Situation: Unless you just returned from 10 yrs on another planet, you know that financial innovation almost crashed this planet’s largest economies in 2008. The financial services industry in the US had earlier been given free reign to “innovate” by the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999. Prior to that Act, any one financial services institution had been prohibited “from acting as any combination of an investment bank, a commercial bank, and an insurance company.” Not only did such combinations become legal but the Securities and Exchange Commission was denied authority to regulate the “large investment bank holding companies” enabled by the Act: The fox would be running the henhouse.
Once the consequences of that became clear in 2008, the US Congress was moved to pass the Dodd-Frank Wall Street Reform and Consumer Protection Act; President Obama signed it into law on July 21, 2010. Most of the reforms enabled by that Act will be extended worldwide when the Third Basel Accord (Basel III) takes effect on March 31, 2019. However, we note that Mervyn King, the former Bank of England Governor, doubts whether Basel III will prevent another financial calamity.
Now that the status quo ante has largely been restored, we can take a fresh look at financial services institutions, beginning with the remaining Bank Holding Companies. Those 33 money center banks are now called Global SIFIs (Systemically Important Financial Institutions) or G-SIBs. To remain Bank Holding Companies, each is required to carry large amounts of reserve capital and publish a “living will” that has been approved by its central bank. So, if a financial calamity were to consume all of a holding company’s reserve capital, there is a plan in place to resolve the difficulty in an orderly manner. To prepare for that day, each G-SIB has to lock away tens of billion dollars. Those funds are unavailable for making loans or serving as collateral. The idea is to have G-SIBs gradually go away, since restrictions on their ability to provide loans or collateral make it difficult for them to sustain competition against investment banks, commercial banks and insurance companies. Three of the original 33 G-SIBs have already been broken up.
Mission: Given that G-SIB CEOs believe there is a competitive advantage to providing a complete range of financial services for their customers, we’ll look at a variety of metrics and decide whether or not they’re on a quixotic mission. Why should we care? Because the severity of regulation being applied by central bankers almost guarantees that G-SIBs won’t collapse. If you own stock in one, you’ll almost certainly make money. We’ll limit our attention to the 8 G-SIBs in North America, i.e., those that appear in the recently published 2016 Barron’s 500 List.
Execution: We’ll deploy our recently expanded spreadsheet (see Table). There you’ll find performance data and new metrics designed to scope out future prospects for success. Column L in the Table shows the consensus of analyst’s estimates for the trend in each company’s earnings over the next 5 yrs. The green highlights in Columns P and Q indicate that cash-flow based ROIC and sales have been improving at each of the 8 companies for the past 3 yrs. Column T gives the Graham Number and Column U gives the stock price. The Graham Number is where the stock price would be if it were to reflect 15 times earnings per share and 1.5 times book value per share. Benjamin Graham is the “father of value investing” and was the Professor of Economics at Columbia Business School who had such a large effect on Warren Buffett (MSc Economics, 1951).
Bottom Line: Wall Street banks have become a thicket of thorns. Financial engineering has not paid off for them, and the various routes they have discovered for creative finance are now blocked. Workarounds have been forged, and may yet pay off. For the retail investor, these are not promising stocks. The only exception is Wells Fargo (WFC), which has long avoided the kind of creative finance that brought us the Lehman Panic.
Risk Rating = 9 (Treasuries = 1 and gold = 10).
Full Disclosure: I dollar-average into JPM.
NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 14 in the Table). Metrics highlighted in green at Columns P and Q 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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 19
Week 259 - Barron’s 500 Utilities
Situation: You’ve been here before. We like utility stocks as bond substitutes. They grow, albeit slowly, giving investors some protection against the risk posed by rising interest rates. On the downside, utilities are a “crowded trade” because persistently low interest rates continue to drive investors away from bonds. If you’re migrating away from a 50:50 allocation for bonds and stocks, you’re probably targeting 60% stocks and 40% bonds. That means you’ll need to hold sizable positions in several utility companies, or an Exchange Traded Fund (ETF) for utilities such as iShares US Utilities ETF (IDU at Line 19 in the Table). Be aware that variable costs are high for these companies because of extensive maintenance requirements that exceed depreciation allowances. On the other hand, they are monopolies that benefit from state and Federal regulations which lower borrowing costs and ensure that customers will pay a fair price for utility services.
Mission: Provide a capsule summary for investors in Utilities. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Exclude any company that does not have an S&P bond rating of BBB+ or better, and an S&P stock rating of B+/M or better. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).
Execution: see Table.
Bottom Line: The numbers in the Table reflect high returns and low risk from investing in utility companies. However, this is partly because eight yrs of “monetary easing” has made bond-like stocks more valuable by pushing investors away from buying bonds. Prices for the group of 10 stocks in the Table are than 30% higher than can be justified by their earnings and book values (compare Columns T and U in the Table).
Risk Rating = 4 (Treasuries = 1 and gold =10)
Full Disclosure: I dollar-average into NEE.
NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 16 in the Table). Metrics highlighted in green at Columns P and Q indicate improving performance in fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA indicate a company in current difficulty, ROIC being lower than WACC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Provide a capsule summary for investors in Utilities. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Exclude any company that does not have an S&P bond rating of BBB+ or better, and an S&P stock rating of B+/M or better. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).
Execution: see Table.
Bottom Line: The numbers in the Table reflect high returns and low risk from investing in utility companies. However, this is partly because eight yrs of “monetary easing” has made bond-like stocks more valuable by pushing investors away from buying bonds. Prices for the group of 10 stocks in the Table are than 30% higher than can be justified by their earnings and book values (compare Columns T and U in the Table).
Risk Rating = 4 (Treasuries = 1 and gold =10)
Full Disclosure: I dollar-average into NEE.
NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 16 in the Table). Metrics highlighted in green at Columns P and Q indicate improving performance in fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA indicate a company in current difficulty, ROIC being lower than WACC.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 12
Week 258 - Barron’s 500 Multimodal Transportation Companies
Situation: If you want to feel the pulse of an economy, look at trends in transportation. Those trends won’t tell you where the economy is headed next but they will show you where it’s been, and where the pressure points are. Right now, one pressure point for the US economy is the inefficiency of off-loading cargo from ships to drayage trucks, and transferring containers to warehouses or railroads. Another pressure point is the “final mile,” or how to get goods into the hands of consumers with a minimum of inconvenience. “Vertical integration” appears to be the answer for both problems, meaning companies like FedEx and UPS (and increasingly Amazon) will try to perform as many integrated services in-house as is possible. Finally, there are environmental considerations, namely, how do we move cargo around without leaving such a large carbon footprint. One solution that is off to a good start is replacing diesel truck engines with compressed natural gas (CNG) engines. The largest US truck fleet (JB Hunt Transport Services; JBHT) is an early adopter. Given the centrality of these above-mentioned companies, it would be a good idea for you to hold shares in one, or shares in an Exchange Traded Fund (ETF) for the transportation sector such as the iShares Transportation Average ETF ( IYT at Line 21 in the Table).
Mission: Provide a capsule summary for investors in Air Freight & Logistics companies, as well as multimodal trucking companies and railroads. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).
Execution: see Table.
Bottom Line: Dow Theory is the oldest method to assess current and future value in the stock market. The critical variable is the Dow Jones Transportation Average (DJTA), a running index of stock prices for 20 transportation companies. A “primary uptrend” ( Bull Market) is not declared when the Dow Jones Industrial Average (DJIA) hits new highs, but instead is declared when the DJTA confirms that event by also hitting a new high. We saw a confirmation most recently in November of 2014. The opposite also holds: a “primary downtrend” (Bear Market) must see a new low in the DJIA being confirmed by a new low in the DJTA.
The linchpin that holds transportation together is the Surface Transportation Board (STB), which has “wide discretion...to meet the nation’s changing transportation needs.” The STB is the most powerful Federal regulatory agency that transportation companies (even pipeline carriers) must face. Its power and reach is a boon to investors, since they won’t be permitted to lose much money: There will be volatility but there will be no bankruptcies, or strategic end-runs such as trucking companies underpricing railroads. In this week’s Table, we drill down on the 11 largest companies in the transportation space. Many of you may consider Amazon (AMZN) to be an outlier here, but Amazon is both the largest warehousing operation and the largest logistics company. And there will soon be thousands of Amazon-branded tractor-trailers on the highways. Time is money.
Risk Rating = 7 (where Treasuries = 1 and gold = 10).
Full Disclosure: I dollar-average into UNP and also own shares of CNI.
NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 17 in the Table). Metrics highlighted in green at Columns P and Q 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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Provide a capsule summary for investors in Air Freight & Logistics companies, as well as multimodal trucking companies and railroads. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).
Execution: see Table.
Bottom Line: Dow Theory is the oldest method to assess current and future value in the stock market. The critical variable is the Dow Jones Transportation Average (DJTA), a running index of stock prices for 20 transportation companies. A “primary uptrend” ( Bull Market) is not declared when the Dow Jones Industrial Average (DJIA) hits new highs, but instead is declared when the DJTA confirms that event by also hitting a new high. We saw a confirmation most recently in November of 2014. The opposite also holds: a “primary downtrend” (Bear Market) must see a new low in the DJIA being confirmed by a new low in the DJTA.
The linchpin that holds transportation together is the Surface Transportation Board (STB), which has “wide discretion...to meet the nation’s changing transportation needs.” The STB is the most powerful Federal regulatory agency that transportation companies (even pipeline carriers) must face. Its power and reach is a boon to investors, since they won’t be permitted to lose much money: There will be volatility but there will be no bankruptcies, or strategic end-runs such as trucking companies underpricing railroads. In this week’s Table, we drill down on the 11 largest companies in the transportation space. Many of you may consider Amazon (AMZN) to be an outlier here, but Amazon is both the largest warehousing operation and the largest logistics company. And there will soon be thousands of Amazon-branded tractor-trailers on the highways. Time is money.
Risk Rating = 7 (where Treasuries = 1 and gold = 10).
Full Disclosure: I dollar-average into UNP and also own shares of CNI.
NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 17 in the Table). Metrics highlighted in green at Columns P and Q 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.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 5
Week 257 - Barron’s 500 Defensive Stocks That Have Outperformed the S&P 500 for 16 Years
Situation: This is Blog #3 of a 3-blog series on S&P 500 Index stocks that have outperformed that Index for 16 yrs, i.e., up more and down less (see Week 255 and Week 256). For each blog, the companies we analyze are S&P Dividend Achievers and have high S&P ratings on their stocks and bonds. This week we cover companies in “defensive” S&P industries that have revenues sufficient for inclusion in the recently published 2016 Barron’s 500 List.
Mission: We select Dividend Achievers in defensive industries (Consumer Staples, HealthCare, Utilities, and Communication Services) that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks were 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 have an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher. Net Present Values are calculated; NPV data points are presented in U-Y of the Table. [A full explanation of inputs for NPV calculations is given in the Appendix of last week’s blog (Week 256).]
Execution: see Table.
Bottom Line: Five companies are outstanding. MO, COST, HRL, NEE and CVS have NPVs that are above the group average, as well as improving 3-yr trends in cash-flow based Return on Invested Capital (ROIC) and sales (which determine a company’s Barron’s 500 rank), and an ROIC that exceeds the company’s weighted average cost of capital (WACC).
Risk Ranking: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into JNJ, NEE and PG, and own shares of ABT, HRL, CVS, KO and PEP.
NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 26 in the Table). Metrics highlighted in green at Columns Q and R in the Table indicate improving performance trends for fundamental business parameters. 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 for May 12, 2016, metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: We select Dividend Achievers in defensive industries (Consumer Staples, HealthCare, Utilities, and Communication Services) that have outperformed the S&P 500 Index for the past 16 yrs. By “outperformed” we mean their stocks were 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 have an S&P bond rating of BBB+ or higher and an S&P stock rating of B+/M or higher. Net Present Values are calculated; NPV data points are presented in U-Y of the Table. [A full explanation of inputs for NPV calculations is given in the Appendix of last week’s blog (Week 256).]
Execution: see Table.
Bottom Line: Five companies are outstanding. MO, COST, HRL, NEE and CVS have NPVs that are above the group average, as well as improving 3-yr trends in cash-flow based Return on Invested Capital (ROIC) and sales (which determine a company’s Barron’s 500 rank), and an ROIC that exceeds the company’s weighted average cost of capital (WACC).
Risk Ranking: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into JNJ, NEE and PG, and own shares of ABT, HRL, CVS, KO and PEP.
NOTE: Metrics highlighted in red in the Table indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 26 in the Table). Metrics highlighted in green at Columns Q and R in the Table indicate improving performance trends for fundamental business parameters. 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 for May 12, 2016, metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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