Week 189 - Buffett Buy Analysis of Barron’s 500 List

Situation: What factors underlie pricing for the S&P 500 Index? Is it the capital gains of the collective companies? Is it dividends? Is it stable and/or predictable interest rates? And how much do random fluctuations in the appetite of investors affect prices? With the appearance of big main-frame computers in the 1980s, academicians could start to model these questions. It turns out that only two things matter to S&P 500 Index pricing, earnings and short-term interest rates. That predicts the market may be headed for a fall, given the current expectation that the Federal Reserve will start raising short-term interest rates later this year.

In that event, you’ll want to know which stocks are best positioned to weather such a storm. I know of no other way to answer the question than to subject the 500 stocks in the Barron’s 500 List to the Buffett Buy Analysis (see Week 183 and Week 30 for details). The “BBA” is only useful if the company has been growing its wealth (Tangible Book Value) steadily over the previous decade. By “growing its wealth”, Mr. Buffett means TBV is rising at a rate over ~9%/yr. (We’ll settle for 7%.) By “steadily”, Mr. Buffett means that TBV fell no more than two yrs over the past decade. The BBA is simply an extension for 10 more yrs of the rate at which core earnings grew over the past 10 yrs. That estimates the company’s earnings for 2024, which are multiplied by the lowest P/E seen during the past decade to arrive at the expected stock price in 2024. But if the company pays a yearly dividend, that amount is multiplied by 10 and added. The expected price in 2024 is compared to the current price to give the average total return/yr over the next 10 yrs (BBA) by using a Compound Annual Growth Rate (CAGR) calculator. You’ll find the key numbers in Columns N through R of this week’s Table. 

Sadly, there were only 16 companies with a BBA higher than ~7%/yr. For the most part, that is because prices have been driven up by short-term interest rates that have been under 1% for almost 6 yrs, thus making it cheap for investors to borrow money and invest it in stocks. Those currently elevated stock prices lower the CAGR that prices can achieve over the next 10 yrs.

What can we conclude from the 16 companies that passed the BBA test? For starters, two are railroads, Union Pacific (UNP) and CSX. Those industrial companies are joined by two more: Fluor (FLR) and Expeditors International of Washington (EXPD). Five additional companies are in the information technology sector: Apple (AAPL), Google (GOOGL), Oracle (ORCL), QUALCOMM (QCOM), and Cognizant Technology Solutions (CTSH). Three are Consumer Discretionary stocks: Ross Stores (ROST), Dick’s Sporting Goods (DKS), and Starbucks (SBUX). Two are oil exploration companies: Cameron International (CAM) and National Oilwell Varco (NOV). Two are financial services companies: JP Morgan Chase (JPM) and Travelers (TRV). In summary, 5 of the 10 S&P industry sectors failed to make an appearance (Consumer Staples, Healthcare, Utilities, Communication Services, and Materials), suggesting that those will be contributing little to growth.

Bottom Line: There are some bumps coming for the stock market. Prices have been inflated by cheap money and the lack of competition from bonds. Lifeboat Stocks (see Week 174) are particularly overpriced so you’ll need to maintain a program for investing in growth industries. In this week’s Table, there are 16 growth stocks that get passing grades from the Buffett Buy Analysis.

Risk Rating: 6

Full Disclosure: I dollar-average into JPM, and also own shares of QCOM. 

NOTE: Metrics highlighted in red denote underperformance relative to our benchmark, VBINX; metrics are brought current as of the Sunday of publication.

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