Week 155 - 41 of the 63 Companies in Our “Universe” Have Improving Fundamentals

Situation: We can all agree by now that the stock market is overvalued, and will likely remain so until lost jobs are recovered. In the meantime, you need to continue building your retirement nest egg. As always, there is a need to diversify your holdings but now you have the added problem of buying into an overpriced market.

How do we help you find good value for the money you’ll be putting down? Central banks around the world have made bonds an unrewarding investment, which encourages investors to buy stock instead. That has worked to boost the world economy to an extent, and many companies have found a way to do well even though millions of workers remain unemployed. In this week’s blog, we highlight 41 companies typifying that improved outlook. We culled those from our “universe” of 63 companies (see the Table for Week 122). Those were chosen because they’re among the 500 largest companies by revenues in the US and Canada (the Barron’s 500 List) but also because they’re Dividend Achievers with 10+ years of dividend growth AND have strong balance sheets with an S&P bond rating of A- or better. To summarize, we cut the list of 239 Dividend Achievers down to 63 by screening for size (large) and safety. But how does that help us find QUALITY?

You’ll remember that the Barron’s 500 List has special value  because it ranks companies by a formula that has 3 inputs: 1) sales growth over one year, 2) cash-flow based ROIC (return on invested capital) growth over 3 yrs, and 3) average ROIC over 3 yrs. The just-published (5/5/14) 2014 edition of the Barron’s 500 List gives us the information we need. It assigns a rank for each company’s performance over the past year and compares that to its rank for the previous year (Columns M and N in the Table). The 41 companies in the Table are the ones from our “universe” of 63 that have either improved their rank over the past year or were in the top 200 for both years. Those 41 are where you want to focus your research because “the trend is your friend”, which is perhaps the most important maxim of stock trading.

The Table provides other information that you’ll find useful, such as the website for setting up a dividend reinvestment plan (DRIP) for each stock, where you can make automatic monthly contributions from your checking account (Column P, titled “DRIP vendor”). But you’ll be distressed by Column J (P/E), which shows just how good investors have been at moving money into companies because of the improving fundamentals that we highlight here, i.e., sales growth that efficiently converts into ROIC growth. 

You’ll want to take a keen interest in the few companies that don’t have their P/E (Column J) highlighted in red, because that means the investor pays less for a share in each dollar of earnings than she would by investing in shares of our benchmark--the Vanguard Balanced Index Fund (VBINX) on Line 53. And, of course, you’ll want to bypass companies with a Finance Value (Column E) highlighted in red, unless you’ve learned a great deal about them that justifies your placing a bet. Those two steps leave you with 9 tickers to consider: ED, XEL, JNJ, ROST, MCD, CB, IBM, LMT and ACE. That’s not bad--notice that 3 “blue chips” are still on the bargain shelf: Johnson & Johnson (JNJ), McDonald’s (MCD), and International Business Machines (IBM). Those 3 don’t excite the kind of speculation that sends P/E values to the roof, which makes them excellent choices for the DRIP investor (although IBM did get pricey in the runup to the “dot.com” crash of 2000). 

Bottom Line: When markets are overpriced, we need to select stocks carefully and build our positions slowly through “dollar-cost averaging”, by adding a fixed amount of money each month. By using online dividend reinvestment plans (DRIPs), you can add $50-100/mo while keeping transaction costs in the 1-2% range; dividend reinvestment is typically cost-free. Eventually, there will be a market correction (or even a bear market). Then you’ll be buying more shares with the fixed amount you invest each month. Over time, prices will revert to each stock’s long-term growth rate, so you needn’t worry about paying too much. Just keep the automatic monthly investments going when the market is down and appears to be headed even lower. (Sort of counter-intuitive, isn’t it??) Try to make regular additions to 10 DRIPs, one for each of the 10 S&P industries noted in Column O (see Week 149).

Risk Rating: 4

Full Disclosure of current investment activity relative to stocks in the Table: I make monthly additions to DRIPs for JNJ, IBM, NEE, and NKE.

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