Seeking Consistency And Predictability

by: Alex Rasmussen

Many today are looking to treat blue chip equities like bonds. From utilities to International Business Machines Corporation (NYSE:IBM), people are simply not satisfied with the yields on most fixed income products. On the other hand, with dividend yields at record highs, it does make sense to add income stocks to a diversified portfolio.

That said, it doesn't mean buying every company in the Dow 30 and every household name stock is a good strategy. We have many tools to systematically pick the best one. In doing so, we'd look for the stock with the lowest volatility, combined with the most predictable earnings, selling at a stable price, with a good dividend track record, as well as a bright outlook for those dividends. The results of my initial screen are shown below.

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As a value investor, I tend to disregard modern portfolio theory, though the calculation of standard deviation and beta, over longer periods of time (3, 5, and 10 years) is meaningful. I had some pretty strict inputs, so all of these companies are suitable, though I think we can narrow it down even further from good to great.

I was unimpressed with the dividend history and outlook for a few of them, including Abbot Laboratories (NYSE:ABT), Kellogg Company (NYSE:K), Aqua America, Inc. (NYSE:WTR), and C.R. Bard, Inc. (NYSE:BCR). On the other hand, the companies that stood out as exceptional to the basket were Church & Dwight Co Inc. (NYSE:CHD) and Becton, Dickinson and Company (NYSE:BDX).

McDonald's Corporation (NYSE:MCD) and Wal-Mart Stories, Inc. (NYSE:WMT) don't have the same track-records, though the outlook for their dividends is phenomenal. I've looked into McDonald's quite a bit and can never seem to get it cheap enough, though with Wal-Mart receiving some negative headlines, this may be a nice entry for some retirement portfolios and other investors with longer-time horizons. I personally think both companies have serious issues to deal with from an enviro-social perspective, though economically, they are two of the best businesses you can own.

Johnson & Johnson (NYSE:JNJ), Kimberly-Clark Corporation (NYSE:KMB), and General Mills, Inc. (NYSE:GIS) are the three least volatile of the basket, with General Mills being the far and away leader. These companies do not fluctuate, and that is represented in their ultra-low standard deviations and betas. For mom and pop out there with kids to feed and mortgages to pay, the emotional value of not riding a roller-coaster with your life savings every day is worth the premium you pay to own these companies.

As a side note, I calculated a 'combined standard deviation,' which simply adds the 10-year, 5-year, and 3-year standard deviations. General Mills had the lowest combined standard deviation of the past decade.

As sort of a second test, I thought I'd take a look at only the companies that stood out (in a positive way) from the rest of the basket and analyze them on a more fundamental level. Results are below.

Becton, Dickinson and Company is selling nicely below five-year average earnings; this combined with a low payout ratio make it stand out. Wal-Mart also has a low payout ratio.

General Mills, Johnson & Johnson, and Kimberly-Clark are yielding over 3%, which is what we're here for in the first place right? That being said, Johnson & Johnson and Kimberly-Clark are doing so with payout ratios above 60%.

Based on this analysis, I would do some more due diligence on Becton, Dickinson and Company. Although it looks very interesting, I know it has been a Buffett buy in the past. Why he sold is definitely something that would need to be explored. General Mills would be my second pick; I am very impressed with both the consistency and predictability with which it marches upward.

Hopefully, you can make some use of this analysis and pick the stalwarts for your portfolio with a little more sophistication.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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