 16 hedge stocks; Procter & Gamble (PG) is already in the S&P 100 Index but fell just short of being a hedge stock. Why? Because during the Lehman Panic it lost slightly more than our benchmark, the Vanguard Balanced Index Fund (VBINX -- Column D in the Table). But PG is already used by investors around the world to hedge against the risk of their other investments, so we’ll sneak it into our list of S&P 100 hedge stocks.
These 10 stocks have superior long-term Finance Value (Column E in the Table), meaning that after subtracting losses during the Lehman Panic from long-term gains investors came out ahead of our benchmark (VBINX). We assess short-term Finance Value by referencing the Barron’s 500 list for 2013 vs. the 2012 list, to determine whether there has been recent growth in sales and cash flow (Columns L & M in the Table). Of the 3 companies that were in the top 200 in 2012 (ABT, MCD, GIS), only McDonald’s (MCD) slipped out of that group in 2013. Of the remaining 7 companies, only PepsiCo (PEP) had a significantly lower rank in 2013 than in 2012. That leaves us with 8 hedge stocks that have both long and short term Finance Value. Those are the ones you need to study closely. Then think about setting up a DRIP through computershare (which offers DRIPs for all 10).
What’s not to like? Let’s start with the fact that nobody really likes the idea of investing in a hedge fund or hedge stock, since those mainly make money for you by falling less during a bear market at the expense of rising less during a bull market like the one we’ve seen over the past 5 yrs (Column G). Half of those 10 companies failed to make as much money as our VBINX benchmark, which is itself hedged (40% invested in bonds). Returns for those laggards are highlighted in red, as are any other numbers in the Table denoting underperformance vs. VBINX. The S&P 500 Index (VFINX) did even better than VBINX, as you would expect in a bull market.
Now you see what’s not to like. Taken together, the 10 stocks underperformed VBINX over the past 5 yrs (Line 14 at Column G in the Table) and did even worse vs. the S&P 500 Index fund (VFINX): Lines 25 & 26 at Column G in the Table. Think of hedge stocks as ballast, deep in the hold of the ship taking you to retirement. The ship goes slower because the ballast is heavy, but the ship will rock less in a big storm instead of foundering. To give that ship some zip faster after the storm, put a large dollop of our retirement savings in Core Holdings (see Week 102). Those are growth companies that have to be hedged with bonds, but they’ll outperform the S&P 500 Index in a bull market. Note that our list of 10 hedge stocks in the S&P 100 Index has only one Core Holding (MCD). The other 9 are Lifeboat Stocks (see Week 106). No surprise there!
Bottom Line: Hedge stocks don’t need to be backed up with bonds. They’ll carry you through a bear market by losing ~40% less than the S&P 500 Index. Some, like Wal-Mart (WMT) and McDonald’s (MCD), will even gain in value. Why? Because people shop for the cheapest food they can find after they’ve lost their job. Over the past 100+ yrs, market cycles have lasted about 5 yrs and bear markets have accounted for a third of that; bull markets account for 2/3rds. However, the first half of a bull market only serves to get the S&P 500 Index back where it was at the beginning of the bear market. Since the market only makes new highs a third of the time, it is possible for a company’s stock to beat the market by losing less the other 2/3rds of the time. That’s the whole premise behind a hedge fund or hedge stock.
Large companies have a better chance of doing that than small companies, given that they have more product lines, pay lower interest on their loans, and maintain larger cash hoards relative to earnings. The 10 large capitalization stocks in the Table won’t, as a group, do as well as the S&P 500 Index in a bull market but they’ll serve you much better in a bear market. And we’ve had two of those since 3/24/00, when the market peaked just before the “dot.com recession.” Over the 13.5 yrs since then, those 10 stocks have kept more than 7% ahead of inflation (Column C) while the S&P 500 Index still struggles to beat inflation by 1%. You get the point.
Risk Rating: 3
Full Disclosure: I regularly add to DRIPs in 6 of these companies (WMT, PG, KO, JNJ, ABT, NEE), and also own stock in MCD and GIS.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
We’ll look at the long and short term Finance Values of those seven. In addition, we’ll look at 3 more companies that are on the border for inclusion that august group: General Mills (GIS) and NextEra Energy (NEE) have ~$35B of market capitalization and are in our list of 16 hedge stocks; Procter & Gamble (PG) is already in the S&P 100 Index but fell just short of being a hedge stock. Why? Because during the Lehman Panic it lost slightly more than our benchmark, the Vanguard Balanced Index Fund (VBINX -- Column D in the Table). But PG is already used by investors around the world to hedge against the risk of their other investments, so we’ll sneak it into our list of S&P 100 hedge stocks.
These 10 stocks have superior long-term Finance Value (Column E in the Table), meaning that after subtracting losses during the Lehman Panic from long-term gains investors came out ahead of our benchmark (VBINX). We assess short-term Finance Value by referencing the Barron’s 500 list for 2013 vs. the 2012 list, to determine whether there has been recent growth in sales and cash flow (Columns L & M in the Table). Of the 3 companies that were in the top 200 in 2012 (ABT, MCD, GIS), only McDonald’s (MCD) slipped out of that group in 2013. Of the remaining 7 companies, only PepsiCo (PEP) had a significantly lower rank in 2013 than in 2012. That leaves us with 8 hedge stocks that have both long and short term Finance Value. Those are the ones you need to study closely. Then think about setting up a DRIP through computershare (which offers DRIPs for all 10).
What’s not to like? Let’s start with the fact that nobody really likes the idea of investing in a hedge fund or hedge stock, since those mainly make money for you by falling less during a bear market at the expense of rising less during a bull market like the one we’ve seen over the past 5 yrs (Column G). Half of those 10 companies failed to make as much money as our VBINX benchmark, which is itself hedged (40% invested in bonds). Returns for those laggards are highlighted in red, as are any other numbers in the Table denoting underperformance vs. VBINX. The S&P 500 Index (VFINX) did even better than VBINX, as you would expect in a bull market.
Now you see what’s not to like. Taken together, the 10 stocks underperformed VBINX over the past 5 yrs (Line 14 at Column G in the Table) and did even worse vs. the S&P 500 Index fund (VFINX): Lines 25 & 26 at Column G in the Table. Think of hedge stocks as ballast, deep in the hold of the ship taking you to retirement. The ship goes slower because the ballast is heavy, but the ship will rock less in a big storm instead of foundering. To give that ship some zip faster after the storm, put a large dollop of our retirement savings in Core Holdings (see Week 102). Those are growth companies that have to be hedged with bonds, but they’ll outperform the S&P 500 Index in a bull market. Note that our list of 10 hedge stocks in the S&P 100 Index has only one Core Holding (MCD). The other 9 are Lifeboat Stocks (see Week 106). No surprise there!
Bottom Line: Hedge stocks don’t need to be backed up with bonds. They’ll carry you through a bear market by losing ~40% less than the S&P 500 Index. Some, like Wal-Mart (WMT) and McDonald’s (MCD), will even gain in value. Why? Because people shop for the cheapest food they can find after they’ve lost their job. Over the past 100+ yrs, market cycles have lasted about 5 yrs and bear markets have accounted for a third of that; bull markets account for 2/3rds. However, the first half of a bull market only serves to get the S&P 500 Index back where it was at the beginning of the bear market. Since the market only makes new highs a third of the time, it is possible for a company’s stock to beat the market by losing less the other 2/3rds of the time. That’s the whole premise behind a hedge fund or hedge stock.
Large companies have a better chance of doing that than small companies, given that they have more product lines, pay lower interest on their loans, and maintain larger cash hoards relative to earnings. The 10 large capitalization stocks in the Table won’t, as a group, do as well as the S&P 500 Index in a bull market but they’ll serve you much better in a bear market. And we’ve had two of those since 3/24/00, when the market peaked just before the “dot.com recession.” Over the 13.5 yrs since then, those 10 stocks have kept more than 7% ahead of inflation (Column C) while the S&P 500 Index still struggles to beat inflation by 1%. You get the point.
Risk Rating: 3
Full Disclosure: I regularly add to DRIPs in 6 of these companies (WMT, PG, KO, JNJ, ABT, NEE), and also own stock in MCD and GIS.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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