I was busy over the weekend, doing an analysis of capex expenditures for companies in both the S&P 500 and 1,500 indexes. Larry Fink gave a speech in which he stated US companies weren't doing enough capex, due to market preference for dividends and buybacks, short CEO tenure, and uncertainty caused by political dysfunction.
Using a simple test, whether capex exceeded depreciation for both of the past two years, well less than half of US companies get a passing grade. The passing percentage varies substantially by sector, with Utilities and Energy by their nature getting higher capex.
There is only 100 cents in a dollar, and dividends and buybacks compete with capex for their share of cash flow deployment. Ten years ago, it was rare to find a dividend growth stock that could pass the capex test. Under current conditions of high margins and low borrowing costs, the combination is not that rare.
I found that using a passing grade on the capex test as an investment criterion stabilized portfolio performance and reduced maximum drawdown on a backtest, when included with a dividend growth criterion. Beta is less important, and I dropped the beta requirement: it produces a portfolio that is imbalanced toward defensive sectors, and concentrated in stocks that are above rational valuations.
I'm investing on the basis that companies that pass the capex test will provide better and more stable returns over the long term - five years, which is my horizon.
Portfolio adjustments will be made today, closing positions in Bristol Meyers (NYSE:BMY), Chlorox (NYSE:CLX), Johnson & Johnson (NYSE:JNJ), Kimberly Clark (NYSE:KMB), Lorillard (NYSE:LO), Microchip (NASDAQ:MCHP), Raytheon (NYSE:RTN) and Texas Instruments (NYSE:TXN). I have large profits on these stocks and most of them are over-valued by objective standards.
I will be opening positions in Caterpillar (NYSE:CAT), Coach (NYSE:COH), Conoco Phillips (NYSE:COP), CSX Corp (NYSE:CSX), Deere & Co (NYSE:DE), Helmerich and Payne (NYSE:HP), Intel (NASDAQ:INTC) and Occidental Petroleum (NYSE:OXY). All of them meet my usual PE5 valuation standard, and I am comfortable with what I saw looking at FASTgraphs and M*.
I'm working on a more detailed discussion of the issue and my thinking on it, for publication later this week. In the meantime, I decided to post my planned trades and the rationale behind them for those who are interested.