Here's What You Should Buy, Y'all

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Includes: AAPL, AMGN, BBL, COST, CVS, CVX, DE, GILD, GIS, JNJ, KMI, MCD, MCK, MMM, MO, NKE, RAI, SBUX, T, V, XOM
by: Matthew Waterman

Summary

A question from another contributor was posed: He sold one thing, what should he purchase?

That contributor is seeking diversification and reduced trading costs.

Opinions will vary widely, but there is a fairly easy way to narrow down the choices.

(click to enlarge, images from respective company websites) Click to enlarge

I'm a reader too, right?

I came across an article on our front page by Mike Nadel today titled "Apple? Nike? Starbucks? Gilead? What Should I Buy, Y'all?". Interesting concept, having the readers take a stab at your allocations for you. I'd like to issue a reply here in a couple of terms, from both the percentages of holdings, as well as from where someone with none of these holdings might want to try to drop anchor.

Well I'll tell you what, I actually get similar requests to this from various people in the comments area and also from conversations away from Seeking Alpha. This is a good chance for me to show you some tricks I use to answer a question like this one.

Introducing the "Life Cross". Sweet Salvation.

I did two things to start off with; first, I put every tick symbol referenced in Mike's article into a spreadsheet, and organized them in two ways: Current dividend yield, and P/E ratio. These are as of market close on 8/9/2016.

Company Name Yield P/E
Apple (AAPL) 2.12

12.69

Amgen (AMGN) 2.3 17.61
Costco (COST) 1.07 31.73
CVS/Caremark (CVS) 1.75 22.42
Deere (DE) 3.06 15.83
Gilead Sciences (GILD) 2.34 6.96
General Mills (GIS) 2.72 25.61
Johnson & Johnson (JNJ) 2.58 23
McDonald's (MCD) 2.99 22.59
McKesson (MCK) 0.58 20.38
3M (MMM) 2.49 22.77
Altria (MO) 3.4 23.13
Nike (NKE) 1.15 25.82
Reynolds American (RAI) 3.43 13.35
Starbucks (SBUX) 1.43 31.01
AT&T (T) 4.45 18.58
Visa (V) 0.7 34.02
Exxon Mobil (XOM) 3.43 35.23
BHP Billiton (BBL) 2.38 27.79
Chevron (CVX) 4.26 21.51
Kinder Morgan (KMI) 2.46 27.27
Click to enlarge

Three companies from his list had either negative trailing earnings per share, these would be Chevron, and BHP Billiton, or a sky high ratio on trailing earnings, as Kinder Morgan has. For those three I used estimated forward P/E ratios.

Here's what a graph of all of this looks like:

Click to enlarge

You know how people who read charts have talked about a technical analysis signal called the "Death Cross"? Well let's call this the "Life Cross". We can use it as your personal savior to redeem your portfolio.

It's not hard to understand, the stocks below the red X have lower than average stock prices, and the stocks to the right of the X have higher than average yields. All else equal then, the stocks in the lower right quadrant should be the best value for your money.

Conversely, BHP Billiton, being in the upper left quadrant, is in the zone for selling. Mike's intuition here served him well.

So according to this, you should buy:

  • Reynolds American
  • Deere
  • AT&T

But what about Mike? What about his individual situation?

This should be considered, and everyone out there has various needs from their investments. I know that a whole lot of the readers of this site lean towards stocks with high rates of dividend growth. You need to sort of customize the above chart to your preferences. Shift, for example, the stocks with higher dividend growth a little closer to the bottom right, and shift the lower growth stocks towards the top left.

In Mike's case, he is concerned about the risk of being undiversified, but he is also most interested in adding to companies he already has stakes in. So we need to take AT&T out of these choices.

Which leaves Deere and Reynolds right in the headlights.

Mike's portfolio is pretty conservative, and is what we commonly refer to as a "sleep soundly at night" set of stocks. My personal preference is to take concentrated positions in the stocks that I think have the largest chance of increasing. Mike mentioned that his largest "loser" is Gilead Sciences.

If this were my own portfolio, I would be looking to add some of that to lower my cost basis, and his position size is still small enough to afford that wiggle room. As a matter of fact, I am considering adding some of it to my own. The share repurchases that the company has been doing should give a healthy boost to their dividends, causing the stock to yield more at the same P/E ratio.

These changes would shift the position of GILD on the chart, moving it closer towards the lower right. I look for situations where there is a good chance of this exact scenario happening, as it brings in price support from various ETFs that are forced to buy the shares when they meet certain types of these criteria.

In Closing:

I give strong buy ratings here to Reynolds American, Deere and Gilead Sciences, y'all. Especially if you don't have holdings in any of these.

Be sure to follow me!

If you enjoyed this portfolio breakdown, it's something I am interested in doing more of in the future. I'm especially interested in doing more graphs like this. There are high level mathematicians who struggle with the dynamic rules of the stock market, but in my opinion, it's that they're just over thinking the thing.

My preference is to keep it as simple to understand as I can. Go click that follow button, and thanks for reading. See you soon!

Disclosure: I am/we are long AAPL, GILD, JNJ, MCD, MO, NKE, SBUX, XOM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.