Situation: You will become a “risk-off” investor the day you retire. The most you’ll be able to draw from your retirement savings is 4%/yr, preferably 3.5%. That amount has to be re-calculated each year by adding enough to compensate for inflation. You’ll also need to match revenues with expenses, with the goal of spending 1/12th of that yearly income each month. Inflation won’t be your main problem, as long as 50% of your retirement savings are in the stock market, where prices inflate at about the same rate as your food and utility bills. In normal economic times, the interest paid on bonds you own will also track inflation. For example, the yield on 10-yr Treasuries has stayed at 2.3%/yr ahead of inflation since 2000, and over the past 140 yrs. Your problem will be living on a fixed income with an inflexible budget. Money to buy new clothes or take a vacation will have to come from a savings account that you’ve set up for non-recurring capital expenditures, an account that you contribute to every month.
To increase your spending power, three options are relatively common: 1) rent out part of your house and raise the rent faster than inflation raises your expenses; 2) find a part-time job where your after-tax income is likely to grow faster than inflation; and/or 3) benefit from “risk-off” stocks that you bought before retiring, stocks that you never plan to sell (because they pay a good and growing dividend). Let’s dig deeper on Option 3, living off dividend income.
Mission: Provide fundamental information about each company that pays “risk-off” dividends likely to grow faster than inflation.
Execution: I know what you’re thinking: this is alchemy. And you’re right. In a world that arbitrages every financial asset every day, there is no such thing as free money after accounting for inflation and transaction costs. So, let’s start with how finance professionals do it. They invest in AAA sovereign bonds. These days, they have to pay for that privilege. In other words, the safest bonds (German Bunds) pay negative interest. You’re not going to do that, so you’ll have to take a little bit of risk.
What is a “risk-off” dividend-growing stock? The risk that a dividend won’t increase continuously relates to the health of that company’s Balance Sheet. You’ve heard the phrase: “Bullet-proof Balance Sheet.” That means the company keeps cash (and cash-equivalents like US Treasury Bills) in a bank vault or with the US Treasury, and also has non-strategic assets that traders know can be sold for a good price, even during a recession. In recent blogs, we’ve talked about companies that have a “clean Balance Sheet” and have boiled that term down to tracking 4 ratios:
1. Total Debt:Equity is under 100% (or under 200% if the company is a regulated public utility). That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is the most important marker of a company’s “general financial condition." That ratio needs to be under 30% (35% if a regulated public utility). Long-term debt has to either be renewed at maturity or returned to the lender. In a financial crisis, the rate of interest that bankers charge for a renewal (“rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling assets or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies mainly in the perceived value of their brand, which accountants call “goodwill” when the company is sold for more than its book value. But remember that property, plant and equipment are carried at historic cost when calculating book value. So, goodwill is more than just the perceived value of the brand. It’s the buyer’s perception of current value for property, plant, and equipment. TBV may be negative for a short period after a company restructures, e.g. by selling non-strategic assets to pay down LT debt as Procter & Gamble (at Line 7 in the Table) did recently. If the other 3 ratios indicate a clean Balance Sheet, the TBV will likely continue to be raised on schedule.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow (i.e., “cash from operations” minus capital expenditures).
Administration: Most companies with A-rated stocks pay good and growing dividends. S&P calls those with a 10+ yr record of annual dividend boosts Dividend Achievers. Another quick way to find relatively safe stocks is to take a close look at those issued by companies in “defensive” industries (Consumer Staples, HealthCare, Utilities, and Communications Services). Why? Because they sell essential goods and services. Unfortunately, that extra bulwark against bankruptcy leads many of those companies away from maintaining a clean Balance Sheet and toward a reliance on borrowed money. And banks will comply. Even during the Lehman Panic, Johnson & Johnson (with its AAA credit rating) had no difficulty borrowing money at attractive interest rates. We also use another safety factor when looking for “risk-off” companies, which is to confine our search to Barron’s 500 companies. Why? Because those companies have large revenue streams, capturing revenue from multiple product lines. One or two of those lines will continue to grow during a recession, reducing the impact from lines that loose sales.
We find 7 Dividend Achievers in defensive industries that are sufficiently “risk-off” to be suitable for inclusion in a “buy and hold” retirement savings plan (see Table).
Bottom Line: It’s a nice idea, to find “safe companies” that pay a good and growing dividend. A retiree who paid $50,000 for stock in such companies over a 10 yr period prior to retirement will not be confined to living on a fixed income. By the time she retires, those stocks will be yielding 4-5% of their initial cost, and that $2000+/yr of income can be expected to grow 9+%/yr going forward. Ten yrs into retirement, she’ll be receiving dividend checks totaling ~$5000/yr. We’ve turned up 7 Dividend Achievers that are good bets for accomplishing that feat. In the aggregate, they’ve increased their dividend 12%/yr over the past 16 yrs (see Column H in the Table). None have a statistical risk of price loss in a Bear Market that exceeds the 31% loss projected for the S&P 500 Index, and their average projected loss is only 25% (see Column M in the Table).
Risk Rating: 4 (where Treasuries
= 1 and gold = 10)
Full Disclosure: I dollar-average monthly (www.computershare.com) into NEE, PG and JNJ, and also own shares in WMT and HRL.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. 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 = the 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 16-Yr CAGR. Price Growth Rate is the mean or trendline 16-Yr Price CAGR (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 28
Sunday, August 21
Week 268 - "Buy and Hold" Barron’s 500 Growth Stocks
Situation: Every investor has to know when to leave the party. Or, as Warren Buffett says, “be fearful when others are greedy and greedy when others are fearful.”
Mission: Design a template for leaving the party.
Execution: You’ll need a Central Thought. Mine is to stay invested in growth stocks, the ones that do badly in a recession. That means continue to invest in companies from the following 6 S&P industries: Consumer Discretionary, Financial, Information Technology, Industrial, Basic Materials, and Energy. The trick is to dump stocks with problematic Balance Sheets and buy stocks with clean Balance Sheets.
Administration: Start by defining a clean Balance Sheet. Accountants do this by picking their favorite ratios. My favorite ratios are (see Columns Y thru AB in the Table):
1. Total Debt:Equity is under 200%. That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is under 30%. Long-term debt has to either be renewed upon maturity or returned to the lender. In a crisis, the rate of interest that bankers charge for a renewal loan (called a “rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling company assets at firesale prices or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies in the perceived value of their brand.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow.
There are other ways to know a company is likely to come through a Bear Market or recession unharmed. S&P stock and bond ratings are worth taking seriously: try to hold stock in A-rated companies (see Columns P and Q in the Table). Stick to companies with multiple product lines, i.e., those large enough to warrant inclusion in the Barron’s 500 List (see Columns N and O in the Table). That list ranks companies by cash flow and revenue. You can tell how a company is doing by comparing this year’s rank to last year’s.
You’ll also want to restrict your choices to companies that pay growing dividends, even if the dividend is low. An S&P Dividend Achiever is a company that has raised its dividend annually for the past 10 yrs. With one exception, all of the companies in this week’s Table are Dividend Achievers. Union Pacific is the exception but UNP will become a Dividend Achiever next February with a scheduled dividend increase.
Bottom Line: You can’t hope to keep up with the lowest-cost S&P 500 Index fund (VFINX at Line 21 in the Table) unless you stay invested in growth stocks. So, learn to pick growth stocks with clean Balance Sheets. Those are the ones likely to hold value in a Bear Market. Invest small amounts at a time by dollar-averaging your stock purchases automatically online. Then you’re certain to buy more shares per dollar invested when the market’s down.
Risk Rating: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into NKE, MSFT and UNP, and also own shares of ROST, TJX, MMM, and EMR.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the 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 dividend CAGR for the past 16 years. Price Growth Rate is mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/). Price Return from selling all shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Design a template for leaving the party.
Execution: You’ll need a Central Thought. Mine is to stay invested in growth stocks, the ones that do badly in a recession. That means continue to invest in companies from the following 6 S&P industries: Consumer Discretionary, Financial, Information Technology, Industrial, Basic Materials, and Energy. The trick is to dump stocks with problematic Balance Sheets and buy stocks with clean Balance Sheets.
Administration: Start by defining a clean Balance Sheet. Accountants do this by picking their favorite ratios. My favorite ratios are (see Columns Y thru AB in the Table):
1. Total Debt:Equity is under 200%. That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is under 30%. Long-term debt has to either be renewed upon maturity or returned to the lender. In a crisis, the rate of interest that bankers charge for a renewal loan (called a “rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling company assets at firesale prices or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies in the perceived value of their brand.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow.
There are other ways to know a company is likely to come through a Bear Market or recession unharmed. S&P stock and bond ratings are worth taking seriously: try to hold stock in A-rated companies (see Columns P and Q in the Table). Stick to companies with multiple product lines, i.e., those large enough to warrant inclusion in the Barron’s 500 List (see Columns N and O in the Table). That list ranks companies by cash flow and revenue. You can tell how a company is doing by comparing this year’s rank to last year’s.
You’ll also want to restrict your choices to companies that pay growing dividends, even if the dividend is low. An S&P Dividend Achiever is a company that has raised its dividend annually for the past 10 yrs. With one exception, all of the companies in this week’s Table are Dividend Achievers. Union Pacific is the exception but UNP will become a Dividend Achiever next February with a scheduled dividend increase.
Bottom Line: You can’t hope to keep up with the lowest-cost S&P 500 Index fund (VFINX at Line 21 in the Table) unless you stay invested in growth stocks. So, learn to pick growth stocks with clean Balance Sheets. Those are the ones likely to hold value in a Bear Market. Invest small amounts at a time by dollar-averaging your stock purchases automatically online. Then you’re certain to buy more shares per dollar invested when the market’s down.
Risk Rating: 6 (Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into NKE, MSFT and UNP, and also own shares of ROST, TJX, MMM, and EMR.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the 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 dividend CAGR for the past 16 years. Price Growth Rate is mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/). Price Return from selling all shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 14
Week 267 - Interesting Q3 Stock Picks From Merrill Lynch
Situation: At the beginning of each quarter, Merrill Lynch picks 10 stocks (often including two “shorts” to bet against). I have come to respect their picks but rarely act on those. Why? Because they are, for the most part, risky companies in risky industries. But when the Q3 picks came out on June 30, I was startled. Most of the picks are Dividend Achievers, i.e., companies with a record of increasing dividends for 10+ yrs. As the industry leader, with $2.2 Trillion in client assets under management, Merrill Lynch is encouraging its clients to make defensive investments. They see a Bear Market coming.
Mission: Highlight reasons to expect a Bear Market, and analyze the recommendations by Merrill Lynch.
Execution: The US economy is on solid footing. Jobs are becoming more plentiful, and wages are climbing faster than inflation. The unemployment rate in June 2016 was 4.9% (vs. 4.6% in June of 2006). However, labor market participation (62.7% in June 2016) hasn’t returned to it’s high from 10 yrs ago (66.2% in June 2006). When those who are underemployed (i.e., part-time workers), and those who are out of work but too discouraged to look for jobs, are added to the officially unemployed (i.e., job seekers), the “U-6” unemployment rate for June 2016 was 9.7% (vs. 8.4% in June 2006). Another problem is that many of the jobs that had been available to those without a college education, and paid well enough to allow those workers to become homeowners, have disappeared. The Information Revolution is replacing the Industrial Revolution but beneficiaries need to have a 4-yr college degree in math, science, engineering or technology to participate fully.
On a global scale, the US economy is an outlier. No other economy can be said to have recovered from the Lehman Panic. Great Britain was recovering but now faces recession due to fallout from Brexit. The rest of Europe is mired in economic troubles mainly caused by an over-reliance on debt financing that cannot be resolved without increases in productivity through education, “creative destruction” of outmoded industries and employment practices, automation, and increased free trade to leverage its competitive advantages. China has an “800 pound elephant in the room” called State-Owned Enterprises. Those continue to grow through municipal borrowing despite the best efforts of China’s economic leaders. Japan has found no way to emerge from decades of recession. Brazil and Russia are in deep recessions. India and South Africa are on growth trajectories but remain mired in structural unemployment. The “Arab Spring” unleashed unimaginable levels of discontent that remain poorly understood but affect the entire globe. The economies of those countries will remain in stasis until political solutions acceptable to those populations can be implemented. What is the “root cause” for underperformance in so many regional economies? Experts point to modern communications, like social media. Anyone with access to a cell phone, laptop or TV is a candidate to develop a more materialistic lifestyle, by whatever means necessary.
We don’t know how the next Bear Market will be triggered, so the S&P 500 Index continues to make new highs driven by ever-lower interest rates. There are many candidates, overvaluation being prominent among them, with the S&P 500 Index sporting a P/E of 25. Growth of the US economy (GDP) faster than 3%/yr could cure that problem but it doesn’t appear to be happening. Perhaps our government agencies, our corporations and our households have borrowed too much money, and interest payments consume too much of those budgets to allow enough investment in growth. There is also too much uncertainty about the future, so companies are reluctant to move forward with hiring and expand operations. No one issue, whether Brexit or the upcoming US election, has the capacity to trigger a recession on its own. But the above-mentioned points will amplify any crisis atmosphere that arises out of a destabilizing event like a natural disaster, a nuclear accident, or a civil war.
Administration: The Merrill Lynch Q3 recommendations include two candidates for short sales and a company that recently went public. We’re not interested in those. But do check out the other 7 (including 6 Dividend Achievers) that are worth a look by anyone seeking “buy-and-hold” stocks for a retirement portfolio (see Table).
Bottom Line: Merrill Lynch analysts apparently think a Bear Market is coming soon, and have advised clients to pick stocks that are likely to hold value in such an environment. Seven appear suitable as long-term holdings (see Table). Six of those are Dividend Achievers: NextEra Energy (NEE), Realty Income (O), AT&T (T), Raytheon (RTN), Walgreen Boots Alliance (WBA) and Lowe’s (LOW). The non-dividend paying stock, salesforce.com (CRM), is the seventh and has growth prospects that could support continued price accumulation in a recession. However, our analysis suggests that only NEE is worth buying when the market is overheated (see Table).
Risk Rating: 6 (Treasuries = 1 and gold = 10)
Full disclosure: I dollar-average each month into NEE and T.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% used to buy ~$5000 worth of shares), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is the mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/), and Price Return for selling shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Highlight reasons to expect a Bear Market, and analyze the recommendations by Merrill Lynch.
Execution: The US economy is on solid footing. Jobs are becoming more plentiful, and wages are climbing faster than inflation. The unemployment rate in June 2016 was 4.9% (vs. 4.6% in June of 2006). However, labor market participation (62.7% in June 2016) hasn’t returned to it’s high from 10 yrs ago (66.2% in June 2006). When those who are underemployed (i.e., part-time workers), and those who are out of work but too discouraged to look for jobs, are added to the officially unemployed (i.e., job seekers), the “U-6” unemployment rate for June 2016 was 9.7% (vs. 8.4% in June 2006). Another problem is that many of the jobs that had been available to those without a college education, and paid well enough to allow those workers to become homeowners, have disappeared. The Information Revolution is replacing the Industrial Revolution but beneficiaries need to have a 4-yr college degree in math, science, engineering or technology to participate fully.
On a global scale, the US economy is an outlier. No other economy can be said to have recovered from the Lehman Panic. Great Britain was recovering but now faces recession due to fallout from Brexit. The rest of Europe is mired in economic troubles mainly caused by an over-reliance on debt financing that cannot be resolved without increases in productivity through education, “creative destruction” of outmoded industries and employment practices, automation, and increased free trade to leverage its competitive advantages. China has an “800 pound elephant in the room” called State-Owned Enterprises. Those continue to grow through municipal borrowing despite the best efforts of China’s economic leaders. Japan has found no way to emerge from decades of recession. Brazil and Russia are in deep recessions. India and South Africa are on growth trajectories but remain mired in structural unemployment. The “Arab Spring” unleashed unimaginable levels of discontent that remain poorly understood but affect the entire globe. The economies of those countries will remain in stasis until political solutions acceptable to those populations can be implemented. What is the “root cause” for underperformance in so many regional economies? Experts point to modern communications, like social media. Anyone with access to a cell phone, laptop or TV is a candidate to develop a more materialistic lifestyle, by whatever means necessary.
We don’t know how the next Bear Market will be triggered, so the S&P 500 Index continues to make new highs driven by ever-lower interest rates. There are many candidates, overvaluation being prominent among them, with the S&P 500 Index sporting a P/E of 25. Growth of the US economy (GDP) faster than 3%/yr could cure that problem but it doesn’t appear to be happening. Perhaps our government agencies, our corporations and our households have borrowed too much money, and interest payments consume too much of those budgets to allow enough investment in growth. There is also too much uncertainty about the future, so companies are reluctant to move forward with hiring and expand operations. No one issue, whether Brexit or the upcoming US election, has the capacity to trigger a recession on its own. But the above-mentioned points will amplify any crisis atmosphere that arises out of a destabilizing event like a natural disaster, a nuclear accident, or a civil war.
Administration: The Merrill Lynch Q3 recommendations include two candidates for short sales and a company that recently went public. We’re not interested in those. But do check out the other 7 (including 6 Dividend Achievers) that are worth a look by anyone seeking “buy-and-hold” stocks for a retirement portfolio (see Table).
Bottom Line: Merrill Lynch analysts apparently think a Bear Market is coming soon, and have advised clients to pick stocks that are likely to hold value in such an environment. Seven appear suitable as long-term holdings (see Table). Six of those are Dividend Achievers: NextEra Energy (NEE), Realty Income (O), AT&T (T), Raytheon (RTN), Walgreen Boots Alliance (WBA) and Lowe’s (LOW). The non-dividend paying stock, salesforce.com (CRM), is the seventh and has growth prospects that could support continued price accumulation in a recession. However, our analysis suggests that only NEE is worth buying when the market is overheated (see Table).
Risk Rating: 6 (Treasuries = 1 and gold = 10)
Full disclosure: I dollar-average each month into NEE and T.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% used to buy ~$5000 worth of shares), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is the mean Price CAGR for the past 16 years (http://invest.kleinnet.com/bmw1/), and Price Return for selling shares in the 10th year is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 7
Week 266 - “Buy-and-hold” Barron's 500 Dividend Achievers in the Consumer Staples Industry
Situation: Let’s say you’re in your 50s and have made good investments through the tax-deferred retirement plan at your workplace, and your IRA. But you doubt those investments will replace 80% of your income after you retire. Taxable investments will have to fill the breach, mainly stocks that throw off ~2.5%/yr in dividends and grow those dividends ~10%/yr. There is no mutual fund that will do that for you. You have to pick stocks and reinvest dividends while you’re still working. By the time you retire, annual dividends/share will probably amount to more than 4% of your initial investment in shares. You can have the dividends sent to your bank and spend that income while preserving the shares. Utilities (and Communication Services companies) pay higher dividends but grow those more slowly, so you’ll probably do as well by holding stock in Consumer Staples companies.
Mission: Find high quality Consumer Staples stocks to “buy-and-hold.” That’s not easy, given that the market for consumer staples grows slowly. However, the market has the advantage of low elasticity (i.e., it doesn’t stop growing during a recession). That stability means companies can try to grow earnings faster (enough to attract investors) by using leverage, i.e., over-borrowing. Usually, that leaves companies with negative Tangible Book Value. But their managers don’t worry about that because the risk of bankruptcy is low, since elasticity is low. The beauty of leverage is two-fold: 1) the government picks up the tab (interest isn’t taxable); 2) Return on Equity (ROE) soars because the company is mainly capitalized with long-term bonds. But you’re investing for your retirement, and know that leverage always creates risk, i.e., the stock’s price will collapse, someday.
Execution: As a prudent investor, you always want to avoid owning stock in companies that 1) carry twice as much debt as equity, 2) are capitalized more than 50% with long-term bonds, and 3) have negative Tangible Book Value (see Columns AD through AF in this week’s Table). Among the 20 Consumer Staples industry Dividend Achievers on the 2016 Barron’s 500 List, those restrictions leave us with only 8 to consider (see Table).
Bottom Line: You don’t want to outlive your retirement savings, so you’ll spend no more than 4% of your savings each year. But stocks are different than mutual funds because you can select stocks that pay a good and growing dividend. By using dividend reinvestment during your working years, those stocks can by paying a 4% dividend (on their initial cost) by the time you retire. That allows you to avoid selling any shares and simply spend the income. Those shares will continue to grow in value and spin off proportionately higher dividends. Your nest egg of shares in individual stocks becomes the rarest of retirement asset classes. It is one that grows during retirement while allowing you to take out 4%/yr. The trick is to find high quality companies that reliably pay a good and growing dividend. Most likely, you’ll find such companies in only 3 of the 10 S&P industries: Utilities, Communication Services, and Consumer Staples. This week we cover Consumer Staples.
Risk Rating: 4 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into PG, and also own stock in WMT, KO, HRL and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Find high quality Consumer Staples stocks to “buy-and-hold.” That’s not easy, given that the market for consumer staples grows slowly. However, the market has the advantage of low elasticity (i.e., it doesn’t stop growing during a recession). That stability means companies can try to grow earnings faster (enough to attract investors) by using leverage, i.e., over-borrowing. Usually, that leaves companies with negative Tangible Book Value. But their managers don’t worry about that because the risk of bankruptcy is low, since elasticity is low. The beauty of leverage is two-fold: 1) the government picks up the tab (interest isn’t taxable); 2) Return on Equity (ROE) soars because the company is mainly capitalized with long-term bonds. But you’re investing for your retirement, and know that leverage always creates risk, i.e., the stock’s price will collapse, someday.
Execution: As a prudent investor, you always want to avoid owning stock in companies that 1) carry twice as much debt as equity, 2) are capitalized more than 50% with long-term bonds, and 3) have negative Tangible Book Value (see Columns AD through AF in this week’s Table). Among the 20 Consumer Staples industry Dividend Achievers on the 2016 Barron’s 500 List, those restrictions leave us with only 8 to consider (see Table).
Bottom Line: You don’t want to outlive your retirement savings, so you’ll spend no more than 4% of your savings each year. But stocks are different than mutual funds because you can select stocks that pay a good and growing dividend. By using dividend reinvestment during your working years, those stocks can by paying a 4% dividend (on their initial cost) by the time you retire. That allows you to avoid selling any shares and simply spend the income. Those shares will continue to grow in value and spin off proportionately higher dividends. Your nest egg of shares in individual stocks becomes the rarest of retirement asset classes. It is one that grows during retirement while allowing you to take out 4%/yr. The trick is to find high quality companies that reliably pay a good and growing dividend. Most likely, you’ll find such companies in only 3 of the 10 S&P industries: Utilities, Communication Services, and Consumer Staples. This week we cover Consumer Staples.
Risk Rating: 4 (where US Treasuries = 1 and gold = 10)
Full Disclosure: I dollar-average into PG, and also own stock in WMT, KO, HRL and ADM.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for price over the past 50 days (corrected for transaction costs of 2.5%), Dividend Growth Rate is Dividend CAGR for the past 16 years, Price Growth Rate is Price CAGR for the past 30 years, and Price Return in the 10th year is corrected for transaction costs of 2.5%. The calculation template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
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