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.

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