Month 142 - Dow Jones Industrial Average - May 2023

Situation: We have yet to help you create a scorecard for your side business, which is saving for retirement. That means we have to address Warren Buffett’s Rule #1 (“Never lose money”) and his Rule #2 (“See Rule #1”) in a direct and straightforward manner.

Mission: Set up a thought experiment wherein your side business has invested equal amounts of money in each of the 30 stocks in the Dow Jones Industrial Average. Then assume you retire after either one or ten years (liquidate your side business). For each stock, calculate the Weighted Average Cost of Capital (WACC) and the Return on Invested Capital (ROIC) after each holding period. In the Bottom Line section, list the companies that returned the full value of your money (or more) after both holding periods.

Execution: see Columns V-W and Columns D-E in the Table. Purple highlights denote a return on capital that is less than the cost of capital.

Analysis: Warren Buffett’s favorite metric is found in Column S of the Table: Return on Tangible Capital Employed. He thinks a 20% return for the last fiscal year (lfy) is a good number. Twelve companies do so: MRK, UNH, AMGN, KO, V, JNJ, MCD, PG, MSFT, AAPL, HD, CSCO. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar reports (see Column AP) and is negatively impacted by the degree to which managers capitalize the company by issuing long-term bonds (see Column Y). Nine companies have a BUY rating from Morningstar (HON, GS, CSCO, VZ, WBA, MMM, CRM, DIS, DOW), and 15 companies have a Long-term Debt to Equity ratio lower than 1.0 (CVX, MRK, UNH, TRV, V, JNJ, WMT, PG, MSFT, CSCO, NKE, CRM, DIS, INTC, DOW). Mr. Buffett also states that a high Free Cash Flow Yield (Column K) reflects good management because Retained Earnings allow the company to expand operations (or pay down debt) at zero cost; 26 companies meet that standard (CVX, MRK, UNH, CAT, TRV, AMGN, HON, KO, V, JNJ, MCD, WMT, BA, IBM, PG, AXP, MSFT, GS, AAPL, JPM, HD, CSCO, MMM, CRM, DIS, DOW). His third point (that the stock be available “at a sensible price”) is addressed by 1-yr and 3-year Forward PEG ratios (see Columns N and O); 9 companies (UNH, CAT, TRV, AMGN, V, AXP, CRM, DIS, DOW) have PEGs under 2.0 at both intervals. Five companies are A-rated (MRK, JNJ, WMT, PG, CSCO). Eight companies are cited 4 times (MRK, UNH, V, JNJ, PG, CSCO, DIS, DOW).

Bottom Line: Your side business didn’t lose money when invested for 1-year and 10-year periods in 15 DJIA stocks: MRK, UNH, CAT, AMGN, HON, V, JNJ, MCD, WMT, PG, MSFT, AAPL, JPM, HD, NKE. Your batting average is 0.500.

Risk Rating: 7 (10-yr U.S. Treasury Note = 1; S&P 500 Index = 5; gold bullion = 10) 

Full Disclosure: I dollar-average into MRK, CAT, JNJ, MSFT, HD, WMT, PG, WBA, and also own shares of UNH, AMGN, HON, KO, MCD, CSCO, NKE, VZ, INTC, BA, JPM, IBM, MMM.

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