Week 186 - Stock-pickers Secret Fishing Hole Revisited

Situation: Every so often we go back to our comfort zone, the Dow Jones Composite Average (DJCA) of 65 tried-and-true companies. We call it the Stock-pickers Secret Fishing Hole (see Week 29). Why? Because the DJCA tends to outperform the S&P 500 Index and it has lots of the “old” companies that Warren Buffett likes, i.e., boring but stable moneymakers. Fifteen of the companies are regulated electric utilities (Dow Jones Utility Average or DJUA) and 20 are transportation firms (Dow Jones Transportation Average or DJTA), i.e., railroads, trucking outfits, freight forwarders, airlines, and ocean shippers. The remaining 30 are the so-called “blue chip” companies that make up the Dow Jones Industrial Average (DJIA). We like to periodically revisit the 65 company list because it includes many steady performers that don’t generate much excitement and may even be underpriced. And that’s exactly the kind of company we love to feature.

The annual fixed costs of railroads and electric utilities are so high that they’re organized as “legal monopolies” and require government regulation, which allows them to attract investors but still protect customers from being overcharged. Return on Equity is generally in the 10-12% range, and the effect that price changes have on demand (elasticity) is minimal. Warren Buffett likes that combination, so Berkshire Hathaway’s most prominent moneymakers are Berkshire Hathaway Energy (the largest electric utility in the US), and Burlington Northern Santa Fe (the second-largest railroad). Berkshire Hathaway also owns large blocks of stock in 8 DJIA companies: American Express (AXP), Coca-Cola (KO), ExxonMobil (XOM), General Electric (GE), Goldman Sachs (GS), International Business Machines (IBM), Johnson & Johnson (JNJ), and Wal-Mart Stores (WMT).

To drill down to those companies with exceptional value (see Table), we start with the Barron’s 500 List because it a) contains information on revenues and ROIC (Return on Invested Capital), b) uses that information to rank-order the largest US and Canadian companies, and c) lists the year-over-year change in rank. We then eliminate companies that don’t have S&P bond ratings of at least BBB+ and S&P stock ratings of at least B+/M. Finally, the 37 companies that remain are winnowed down to 20 by excluding those with a Finance Value (Column E in the Table) that doesn’t beat VBINX (Vanguard Balanced Index Fund). In other words, the excluded companies had losses during the 18-month Lehman Panic that were not mitigated by long-term gains. That leaves us with 11 DJIA, 4 DJTA, and 5 DJUA companies (see Table). As a group, these are safe stocks to own because they had losses during the 18-month Lehman Panic of only 18.4% vs. 46.5% for the lowest-cost S&P 500 Index fund, VFINX, and their 5-yr Beta is ~0.65 vs. 1.00 for VFINX. 

Bottom Line: Embrace Sutton’s Law (i.e., go where the money is). It’s easier to cull a list of 65 for winners than a list of 500, and even more rewarding if the shorter list outperforms the longer one. For the past 34 yrs, the 65-stock Dow Jones Composite Index has returned 8.7%/yr (without dividends reinvested) vs. 8.3%/yr for the S&P 500 Index. As a typical stock-picker, i.e., someone who has a day job and a family, you have little time to research stocks. We’re here to help, and that means highlighting stocks worth holding in a retirement account. This week there are 20 for you to consider and 5 happen to be Warren Buffett favorites: Wal-Mart Stores (WMT), Johnson & Johnson (JNJ), ExxonMobil (XOM), International Business Machines (IBM), and Coca-Cola (KO). Fourteen are Dividend Achievers (see Column P in the Table) with 10+ yrs of annual dividend increases. Start your hunt by taking a closer look at those but be aware that 4 of the 14 appear to be overpriced (see Column K in the Table): Procter & Gamble (PG), Coca-Cola (KO), Dominion Resources (D), and Nike (NKE). 

Risk Rating: 5

Full Disclosure: I dollar-average into WMT, NKE, XOM, and NEE, and also hold shares of MCD, D, IBM, JNJ, and CVX for dividend re-investment.

Note: metrics are current as of the Sunday of publication; red highlights denote underperformance vs. VBINX.

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