Week 238 - Let’s Revisit The “Stockpicker’s Secret Fishing Hole”

Situation: Stock-picking is a good way to build a retirement portfolio, if you have enough time and enthusiasm. It requires that you delve into fundamental company practices far enough to select and follow a dozen or more stocks. But how do you start, and where should you focus your efforts? For sure, you’re not going to analyze all 500 stocks in the S&P 500 Index (^GSPC). But you can become familiar with the 65 stocks in the Dow Jones Composite Index (^DJA). We call it the Stockpicker’s Secret Fishing Hole because it often outperforms the S&P 500 Index. For example, price appreciation over the past two market cycles for ^DJA has been twice as great as for ^GSPC (see Column C at Lines 52 & 54 in the Table). ^DJA also benefits from being a “managed” index: its stocks are picked by a Wall Street Journal committee chaired by the Managing Editor.

Mission: Produce our standard spreadsheet for all ^DJA stocks that have revenues high enough to warrant inclusion in the Barron’s 500 List. Exclude any that have an S&P stock rating lower than B+/M, or an S&P bond rating lower than BBB+, and determine which of the remainder have a Durable Competitive Advantage (DCA). 

Execution: Of the 38 companies that meet mission criteria, 18 are suitable for long-term investment because much of their book value is in real (“tangible”) assets that track earnings growth. Warren Buffett says this confers a “Durable Competitive Advantage” if tangible assets have been growing at least 9% per year over the most recent decade, and if there have been no more than two down years (see The Warren Buffett Stock Portfolio by Mary Buffett and David Clark, Scribner, New York, 2011). Given that the Great Recession sharply reduced economic growth over the past decade, I’ve loosened that standard to 7%/yr with no more than 3 down years. 

The 18 companies listed below meet our requirements. All have a Price/Tangible Book Value ratio that is less than 10. In other words, real assets (as opposed to brand value or “goodwill”) represent at least 10% of the share price (see Columns T-V in the Table). I use this system, and dollar-average into the 7 stocks with bold typeface: 

        Apple
        Nike
        NiSource
        Public Service Enterprise Group
        NextEra Energy
        Microsoft
        JB Hunt Transport Services
        Wal-Mart Stores
        American Express
        Union Pacific
        Chevron
        ExxonMobil
        Travelers
        Expeditors International of Washington
        CSX
        Cisco Systems
        JP Morgan Chase
        Goldman Sachs

Bottom Line: “High quality megacaps are the name of the game.” You’ll need a system for recognizing value and sustainability among those large capitalization companies. S&P charts for individual companies list the Tangible Book Value (TBV) for each of the past 10 yrs and are available through most brokerages, as well as S&P. By using a calculator for Compound Annual Growth Rate, you can arrive at each company’s Durable Competitive Advantage (growth in TBV). If the company has no TBV, its liabilities exceed the value of its real assets; you’ll need to delve into its Balance Sheet before deciding to assume that much risk. We’ve filtered through the 65-stock Dow Jones Composite Index and come up with 18 companies that look worthwhile, using our standard spreadsheet supplemented with calculations of their Durable Competitive Advantage.

Risk rating: 5

Full Disclosure: In addition to the 7 stocks above that I dollar-average into, I own shares of UTX, DD, MMM, INTC, KO, IBM, JNJ and MCD.

Note: Metrics in the Table are current for the Sunday of publication; those highlighted in red denote underperformance vs. our key benchmark (VBINX at Line 45 in the Table). Total returns/yr (in Column C of the Table) date to the penultimate S&P 500 Index peak that occurred on 9/1/2000.

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