Situation: Saving for retirement is aided by having a taxable account of individual stocks that pay a good and growing dividend. To pick safe stocks for that purpose, first assess risk. There are 4 requirements, i.e., that the company’s bond issue has an S&P Credit Rating of A- or better, its finance value exceeds that for the S&P 500 Index ETF SPY (see Column G in the Table), its Return On Invested Capital (ROIC) exceeds its Weighted Average Cost of Capital (WACC) as shown in Columns V and W, and that its 10-yr Actual Rate of Return (10-Yr ROIC) exceeds its 10-yr Required Rate of Return (which is a proxy for 10-yr WACC) as shown in Columns D and E.
Mission: Find safe stocks for retirement income.
Execution: see Table of 11 companies.
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 is a good number. Six companies do so: MRK, LMT, HSY, SNA, PEP, PG. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar reports (Column AP) and is negatively impacted by the extent to which managers capitalize the company by issuing long-term bonds (Column Y). One company has a BUY rating from Morningstar (HON), and 6 companies have a Long-Term Debt to Equity ratio lower than 1.0 (MRK, ADM, SNA, APD, WMT, HRL). 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; 9 companies meet that standard (MRK, LMT, ADM, HSY, SNA, HON, WMT, PG, HRL). His third point (that the stock be available “at a sensible price”) is addressed by 1-yr and 3-year Forward PEG ratios (Columns N and O); 3 companies (MRK, HON, APD) have PEGs of 2.5 or below at both intervals. MRK is cited most (4 times).
Bottom Line: The goal is to build a large position in a few of these stocks by the time you retire. Since ~40% of daily movement in the S&P 500 Index is driven by its 20 largest companies, you’re likely to find success with the 4 stocks in the Table that are among those 20: MRK, PEP, WMT, PG. All 4 are low-volatility Sleep-Well-At-Night stocks (SWANs) that thrive on market downturns, have an average dividend yield of 2.4%/yr, and an average dividend growth rate of 6.1%/yr. Over the past 3 market cycles (20 years), those 4 have averaged a price return of 10.0%/yr vs. 8.0%/yr for SPY (Column P) while having less risk of loss (Column R).
Risk Rating: 4 (where a 10-yr Treasury Note = 1, SPY = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into MRK, LMT, SNA, PEP, WMT and PG, and also own shares of HON, AOD and HRL.
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