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