Situation: Utilities, including communication services companies like AT&T, have such high fixed costs that they’re mainly capitalized by loans. Their stock investors are compensated for this impairment by being awarded high dividend payouts. That places share prices in direct competition with corporate bonds, meaning that newly issued bonds will have higher interest rates than legacy bonds. The price paid for legacy bonds will fall, putting downward pressure on the price paid for utility stocks. Now that the Federal Reserve is determined to raise short-term interest rates we can expect this to occur. The highest quality utility stocks will see only a temporary effect, since earnings growth will continue unabated.
Mission: Identify the highest quality utility stocks in the Barron’s 500 List by picking out the Dividend Achievers, i.e., those that have paid a larger dividend every year for at least the past 10 yrs. Exclude any companies that have an S&P bond rating less than BBB+ and/or an S&P stock rating lower than B+/M. Assess the long-term value of owning these stocks by collecting 25-yr data on price appreciation and risk of loss at the BMW Method website.
Execution: Eight companies are identified as meeting our criteria (see Table).
Bottom Line: Over the long term, this group of 8 companies shows a materially higher total return/yr than the S&P 500 Index, along with a materially lower risk of loss. Over the past 3 yrs, their performance with respect to key metrics of cash flow and revenue has improved, as demonstrated by the data collected for Barron’s 500 rankings in 2015.
Risk Rating: 4
Full Disclosure: I dollar average into NEE and own shares of T.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 27
Sunday, December 20
Week 233 - Barron’s 500 “Industrials” That Are Dividend Achievers
Situation: The US dollar is outperforming all other major currencies, which decreases demand for goods shipped from the US to world markets. As a result, earnings for US industrial companies that gain most of their sales overseas have fallen 20-50%. This weighs on their stock prices but creates an opportunity for investors, provided the management of those companies is aggressively preparing for the day when other currencies recover.
Mission: Take a close look at large industrial companies and their performance over the past 3 yrs, as detailed in the 2015 Barron’s 500 List. Then determine which of those have a long history of relatively steady growth, as expressed by having a 10+ yr history of raising their dividend annually. S&P calls such companies Dividend Achievers.
Execution: All of the “industrials” that appear on both lists are found in the accompanying Table, except those that have an S&P bond rating lower than BBB+ or an S&P stock rating lower that B+/M. Information on price appreciation (over the past 25 yrs) and risk of loss, per the BMW Method, is found in Columns M through O of the Table. Four companies did not have 25-yr price appreciation data and are not included in the Table.
Bottom Line: Industrial companies, as a group, carry almost 10% higher risk of loss than the S&P 500 Index. That is offset by price appreciation that is almost twice as great. If you’re going to invest in this sector, you have to be in it for the long term and expect some rough years.
Risk Rating: 7
Full Disclosure: I own stock in UTX, ITW, MMM, and DE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Take a close look at large industrial companies and their performance over the past 3 yrs, as detailed in the 2015 Barron’s 500 List. Then determine which of those have a long history of relatively steady growth, as expressed by having a 10+ yr history of raising their dividend annually. S&P calls such companies Dividend Achievers.
Execution: All of the “industrials” that appear on both lists are found in the accompanying Table, except those that have an S&P bond rating lower than BBB+ or an S&P stock rating lower that B+/M. Information on price appreciation (over the past 25 yrs) and risk of loss, per the BMW Method, is found in Columns M through O of the Table. Four companies did not have 25-yr price appreciation data and are not included in the Table.
Bottom Line: Industrial companies, as a group, carry almost 10% higher risk of loss than the S&P 500 Index. That is offset by price appreciation that is almost twice as great. If you’re going to invest in this sector, you have to be in it for the long term and expect some rough years.
Risk Rating: 7
Full Disclosure: I own stock in UTX, ITW, MMM, and DE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 13
Week 232 - Safe and Effective Stocks for Trying to Beat the S&P 500 Index Long-Term
Situation: As a general rule, you should use index funds to build a retirement portfolio. Why? Because you can’t beat the market on a risk-adjusted basis (after allowing for transaction costs) unless you apply the art of buying low and selling high. A reasonable alternative to index funds is to “buy and hold” high quality stocks. The growth in their dividend payouts often beats inflation by a wider margin than payouts from a low-cost S&P 500 Index fund like the Vanguard 500 Index Fund (VFINX) or its bond-hedged version--the Vanguard Balanced Index Fund (VBINX) which we use as our benchmark. You’ll want to look for companies that have a Durable Competitive Advantage, i.e., those that have doubled their Tangible Book Value over the past decade. Nonetheless, you’ll need to have rules that give you a chance to beat the S&P 500 Index on a total return basis long-term. Otherwise, you’d be better off investing in VFINX or VBINX.
Mission: Set up rules that allow an investor to take calculated risks in order to buy high quality stocks that have a reasonable chance of beating the S&P 500 Index long-term.
Execution: Rule #1 is to buy stocks that have demonstrated improving fundamentals over the most recent 3 yrs, as determined by the stock’s Barron’s 500 Rank this year compared to last year. Rule #2 is to buy stocks that have a Durable Competitive Advantage (see Week 227 for further elaboration on Rules #1 and #2). Rule #3 is to find out which of those stocks have a price appreciation history that beats the S&P 500 Index over the past 2-3 market cycles while having less risk of loss, as determined by the BMW Method. Rule #4 is to not overpay for the stock, i.e., EV/EBITDA needs to be no greater than that for the S&P 500 Index, which is rarely higher than 11. Finally, you don’t want to buy stock in companies that have sustainability issues, meaning the S&P stock rating is lower than B+/M or the S&P bond rating is lower than BBB+ (see Table).
By adhering to this algorithm, you’re focus will be on building a position in companies that are out-of-favor, companies that are preparing to outperform when current headwinds lose their strength. Warren Buffett has often addressed this point: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.“ The trick is to see through the headwinds that are holding down a company’s stock. No one knows when that will occur, but it is not hard to find out if a company’s management is preparing for that day.
Bottom Line: Given that the US stock market is currently overpriced, we are able to come up with only 6 candidate stocks for purchase. Four of those 6 are electric utilities. Utilities pay high dividends. So, utility stocks are expected to fall in price as the Federal Reserve raises interest rates. In other words, that fall in price compensates for the eroded value of their dividends compared interest payouts on newly-issued bonds.
Risk Rating: 6
Full Disclosure: I dollar-average into NEE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Set up rules that allow an investor to take calculated risks in order to buy high quality stocks that have a reasonable chance of beating the S&P 500 Index long-term.
Execution: Rule #1 is to buy stocks that have demonstrated improving fundamentals over the most recent 3 yrs, as determined by the stock’s Barron’s 500 Rank this year compared to last year. Rule #2 is to buy stocks that have a Durable Competitive Advantage (see Week 227 for further elaboration on Rules #1 and #2). Rule #3 is to find out which of those stocks have a price appreciation history that beats the S&P 500 Index over the past 2-3 market cycles while having less risk of loss, as determined by the BMW Method. Rule #4 is to not overpay for the stock, i.e., EV/EBITDA needs to be no greater than that for the S&P 500 Index, which is rarely higher than 11. Finally, you don’t want to buy stock in companies that have sustainability issues, meaning the S&P stock rating is lower than B+/M or the S&P bond rating is lower than BBB+ (see Table).
By adhering to this algorithm, you’re focus will be on building a position in companies that are out-of-favor, companies that are preparing to outperform when current headwinds lose their strength. Warren Buffett has often addressed this point: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.“ The trick is to see through the headwinds that are holding down a company’s stock. No one knows when that will occur, but it is not hard to find out if a company’s management is preparing for that day.
Bottom Line: Given that the US stock market is currently overpriced, we are able to come up with only 6 candidate stocks for purchase. Four of those 6 are electric utilities. Utilities pay high dividends. So, utility stocks are expected to fall in price as the Federal Reserve raises interest rates. In other words, that fall in price compensates for the eroded value of their dividends compared interest payouts on newly-issued bonds.
Risk Rating: 6
Full Disclosure: I dollar-average into NEE.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX). Column C in the Table lists the total return/yr on a stock purchase made 9/28/92, the first day of trading for VBINX.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 6
Week 231 - Can the 4% Rule Sustain You in Retirement Without Eroding Principal?
Situation: You don’t want to outlive your money. So, you’ll need a retirement plan that is robust enough to stay on track until you’re 100. Monthly payments from Social Security, plus Required Minimal Distributions from a 401(k) Plan, should see you through. However, a fixed-income private annuity or a workplace pension plan won’t keep up with inflation. After age 50, you’re allowed to add $6,500/yr to your IRA, which can contain stocks, bonds and mutual funds of your own choosing. To spend from your “Nest Egg” in retirement, most advisors recommend some variation of the “4% Rule." Its originator, Bill Bengen, back-tested the math (assuming an even split between bonds and stocks) and “found that retirees who withdrew 4 percent of their initial retirement portfolio balance, and then adjusted that dollar amount for inflation each year thereafter, would have created a paycheck that lasted for 30 years”. Nowadays, interest rates are being held at artificially low levels by almost every Central Bank. So, you’d better start your retirement with an appropriate adjustment (~60% stocks and ~40% bonds).
Mission: Find out if a new retiree who has stocks and bonds in a 60:40 mix can follow the 4% rule without drawing down principal (the initial retirement balance adjusted for inflation). Given that retirement savings are defensive by definition, those bonds should be 10-yr US Treasury Notes and/or a low-cost intermediate-term investment-grade bond fund like the Vanguard Interm-Term Bond Index (VBINX in the Table). Those stocks should be issued by 6 or 7 large-capitalization companies (i.e., those in the S&P 100 Index) selected from the list of Dividend Achievers representative of the 4 defensive S&P industries (HealthCare, Utilities, Communication Services, and Consumer Staples).
Execution: The Table reflects a 20 yr period of analysis using our standard spreadsheet. The assumption is that retirement began 20 yrs ago, and that each line item had the same value as every other line item at that time. No additional funds have been added. PLAN A represents my approach, i.e., to invest in 7 stocks that are collateralized with 10-yr US Treasury Notes (reinvested upon reaching maturity). PLAN B uses a bond fund instead of 10-yr Treasuries and stocks that are more growth-oriented (see Column L in the Table). Overall, there are 12 stocks in the S&P 100 Index that qualify by having Dividend Achiever status, an S&P stock rating of B+/M or better, and an S&P bond rating of BBB+ or better. NOTE: NextEra Energy (NEE) meets all criteria for inclusion in the S&P 100 and will likely be added soon, making a total of 13 stocks that are suitable for inclusion in a conservative retirement plan.
Bottom Line: Inflation averaged ~2.2%/yr over the past 20 yrs, so the 4% rule would fail to maintain principal if the average total return/yr for Plan A or Plan B were less than 4.0% + 2.2%. Plan A returned over 7%/yr and Plan B returned approximately 10%/yr. So, the value of the original investment, corrected for inflation, remained intact over the first 20 yrs of retirement. The same is true for the past 5 yrs (shown in Column F of the Table) when inflation averaged ~1.5%/yr. There is no material difference between PLAN A and PLAN B, given the slightly higher risk profile of PLAN B (see Columns J through L in the Table).
Risk Ratings: 4 (PLAN A) and 5 (PLAN B)
Full Disclosure: I have stock in KO, JNJ and WMT, and dollar-average into NEE, T, PEP and ABT as well as 10-yr T-Notes.
Note: Metrics highlighted in red denote underperformance vs. our benchmark (VBINX). Metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Find out if a new retiree who has stocks and bonds in a 60:40 mix can follow the 4% rule without drawing down principal (the initial retirement balance adjusted for inflation). Given that retirement savings are defensive by definition, those bonds should be 10-yr US Treasury Notes and/or a low-cost intermediate-term investment-grade bond fund like the Vanguard Interm-Term Bond Index (VBINX in the Table). Those stocks should be issued by 6 or 7 large-capitalization companies (i.e., those in the S&P 100 Index) selected from the list of Dividend Achievers representative of the 4 defensive S&P industries (HealthCare, Utilities, Communication Services, and Consumer Staples).
Execution: The Table reflects a 20 yr period of analysis using our standard spreadsheet. The assumption is that retirement began 20 yrs ago, and that each line item had the same value as every other line item at that time. No additional funds have been added. PLAN A represents my approach, i.e., to invest in 7 stocks that are collateralized with 10-yr US Treasury Notes (reinvested upon reaching maturity). PLAN B uses a bond fund instead of 10-yr Treasuries and stocks that are more growth-oriented (see Column L in the Table). Overall, there are 12 stocks in the S&P 100 Index that qualify by having Dividend Achiever status, an S&P stock rating of B+/M or better, and an S&P bond rating of BBB+ or better. NOTE: NextEra Energy (NEE) meets all criteria for inclusion in the S&P 100 and will likely be added soon, making a total of 13 stocks that are suitable for inclusion in a conservative retirement plan.
Bottom Line: Inflation averaged ~2.2%/yr over the past 20 yrs, so the 4% rule would fail to maintain principal if the average total return/yr for Plan A or Plan B were less than 4.0% + 2.2%. Plan A returned over 7%/yr and Plan B returned approximately 10%/yr. So, the value of the original investment, corrected for inflation, remained intact over the first 20 yrs of retirement. The same is true for the past 5 yrs (shown in Column F of the Table) when inflation averaged ~1.5%/yr. There is no material difference between PLAN A and PLAN B, given the slightly higher risk profile of PLAN B (see Columns J through L in the Table).
Risk Ratings: 4 (PLAN A) and 5 (PLAN B)
Full Disclosure: I have stock in KO, JNJ and WMT, and dollar-average into NEE, T, PEP and ABT as well as 10-yr T-Notes.
Note: Metrics highlighted in red denote underperformance vs. our benchmark (VBINX). Metrics are current as of the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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