Situation: Most of us tread carefully when we start picking stocks for a retirement portfolio, usually by focusing on big companies that reliably pay an above-market dividend. A good way to build your own Watch List is to start with the portfolio holdings of VYM, the Vanguard High Dividend Yield Index Fund ETF. Then you might want to check out the choices made by the most effective stock picker over the past 125 years, which is the team directed by the Managing Editor of the Wall Street Journal that picks stocks for the 30-stock Dow Jones Industrial Average (DIA), the 15-stock Dow Jones Utility Average (XLU), and the 20-stock Dow Jones Transportation Average (IYT).
Mission: Pick A-rated companies from the 65-stock Dow Jones Composite Index by applying these criteria: 1) Inclusion in the VYM portfolio; 2) an S&P Bond Rating of A- or better; 3) an S&P Stock Rating of B+/M or better; 4) positive Book Value for the most recent quarter (mrq); 5) positive Earnings Per Share (EPS) for the Trailing Twelve Months (TTM); 6) 20+ year trading history on US exchanges.
Execution: Analyze those 20 companies (see Table)
Administration: My administrative guidelines are taken from the 2020 Annual Report of Berkshire Hathaway, where Warren Buffett writes that “we constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price.”
Bottom Line: Warren’s first point is addressed in Column Q of the Table: Return on Tangible Capital Employed. He thinks anything over 20% to be a good number. MRK, AMGN, CSCO, INTC, KO, PG and MMM pass that test. The second point is a bit harder to parse. Morningstar’s analyst reports dwell on the management team’s plan going forward (see Column AK in the Table), and the degree to which management boosts tangible assets by issuing long-term bonds indicates how much trouble management has relying on retained earnings. The applicable metric, called “gearing,” is the ratio of long-term debt to equity (see Column U in the Table). MRK, CSCO and INTC have BUY ratings from Morningstar and gearing ratios under 1.0. The third point is addressed by the 5-yr estimated PEG Ratio (see Column M in the Table): MRK, AMGN, CSCO, AEP, INTC, JNJ, TRV and UPS have PEG Ratios under 3.0 but only MRK, AMGN, INTC and TRV have ratios under 2.0. Conclusion: MRK, CSCO and INTC are BUYs.
Risk Rating: 7 (where 10-yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MRK, NEE, CSCO, INTC, KO, PG, WMT, JPM, JNJ and IBM, and also own shares of DUK, SO, CAT and MMM. NOTE: I dollar-average into 3 stocks that are overpriced per Benjamin Graham’s criteria (Graham Number and 7-yr P/E): NEE, KO and PG. This is justified by their low risk of loss in combination with their strong 20-yr record of price appreciation (see Columns N-P in the Table).
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