While equity markets enjoyed a strong start to 2012, there have been signs of fatigue as investors and traders focus on the risks to the market. The market has serious headwinds that must be acknowledged. Most prominent is the debt overhang in the developed world.
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Risks to the market include:
- Ongoing sovereign debt crisis centered in Europe
- Slowdown in China
- Tail risk to Japanese interest rates
- High unemployment and structural unemployment issues, including long-term unemployment and youth unemployment
- Presidential election
- Geopolitical issues in the Middle East
- High oil prices
- Weak and stagnant housing market
Retirees who are seeking yields and are long-term bullish on the markets should stick with high-quality equities. With interest rates in the developed world at record lows and central bankers focused on fueling inflation, I am hesitant about holding long-duration bonds despite their strong performance throughout the crisis.
Retirees should combine quantitative metrics (equity screeners) with qualitative attributes when looking for equities to add to their portfolios.
While the economic environment is poor, equities are relatively cheap. The S&P 500 (SPY) is trading at a modest 13.0 times price to earnings ratio. The equities listed below have been able to increase cash flow, earnings, and dividends over the last decade. I expect the management teams to be able to increase dividends over the next decade due to the wide moats of their business models.
In terms of qualitative attributes, I look for companies with strong market share in their respective markets with business models that are recession-resilient.
- Price-to-Earnings ratio less than 20.0 times -- focused on relatively inexpensive equities.
- Dividend Yields greater than the 10-year Treasury -- focused on equities that will provide cash income greater than the 10-year Treasury. While the equity price (principle value) might fluctuate due to market conditions, holders can count on the cash flow from dividends.
- Low Debt-to-EBITDA ratios -- focused on equities with modest debt relative to cash flow. EBITDA (earnings before interest, taxes, depreciation and amortization) is a proxy for cash flow.
- Market Capitalization greater than $5 billion -- focused on large capitalization equities, which generally have better access to capital markets and have more durable business models.
Molson Coors Brewing Co. (TAP) -- beverages
Price to Earnings: 11.3 times
Dividend Yield: 3.1%
Debt to EBITDA: 2.9 times
Market Capitalization: $7.4 billion
Rationale: Molson Coors Brewing is the second largest brewer in Canada and the U.S. While the company operates in a low-growth end market, the beer business is relatively stable. Its scale provides cost benefits over other competitors.
Waste Management (WM) -- waste management services
Price to Earnings: 17.2 times
Dividend Yield: 4.0%
Debt to EBITDA: 3.0 times
Market Capitalization: $16.3 billion
Rationale: Waste Management is a dominant player in the landfill and waste management business. The company operates 300 landfills. It operates a stable, annuity-like business and provides investors with a strong 4% dividend.
Coca-Cola Co. (KO) -- beverages
Price to Earnings: 19.5 times
Dividend Yield: 2.8 %
Debt to EBITDA: 2.2 times
Market Capitalization: $162.9 billion
Rationale: The company operates a global brand with an unparalleled distribution network. Coca-Cola has strong growth opportunities in the emerging markets. The company maintains a strong balance sheet and will provide investors with strong dividends for years to come.
Medtronic (MDT) -- healthcare
Price to Earnings: 12.1 times
Dividend Yield: 2.6%
Debt to EBITDA: 1.9 times
Market Capitalization: $39.0 billion
Rationale: Medtronic is the largest medical device manufacturer in the world. The company holds nearly 50% share in the heart device market. Aging demographics in the developed world will benefit this name.
Pfizer (PFE) -- pharma
Price to Earnings: 19.7 times
Dividend Yield: 4.0%
Debt to EBITDA: 1.4 times
Market Capitalization: $164.6 billion
Rationale: The company has a strong pipeline of drugs and provides a strong dividend to shareholders. Pfizer will benefit from an aging global population that is seeking drugs to cure ailments. Its scale provides significant economies of scale. Pfizer has a strong balance sheet to support the development or acquisition of new drugs.
Johnson & Johnson (JNJ) -- consumer/healthcare
Price to Earnings: 18.2 times
Dividend Yield: 3.6%
Debt to EBITDA: 1.0 times
Market Capitalization: $174.4 billion
Rationale: Johnson & Johnson commands the No. 1 or No. 2 position in the majority of its markets. The company's business model is recession-resilient. Aging demographics and the increased spending on healthcare will benefit the company.