Situation: We’re always on the lookout for improved business conditions in companies that depend on “long-cycle” commodities. “Green shoots” are now popping up for those that use rocks and minerals as their main feedstock. Why should you care, since all classes of commodities have been falling in price for some time now? Our reasoning is that you need to follow commodities, if only from a distance, because their prices often respond to factors unrelated to the business cycle. What this means is that commodities can help balance risk associated with stocks and/or bonds. Commodity-related companies represent what’s known as “non-correlated assets.” Their stocks have particular value as moderators of portfolio performance. The reason for this is that commodity production carries large initial fixed costs and usually requires extensive logistical networks, but those large “costs of entry” also discourage competitors, so companies have an opportunity to build a strong brand if not a wide moat. There are risks. Once a commodity is found to be in short supply, it takes years to expand production (because of those large fixed costs), by which time shortages may have been corrected through innovative technologies or product substitution. The commodity’s price may fall because of innovations, substitution and newly expanded production. This will make it difficult to justify further investment but also makes it easy for strong companies to “buy out” weak competitors. Possibly one or two of these strong companies will become responsible for further innovation and substitution, then earn profits that exceed those of its competitors. Any excess of the commodity will likely be placed in storage because dialing back production (to meet demand) will not happen fast enough to prevent a precipitous drop in prices.
Mission: Identify large metals and mining companies that are showing steady improvement in Return on Invested Capital (ROIC) and revenues.
Execution: We’ll start with the Barron’s 500 Lists for 2014 and 2015, which rank the 500 largest companies traded on the Toronto and New York stock exchanges by revenue. Those rankings “compare companies on the basis of three equally weighted measures: (1) median three-year cash-flow-based return on investment; (2) the one-year change in that measure, relative to the three-year median; (3) sales growth in the latest fiscal year.” Eight metals and mining companies had a higher rank in 2015 than 2014 (see Table). Only one, Nucor (NUE), is an S&P Dividend Achiever, meaning its dividend has been increased annually for at least the past 10 yrs. Interestingly, all but Southern Copper (SCCO) carry a “buy” recommendation from S&P and/or Morningstar (see Columns T and U in the Table). With respect to our favorite performance metrics, these 8 companies as a group (see Line 10 in the Table) have greatly out-performed the S&P index fund for metals and mining companies (XME) at Line 19 in the Table.
Bottom Line: These 8 leading metals and mining companies are in recovery mode after a bad decade. While their stocks represent speculative investments by any standard, they also carry modest valuations, selling at 1.8 times book value vs. 2.7 for the S&P 500 Index (see Column K in the Table). However, most of the companies in the metals and mining sector ETF (XME) have yet to show signs of recovering from a deflationary decade and sell at only 1.4 times book value. It still remains to be seen whether the world economy will be successful at emerging from the deflation that followed the Lehman Panic. But if it is, most of these companies will double in value over the next two years. Caveat Emptor: these are speculative stocks; none are suitable for inclusion in a retirement portfolio.
Risk Rating: 9
Full Disclosure: I recently purchased stock in Alcoa (AA).
Note: Metrics in the Table are current as of the Sunday of Publication; those highlighted in red denote underperformance relative to our key benchmark (VBINX at Line 16 in the Table).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 30
Sunday, August 23
Week 216 - Short on Retirement Savings? It’s Time to “Right-size” Your Life.
Situation: Many of us (most?) will not make our “Retirement Savings Number” by the time we qualify for full Social Security benefits. What’s a Retirement Savings Number? That is the dollar amount of retirement benefits needed to replace 75% of your pre-retirement wages and salary. Will you make your number? If not, aspects of your life will probably need to be replaced by less costly versions. Why not start working on “right-sizing” your life now and delay full retirement a little longer?
Mission: Outline the areas where lifestyle adjustments can be made without feeling the full effects that job loss entails. Forty years of working a job makes it more than a livelihood; it becomes a “personhood.” Chances are you will miss at least some aspects of the job and the respect it gave you in the eyes of others. Now is the time to focus on finding ways to limit costs but still invest in yourself enough to afford retirement.
Execution: Let’s start with your home. Frequently, we have more living space than needed. Let’s assume you’re comfortable and the mortgage is almost paid off. How can you turn it into income? Reverse mortgages carry hidden costs that limit their attractiveness. Instead, think about converting part of your house into an attractive apartment for rent. Better yet, sell the house and take out a low-cost annuity through TIAA-CREF or Vanguard. Rent only enough living space to meet your retirement needs.
Next is your car. Think about leasing because it is then possible to have a new car every 3 years and benefit from greater dealer incentives than can be had by purchasing a car. Remember that by leasing a scaled-down version of the vehicle you’ve been driving you’ll save money needed for paying bills that increase in retirement (like medical bills). Japan specializes in producing trouble-free but high-quality cars; Honda Civics and Toyota Corollas get excellent gas mileage and come without “sticker-shock.”
This leads into the importance of drawing up a monthly budget. Start by eliminating all debts; use whatever means necessary. This effort will gradually decrease the amount of interest you pay, leaving more money to spend. Food, utilities, rent, and your car lease are the big expenditures; dedicate specific parts of your income to paying those bills. Next comes clothes and entertainment, including travel and recreation. For most retirees, clothes and travel become items they save for, so dedicate part of your income to a savings account. If enough money doesn’t reach that account, then buying new clothes and taking trips will have to be curtailed. This budget limits you to spending “cash on hand.” Your credit cards will show a zero balance at the end of each month, no matter what.
It has been shown through many medical and wellness studies that your weight will have a very big impact on the quality of your life. As we near retirement age, 2/3rds of us are overweight. That translates into both inconvenience and expense during your sunset years. Now is the time to learn how to eat less and smarter. Learn to love having more nuts and veggies, make a habit of “meatless Mondays”, and give up pastries and desserts. Exercise is important for cardiac health but it also makes you hungrier. You won’t lose weight unless you have the discipline to stick with a 2000 Calories/day diet.
“Where's the money [discussion], Lebowski?” You want to find a way to make your Retirement Number, and hope we’ll provide a clear path to resolving that problem. It starts indirectly with lifestyle adjustments that lower expenses and increase income. After that, move directly into plugging any holes in your finances. Three options are available, starting with a delayed retirement. The Social Security Administration will increase your lifetime monthly benefit 8% for each year that you put off retirement. If you retire at age 70 instead of age 62, you’ll go from having your full retirement benefit cut by 25% (retirement at age 62) to having it increased by 32% (retirement at age 70).
It’s now becoming reasonable to make stocks a larger part of your overall retirement savings, to balance the amount of money most of us currently have in bonds. Social Security is a system for paying out interest on US Treasury Bonds. If your full benefit is going to be $1500/mo, and 30-yr Treasuries are paying 3% interest, you have a non-transferable account at the US Treasury worth $600,000. That means the rest of your retirement accounts (defined-benefit pension, IRA, 401k, 403b, plus taxable stocks and bonds) likely need to be 75% in stocks (see this week’s Table for a 12-asset example which carries an expense ratio of only 0.51%). Even then, you’re unlikely to reach the recommended 50/50 balance between stocks and bonds. Does having that much in stocks make you nervous, given recent history? Well, 100 years of history gives a better perspective: Stocks, with dividends reinvested, have grown at 10.1%/yr vs. 5.0%/yr for 10-yr Treasury Notes with interest reinvested. Inflation averaged 3.2%/yr. A 50/50 balance between stocks and bonds would have grown 4.0%/yr after inflation (allowing 0.2%/yr for transaction costs).
Your third option is to prepare to hold a part-time job after you retire. That may require you to get more college education or pay for training and credentialing. (Licensed Practical Nurses and long-haul truck drivers, for example, are in short supply.) But find a way to do that without borrowing money. Why do you need to have no debts when you transition to part-time employment, and have to remain debt-free thereafter? Because you’ll be living on a fixed income (except for any dividend-growing stocks you might own and any salary increase you might get from your part-time job). That means your Return on Assets (ROA) is essentially zero (negative after considering inflation). Debts predictably grow larger when ROA is less than the interest rate of those debts.
Bottom Line: Making money is about cutting costs and investing in yourself. For example, pay off your debts and invest in your health. If you can't afford to retire then delay retirement, live on a budget, right-size your life, and accept the necessity for part-time employment after you retire. You'll also need to keep investing in stocks for the rest of your life, learning along the way to safely make money with money. That means taking advantage of the magic of compound interest by reinvesting dividends and interest. It also means low-cost investing, online, making automatic monthly additions to dividend-growing stocks from your checking account and backstopping those with 10-yr Treasury Notes at zero cost. You can start today by gradually rebalancing your personal retirement accounts (IRA, 401k, 403b) to reflect the fact that Social Security and Defined Benefit Pensions are bond equivalent holdings in your name. You’ll want those tax-deferred accounts to be 75% invested in stock mutual funds (as well as your taxable accounts) to achieve the 50/50 stock/bond balance that most advisors recommend you maintain throughout retirement.
Risk Rating: 4
Full Disclosure: I dollar-average into 10-yr Treasury Notes and all 9 of the stocks listed in the Table.
Note: Metrics in the Table are current for the Sunday of publication; red highlights denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Outline the areas where lifestyle adjustments can be made without feeling the full effects that job loss entails. Forty years of working a job makes it more than a livelihood; it becomes a “personhood.” Chances are you will miss at least some aspects of the job and the respect it gave you in the eyes of others. Now is the time to focus on finding ways to limit costs but still invest in yourself enough to afford retirement.
Execution: Let’s start with your home. Frequently, we have more living space than needed. Let’s assume you’re comfortable and the mortgage is almost paid off. How can you turn it into income? Reverse mortgages carry hidden costs that limit their attractiveness. Instead, think about converting part of your house into an attractive apartment for rent. Better yet, sell the house and take out a low-cost annuity through TIAA-CREF or Vanguard. Rent only enough living space to meet your retirement needs.
Next is your car. Think about leasing because it is then possible to have a new car every 3 years and benefit from greater dealer incentives than can be had by purchasing a car. Remember that by leasing a scaled-down version of the vehicle you’ve been driving you’ll save money needed for paying bills that increase in retirement (like medical bills). Japan specializes in producing trouble-free but high-quality cars; Honda Civics and Toyota Corollas get excellent gas mileage and come without “sticker-shock.”
This leads into the importance of drawing up a monthly budget. Start by eliminating all debts; use whatever means necessary. This effort will gradually decrease the amount of interest you pay, leaving more money to spend. Food, utilities, rent, and your car lease are the big expenditures; dedicate specific parts of your income to paying those bills. Next comes clothes and entertainment, including travel and recreation. For most retirees, clothes and travel become items they save for, so dedicate part of your income to a savings account. If enough money doesn’t reach that account, then buying new clothes and taking trips will have to be curtailed. This budget limits you to spending “cash on hand.” Your credit cards will show a zero balance at the end of each month, no matter what.
It has been shown through many medical and wellness studies that your weight will have a very big impact on the quality of your life. As we near retirement age, 2/3rds of us are overweight. That translates into both inconvenience and expense during your sunset years. Now is the time to learn how to eat less and smarter. Learn to love having more nuts and veggies, make a habit of “meatless Mondays”, and give up pastries and desserts. Exercise is important for cardiac health but it also makes you hungrier. You won’t lose weight unless you have the discipline to stick with a 2000 Calories/day diet.
“Where's the money [discussion], Lebowski?” You want to find a way to make your Retirement Number, and hope we’ll provide a clear path to resolving that problem. It starts indirectly with lifestyle adjustments that lower expenses and increase income. After that, move directly into plugging any holes in your finances. Three options are available, starting with a delayed retirement. The Social Security Administration will increase your lifetime monthly benefit 8% for each year that you put off retirement. If you retire at age 70 instead of age 62, you’ll go from having your full retirement benefit cut by 25% (retirement at age 62) to having it increased by 32% (retirement at age 70).
It’s now becoming reasonable to make stocks a larger part of your overall retirement savings, to balance the amount of money most of us currently have in bonds. Social Security is a system for paying out interest on US Treasury Bonds. If your full benefit is going to be $1500/mo, and 30-yr Treasuries are paying 3% interest, you have a non-transferable account at the US Treasury worth $600,000. That means the rest of your retirement accounts (defined-benefit pension, IRA, 401k, 403b, plus taxable stocks and bonds) likely need to be 75% in stocks (see this week’s Table for a 12-asset example which carries an expense ratio of only 0.51%). Even then, you’re unlikely to reach the recommended 50/50 balance between stocks and bonds. Does having that much in stocks make you nervous, given recent history? Well, 100 years of history gives a better perspective: Stocks, with dividends reinvested, have grown at 10.1%/yr vs. 5.0%/yr for 10-yr Treasury Notes with interest reinvested. Inflation averaged 3.2%/yr. A 50/50 balance between stocks and bonds would have grown 4.0%/yr after inflation (allowing 0.2%/yr for transaction costs).
Your third option is to prepare to hold a part-time job after you retire. That may require you to get more college education or pay for training and credentialing. (Licensed Practical Nurses and long-haul truck drivers, for example, are in short supply.) But find a way to do that without borrowing money. Why do you need to have no debts when you transition to part-time employment, and have to remain debt-free thereafter? Because you’ll be living on a fixed income (except for any dividend-growing stocks you might own and any salary increase you might get from your part-time job). That means your Return on Assets (ROA) is essentially zero (negative after considering inflation). Debts predictably grow larger when ROA is less than the interest rate of those debts.
Bottom Line: Making money is about cutting costs and investing in yourself. For example, pay off your debts and invest in your health. If you can't afford to retire then delay retirement, live on a budget, right-size your life, and accept the necessity for part-time employment after you retire. You'll also need to keep investing in stocks for the rest of your life, learning along the way to safely make money with money. That means taking advantage of the magic of compound interest by reinvesting dividends and interest. It also means low-cost investing, online, making automatic monthly additions to dividend-growing stocks from your checking account and backstopping those with 10-yr Treasury Notes at zero cost. You can start today by gradually rebalancing your personal retirement accounts (IRA, 401k, 403b) to reflect the fact that Social Security and Defined Benefit Pensions are bond equivalent holdings in your name. You’ll want those tax-deferred accounts to be 75% invested in stock mutual funds (as well as your taxable accounts) to achieve the 50/50 stock/bond balance that most advisors recommend you maintain throughout retirement.
Risk Rating: 4
Full Disclosure: I dollar-average into 10-yr Treasury Notes and all 9 of the stocks listed in the Table.
Note: Metrics in the Table are current for the Sunday of publication; red highlights denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 16
Week 215 - “Buy-and-hold” Barron’s 500 Biotechnology Stocks
Situation: All asset classes are currently high-priced, and biotechnology stocks are the highest priced. If earnings reports don’t surprise on the upside, they’re over-priced and a bubble may be forming. Most companies use borrowed money for approximately half their capital needs, which means they have little in the way of tangible book value. Remember: Assets = Liabilities + Equity. To “make serious money,” you’ll need to focus on asset classes that have strong growth prospects and modest indebtedness. That means technology stocks should be ~10% of your retirement savings. Currently, biotechnology stocks have the best growth prospects, and it is in your best interest to have stock in one or two of those companies. Given that retirement savings should be composed of “buy-and-hold” stocks and bonds, you’ll want a list of candidate biotechnology stocks to choose from. Is there any such thing as a buy-and-hold biotechnology stock?
Mission: Create a spreadsheet of candidate “buy-and-hold” biotechnology stocks from the recently published 2015 Barron’s 500 List.
Execution: This hasn’t been easy but we’ve managed to come up with the names of 7 candidate companies (see Table). Two are “plain vanilla” biotechnology companies: Gilead Sciences (GILD) and Amgen (AMGN). Two are agriculture companies that produce genetically-modified seeds: Monsanto (MON) and duPont (DD). Three are traditional pharmaceutical companies that have sizeable biotechnology divisions: Johnson & Johnson (JNJ), Eli Lilly (LLY), and Bristol-Myers Squibb (BMY). Columns W-Y of the Table contain long-term statistical data available at the BMW Method website (see Week 193). That website lists AMGN and LLY as being “potentially overpriced”, along with the NASDAQ Biotechnology Index.
Bottom Line: The NASDAQ Biotechnology Index at Line 14 in the Table has the big picture. Returns for these stocks are 3 times higher than for the S&P 500 Index over the past 16 yrs (see Column W) but our enthusiasm is dampened by the BMW Method projection of a 53% loss in a future Bear Market vs. a 32% loss for the S&P 500 index. Six of our 7 “buy-and-hold” candidates are speculative by most measures (see Table); only Johnson & Johnson (JNJ) appears to be a better bet than simply putting your money to work in a bond-hedged S&P 500 Index fund (VBINX).
Risk Rating: 7
Full Disclosure: I dollar-average into JNJ, and also own stock in MON and DD.
Note: Metrics in the Table that are highlighted in red denote underperformance vs. our key benchmark (VBINX); metrics are brought current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Create a spreadsheet of candidate “buy-and-hold” biotechnology stocks from the recently published 2015 Barron’s 500 List.
Execution: This hasn’t been easy but we’ve managed to come up with the names of 7 candidate companies (see Table). Two are “plain vanilla” biotechnology companies: Gilead Sciences (GILD) and Amgen (AMGN). Two are agriculture companies that produce genetically-modified seeds: Monsanto (MON) and duPont (DD). Three are traditional pharmaceutical companies that have sizeable biotechnology divisions: Johnson & Johnson (JNJ), Eli Lilly (LLY), and Bristol-Myers Squibb (BMY). Columns W-Y of the Table contain long-term statistical data available at the BMW Method website (see Week 193). That website lists AMGN and LLY as being “potentially overpriced”, along with the NASDAQ Biotechnology Index.
Bottom Line: The NASDAQ Biotechnology Index at Line 14 in the Table has the big picture. Returns for these stocks are 3 times higher than for the S&P 500 Index over the past 16 yrs (see Column W) but our enthusiasm is dampened by the BMW Method projection of a 53% loss in a future Bear Market vs. a 32% loss for the S&P 500 index. Six of our 7 “buy-and-hold” candidates are speculative by most measures (see Table); only Johnson & Johnson (JNJ) appears to be a better bet than simply putting your money to work in a bond-hedged S&P 500 Index fund (VBINX).
Risk Rating: 7
Full Disclosure: I dollar-average into JNJ, and also own stock in MON and DD.
Note: Metrics in the Table that are highlighted in red denote underperformance vs. our key benchmark (VBINX); metrics are brought current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 9
Week 214 - “Buy-and-hold” Candidates Among Dividend Achievers
Situation: You want to research stocks that might be good long-term holdings for your retirement portfolio. But “buy-and-hold” investing is tricky, even for Warren Buffett. So, you’ll need to start strategizing with a few constraints in mind. For example, you don’t want to invest in companies that are primarily capitalized with bank loans or bonds issued by the company. Why? Because there will come a time when the rate of interest that has to be paid is higher than the rate of earnings growth, and the firm will no longer be able to get loans at attractive interest rates. The company might try to reduce its debt by selling off some assets or issuing more stock. But chances are they’ll be bought out by a competitor or Private Equity fund, and then be “right-sized.”
Mission: Arrive at a spreadsheet of “buy-and-hold” candidate stocks by screening the 2015 Barron’s 500 List of the largest companies by revenue that are listed on the New York and Toronto stock exchanges. Start with companies that have raised their dividend annually for at least the past 10 yrs, i.e., the companies that S&P calls Dividend Achievers. Screen out companies with S&P bond ratings lower than BBB+ and/or S&P stock ratings lower than B+/M. Then screen out companies that are capitalized mainly by debt, and companies that have underperformed our benchmark (VBINX at Line 32 in the Table) on a risk-adjusted basis (i.e., Finance Value in Column E of the Table) since the S&P 500 Index reached a peak on 9/1/2000.
Execution: The 2015 Barron’s 500 List has 98 Dividend Achievers, and 72 remain after screening out companies that don’t have S&P bond and stock ratings suitable for a retirement portfolio. After eliminating 30 companies that have a debt:equity ratio higher than 100%, and 18 that don’t have a Finance Value that beats VBINX, we’re left with 24 companies for you to consider (see Table). Two of those were excluded because they grew dividends at less than 3 times the rate of inflation over the past 16 yrs, which was 2.3%/yr (see Column H in the Table). Twelve of the remaining 22 have less risk of loss in the next bear market than the S&P 500 Index (see Column T in the Table), according to statistical projections available at the BMW Method website. Two have a statistical risk of loss, i.e., more than 2 Standard Deviations below trendline, that exceeds 40%; both have been excluded. Columns R and S in the Table also provide BMW Method data concerning 16-yr growth rates and current price trends for each stock. Every one of the 20 remaining companies beat the S&P 500 Index over that 16-yr period (see Columns C and R in the Table).
Bottom Line: It is almost impossible to find a stock that will outperform the S&P 500 Index on a risk-adjusted basis, and also pay you dividends in retirement that grow faster than inflation. But if you want to stretch beyond index fund investing, you need to try finding such stocks. We’ve come up with 20 candidates that beat the S&P Index since it peaked on 9/1/2000. These twelve have less risk of loss in a future bear market than the S&P 500 Index: WMT, HRL, ABT, NKE, GWW, CB, JNJ, ES, CVX, XOM, NSC, PG.
Risk Rating: 5
Full Disclosure: I dollar-average into ABT, NKE and JNJ, and also own shares of TJX, ADM, HRL, CVX, WMT, XOM, and PG.
Note: The Table is current for the Sunday of publication; metrics highlighted in red denote underperformance relative to our key benchmark, VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Arrive at a spreadsheet of “buy-and-hold” candidate stocks by screening the 2015 Barron’s 500 List of the largest companies by revenue that are listed on the New York and Toronto stock exchanges. Start with companies that have raised their dividend annually for at least the past 10 yrs, i.e., the companies that S&P calls Dividend Achievers. Screen out companies with S&P bond ratings lower than BBB+ and/or S&P stock ratings lower than B+/M. Then screen out companies that are capitalized mainly by debt, and companies that have underperformed our benchmark (VBINX at Line 32 in the Table) on a risk-adjusted basis (i.e., Finance Value in Column E of the Table) since the S&P 500 Index reached a peak on 9/1/2000.
Execution: The 2015 Barron’s 500 List has 98 Dividend Achievers, and 72 remain after screening out companies that don’t have S&P bond and stock ratings suitable for a retirement portfolio. After eliminating 30 companies that have a debt:equity ratio higher than 100%, and 18 that don’t have a Finance Value that beats VBINX, we’re left with 24 companies for you to consider (see Table). Two of those were excluded because they grew dividends at less than 3 times the rate of inflation over the past 16 yrs, which was 2.3%/yr (see Column H in the Table). Twelve of the remaining 22 have less risk of loss in the next bear market than the S&P 500 Index (see Column T in the Table), according to statistical projections available at the BMW Method website. Two have a statistical risk of loss, i.e., more than 2 Standard Deviations below trendline, that exceeds 40%; both have been excluded. Columns R and S in the Table also provide BMW Method data concerning 16-yr growth rates and current price trends for each stock. Every one of the 20 remaining companies beat the S&P 500 Index over that 16-yr period (see Columns C and R in the Table).
Bottom Line: It is almost impossible to find a stock that will outperform the S&P 500 Index on a risk-adjusted basis, and also pay you dividends in retirement that grow faster than inflation. But if you want to stretch beyond index fund investing, you need to try finding such stocks. We’ve come up with 20 candidates that beat the S&P Index since it peaked on 9/1/2000. These twelve have less risk of loss in a future bear market than the S&P 500 Index: WMT, HRL, ABT, NKE, GWW, CB, JNJ, ES, CVX, XOM, NSC, PG.
Risk Rating: 5
Full Disclosure: I dollar-average into ABT, NKE and JNJ, and also own shares of TJX, ADM, HRL, CVX, WMT, XOM, and PG.
Note: The Table is current for the Sunday of publication; metrics highlighted in red denote underperformance relative to our key benchmark, VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 2
Week 213 - Barron’s 500 Companies with 16 years of Above-market Returns and Below-market Risk
Situation: It has been difficult for us to set objective standards for stock-picking this year. In an overheated market, there are few stocks that meet our standards for safety. And those that do often have issues that end up explaining why they’re attractively priced. So, we’ve emphasized long-term metrics (see Week 199 and Week 206). Our goal in those two blogs has been to uncover “unicorns” -- the few companies that achieve above-market long-term returns at below-market risk. In this week’s blog we continue the hunt, hoping that enough such companies are out there to allow us to categorize the sub-sectors of the economy where they might be found.
Mission: Develop an algorithm for identifying which Barron’s 500 stocks have risk metrics that do not exceed those of the S&P 500 Index while also having 16-yr returns that beat the S&P 500 Index.
Execution: Screen the 2015 list of Barron’s 500 companies by applying a set of short- and long-term risk measurements. For example, stocks with a 5-yr Beta over 1.00 are excluded, since those have a variance higher than the S&P 500 Index. Instead of using volatile P/E values as the other tool for assessing short-term risk, we use Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation and Amortization or "EV/EBITDA" and exclude stocks with a value higher than 11, which is the EV/EBITDA value for the S&P 500 Index. In other words, a company’s market capitalization (EV) is the current value of the bonds and stocks that it has issued; its earnings (EBITDA) exclude the complex and powerful effect that interest (paid on those bonds) has in lowering taxes. EV/EBITDA gives the kind of price/earnings information that investors need, one that eliminates distortions introduced by sources and sinks for cash.
To assess 16-yr returns, we primarily use the statistical (Standard Deviation of weekly prices) records found at the BMW Method website. That data set also generates estimates for the percent loss (or gain) in price that can be expected to occur at a variance of one or two Standard Deviations. For example, a drop of -2 SD is the loss that can be expected to occur in a future Bear Market. To supplement this “price only” data, we use the Buyupside website to calculate the added benefit that comes from dividends paid (i.e., Total return) from making a single stock purchase 16 yrs ago (see Column C in the Table). We also use that website to assess risk by calculating the Lehman Panic total return (10/07-4/09), which is recorded at Column D in the Table for each of our weekly blogs.
To help you gain perspective on these methods of analysis, we’ve made two additions to our list of BENCHMARKS: 1) Coca-Cola (KO), because it is the only specific stock recommendation that Warren Buffett has made for retail investors; 2) the Exchange-Traded Fund (ETF) for the Dow Jones Industrial Average (DIA or ^DJI), which has 10% better returns than the S&P 500 Index (VFINX or ^GSPC) over 3-4 market cycles with 5% less statistical risk of loss at -2SD: see 30-yr data for ^DJI vs. ^GSPC at the BMW Method website.
Bottom Line: We’ve found 10 companies that meet all of our standards for rewards vs. risk over the past 16 yrs relative to the S&P 500 Index. Five are monopolies in heavily regulated industries: Union Pacific (UNP), NextEra Energy (NEE), Eversource Energy (ES), AGL Resources (GAS), DTE Energy (DTE). Three derive the largest portion of their revenues from food: Wal-Mart Stores (WMT), Kimberly-Clark (KMB) and Sysco (SYY). It is unlikely that all 10 of these companies will continue to outperform the S&P 500 Index over the next 16 yrs, since that performance will attract more buyers and thereby elevate the short-term risk metrics (5-yr Beta, EV/EBITDA). But you get the idea: 1) “Bet with the house” which would be the government-regulated monopolies; 2) prioritize food-related investments.
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and NEE, and also own shares of ITW and UNP.
Note: Metrics are current as of the Sunday of publication; metrics highlighted in red denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Develop an algorithm for identifying which Barron’s 500 stocks have risk metrics that do not exceed those of the S&P 500 Index while also having 16-yr returns that beat the S&P 500 Index.
Execution: Screen the 2015 list of Barron’s 500 companies by applying a set of short- and long-term risk measurements. For example, stocks with a 5-yr Beta over 1.00 are excluded, since those have a variance higher than the S&P 500 Index. Instead of using volatile P/E values as the other tool for assessing short-term risk, we use Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation and Amortization or "EV/EBITDA" and exclude stocks with a value higher than 11, which is the EV/EBITDA value for the S&P 500 Index. In other words, a company’s market capitalization (EV) is the current value of the bonds and stocks that it has issued; its earnings (EBITDA) exclude the complex and powerful effect that interest (paid on those bonds) has in lowering taxes. EV/EBITDA gives the kind of price/earnings information that investors need, one that eliminates distortions introduced by sources and sinks for cash.
To assess 16-yr returns, we primarily use the statistical (Standard Deviation of weekly prices) records found at the BMW Method website. That data set also generates estimates for the percent loss (or gain) in price that can be expected to occur at a variance of one or two Standard Deviations. For example, a drop of -2 SD is the loss that can be expected to occur in a future Bear Market. To supplement this “price only” data, we use the Buyupside website to calculate the added benefit that comes from dividends paid (i.e., Total return) from making a single stock purchase 16 yrs ago (see Column C in the Table). We also use that website to assess risk by calculating the Lehman Panic total return (10/07-4/09), which is recorded at Column D in the Table for each of our weekly blogs.
To help you gain perspective on these methods of analysis, we’ve made two additions to our list of BENCHMARKS: 1) Coca-Cola (KO), because it is the only specific stock recommendation that Warren Buffett has made for retail investors; 2) the Exchange-Traded Fund (ETF) for the Dow Jones Industrial Average (DIA or ^DJI), which has 10% better returns than the S&P 500 Index (VFINX or ^GSPC) over 3-4 market cycles with 5% less statistical risk of loss at -2SD: see 30-yr data for ^DJI vs. ^GSPC at the BMW Method website.
Bottom Line: We’ve found 10 companies that meet all of our standards for rewards vs. risk over the past 16 yrs relative to the S&P 500 Index. Five are monopolies in heavily regulated industries: Union Pacific (UNP), NextEra Energy (NEE), Eversource Energy (ES), AGL Resources (GAS), DTE Energy (DTE). Three derive the largest portion of their revenues from food: Wal-Mart Stores (WMT), Kimberly-Clark (KMB) and Sysco (SYY). It is unlikely that all 10 of these companies will continue to outperform the S&P 500 Index over the next 16 yrs, since that performance will attract more buyers and thereby elevate the short-term risk metrics (5-yr Beta, EV/EBITDA). But you get the idea: 1) “Bet with the house” which would be the government-regulated monopolies; 2) prioritize food-related investments.
Risk Rating: 4
Full Disclosure: I dollar-average into WMT and NEE, and also own shares of ITW and UNP.
Note: Metrics are current as of the Sunday of publication; metrics highlighted in red denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX).
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