Situation: Young couples are often advised to make payments each month on 1) a home mortgage, and 2) a “whole life” insurance policy. Homes are not good investments, and neither are “whole life” policies. They’re a form of compelled savings. If we later find ourselves unprepared for retirement, we may be guided to recoup those savings by “taking out” a reverse mortgage or “borrowing against” a whole life policy. The government joins the party by compelling us to save during our working years (under the Federal Insurance Contributions Act of 1935), and then guides us to recoup our “Social Security” savings in retirement.
Mission: Look at the costs and benefits of reverse mortgages. NOTE: To obtain more detailed information, I suggest reading this article that appeared in USA Today on October 28.
Execution: “On the plus side, reverse mortgages are considered loan advances to you, not income you earned. Thus, the payments you receive are not taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.” Emotional benefits play a role, given that 1) you get to keep living in your home without paying rent, and 2) your children get to inherit a house that retains considerable equity. And, reverse mortgages make a great Rainy Day Fund.
On the negative side, there is “opportunity cost”: You are giving up the opportunity to invest a large sum of your own money, if you sell the house and rent a place more suited to your needs. Transaction costs on the sale are the same as those for taking out a reverse mortgage (6%), which leaves 94% for you to invest. We provide an example (see Table) of how you might set up an online investment in bonds and stocks that pays out at least 2%/yr (after transaction costs) and grows those payments at least 2%/yr.
Administration: The investment example has an asset allocation of 50% bonds/50% stocks. The bonds are “zero risk/zero cost” 10-Yr Treasury Notes accessed through the government website; that site also offers inflation-protected Treasury Notes. You can invest in KO, JNJ and WMT online but have to use a different website to invest in PG. Each pays a good and growing dividend, and had Total Returns/yr during the Housing Crisis that were better than those for our key benchmark, the Vanguard Balanced Index Fund (VBINX; see Column D in the Table).
It is best to make these investments over time, starting with 40% of your proceeds then adding $100/mo to each of the 4 stocks and $1200/qtr to T-Notes. So, 60% of the proceeds from selling your house would initially go to an FDIC-insured savings account paying little interest. Part of that 60% will never be invested because it serves as your Rainy Day Fund. Nonetheless, you’ll be in a position to withdraw $9600/yr for electronic transfers to bond and stock accounts. Annual transaction costs come to ~$72/yr (see Column N in the Table).
Bottom Line: Reverse mortgages can be a good idea, if you’ve paid off your home mortgage and have almost no source of retirement income outside of Social Security. But inflation will always be with us, so it might be better to sell your house and move to a place that is not designed for raising children. Then, you can invest the proceeds from selling your house in a manner that costs you little and provides an opportunity to protect yourself from inflation.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG and JNJ, as well as inflation-protected Savings Bonds (which are an IRA-like version of 10-Yr Treasury Notes). I also own shares of KO and WMT.
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Sunday, December 25
Sunday, December 18
Week 285 - 2017 Master List
Situation: You want to make money from investments, and you know that the best way to do that is not to lose money. Stocks pose the risks of volatility and selection bias, so you need to pick stocks that represent all 10 S&P industries while taking care to focus on large companies with competitive advantages, i.e., strong brands and clean balance sheets. Those advantages will help to insure your portfolio against market outages.
Mission: Develop a spreadsheet of A-rated S&P 100 companies with clean balance sheets that are both Global 500 Best Brands and S&P Dividend Achievers. Exclude companies with less than 25 yrs of trading data. Some companies in the Table have more than one top brand (see Appendix A).
Execution: see Table. There is one caveat: Union Pacific (UNP) will not qualify for S&P Dividend Achiever status until February, 2017.
Administration: We think a Balance Sheet isn’t “clean” if long-term debt represents more than a third of total assets, dividend payments in the two most recent quarters could not be met from Free Cash Flow, or Tangible Book Value is a negative number (see Columns N-P in the Table).
Bottom Line: There really is no need to take a risk with stocks. You already know volatility is “just around the corner” and that you shouldn’t “concentrate your bets”. All you need to do is follow metrics that have a solid track record for identifying companies that have executed their Business Plan in a safe and effective manner. We have selected 12 S&P 100 companies by using what we consider to be the most impactful metrics (see Table). We like S&P 100 companies because a) they are large enough to have multiple product lines (i.e., internal lines of support that insure against company-wide losses during a recession), and b) are required to have actively traded put and call options on the Chicago Board Options Exchange (i.e., the CBOE facilitates efficient price discovery 24/7/365).
Risk Rating: 5 (where 10-yr Treasury Notes = 1 and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, NKE, JNJ, PG, and MSFT. I also own shares of CAT, MMM, WMT and EMR.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr trendline (“least squares”) CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 26 in the Table. The ETF for that index is MDY at Line 20.
Appendix A: Companies in the Table that have more than one top brand (2016/2015 rank #):
Microsoft: Microsoft (5/4), Xbox (200/196), LinkedIn (334/476).
Wal-Mart Stores: Wal-Mart (8/7), Sam’s Club (101/78).
Johnson & Johnson: Johnson’s (79/60), Neutrogena (250/143).
Procter & Gamble: Gillette (185/138), Pampers (214/225), Pantene (296/264), Tide (493/NR).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Develop a spreadsheet of A-rated S&P 100 companies with clean balance sheets that are both Global 500 Best Brands and S&P Dividend Achievers. Exclude companies with less than 25 yrs of trading data. Some companies in the Table have more than one top brand (see Appendix A).
Execution: see Table. There is one caveat: Union Pacific (UNP) will not qualify for S&P Dividend Achiever status until February, 2017.
Administration: We think a Balance Sheet isn’t “clean” if long-term debt represents more than a third of total assets, dividend payments in the two most recent quarters could not be met from Free Cash Flow, or Tangible Book Value is a negative number (see Columns N-P in the Table).
Bottom Line: There really is no need to take a risk with stocks. You already know volatility is “just around the corner” and that you shouldn’t “concentrate your bets”. All you need to do is follow metrics that have a solid track record for identifying companies that have executed their Business Plan in a safe and effective manner. We have selected 12 S&P 100 companies by using what we consider to be the most impactful metrics (see Table). We like S&P 100 companies because a) they are large enough to have multiple product lines (i.e., internal lines of support that insure against company-wide losses during a recession), and b) are required to have actively traded put and call options on the Chicago Board Options Exchange (i.e., the CBOE facilitates efficient price discovery 24/7/365).
Risk Rating: 5 (where 10-yr Treasury Notes = 1 and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, NKE, JNJ, PG, and MSFT. I also own shares of CAT, MMM, WMT and EMR.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr trendline (“least squares”) CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 26 in the Table. The ETF for that index is MDY at Line 20.
Appendix A: Companies in the Table that have more than one top brand (2016/2015 rank #):
Microsoft: Microsoft (5/4), Xbox (200/196), LinkedIn (334/476).
Wal-Mart Stores: Wal-Mart (8/7), Sam’s Club (101/78).
Johnson & Johnson: Johnson’s (79/60), Neutrogena (250/143).
Procter & Gamble: Gillette (185/138), Pampers (214/225), Pantene (296/264), Tide (493/NR).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 11
Week 284 - Barron’s 500 List: Food and Agriculture Companies
Situation: There is some evidence that a new Commodity Supercycle is starting. For example, the Dow Jones Commodity Index recently recalled its 1998 low and is now rising. Corn and soybean prices have stabilized well above their 1999 low. We recently took a close look at all of the larger companies supporting Agriculture Production (see Week 279) and concluded that fundamental metrics are on the upswing, in spite of a February 2016 Bear Market in commodity-related stocks. Now 9 months have passed and we need to again look closely at the data while adding Agriculture Processing companies to our analysis.
If, after closer study, you’d still like to buy stock in one of these companies, you need to understand that you’d be making a “risk-on” trade with multiple opportunities for loss. For example, the February 2016 Bear Market apparently arose because “...investors’ appetite for riskier securities nose-dived early in 2016 [due to] concerns about an economic slowdown in China and the U.S., falling commodities prices, and the uncertain direction of interest rates were roiling global markets.”
Mission: Capture data on all Food and Agriculture companies in the 2016 Barron’s 500 List that have S&P stock ratings of B+/M or higher. Include columns that note whether the 200d moving average of a stock’s price is moving higher, and whether the 50d moving average has risen above the 200d average to lead it higher. Also include 2 columns that compare the 2016 brand rank to the 2015 brand rank among the top 500 global brands, and 3 columns to assess whether the company has a clean Balance Sheet.
Execution: see Table.
Bottom Lines: Food and Agriculture companies have been struggling over the past 4 years, along with other commodity-related companies. Hundreds of billions of dollars were invested in expansion projects, which became monuments to futility as the buildout of China’s infrastructure suddenly sputtered. The world now has the capacity to produce, process, transport, and market more oil, natural gas, coal, gold, steel, aluminum and protein-rich foods than it needs. That means the prices that food processors are asked to pay for corn and soybeans have fallen, but the good news is that those prices are now coming off historic lows relative to inflation.
Multi-decade commodity cycles have been with us forever and a new one appears to be starting, now that a number of production companies have gone bankrupt and all of those remaining have drastically curtailed their expansion plans. “Dr. Copper” is the generally accepted as the main barometer for expansion vs. contraction in commodity production. Freeport-McMoRan (FCX) is the largest company that mainly produces copper (see Line 24 in the Table). Caterpillar (CAT) is another widely-accepted barometer (see Line 10 in the Table). With regard to stock prices, the 200 day moving averages for both companies bottomed in the early summer and have been rising steadily since the late summer (see Columns AE-AF in the Table).
Risk Rating: 8 (where a 10-yr US Treasury Note = 1, and gold bullion = 10).
Full Disclosure: I dollar-average into MON, and also own shares of CAT, HRL, KO, and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 27 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 33 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
If, after closer study, you’d still like to buy stock in one of these companies, you need to understand that you’d be making a “risk-on” trade with multiple opportunities for loss. For example, the February 2016 Bear Market apparently arose because “...investors’ appetite for riskier securities nose-dived early in 2016 [due to] concerns about an economic slowdown in China and the U.S., falling commodities prices, and the uncertain direction of interest rates were roiling global markets.”
Mission: Capture data on all Food and Agriculture companies in the 2016 Barron’s 500 List that have S&P stock ratings of B+/M or higher. Include columns that note whether the 200d moving average of a stock’s price is moving higher, and whether the 50d moving average has risen above the 200d average to lead it higher. Also include 2 columns that compare the 2016 brand rank to the 2015 brand rank among the top 500 global brands, and 3 columns to assess whether the company has a clean Balance Sheet.
Execution: see Table.
Bottom Lines: Food and Agriculture companies have been struggling over the past 4 years, along with other commodity-related companies. Hundreds of billions of dollars were invested in expansion projects, which became monuments to futility as the buildout of China’s infrastructure suddenly sputtered. The world now has the capacity to produce, process, transport, and market more oil, natural gas, coal, gold, steel, aluminum and protein-rich foods than it needs. That means the prices that food processors are asked to pay for corn and soybeans have fallen, but the good news is that those prices are now coming off historic lows relative to inflation.
Multi-decade commodity cycles have been with us forever and a new one appears to be starting, now that a number of production companies have gone bankrupt and all of those remaining have drastically curtailed their expansion plans. “Dr. Copper” is the generally accepted as the main barometer for expansion vs. contraction in commodity production. Freeport-McMoRan (FCX) is the largest company that mainly produces copper (see Line 24 in the Table). Caterpillar (CAT) is another widely-accepted barometer (see Line 10 in the Table). With regard to stock prices, the 200 day moving averages for both companies bottomed in the early summer and have been rising steadily since the late summer (see Columns AE-AF in the Table).
Risk Rating: 8 (where a 10-yr US Treasury Note = 1, and gold bullion = 10).
Full Disclosure: I dollar-average into MON, and also own shares of CAT, HRL, KO, and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 27 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 33 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 4
Week 283 - Investing for Retirement Income
Situation: Investing for Capital Appreciation is mainly about reward, whereas, investing for Income is mainly about risk aversion. Upon retirement, you should try to forget about Capital Gains, i.e., selling growth stocks after a 10-yr Holding Period using a target discount rate of 9% (see Week 281). That’s what you do in your working years. In retirement, your discount rate is the average payout rate for interest and dividends from your bonds and stocks. Instead of using the S&P 400 MidCap Index as your benchmark, you’re now using the Vanguard Total Bond Market Index Fund (VBMFX), paying 2.3%/yr, and the Dow Jones Industrial Average (DIA), paying 2.5%/yr.
However, this could create a new problem given that half your retirement savings are in bonds and half are in stocks. This implies that you will have 2.4% of your savings available to spend each year, unless you’re willing to sell some stocks or bonds. Try those sales for a few years, and see if you start having nightmares about outliving your money.
Financial advisors (and you should have one) address that concern by recommending clients initially follow The 4% Rule for annual spending, adjusted for inflation. That rule was created decades ago by Bill Bengen, an aerospace engineer who had access to a really powerful computer that could run partial differential equations with 3 variables. People live longer now, and assets pay less. So, Bill Bengen is having second thoughts. Maybe a withdrawal rate of 3%/yr is more prudent for today’s retirees. But the message is clear. Whenever a retiree’s assets pay less than 4%/yr, she’ll have to sell stocks (to capture Capital Gains) or risk outliving her money.
Mission: Set up a spreadsheet of A-rated Dividend Achievers that a) pay at least 2.5%/yr, and b) have a statistically lower risk of loss than the S&P 500 Index (see Column M in the Table). Eliminate companies that have long-term bonds that account for more than 1/3rd of total assets. Eliminate companies with insufficient revenue to be on the Barron’s 500 List published 4/30/16, as well as companies with insufficient Free Cash Flow to fund dividends paid in the first half of 2016. Also exclude companies if their Weighted Average Cost of Capital (WACC) exceeds their Return on Invested Capital (ROIC).
Execution: Only 8 companies meet our requirements (see Table).
Bottom Line: As a group, these companies pay ~3.0%/yr and have dividend growth of almost 10%/yr. Except for Wal-Mart Stores (WMT), they offer a positive NPV (see Column X in the Table) and will likely have good Capital Gains over the next 10 yrs should you have need of more income.
Risk Rating: 4 (where 1 = 10-yr US Treasury Notes, and 10 = gold bullion).
Full Disclosure: I dollar-average into JNJ, PG, and NEE, and also own shares of WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 23 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
However, this could create a new problem given that half your retirement savings are in bonds and half are in stocks. This implies that you will have 2.4% of your savings available to spend each year, unless you’re willing to sell some stocks or bonds. Try those sales for a few years, and see if you start having nightmares about outliving your money.
Financial advisors (and you should have one) address that concern by recommending clients initially follow The 4% Rule for annual spending, adjusted for inflation. That rule was created decades ago by Bill Bengen, an aerospace engineer who had access to a really powerful computer that could run partial differential equations with 3 variables. People live longer now, and assets pay less. So, Bill Bengen is having second thoughts. Maybe a withdrawal rate of 3%/yr is more prudent for today’s retirees. But the message is clear. Whenever a retiree’s assets pay less than 4%/yr, she’ll have to sell stocks (to capture Capital Gains) or risk outliving her money.
Mission: Set up a spreadsheet of A-rated Dividend Achievers that a) pay at least 2.5%/yr, and b) have a statistically lower risk of loss than the S&P 500 Index (see Column M in the Table). Eliminate companies that have long-term bonds that account for more than 1/3rd of total assets. Eliminate companies with insufficient revenue to be on the Barron’s 500 List published 4/30/16, as well as companies with insufficient Free Cash Flow to fund dividends paid in the first half of 2016. Also exclude companies if their Weighted Average Cost of Capital (WACC) exceeds their Return on Invested Capital (ROIC).
Execution: Only 8 companies meet our requirements (see Table).
Bottom Line: As a group, these companies pay ~3.0%/yr and have dividend growth of almost 10%/yr. Except for Wal-Mart Stores (WMT), they offer a positive NPV (see Column X in the Table) and will likely have good Capital Gains over the next 10 yrs should you have need of more income.
Risk Rating: 4 (where 1 = 10-yr US Treasury Notes, and 10 = gold bullion).
Full Disclosure: I dollar-average into JNJ, PG, and NEE, and also own shares of WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 23 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 27
Week 282 - “Moneyball” Revisited: The Art of Investing in MidCap Stocks
Situation: The S&P 400 MidCap Index is a very good investment. So let’s dig deeper and ask whether there are MidCap stocks that might represent an even better investment? We’ve toyed with this idea in the past (see Week 263 - “Bond-like” Stocks That Fly Under The Radar). Now we undertake a systematic study.
Mission: Make a spreadsheet based on the 65 Dividend Achievers in the S&P MidCap 400 Index. Then remove companies that don’t have 16-yr trading records, or S&P stock ratings of at least B+/M. Remove companies where long-term debt accounts for more than 1/3rd of Total Assets, as well as companies that have been unable to make dividend payments over the past 2 quarters exclusively from Free Cash Flow, or have a Return on Invested Capital (ROIC) that is less than their Weighted Average Cost of Capital (WACC).
Execution: We find that only 8 companies meet our criteria (see Table).
Administration: Only one of those companies, Owens & Minor (OMI), pays a good and growing dividend. However, OMI had a total return of less than 6%/yr over the past 5 yrs, whereas, the other 7 companies returned at least 11%/yr. The good news is that 5 of those beat MDY (the S&P 400 Index ETF at Line 19 in the Table) and two (CHD and SON) are likely to lose less than the S&P 400 MidCap Index in the next Bear Market (see Column M in the Table).
Bottom Line: None of these stocks looks to be a good “stand alone” bet. MidCap companies rarely have more than one product line. So, you would need to own stock in several to take advantage of “MidCap growth”. You would also have to pick those stocks to achieve an overall result that minimizes areas of vulnerability but maximizes areas of strength. That statistical exercise is now called “moneyball,” after the book by Michael Lewis (and hit movie) that explains how a young economist brought success to a major league baseball team that could only afford “MidCap players”.
Risk Rating: 6 (for owning stock in all 8 companies)
Full Disclosure: I do not own stock in any of these companies, but do own shares of ARTMX (the “MidCap Blend” Mutual Fund at Line 18 in the Table) and a 401(k) clone of VEXMX (the “MidCap Blend” Index Fund at Line 21).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 20 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is designed to approximate Total Returns/yr from a stock index of similar risk (S&P 400 MidCap Index at Line 26) to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Make a spreadsheet based on the 65 Dividend Achievers in the S&P MidCap 400 Index. Then remove companies that don’t have 16-yr trading records, or S&P stock ratings of at least B+/M. Remove companies where long-term debt accounts for more than 1/3rd of Total Assets, as well as companies that have been unable to make dividend payments over the past 2 quarters exclusively from Free Cash Flow, or have a Return on Invested Capital (ROIC) that is less than their Weighted Average Cost of Capital (WACC).
Execution: We find that only 8 companies meet our criteria (see Table).
Administration: Only one of those companies, Owens & Minor (OMI), pays a good and growing dividend. However, OMI had a total return of less than 6%/yr over the past 5 yrs, whereas, the other 7 companies returned at least 11%/yr. The good news is that 5 of those beat MDY (the S&P 400 Index ETF at Line 19 in the Table) and two (CHD and SON) are likely to lose less than the S&P 400 MidCap Index in the next Bear Market (see Column M in the Table).
Bottom Line: None of these stocks looks to be a good “stand alone” bet. MidCap companies rarely have more than one product line. So, you would need to own stock in several to take advantage of “MidCap growth”. You would also have to pick those stocks to achieve an overall result that minimizes areas of vulnerability but maximizes areas of strength. That statistical exercise is now called “moneyball,” after the book by Michael Lewis (and hit movie) that explains how a young economist brought success to a major league baseball team that could only afford “MidCap players”.
Risk Rating: 6 (for owning stock in all 8 companies)
Full Disclosure: I do not own stock in any of these companies, but do own shares of ARTMX (the “MidCap Blend” Mutual Fund at Line 18 in the Table) and a 401(k) clone of VEXMX (the “MidCap Blend” Index Fund at Line 21).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 20 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is designed to approximate Total Returns/yr from a stock index of similar risk (S&P 400 MidCap Index at Line 26) to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 20
Week 281 - Investing for Capital Gains
Situation: Don’t leave money on the table. That means don’t accept a lower rate of return when you could get a higher rate of return by investing in the same asset class while taking the same risk.
This week we’ll focus on A-rated companies with over 9%/yr long-term growth in both Dividend and Price. Investing for Capital Gains starts with avoiding stocks that grow their dividends slower than 9%/yr. Why? Because you’ll soon find that 80% of the worthwhile companies are S&P Dividend Achievers, companies that have raised their dividend each year for at least the past 10+ years. Your benchmark is the S&P 400 MidCap Index, or its ETF (MDY). That index has a long-term growth rate of 9-10%/yr, which is higher than the growth rate for the S&P 500 Index while having a lower risk of loss (see Columns K & M at Lines 32 & 33 in the Table).
Mission: Make a spreadsheet of Dividend Achievers that have 1) grown their dividend at least 9%/yr over the past 10 yrs, and 2) have demonstrated price appreciation of at least 9%/yr over the past 25 yrs. We define price appreciation statistically, i.e., as the trendline derived from a “least squares” calculation of Standard Deviation for weekly price points . We exclude companies that have either an S&P stock rating lower than A-/M or an S&P bond rating lower than A-. We also exclude companies having a) Long-Term debt that amounts to more than 1/3rd of total assets (see Column N of the Table), b) insufficient revenue to be on the Barron’s 500 List published 4/30/16, c) insufficient Free Cash Flow in the most recent two quarters to fund their dividend (see Column O of the Table), and d) negative Tangible Book Value (see Column P in the Table). We also exclude any companies with a Weighted Average Cost of Capital (WACC) that exceeds their Return on Invested Capital (ROIC), as shown in Columns AB & AC of the Table. In other words, all of the companies listed have a clean Balance Sheet.
Execution: We find that 17 companies meet our requirements. Some have performed poorly under stress, i.e., during the 4.5 year Housing Crisis (e.g. the 5 stocks highlighted in red in Column D), or have a history of price volatility that predicts a greater loss in the next Bear Market than the S&P 500 Index (e.g. the 7 stocks highlighted in red in Column M not already highlighted in Column D). You might want to pay more attention to the 5 companies that had neither problem, namely, GWW, HRL, WEC, PH, APD.
Administration: Picking large-capitalization stocks for your retirement portfolio is fraught with risks, no matter how high you set the quality bar. Why? Because those companies typically have multiple product lines and strong brands, which allows them to borrow lots of money at low cost. Managers are incentivized to do this because their performance is often measured by Return on Equity (ROE). The more they use borrowed money, the higher ROE goes because returns go up while equity remains unchanged. Mid-Capitalization companies don’t yet have multiple product lines or strong brands, so their managers can’t borrow as much money. For those same reasons, it is rarely prudent to own stock in a Mid-Cap company, unless its Tangible Book Value is remarkably high. But a large aggregate of Mid-Cap companies (e.g. the S&P 400 MidCap Index) makes an excellent investment because there is little risk posed by long-term debt.
Owning individual stocks in a 401(k) through a mutual fund costs at least 1.59% more per year than owning index funds. Your costs, as an individual who likes to pick her own stocks, are at least 2%/yr more. Why would you do that? For starters, index funds are inefficient in ways that cost you almost 1%/yr. We all know another reason, which is that you can invest in Berkshire Hathaway (e.g. low-cost “B shares”) and beat the lowest-cost S&P 500 Index fund long-term while incurring less risk (compare Lines 23 & 28 in the Table). You can say the same about a few other companies, such as Johnson & Johnson at Line 22 in the Table. The cost of dollar-averaging $200/mo into JNJ stock online is 0.5%/yr.
I think the best reason to go with stock-picking is that a majority of companies in the S&P 500 Index have messy Balance Sheets and weak brands. If you confine your picks to companies with strong Balance Sheets and strong brands, as shown in Columns N through R in the Table, you will minimize losses in a downturn, as shown in Column D of the Table. Not losing money is the secret of making money. As Warren Buffett says, "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."
Bottom Line: Investing requires a disciplined approach to goals. When capital appreciation is the goal, you’ll want to use a benchmark that achieves that goal with the least risk. We think the S&P 400 MidCap Index is appropriate, given that it has 20% less risk of loss than the S&P 500 Index and 10% greater price appreciation. By using the S&P 400 MidCap Index as our benchmark, we arrive at a 9% discount rate for the Net Present Value (NPV) calculation (see Appendix to Week 256). If your growth stock selections generate a negative NPV, you’d be better off investing in MDY, the SPDR Exchange-Traded Fund that tracks the S&P 400 MidCap Index. This week’s Table has 17 Dividend Achievers with positive NPVs after being “handicapped” by the 9% discount rate. Those are worthwhile dividend-growing stocks for your retirement portfolio, as evidenced by how well their price held up during the Housing Crisis (see Column D in the Table).
Risk Rating: 6 (where 1 = 10-yr US Treasury Notes and 10 = gold bullion).
Full Disclosure: I dollar-average into MSFT, NKE, and UNP. I also own shares of ROST, TJX, HRL, WMT, and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
This week we’ll focus on A-rated companies with over 9%/yr long-term growth in both Dividend and Price. Investing for Capital Gains starts with avoiding stocks that grow their dividends slower than 9%/yr. Why? Because you’ll soon find that 80% of the worthwhile companies are S&P Dividend Achievers, companies that have raised their dividend each year for at least the past 10+ years. Your benchmark is the S&P 400 MidCap Index, or its ETF (MDY). That index has a long-term growth rate of 9-10%/yr, which is higher than the growth rate for the S&P 500 Index while having a lower risk of loss (see Columns K & M at Lines 32 & 33 in the Table).
Mission: Make a spreadsheet of Dividend Achievers that have 1) grown their dividend at least 9%/yr over the past 10 yrs, and 2) have demonstrated price appreciation of at least 9%/yr over the past 25 yrs. We define price appreciation statistically, i.e., as the trendline derived from a “least squares” calculation of Standard Deviation for weekly price points . We exclude companies that have either an S&P stock rating lower than A-/M or an S&P bond rating lower than A-. We also exclude companies having a) Long-Term debt that amounts to more than 1/3rd of total assets (see Column N of the Table), b) insufficient revenue to be on the Barron’s 500 List published 4/30/16, c) insufficient Free Cash Flow in the most recent two quarters to fund their dividend (see Column O of the Table), and d) negative Tangible Book Value (see Column P in the Table). We also exclude any companies with a Weighted Average Cost of Capital (WACC) that exceeds their Return on Invested Capital (ROIC), as shown in Columns AB & AC of the Table. In other words, all of the companies listed have a clean Balance Sheet.
Execution: We find that 17 companies meet our requirements. Some have performed poorly under stress, i.e., during the 4.5 year Housing Crisis (e.g. the 5 stocks highlighted in red in Column D), or have a history of price volatility that predicts a greater loss in the next Bear Market than the S&P 500 Index (e.g. the 7 stocks highlighted in red in Column M not already highlighted in Column D). You might want to pay more attention to the 5 companies that had neither problem, namely, GWW, HRL, WEC, PH, APD.
Administration: Picking large-capitalization stocks for your retirement portfolio is fraught with risks, no matter how high you set the quality bar. Why? Because those companies typically have multiple product lines and strong brands, which allows them to borrow lots of money at low cost. Managers are incentivized to do this because their performance is often measured by Return on Equity (ROE). The more they use borrowed money, the higher ROE goes because returns go up while equity remains unchanged. Mid-Capitalization companies don’t yet have multiple product lines or strong brands, so their managers can’t borrow as much money. For those same reasons, it is rarely prudent to own stock in a Mid-Cap company, unless its Tangible Book Value is remarkably high. But a large aggregate of Mid-Cap companies (e.g. the S&P 400 MidCap Index) makes an excellent investment because there is little risk posed by long-term debt.
Owning individual stocks in a 401(k) through a mutual fund costs at least 1.59% more per year than owning index funds. Your costs, as an individual who likes to pick her own stocks, are at least 2%/yr more. Why would you do that? For starters, index funds are inefficient in ways that cost you almost 1%/yr. We all know another reason, which is that you can invest in Berkshire Hathaway (e.g. low-cost “B shares”) and beat the lowest-cost S&P 500 Index fund long-term while incurring less risk (compare Lines 23 & 28 in the Table). You can say the same about a few other companies, such as Johnson & Johnson at Line 22 in the Table. The cost of dollar-averaging $200/mo into JNJ stock online is 0.5%/yr.
I think the best reason to go with stock-picking is that a majority of companies in the S&P 500 Index have messy Balance Sheets and weak brands. If you confine your picks to companies with strong Balance Sheets and strong brands, as shown in Columns N through R in the Table, you will minimize losses in a downturn, as shown in Column D of the Table. Not losing money is the secret of making money. As Warren Buffett says, "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."
Bottom Line: Investing requires a disciplined approach to goals. When capital appreciation is the goal, you’ll want to use a benchmark that achieves that goal with the least risk. We think the S&P 400 MidCap Index is appropriate, given that it has 20% less risk of loss than the S&P 500 Index and 10% greater price appreciation. By using the S&P 400 MidCap Index as our benchmark, we arrive at a 9% discount rate for the Net Present Value (NPV) calculation (see Appendix to Week 256). If your growth stock selections generate a negative NPV, you’d be better off investing in MDY, the SPDR Exchange-Traded Fund that tracks the S&P 400 MidCap Index. This week’s Table has 17 Dividend Achievers with positive NPVs after being “handicapped” by the 9% discount rate. Those are worthwhile dividend-growing stocks for your retirement portfolio, as evidenced by how well their price held up during the Housing Crisis (see Column D in the Table).
Risk Rating: 6 (where 1 = 10-yr US Treasury Notes and 10 = gold bullion).
Full Disclosure: I dollar-average into MSFT, NKE, and UNP. I also own shares of ROST, TJX, HRL, WMT, and MMM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 13
Week 280 - A-rated Commodity-related Dividend Aristocrats
Situation: The S&P 500 Index is increasingly overvalued, and now has a P/E that is 25 times trailing earnings. Investors have withdrawn almost $100 Billion in the past 12 months but the S&P 500 Index keeps rising because companies have bought back even more of their own stock. Earnings of ~$150 Billion barely cover dividend payments. Unless demand picks up, companies will continue returning profits to investors instead of using those for expansion. If planet-wide demand does pick up, stocks will return to reasonable valuations. If it doesn’t, we’ll have a correction or Bear Market.
One slice of the market already appears to have started an upswing, i.e., commodity-related companies. We have documented this from various points of view in several recent blogs. To be very cautious, you might consider investing small amounts of money regularly in one or two of the best companies. Look at the few Dividend Aristocrats in that sector having A-rated stocks and bonds. Dividend Aristocrats are rarely in the spotlight because so few companies have the earnings consistency to generate 25+ consecutive years of dividend increases.
Mission: We’ve checked, and there are only 11 such commodity-related companies. So let’s drill down on those (see Table).
Execution: I know what you’re thinking, that 9 of those 11 companies have P/Es over 20. If the market does drop 10-20%, those 9 will drop at least that much. True enough (quality goods attract money). Either you buy the idea of putting a similar amount of money into the stock market each and every quarter, or you don’t. When the market is down, that money buys more shares of stock. If you have a 401(k) plan at work, dollar-cost averaging is already on automatic pilot.
The main point is to be a disciplined buyer. Never put a big slug of dollars into the market at once, and avoid “one-off” purchases. Pick a theme and build on it over time. Eventually you’ll settle on a plan and fund it with automatic monthly withdrawals from your checking account. Then, sit back and do the math: See how your stock picks perform in comparison to your benchmark mutual fund, e.g. MDY, which is the S&P 400 MidCap Index ETF. If your stocks perform poorly or erratically, invest in the benchmark instead of trying to pick stocks.
Bottom Line: You want safe and effective investments. You have to be careful about investing in companies that draw their feedstocks from the ground. Stocks issued by those companies are vulnerable to boom-and-bust commodity cycles. But the A-rated ones can be safe and effective bets over a 10-year holding period, IF they’ve increased their dividend each year for at least the past 25 years.
Risk Rating: 6
Full Disclosure: I dollar-average into XOM, and also own shares of HRL, MKC, KO, and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column L (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is designed to approximate Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index (at Line 26 in the Table). MDY (at Line 20 in the Table) is the ETF for that index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
One slice of the market already appears to have started an upswing, i.e., commodity-related companies. We have documented this from various points of view in several recent blogs. To be very cautious, you might consider investing small amounts of money regularly in one or two of the best companies. Look at the few Dividend Aristocrats in that sector having A-rated stocks and bonds. Dividend Aristocrats are rarely in the spotlight because so few companies have the earnings consistency to generate 25+ consecutive years of dividend increases.
Mission: We’ve checked, and there are only 11 such commodity-related companies. So let’s drill down on those (see Table).
Execution: I know what you’re thinking, that 9 of those 11 companies have P/Es over 20. If the market does drop 10-20%, those 9 will drop at least that much. True enough (quality goods attract money). Either you buy the idea of putting a similar amount of money into the stock market each and every quarter, or you don’t. When the market is down, that money buys more shares of stock. If you have a 401(k) plan at work, dollar-cost averaging is already on automatic pilot.
The main point is to be a disciplined buyer. Never put a big slug of dollars into the market at once, and avoid “one-off” purchases. Pick a theme and build on it over time. Eventually you’ll settle on a plan and fund it with automatic monthly withdrawals from your checking account. Then, sit back and do the math: See how your stock picks perform in comparison to your benchmark mutual fund, e.g. MDY, which is the S&P 400 MidCap Index ETF. If your stocks perform poorly or erratically, invest in the benchmark instead of trying to pick stocks.
Bottom Line: You want safe and effective investments. You have to be careful about investing in companies that draw their feedstocks from the ground. Stocks issued by those companies are vulnerable to boom-and-bust commodity cycles. But the A-rated ones can be safe and effective bets over a 10-year holding period, IF they’ve increased their dividend each year for at least the past 25 years.
Risk Rating: 6
Full Disclosure: I dollar-average into XOM, and also own shares of HRL, MKC, KO, and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column L (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is designed to approximate Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index (at Line 26 in the Table). MDY (at Line 20 in the Table) is the ETF for that index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 6
Week 279 - Barron’s 500 Agricultural Producers
Situation: This week’s blog looks at how the 12 largest Ag Producers have been doing since 2012. They had been in a slump but have appeared to turn the corner. It seems hard to believe. Agricultural commodity prices remain in a slump and the Dow Jones Commodity Index (^DCI) has shown trendline growth of only 2.0%/yr after completing a 25 yr Commodity Supercycle. But that Index recently bounced off its 1999 low, likely heralding a new Commodity Supercycle . Our regular readers know we think food commodities should be able to buck that trend for two reasons: 1) food is an essential good; 2) the global middle class is projected to grow 10%/yr through 2030.
Mission: Prove that Ag Producers “have turned the corner”.
Execution: First, we’ll look at the negative side of the argument. Farm production has exceeded demand for 3 years. That has resulted in low crop prices, which have a) reduced farm incomes, b) limited the ability of farmers to buy farm equipment , and c) depressed farmland prices: “The amount of rent farmers pay to landowners also dropped precipitously in the St. Louis area. Farmland rent slid 10% and ranchland rent by 20% in the quarter."
Now we’ll look on the positive side. The 12 Barron’s 500 companies that produce equipment, fertilizer, seeds, and agronomy chemicals appear to be doing better. Year-over-year rankings comparing 2013 rankings with 2012 rankings show that only one (Monsanto) did better in terms of cash flow and revenues. However, 8 of the 12 did better when comparing 2015 to 2014. Sequential year-over-year results are shown for all 12 in Columns N-Q of the Table, with green highlights denoting year-over-year improvement.
Administration: Drill down on those largest Ag Producers and try to figure out why they turned the corner in 2015. It shouldn’t have happened, since crop inventories were rising and crop prices were falling, partly because Food Stamp usage in the US fell by 15%. The increased Federal spending to expand Food Stamp participation (after the 2008-2009 Recession) ended when The Recovery Act expired on 11/1/2013.
Bottom Line: Ag Producers are recovering. Briefly, we explain why by noting that the S&P 500 Index went through 10% corrections in October of 2014 and February of 2016. That last correction was associated with a 25% Bear Market for the Basic Materials Industry (XLB at Line 22 in the Table), and coincided with a bottoming of stock prices for 11 of our 12 Ag Producers. For 2015 vs. 2014, 10 of those 12 companies are highlighted in green, indicating improved sales and ROIC (see Columns O and P in the Table), and the aggregate Barron’s 500 Rank for all 12 companies improved to 369 from 398.
Risk Ranking: 7
Full Disclosure: I dollar-average into MON and also own shares of CAT and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is designed to approximate Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index (at Line 27 in the Table), and MDY (at Line 20 in the Table) is the ETF for that index.
Mission: Prove that Ag Producers “have turned the corner”.
Execution: First, we’ll look at the negative side of the argument. Farm production has exceeded demand for 3 years. That has resulted in low crop prices, which have a) reduced farm incomes, b) limited the ability of farmers to buy farm equipment , and c) depressed farmland prices: “The amount of rent farmers pay to landowners also dropped precipitously in the St. Louis area. Farmland rent slid 10% and ranchland rent by 20% in the quarter."
Now we’ll look on the positive side. The 12 Barron’s 500 companies that produce equipment, fertilizer, seeds, and agronomy chemicals appear to be doing better. Year-over-year rankings comparing 2013 rankings with 2012 rankings show that only one (Monsanto) did better in terms of cash flow and revenues. However, 8 of the 12 did better when comparing 2015 to 2014. Sequential year-over-year results are shown for all 12 in Columns N-Q of the Table, with green highlights denoting year-over-year improvement.
Administration: Drill down on those largest Ag Producers and try to figure out why they turned the corner in 2015. It shouldn’t have happened, since crop inventories were rising and crop prices were falling, partly because Food Stamp usage in the US fell by 15%. The increased Federal spending to expand Food Stamp participation (after the 2008-2009 Recession) ended when The Recovery Act expired on 11/1/2013.
Bottom Line: Ag Producers are recovering. Briefly, we explain why by noting that the S&P 500 Index went through 10% corrections in October of 2014 and February of 2016. That last correction was associated with a 25% Bear Market for the Basic Materials Industry (XLB at Line 22 in the Table), and coincided with a bottoming of stock prices for 11 of our 12 Ag Producers. For 2015 vs. 2014, 10 of those 12 companies are highlighted in green, indicating improved sales and ROIC (see Columns O and P in the Table), and the aggregate Barron’s 500 Rank for all 12 companies improved to 369 from 398.
Risk Ranking: 7
Full Disclosure: I dollar-average into MON and also own shares of CAT and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is designed to approximate Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index (at Line 27 in the Table), and MDY (at Line 20 in the Table) is the ETF for that index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 30
Week 278 - Living From One Month To The Next On Social Security
Situation: 60℅ of Americans over age 65 are “overwhelmingly” dependent on Social Security and 20% are totally dependent (“Animal Spirits”, George A. Akerlof and Robert J. Shiller, Princeton University Press, Princeton and Oxford, 2009, p. 124). To maintain Social Security in its current form, with cost of living adjustments (COLA), would consume ~2℅ of the country's taxable income going forward. The average monthly benefit (July 2016) for a retired worker is $1350. Contrast this with the US “poverty threshold” of $1200/mo.
Mission: Outline constraints on the 20% who are totally dependent on Social Security and the 40% who have some savings but remain overwhelmingly dependent on Social Security. Create a spreadsheet of the types of assets held by the latter group.
Execution: To live independently on $1350/mo, an individual or couple would have to start retirement debt-free and remain so. If they are living rent and mortgage free in their home, they will not be able to afford the expenses (maintenance, property tax, utilities) unless they take in a renter. A car would also not be affordable due to expenses (insurance, tires, maintenance, registration). The discipline of sticking to a budget rules out the use of credit cards; a debit card and checking account are a better plan. They would need to use accrual accounting. That is, assign all $1350 of income each month to budgeted expense, including a savings account for non-recurring capital expenditures on new clothes, vacations, income taxes and medical/dental expenses.
The 40% who find themselves overwhelmingly dependent on Social Security probably had no intention of ever owning stocks or stock mutual funds, preferring instead to use FDIC-insured savings accounts, Savings Bonds, whole life insurance, 1/10th ounce gold coins and a money market fund (or short-term bond fund) obtained from a broker. They are savers rather than investors and don’t want to place their savings at risk. They’d like to avoid losing money to inflation, and may be aware that the only zero-risk/zero-cost investments are 10-Yr Inflation-protected Treasury Notes and IRA-like Inflation-protected Savings Bonds obtained online.
This cohort doesn’t want to gamble, which means they don’t want to invest in asset classes that always seem to fall in value during a recession. That restraint rules out stocks, corporate bonds, and REITs but not the equity in their own home. They may strive to own a home, but until the Housing Crisis they weren’t fully aware of the risk. Now they know that only Treasury Notes and gold can be counted on to rise in value during a financial crisis.
Administration: see Table.
Bottom Line: Live small, stay out of debt, close any credit card accounts and keep track of every penny in an accrual accounting ledger.
Risk Rating: 3 (where Treasury Notes = 1 and gold = 10).
Full Disclosure: I dollar-average into Savings Bonds and hold Treasury Notes at www.treasurydirect.gov. I hold an intermediate-term US Treasury Bond Fund in a retirement account.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Outline constraints on the 20% who are totally dependent on Social Security and the 40% who have some savings but remain overwhelmingly dependent on Social Security. Create a spreadsheet of the types of assets held by the latter group.
Execution: To live independently on $1350/mo, an individual or couple would have to start retirement debt-free and remain so. If they are living rent and mortgage free in their home, they will not be able to afford the expenses (maintenance, property tax, utilities) unless they take in a renter. A car would also not be affordable due to expenses (insurance, tires, maintenance, registration). The discipline of sticking to a budget rules out the use of credit cards; a debit card and checking account are a better plan. They would need to use accrual accounting. That is, assign all $1350 of income each month to budgeted expense, including a savings account for non-recurring capital expenditures on new clothes, vacations, income taxes and medical/dental expenses.
The 40% who find themselves overwhelmingly dependent on Social Security probably had no intention of ever owning stocks or stock mutual funds, preferring instead to use FDIC-insured savings accounts, Savings Bonds, whole life insurance, 1/10th ounce gold coins and a money market fund (or short-term bond fund) obtained from a broker. They are savers rather than investors and don’t want to place their savings at risk. They’d like to avoid losing money to inflation, and may be aware that the only zero-risk/zero-cost investments are 10-Yr Inflation-protected Treasury Notes and IRA-like Inflation-protected Savings Bonds obtained online.
This cohort doesn’t want to gamble, which means they don’t want to invest in asset classes that always seem to fall in value during a recession. That restraint rules out stocks, corporate bonds, and REITs but not the equity in their own home. They may strive to own a home, but until the Housing Crisis they weren’t fully aware of the risk. Now they know that only Treasury Notes and gold can be counted on to rise in value during a financial crisis.
Administration: see Table.
Bottom Line: Live small, stay out of debt, close any credit card accounts and keep track of every penny in an accrual accounting ledger.
Risk Rating: 3 (where Treasury Notes = 1 and gold = 10).
Full Disclosure: I dollar-average into Savings Bonds and hold Treasury Notes at www.treasurydirect.gov. I hold an intermediate-term US Treasury Bond Fund in a retirement account.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 23
Week 277 - Counter-cyclical Barron’s 500 Dividend Achievers
Situation: What’s the biggest problem with owning stocks? When JP Morgan was asked this question, he answered: “It will fluctuate.” Benjamin Graham was more specific, noting in Chapter 14 (Stock Selection for the Defensive Investor) of his famous book (The Intelligent Investor, 4th Revised Edition, Harper & Row, New York, 1973, p.195) that:
“Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.”
But a stock’s price will rise far higher when investors clamor to “get in on the story.” All too often, that story reflects the investment that the company’s managers have made in Public Relations (e.g. advertising) at the expense of investments that grow Tangible Book Value (e.g. property, plant, equipment, and software). As a result, the company’s stock price will falter whenever the macro-economic outlook is negative.
Mission: This week we’ll build on Warren Buffett’s observation that “only when the tide goes out do you discover who’s been swimming naked.” That last happened with the 4.5 yr Housing Crisis, i.e., year-over-year house prices (for conforming new sales nationwide) turned negative in Q3 of 2007 and didn’t turn positive again until Q1 of 2012. Most companies were exposed as naked swimmers, and their stock prices soon fell to a level more consistent with Benjamin Graham’s formula (see above). But a few outperformed during that 4.5 yr period. Total Returns/Yr proved to be greater than Total Returns/Yr have been over the 26+ yr period since the Savings & Loan Crisis of 1990-91. Do those companies have anything in common? We’d like to know, since owning shares in 2 or 3 such companies would help protect our portfolios from the ravages of the next crisis.
Mission: Look for companies in the Barron’s 500 List that 1) outperformed in the Housing Crisis, 2) have improved revenues and cash flow over the past 3 yrs, 3) have high S&P ratings on their bond and stock issues, and 4) are Dividend Achievers.
Execution: (see Table)
Administration: The first 3 companies in our Table (ROST, TJX, MCD) represent the Consumer Discretionary industry and see thrifty consumers as “core” clientele. Their Business Plan is designed to outperform in a recession because people will have an ongoing need to purchase their products and services, and more people will have become thrifty-minded. Four companies at the bottom of the list (WEC, XEL, ES, ED) are regulated public utilities that play a similar role: everyone needs to turn on lights and recharge their cell phones every day. Somehow the money will be found to pay the utility bill.
It is harder to explain how the remaining two companies, IBM and WW Grainger (GWW), made the list. When a company needs information technology maintenance or upgrades, IBM has always had the reputation of being a safe and effective recommendation for a company’s Chief Information Officer to make. A deep recession is exactly when such upgrades are in demand, given that the company has had to reduce staffing to avoid being bought out by a stronger competitor. Automation and global sourcing are the paramount strategies to deploy in a recession. Similarly, GWW is the leading supplier of maintenance, repair, and operating products to businesses. So, demand for at least some of their products will have remained steady.
Among the BENCHMARKS and Standard Indices in our Table, note that only two asset classes that outperformed their long-term trend during the Housing Crisis: bonds and gold. This will always be the case in a financial crisis.
In the aggregate, these 9 stocks have a 5-Yr Beta below 0.5 (see Column I in the Table) which suggests that there would be less risk of loss vs. the S&P 500 Index in a Bear Market. But statistical analysis of weekly prices over the past 25 yrs suggests otherwise (see Column M in the Table). Taking both metrics into consideration, we see that WEC Energy Group (WEC) and Consolidated Edison (ED) are the only low-risk investments.
Bottom Line: The “common thread” of our 9 recession-proof companies is a combination of skilled management and having a product line that includes goods and services exhibiting near-zero elasticity. Companies like Ross Stores (ROST), TJX (TJX) and McDonald’s (MCD), which appeal to the budget-minded among us, will ride out almost any storm. Electric utilities that are well-managed, like WEC Energy Group (WEC), or serve upscale markets, like Denver (XEL), Boston (ES) and New York City (ED), will emerge unscathed from recession. Finally, there are companies like IBM and Grainger (GWW) that provide maintenance and information technology to a long roster of companies, and these often cannot be pushed into the next quarter.
Risk Rating: 5 (where Treasuries = 1, and gold = 10)
Full Disclosure: I own shares of ROST, TJX, MCD, and IBM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Use of such a long-term trendline CAGR instead of a shorter-term current CAGR emphasizes the predictive value of “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small number of large-cap stocks where selection bias is paramount. That stock index is the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
“Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.”
But a stock’s price will rise far higher when investors clamor to “get in on the story.” All too often, that story reflects the investment that the company’s managers have made in Public Relations (e.g. advertising) at the expense of investments that grow Tangible Book Value (e.g. property, plant, equipment, and software). As a result, the company’s stock price will falter whenever the macro-economic outlook is negative.
Mission: This week we’ll build on Warren Buffett’s observation that “only when the tide goes out do you discover who’s been swimming naked.” That last happened with the 4.5 yr Housing Crisis, i.e., year-over-year house prices (for conforming new sales nationwide) turned negative in Q3 of 2007 and didn’t turn positive again until Q1 of 2012. Most companies were exposed as naked swimmers, and their stock prices soon fell to a level more consistent with Benjamin Graham’s formula (see above). But a few outperformed during that 4.5 yr period. Total Returns/Yr proved to be greater than Total Returns/Yr have been over the 26+ yr period since the Savings & Loan Crisis of 1990-91. Do those companies have anything in common? We’d like to know, since owning shares in 2 or 3 such companies would help protect our portfolios from the ravages of the next crisis.
Mission: Look for companies in the Barron’s 500 List that 1) outperformed in the Housing Crisis, 2) have improved revenues and cash flow over the past 3 yrs, 3) have high S&P ratings on their bond and stock issues, and 4) are Dividend Achievers.
Execution: (see Table)
Administration: The first 3 companies in our Table (ROST, TJX, MCD) represent the Consumer Discretionary industry and see thrifty consumers as “core” clientele. Their Business Plan is designed to outperform in a recession because people will have an ongoing need to purchase their products and services, and more people will have become thrifty-minded. Four companies at the bottom of the list (WEC, XEL, ES, ED) are regulated public utilities that play a similar role: everyone needs to turn on lights and recharge their cell phones every day. Somehow the money will be found to pay the utility bill.
It is harder to explain how the remaining two companies, IBM and WW Grainger (GWW), made the list. When a company needs information technology maintenance or upgrades, IBM has always had the reputation of being a safe and effective recommendation for a company’s Chief Information Officer to make. A deep recession is exactly when such upgrades are in demand, given that the company has had to reduce staffing to avoid being bought out by a stronger competitor. Automation and global sourcing are the paramount strategies to deploy in a recession. Similarly, GWW is the leading supplier of maintenance, repair, and operating products to businesses. So, demand for at least some of their products will have remained steady.
Among the BENCHMARKS and Standard Indices in our Table, note that only two asset classes that outperformed their long-term trend during the Housing Crisis: bonds and gold. This will always be the case in a financial crisis.
In the aggregate, these 9 stocks have a 5-Yr Beta below 0.5 (see Column I in the Table) which suggests that there would be less risk of loss vs. the S&P 500 Index in a Bear Market. But statistical analysis of weekly prices over the past 25 yrs suggests otherwise (see Column M in the Table). Taking both metrics into consideration, we see that WEC Energy Group (WEC) and Consolidated Edison (ED) are the only low-risk investments.
Bottom Line: The “common thread” of our 9 recession-proof companies is a combination of skilled management and having a product line that includes goods and services exhibiting near-zero elasticity. Companies like Ross Stores (ROST), TJX (TJX) and McDonald’s (MCD), which appeal to the budget-minded among us, will ride out almost any storm. Electric utilities that are well-managed, like WEC Energy Group (WEC), or serve upscale markets, like Denver (XEL), Boston (ES) and New York City (ED), will emerge unscathed from recession. Finally, there are companies like IBM and Grainger (GWW) that provide maintenance and information technology to a long roster of companies, and these often cannot be pushed into the next quarter.
Risk Rating: 5 (where Treasuries = 1, and gold = 10)
Full Disclosure: I own shares of ROST, TJX, MCD, and IBM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Use of such a long-term trendline CAGR instead of a shorter-term current CAGR emphasizes the predictive value of “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small number of large-cap stocks where selection bias is paramount. That stock index is the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 16
Week 276 - Barron’s 500 Companies With Clean Balance Sheets and Improving Fundamentals
Situation: Stock market valuations are still in nosebleed territory. The S&P 500 Index is 25 times trailing 12-mo earnings. The cyclically-adjusted PE ratio is 27 times trailing 10-yr earnings, i.e., just shy of the last peak reached in October of 2007. You get the point, so you’re in “risk-off” mode. But you’re not going to save for the future by hiding money under your mattress. How should a prudent investor continue adding money to the market, knowing that a precipice looms? With dollar-cost averaging, an investor can add small amounts each month to stocks from several different industries, i.e., more shares per dollar when the market swoons. But which stocks? When you’re in risk-off mode, those need to be A-rated, large-capitalization stocks with improving fundamentals, and at least a 25 yr trading record.
Mission: Screen the 2016 Barron’s 500 List for companies that have improved in rank and have 25 yrs of quantitative data at the BMW Method website. Eliminate companies that don’t have a clean Balance Sheet (as defined in the Appendix for Week 271). Assess growth prospects by calculating Net Present Value (NPV) for each stock. For companies with Top 500 Global Brands, provide 2016 and 2015 brand ranks.
Execution: see Table.
Bottom Line: We’ve used a tight screen to come up with 10 companies worth dollar-averaging through a Bear Market. Three represent the Consumer Staples industry: HRL, COST, WMT. Four represent the Consumer Discretionary industry: ROST, TJX, NKE, DIS. There’s also one Industrial company (PH), an Information Technology company (ADP) and a Basic Materials company (APD). All but the 3 companies with strong brands (NKE, COST, ADP) are likely to fall in value as much as the S&P 500 Index in the next Bear Market (see Columns AC and AD in the Table). NPV calculations (see Column V in the Table) suggest that buying shares in any of the 10 companies would result in a greater gain after 10 yrs than buying shares in the lowest cost S&P 500 Index fund (VFINX at Line 18 in the Table).
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, and gold = 10)
Full Disclosure: I dollar-average into NKE and also own shares of ROST, TJX, HRL and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate for this week is the25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/), done to emphasize “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Screen the 2016 Barron’s 500 List for companies that have improved in rank and have 25 yrs of quantitative data at the BMW Method website. Eliminate companies that don’t have a clean Balance Sheet (as defined in the Appendix for Week 271). Assess growth prospects by calculating Net Present Value (NPV) for each stock. For companies with Top 500 Global Brands, provide 2016 and 2015 brand ranks.
Execution: see Table.
Bottom Line: We’ve used a tight screen to come up with 10 companies worth dollar-averaging through a Bear Market. Three represent the Consumer Staples industry: HRL, COST, WMT. Four represent the Consumer Discretionary industry: ROST, TJX, NKE, DIS. There’s also one Industrial company (PH), an Information Technology company (ADP) and a Basic Materials company (APD). All but the 3 companies with strong brands (NKE, COST, ADP) are likely to fall in value as much as the S&P 500 Index in the next Bear Market (see Columns AC and AD in the Table). NPV calculations (see Column V in the Table) suggest that buying shares in any of the 10 companies would result in a greater gain after 10 yrs than buying shares in the lowest cost S&P 500 Index fund (VFINX at Line 18 in the Table).
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, and gold = 10)
Full Disclosure: I dollar-average into NKE and also own shares of ROST, TJX, HRL and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate for this week is the25-Yr trendline CAGR found at Column K (http://invest.kleinnet.com/bmw1/), done to emphasize “reversion to the mean”. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 9
Week 275 - Food Processors With Improving Fundamentals
Situation: Grain prices are low, which means equipment and seed vendors find that few farmers are eager to buy. But grain processors benefit when prices are low.
Mission: Look for improvements in cash flow and revenue among the largest food processors, and assess the benefits and risks of investing in those companies. Look for Brand Value and clean Balance Sheets in addition to calculating Net Present Value.
Execution: see Table.
Administration: We’ve found 12 food processing companies that rank higher on the 2016 Barron’s 500 List than they did on the 2015 List. Those companies had a better overall score based on 3 criteria: A) Cash flow-based ROIC, B) 2015 ROIC vs. the 3-yr median, and C) sales growth in 2015 vs. 2014. All 12 companies have a 16+ year trading history that has been analyzed quantitatively by using the BMW Method; see Columns K-M in the Table.
With respect to broad indications of quality (i.e., S&P bond and stock ratings at Columns P and Q in the Table), only 6 companies meet our standards. Our measures include a bond rating of BBB+ or better and a stock rating of B+/M or better. The 6 stocks are: Hershey (HSY), General Mills (GIS), Hormel Foods (HRL), Coca-Cola (KO), Campbell Soup (CPB), Archer Daniels Midland (ADM). Only 4 of those stocks are Dividend Achievers (annual dividend increases for 10+ yrs): GIS, HRL, KO, ADM.
With respect to Net Present Value (see Column V in the Table), the top 4 companies are Ingredion (INGR), Hormel Foods (HRL), JM Smucker (SJM), Tyson Foods (TSN).
Hormel Foods (HRL) is the only company with a clean Balance Sheet. We have a problem when evaluating Balance Sheets for food processors (see Columns Y-AB). Those companies are able to be somewhat unconcerned about bankruptcy, since food prices tend to be inelastic (i.e., food is an “essential good”). This allows company managers to spend more on advertising than on growing Tangible Book Value. In the aggregate, these 12 companies carry too much debt. Their total debt is 160% of equity whereas 100% is the upper limit for a clean Balance Sheet. Long-term debt is 29% of total assets, which is barely acceptable. Tangible Book Value is 1% of each share’s price, which is barely acceptable. In the first half of 2016, two of the Dividend Achievers, Coca-Cola (KO) and Archer Daniels Midland (ADM), had insufficient free cash flow (FCF) to pay dividends. That means they either had to borrow the necessary funds or sell a non-strategic asset.
With respect to brand value, Best Global Brands ranks the top 500 brand names annually. Three of the companies in our Table are among the top 500 for 2016. Those 3 are: Coca-Cola (KO), Kellogg (K), Tyson Foods (TSN). Two additional Coca-Cola brands appear on the list, Sprite and Fanta. Coca-Cola ranks #17 (down from #12), Kellogg ranks #183 (down from #181), Tyson ranks #307 (up from #353), Sprite ranks #411 (down from #391), and Fanta ranks #488 (unchanged). Interestingly, Hershey (HSY) is not a top 500 global brand.
Bottom Line: The “take-home message” is that stocks whose prices vary with the weather and global crop yields are speculative. The investment that farmers make in equipment, software, irrigation systems, seeds and chemicals will determine their crop yields, given favorable weather. Over the past 3 yrs of good weather (El Nino), those investments have paid off in all the countries of the Northern Hemisphere that have a strong agriculture sector. That means the prices that food processors pay for wheat, soybeans, rice, corn and meat have fallen. The other key fact that drives those growing profits is the addition of some 20 million people a year to the middle class, meaning they can finally afford to eat a 60 gm protein diet every day.
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1 and gold = 10).
Full Disclosure: I own shares of HRL, KO and ADM but recently sold shares of GIS. I thought GIS shares had become overpriced but the current NPV calculation suggests that GIS shares continue to have considerable value (see Line 3 in the Table, at Column V).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index at Line 26. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 20. The NPV calculation for MDY (at Column V and Line 20) includes transaction costs of 2.5% on purchase and 2.5% on sale.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Look for improvements in cash flow and revenue among the largest food processors, and assess the benefits and risks of investing in those companies. Look for Brand Value and clean Balance Sheets in addition to calculating Net Present Value.
Execution: see Table.
Administration: We’ve found 12 food processing companies that rank higher on the 2016 Barron’s 500 List than they did on the 2015 List. Those companies had a better overall score based on 3 criteria: A) Cash flow-based ROIC, B) 2015 ROIC vs. the 3-yr median, and C) sales growth in 2015 vs. 2014. All 12 companies have a 16+ year trading history that has been analyzed quantitatively by using the BMW Method; see Columns K-M in the Table.
With respect to broad indications of quality (i.e., S&P bond and stock ratings at Columns P and Q in the Table), only 6 companies meet our standards. Our measures include a bond rating of BBB+ or better and a stock rating of B+/M or better. The 6 stocks are: Hershey (HSY), General Mills (GIS), Hormel Foods (HRL), Coca-Cola (KO), Campbell Soup (CPB), Archer Daniels Midland (ADM). Only 4 of those stocks are Dividend Achievers (annual dividend increases for 10+ yrs): GIS, HRL, KO, ADM.
With respect to Net Present Value (see Column V in the Table), the top 4 companies are Ingredion (INGR), Hormel Foods (HRL), JM Smucker (SJM), Tyson Foods (TSN).
Hormel Foods (HRL) is the only company with a clean Balance Sheet. We have a problem when evaluating Balance Sheets for food processors (see Columns Y-AB). Those companies are able to be somewhat unconcerned about bankruptcy, since food prices tend to be inelastic (i.e., food is an “essential good”). This allows company managers to spend more on advertising than on growing Tangible Book Value. In the aggregate, these 12 companies carry too much debt. Their total debt is 160% of equity whereas 100% is the upper limit for a clean Balance Sheet. Long-term debt is 29% of total assets, which is barely acceptable. Tangible Book Value is 1% of each share’s price, which is barely acceptable. In the first half of 2016, two of the Dividend Achievers, Coca-Cola (KO) and Archer Daniels Midland (ADM), had insufficient free cash flow (FCF) to pay dividends. That means they either had to borrow the necessary funds or sell a non-strategic asset.
With respect to brand value, Best Global Brands ranks the top 500 brand names annually. Three of the companies in our Table are among the top 500 for 2016. Those 3 are: Coca-Cola (KO), Kellogg (K), Tyson Foods (TSN). Two additional Coca-Cola brands appear on the list, Sprite and Fanta. Coca-Cola ranks #17 (down from #12), Kellogg ranks #183 (down from #181), Tyson ranks #307 (up from #353), Sprite ranks #411 (down from #391), and Fanta ranks #488 (unchanged). Interestingly, Hershey (HSY) is not a top 500 global brand.
Bottom Line: The “take-home message” is that stocks whose prices vary with the weather and global crop yields are speculative. The investment that farmers make in equipment, software, irrigation systems, seeds and chemicals will determine their crop yields, given favorable weather. Over the past 3 yrs of good weather (El Nino), those investments have paid off in all the countries of the Northern Hemisphere that have a strong agriculture sector. That means the prices that food processors pay for wheat, soybeans, rice, corn and meat have fallen. The other key fact that drives those growing profits is the addition of some 20 million people a year to the middle class, meaning they can finally afford to eat a 60 gm protein diet every day.
Risk Rating: 7 (where 10-Yr US Treasury Notes = 1 and gold = 10).
Full Disclosure: I own shares of HRL, KO and ADM but recently sold shares of GIS. I thought GIS shares had become overpriced but the current NPV calculation suggests that GIS shares continue to have considerable value (see Line 3 in the Table, at Column V).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to owning a small portfolio of large-cap stocks, i.e., the S&P MidCap 400 Index at Line 26. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 20. The NPV calculation for MDY (at Column V and Line 20) includes transaction costs of 2.5% on purchase and 2.5% on sale.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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