Situation: A Retirement Portfolio may benefit from some exposure to commodity-related Energy and Basic Materials companies. Yes, I know. During the 4.5 year Housing Crisis (from April 2007 to October 2011), stocks in the Basic Materials index fund (XLB) lost more than the S&P 500 Index, and stocks in the Energy index fund (XLE) didn’t do much better (see Column D in the Table). So let’s confine our attention to companies that kept increasing their dividend throughout that crisis, i.e., companies that S&P calls Dividend Achievers.
Mission: Apply our standard spreadsheet analysis to Basic Materials and Energy companies in the 2016 Barron’s 500 List that are a) Dividend Achievers, b) have traded long enough to appear on the 16-yr BMW Method List, and c) have an investment-grade rating on their bonds from Standard & Poor’s. Only 9 companies meet those 4 requirements, if we include a Canadian energy company (Enbridge) that has grown its dividend annually for the past 10+ yrs. (Canadian companies are not surveyed by S&P for inclusion on the Dividend Achievers list.)
Execution: see Table.
Administration: During the 4.5 year Housing Crisis, all 9 companies outperformed the S&P 500 Index (see Column D in the Table). However, 5 of these companies are projected to lose more than that index in the next Bear Market (see Column M in the Table), as determined by statistical analysis conducted by the BMW Method. NOTE: stocks from this sector can’t balance out the effect of cyclical forces on your portfolio because they’re at the mercy of the multi-decade Commodities Supercycle: “A commodities supercycle is an approximately 10-35 year trend of rising commodity prices. The commodities super-cycle is based on the assumption that population growth and the expansion of infrastructure in emerging market nations drive long-term demand and higher prices for industrial and agricultural commodities.” It now appears that a new supercycle is beginning, in that the Dow Jones Commodity Index (^DJC) of 22 futures contracts in 7 sectors has “bounced off” its 1999 low and is heading upward.
Bottom Line: These companies issue stocks that represent high-risk/high-reward investments (see Columns I and M in the Table). The Net Present Value calculations are highest for ENB and SHW (see Column Y in the Table). When evaluating commodity-related companies, recall that copper prices set the trend for commodity prices. High grade copper prices fell 14%/yr from 2011 through 2015 but have risen 30% over the past year.
Risk Rating: 8 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into MON and own shares of ENB.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends accrue in 10th year), Initial Cost = average 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 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/Yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 26 in the Table. The ETF for that index is MDY at Line 18.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 19
Week 298 - Barron’s 500 “Financial Services” Companies That Are Dividend Achievers
Situation: Even a Retirement Portfolio needs some exposure to Financial Services companies. Yes, I know. During the 4.5 year Housing Crisis (from April 2007 to October 2011), stocks in the Financial Services index fund (XLF) lost 20%/yr vs. 3%/yr for the S&P 500 Index (see Column D in the Table). So, let’s confine our attention to companies that kept increasing their dividend throughout that crisis, i.e., companies S&P calls Dividend Achievers.
Mission: Apply our standard spreadsheet analysis to financial services Dividend Achievers on the 2016 Barron’s 500 List, specifically those that have traded their stock long enough for it to appear on the 16-Yr BMW Method List, and have an investment-grade bond rating from Standard & Poor's. Only 5 companies meet our requirements, but all of those have clean balance sheets (see Columns P-R).
Execution: see Table.
Administration: During the 4.5 year Housing Crisis, 3 of the 5 companies outperformed the lowest-cost S&P 500 Index Fund, VFINX at Column D in the Table. But read the fine print:
Caveat emptor: You’ll want to know exactly why it’s a good idea to add Financial Services companies to your retirement portfolio. Relatively safe stocks, i.e., dividend-growing stocks issued by companies in one of the 4 “defensive” S&P Industries (Utilities, HealthCare, Consumer Staples, Communication Services), are what you buy to reduce Risk. Unfortunately, there are so many “savers” who seek to reduce risk that those stocks are almost always overvalued. You can’t get them at a fair price, so you have to break a key Warren Buffett rule to build a sizable position over time. You can only make real money if you sell those stocks when savers are desperate to buy them. But there’s another side to that coin: growth stocks. Those are issued by companies in the Financial Services, Information Technology, Industrial, and Consumer Discretionary industries. Buy them when they have a bad smell due to the powerful aversion training (think Pavlov’s dog) that we all experience from untoward events like the Housing Crisis. That calamity had such a negative effect on the value of Financial Services companies that their Return on Invested Capital (ROIC) didn’t rise above their Weighted Average Cost of Capital (WACC) until last year. You had a 7-yr opportunity to buy stock in fundamentally sound companies at absurdly low prices. Now, it’s too late to make real money on that trade. Almost any flavor of Financial Services stock is speculative: you need to know when to buy and when to sell. You sell when ROICs are twice as high as WACCs, and stock brokers start recommending Financial Services stocks to financially naive people. I’m afraid we’ve already reached that point, with respect to Money Center banks (see Columns AB and AC at Line 16).
Bottom Line: These companies represent high-risk/high-reward investments (see Columns D, I, and M in the Table). Four of the 5 sell insurance products. The exception is Franklin Resources (BEN), which sells mutual funds to institutions and wealthy individuals. Standard & Poor’s has A-ratings for stocks and bonds issued by Travelers (TRV) and Aflac (AFL), so consider buying one of those through an online dollar-averaging program. The Net Present Value calculation is higher for TRV (see Column Y in the Table).
Risk Rating: 8 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I own shares in TRV.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends accrue in 10th year), Initial Cost = average 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 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/Yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 21 in the Table. The ETF for that index is MDY at Line 12.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Apply our standard spreadsheet analysis to financial services Dividend Achievers on the 2016 Barron’s 500 List, specifically those that have traded their stock long enough for it to appear on the 16-Yr BMW Method List, and have an investment-grade bond rating from Standard & Poor's. Only 5 companies meet our requirements, but all of those have clean balance sheets (see Columns P-R).
Execution: see Table.
Administration: During the 4.5 year Housing Crisis, 3 of the 5 companies outperformed the lowest-cost S&P 500 Index Fund, VFINX at Column D in the Table. But read the fine print:
Caveat emptor: You’ll want to know exactly why it’s a good idea to add Financial Services companies to your retirement portfolio. Relatively safe stocks, i.e., dividend-growing stocks issued by companies in one of the 4 “defensive” S&P Industries (Utilities, HealthCare, Consumer Staples, Communication Services), are what you buy to reduce Risk. Unfortunately, there are so many “savers” who seek to reduce risk that those stocks are almost always overvalued. You can’t get them at a fair price, so you have to break a key Warren Buffett rule to build a sizable position over time. You can only make real money if you sell those stocks when savers are desperate to buy them. But there’s another side to that coin: growth stocks. Those are issued by companies in the Financial Services, Information Technology, Industrial, and Consumer Discretionary industries. Buy them when they have a bad smell due to the powerful aversion training (think Pavlov’s dog) that we all experience from untoward events like the Housing Crisis. That calamity had such a negative effect on the value of Financial Services companies that their Return on Invested Capital (ROIC) didn’t rise above their Weighted Average Cost of Capital (WACC) until last year. You had a 7-yr opportunity to buy stock in fundamentally sound companies at absurdly low prices. Now, it’s too late to make real money on that trade. Almost any flavor of Financial Services stock is speculative: you need to know when to buy and when to sell. You sell when ROICs are twice as high as WACCs, and stock brokers start recommending Financial Services stocks to financially naive people. I’m afraid we’ve already reached that point, with respect to Money Center banks (see Columns AB and AC at Line 16).
Bottom Line: These companies represent high-risk/high-reward investments (see Columns D, I, and M in the Table). Four of the 5 sell insurance products. The exception is Franklin Resources (BEN), which sells mutual funds to institutions and wealthy individuals. Standard & Poor’s has A-ratings for stocks and bonds issued by Travelers (TRV) and Aflac (AFL), so consider buying one of those through an online dollar-averaging program. The Net Present Value calculation is higher for TRV (see Column Y in the Table).
Risk Rating: 8 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I own shares in TRV.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 13 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends accrue in 10th year), Initial Cost = average 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 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/Yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 21 in the Table. The ETF for that index is MDY at Line 12.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 12
Week 297 - Sugary Soft Drinks And Milk Lead The Food & Beverage Sector In Sales
Situation: Milk is still the leading category of food expenditures for the 80% of households that pay with cash or credit/debit cards, but the 20% of households that pay with Food Stamps bring sugary soft drink sales up to first place nationwide. Milk is perhaps the single most nutritious food (see Week 254), whereas, refined sugar is the only “food” found in sugary soft drinks. Those drinks are being held responsible for the strong link between poverty and obesity, as well as the strong link between obesity and Type II diabetes.
So, let’s revisit the large and well-established Food & Beverage companies to see which are doing well from an investor’s standpoint. We need to know how much refined sugar contributes to their prosperity, as opposed to milk, those being the top revenue producers. Has publicity about the detrimental effects of refined sugar been effective? In other words, are sugary soft drink sales still rising and milk sales still falling?
Mission: Apply our standard spreadsheet analysis to Food & Beverage companies on the 2016 Barron’s 500 List that have had their stock traded long enough to appear on the 16-Yr BMW Method list.
Execution: see Table.
Administration: We find that 19 companies meet the requirements for size and longevity. But only 8 are Dividend Achievers (see Column AD in the Table), and only 4 of the 16 dividend payers have clean Balance Sheets, HRL, INGR, KO and ADM (see Columns P-R). This tells me that the largest and best-established food companies are struggling. Their managers must be having a hard time figuring out how to grow sales faster than the rate of population growth. A favorite tactic is to have a large advertising budget to promote products that the consumer is expected to like (based on marketing studies). That strategy has pushed Coca-Cola and PepsiCo to the top of the pack, with market capitalizations more than 4 times higher than the next largest food processor: General Mills (GIS; see Column AA in the Table).
Bottom Line: Food & Beverage stocks are thought to be “defensive” because of being in the S&P Consumer Staples industry. However, they’re commodity-related (high risk/high reward) because of being tied to global weather cycles. In my opinion, only 2 of the 19 companies in the Table are sufficiently safe and effective for your retirement portfolio (HRL and KO). Procter & Gamble (PG) is perhaps a better way to invest in Consumer Staples (see Line 23 in the Table).
Coca-Cola (KO) and/or PepsiCo (PEP) dominate sales for sugary soft drinks in every country, even though the sales of such drinks have fallen for 11 yrs in a row, and great efforts have been made to find healthy alternatives. Coca-Cola still derives 70% of its revenue from sugary soft drinks, even though it has diversified into milk (Fairlife), fruit juice (Minute Maid, Simply Orange), sugary vegetable drinks (Suja Juice, Fuze, Odwalla), energy drinks (Monster), and Coca-Cola Life that uses the natural sweetener Stevia. The good news is that the detrimental effects of sugary soft drinks have become well known and consumers expect companies do something about it. Both PepsiCo and Coca-Cola appear to be making every effort to comply, while continuing to rely on the aggressive marketing of sugary soft drinks. In summary, the trendline for sugary soft drink sales is tilting downward while milk continues to fall without pausing.
With regard to milk sales here in the US, the main processor, Dean Foods (DF), almost faced bankruptcy because sales have fallen 30% since 1975. Dean Foods survived by splitting off its most successful subsidiary, WhiteWave Foods, the producer of Horizon Organic milk and Silk soy milk. “The move was designed to get investors to pay more for shares in a business unit with higher profit margins and faster growth prospects than conventional milk.”
Kroger (KR) operates 16 dairies that distribute milk to 34 states, and Coca-Cola (KO) has assembled a large group of dairy co-operatives to produce “ultra-filtered milk.” That new technology separates milk ingredients then recombines those selectively to produce a more nutritious product called "Fairlife," which has half the sugar and twice the protein. Fairlife Milk is distributed to grocery stores nationwide by the Minute Maid division, and is currently priced at an 11% premium to Parmalat Milk in Wal-Mart Stores. Fairlife Milk has been available for less than two years; people who shop with food stamps presumably don’t yet know its benefits and would perhaps shy away from paying the 11% premium price even if they knew.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-cost average into KO, and also own shares of HRL and PG.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 28 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends accrue in 10th year), Initial Cost = average 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 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/Yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 33 in the Table. The ETF for that index is MDY at Line 27.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
So, let’s revisit the large and well-established Food & Beverage companies to see which are doing well from an investor’s standpoint. We need to know how much refined sugar contributes to their prosperity, as opposed to milk, those being the top revenue producers. Has publicity about the detrimental effects of refined sugar been effective? In other words, are sugary soft drink sales still rising and milk sales still falling?
Mission: Apply our standard spreadsheet analysis to Food & Beverage companies on the 2016 Barron’s 500 List that have had their stock traded long enough to appear on the 16-Yr BMW Method list.
Execution: see Table.
Administration: We find that 19 companies meet the requirements for size and longevity. But only 8 are Dividend Achievers (see Column AD in the Table), and only 4 of the 16 dividend payers have clean Balance Sheets, HRL, INGR, KO and ADM (see Columns P-R). This tells me that the largest and best-established food companies are struggling. Their managers must be having a hard time figuring out how to grow sales faster than the rate of population growth. A favorite tactic is to have a large advertising budget to promote products that the consumer is expected to like (based on marketing studies). That strategy has pushed Coca-Cola and PepsiCo to the top of the pack, with market capitalizations more than 4 times higher than the next largest food processor: General Mills (GIS; see Column AA in the Table).
Bottom Line: Food & Beverage stocks are thought to be “defensive” because of being in the S&P Consumer Staples industry. However, they’re commodity-related (high risk/high reward) because of being tied to global weather cycles. In my opinion, only 2 of the 19 companies in the Table are sufficiently safe and effective for your retirement portfolio (HRL and KO). Procter & Gamble (PG) is perhaps a better way to invest in Consumer Staples (see Line 23 in the Table).
Coca-Cola (KO) and/or PepsiCo (PEP) dominate sales for sugary soft drinks in every country, even though the sales of such drinks have fallen for 11 yrs in a row, and great efforts have been made to find healthy alternatives. Coca-Cola still derives 70% of its revenue from sugary soft drinks, even though it has diversified into milk (Fairlife), fruit juice (Minute Maid, Simply Orange), sugary vegetable drinks (Suja Juice, Fuze, Odwalla), energy drinks (Monster), and Coca-Cola Life that uses the natural sweetener Stevia. The good news is that the detrimental effects of sugary soft drinks have become well known and consumers expect companies do something about it. Both PepsiCo and Coca-Cola appear to be making every effort to comply, while continuing to rely on the aggressive marketing of sugary soft drinks. In summary, the trendline for sugary soft drink sales is tilting downward while milk continues to fall without pausing.
With regard to milk sales here in the US, the main processor, Dean Foods (DF), almost faced bankruptcy because sales have fallen 30% since 1975. Dean Foods survived by splitting off its most successful subsidiary, WhiteWave Foods, the producer of Horizon Organic milk and Silk soy milk. “The move was designed to get investors to pay more for shares in a business unit with higher profit margins and faster growth prospects than conventional milk.”
Kroger (KR) operates 16 dairies that distribute milk to 34 states, and Coca-Cola (KO) has assembled a large group of dairy co-operatives to produce “ultra-filtered milk.” That new technology separates milk ingredients then recombines those selectively to produce a more nutritious product called "Fairlife," which has half the sugar and twice the protein. Fairlife Milk is distributed to grocery stores nationwide by the Minute Maid division, and is currently priced at an 11% premium to Parmalat Milk in Wal-Mart Stores. Fairlife Milk has been available for less than two years; people who shop with food stamps presumably don’t yet know its benefits and would perhaps shy away from paying the 11% premium price even if they knew.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-cost average into KO, and also own shares of HRL and PG.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 28 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends accrue in 10th year), Initial Cost = average 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 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/Yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 33 in the Table. The ETF for that index is MDY at Line 27.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 5
Week 296 - Testing Our Stock-picking Algorithm
Situation: The “normal” way to invest in stocks is to play the Market as a whole. Typically, that means dollar-cost averaging into index funds such as those offered by Vanguard Group (VFINX, VEXMX, VTSMX, VGTSX) or SPDR State Street Global Advisors (SPY, MDY, DGT). That way, transaction costs are minimized and you can’t miss out on market moves. Or, you can try to beat the Market by building (and managing) a portfolio composed of many stocks representing all 10 S&P Industries. There’s no shortage of books on the subject but one will suffice: “The Four Pillars of Investing: Lessons for Building a Winning Portfolio” by William J. Bernstein, 2002, McGraw-Hill. There you’ll find a mathematical exercise proving that the only logical way to do well from investing in stocks is to focus on dividend growth.
Mission: Lay out an algorithm for stock selection.
Execution: Start with companies that have grown their dividend annually for 10 or more years, i.e., S&P Dividend Achievers. Select the ones that have grown their dividend faster than our benchmark S&P 500 index fund, VFINX, over the past 10 years, which is 6.8%/yr. Narrow that list down to those companies large enough to be on the Barron’s 500 List. Why? Because large companies a) have multiple product lines, and b) their stock has enough activity on the CBOE (Chicago Board Options Exchange) to facilitate price discovery. Remove any companies that don’t have an S&P Bond Rating of at least A- and an S&P Stock Rating of at least A-/M. Remove any companies that don’t have a 16-yr trading record that has been analyzed statistically by the BMW Method. Exclude companies that rely on long-term debt for more than 1/3rd of total capitalization, or couldn't meet dividend payments from free cash flow (FCF) in the two most recent quarters. Also exclude companies that are over-reliant on short-term debt, i.e., have more than 5% negative Tangible Book Value.
Administration: There are 27 companies that pass the above screen. By using the BMW Method, we have separated those into a group of 16 that has no greater chance of loss in a future Bear Market than the S&P 500 Index (see Column M of the Table under “Non-Gambling”), and a group of 11 that has a greater chance of loss (see red highlights in Column M under “Gambling”). If you do choose to invest in one of the Gambling companies, watch price-action because you’ll likely want to SELL at some point. In Columns N-P we provide data on 3 ratios that assess the overall health of Financial Statements.
Bottom Line: The purpose of stock-picking is to Beat the Market. It is very difficult, expensive, and time-consuming to do so over more than one Market Cycle. We have laid out a system for picking stocks, and back-tested it. It has a Failure Rate of 4%. In other words, 25 of the 26 stocks beat the S&P 500 Index over the past 16 years (see Column K in the Table). Just to be clear, we recommend that you dollar-average into index funds (see BENCHMARKS section of Table), and/or Berkshire Hathaway B-shares (where you would be building a position in over 100 large and mid-cap companies).
Of the 16 stocks we designate as non-gambling investments, most carry market multiples (or lower) for EV/EBITDA: GWW, UNP, CNI, WEC, APD, NEE, TRV, WMT, TGT. Those stocks are attractive for purchase if no issues arise from your further research, such as reading the Morningstar evaluation.
Risk Rating is 7 for the stock selection system outlined above. Why is that? Because of Selection Bias (https://en.wikipedia.org/wiki/Selection_bias) and Transaction Costs (http://www.investopedia.com/terms/t/transactioncosts.asp).
Full Disclosure: I dollar-average into UNP, NKE, JNJ, PG, NEE and MSFT, and also own shares of CNI, MMM, WMT, HRL, TRV, MKC, ROST, TJX, GD and CAT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 40 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends collected in 10th year), Initial Cost = average 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 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 45 in the Table. The ETF for that index is MDY at Line 39.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Lay out an algorithm for stock selection.
Execution: Start with companies that have grown their dividend annually for 10 or more years, i.e., S&P Dividend Achievers. Select the ones that have grown their dividend faster than our benchmark S&P 500 index fund, VFINX, over the past 10 years, which is 6.8%/yr. Narrow that list down to those companies large enough to be on the Barron’s 500 List. Why? Because large companies a) have multiple product lines, and b) their stock has enough activity on the CBOE (Chicago Board Options Exchange) to facilitate price discovery. Remove any companies that don’t have an S&P Bond Rating of at least A- and an S&P Stock Rating of at least A-/M. Remove any companies that don’t have a 16-yr trading record that has been analyzed statistically by the BMW Method. Exclude companies that rely on long-term debt for more than 1/3rd of total capitalization, or couldn't meet dividend payments from free cash flow (FCF) in the two most recent quarters. Also exclude companies that are over-reliant on short-term debt, i.e., have more than 5% negative Tangible Book Value.
Administration: There are 27 companies that pass the above screen. By using the BMW Method, we have separated those into a group of 16 that has no greater chance of loss in a future Bear Market than the S&P 500 Index (see Column M of the Table under “Non-Gambling”), and a group of 11 that has a greater chance of loss (see red highlights in Column M under “Gambling”). If you do choose to invest in one of the Gambling companies, watch price-action because you’ll likely want to SELL at some point. In Columns N-P we provide data on 3 ratios that assess the overall health of Financial Statements.
Bottom Line: The purpose of stock-picking is to Beat the Market. It is very difficult, expensive, and time-consuming to do so over more than one Market Cycle. We have laid out a system for picking stocks, and back-tested it. It has a Failure Rate of 4%. In other words, 25 of the 26 stocks beat the S&P 500 Index over the past 16 years (see Column K in the Table). Just to be clear, we recommend that you dollar-average into index funds (see BENCHMARKS section of Table), and/or Berkshire Hathaway B-shares (where you would be building a position in over 100 large and mid-cap companies).
Of the 16 stocks we designate as non-gambling investments, most carry market multiples (or lower) for EV/EBITDA: GWW, UNP, CNI, WEC, APD, NEE, TRV, WMT, TGT. Those stocks are attractive for purchase if no issues arise from your further research, such as reading the Morningstar evaluation.
Risk Rating is 7 for the stock selection system outlined above. Why is that? Because of Selection Bias (https://en.wikipedia.org/wiki/Selection_bias) and Transaction Costs (http://www.investopedia.com/terms/t/transactioncosts.asp).
Full Disclosure: I dollar-average into UNP, NKE, JNJ, PG, NEE and MSFT, and also own shares of CNI, MMM, WMT, HRL, TRV, MKC, ROST, TJX, GD and CAT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 40 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years (no dividends collected in 10th year), Initial Cost = average 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 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 45 in the Table. The ETF for that index is MDY at Line 39.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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