Week 339 - HealthCare Companies in the Vanguard High Dividend Yield Index

Situation: American culture has increasingly disparate trends, but almost every adult is interested in occasionally partaking of a mood-altering substance. The cultural shift toward “Better Living Through Chemistry” now extends well beyond recreational drug use. Drugs are successfully being marketed for “wellness” without evidence-based research attesting to their efficacy. (These are medications that the FDA has approved for use in other conditions or diseases than those being touted in marketing materials.) As an example, WebMD has a list of 46 drugs and vitamins that are used to help prevent or treat Alzheimer’s Disease while noting that none have proof of efficacy.

Mission: Use our Standard Spreadsheet to list established HealthCare companies that pay a good and growing dividend.

Execution: see Table.

Administration: Eight of the 400 US companies in the FTSE Global High Dividend Yield Index are 1) in the S&P HealthCare Industry, 2) have trading records that extend for at least the 16 year period needed for statistical analysis by the BMW Method, and 3) are in the 2017 Barron’s 500 Index that ranks companies by using cash-flow based metrics.

Bottom Line: The main thing to remember about HealthCare companies is that their revenues will grow approximately three times faster than GDP, and (here’s the good part) growth is likely to continue during a recession when GDP is falling. In other words, some pharmaceuticals like anti-platelet drugs enjoy steady (inelastic) demand regardless of price. Investors also need to remember that prescription drugs have only 20 years of patent protection, and that clock starts ticking when clinical trials begin. Drug development is an expensive multi-year process which fails more often than it succeeds. Risk-adjusted returns on investment for these companies are no better than those for the aggregate of companies in the S&P 500 Index.

Risk Rating: 7 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into JNJ, and also own shares of ABT, PFE and AMGN.

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Week 338 - Alternative Investments (REITs, Pipelines, Copper, Silver and Gold)

Situation: You want to minimize losses from the next stock market crash. News Flash: The safe and effective way to do that is to have 50% of your assets in medium-term investment-grade bonds. Those will go up 10-25% whenever stocks swoon. But a plain vanilla form of protection won’t resonate with your neighbors after the crash hits. You’ll want to tell them about something cool that you did to protect yourself. And, while waiting for the next crash you don’t like the low interest income that you’d receive from a low-cost Vanguard intermediate-term investment-grade bond index fund like VBIIX or BIV. The exotic-seeming alternative is to bet on something related to land and its uses. Those bets carry valuations that track long supercycles, which overlap 3 or 4 economic cycles. But supercycles contain pitfalls for the unwary, and even for professional commodity traders.

Mission: Use our Standard Spreadsheet to examine Alternative Investments, and describe the pros and cons of owning those.

Execution: see Table.

Administration: The main bets are on real estate, oil/gas pipelines, copper, silver and gold. Traders mitigate losses during a recession by hoarding such assets until prices recover. Let’s look at the odds of success. The SEC (Securities and Exchange Commission) is responsible for guiding the average investor away from loss-making bets. For example, the SEC doesn’t allow a stock to be listed on a public exchange unless it has Tangible Book Value (TBV) and appears likely to continue having TBV after being listed. So, S&P identifies 10 Industries that have the structural profitability needed to maintain TBV and dividend payouts for retail investors. 

Real Estate is not such an industry. However, S&P has started evaluating Real Estate Investment Trusts (REITs) with a view toward someday including those. However, the Financial Times of London does not include Real Estate companies in either its FTSE Global High Dividend Yield Index, or the US version of that index, which you can invest in at low cost through an ETF marketed by the Vanguard Group (VYM). Nonetheless, we’ll list what we think are the 7 best REITs in the accompanying Table.

Oil and gas pipelines offer a way to capture tax-advantaged dividend income that transcends the ups and downs of the economy, but typically requires you to buy into a Limited Partnership. To do so, the SEC requires you to be an Accredited Investor. “To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income.” You’re also liable for taxes levied by most states through which the pipelines run. As a retail investor, you aren’t going to buy shares of a Limited Partnership. So, none are listed in our Table. But a few “midstream” oil & gas companies issue common stock to help fund a large network of integrated pipelines. Those pay the same high dividends expected of Limited Partnerships, and two companies are listed in the FTSE High Dividend Yield Index for US companies (VYM): ONEOK (OKE) and Williams (WMB). This indicates that each company’s dividend policy is thought to be sustainable. ONEOK has the additional distinction of being an S&P Dividend Achiever because of 10+ years of annual dividend increases.

Gold is the traditional Alternative Investment, which also brings copper and silver into play given that all 3 are found in the same geological formations. Any copper mine that fails to process the small amounts of gold it unearths is a copper mine not worth owning. The same can be said of gold miners who ignore silver deposits. The problem for investors is that mines are costly to develop and have an unknown shelf life. So, owning common stocks issued by miners has fallen out of favor: Dividends are rare and fleeting, and long-term price appreciation is neither substantial nor steady. Nonetheless, we have listed 4 miners in the Table: Freeport McMoRan (FCX) and Southern Copper (SCCO) both focus on mining copper; Newmont Mining (NEM, focused on mining gold), and Pan American Silver (PAAS). 

A better way to invest in precious metals is to buy stock in financial companies based on loaning money to miners on condition of being paid later either in royalties or ownership of a stream of product, should the mine become a successful enterprise. We have listed two such companies: Royal Gold (RGLD), which seeks royalties; Wheaton Precious Metals (WPM), which mainly seeks silver streaming contracts. See our Week 307 blog for a detailed discussion of silver. 

Bottom Line: If you want to venture into Alternative Investments, and would like to take a relatively safe and effective approach, we suggest that you buy shares in the REIT ETF marketed by the Vanguard Group (VNQ at Line 19 in the Table). Better yet, stick to companies in “The 2 and 8 Club” that represent more reasonable bets in the Natural Resources space: ExxonMobil (XOM), Caterpillar (CAT), and Archer Daniels Midland (ADM). One pipeline company is also worth your consideration: ONEOK (OKE, see comments above). 

Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into XOM, and also own shares of OKE, CAT and WPM.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com

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Week 337 - Agriculture-related Companies in “The 2 and 8 Club” (Extended Version)

Situation: We’ve narrowed our “universe” to large & established US companies that reliably pay a good & growing dividend, and called it The 2 and 8 Club. Why? Because “good ” means 2% or better and “growing” means 8% or better. We use a wash/rinse/repeat method to find those companies. 

In the “wash” cycle, we collect companies that are listed at each of the 3 online spreadsheets we value: 1) The capitalization-weighted FTSE High Dividend Yield Index for US companies, which is simply the 400 companies in the Vanguard High Dividend Yield ETF. 2) The S&P 100 Index, which has the advantage of price discovery through the requirement that stocks in these large companies have active markets in Put and Call Options. 3) The BMW Method List of statistical data for stocks that have been traded on a public exchange for at least 16 years. 

In the “rinse” cycle, we look up information online about each stock that passed through the wash: 1) We make sure bonds issued by that company have an S&P Rating of A- or better. 2) We make sure stocks issued by that company have an S&P Rating of B+/M or better (go to your broker’s website). 3) We make sure the company’s annual dividend payout has been growing 8% or faster over the past 5 years, i.e., we get a list of payouts from the relevant Yahoo Finance page then put the most recent year’s payout and the payout for 5 years ago into a Compound Annual Growth Rate calculator. 

In the “repeat” cycle, we take the same steps 3 months later, then select stocks to add or delete by using a brokerage that charges you a flat fee of ~1% of Net Asset Value/yr. This allows you to trade without incurring transaction costs (including dividend reinvestment). 

If you’re a glutton for punishment, you can extend your oversight beyond S&P 100 stocks to include those on the Barron’s 500 List, published each year in May, which has the advantage of ranking companies by using 3 cash flow metrics. Then you’ll be running the Extended Version of The 2 and 8 Club, which currently has 32 companies (see Table for Week 329). This week’s blog drills down on the 10 companies in the Extended Version that ultimately depend on feedstocks provided by farmers, to ultimately market foods & beverages, motor engine fuels, animal feed, cigarettes, cotton shirts, and plastics made from corn. 

Mission: Set up a Standard Spreadsheet of those 10 companies.

Execution: see Table.

Administration: Farmers operate a capital-intensive business that requires large-scale production on ~1000 acres to justify the cost of chemicals and fertilizer plus the main cost, which is for the purchase and maintenance of equipment (e.g. combines, tractors, grain carts, center-pivot irrigation systems, sprayers, semi-tractors that haul 30 tons of grain, grain-drying bins, grain storage bins, and satellite navigation links needed for weather forecasting and precision agriculture). Their mobile powered equipment requires diesel fuel, and their grain-drying bins require natural gas or propane. 

Archer-Daniels-Midland is the only pure Ag company on the list. ADM collects crops at railheads for further shipment and initial processing, and distributes products worldwide. Much of that distribution begins by loading grain onto barges in the Mississippi River. 

Weather is the key variable. The software and hardware on weather satellites is IBM gear, and IBM owns The Weather Channel. GPS-based software is an important part of precision agriculture, and similarly depends on satellites running IBM equipment. Cummins (CMI) and Caterpillar (CAT) provide diesel engines, and ExxonMobil (XOM) is one of the largest sources of diesel fuel. CAT also makes skid-loaders and backhoe/end-loaders that some farmers use.

PepsiCo (PEP) and Coca-Cola (KO) process a variety of farm products (including milk, cheese, oranges, oats, coffee and tea) into dozens of branded foods and beverages that are found worldwide. Altria Group (MO) processes tobacco plants into cigarettes and smokeless tobacco for the US market. VF Corporation (VFC) is the largest company that fabricates clothing for a variety of markets, and depends on farmers to produce its main feedstock (cotton). Target (TGT) markets clothing, and Super Target stores offer a large variety of foods and beverages. 

Bottom Line: Farm incomes have fallen 20%/yr over the last 3 years, but appear to have stabilized with this year’s harvest. Cost-cutting and scaling-up are the main survival strategies. Farms that are large enough to sustain a family are multi-million dollar enterprises that cultivate more than a square mile of ground. When farmers are forced to cut costs, suppliers are forced into being acquired by (or merged with) other companies. To further complicate matters, efficient transportation networks now circle the planet. The supply of crop commodities outstrips demand enough that the effects of drought or war in one place are mitigated by bumper crops in another place. 

Risk Rating: 8 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).

Full Disclosure: I dollar-cost average into KO, XOM, and IBM, and also own shares of CAT and MO.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com

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Week 336 - Version 3.0 of The Growing Perpetuity Index Reflects “The 2 and 8 Club”

Situation: We started this blog six years ago with the idea to create a Growing Perpetuity Index as a way to save for retirement, by selecting from a workable “watch list” of high-quality stocks (see Week 21). We chose to base the index on companies in the 65-stock Dow Jones Composite Average (^DJA), and ended up selecting 12 from the 14 that had earned S&P’s designation of Dividend Achiever, i.e., companies that had raised their dividend annually for the previous 10 years or longer:
        Exxon Mobil
        Wal-Mart Stores
        Procter & Gamble
        Johnson & Johnson
        IBM
        Chevron
        Coca-Cola
        McDonald’s 
        United Technologies
        3M
        Norfolk Southern
        NextEra Energy

Our thought was that investors could select stocks from this index to safely dollar-cost average automatic online contributions into their Dividend Reinvestment Plan (DRIP). That would allow relatively safe and efficient growth in their retirement assets. Version 2.0 (see Week 224) added back the two companies that had been left out, Caterpillar (CAT) and Southern Company (SO), plus two newly qualified companies: Microsoft (MSFT) and CSX (CSX).

Now we’ll apply a lesson learned from running Net Present Value (NPV) calculations, namely that Discounted Cash Flows from good and growing dividends are more likely to predict rewards to the investor than Capital Gains from a history of price appreciation. Accordingly, Version 3.0 re-casts the index to include only those ^DJA companies that are in “The 2 and 8 Club” (see Week 329) of high-quality companies with a dividend yield of at least 2% and a dividend growth rate of at least 8% for the past 5 years. The result is a 13 company Watch List, not all of which are Dividend Achievers. Only 7 are holdovers from Growing Perpetuity Index, v2.0:
   NextEra Energy
   3M
   Exxon Mobil
   Coca-Cola
   IBM
   Microsoft
   Caterpillar

Mission: Apply our standard spreadsheet (see Table) to the 13 companies in the 65-company Dow Jones Composite Index that are in “The 2 and 8 Club.”

Execution: see Table.

Bottom Line: The value of picking from among the highest-quality stocks in the Dow Jones Composite Index is not just that it’s the smallest and oldest index, but also that it is continuously vetted by the managing editor of The Wall Street Journal. Companies that don’t stand muster are replaced by companies that do. By adding the several requirements for inclusion in “The 2 and 8 Club” (e.g. S&P bond ratings cannot be lower than A-), you have a good chance of selecting half a dozen stocks that will beat the S&P 500 Index over a 10-Yr Holding Period (see Column Y in the Table). You’ll also be taking on more risk (see Columns D, I, and M in the Table), which you’ll ameliorate by trading new entrants to “The 2 and 8 Club” for those that are leaving.

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

Full Disclosure: I dollar-cost average into MSFT, XOM, NEE, KO, JPM and IBM, and also own shares of TRV, PFE, MMM, and CAT.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com

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Week 335 - Invest in “The 2 and 8 Club” Without Gambling

Situation: You’d like to invest in stocks without leaving money on the table. The alternative is to invest in the S&P 500 Index, which is a derivative subject to the kind of Program Trading that caused the “Black Monday” crash on October 19, 1987. Even after 3 decades of refining New York Stock Exchange technology to apply lessons learned from that crash, its recurrence remains a distinct possibility. 

You can invest in stocks without getting swept up in full fury of the next crash by using a few precautions: 1) Avoid stocks that have a statistical likelihood of losing more money than the S&P 500 Index per the BMW Method, i.e., avoid stocks highlighted in red at Column M in our Tables. 2) Use dollar-cost averaging to invest through a Dividend Re-Investment Plan (DRIP) in stocks that aren’t highlighted in red, and continue automatically investing in those each month throughout the next crash. 3) Avoid non-mortgage debt and have at least 25% of your assets in Savings Bonds, 2-10 Year US Treasury Notes, cash and cash equivalents. 

Mission: Looking at the 30 stocks in “The 2 and 8 Club” (see Week 329), set up a spreadsheet of those that do not have red highlights in Column M.

Execution: There are 12 such stocks (see Table).

Administration: Note that Costco Wholesale (COST) is not listed in the FTSE High Dividend Yield Index upon which “The 2 and 8 Club” is based. While dividend growth rate is 13.0%/yr, its dividend yield is only 1.3%, which is much lower than the ~2%/yr required for inclusion in the FTSE High Dividend Yield Index. This overlooks the fact that Costco Wholesale issues special dividends of $5 or more every other year! So, I’ve chosen to make COST an honorary member of “The 2 and 8 Club.”  

Bottom Line: You do have a chance of beating the S&P 500 Index without gambling, by investing in high quality growth stocks that are unlikely to lose as much as that index in the next market crash. But we find only 12 such stocks, which means you’d need to invest in all 12 to avoid selection bias.

Risk Rating is 5, where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10. 

Full Disclosure: I dollar-cost average into IBM, KO, XOM and NEE, and also own shares of MO and TRV.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com