ETF Update - Don't Forget Your Dividends

Our S&P 500 ETF holds large and mid-sized companies, and it outperformed our Russell 2000 small cap ETF during the week.  Both of these ETF’s are very low cost, and add important diversification to our Blue Harbinger 15 and to our Lazy Person Portfolio.

Important to note, the S&P 500 ETF pays dividends at the end of each January, April, July and October, which means its dividend payment will be showing up soon if it’s not already in your account.  If you don’t need this dividend for your own personal spending purposes, then it is important to reinvest the cash received so it doesn’t add up and drag down the returns of your account over the long term.

Ideally, we want zero cash in a long-term investment account, but generally speaking it is not the end of the world if you have 1% cash in your account.  But if you accumulate much more than 1% then you should really think about getting that invested as soon as possible.  As a reminder, most discount brokers (E-Trade, Scottrade, TD Ameritrade) offer automatic dividend reinvestment programs, and it’s a good idea to take advantage of these programs if you are a long-term investor and don’t need the cash right away.  However, if you do need the cash then it’s always especially nice to see those dividends come rolling in quarter after quarter.

You can read our complete Russell 2000 Small Cap ETF thesis and research report here, and you can view the same for our S&P 500 SPDR ETF (SPY) here.

Westar Energy (WR) Update - Sensitivity to Interest Rates

Our “Blue Harbinger 15” utilities stock, Westar Energy (WR), declined sharply this week immediately after the Fed came out with its more hawkish announcement on interest rates, but then gained back a significant portion of the losses by the end of the week.  We continue to believe in Westar going forward because the company sources its electricity from diversified sources including renewables (not just dirty coal like other utilities).  Also, it’s in a state that is more balanced in its views on the tradeoffs between economics and expensive regulations.  Additionally, it adds diversification to our overall Blue Harbinger 15 portfolio.  Lastly, its 3.6% dividend yield is attractive, and suggests the stock has some upside because 3.6% is historically high for the company.  You can read our complete Westar thesis and research report here.

Procter & Gamble Update - Strong Earnings Announcement

Good news from Procter & Gamble today.  The company announced earnings of $2.6 billion, or 91 cents per share, up from 69 cents per share a year earlier.  Earnings were above analyst expectations due to cost savings and wider profit margins.  And while overall sales declined in the third quarter, the company said it expects next quarter’s earnings to grow.  The stock was up 2.91% for the day.

Procter & Gamble has underperformed over the last year declining 7.5% versus a gain of 10.0% for the overall market as measured by the S&P 500.  This relative underperformance makes us like the company even more because we believe the company has sold off more than it should have.  The company has been hampered by foreign currency headwinds, and they’re also in the middle of a multi-year restructuring whereby they’re shedding some sub-optimal brands.  We believe the company has nearly 30% upside.  We also are attracted to the 3.44% dividend yield which is near the highest level it’s been in about 25 years.

You can view our previous P&G updates here, and you can view our full research report and thesis here.

Union Pacific (UNP) Update – Up 4% on Earnings

We received good news yesterday on railroad company and Blue Harbinger 15 holding, Union Pacific.  Specifically, the stock was up as the company announced earnings that exceeded analyst expectations.  The earnings “beat” was largely the result of improved operational efficiency.  Specifically, UNP improved its operating ratio to 60.3% which is a quarterly record.

However, Union Pacific has declined 14% over the last year while the S&P 500 is up 6%.  The underperformance is due to decreased revenues.  Specifically, coal freight revenue declined 18%, and industrial products and intermodal freight revenue fell 16% and 11%, respectively, versus a year ago.  Less demand from China is a big reason for the decline.  Additionally, the company is generating less revenue as fuel surcharges have also declined.

The silver lining of the revenue decline is that the company has dramatically increased its operating efficiency which will pay increased dividends when the company’s revenue slide turns around.  Union Pacific is at a low point in the market cycle, and we believe this will eventually turn around.  As contrarian investors, we believe Union Pacific has more upside potential over the coming years that the rest of the market.  You can read our earlier UNP updates here, and you can read our complete UNP research report and thesis here.

McDonald's (MCD) Update - Earnings Home Run

McDonald’s (a Blue Harbinger 15 stock) is a great example of how it pays to be a contrarian investor.  Despite a recent outpouring of negativity about the company in the media, McDonald’s gained over 8% yesterday after announcing its earnings beat Wall Street expectations on stronger than expected sales.  Over the last year we’ve heard the pundits crying things like “McDonald’s is too big,” “McDonald’s can’t compete with healthier alternatives,” “McDonald’s brand is dead.”  And despite the negativity, McDonald’s has outperformed the overall market (MCD is up 23% in the last year versus a gain of only 6% for the S&P 500).

We continue to believe in McDonald’s going forward as the company moves past some historical missteps, and it continues to be a cash generation machine with lots of growth opportunities.  Regarding missteps, McDonald’s had some supplier issues in China last year that caused a large drop in sales, but this has been corrected and the company continues to gain traction in China.  Additionally, new CEO Steve Easterbrook has made changes to simplify the menu and improve some ingredients which should also help profitability going forward.  Also, MCD’s introduction of all-day-breakfast in the US is expected to have a positive impact on the company’s future earnings announcements.

You can read our previous McDonald’s updates here, and our complete McDonald’s thesis and research report here.

McDonald’s (MCD) Update - Possible Real Estate Spinoff

According to the Wall Street Journal, McDonald’s board member Miles D. White said on Thursday that the company may soon make a decision on what to do with its vast real estate holdings.  There has been continued murmurings that the company should spinoff its real estate holdings into a REIT (Real Estate Investment Trust) vehicle because it could potentially unlock value for shareholders.  REITs often pay little or no taxes on earnings as long as they distribute most profits through dividends, and they typically receive a higher valuation multiple than retail companies like McDonald’s.  Some investors, such as Larry Robbins of Glenview Capital Management, believe a real estate spinoff could unlock $20 billion in shareholder value.  However, Morgan Stanley analyst John Glass says the possibility of forming a REIT is remote and doing so would not create as much value as one might think.

McDonald’s stock has underperformed the S&P 500 over the last 2 and 1/2 years, but has been outperforming so far this year as management works hard to end the slump.  Regardless the 2 and 1/2 year slump, McDonald’s remains hugely profitable, and we believe has the potential to outperform the market in the coming years.  You can read our complete McDonald’s research report here, and you can view our previous McDonald’s updates here.

Johnson & Johnson (JNJ) Update - Earnings, Currency and Buybacks

In Johnson & Johnson’s (JNJ) earnings release yesterday the company highlighted the impacts of foreign currency, raised its full-year earnings guidance, and announced a $10 billion share buyback program that will be funded with debt.  Overall, the company is in very good shape, and we believe it is a great blue chip stock to own.

Regarding the impacts of foreign currency, JNJ’s revenues declined 7.4% in the quarter versus the same quarter a year ago, but unfavorable currency rates were responsible for 8.2% of the decline.  Said differently, revenues were up 0.8% in constant currency terms.  For reference, about half of JNJ’s sales are overseas, which has had an unfavorable impact as the US dollar strengthened.  However, this is par for the course for JNJ (in future quarters foreign currency will work in their favor), and it is no reason for alarm.

Regarding full-year guidance, we are encouraged that they raised their earnings outlook to $6.15 to $6.20 a share, excluding certain items, up from an earlier range of $6.04 to $6.19.  Growing earnings is a sign of health and it is good for investors.

Finally, the company announced that it plans to buy back up to $10 billion of its own stock, or about 3.7% of the shares outstanding.  JNJ will issue debt to fund the buyback which causes concern to some people even though it should not.  Like most companies, JNJ uses some debt (leverage) to fund its operations because it can earn a higher rate of return on the money than it pays for interest on the debt.  And borrowing to repurchase shares is common, and the result is that it levers long-term returns for stock holders if the company is profitable, which it is.

Overall, we continue to believe in Johnson & Johnson as a great long-term investment.  Not only does it offer attractive returns opportunities, but it adds important diversity to our Blue Harbinger 15 portfolio.  You can view our full Johnson & Johnson thesis here.

Westar Energy (WR) - Thesis

Rating: BUY
Current Price: $39.92
Price Target: $46.48

Thesis:
We own Westar Energy because it offers shareholders a growing dividend and opportunities for capital appreciation.  We also appreciate the company’s diverse energy generation mix, including its growing renewables capacity.  Lastly, as a utilities company, Westar adds important diversification to our Blue Harbinger 15 portfolio.

Westar Energy is the largest electric energy provider in Kansas.  The company provides generation, transmission and distribution to approximately 687,000 customers.  Westar maintains a flexible and diverse energy supply portfolio.  In doing so, they continue to make environmental upgrades to their coal-fired power plants, develop renewable generation, build and upgrade their electric infrastructure and develop systems and programs with regard to how their customers use energy.  The following chart shows Westar’s mix of energy generation capacity:

The diverse sources of energy, particularly renewables, are important and valuable because Westar faces significant environmental regulation challenges.  Some companies throughout the US generate almost all of their energy from coal, and this exposes them to heightened regulatory risks as coal is the dirtiest form of energy.  Westar acknowledges this risk in their annual report as follows:

“Our costs of compliance with environmental laws and regulations, including those relating to greenhouse gas emissions, are significant, and the future costs of compliance with environmental laws and regulations could adversely impact our operations and consolidated financial results.”

Because Westar has significant renewables capacity, it keeps the company out of the direct cross-hairs of federal regulators who often have little regard for the economic impacts of expensive regulations on the well-being of the surrounding communities.  Additionally, Kansas is a strongly republican state which means it tends to be less extreme with regards to the imposition of expensive environmental regulations.

Important for future growth of the company, Westar operates in economically healthy regions of Kansas including the cities of Topeka, Lawrence, Manhattan, Salina, Hutchinson and Wichita.  Unemployment is low in these areas, and Westar is a large employer.  The strong economy helps ensure Westar also remains strong.  The following chart shows the breakdown of Westar’s customer base:

In March 2015, Westar requested approval from the Kansas Corporation Commission to increase the rates it charges by 7.9% or $152 million to recover Environmental Protection Agency (EPS) costs as well as increased service reliability.  And in August they reached an agreement for a $78 million rate increase.  The approved rate increase demonstrates the region’s support for Westar Energy.

Valuation:
We value Westar at $46.48 per share by discounting its $2.44 expected 2015 earnings per share using a required rate of return of 6% (weighted average cost of capital) and a growth rate of only 0.75% per year which is the long-term rate Westar expects (annual report p.28).  If the growth rate ends up being higher than 0.75% then the stock is worth even more.  Our $46.48 price target gives the stock more than 16% upside, with potential for further increases depending on the company’s future growth and profitability.

Dividends:
In addition to potential gains via capital appreciation, Westar offers shareholders an increasing dividend. Dividends are common for stable utility companies like Westar, and in this case Westar offers and attractive 3.62% dividend yield.  And the amount of Westar’s dividend payments has increased over time (see graph below), and the company expects this trend to continue.

Conclusion:
Westar is a diversified electric utility company that rewards shareholders with a growing dividend and opportunity for capital appreciation.  Additionally, this electric utility company investment adds important sector diversification to our Blue Harbinger 15 portfolio.  It is important to invest across a variety of market sectors (e.g. utilities, consumer discretionary, technology, etc.) to reduce exposure to sector specific risks and to minimize overall volatility in the value of your investment portfolio.

Large Value ETF (IWD) Update – Great Time to Own Value

It was a great week for our large cap value ETF (IWD), as it gained 4.0%.  Value stocks (such as the ones in our ETF) have a long history of outperforming growth stocks over the long term (e.g. 10+ year periods).  And now is a great time to own value stocks given that they have been underperforming growth in recent years.  Said differently, now is a great time to buy low.

Growth stocks have performed well over the most recent market cycle because of the accommodative monetary policies in the US.  With the fed setting interest rates so low, it’s been easier for risky growth companies to borrow money to fuel cheap growth.  However, it will be bad news for growth stocks when the fed eventually starts to raise interest rates as they are widely expected to do within the next several months.  It’s unusual for growth stocks to outperform value for as long as they have (see the chart above) but when it does happen it usually ends badly for growth stocks.  For example, it ended very badly for growth stocks when the tech bubble burst in the early 2000’s.  As contrarian investors, we believe now is a great time to own value stocks such as the ones in our large cap value ETF (IWD).

Walt Disney (DIS) Update - New Films and ESPN Fears

Disney (DIS) stock continues present a great buying opportunity as it trades about 13% off its 52-week high.  The stock declined sharply after last quarter's earnings announcement where they missed earnings estimates and expressed fears that ESPN will lose more customers as young people continue to cut the (cable) cord.  However, there is a lot more to this amazing company than ESPN.  For example, the upcoming Star Wars movie should create a big boost for revenues.  Disney released its updated movie schedule this week, and you can view it below.  And to read our complete Disney research report, click here. 

• June 16, 2017: “CARS 3”
• Nov. 22, 2017: “Coco”
• Dec. 22, 2017: “Untitled Disney Fair Tale – Live Action”
• Feb. 16, 2018: “Black Panther”
• March 9, 2018: “Gigantic”
• June 15, 2018: “Toy Story 4”
• July 6, 2018: “Ant-Man and the Wasp”
• Nov. 2, 2018: “Untitled Disney Fairy Tale – Live Action”
• March 8, 2019: “Captain Marvel”
• March 29, 2019: “Untitled Disney Fairy Tale – Live Action”
• April 12, 2019: “Untitled Disneytoon Studios”
• June 21, 2019: “The Incredibles 2”
• Nov. 8, 2019: “Untitled Disney Fairy Tale – Live Action”
• March 13, 2020: “Untitled Pixar Animation”
• May 1, 2020: “Untitled Marvel”
• June 19, 2020: “Untitled Pixar Animation”
• July 10, 2020: “Untitled Marvel”
• Nov. 6, 2020: “Untitled Marvel”
• Nov. 25, 2020: “Untitled Disney Animation”

release schedule source: Wall Street Journal

Johnson & Johnson (JNJ) - Thesis

Rating: BUY

Current Price: $95.06

Price Target: $122.60

Thesis:
Johnson & Johnson is a blue chip among blue chip companies, and now is an excellent time to buy.  JNJ has an amazing track record of increasing its adjusted earnings for 31 consecutive years and increasing its dividend for 53 consecutive years.  The dividend yield is currently an attractive 3.2%, and the stock price has recently pulled back making now a great time to buy.

Overview:
Operating across its three main segments (Consumer, Pharmaceutical, and Medical Devices), the company is home to many names you’ve heard of (e.g. Band-Aid, Tylenol, Listerine, Visine) and many other great health care products people rely on around the world (you can view the company’s products here).  In fact, Johnson & Johnson sells products in virtually every country in the world.  The company’s global sales gives investors an added level of diversification beyond just the diversified products and business segments.  In 2014, JNJ had $74.3 billion in total sales.  Forty-three percent of the sales came from the Pharmaceutical segment, 37% from Medical Devices and the remaining 20% from the Consumer segment.

Valuation:
We value JNJ using a 50/50 combination of discounted free cash flows and Ben Graham’s (EPSx(8.5+2xGr)) formula.  In both valuations, we assume the company can grow at 5% per year.  The average 5-year earnings growth estimate of the 19 professional analysts included on Yahoo Finance is 4.96%.  We believes JNJ provides will benefit from a global demographic trend which the company aptly explains as follows: “the historic aging rate of the world’s population, along with a growing middle class around the world, brings dramatically greater demand for higher quality health care” (Annual Report, p.3).  Our discounted cash flows analysis uses a 9% required rate of return (CAPM derived), and values JNJ at $131.54 per share.  Graham’s formula assigns the company a $113.65 price per share.  We use the average of the two to value JNJ at $122.60, which is well above its current price.

Cash:
JNJ has a history of returning cash to shareholders through dividends and share buybacks.  As mentioned previously, the dividend has increased for 53 consecutive years.  In aggregate, the company paid $7.8 billion for dividends in 2014.  They also repurchased $7.1 billion of its own stock (this is another way to return cash to shareholders).

Buying Opportunity:
JNJ’s stock price is down this year for two main reasons, and the fact that it is down makes now a good time to buy.  First, JNJ is down with the rest of the broader market.  As bad economic data out of China and jitters about the US Federal Reserve’s upcoming interest rate hike have hit JNJ just like almost every other stock in the market.  And second, JNJ earnings are being hurt by foreign currency fluctuations.  Specifically, the strong US dollar makes international sales less profitable for the company.  However, these two things make JNJ more attractive now than it was before because the broad market pullback is only temporary (the world will go on) and foreign currency volatility is stabilizing. (currency markets have been highly volatile since the “Great Recession” on 2008-2009). 

Conclusion:
The main reason most individual investors buy Johnson & Johnson stock is for the dividend.  It’s a steady stable company, and the dividend payments keep rolling in quarter after quarter.  However, the stock also offers the opportunity for capital appreciation.  And while there is no guarantee the stock price will go up tomorrow, this month, or this year, we believe strongly it will go up over the long-term.  As the company says “the historic aging rate of the world’s population, along with a growing middle class around the world, brings dramatically greater demand for higher quality health care,” and JNJ is a leader in meeting these needs.

American Express Update - Sam's Club

It was announced this week that American Express cards will soon be accepted at Sam's Club (the eighth largest U.S. retailer and a leading membership warehouse club for small businesses and consumers).  We view this as an incremental positive for American Express (AXP), especially after losing their exclusivity deal with Costco earlier this year.

We consider now a great time to invest in American Express because the stock is trading at an attractive valuation.  The valuation is attractive because the market over-reacted to some negative news earlier this year (i.e. AXP has underperformed the broader market year-to-date due to the loss of Costco exclusivity as mentioned above, and due to a negative antitrust ruling).  However, AXP is still an extremely profitable company, with lots of room to grow, and an attractive dividend yield.  You can read our complete AXP thesis here.