Situation: Successful investing is largely about minimizing uncertainty. It should be advantageous to invest in companies that provide essential goods and services (food, transportation fuels, natural gas, electricity). There are two problems with that: 1) pricing power is lost, since demand is inelastic to price; 2) earnings growth is slow, since it’s largely a function of population growth.
To invest in food & agriculture companies, the safe & efficient approach is to look for shareholder-friendly companies–namely those with a commitment to increasing their dividend annually. They’re called dividend achievers if they’ve been doing that for ten or more years. However, a problem arises when a company’s stock price crashes: high dividends payouts often become unsustainable, since recovery of the former price happens slowly and often requires some assets be sold. Vanguard’s Dividend Appreciation ETF avoids that problem by excluding the 25% of Dividend Achievers with the highest dividend yields.
Mission: Use our spreadsheet to analyze all the Vanguard Dividend Appreciators that issue bonds rated BBB- or higher by S&P, have a complete S&P Report rating the stock B/M or higher, and have a 16+ year trading history. Exclude any companies with negative year-over-year earnings or negative Book Values.
Execution: see Table of 16 companies.
Analysis: Warren Buffett’s favorite metric is found in Column T of the Table: Return on Tangible Capital Employed. He thinks anything higher than 20% return is a good number. Six companies meet this standard: MKC, HSY, TTC, PEP, TSN, SJM. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar reports (see Column AO) and is negatively impacted by the degree to which managers have capitalized the company by issuing long-term bonds (see Column X). Three companies have a BUY rating from Morningstar: TSN, SJM, INGR. Eight companies have a Long-term Debt to Equity ratio lower than 1.0: HRL, COST, ADM, TTC, TSN, WMT, SJM, INGR. Mr. Buffett also states that a high Free Cash Flow Yield (Column L) reflects good management because Retained Earnings allow the company to expand its operations (or pay down debt) at zero cost. Twelve companies have Retained Earnings: HRL, COST, MKC, ADM, SYY, KR, HSY, KO, TTC, TSN, CAT, SJM. His third point (that the stock be available “at a sensible price”) is addressed by the 1 year and 3-5 year Forward PEG ratios (see Columns O and P): Three companies have PEGs lower than 2.0 at both time points: SYY, CAT, INGR. Two companies are cited 4 times: TSN and SJM.
Eight companies are A-rated (see Column AR): HRL, ADM, HSY, KO, TGT, PEP, WMT, CAT. Four of those are in The 2 & 8 Club (see bolded numbers in Column M): HRL, HSY, TGT, CAT. Stocks issued by 5 companies meet our “Value Stock” requirements (see Appendix): ADM, KR, TSN, SJM, INGR.
Bottom Line: These companies tend to be overvalued because of their stable earnings (see Column N). That is largely because demand is inelastic to price. (Food inflation has little effect on the volume of food purchased.) To put a fine point on this, Warren Buffett is only on record for having recommended one stock: Coca-Cola (KO).
Risk Rating: 7 (where 1 = 10-yr US Treasury Notes, 5 = S&P 500 Index, 10 = gold bullion)
Full Disclosure: I dollar-average into COST, PEP, WMT and CAT, and also own shares of TSN, MKC, KO and TGT.
Appendix: A “Value Stock” meets 3 criteria: 1) price (50d MA) is no greater than twice the Graham Number (see Columns AG & AH); 2) 7-yr P/E is no greater than 25 (see Column AJ); 3) Price (50d MA) is no greater than 6 times Book Value (see Column AI).
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