Week 211 - Buffet Buy Analysis of 2015 Barron's 500 List

Situation: All investors need a system for projecting the future cash flows (dividends or earnings) of their investments. The one we employ can be found at Column H in any of our weekly tables. It’s labeled “Growth Based on Calculating the Log-linear Compound Annual Growth Rate (CAGR)” of dividend payouts over the past 10-30 yrs. Once a year we calculate the Buffett Buy Analysis (see Week 30) for the 500 stocks found on either the S&P 500 Index or the Barron’s 500 List. This week we’ve used the recently published Barron’s 500 List for 2015. It ranks companies by earnings and revenue growth over the past 3 yrs. 

Mission: Calculate the Buffett Buy Analysis (BBA) for each stock on the 2015 Barron’s 500 List, screening out the large number that haven’t shown at least a 7%/yr increase in Tangible Book Value (TBV) over the past decade and/or had more than two yrs when TBV fell. In other words, the BBA requires companies to have what Warren Buffett calls a Durable Competitive Advantage (DCA).  

Execution: The Table lists 13 companies with a projected return to investors of 7%/yr or more over the next decade. The BBA for each is displayed in Columns M-R of the Table. Companies with an S&P (or Moody’s) bond rating lower than BBB+ have been excluded, as have companies with an S&P stock rating lower than B+/M (see Columns K and L in the Table). 

In previous years of tallying companies that pass the BBA test (see Week 59, Week 94 and Week 158), we’ve found that the number of such companies has steadily declined. This year continues that trend. The reason is that the Bull Market continues to make investors optimistic, leading them to “crowd-fund” companies with persistent earnings growth. Briefly, this is how the BBA works: The trend in tangible earnings growth is projected out 10 yrs. That dollar amount is then multiplied by the lowest P/E over the past decade, and the current dividend x10 is added to give the stock’s price 10 yrs from now. Yes, you get the idea. A higher price paid for a company’s stock today means a slower growth rate (BBA) is needed to reach the calculated price 10 yrs from now. That growth rate (BBA) needs to exceed 7%/yr to meet the “business case” for investing, which is to double one’s investment over 10 yrs. 

That explains why there are fewer names on the list each year, but it doesn’t explain why certain names keep turning up year after year. That can only occur if investors either fail to see the value of those stocks or they’re too nervous to spend more money on them. Now we’ve narrowed the list down to only 13 remaining stocks (see Table), and only one of those hasn’t appeared on earlier lists: MasterCard (MA), which was previously excluded only because it hadn’t been traded for a full 10 yrs. To summarize: Week 59 had 90 companies that included Ross Stores, Apple, QUALCOMM, Union Pacific and Expeditors International. Week 94 had 42 companies that included Ross Stores, Apple, QUALCOMM, Expeditors International, Google and Starbucks. Week 158 had 22 companies that included Ross Stores, Apple, QUALCOMM, Union Pacific, Expeditors International, Google, Starbucks, TJX, Travelers, CSX, Fluor and Dick’s Sporting Goods. 

Bottom Line: If you don’t already have stock in one or two of these companies, think about taking time to look again at their merits. But be aware that the first step of the Buffett Buy Analysis (BBA) is to list the companies that have increased their Tangible Book Value (TBV) faster than 7%/yr over the past decade without their TBV having slowed in more than two of those years. That means the BBA test is only applied to companies that already have a high and stable rate of earnings growth. Those stocks often exhibit high price variance in good times, meaning they’ll also exhibit high price variance in bad times. Apple stock (AAPL) tells that story well (see Column D at Line 5 in the Table). For further confirmation of that point, look at the 5-yr Beta values in Column I of the Table. All of those are high except Union Pacific, which is a government-regulated monopoly. Now you know why the stocks on this week’s list (except MasterCard) have appeared on one or more of our BBA lists over the past 3 yrs, and that’s because they make investors nervous about adding more money. In spite of the obvious merits of these stocks, they haven’t yet become “crowded trades.” 

Risk Rating: 7

Full Disclosure: I have stock in QCOM, UNP, and TJX.

Note: Metrics in the Table that are highlighted in red indicate underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX). Metrics in the Table are current for the Sunday of publication.

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