Situation: Stock-picking is essentially about forming three habits: 1) Corral a workable group of companies that have something of fundamental value in common, then study (and learn from) those. 2) Keep an eye on their debts (and yours). 3) Follow their Morningstar Reports. Your goal is to overweight the underpriced stocks in your corral and underweight the overpriced stocks.
Mission: This month’s newsletter is about my corral. I’m looking for companies that are potentially underpriced, starting with those that have a dividend yield above ~2.5%: PFE, AMGN, JNJ, INTC, PEP, LMT, MMM, IBM.
Execution: I decide which of those 8 companies have debt problems and an unflattering Morningstar Report, then cross those off my Watch List. AMGN, PEP, IBM have debt problems and are “overvalued” according to Morningstar. Five companies remain on the "Watch List": PFE, JNJ, INTC, LMT, MMM. Now let’s analyze all 22 companies in the corral, because some of those will face challenges in the future and become underpriced.
Analysis: Warren Buffett’s favorite metric is addressed in Column R of the Table: Return on Tangible Capital Employed. He thinks anything over 20% for the last fiscal year (lfy) is a good profit margin. 12 companies meet that standard (CSCO, PG, HD, AMGN, TXN, JNJ, INTC, PEP, LMT, EMR, CL, MMM). His second point -- that the company is “run by able and honest managers” -- is addressed in Morningstar Reports (see Column AL) and also is negatively impacted by the degree to which managers choose to capitalize the company with long-term bonds rather than common stock (see Column V). 4 companies (INTC, CMCSA, LMT, EMR) have a BUY rating from Morningstar; 11 companies have Long-Term Debt to Equity ratios lower than 1.0 (CSCO, PFE, PG, TGT, TXN, LIN, JNJ, INTC, EMR, RTX, GD). Mr. Buffett has also stated that high Free Cash Flow Yield (Column I) reflects good management because Retained Earnings allow the company to expand (or pay down debt) at zero cost. 13 companies (LLY, CSCO, HD, AMGN, TGT, LIN, INTC, CMCSA, LMT, EMR, CL, GD, IBM) have Retained Earnings after dividend payouts. His third point -- that the stock be available “at a sensible price” -- is addressed by the 1-yr and 5-yr Forward PEG ratios (see Columns M and N): 4 companies have PEG ratios under 2.0 at both time points (PFE, AMGN, CMCSA, RTX). 9 companies are members of The 2 and 8 Club (Column J): LLY, NEE, CSCO, HD, AMGN, TXN, CMCSA, LMT, GD.
Bottom Line: Cisco Systems (CSCO) is cited 4 times; Intel (INTC) and Lockheed Martin (LMT) are each cited 3 times. Since INTC and LMT are on my Watch List, those become BUYs.
Risk Rating: 7 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into NEE, CSCO, PFE, PG, INTC, JNJ and RTX, and also own shares of HD, TXN, LIN, CMCSA, LMT, GD, IBM and MMM.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com.
