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).

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