Week 313 - High-quality Dividend Achievers That Beat The S&P 500 For 35 Years With Less Risk

Situation: Most investors don’t like to micromanage their stock holdings, preferring instead to “buy-and-hold.” But we occasionally lose money because we haven’t been paying adequate attention. Deciding when to sell is much harder than deciding when to buy. The basic rule is to buy stocks with an ROIC (Return On Invested Capital) that is more than twice their WACC (Weighted Average Cost of Capital), then sell when they no longer meet that standard. But that approach doesn’t work for technology stocks, where the ROIC is many times greater than the WACC, or for many stable and/or slowly growing companies. For example, Berkshire Hathaway (BRK-B) has had an ROIC that is only a little higher than its WACC for long periods.

If we are to “buy-and-hold” a stock, the underlying company needs to have a long record of stable price growth that outperforms the lowest-cost S&P 500 Index fund (VFINX). Otherwise, we would simply invest in VFINX and forget about picking stocks. We would also like those companies to have had less stock price volatility than VFINX over a long period of time . . . decades. The necessary statistical data is found at the BMW Method website.

Mission: For this week’s blog, we’ll look at how publicly-traded stocks have performed over 35 year holding periods. Next week, we’ll run the same spreadsheet for 25 year holding periods and the following week we’ll look at the 30 year period.

Execution: see Table.

Administration: We exclude companies that do not have high ratings from S&P on their stocks and bonds. We also exclude companies that S&P hasn’t designated as Dividend Achievers. “Less risk” is defined as a statistically lower risk of loss at 2 standard deviations below trendline than that for the S&P 500 Index (see Column M in the Table, where red highlights denote more risk).

Bottom Line: After analysis, we find that all 10 companies had better price returns than our benchmark (VBINX) over the two year correction in commodity prices from July of 2014 to July of 2016. Most of these companies showed unusually strong performance, meaning investors chose to shunt money away from commodity-related companies and into these companies. It is instructive to get an idea as to why these company’s products and services seemed more valuable to investors. Yes, it was a “risk-off” decision. This is because investors know that the best way to make money is to avoid losing money. Of the 10 stocks highlighted here, only 3 (MCD, MMM, APD) are in “growth” industries; the others are in “defensive” industries (healthcare, consumer staples, and utilities) where earnings tend to hold up better in a downturn. But why not build a portfolio of “risk-off” investments in the first place, given that those appear to outperform the S&P 500 Index over long periods? We’ll check that theory out at 25 and 30 year holding periods, to see how well it holds up. In the meantime, remember Warren Buffett’s Rule #1: “Never lose money.”

Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold = 10)

Full Disclosure: I own shares of GIS, MCD, MKC, and MMM.

Note: We use discounted cash flow from dividends and sale of the stock (after a 10-Yr holding period) to estimate Net Present Value; see Columns U-Y in the Table. The exponential growth rate in stock price over the next 10 years is estimated to be an extrapolation of the growth in stock price over the past 16 years. The Discount Rate is set at 9%, meaning that a stock with a positive NPV would return more over 10 years than a 10-Yr US Treasury Note paying 9%/Yr. Dividend Growth over the next 10 years is extrapolated from Dividend Growth over the past 4 years. Be aware that our NPV calculation is for comparative purposes only. Any rise in the rate of interest paid by 10-Yr Treasury Notes would diminish stock NPVs, provided that those Notes continue to carry a AAA credit rating from S&P.

Red highlights in the Table denote underperformance relative to our benchmark: Vanguard Balanced Index Fund (VBINX) at Line 18. Purple highlights denote metrics of concern.

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