Situation: The top 3 grocery basket items are sugary soft drinks, milk, and bread (see Week 297). By USDA category, “sweetened beverages” represent 7.5% of grocery store sales, “milk” represents 3.7%, and “bread and crackers” represent 6.1%. Bread and milk are basic foodstuffs because of their nutritional value, meaning they are rich in energy (starches and sugars) and body-building proteins. Bread is made from high-gluten flour that comes from hard red or hard white wheat. Milk is perishable and has to be sourced from regional dairy herds. It has high protein content (both caseins and whey proteins). Milk proteins and gliadin (the gluten protein found in hard red and white wheat) contain all 9 of the “essential” amino acids that cannot be synthesized in the human body.
Mission: Find out which well-established companies in the Food & Beverage sub-industry process either dairy products or high-gluten flour to put milk or bread on your grocery store’s shelves. Focus on the companies that have over a billion dollars of stock market capital and own their own bakery or milk processing plant.
Execution: There are 9 companies that meet our criteria (Table).
Administration: Three of those 9 companies derive the majority of their sales from groceries. Namely, Wal-Mart Stores (WMT), Costco Wholesale (COST) and Kroger (KR). Kroger has 17 milk processing plants and 9 bakeries. Wal-Mart’s first food production plant in the US will be a milk processing plant in Fort Wayne, Indiana, scheduled to open this fall. Otherwise, Wal-Mart sources milk from regional dairies. Many of Costco’s warehouse stores have a bakery nearby. Wal-Mart sources its bread from Grupo Bimbo USA. Grupo Bimbo is a Mexican company that sells more bread than any other company in the world.
The only bakery that delivers bread throughout the US is Flowers Foods (FLO). The only milk processor that has nationwide processing plants is Dean Foods (DF).
Both Bunge (BG) and Archer Daniels Midland (ADM) process wheat into high-gluten flour for wholesale delivery nationwide. General Mills (GIS) sells the leading brand of flour on grocery store shelves (Gold Label), particularly the high-gluten flour that is required for making bread.
Coca-Cola (KO) co-produces a high-nutrition “ultra-filtered” milk called “Fairlife” for distribution nationwide. Fairlife costs approximately twice as much per ounce as standard milk. In return, you get twice as much protein and half as much sugar per ounce.
Bottom Line: Basic foodstuffs like bread and milk are typically produced locally, by limited liability companies (LLCs). Production processes are standardized and widespread, so local producers have the advantages of low shipping costs and guaranteed freshness. To compete, a for-profit national corporation would have to introduce special features in its milk or bread products, and achieve economies of scale. That would mean owning several large processing plants and a dedicated fleet of trucks. In return for marketing a product with razor-thin profit margins, the company is distributing an “essential good”, which means that price changes would have a minimal impact on per-unit sales. Such products are said to be inelastic. Kroger (KR) is the only company that produces both milk and bread for nationwide distribution.
We have calculated the Net Present Value (NPV) of owning a stock for the next 10 yrs then selling it (see Column Y in the Table). NPV aggregates the income streams from the current dividend (Column G), continuation of the dividend growth rate that has been established over the past 3 yrs (Column H), and continuation of the price growth rate that has been established over the past 20 yrs (Column K). A positive number suggests a total return of 9%/yr or more. Per NPV, your leading choices are Flowers Foods (FLO) and Costco Wholesale (COST).
Risk Rating: 6 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into KO, and also own shares of COST and WMT.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 17 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, 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 3-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 shares in 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 29 in the Table. The ETF for that index is MDY at Line 16. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 30
Sunday, April 23
Week 303 - A-rated Barron’s 500 Industrial Companies That Are Dividend Achievers
Situation: There are a number of large and well-established industrial companies. By taking a “buy and hold” approach to owning stock in a few of those, you’ll likely realize your best results as a stock-picker. Yes, they’re cyclical. But the level of reward found in purchasing these stocks is generally higher than their level of risk.
Mission: Focus on companies that 1) pay a good and growing dividend, 2) are big enough to be included in the Barron’s 500 List of US and Canadian companies with the highest revenues, 3) have been analyzed statistically over the past 20 yrs by the BMW Method, as shown in Columns K-M in the Table, 4) issue bonds and stocks that S&P rates as A- or better, and 5) have a clean Balance Sheet (see Columns P-R in the Table), which means that a) long-term debt constitutes no more than 1/3rd of total assets, b) Tangible Book Value is not a negative number, and c) dividends are consistently paid out of Free Cash Flow (FCF).
Execution: see Table.
Administration: We have applied our standard spreadsheet with one change. The compound annual growth rate (CAGR) of weekly prices is 20 yrs, instead of the customary 16 yrs (see Column K).
Bottom Line: To help you narrow your choices, we have focused on A-rated Dividend Achievers that have clean balance sheets. We have also calculated the Net Present Value (NPV) of owning a stock for the next 10 yrs then selling it (see Column Y in the Table). That statistic assembles income streams from the current dividend (Column G), maintenance of the dividend growth rate that has been established over the past 3 yrs (Column H), and maintenance of the price growth rate that has been established over the past 20 yrs (Column K). A positive number suggests a total return of 9%/yr or more, whereas a negative number projects a lower rate. Per NPV, the leading choice is Canadian National Railway (CNI).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, and also own shares of CNI, CAT, MMM, and GD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 16 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, 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 3-Yr CAGR found at Column H. Price Growth Rate is the 20-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 shares in 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 22 in the Table. The ETF for that index is MDY at Line 15. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Focus on companies that 1) pay a good and growing dividend, 2) are big enough to be included in the Barron’s 500 List of US and Canadian companies with the highest revenues, 3) have been analyzed statistically over the past 20 yrs by the BMW Method, as shown in Columns K-M in the Table, 4) issue bonds and stocks that S&P rates as A- or better, and 5) have a clean Balance Sheet (see Columns P-R in the Table), which means that a) long-term debt constitutes no more than 1/3rd of total assets, b) Tangible Book Value is not a negative number, and c) dividends are consistently paid out of Free Cash Flow (FCF).
Execution: see Table.
Administration: We have applied our standard spreadsheet with one change. The compound annual growth rate (CAGR) of weekly prices is 20 yrs, instead of the customary 16 yrs (see Column K).
Bottom Line: To help you narrow your choices, we have focused on A-rated Dividend Achievers that have clean balance sheets. We have also calculated the Net Present Value (NPV) of owning a stock for the next 10 yrs then selling it (see Column Y in the Table). That statistic assembles income streams from the current dividend (Column G), maintenance of the dividend growth rate that has been established over the past 3 yrs (Column H), and maintenance of the price growth rate that has been established over the past 20 yrs (Column K). A positive number suggests a total return of 9%/yr or more, whereas a negative number projects a lower rate. Per NPV, the leading choice is Canadian National Railway (CNI).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, and also own shares of CNI, CAT, MMM, and GD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 16 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, 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 3-Yr CAGR found at Column H. Price Growth Rate is the 20-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 shares in 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 22 in the Table. The ETF for that index is MDY at Line 15. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 16
Week 302 - Barron’s 500 “Information Technology” Dividend Achievers
Situation: The Information Technology (IT) Industry represents almost 20% of US stock market capitalization. The Information Age has replaced the Industrial Age. If you’re saving for retirement, you’ll need to allocate a full 20% of your equity exposure to IT companies, because that’s where the money is (Sutton’s Rule). But those companies carry famously high risk. Stock prices exhibit a level of volatility that is ~25% greater than the S&P 500 Index’s volatility. That means prices can be expected to go up 25% more, and down 25% more, than the S&P 500 Index.
Can you invest in IT companies without taking some gambles? No. But some of the larger and longer-established companies have managed to increase their dividend annually for at least the past 10 yrs, earning the S&P designation of “Dividend Achiever.” And most of those pay an above-market dividend to help the investor overlook the risk of loss due to rapid innovation, which can wipe out any given company’s product line within a few short years.
Risk is disquieting. But missing out on the Information Revolution is unacceptable when you’re saving for retirement.
Mission: Focus on IT companies that 1) pay a good and growing dividend, 2) are big enough to be included in the Barron’s 500 List of US and Canadian companies with the highest revenues, 3) are established well enough to be included in the 16-year version of the BMW Method’s statistical study of weekly price price changes, as shown in Columns K-M in the Table, 4) issue bonds that S&P rates as A- or better, and 5) have a clean Balance Sheet (see Columns P-R in the Table): a) long-term debt constitutes no more than 1/3rd of total assets, b) Tangible Book Value is not a negative number, and c) dividends are consistently paid out of Free Cash Flow (FCF).
Execution: see Table.
Administration: Only 4 companies meet our standard. But we have added one of the leading IT companies, Accenture (ACN at the top line in the Table), even though it only has a 15-yr trading record. That means ACN has been included even though its price volatility (see Column M in the Table) has not been quantified using the BMW Method statistical package.
Bottom Line: By selecting the highest quality companies, using a number of criteria, we find that none of these companies enjoys reduced volatility. They have high 5-Yr Betas (see Column I in the Table) and high price volatility (see Column M in the Table). Indeed, price volatility in Column M is more than 3 times greater than price appreciation in Column K. Only Automatic Data Processing (ADP) and one of our BENCHMARK stocks, Apple (AAPL), have volatility that is less than 3 times their price appreciation. But we do find some good news among the otherwise gloomy risk metrics. The broad index of IT companies (XLK at Line 17 in the Table) had the same rate of gain (1.5%/yr) during the 4.5-yr Housing Crisis as did our BENCHMARK, the Vanguard Balanced Index Fund, VBINX at Line 15 (see Column D).
How should you invest? Most IT companies have earned little or nothing for investors (see Line 17 in Column C); owning shares in the index fund for IT companies (XLK) isn’t an attractive option. You’re best served by picking two of the 8 quality stocks in the Table, and dollar-averaging your investment online. By using the Net Present Value calculation (see Column Y), Accenture (ACN) and Apple (AAPL) look like the best bets going forward.
Risk Rating: 7 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MSFT online, and also own shares of ACN, AAPL, IBM and INTC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 15 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, 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 3-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 shares in 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 22 in the Table. The ETF for that index is MDY at Line 14. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Can you invest in IT companies without taking some gambles? No. But some of the larger and longer-established companies have managed to increase their dividend annually for at least the past 10 yrs, earning the S&P designation of “Dividend Achiever.” And most of those pay an above-market dividend to help the investor overlook the risk of loss due to rapid innovation, which can wipe out any given company’s product line within a few short years.
Risk is disquieting. But missing out on the Information Revolution is unacceptable when you’re saving for retirement.
Mission: Focus on IT companies that 1) pay a good and growing dividend, 2) are big enough to be included in the Barron’s 500 List of US and Canadian companies with the highest revenues, 3) are established well enough to be included in the 16-year version of the BMW Method’s statistical study of weekly price price changes, as shown in Columns K-M in the Table, 4) issue bonds that S&P rates as A- or better, and 5) have a clean Balance Sheet (see Columns P-R in the Table): a) long-term debt constitutes no more than 1/3rd of total assets, b) Tangible Book Value is not a negative number, and c) dividends are consistently paid out of Free Cash Flow (FCF).
Execution: see Table.
Administration: Only 4 companies meet our standard. But we have added one of the leading IT companies, Accenture (ACN at the top line in the Table), even though it only has a 15-yr trading record. That means ACN has been included even though its price volatility (see Column M in the Table) has not been quantified using the BMW Method statistical package.
Bottom Line: By selecting the highest quality companies, using a number of criteria, we find that none of these companies enjoys reduced volatility. They have high 5-Yr Betas (see Column I in the Table) and high price volatility (see Column M in the Table). Indeed, price volatility in Column M is more than 3 times greater than price appreciation in Column K. Only Automatic Data Processing (ADP) and one of our BENCHMARK stocks, Apple (AAPL), have volatility that is less than 3 times their price appreciation. But we do find some good news among the otherwise gloomy risk metrics. The broad index of IT companies (XLK at Line 17 in the Table) had the same rate of gain (1.5%/yr) during the 4.5-yr Housing Crisis as did our BENCHMARK, the Vanguard Balanced Index Fund, VBINX at Line 15 (see Column D).
How should you invest? Most IT companies have earned little or nothing for investors (see Line 17 in Column C); owning shares in the index fund for IT companies (XLK) isn’t an attractive option. You’re best served by picking two of the 8 quality stocks in the Table, and dollar-averaging your investment online. By using the Net Present Value calculation (see Column Y), Accenture (ACN) and Apple (AAPL) look like the best bets going forward.
Risk Rating: 7 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MSFT online, and also own shares of ACN, AAPL, IBM and INTC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 15 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, 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 3-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 shares in 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 22 in the Table. The ETF for that index is MDY at Line 14. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 9
Week 301 - Fertilizer
Situation: Want to bet on agriculture? Then pay attention to fertilizer stocks. That’s where returns outweigh risk (whereas, risk outweighs returns from commodity futures in grain and soybeans because futures incorporate borrowed money). But realize that net farm income has fallen 46% over the past 3 yrs here in the US. A decline that large and lasting that long hasn’t happened since the Great Depression. The reasons for that decline relate to improvements worldwide in technology (e.g. GMO seeds), infrastructure (e.g. paved roads), and logistics (e.g. free trade agreements), resulting in an overproduction of crops. The USDA Foreign Agricultural Service website is a good starting place, if you want to learn more about how this happened.
US farmland has grown 7%/yr in value since 2002, going from an average price of $1,590/acre to $4,090/acre, partly because 8% of the acreage disappeared due to urbanization and the conversion of farmland to parks and pasture. Farmers increasingly overuse their land to justify its cost, which leads to a greater dependence on improvements in technology, infrastructure and logistics. But at the most basic level, “overuse” means that more fertilizer will be applied to counteract the depletion of nitrogen, potassium and phosphate from the soil.
Mission: Apply our standard spreadsheet analysis to large fertilizer companies in the US and Canada, namely those that have appeared on the annual Barron’s 500 List in recent years. Exclude companies that haven’t had their stock traded long enough to appear on the 16-yr BMW Method List. Include 5-yr returns on key commodity contracts (corn, soybeans, wheat, cattle and copper). In making this analysis, we find that only 5 companies meet our requirements, and none are Dividend Achievers.
Execution: see Table.
Administration: Commodity-related investments are speculative. With farming, there are additional variables to consider, namely, dependence on soil, sunshine and water. Soil has to supply 5 of the 7 elements essential for life: nitrogen, phosphorus, and potassium being the most important. In addition, soil provides sodium and chlorine ions that come from the life cycle of small organisms living within the soil. Finally, sunshine and water allow healthy plants to synthesize the other two essential elements by combining carbon dioxide in the atmosphere with water: oxygen, and useful forms of carbon -- sugar and cellulose.
Farmers have traditionally tried to reverse soil depletion by 1) rotating crops, 2) leaving fields fallow every 3 yrs, and 3) pasturing cows on the field in the off-season, to distribute natural fertilizer (manure). But the costs for farm implements and land have risen so much that farmers reach for the maximum yield of whatever crop will give them the greatest return on investment. Therefore, they will over-plant every field every year. This over-planting leads to the purchase of more fertilizer, which is distributed using bigger sprayers. As millions of farmers around the world are adopting this approach, the supply of grain and soybeans has come to exceed demand. The result has been that the prices farmers receive for their grain and soybeans collapsed 3 yrs ago, and has yet to recover. Farmers have tried to stop buying new machinery and the most expensive seeds, i.e., the seeds that have been genetically engineered to carry yield-maximizing traits. And, farmers have tried to spend less on fertilizer, water, insecticides, fungicides and herbicides. In other words, the vendors that serve farmers are merging operations in a desperate attempt to stave off bankruptcy.
Bottom Line: You can make a lot of money on volatile commodity investments like fertilizer stocks but if you don’t know when to sell, you’ll incur large losses. To allay that risk, it is necessary to study the trends in a) crop prices, b) weather cycles (El Nino and La Nina), and c) inventories of foodstuffs and agronomy chemicals, particularly fertilizer. Or, you can follow a Warren Buffett recommendation: dollar-cost average your investment, and continue spending a fixed-dollar amount each quarter on that (now) cheapened stock. You’ll have bought many shares at absurdly low prices, so you’ll be ahead nicely on your investment when prices recover. But beware: Shares in Potash Corporation of Saskatchewan (the largest fertilizer company) went for $61.60 in 2/1/11 and $18.55 on 2/1/17. That’s a 70% loss over 6 yrs. When it comes to commodity-related stocks, dollar-averaging is a fool’s errand. You have to sell quickly whenever you conclude that earnings are likely to stop growing.
Which fertilizer stock of the five in the Table looks the most promising? Not surprisingly, the two largest players (by market capitalization) are merging with one another: Agrium (AGU) and Potash Corporation of Saskatchewan (POT). Why? Because the multi-year collapse in grain and soybean prices has pulled the rug out from under fertilizer sales (see Column F in the Table under “commodity futures”). If you buy stock in either POT or AGU you’ll eventually be rewarded because 1) population growth increases the demand for food, and 2) urban sprawl (combined with droughts due to global warming) reduces the availability of arable land.
Risk level: 9 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and Gold Bullion = 10)
Full disclosure: I own shares of AGU.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 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 3-5 Yr CAGR found at Column H. Price Growth Rate is the 20-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 31 in the Table. The ETF for that index is MDY at Line 14.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
US farmland has grown 7%/yr in value since 2002, going from an average price of $1,590/acre to $4,090/acre, partly because 8% of the acreage disappeared due to urbanization and the conversion of farmland to parks and pasture. Farmers increasingly overuse their land to justify its cost, which leads to a greater dependence on improvements in technology, infrastructure and logistics. But at the most basic level, “overuse” means that more fertilizer will be applied to counteract the depletion of nitrogen, potassium and phosphate from the soil.
Mission: Apply our standard spreadsheet analysis to large fertilizer companies in the US and Canada, namely those that have appeared on the annual Barron’s 500 List in recent years. Exclude companies that haven’t had their stock traded long enough to appear on the 16-yr BMW Method List. Include 5-yr returns on key commodity contracts (corn, soybeans, wheat, cattle and copper). In making this analysis, we find that only 5 companies meet our requirements, and none are Dividend Achievers.
Execution: see Table.
Administration: Commodity-related investments are speculative. With farming, there are additional variables to consider, namely, dependence on soil, sunshine and water. Soil has to supply 5 of the 7 elements essential for life: nitrogen, phosphorus, and potassium being the most important. In addition, soil provides sodium and chlorine ions that come from the life cycle of small organisms living within the soil. Finally, sunshine and water allow healthy plants to synthesize the other two essential elements by combining carbon dioxide in the atmosphere with water: oxygen, and useful forms of carbon -- sugar and cellulose.
Farmers have traditionally tried to reverse soil depletion by 1) rotating crops, 2) leaving fields fallow every 3 yrs, and 3) pasturing cows on the field in the off-season, to distribute natural fertilizer (manure). But the costs for farm implements and land have risen so much that farmers reach for the maximum yield of whatever crop will give them the greatest return on investment. Therefore, they will over-plant every field every year. This over-planting leads to the purchase of more fertilizer, which is distributed using bigger sprayers. As millions of farmers around the world are adopting this approach, the supply of grain and soybeans has come to exceed demand. The result has been that the prices farmers receive for their grain and soybeans collapsed 3 yrs ago, and has yet to recover. Farmers have tried to stop buying new machinery and the most expensive seeds, i.e., the seeds that have been genetically engineered to carry yield-maximizing traits. And, farmers have tried to spend less on fertilizer, water, insecticides, fungicides and herbicides. In other words, the vendors that serve farmers are merging operations in a desperate attempt to stave off bankruptcy.
Bottom Line: You can make a lot of money on volatile commodity investments like fertilizer stocks but if you don’t know when to sell, you’ll incur large losses. To allay that risk, it is necessary to study the trends in a) crop prices, b) weather cycles (El Nino and La Nina), and c) inventories of foodstuffs and agronomy chemicals, particularly fertilizer. Or, you can follow a Warren Buffett recommendation: dollar-cost average your investment, and continue spending a fixed-dollar amount each quarter on that (now) cheapened stock. You’ll have bought many shares at absurdly low prices, so you’ll be ahead nicely on your investment when prices recover. But beware: Shares in Potash Corporation of Saskatchewan (the largest fertilizer company) went for $61.60 in 2/1/11 and $18.55 on 2/1/17. That’s a 70% loss over 6 yrs. When it comes to commodity-related stocks, dollar-averaging is a fool’s errand. You have to sell quickly whenever you conclude that earnings are likely to stop growing.
Which fertilizer stock of the five in the Table looks the most promising? Not surprisingly, the two largest players (by market capitalization) are merging with one another: Agrium (AGU) and Potash Corporation of Saskatchewan (POT). Why? Because the multi-year collapse in grain and soybean prices has pulled the rug out from under fertilizer sales (see Column F in the Table under “commodity futures”). If you buy stock in either POT or AGU you’ll eventually be rewarded because 1) population growth increases the demand for food, and 2) urban sprawl (combined with droughts due to global warming) reduces the availability of arable land.
Risk level: 9 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and Gold Bullion = 10)
Full disclosure: I own shares of AGU.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 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 3-5 Yr CAGR found at Column H. Price Growth Rate is the 20-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 31 in the Table. The ETF for that index is MDY at Line 14.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 2
Week 300 - $185/week For A Low-cost Online Retirement Fund
Situation: Let’s say you make $64,000/yr but don’t have a workplace Retirement Plan. You still need to put 15% of your income (or $9,600/yr or $185/week) into a Retirement Plan. You can’t expect Social Security checks to replace more than 40% of your salary.The lowest cost self-directed plan would be composed of an IRA for stocks and Inflation-protected US Savings Bonds (ISBs) for bonds. We define costs as a) transaction costs, b) taxes, and c) inflation. The annual IRA contribution limit is $5,500/yr ($6,500/yr if you’re over 50). That doesn’t cover the $9,600/yr you need to shield from taxes, which is where ISBs come in handy. Those have a $10,000/yr contribution limit, work like an IRA to defer taxes, and carry the added benefit of shielding you from inflation.
Mission: Set up our standard spreadsheet (see Table) for $6000/yr of online stock purchases which go into an IRA, and $3600/yr of online bond purchases, which go into ISBs.
Execution: see Table, where the Vanguard Interm-Term Bond Index Fund (VBIIX) is a proxy for ISBs to facilitate comparison with stocks, which are neither inflation-protected nor tax-advantaged.
Administration:
Plan A: You can put $100/mo into each of 5 stocks purchased online through computershare, then have your accountant declare that account at computershare to be your IRA. This assumes you’re over 50 years old when you start this plan.
Plan B: You can put $500/mo into a Total Stock Market Index Fund (VTSMX) IRA marketed by the Vanguard Group. VTSMX carries an expense ratio of only 0.16%/yr vs. 0.58%/yr for stocks purchased through computershare (see Column P in the Table). NOTE: Plan B is the smarter option. Why? a) The expense ratio is lower. b) An index fund eliminates the considerable risk of selection bias.
With either Plan, $300/mo is put into ISBs with automatic online withdrawals from your checking account. Less money is put into bonds than into stocks because Social Security payments are made from a US Treasury Bond Fund. The interest payments on ISBs are based off the interest payments for 10-yr Treasury Notes corrected for the value of the tax deferral benefit and inflation correction benefit. Also, remember that ISBs have zero transaction costs and zero inflation risk; interest accrues biannually and cannot be taxed until the bond is redeemed. To better understand why you should confine your bond investments to 10-yr US Treasury Notes, read the fine print:
Caveat emptor: “The hard part of setting up a Retirement Plan is understanding the role of bonds. Those go up in value when stocks go down, so bonds need to form half of the assets meant to sustain you in retirement. Why do bonds go up in value when stocks go down? Because bankruptcy drops bond prices to the liquidation value of collateral, say 70 cents on the dollar, whereas bankruptcy drops stock prices to zero. The easy part to understand is that the risk that a bond will end up in bankruptcy court is specified by the interest rate: no investor will buy a bond that doesn’t pay enough interest to compensate for the risk being assumed. The zero-risk set point for interest rates everywhere is the 10-yr US Treasury Note. A commercial bond has to pay sufficiently more interest to draw in a buyer. On a risk-adjusted basis, all publicly-traded bonds pay the same rate of interest. Given that Treasuries are obtained online at zero cost, there is no reason to own any other type of fixed-income investment (unless you’re a bond trader).”
Bottom Line: Investment-grade bond and total stock market indexes have approximately the same inflation-adjusted total returns over multi-decade periods of ~3%/yr (e.g. see Lines 21 and 22 in the Table). Those returns remain roughly equivalent, otherwise investors would accumulate less money in one in order to favor the other.
Instead of using stock & bond indexes, you can have professionals pick stocks and bonds for you. This is tempting, since most stock and bonds make unattractive investments (because most companies have Balance Sheet problems or a weak Brand). That’s why an actively managed & balanced mutual fund like Vanguard Wellesley Income Fund (VWINX) outperforms a 50:50 mix of stock and bond index funds (compare Line 13 to Line 23 in the Table).
Or you can pick conservative bonds and stocks for yourself and keep transaction costs low by investing online (compare Line 10 to Lines 13 and 23 in the Table). NOTE: transaction costs in Column AB, which come to 0.58%/yr ($56/$9600).
Risk Rating: 4 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, KO, IBM, JNJ, NEE, and ISBs.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Set up our standard spreadsheet (see Table) for $6000/yr of online stock purchases which go into an IRA, and $3600/yr of online bond purchases, which go into ISBs.
Execution: see Table, where the Vanguard Interm-Term Bond Index Fund (VBIIX) is a proxy for ISBs to facilitate comparison with stocks, which are neither inflation-protected nor tax-advantaged.
Administration:
Plan A: You can put $100/mo into each of 5 stocks purchased online through computershare, then have your accountant declare that account at computershare to be your IRA. This assumes you’re over 50 years old when you start this plan.
Plan B: You can put $500/mo into a Total Stock Market Index Fund (VTSMX) IRA marketed by the Vanguard Group. VTSMX carries an expense ratio of only 0.16%/yr vs. 0.58%/yr for stocks purchased through computershare (see Column P in the Table). NOTE: Plan B is the smarter option. Why? a) The expense ratio is lower. b) An index fund eliminates the considerable risk of selection bias.
With either Plan, $300/mo is put into ISBs with automatic online withdrawals from your checking account. Less money is put into bonds than into stocks because Social Security payments are made from a US Treasury Bond Fund. The interest payments on ISBs are based off the interest payments for 10-yr Treasury Notes corrected for the value of the tax deferral benefit and inflation correction benefit. Also, remember that ISBs have zero transaction costs and zero inflation risk; interest accrues biannually and cannot be taxed until the bond is redeemed. To better understand why you should confine your bond investments to 10-yr US Treasury Notes, read the fine print:
Caveat emptor: “The hard part of setting up a Retirement Plan is understanding the role of bonds. Those go up in value when stocks go down, so bonds need to form half of the assets meant to sustain you in retirement. Why do bonds go up in value when stocks go down? Because bankruptcy drops bond prices to the liquidation value of collateral, say 70 cents on the dollar, whereas bankruptcy drops stock prices to zero. The easy part to understand is that the risk that a bond will end up in bankruptcy court is specified by the interest rate: no investor will buy a bond that doesn’t pay enough interest to compensate for the risk being assumed. The zero-risk set point for interest rates everywhere is the 10-yr US Treasury Note. A commercial bond has to pay sufficiently more interest to draw in a buyer. On a risk-adjusted basis, all publicly-traded bonds pay the same rate of interest. Given that Treasuries are obtained online at zero cost, there is no reason to own any other type of fixed-income investment (unless you’re a bond trader).”
Bottom Line: Investment-grade bond and total stock market indexes have approximately the same inflation-adjusted total returns over multi-decade periods of ~3%/yr (e.g. see Lines 21 and 22 in the Table). Those returns remain roughly equivalent, otherwise investors would accumulate less money in one in order to favor the other.
Instead of using stock & bond indexes, you can have professionals pick stocks and bonds for you. This is tempting, since most stock and bonds make unattractive investments (because most companies have Balance Sheet problems or a weak Brand). That’s why an actively managed & balanced mutual fund like Vanguard Wellesley Income Fund (VWINX) outperforms a 50:50 mix of stock and bond index funds (compare Line 13 to Line 23 in the Table).
Or you can pick conservative bonds and stocks for yourself and keep transaction costs low by investing online (compare Line 10 to Lines 13 and 23 in the Table). NOTE: transaction costs in Column AB, which come to 0.58%/yr ($56/$9600).
Risk Rating: 4 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into UNP, KO, IBM, JNJ, NEE, and ISBs.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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