Tag Archives: yield

Digging For Value in a Pile of Manure

A special thank you to Brett Freeze of Global Technical Analysis for his analytical rigor and technical expertise.

There is an old story about a little boy who was such an extreme optimist that his worried parents took him to a psychiatrist. The doctor decided to try to temper the young boy’s optimism by ushering him into a room full of horse manure. Promptly the boy waded enthusiastically into the middle of the room saying, “I know there’s a pony in here somewhere!”

Such as it is with markets these days.

Finding Opportunity

These days, we often hear that the financial markets are caught up in the “Everything Bubble.” Stocks are overvalued, trillions in sovereign debt trade with negative interest rates, corporate credit, both investment grade, and high yield seem to trade with far more risk than return, and so on. However, as investors, we must ask, can we dig through this muck and find the pony in the room.

To frame this discussion, it is worth considering the contrast in risk between several credit market categories. According to the Bloomberg-Barclays Aggregate Investment Grade Corporate Index, yields at the end of January 2020 were hovering around 2.55% and in a range between 2.10% for double-A (AA) credits and 2.85% for triple-B (BBB) credits. That means the yield “pick-up” to move down in credit from AA to BBB is only worth 0.75%. If you shifted $1 million out of AA and into BBB, you should anticipate receiving an extra $7,500 per year as compensation for taking on significantly more risk. Gaining only 0.75% seems paltry compared to historical spreads, but in a world of microscopic yields, investors are desperate for income and willing to forego risk management and sound judgment.

As if the poor risk premium to own BBB over AA is not enough, one must also consider there is an unusually high concentration of BBB bonds currently outstanding as a percentage of the total amount of bonds in the investment-grade universe. The graph below from our article, The Corporate Maginot Line, shows how BBB bonds have become a larger part of the corporate bond universe versus all other credit tiers.

In that article, we discussed and highlighted how more bonds than ever in the history of corporate credit markets rest one step away from losing their investment-grade credit status.

Furthermore, as shared in the article and shown below, there is evidence that many of those companies are not even worthy of the BBB rating, having debt ratios that are incompatible with investment-grade categories. That too is troubling.

A second and often overlooked factor in evaluating risk is the price risk embedded in these bonds. In the fixed income markets, interest rate risk is typically assessed with a calculation called duration. Similar to beta in stocks, duration allows an investor to estimate how a change in interest rates will affect the price of the bond. Simply, if interest rates were to rise by 100 basis points (1.00%), duration allows us to quantify the effect on the price of a bond. How much money would be lost? That, after all, is what defines risk.

Currently, duration risk in the corporate credit market is higher than at any time in at least the last 30 years. At a duration of 8.05 years on average for the investment-grade bond market, an interest rate increase of 1.00% would coincide with the price of a bond with a duration of 8.05 to fall by 8.05%. In that case a par priced bond (price of 100) would drop to 91.95.

Yield Per Unit of Duration

Those two metrics, yield and duration, bring us to an important measure of value and a tool to compare different fixed income securities and classes. Combining the two measures and calculating yield per unit of duration, offers unique insight. Specifically, the calculation measures how much yield an investor receives (return) relative to the amount of duration (risk). This ratio is similar to the Sharpe Ratio for stocks but forward-looking, not backward-looking.

In the case of the aggregate investment-grade corporate bond market as described above, dividing 2.55% yield by the 8.05 duration produces a ratio of 0.317. Put another way, an investor is receiving 31.7 basis points of yield for each unit of duration risk. That is pretty skinny.

After all that digging, it may seem as though there may not be a pony in the corporate bond market. What we have determined is that investors appear to be indiscriminately plowing money into the corporate credit market without giving much thought to the minimal returns and heightened risk. As we have described on several other occasions, this is yet another symptom of the passive investing phenomenon.

Our Pony

If we compare the corporate yield per unit of duration metric to the same metric for mortgage-backed securities (MBS) we very well may have found our pony. The table below offers a comparison of yield per unit of duration ratios as of the end of January:

Clearly, the poorest risk-reward categories are in the corporate bond sectors with very low ratios. As shown, the ratios currently sit at nearly two standard deviations rich to the average. Conversely, the MBS sector has a ratio of 0.863, which is nearly three times that of the corporate sectors and is almost 1.5 standard deviations above the average for the mortgage sector.

The chart below puts further context to the MBS yield per unit of duration ratio to the investment-grade corporate sector. As shown, MBS are at their cheapest levels as compared to corporates since 2015.

Chart Courtesy Brett Freeze – Global Technical Analysis

MBS, such as those issued by Fannie Mae and Freddie Mac, are guaranteed against default by the U.S. government, which means that unlike corporate bonds, the bonds will always mature or be repaid at par. Because of this protection, they are rated AAA. MBS also have the added benefit of being intrinsically well diversified. The interest and principal of a mortgage bond are backed by thousands and even tens of thousands of different homeowners from many different geographical and socio-economic locations. Maybe most important, homeowners are desperately interested in keeping the roof over their head

In contrast, a bond issued by IBM is backed solely by that one company and its capabilities to service the debt. No matter how many homeowners default, an MBS investor is guaranteed to receive par or 100 cents on the dollar. Investors of IBM, or any other corporate bond, on the other hand, may not be quite so lucky.

It is important to note that if an investor pays a premium for a mortgage bond, say a 102-dollar price, and receives par in return, a loss may be incurred. The determining factor is how much cash flow was received from coupon payments over time. The same equally holds for corporate bonds. What differentiates corporate bonds from MBS is that the risk of a large loss is much lower for MBS.

Summary

As the chart and table above reveal, AAA-rated MBS currently have a very favorable risk-reward when compared with investment-grade corporate bonds at a comparable yield.

Although the world is distracted by celebrity investing in the FAANG stocks, Tesla, and now corporate debt, our preference is to find high quality investment options that deliver excellent risk-adjusted returns, or at a minimum improve them.

This analysis argues for one of two outcomes as it relates to the fixed income markets. If one is seeking fixed income credit exposure, they are better served to shift their asset allocation to a heavier weighting of MBS as opposed to investment-grade corporate bonds. Secondly, it suggests that reducing exposure to corporate bonds on an outright basis is prudent given their extreme valuations. Although cash or the money markets do not offer much yield, they are always powerful in terms of the option it affords should the equity and fixed income markets finally come to their senses and mean revert.

With so many assets having historically expensive valuations, it is a difficult time to be an optimist. However, despite limited options, it is encouraging to know there are still a few ponies around, one just has to hold their nose and get a little dirty to find it.

Fixed Income Review – April 2019

The positive trends of the first quarter extended into April with broad-based total return gains across nearly every major fixed-income category. Only the safest corners of the bond markets posted negative returns last month, albeit those losses were quite minor in contrast with the positive returns since the end of 2018.

Returns in April, across the spectrum of indices, were not as impressive as those seen in the first three months of the year. No one expected those types of moves nor would anyone, having enjoyed them, expect them indefinitely. The performance for the rest of the year no doubt depends more on coupon than price appreciation as spreads are tight and headwinds, especially in credit-sensitive sectors, are becoming more obvious as we will discuss below.

As mentioned, the only two modest losers in April were Treasuries and securitized products (mortgages, asset-backeds, and commercial mortgages). Otherwise, the high yield sector again won the day head and shoulders above investment grade corporates, the next closest performer. According to the heat map below, like last month, all sectors are green across all longer time frames adding emphasis to the impressive rally seen since Christmas.

We would not speculate on the likelihood of this trend continuing, as odds favor a weaker performance trajectory. That does not mean poor performance, but risks rise with prices and spreads perched at historically tight levels.

The charts below illustrate the option-adjusted spreads (OAS) for the major categories in the corporate universe. They have all tightened dramatically since the end of the year. If we are correct that the spread tightening is largely done, then the preference would be to play for safety, and some interest carry for the next few months. In doing so, one may miss another unexpected move tighter in very risky high yield bond spreads; however, given current spread levels, one may also avoid increased odds of poor performance and possible losses.

Understanding that compounding wealth depends on avoiding large, damaging, emotional losses we would prefer to accept the risk of lower returns with high-grade securities while reducing our exposure to the riskier, more volatile sectors.

Although cheapening more dramatically than the Investment Grade (IG) sector in the fourth quarter, High Yield (junk) bonds recaptured much of that in the first four months of this year and in doing so returns junk bonds to (more than) full-value status.

The same can also be said for the lower credit sectors within the IG population. A long-term perspective offers proper context for where valuations are today relative to the past 25 years. The risk is clearly skewed to wider credit spreads and cheaper valuations (losses).

The Trend Continues

The recent tightening of spreads offers little new to discuss other than some deceleration of price and spread action. Importantly, and as recent articles have emphasized, this is a very late stage cycle rally. Risks are rising that corporate margin headwinds, slowing global economic activity, and a high bar for rate cuts given the optical strength of the economy limit the scope for price and spread gains in credit.

Overweighting lower rated credit sectors of the fixed income market is currently akin to the well-known phrase “picking nickels up in front of a steam roller.”

All Data Courtesy Barclays

Time To Recycle Your Junk

Invariably, investors who disregard where they stand in cycles are bound to suffer serious consequences” – Howard Marks

If you believe, as we do, that the current economic cycle is likely at a similar point as 2006/07, then you should consider heeding the warning of the charts we are about to show you.

The current economic cycle stretching from the market peak of 2006/07 to today started with euphoria in the housing markets and investors taking a general indifference towards risk-taking. In 2008, reality caught up with the financial markets and desperation fueled sharp drawdowns, punishing many risky assets. The recovery that began in 2009 has been increasingly fueled by investor enthusiasm. While the stock market gets the headlines, this fervor has been every bit as evident in the junk bond sector of the corporate fixed- income markets.

Has This Cycle Reached Its Tail illustrated how investor sentiment and economic activity has evolved, or cycled, over the last 12 years. We recommend reading it as additional background for this article.

The Popularity of Junk

Junk debt or non-investment grade securities also known as high yield debt will be referred to as “junk” for the remainder of this article. They are defined as corporate debt with a credit rating below the investment grade threshold (BBB-/Baa3), otherwise known as “triple B.”

Historically, buyers of junk debt were credit specialists due to the need for an in-depth understanding of the accounting and financial statements of companies that bear a larger risk of default. Extensive analysis was required to determine if the higher yield offered by those securities was enough to cushion the elevated risk of default. The following questions are just a small sample of those a junk investor would want to answer:

  • Will the company’s cash flow be sufficient to make the payments on the debt?
  • If not, what collateral does the company have to support bond holders?
  • What is the total recovery value of plant, property and other capital represented by the company?
  • Does the yield on the junk bond offer a reasonable margin of safety to justify an investment?   

Since the financial crisis, the profile of the typical junk investor has changed markedly. Gone are the days when the aforementioned specialized analysts, akin to accountants, were the predominant investors. New investors, many of whom lack the skills to properly evaluate such investments, have entered the high yield debt arena to boost their returns. We believe that many such investors are ill-prepared for the risk and volatility that tend to be associated with non-investment grade bonds when the economic cycle turns.

The advent of exchange-traded funds (ETF’s) has made investing in junk-rated debt much easier and more popular. It has opened the asset class to a larger number of investors that have traditionally avoided the sector or simply did not have access due to investment restrictions. ETF’s have turned the junk market into another passive tool for the masses.

The combination of investors’ desperate need for yield along with the ease of investing in junk has pushed spreads and yields to very low levels as shown below. While a yield of 6.40% may seem appealing versus Treasury bonds yielding little more than the rate of inflation, consider that junk yields do not factor in losses due to default. Junk default rates reached double digits during each of the last three recessions. A repeat of those default rates would easily wipe out years of returns. Even in a best-case scenario, an annual 2.5-3.5% default rate would significantly reduce the realized yield. The graph below charts yields and option-adjusted spread (OAS).

OAS measures the spread, or additional yield, one expects to receive versus investing in a like maturity, “risk-free” U.S. Treasury bond. It is important to note that spread is but one measure investors must consider when evaluating prospective investments. For example, even if OAS remains unchanged while Treasury yields increase 300bps, the yield on the junk bond also increases 300bps and produces an approximate 15% price decline assuming a 5-year duration.

Junk Debt Spreads (OAS) and Economic Data

Economic activity and corporate profits are well -correlated. Given the tenuous nature of companies in junk status, profits and cash flows are typically extremely sensitive to economic activity. The following graphs illustrate current valuations and guide where spreads may go under certain economic environments. The label R² in the graph is a statistical measure that calculates the amount of variance of one factor based on the other factor. The R², of .58 in the graph below, means that 58% of the change in OAS is due to changes in real GDP.

In the scatter plot below, each dot represents the respective intersection of OAS and GDP for each quarterly period. Currently, as indicated by the red triangle, OAS spreads are approximately 175 basis points too low (expensive) given the current level of GDP. More importantly, the general upward slope of the curve denotes that weaker economic activity tends to result in wider spreads. For instance, we should expect OAS to widen to 10% if a recession with -2.00% growth were to occur.

The following are scatter plots of OAS as contrasted with PMI (business confidence/plans) and Jobless Claims (labor market).  The current OAS versus the dotted trend line is fair given the current level of PMI and Jobless Claims. However, if the economy slows down resulting in weaker PMI and rising jobless claims, we should expect a much higher OAS. Note both graphs have a significant R².

As discussed earlier, frothy equity markets and junk spreads have rewarded investors since the financial crisis. The scatter plot below compares OAS to CAPE10 valuations. A return to an average CAPE (16) should result in an OAS of nearly 10. Assuming that such an event was to occur, an investor with a five-year junk bond could lose almost 30% in the price of the bond assuming no default. Default would harm the investor much more.

We finish up with a similar graph as we presented in Has This Cycle Reached Its Tail. A special thank you to Neil Howe for the idea behind the graph below.

The graph, using two year averages compares the U.S. Treasury yield curve and junk OAS. The yield curve serves as a proxy for the economic cycle. The cycle started with the blue triangle which is the average yield curve and OAS for 2006 and 2007. As the cycle peaked and the financial crisis occurred, the yield curve widened, and junk OAS increased significantly. Starting in 2009, recovery took hold resulting in a flattening yield curve and lower junk OAS. The current one month point denoted by the red dot shows that we have come full circle to where the cycle began over ten years ago.

Trade Idea

Given the unrewarding risk-return profile of junk bonds, we recommend investors consider reallocating from junk to investment grade corporates, mortgages or U.S. Treasuries. For those more aggressive investors, we recommend a paired trade whereby one shorts the liquid ETF’s (HYG/JNK) and purchases an equal combination of investment grade corporates (LQD) and U.S. Treasuries (IEI).

Had one put on the paired trade mentioned above in 2014, when junk yields were at similar levels, and held the trade for two years, the total return over the holding period was 16.75%. Similarly, such a trade established in January of 2007 and held for two years would have resulted in an approximate total return of nearly 38.85%.

Investment return data used in pair trade analysis courtesy of BofA Merrill Lynch US high yield and Corporate Master Total Return Indexes. Treasury data from Barclays.

Summary

Junk debt is highly correlated with economic activity and stock market returns. When potential default rates are considered with signs that the economic cycle is turning, and extreme equity valuations, investors should be highly attuned to risks. This is not to say junk bond holders will suffer, but it should raise concern about the amount of risk being taken for a marginal return at best.

If you have owned junk debt for the last few years, congratulations. You earned a return greater than those provided by more conservative fixed-income investments. That said, we strongly recommend a critical assessment of the trade. Math and historical precedence argue that the upside to holding junk debt is quite limited, especially when compared to investment grade corporate bonds that offer similar returns and expose the investor to much less credit risk.

At RIA Advisors, we have sold the vast majority of our junk bond holdings over the last month. We are concerned that the minimal spread over Treasuries does not nearly compensate our clients enough for the real risk that the current economic cycle is coming to an end.

Fixed Income Review – March 2019

The first quarter of 2019 offered one of the most powerful surges in risky asset valuations seen in history. Closing at 2506 on December 31, 2018, the S&P 500 proceeded to rise 328 points (14.37%) to 2834 in the first quarter. The near vertical leap skyward corresponds directly to the abrupt change in posture from the Federal Reserve (Fed) as they eliminated all threats of rate hikes in 2019. They took the further step of announcing a schedule to halt quantitative tightening (QT).

As might be expected, high yield credit was the best performing sector for the quarter with a total return of 7.26%. Somewhat counter-intuitively, U.S. Treasuries (+2.11%) also rallied for the quarter although they lagged all other major fixed-income sectors as shown in the table below.

For March, risk markets stalled slightly after the big run in the prior two months. Although posting returns of nearly 1%, high yield was the worst performer while investment grade was the best.

The contrast in performance between high-quality and low-quality bonds may be telling. In what could be a related issue, interest rate volatility in the U.S. Treasury market as measured by the MOVE Index spiked higher mid-month and had implications for the credit markets.

As shown in the tables below, only the BBB spread tightened slightly with all others widening by 1-3 basis points. Putting it together, despite solid total returns for the month, the spread widening tells us that corporate credit did not keep pace with falling Treasury yields in March, particularly at the end of the month.

From a macro perspective, the changes in Treasury yields and the yield curve raise broad concerns. Namely, are we nearing the end of the current expansion? As discussed in far more detail in our prior article, Yesterday’s Perfect Recession Warning May Be Failing You, the yield curve has a durable track record of signaling major changes in the economic cycle especially when it inverts (longer-term interest rates drop below short-term rates). When an inverted curve is considered with the end of a Fed rate hike cycle, the evidence becomes even more compelling. The Fed abruptly altered their outlook for monetary policy in March putting to rest any concern for further hikes. The market is now pricing for 1 or 2 rate cuts in 2019.

The last time we observed this combination of circumstances, an inverted curve and a market implying fed funds rate cuts, was ominously in late 2006. In October of last year, when the yield curve spread was decidedly positive, most economists including National Economic Council director Larry Kudlow pointed to this barometer and said we were nowhere near recession. The current market narrative now claims we should not pay too much attention to this important historical precedent. As opposed to trying to shape the narrative to suit our interests, we prefer instead to heed history. The odds are that this time is not different.

Time will tell.

All data sourced from Bloomberg and Barclays

10 Stocks With Growing Dividends

In the recent report “GE – Bringing Investment Mistakes To Life,” I discussed the basic investor fallacy of “I bought it for the dividend.” 

However, most importantly, as I noted:

“While I completely agree that investors should own companies that pay dividends (as it is a significant portion of long-term total returns), it is also crucial to understand that companies can, and will, cut dividends during periods of financial stress. During the next major market reversion, we will see much of the same happen again.”

As you may already suspect, by looking out our portfolios on the site, we have a preference for high-quality names that also provide dividends. Normally, we screen our database of over 8000 stocks for companies which fit several fundamental and value factors to ensure we are buying top-quality names. However, for today’s purpose of a specific dividend focus, we are looking primarily for companies which are members of the S&P 500 index and have a history of growing their dividends over the last 5-years, a declining payout ratio relative to their earnings per share, and we are taking only the top 10 highest rated stocks.

The criteria for our Dividend screen are:

  • Market Capitalization > $1 Billion
  • Index Constituency: Must Be A Member of the S&P 500 Index
  • Dividend Yield > 1% 
  • 5-Year Dividend Growth Rate > 0
  • Change In Payout Ratio < 0
  • Zack’s Investment Ranking = Top 10

The table below are the 10-candidates which resulted from the latest screening.

The combination of these fundamental measures should yield an excess return over the market during the previous 5-year time frame. The table below assumes that over the last 5-years you bought all 10-stocks and rebalanced them semi-annually.

Over the 21-quarterly rebalancing periods, the portfolio had an annualized return of 14.9% versus the 12.1% for the market. This 2.6% annual outperformance versus the S&P 500 is shown in the charts below.

Even though interest rates have risen from the lows of last year, the price of money has been persistently lower in this economic cycle than it has been in the past. This factor continues to provide support for income-yielding stocks as many investors, including the growing population of retirees, are seeking more stable, fixed income-like returns.

The risk of this strategy is that valuations for many companies, including higher dividend payers, have expanded much more than normal, and is reminiscent of the “Nifty-Fifty” period in the late 1970’s.

While investing in dividend yielding stocks certainly provides an additional return to portfolios, as “GE” should have reminded you, stocks are “not safe” investments. They can, and will lose value, and often much more than you can withstand.

This is why for our “safe money” we continue to use rallies in interest rates to buy bonds which provide both higher rates of income and safety of principal.

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With valuation and safety being a top concern for investors, especially with markets signaling more troubling technical trends, we continue to believe that the best way for investors to generate capital is to invest in quality businesses trading at a reasonable discount to their intrinsic value. As such, we focus on names which still maintain a reasonable valuation, are consistently growing, and are well founded in their industries. We think these names are more likely to offer investors both the yield they are looking for and are currently trading at prices that provide a reasonable margin of safety.


Disclaimer: Nothing in this post should be construed as an offer to buy or sell any securities. This content is for informational purposes only. Past performance is no guarantee of future results. Use at your own risk and peril.

10-Fundamentally Strong Value Stocks Hitting Our Radar

Trying to find value in an over-valued market is difficult to say the least. This becomes even more problematic when we discuss the issue within the reality of a late-stage economic cycle and the potential for an economic recession.

So, in looking for opportunity at a time where there is a rising unfavorable economic and earnings backdrop, we turned to our database to screen for stocks with a very strict set of fundamental guidelines.

In order for a company to become a watch list candidate it must have:

  • Five-year average returns on equity (ROE) greater than 15%;
  • Five-year average returns on invested capital (ROIC) greater than 15%;
  • Debt-to-equity (D/E) less than or equal to 80% of the industry average;
  • Five-year average pretax profit margin (PM) 20% higher than the industry average;
  • Current price-to-book value multiples(P/B) below historical and industry multiples;
  • Current price-to-cash flow (P/CF) ratios below the industry average

Out of the universe of more than 6,500 issues, only 10 passed the test.

This should immediately ring some alarm bells on the market as a whole with respect to valuations and the risk being undertaken by investors in general.

However, here are the 10 top stocks we are adding to our watch list currently.

*Disclosure: We currently own BA in both our Equity and Equity/ETF portfolio models.
**While REMI made the screening list, it is excluded from consideration due to being under $5/share.

Below I am providing a brief snapshot of each for your own review.

CL

SNBR

DENN

PZZA

  • Warning:  The company is facing numerous class action lawsuits which could have an adverse effect on the company.

ANIK

CBPO

TARO

REMI

  • Warning: This is a sub-$5 stock and is extremely high risk. It is not suitable for investors or our portfolios.

LII

BA

Importantly, just because these companies cleared a screen, such is only the first step in determining if it should be added to an investment portfolio. Each company must be evaluated not only on it fundamental merits but its price trends as well. They should also be evaluated relative to other holdings in your portfolio, your own personal risk tolerance, and your investment objectives.

Disclaimer: As always, you must do your homework BEFORE making any investment. The information contained herein should not be construed as investment advice or a solicitation to buy or sell any security. Past performance is no guarantee of future results. Use of this information is at your own risk and peril. 

8-GARP Stocks That Are Strong Buys

In our previous article we noted that one of the biggest challenges in managing money is finding the right stocks to add to your portfolio. It is hard enough to cull through the 1500 stocks that make up the S&P 500, 400, and 600 indexes much less the more than 6,000 other securities available for investing in.

While we covered dividend income stock last time, this time we thought we would dig around stocks which are trading at a discount to expected growth or, more commonly known as, “Growth At A Reasonable Price.”

GARP investors look for companies that are somewhat undervalued (a feature of value investing) with solid sustainable growth potential (a tenet of growth investing) – an approach that attempts to avoid the extremes of either value or growth investing.

It’s worth noting that we are not talking about owning a portfolio of stocks where some are growth and some are value but rather a portfolio of stocks that on an individual basis have both value and growth characteristics. This is also not to say that you couldn’t combine our value and dividend stocks with growth and value stocks as part of an overall investment strategy.

The criteria for our GARP screen are:

  • Current P/E Divided By The 5-Year Average <= 5
  • Percentage Change Of Next Years Estimates Over Last 12-Weeks >= 0
  • P/E Using 12-Month Forward EPS Estimates <= 15
  • 5-Year Historical EPS Growth (%) >= 5
  • Next 3-5 Years Estimated EPS Growth (%/Year) >= 5
  • Rank = Strong Buy
  • P/E Using 12-Month Forward EPS Estimate >= 8

The table below are the 8-candidates which resulted from the latest screening.

In a market that is fundamentally overvalued, buying value at a reasonable price is become more exceedingly difficult. However, in theory, buying stocks that exhibit both strong value and growth characteristics should yield an excess return over the market over time. The table below assumes that over the last 5-years you bought all the stocks yielded by the screen and rebalanced them quarterly.

(The number of holdings ranged from a low of 6 in July of 2016 to a maximum of 31 following the market rout in February of this year. The last period for the holding period was for May of 2018 which yielded 18 holdings. Following the recent run-up, the number of holdings has been reduced to 8 which is the tied with the second lowest number of holdings since 2013. Note that low holdings preceded the market routs of 2015-2016 and 2018.)

Over the 21-quarterly rebalancing periods the portfolio had an annualized return of 16.6% versus the 13.6% for the market. This 2.7% annual outperformance versus the S&P 500 is shown in the charts below.

Because a GARP strategy employs principles from both value and growth investing, the returns seen during certain market phases can be quite different that returns seen in a strict value or growth portfolio. However, as shown in the portfolio metrics, while a GARP strategy can provide outperformance over the index overtime, given proper risk management practices, but can have higher volatility because of the growth component.

By combing this strategy with a dividend-income strategy as discussed last time, it is possible to smooth out some of the volatility while still maintaining returns.

In short, the GARP strategy not only fuses growth and value stock-picking criteria, but also experiences a combination of their types of returns. While a value investor will do better in bearish conditions; a growth investor will do better in a bull market; therefore, GARP investing should be rewarded with more consistent and predictable returns.

There is no doubt we are in a full-blown bull market currently. However, valuations are suggesting that returns may be significantly lower in the future making a GARP portfolio, and potentially one combined with a dividend strategy, much more beneficial.

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One of the best known GARP investors was Peter Lynch, who has written several popular books, including “One Up on Wall Street” and “Learn to Earn.” Of course, he was an investing legend due to his 29% average annual return over his 13-year stretch from 1977-1990 as manager of the Fidelity Magellan fund. Of course, the advantage to Peter Lynch was starting his run when valuations were deeply depressed at 7-9x earnings rather than 33x today.

This is why, with valuation and safety being a top concern for our clients, especially with markets at all-time highs, we continue to believe that the best way for investors to generate capital is to invest in quality businesses trading at a reasonable discounts to their intrinsic value. As such, we focus on names which still maintain a reasonable valuation, are consistently growing, and are well founded in their industries.


Disclaimer: Nothing in this post should be construed as an offer to buy or sell any securities. This content is for informational purposes only. Past performance is no guarantee of future results. Use at your own risk and peril.

10 Value-Dividend Stocks In An Overvalued Market

One of the biggest challenges in managing money is finding the right stocks to add to your portfolio. It is hard enough to cull through the 1500 stocks that make up the S&P 500, 400 and 600 indexes much less the more than 6,000 other securities available for investing in.

As you may already suspect, by looking out our portfolios on the site, we have a preference for high-quality names that also provide dividends. We do this by screening our database of stocks for several fundamental and value factors to ensure we are buying top-quality names and then refining that list down to the top-10 dividend payers. We believe that these value stocks, combined with dividends should generate an excess return versus the benchmark index over time.

The criteria for our Fundamental Value Dividend screen are:

  • Market Cap > $1 Billion
  • Dividend Yield > Top 10 
  • Return On Equity > 15%
  • Price To Sales <= 1.5x
  • EPS Growth Over The Last 3-Years > 0

The table below are the 10-candidates which resulted from the latest screening.

You will note that we recently added CVS Health (CVS) to both the Equity and the Equity/ETF models. 

As I stated, the combination of these fundamental measures should yield an excess return over the market over time. The table below assumes that over the last 5-years you bought all 10-stocks and rebalanced them quarterly.

Over the 21-quarterly rebalancing periods the portfolio had an annualized return of 15.6% versus the 13.8% for the market. This 1.80% annual outperformance versus the S&P 500 is shown in the charts below.

Even though interest rates have risen from the lows of last year, the price of money has been persistently lower in this economic cycle than it has been in the past. This factor continues to provide support for income yielding stocks as many investors, including the growing population of retirees, are seeking more stable, fixed income-like returns.

The risk of this strategy is that valuations for many companies, including higher dividend payers, have expanded much more than normal, and is reminiscent of the “Nifty-Fifty” period in the late 1970’s.

While investing in dividend yielding stocks certainly provides additional return to portfolios, just remember that stocks are “not safe” investments. They can and will lose value during a market decline.

This is why for our “safe money” we continue to use rallies in interest rates to buy bonds which provide both higher rates of income and safety of principal.

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With valuation and safety being a top concern for investors, especially with markets at all-time highs, we continue to believe that the best way for investors to generate capital is to invest in quality businesses trading at a reasonable discounts to their intrinsic value. As such, we focus on names which still maintain a reasonable valuation, are consistently growing, and are well founded in their industries. We think these names are more likely to offer investors both the yield they are looking for and are currently trading at prices that provide a reasonable margin of safety.


Disclaimer: Nothing in this post should be construed as an offer to buy or sell any securities. This content is for informational purposes only. Past performance is no guarantee of future results. Use at your own risk and peril.

Attention Savers: Yields Are Up

Cash instruments are now paying around 2%, and that’s a boon for savers. The first rule of financial planning is to have a short-term savings account in case of job loss, major health issue, or other emergency. Hopefully, your short-term savings can see you through six months or a year of unemployment. Now, after nearly a decade of interest rates at or near zero, you can finally earn something approaching the rate of inflation on short-term, emergency savings.

First, check out online banks. Synchrony is paying 1.85% on its high yield savings account. It’s also paying 2.45% on a one-year CD, though that won’t provide the liquidity of the savings account. Ally is paying 1.80% on online savings at all balance tiers. American Express has an online bank, and it’s paying 1.75% on savings accounts. Accounts at these banks are FDIC guaranteed.

Ally and American Express allow six withdrawals or transfers per statement cycle. Synchrony says it allows six withdrawals/transfers in a statement cycle, after which it won’t necessarily charge a fee unless that many withdrawals or transfers occur on more than an occasional basis. The American Express bank website advertises “no monthly fees, no minimum balance.” Ally offers this statement about withdrawals on its savings account:

There are Federal limits on transactions from U.S. savings and money market accounts.You can always call us and request a check made out to you. You can also make unlimited deposits and ATM withdrawals. But, Federal law limits other electronic, telephone and check transactions to a total of 6 per statement cycle. These limited transactions can be to other accounts or to a third party. If you go over the limit we charge $10 per transaction.

Another option is a money market mutual fund. All of Fidelity’s U.S. Treasury and government money market funds are paying over 1.5%. A few of them are higher than 1.7%.  Fidelity’s Prime or general purpose money markets (which contain commercial paper – or ultra short term loans to corporations — in addition to government securities) are all paying over 1.8%, and six of the eight in the firm’s lineup are paying more than 2%.  The Vanguard Federal Money Market Fund (VMFXX) is paying 1.87%. Its expense ratio, included in the calculation of the yield, is 0.11%. The Vanguard Prime Money Market Fund is yielding 2.06%. Money market mutual funds are not FDIC guaranteed. They can “break the buck” or not be priced at $1 per share per day. But it’s rare for that to happen, and it’s likely harder for it to happen to funds invested in U.S. Government securities.

There have been movements to have money market funds’ net asset values “float” or break the buck, if they must. Fund companies subsidized the funds in some cases during the financial crisis because they know investors expect that stability even if it’s unrealistic based on what the funds are holding. If the NAV’s float, you’ll have to decide if experiencing some price fluctuation is worth it to you.

If you choose a money market mutual fund option, and you anticipate needing to access your funds, it’s a good idea to link the mutual fund or the brokerage account in which it sits to your bank account. Depending on how the fund is held, you may also have to place a trade to liquidate it into another part of a brokerage account. Mutual funds typically trade a 4PM. If you have a link to your bank account, it shouldn’t take a week to get the cash from a money market mutual fund literally into your hand, but it probably won’t take a day either.

Yet another option for investors is buying U.S. Treasury Securities directly from the source. For as little as three months, investors can now get paid an annualized rate of more than 2%

For investors willing to take a little more risk, there’s the PIMCO Enhanced Short Maturity Active ETF (MINT). This is an exchange traded fund that requires a commission to trade. Unlike money market mutual funds, it’s not designed to maintain a $1 per share price everyday. Its 30-day SEC yield is 2.44%, but investors have to incur some extra credit risk for that extra yield. While its effective maturity is a modest 0.42 years, the fund has about 43% in its portfolio in instruments rated A, A-, BBB+, BBB, and BBB- and another 7% of its portfolio in securities that are not rated.

Many argue that cash isn’t the place to take risk, and that argument has some merits. You can reserve risk for other parts of your portfolio. Moreover, the PIMCO fund doesn’t have a track record going back to 2008, so we can’t see how it would have performed during a moment of great credit stress. Many ultra short term funds that existed at that time were caught holding poorly rated debt that inflicted losses on investors. Still, the PIMCO Short Term Bond Fund (PTSHX) — more aggressive and with a longer duration than MINT — sufferred a modest 1.3% loss in 2008, landing it in the top-third of Morningstar’s short term bond fund category that year. Many investors can absorb that as a worst-year scenario, but others view a loss like that  on cash or a cash substitute dimly. You’ll have to decide if this sort of fund deserves part of your cash or not.

Once you have your emergency cash savings fund in place, then it’s time to start thinking about investing for longer term goals. Make an appointment with us if you’re at that stage.