Graham and Dodd viewed stocks as special cases of obligations. That is, they bought stocks for their dividends rather than for potential capital gains. There was, however, a notable difference between stocks and bonds. The former feature an inflation fighter in the form of potential dividend increases, while the latter represent a fixed income stream. In other words, stocks were likely to retain their purchasing power in real terms, meaning that an investor could afford to spend all of their income. Meanwhile, the purchasing power of bonds had to be replenished BY income; not all the yield was expendable.
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The disruptions caused by COVID-19 have led to inflation in the real economy, which has translated into stock price inflation, from the second half of 2020. With indices close to their all-time highs, there are fears a crash. A little less gloomy forecasters have estimated that we have already reaped the capital gains that will be available for the entire decade of the 2020s (this was true at the beginning of the decade of the 2000s). Another area of concern is political; the coming year, 2022, is a “midterm” election year in which US stocks typically fall in price.
Betting on dividend-paying money
Compared to stocks and bonds, “cash” has performed relatively well at times like the 1970s. Rising inflation and interest rates are likely to erode the value of some stocks, especially those. that pay little or no dividends. But the returns on “cash” (ie short-term investments) INCREASE more or less in parallel with inflation. This is different from bonds, which have fixed coupons, and stocks, whose dividends generally do not rise quickly enough to offset short-term rate gains. But these problems have the least impact on stocks with high and growing dividends, that is, those that produce “cash”.
But the returns on “cash” (that is to say, short-term investments) increase more or less in parallel with inflation, unlike bonds, whose coupons are fixed, and stocks, whose dividends are no longer valid. ‘generally not rising quickly enough to offset short-term rate gains. But these problems have the least impact on stocks with high and growing dividends, that is, those that produce “cash”.
And with a decade-long bull market underway (with the exception of the ‘blip’ in early 2020 which was quickly restored), stocks hardly ever meet Graham and Dodd’s demands to be cheap relative to the market. to their balance sheets. The main way to “monetize” strong balance sheets is to pay dividends. (Some analysts believe stock buybacks serve a similar function, but that’s a discussion for another paper.) But in any case, the quality of the balance sheet is a key factor in setting and maintaining dividends. .
There are many ways to measure quality, but perhaps the easiest is the three digits in the lower right corner of a typical value line stock report. (I worked on this decades ago and have a soft spot for the format of its reports and charts.) These are 5 (lowest) to 100 (highest) measures of “predictability of earnings.” “, (stock)” Persistence of price growth, “and” Price stability “. These numbers are lower than the Financial Strength rating, which is rated from A ++ to C, and which is an additional quality rating. But for now, we’ll focus on the three numbers.
A high score on profit predictability suggests a high quality business, a low score the other way around. The “price stability” of the stock represents how the company is viewed in the market. For example, Exxon Mobil Corp (NYSE: XOM) is viewed as a high quality, blue chip stock, but is now only an “average” company at best, as measured by the Value Line quality indices, this which suggests that its stocks may be more volatile than in the past.
On the other hand, with scores of 95, 70 and 75 for earnings predictability, persistence of price growth, and price stability, Intel Corporation (NASDAQ:INTC) is considered a blue chip action. Oddly enough, the key to identifying Intel’s windfall characteristic is dividend yield. Its current yield is very competitive compared to that of the average stock. In fact, at some point in the past few years, the stock was selling almost 4%, almost double the median of the value line at the time. As an admittedly mature company in a growing (tech) industry, Intel should have no trouble matching the 5.5% earnings growth of the S&P 500, meaning that any performance premium over the median of the index is “free” money. Intel’s performance, in the high 2%, is higher than the market median in the high 1%, that is, the performance is one percentage point higher than that of the “market”, although Intel’s growth prospects are also slightly higher. . The “cap”, however, is that Intel’s quality numbers are from a blue chip stock, not a tech stock.
Similar things can be said about our other picks, listed below, taken from the Dow 30. We have scrupulously avoided using companies like Boeing Co (NYSE: BA), Home Depot Inc (NYSE: HD) and Salesforce.com, inc. (NYSE: CRM), which do not have a proper balance sheet, and focus primarily on companies with good equity-to-debt ratios, and the resulting ability to pay significant dividends. Like Intel, most of our picks rank in the top quartile for security based on various metrics along the value line (Goldman Sachs and IBM are just outside that top quartile).
Dogs of the Dow
For illustration purposes, most of our selections, but not all, are from the High Yielding “Dogs of the Dow”, the Top Ten Yielders. The exceptions had either stable or slightly declining returns (by no more than 15 basis points) to compensate for the fact that they were not in the “top ten”. On the other hand, we have excluded certain “dog” stocks (Chevron, Cisco Systems, Walgreens), whose formerly high returns were constrained by sharp price increases in 2021. The choices below are presented in the following format: ( Price for December 23, 2021, the yield for that day and the yield for December 31, 2020.)
Amgen, Inc. (NASDAQ: AMGN) (223.79 3.47%, 3.06%). A stock in a “stable” (pharmaceutical) sector that fell as the dividend increased, leading to higher yields.
Coca-Cola Co (NYSE: KO) (58.22, 2.89%, 2.99%). Not a growth stock, which means expectations are mixed. Should hold up better than most in a falling market, and the above-average dividend further reduces downside risk, both in absolute terms and relative to the market.
Goldman Sachs (NYSE: GS) (385.04, 2.08%, 1.90%). That stock is up over 40% this year, but an even bigger increase in the dividend (from $ 5 to $ 8 per year) means the yield has increased.
Johnson & Johnson (NYSE: JNJ) (168.25, 2.52%, 2.57%). We consider him to be a “high quality dog”. This is a mainstay of stability that would perform in the top ten if you eliminated a few of the substandard issues in the “dogs” group. If the market falls, J & J’s fall is likely to be “less than that of the market as a whole.”
Merck & Co., Inc. (NYSE: MRK) (75.73, 3.64%, 3.18%). This stock has shown remarkable stability, going “nowhere” since the start of 2020. Its yield is high compared to the current (high) market.
IBM (NYSE: IBM) (130.63, 5.02%, 5.16%). This stock is likely to go “nowhere” for the next three to five years. But “nowhere” should be a good performance in the bearish market we expect, at least for the year ahead. And a return above 5% is a nice “consolation” prize.
Intel Corporation (NASDAQ: INTC) (51.31, 2.71%, 2.65%) Another “chicken tech” stock, but with better prospects than IBM. It is more defensive than Cisco Systems, whose recent price spikes have sharply reduced its earlier attractiveness.
3M Co (NYSE: MMM) (174.97, 3.38%, 3.36%) The performance of this blue chip has remained about the same since the start of the year. It is always a defensive asset compared to the market as a whole.
Verizon Communications Inc. (NYSE: VZ) (52.68, 4.86%, 4.27%). This company started the year with a low return (for a telephone operator), but is now more than 50 basis points higher, at a time when returns have contracted almost everywhere else.
Another Dow dog
There is another “Dow Dog” that deserves to be considered for its high performance. We caution, however, that the stock’s safety is only “medium” and falls short of the other choices listed above, due to its recent spin-off (from DuPont).
Dow Inc (NYSE: DOW) (55.14, 5.08%, 5.05%). Not the highest quality issue due to the cyclicality of the business and recent restructuring, but relatively stable price action since mid-2020, and with a yield that has widened slightly since the start of the year.
After a tumultuous 2021, we believe that likely capital gains will be ‘capped’ in single digits, with a significant dip in 2022. As a result, we have chosen (mostly) high-quality stocks whose returns are likely to offset at least in part the possible losses. .