U S Stock Market

It appears to me that the best advice would be to sit tight until after November. There is really no reason to get excited about equities between now and then. Maybe no reason even then. If there should be a severe drop before then and you really can not resist, then make sure that your purchases are in the likes of KO, MCD, ABT, CLX, CVX and PG.

Stocks versus bonds as of August 4, 2010

Recently investors have fled stocks and embraced bonds en mass. Let's take a critical look at the comparison of the two.

US ten year bonds as I write this pay interest of 3.11%. $10,000 invested in these bonds over 10 years will yield a total of $3110 over the life of the bonds disregarding reinvestment of interest. After taxes maybe about $2650 in the 15% bracket. After taxes and inflation maybe, just maybe $1000 optimistically.

Blue chips stocks consisting of KO, MCD, ABT, PG, and CLX invested in equal amounts currently yield at today's price 3.36%. Now these stocks over the past 25 years have each raised their dividends every year. KO ten years ago paid a 0.68 dividend. Today it pays $1.76 or 2.5 times as much. ABT ten years ago paid 0.74 today it pays 1.76 or 2.4 times as much. Ten years ago PG paid 0.64. Today it pays 1.93 or 3 times as much. Ten years ago MCD paid 0.22. Today it pays 2.20 or 10 times as much. Ten years ago CLX paid 0.61. Today it pays 2.20 or 3.6 times as much.

But wait you say. The average price of a stock has lost value over the previous 10 years whereas you know that if you buy a treasury bond in ten years you will get your money back.

Not so fast. It is true that 10 years ago CLX was selling at 26 times earnings on average and today it is selling for only 15 times earnings. In that sense it has lost value. But during that ten years earnings have grown from 1.64 a share to currently about 4.24 a share. Ten years ago the average price per share was 42.50 a share. Today it is 64.50 a share.

10 years ago PG was selling at 35 times earnings on average and today it is selling for only 16 times earnings. During that 10 years earnings have grown from 1.24 a share to 3.67 a share. Ten years ago the average price per share was 43. Today it is 60 a share.

The same case holds true for the other three stocks also.

So if you hold $10,000 worth of 10 year US treasuries, your after tax return will be about $2650 in ten year. On the other hand if you hold these 5 blue chip stocks your expected return over a 10 period based on history will be considerably greater than $2650. It is perhaps unlikely that the dividends will rise as much during the next 10 years as they have during the past 10 years, but let's assume they will rise 8% annually. In that case in 10 years they will be 2.16 times as much as they are now. The total dividends expected during that period will be $4867. If the current tax rate on dividends should continue which it might not, the after tax amount in the 15% bracket would be $4624 less state taxes. Dividends are currently taxed at only 5% in the 15% bracket. In addition to the increased dividends, there should also be based on history capital gains on this investment. If we use the last 10 years as our guide the capital gains will be in the order of 35% in ten years. Remember though that ten years ago these stocks were all selling at a PE ratio that was considerably higher than they are today. KO at 60, today at 16. MCD at 24, today at 16. ABT at 24, today at 12. CLX at 26, today at 15. PG at 35, today at 16. With 35% capital gains there will be an additional $3500 in return which will not be taxed at all so long as the stocks are not sold, giving a total expected potential return of $8124 versus $2650 for 10 year US bonds.

If history is any indication at all, and it might not be, then there is a very strong case that investing in blue chip dividend paying stocks will be a much more worthwhile experience over an extended period of time than investing in bonds.

I will point out that there is more risk in investing is stocks than in bonds but that risk can be mitigated by investing in at least five different stocks and investing in leaders in their industry positions as are these five companies. It is worth pointing out though that at one time GM was an industry leader and also considered a blue chip stock. Last year it went bankrupt. The same could once be said about US Steel. It did not go bankrupt but it is just a shadow of its former self. There are countless other such tales. AIG, C, BAC, GE. The latter four are financial companies. Perhaps that should indicate something to avoid.

One final thought. The average PE of these stocks is among the lowest it has been in the past 10 years. ABT is currently at 12. During the past 10 years it has ranged from 11 to 58. It is currently very near the 10 year low. The same can be said about the other four.

Getting an early start at investing

It may not seem obvious but the earlier one starts investing, the better the odds that one will accumulate the money one requires at a later time. The secret word here as Groucho Marx would have said is compounding. Given sufficient time compounding can turn a small amount of money into a significantly greater amount. The key word here is time. Consequently, a person that starts a saving program at say age 18 is going to accumulate a great deal more wealth than a person who starts a saving program at age 28.

This can best be shown by an example.

A person who is 28 might be expected to be able to save significantly more money than a person age 18, but by the time the person age 18 reaches age 28, that person should also be able to save an equivalent amount other things being equal.

Let's assume that the 18 year old can save only $50 a month and that the growth rate of those savings is 5% annually. Then by age 28 that person will have accumulated $7546. Without saving another red cent, in 40 years that amount will then be worth $53,123 from an initial investment of only $6000.

But how much will the 28 year old have to save each month for 10 years to arrive at the $53,123 at age 68? The answer is $81.44 a month or about 62% more than the 18 year old. But remember the 18 year old is not going to stop investing just because he reached age 28. He/she is going to continue saving and investing.

Dividends

I recently ran across a link to a spreadsheet of US stocks that have increased their dividends each year for at least the last 25 years. It is something that must be shared and here it is.

http://dripinvesting.org/Tools/Tools.asp

I was quite surprised to learn that the list includes 100 companies.

Blue Chip Stocks

What stocks are in fact Blue Chip Stocks? I searched the internet but did not find a list of blue chips.

Let's first define attributes that a blue chip should have.

1. They should have a minimum market capitalization. I will say a minimum of $4 billion dollars.
2. They should have a history of increased sales and earnings going back at least 20 years. It can be somewhat difficult to find financial information for more than 10 years though but not completely impossible. Earnings growth should be significantly greater than the inflation rate.
3. They should have a sound balance sheet with a long term debt/equity ratio no greater than 0.50
4. They should pay a dividend although this could be argued perhaps passionately.
5. Return on equity of at least 15%


One important fact that needs to be stated is that a blue chip stock does not necessarily remain a blue chip stock. One such example would be U S Steel. For many years this company was one of the top blue chips. Not any longer.

Now for my list of what I would consider to be blue chip stocks.

JNJ Johnson and Johnson has a consistent history of increased earnings, sales, and dividends.

BDX Becton Dickinson ditto my comments on JNJ.

WMT Walmart has a consistent history of increased earnings, sales, and dividends except for last year when it did not increase its dividend.

PG Procter & Gamble There are several problems with PG. One is that it has had a history of borrowing lots of money and its d/e has often exceeded 0.50. It has also had more than a couple of earnings stumbles. But it does meet the criteria currently.

NKE Nike is a consistent performer with steady sales and earning growth. It has only in the past few year begun to increase its dividend on an annual basis. The company has virtually no debt. We will have to see how the recession impacts NKE. It may not be too pretty.

KO Coca-Cola has not had so consistent an increase in earnings as the companies above. 1999 and 2000 were disappointing years for KO but it did increase its dividend even in those years.

SYK Stryker has been consistent for the past 8 years but it had stumble in 1999. It has also had problems with anti-competitive behavior.

MCD McDonalds had a couple of stumbles back in 2001 and 2002 and during those years its roe and roa were not too good, but the company did increase its dividend during both years and has performed like a blue chip since.

And acouple of smaller cap stocks:

EXPD Expeditors International has been a steady performer in earning, revenue, and dividends. We will have to see how well it does during this recession. It will be tough.

FDO Familiy Dollar Stores does not quite meet the $4.0 billion market cap criteria. In general it has been a steady performer. It is a steady raiser of its dividend and although its earnings trend has had a few minor bumps along the way and its roe has not been consistantly above 15%, the company nevertheless on average has performed at blue chip standards.

How about some stocks that are on their way to becoming blue chips?

GOOG Google is a company that might eventually make the list. It has not been around long enough to have a decent track record. It has been growing revenue at a steady and remarkable rate and appears to be putting newspapers out of business. Also importantly it has been increasing shareholder equity at a remarkable pace.

And how about a few stocks that fall just a little short of being blue chips?

MSFT Microsoft would be by most standards a blue chip company, but not by mine. They have had a habit of wasting shareholder value by repurchasing company stock. Equity per share has remained constant for the last 10 years, actually has declined during the last 5 years.

Just because a stock might be considered a blue chip does not necessarily mean that it is a good investment. But currently the above stocks are certainly better investments than they have been for many years.