Week 362 - “The 2 and 8 Club” (Extended Version) = Non-S&P 100 Companies In The Russell 1000 Index

Situation: The risk of loss from owning small-capitalization stocks vs. large-capitalization stocks is material, i.e., greater than 5%. Stocks in the S&P 100 Index are safest to own, given that those are required to have actively-traded Put and Call options on the CBOE (Chicago Board Option Exchange), and are usually followed by at least a dozen analysts. Large companies also have the advantage of multiple product lines, one of which is likely to do well in a recession. This same lack of uncertainty makes their stocks boring to own, even though a number of S&P 100 stocks are statistically more likely to weather a Bear Market than the S&P 500 Index (see Column M in any of our Tables). Index investing is even more boring and predictable. 

You’re left trying to find a winner among the other 900 companies of The Russell 1000 Index. A sign that you’ve selected well for your investment occurs when you find that company highlighted in a Wall Street Journal article. Our blog for this week tries to help you do exactly that. We’ve already found a handy way to identify trendy S&P 500 companies, which we call “The 2 and 8 Club” (see Week 348). And, we published an Extended Version (see Week 350) that takes you through promising companies in The Barron’s 500 List. 

Caveat Emptor: “The 2 and 8 Club” focuses exclusively on companies in The Russell 1000 Index that have historically paid an above-market dividend and are judged (by The Financial Times) likely to continue doing so. That means they’re bond-like, and attract investors because of the near-certainty that they will continue to pay a good and growing dividend. The downside of this benefit is that price appreciation will flatten and decline in a rising interest rate environment, just as bond prices do. Why? Because of competition from newly-issued bonds that pay a higher rate of interest and have less risk of default. 

Mission: This week we double-down and identify putative winners in The Russell 1000 Index.

Execution: see Table.

Administration: Rules for membership in “The 2 and 8 Club”: 
   1) The company is listed on the FTSE High Dividend Yield Index (US), which contains the ~400 highest-yielding companies in the Russell 1000 Index. Those are companies that have historically paid an above-market dividend (usually ~2%) without reducing that payout in periods of market stress.
   2) The company has raised its regular quarterly dividend at least 8%/yr over the past 5 years.
   3) The company’s bonds carry an S&P Rating of at least BBB+.
   4) The company’s stock carries an S&P Rating of at least B+/M.
   5) The company’s end-of-week stock price has been analyzed quantitatively by using the BMW Method for the past 16 years.
   6) The company is graded annually as to cash flow trends and revenue growth by the editors of Barron’s.
   7) The company is required to be a Dividend Achiever, to offset the risk of loss of carried by these companies because of being less well capitalized than those in the S&P 100 Index.

Bottom Line: Of the 7 companies in this week’s Table, only two are reasonably safe bets: The Travelers (TRV) and WEC Energy (WEC). In other words, their risk of loss in the next Bear Market is lower than that for investors in the Dow Jones Industrial Average ETF (DIA) (see Column M of the Table). So, why not simply buy shares of DIA instead of gambling on one of the other 5 companies? After all, DIA has an ~2% dividend yield and grows its dividend ~8%/yr. Answer: You’re a speculator and think you can do better than settle for the 7-8% long-term Total Return/Yr you’d realize from owning shares of DIA.

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

Full Disclosure: I own shares of The Travelers (TRV) and Cummins (CMI).

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