In response to 10-year Treasuries yielding near all-time lows due to both "Operation Twist" and continuing eurozone panic, I suggested an "Everyday American Portfolio," which I recently introduced on Seeking Alpha. This portfolio is comprised of either 5 or 10 stocks picked from a proposed basket of 18 blue-chips with strong dividend history and recent earnings growth. The primary purpose of the portfolio is to provide a long-term stable investment for those under the age of 65 who refuse to lock themselves into Treasuries or speculate doomsday inflation via gold.
In order to provide a bit of choice and a feel for individual "ownership", I offered two choices for each category, with the exception that I recommend both Johnson & Johnson (JNJ) and Procter & Gamble (PG) in the 10-stock allocation ("Core 10"). For the overall experiment, I will be tracking the results of the suggested "Core 5," "Core 10," and the 'Total 18' against gold (GLD), 10-year Treasury yields/prices, and the S&P 500 Index (SPY). For a more detailed rehash, please read the overview here.
What Happened Last Recession?
Although historical results are not directly indicative of future returns, there is a lot to learn for investors that choose to take the time and conduct due diligence. Fellow Seeking Alpha Contributor, Robert Keyfitz, suggested that I compare the proposed Everyday American Portfolio's (EAP) historical results from 2007-2009 to indicate how "resilient" these funds would be. I agreed to run the numbers assuming an investment in January 2007 through December 2009 using a DRIP in a tax-free (IRA-type) account, I mentioned that I would also compare the S&P 500 index to these results.
Strong Historical Performance
Before I began my analysis, I knew that McDonald's (MCD) had enjoyed an impressive run in profits and that Microsoft (MSFT) had mostly been stagnant, but I had no idea what had happened regarding most of the others. I knew the dividend growth rates and historical earnings were impressive, but in the short-term anything can happen to stock prices. I honestly expected that they would only beat the S&P by a small margin. To my surprise, the AEP "Core 5" blew away the S&P 500 with to-date gains of 30.13% vs. -5.41% for the S&P 500 (15.6% for "Core 10" and 18.9% for the overall basket). Although the S&P 500 has never fully recovered to its Jan '07 prices, the "Core 5" was only below an initial assumed $9950 value for 10 months. Full recovery from pre-crash (September '08) levels took a bit longer, 1 year and 6 months to be precise.
What about the Dividends?
Going back and calculating the DRIP results for a portfolio of 18 stocks would be a nightmare, and unfortunately, I'm not sure if any relevant tools exist for this purpose on the internet. Instead, I assumed that all dividends remained in cash. Obviously the DRIP gains would be even higher, with the lone exception of Exelon (EXC), which has been a large (-41%) net loser.
Over the past 5 years and 6 months, the "Core 5" has returned $1599.51 in dividends. The "Core 10" distributed $1722.44, and the overall basket gave out $1749.18.
In comparison, 70.696 shares of SPY could have been purchased for $9990 ($10k-1 commission) in January 2007 with a to-date total distribution of $889.
This brings the total return of the "Core 5" to 48.28% vs. 4% total for the S&P 500. "Core 10" returned 34.28% total and the overall basket returned 38.32%.
The graph below (source: Google Finance) highlights the stark difference in equity gains between the "Core 5" and the S&P 500. While there is definitely a high degree of positive correlation, the downswings have been far less painful.
It's easy to go back in hindsight and pick a portfolio of winners. However, I think it's rather ironic how it occurred this time, since I went out looking for fair-valued to under-valued dividend growth stocks for a future 10-year portfolio with very limited knowledge of mid-recent market performance. There are a lot of pundits that argue against dividend-growth investing, but these historical results vs. the S&P 500 are pretty convincing, at least for a period of tough economic times. To best check if hindsight bias is occurring, I decided to a do a historical valuation check with four metrics: Price/Earnings, Price/Sales, Price/Book, and Dividend Yield.
In January 2007:
Chevron (CVX) - $72.77 / 9.33 P/E; .76 P/S; 2.32 P/B; Yield of 2.86%
Target (TGT) - $57.85 / 18.02 P/E; .85 P/S; 3.24 P/B; Yield of 0.83%
MSFT - $29.91 / 21.06 P/E; 5.8 P/S; 9.53 P/B; Yield of 1.34%
MCD - $43.65 / 19.06 P/E; 2.62 P/S; 3.54 P/B; Yield of 2.29%
Johnson & Johnson (JNJ) - 66.13 / 17.73 P/E; 3.67 P/S; 4.98 P/B; Yield of 2.27%
In July 2012:
CVX- 7.63 P/E; 0.81 P/S; 1.7 P/B; Yield of 3.47%
TGT- 13.67 P/E; 0.55 P/S; 2.46 P/B; Yield of 2.43%
MSFT- 10.82 P/E; 3.6 P/S; 4.4 P/B; Yield of 2.67%
MCD- 16.86 P/E; 3.38 P/S; 6.37 P/B; Yield of 3.12%
JNJ- 18.66 P/E; 2.86 P/S; 3.24 P/B; Yield of 3.6%
The results are mind-blowing. Not only did this basket of stocks return 48.3% in the past five and half years, but they are actually valued less today than they were in January 2007! Please keep in mind that with DRIP instated, this portfolio would have returned yielded far greater returns (to be fair, the S&P 500 would also have performed above 4% total).
Potential Downsides from Historical Comparison
As we can see, the overall portfolio, and especially the "Core 5" performed very well during the last recession and market collapse; however, certain equities suffered massive, near-instantaneous, drops. These plummets in stock price could be repeated during a period of stock market upheaval, but the important thing is not to panic. If the fundamental business has not changed, there's no reason to sell based on price alone. Witness the lesson provided by Target . In a matter of two months, TGT dropped from $57.26 to $28.08, a 51% drop! Although Target eventually recovered, the journey took over 18 months of patience. The graphs below show the plummet from $57 to $28, and the eventual recovery, respectively (Source: Google Finance).
Please also read the original article if you have interest in adding these shares to your portfolio. I firmly believe that the "Everyday American Portfolio" is well positioned for a decade of impressive gains, but I recommend that each investor does their own due diligence before ever making a decision.
Although this portfolio is very conservative, the historical lesson of Target shows us that volatility can still strike. Concern yourself only with the partial ownership of a business, not with the instantaneous market value of your shares. If you had just purchased a new asset for your business, such as a truck for $40k, and two months later the same truck was selling for $20k, would you panic and sell your truck back for a $20k loss, do nothing, or go out and buy a second truck?
Investments should be viewed the same way as the business asset scenario. Potential earnings and cash flows are all that matters, as Target showed us, the stock price will eventually correlate. Finally, regardless of your overall portfolio, I recommend that you avoid Treasuries, gold, and excess cash at all costs!