Building A Capital Preservation And Income Portfolio, Part 4

|
 |  Includes: BAX, CSX, IBM, MMM
by: Mark Bern, CFA

by Mark Bern, CPA CFA

<< Click to view Part 3

In Part 3 of this series I provided my thoughts about using precious metals and/or commodity-based equities for hedging purposes, as well as the next four defensive, equity-income offerings of the series. In Part 2 of this series I provided a brief summary of Part I, my thoughts on diversifying into investments denominated in other than the US dollar, and four defensive, equity-income offerings. Part 1 included an overview of what I intended to accomplish with this series, why I decided to write these articles now, and the first four equity-income offerings. In this final article of the series I intend to provide the last four equity-income offerings combined with a summary to tie, as necessary, any loose strings remaining from the first three articles.

The first of the four final equity offerings is IBM (NYSE:IBM). This is one of the world's largest technology companies providing advanced information processing technology, communication systems, services and software products around the globe. When the overall market crashed in 2008 and early 2009 the S&P 500 dropped by 57% from its high point. IBM's stock fell 47% during that same time but while the S&P 500 has still not regained its former high, IBM hit new highs before the end of 2009.

I like the resilience demonstrated by IBM, but why did it outperform the market? The company has reported earnings per share increases each year for the last 9 years, right through perhaps the worst recession since the Great Depression. It has also increased its dividend every year for 16 consecutive years. Most recently the company reported another record year of earnings, experiencing double digit top line growth in emerging markets as it continues to expand in those countries and enter additional new markets. The current price represents, in my opinion, a fair price with a trailing P/E of 14.6 and expected future growth in the range of 12-13% in earnings. The dividend currently yields 1.6% and has increased in each of the last 16 consecutive years. The trend of increasing dividend is highly likely to continue.

Year

2006

2007

2008

2009

2010

2011

EPS

$6.01

$7.18

$8.93

$10.01

$11.52

$13.06

Div. / Share

$1.10

$1.50

$1.90

$2.15

$2.50

$2.90

Click to enlarge

My next equity offering is CSX (NYSE:CSX), a railroad servicing 23 states in the eastern U.S. and two Canadian provinces. I also like Canadian National Railway (NYSE:CNI) and consider it a good substitute, but chose CSX strictly because I believe it provides a better value at current prices. The stock of rail companies dropped more than the overall market during the last recession, but CSX stock rebounded to attain higher highs than it had prior to the crash. Earnings per share fell far less than the stock and rebounded much quicker. Earnings are the fundamental measure of the value of a company. Unfortunately, perception did more damage and the downturn was overdone.

The company has increased its dividend in each of the last 6 consecutive years. The company has more pricing power and less competition now than was apparent a decade ago. Reality is that with more resources being shipped overseas and more finished goods being imported from overseas, rail offers the cheapest means of transportation for large quantities of goods to and from our nation's ports. This trend of increasing international trade is likely to continue, which should bode well for CSX. The current dividend yield is 2.1% but I expect the dividend to grow at a very healthy pace over the next few years along with earnings. The current price represents a good value.

Year

2006

2007

2008

2009

2010

2011

EPS

$0.74

$0.91

$1.17

$0.96

$1.36

$1.70*

Div. / Share

$0.11

$0.18

$0.26

$0.29

$0.33

$0.45

Click to enlarge

*Estimated

My third equity offering is 3M (NYSE:MMM), a diversified global manufacturer and technology company with operations in more than 65 nations. 3M just keeps reinventing itself with new products and variations on old products designed to meet the needs of customers. 2009 represented the first year in my memory that revenue did not increase at 3M. The price of the stock over-reacted, falling more that the broad market. This is where the quality of management is measurable. Reported results for 2010 set records and the stock exceeded its pre-recession highs in less than a year off the bottom. The current dividend yield is 2.5% and the company has a record of increasing the dividend that is excellent: 53 consecutive years of rising dividends so far and still counting. The current price represents, in my opinion, a fair value for the company. It's not a bargain, but it's not overpriced either.

Year

2006

2007

2008

2009

2010

2011

EPS

$5.06

$5.60

$4.89

$4.52

$5.75

$5.96

Div. / Share

$1.84

$1.92

$2.00

$2.04

$2.10

$2.20

Click to enlarge

My final equity offering is Baxter International (NYSE:BAX), another diversified healthcare company. The company has three divisions: Mediation Delivery, BioScience and Renal. It derives 58% of sales from outside the U.S. It is astounding to me that the stock of this company has been so poorly treated since the recession. On the other hand, this also results in greater opportunity. In reality, the stock was probably a little over-priced prior to the recession allowing investors a far better entry point now. While the S&P 500 fell 57% from its 2007 high, Baxter's stock dropped by 37% from its highs. After recovering most of that ground the stock then saw a lower low in 2010. It has since recovered most of that fall again but remains below its pre-recession high.

The stock's doldrums probably relates to the potential harm that the healthcare reform bill may do since much of BAX's products could come under scrutiny. Once again, I believe that the reaction is overdone-- this time to the downside. Reform will not affect its foreign sales or margins, both of which are growing. There seems to be a better than 50% possibility that the reform bill will be either repealed or changed significantly over the next two years. Earnings per share have increased every year for 6 straight years, right through the recession, and I believe that this company will be able to continue that string of successes. The dividend yield is currently 2.5% and the dividend has also increased in each of the last 6 years.

Year

2006

2007

2008

2009

2010

2011

EPS

$2.23

$2.79

$3.38

$3.80

$3.98

$4.31

Div. / Share

$0.58

$0.72

$0.91

$1.07

$1.18

$1.26

Click to enlarge

To summarize, it is my feeling that investors need to be aware of and prepared for another financial crisis in 2012, or at least until it becomes clear that the danger of another crisis has been averted. I have recommended that investors consider taking three steps that would help them achieve a more defensive position to minimize the effects of even a temporary market crash and include income to ease the potential pain during the recovery.

The first is to diversify core holdings to include companies with a high percentage of revenues derived from international sources, sticking with quality companies that held up better than the overall market during the last financial crisis and are more likely to be able to increase dividends in the face of another.

Second, to consider placing a portion of the portfolio in equities or fixed income investments denominated in currencies that are likely to fare better against the U.S. dollar in the event of a weakened U.S. economy and more monetization of our nation's debt.

Third, to consider holding a small reserve (no more than 5%) in either precious metals of small denominations or commodity-based equities that would be protected from inflation and provide ready currency should the financial transactions processing system go offline.

Again, I am not calling for doom and gloom. I am simply attempting to provide some guidance to help prepare for the worst, should it come, while also providing a reasonable income and appreciation potential while we wait for the storm clouds to clear.

The following is a list of all 16 stocks highlighted in this series along with their respective dividend yields.

PG

3.2%

NLY

13.9%

JNJ

3.5%

TE

4.8%

WMT

2.4%

CVX

3.0%

EPB

5.6%

WAG

2.6%

AWK

2.8%

IBM

1.6%

MCD

2.8%

CSX

2.1%

VZ

5.2%

MMM

2.5%

PEP

3.1%

BAX

2.5%

Click to enlarge

If an investor invested an equal amount in each of the above stocks, their annual yield would be 3.85%. For those readers who want to know if I eat what I cook, my current holdings include PEP, CVX, NLY, WAG, PG, JNJ, MCD, IBM and MMM. I am considering adding some of the other stocks from the above list over the course of the next few weeks. In other cases, I already own a company in the same space with similar attributes but did not use it because the one listed offered a better value at the current time. An example would be AT&T (NYSE:T) instead of VZ. I also own VOD in that space and continue to hold both for the long term.

My point isn't to get investors to change their entire portfolio. You, like me, may already own other companies that offer similar characteristics as some of those included above. If you have money to invest and want to put it to work, the list above is presented as a place to start. Draw from it what you find that could fill some gaps or complement what you already own. But please do some additional research on those few stocks to be certain that they fit your portfolio needs and your personal requirements for an investment. A better informed investor generally makes better investment decisions.

Finally, if readers would like more detail on many of these and other stocks with consistently rising dividends, please consider the articles here.

>> Click to view Part 5

Disclosure: I am long IBM, MMM.