Week 256 - Barron's 500 Growth Stocks That Have Outperformed the S&P 500 for 16 Years

Situation: You need a menu that limits your choices when looking for “buy-and-hold” growth stocks in the S&P 500 Index. This is the second blog in a 3-week series for building that menu. Part #1 (see Week 255) looked at S&P 500 stocks that do not have sufficient revenues for inclusion in the recently published 2016 Barron’s 500 List. Those are the largest US and Canadian companies by revenue. It is a valuable resource, which ranks companies by their 3-yr growth in sales and cash-flow based ROIC. This week we introduce a menu of larger S&P 500 growth companies found in the 2016 Barron’s 500 List. Next week, we’ll cover S&P 500 “defensive” companies. 

Mission: All 3 blogs use the same screening tools, starting with a requirement that companies be Dividend Achievers. From those company’s stocks, we select the ones that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks are up more and down less: 16-yr total returns/yr were greater and losses in the last market correction (April through September of 2011) were less. In addition, all companies must be of high quality, with an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher.

Execution: We have assembled a number of metrics for each company that you’ve seen before (see Table). In addition, we calculate the Net Present Value (NPV) for each company by using a standard flow chart. The NPV calculation has been explained briefly in last week’s blog (see Week 255). A detailed description of inputs to that flowchart, and the rationale for those inputs, is explained in the Appendix below. 

Bottom Line: We have screened for S&P 500 growth stocks that have been up more and down less than the S&P 500 Index over the past 16 yrs. The only companies that have been examined are a) Dividend Achievers, b) on the just-published 2016 Barron’s 500 List, and c) have high S&P bond & stock ratings. Net Present Value (NPV) calculations are for stock prices on May 28, 2016. We find that 17 companies meet our criteria (see Table). As a group, their stocks have no greater risk of loss than the S&P 500 Index by even the most severe statistical test per the BMW Method, found at Column P in the Table. Four of the companies offer outstanding long-term value to investors, in that they have NPVs higher than the average for the group, have improving fundamentals according to assessments by the Barron’s 500 editors, and have a Return on Invested Capital (ROIC) that exceeds their Weighted Average Cost of Capital (WACC) as indicated in Columns Z and AA of the Table. Note that 8 of the 17 appear overpriced in that EV/EBITDA is higher than the S&P 500 multiple of 12 (see Column K in the Table).

Risk Rating = 6 (Treasuries = 1 and gold = 10).

Full Disclosure: I dollar-average into NKE, MSFT and XOM, and own TJX, ROST and MCD shares.

NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 23 in the Table). Metrics highlighted in green at Columns Q and R in the Table indicate improving performance trends for fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC. Aside from NPV calculations, metrics are current for the Sunday of publication. 

APPENDIX: Inputs to NPV Calculator:

Discount Rate = 9.0%. Why? Because that is the expected rate of return going forward using the reference index of our choice, the S&P MidCap 400 Index. This index fund has a dividend yield of ~1.5% and a 16-yr price CAGR of ~7.5% (1.5% + 7.5% = 9.0%). Standard practice is to select a Discount Rate that has comparable risk and reward features to the asset class being examined, which in our case are individual stocks in the S&P 500 Index. Therefore, our NPV calculation would yield an NPV of zero if the stock in question merely had a projected return of 9.0%/yr to the investor over the Life of the Project (10 years). A positive number for NPV is necessary to justify investment in a particular stock as opposed to simply choosing to invest in the reference index. 
Initial Cost is the price for ~$5,000 worth of an even number of shares, plus 2.5% in transaction costs. That means $5,128.21 becomes the Initial Cost for XX number of shares priced at exactly $5,000.00. $5,128.21 is entered in the flowchart with a minus sign in front of it. Why? Because the Present Value of Expected Cash Flows is the output of the flow chart, which represents cash received minus cash paid. 
Life of the Project is 10 years. So, the shares purchased at an Initial Cost of $5128.21 are sold in the 10th year for XX amount minus a 2.5% penalty for transaction costs. 
Cash Flow 1 is the annual dividend multiplied by the number of shares purchased. 
Cash Flow 2 is that amount multiplied by the rate of dividend growth over the past 16 yrs (Column H in the Table). For example, a dividend yield of 1% for a stock selling at $100.00 is $1.00; multiplying that by 40 shares gives Cash Flow 1 of $40.00. If the 16-yr Dividend Growth is 10.0%/yr, Cash Flow 2 is 1.1 times $40.00 = $44.00. 
Cash Flows 3-9 are handled the same way to generate estimated dividend payments. 
Cash Flow 10 is the sum of the estimated dividend payment for Year 10 plus the selling price for the shares originally purchased. That price is determined by using the 16-yr price CAGR for that stock in Column N in the Table, to project the original price 10 yrs ahead per the BMW Method. That price return is then decreased by 2.5% to account for transaction costs. Upon clicking Calculate, you arrive at the PV of Expected Cash Flows and NPV which is the PV of Expected Cash Flows left after subtracting 9.0%/yr for the Discount Rate.

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