Investors Alley

Last week, we received word that Charlie Munger had died.

Now, Charlie was about a month away from his hundredth birthday, so I couldn’t describe his passing as a surprise. It was, however, a cause for reflection.

Everyone pays attention to what Munger’s business partner, Warren Buffett, does and says when it comes to business and investing. It would not be fair to say that Charlie has been ignored, but he was never followed as closely as Warren—except by those of us who are also getting older, always a little grouchy, want high returns on our capital, and really wish those damned kids would stay off our lawns.

All in all, we would rather be left alone to read a book.

Rather than tell the same dozen or so Munger stories everyone else will tell, let’s try to use his philosophy to uncover some ideas with the potential to become one of the 100 baggers that helped Munger get rich in the first place.

Munger was far blunter than Warren. He called out crypto as garbage (using much stronger language) that is almost certain to end badly. He compared most active traders to casino gamblers and suggested that many of them would likely meet the same fate; there is a mountain of empirical evidence to suggest that he is right about that. He pointed out that the widely used term “EBITDA” was best replaced with the term, in his words, “Bullshit Earnings.” Any business that does not account for depreciation today will pay for double tomorrow.

Munger loved to buy when everyone else was puking up stocks as fast as possible. He favored concentrated positions.

Munger was worth about $2.5 billion—almost all of it was in shares of Berkshire Hathaway (BRK-A), Daily Journal (DJCO), Costco (COST), and the hedge fund.

Several years ago, Munger was asked what he would do if he were investing smaller sums of money. He suggested that investors should search inefficient markets for fantastic businesses at great prices.

Most of the market is efficient, except at the major turning points.

There are so many eyeballs on the larger companies that almost everything is known, so almost everything is reflected in the current price. You and I cannot gain an edge by studying the financial statements of Apple or by talking to their vendors and retailers.

But a few thousand other people are doing the same thing. Hundreds of those work for major Wall Street firms and have Tim Cook’s cell phone number. The data they gather is crunched by massive computing power. Without these contacts and this technology, there is only one way for you to gain an advantage when it comes to investing in larger companies.

But, unlike those better-connected traders, you and I do not have to act every single day. We have no outside investors looking over our shoulders telling us what we must buy and sell.

We can sit and, as Munger did, do nothing much of the time.

When markets collapse, and career risk demands those same fund managers sell at any price, we can act. Their acts of self-preservation will lead to great businesses selling at attractive prices.

Smaller, even tiny companies, are the real hunting ground of inefficiency in the markets. Few, if any, analysts are covering these businesses, and nobody is talking about these companies on TV or across the interwebs.

None of the wannabe billionaire day traders banging away at their keyboards in search of elusive rapid-fire profits will ever even hear of these companies, much less trade them. (Of course, I’m talking about very small and thinly traded, so you cannot trade them.

If you need liquidity, these are not for you. But if you are an individual long-term-focused investor, you do not need liquidity.

We want smaller companies with solid balance sheets and businesses that can stand the test of time. We want businesses that are earning high returns on capital.

I ran a quick screen for companies that fit these basic criteria and it comes as no surprise that there are not many companies that pass the test. The small and microcap markets are full of garbage, and the first step on the path to inefficient market success is throwing out the trash. Finding a handful of high-return smaller companies and owning them until they become large high-return companies can make you rich.

It is a lot of work.

Most companies will not make the initial cut. May will falter and drop off the list of qualifying companies over the years. But those that stay on the list for a very long time can make you very rich.

Perhaps even rich enough to say whatever you want and hire someone to keep the kids off your lawn while you read in peace like Charlie Munger was able to do for so long.

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Last week, in my 48-Hour Income service, we decided not to sell a cash-secured put on meme-stock favorite, Gamestop (GME). In 48-Hour Income, the goal of the service is to generate 1% to 3% returns per week by selling 2-day puts in certain stocks. GME was up big with retail traders active ahead of earnings

It’s Christmas come early.

Not really, but with Thanksgiving behind us, I wanted to start the Holiday season off with a bang.

As everyone is making precise predictions about what stocks are going to do in 2024, I am using math to answer one simple question.

Is this a good time to buy stocks?

The equations and formulas I used are not overly complex, but they are time tested, and each individually has been very accurate when suggesting the future returns for the stock market will be below average.

In combination, they are extraordinarily accurate.

None of them are precise timing tools. They are more like red light-green light indicators.

On second thought, it’s more like road signs.

One reads, “Bridge out ahead.”

The other reads, “Welcome to the Speedway.”

Right now, all signs indicate that buying the stock indexes as a long-term investment is a bad idea right now.

The sane math is telling me that fixed income-bonds, preferred stocks, and discounted fixed-income closed-end funds are likely to deliver solid returns well in excess of historical stock returns.

Today I have a handful of fixed income ideas at various points on the risk curve that have high cash yields with the potential for even higher total returns.

Enjoy and Prosper!

It’s time to put the November 2023 stock market rally into perspective because I’m seeing investors make the mistake of getting too bullish too fast.

For all I know the rally can certainly squeeze a bit higher, but ultimately high interest rates will slow down the economy.

What’s important to note about the November rally is the level that we’re back at right now.

For example, let’s take a look at consumer discretionary stocks – which have done extremely well this year.

The sector is up about 30% for the year – which is exactly the same level it was in mid-September…

And in June…

And in September of 2022…

So essentially, we’ve gone absolutely nowhere. The same goes for consumer staple and industrial stocks, as they’re back to early September levels too.

This isn’t the raging bull market that everyone wants to believe it is.

But there’s one area of the market that has been doing extremely well… and you can trade it using this ETF.

In today’s 2-minute video, I go over the top tech ETF on the market right now, why now is not the time to get bulled up and the science behind what’s actually happening in the November rally.

I release these weekly tips every Thursday for free, so stay tuned and stay subscribed here. 

In 2023, energy sector stocks have been on a roller coaster. Sector stock prices follow the price of crude oil, which means a lot of ups and downs in the short-term.

But the long-term prospects for oil are very bullish, so don’t be afraid to take advantage of the dips.

In particular, I suggest looking at these four stocks…

Here is the WTI crude oil chart for the last year:

Followed by the Energy Select Sector SPDR ETF (XLE):

I recommend picking stocks from the three energy subsectors. Each of these follows its own pattern in regard to energy commodity prices.

Upstream energy companies are the commodity producers, drilling for oil and gas, with profits directly tied to those commodity prices. In this group, I like the companies that pay variable dividends based on quarterly profits. Here are two:

Devon Energy (DVN) recently released third-quarter results and announced a fixed-plus-variable dividend of $0.77 per share. You can see from the chart above that oil prices were higher in the quarter, allowing Devon to boost the payout by 57%. DVN goes ex-dividend on November 15.

Diamondback Energy (FANG) declared a regular quarterly dividend of $0.84 (giving a 2.1% yield), plus a variable dividend of $2.53 per share. The ex-dividend date is November 15.

Downstream energy companies refine crude oil into fuels such as gasoline and diesel fuel. Refining profits swing with the difference between the cost of crude oil and the market prices for refined fuels. You can use the crack spread to check on refiner profitability. The better refining companies reward investors with growing dividends and stock buybacks after especially profitable quarters. Here are two favorites:

Valero Energy Corp (VLO), which yields 3.2%, should announce a dividend increase in January.

Marathon Petroleum Corp (MPC) recently increased its dividend by 10% and yields 2.3%.

Energy stock investing can be counterintuitive. Traders focus on short-term bad news, which lets long-term investors take advantage of the dips in the longer-term positive trend.

Last week, in our 48-Hour Income service, we sold a cash-secured put on software company, Palantir (PLTR). In 48-Hour Income, the goal of the service is to generate 1% to 3% returns per week by selling 2-day puts in certain stocks. PLTR had earnings coming up the next morning and its put option premiums appeared

It’s gratifying to see the Wall Street Journal catch up with advice I have given to my Dividend Hunter subscribers for several years.

They’ve finally discovered how to eliminate the main problem with investing in bond funds.

They’re late to the party, though – I’ve been telling my readers that for ages.

Let me show you…

I’m talking about defined maturity bond ETFs, as long-time readers may have guessed.

A recent Wall Street Journal article, “These Funds Offer a Way to Lock In High Bond Yields,” highlights the benefits of what they labeled as “defined maturity bond funds.”

This type of fund owns bonds that all mature near a specific date, typically by the end of the target year. This structure contrasts traditional bond funds, which continuously trade bonds to maintain a specific average maturity.

If you buy an investment bond, which could be a Treasury bond, a municipal bond, or a corporate bond, you will earn the yield to maturity in effect at the time of purchase if you hold the bond until it matures.

Bond prices adjust for changing interest rates by moving in the opposite direction of rates—so when interest rates go up, bond prices go down. However, if you hold a bond until it matures, you will earn the positive return you signed up for when you bought it.

With interest rates increasing, traditional bond funds—either ETFs or mutual funds—have posted negative returns for three consecutive years. If you instead invested in a defined maturity ETF that matures in 2023, you would have a positive return when the fund redeems in December.

On March 10, 2022, I purchased the Invesco BulletShares 2023 Corporate Bond ETF (BSCN) shares. Interest rates were lower then, and the fund will produce a 3% average return.

Currently, yields on these funds are much higher. Target maturity bond funds are offered by Invesco, called BulletShares, and BlackRock with their iShares iBonds funds. You can choose from funds investing in Treasury bonds, municipal bonds, investment-grade corporate bonds, and high-yield bonds.

You can choose from funds with maturities of up to 10 years. The fund series lets you set up a traditional bond ladder, the smartest way to invest in bonds. Both companies have tools to tell you exactly what returns you would earn. Here is a four-year ladder using the Invesco High-Yield BulletShares funds:

The yield-to-maturity column is the annual return you will earn if you buy shares now and hold them until they are redeemed. These funds pay monthly dividends; the distribution rate shows the dividend yield.

Locking in 8% plus yields, with the certainty that you will earn those yields, makes a lot of sense in today’s investing environment.
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Until recently, consumer staples stocks had been popular with conservative investors. These companies make and sell products that are everyday essentials, which means their revenues and profits are fairly stable and quite predictable—a characteristic investors should like.

Of course, this type of company is not going to grow rapidly. But their ability to be “Steady Eddies” and grow modestly, while throwing off lots of cash flow, has enabled many of them to pay attractive and growing dividends to their shareholders.

These characteristics make these stocks a better alternative to owning bonds, since they have the bonus of a growing income stream rather than a fixed one.

So, let’s now take a closer look at one of these consumer staples stocks—a Warren Buffett favorite…

Coke’s History

The company, Coca-Cola (KO), founded in 1892, has had to face up to many challenges in the economy over its long history.

Its current brand portfolio—which includes the iconic Coke, as well as Diet Coke, Sprite, Fanta, Schweppes, Dasani water, Innocent smoothies, Minute Maid juices, Costa Coffee and FUZE tea—has millions of loyal customers around the world who keep on buying these products again and again.

Yet, 2023 has been a very difficult year for the company’s investors. On a total return basis, the shares are down more than 11%. This compares with an 8.5% gain for the S&P 500 index. (Keep in mind that up until the start of this year, the stock had actually matched the cumulative performance of the S&P 500 for the previous four years.)

So, what’s gone wrong?

There are a few factors at play here. One is rising interest rates have lessened the attraction of so-called bond proxy stocks, lowering their valuations. Next, inflation is hitting consumers’ disposable income, which is forcing them to buy fewer items or to go for cheaper private label goods.

Finally, and perhaps the most important factor, has been the arrival of the pioneering weight loss drugs made by Novo Nordisk (NVO) and Eli Lilly (LLY), which suppress appetite.

This has raised fears on Wall Street that the demand for many food and drink products will fall—perhaps sharply. In 2023, Wall Street is selling now and asking questions later when it comes to whether companies like Coke will actually be affected by the weight loss drugs.

While the bears think they have a strong case for selling Coke, a closer look at the company suggests that it still has a lot to offer investors.

Coca-Cola still has a diverse brand portfolio and a huge global scale that is unmatched in the soft drinks industry. Its revenues in 2023 are expected to exceed $45 billion.

Recall that Coke makes most of its money by selling concentrates to its network of bottling companies around the world. It is these companies then that add water and sweeteners to the concentrates before packaging the finished products and selling them to retailers and wholesalers.

Coke’s portfolio of brands is backed by the world’s largest soft drinks distribution system. Coke had retained an equity stake in these companies, but in recent years, it has been shedding its investments in bottling and distribution assets to focus more on selling its highly profitable concentrate instead. This has allowed it to improve its operating margin (to around 27%) and maintain a healthy return on capital employed (ROCE) of around 17%.

Despite the bears’ concerns of tapped-out consumers trading down, Coca-Cola’s pricing ability is a real source of strength that should reassure investors. The company’s global scale and tremendous brand power have given it the ability to raise prices year after year, without seeing sales volumes decline.

Coke’s Future

While the company still relies heavily on its legacy Coke brand, it has been very successful in adapting to changes in its markets and customer preferences.

For example, there is Coke’s recent push into the alcoholic ready-to-drink and hard seltzer markets. The trend towards lower-alcohol drinks as a halfway point between soft drinks and more traditional alcoholic drinks is growing, especially among younger consumers.

Coca-Cola has launched a hard seltzer with its Topo Chico water brand; it has also partnered with alcohol companies in the ready-to-drink category. This includes products such as Jack Daniels and Coke, which will be joined next year by an Absolut vodka and Sprite product.

This gives me optimism for the future. But even now, the company continues to perform well.

Despite the doom and gloom surrounding Coke on Wall Street this year, Coca-Cola’s business is doing fine, thank you. Its recent third-quarter results were excellent, and the company raised its full-year revenue and earnings per share (EPS) guidance.

Organic revenue growth for the year is expected to be a very healthy 10% to 11%, with constant currency growth in earnings per share expected to be 13% to 14%. And despite a currency headwind (a strong U.S. dollar), earnings per share growth is expected to be in the 7% to 8% range, which should lead to another hike in the annual dividend payout.

Coke is expected to generate $9.5 billion in annual free cash flow this year, which comfortably funds the dividend payment—about $7.8 billion—while allowing for further share buybacks.

Looking at the valuation of the stock based on its next 12 months’ forecast price/earnings (PE) ratio, Coca-Cola shares trade at about 20 times. This is not a bargain-basement valuation, but it is as cheap as the shares have been on this measure for a number of years.

Coca-Cola is a Dividend Aristocrat, having increased its dividend every year for the past 61 years, and it is currently expected to keep on doing so. Only very good and resilient businesses can do this.

The current dividend yield of 3.23% remains attractive to income-seeking investors who want dependable income growth going forward.

And if interest rates have peaked or are close to peaking—as Wall Street seems to believe—then the shares of Coca-Cola will be poised for a decent recovery, leading to capital gains.

KO is a buy anywhere in the $50s.
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The rapid increase in interest rates over the last 18 months has changed investor sentiment about “cash” investments. Short-term cash investments such as money market mutual funds and Treasury bills now pay around 5%. Meanwhile, over the last two years, the overall stock market has gone basically nowhere, with a lot of volatility along the way.

Stock prices start to rally higher, and just as investors feel confident, prices then turn down. The major market indexes have dropped by about 10% in the three months since the end of July.

As a result, investors have put a massive amount of new money into money market mutual funds instead of into stocks.

This move will, at some point, be the fuel for the next stock market bull market…

It is easy to understand how investors are more comfortable putting large amounts of their investment portfolios in safe 5% investments. A recent Wall Street Journal article highlighted how money market mutual fund assets have climbed from about $3 trillion in 2020 to over $5.5 trillion today. The article also pointed out that, over the last two years, institutional investor cash allocation percentages have climbed from the mid-teens to the low 20s.

The bottom line is that trillions of dollars have come out of riskier investments into safer cash equivalent holdings. This is also money that could quickly flow back into stocks if investors believe the next bull market has started.

What could trigger the movement of money market fund cash back into stocks?

Historically, as we go from the third quarter into the fourth quarter, inflows to stock funds increase dramatically. Recently, TheMarketEar.com reported that equity funds should see inflows of $2.5 billion per day starting in November. The window for corporate stock buybacks stays open until December 8, and the following month could be the strongest period of the year for buybacks, adding $5 billion per day of stock demand.

If stocks rally into the end of the year, investors will start to feel left behind and may begin to move cash into stocks. A final trigger would be the Federal Reserve hinting at when it will start to cut interest rates. When the Fed begins lowering rates, the money market mutual funds yields will also decline.

Real estate investment trusts (REITs) have performed especially poorly as interest rates have increased. The opposite (share price gains) should happen when rates fall, and investors pile cash back into the market. The trick is to figure out the timing of the start of the next bull market.REIT stocks pay attractive dividends, so if you get in a little early and wait patiently for the upcoming bull market, you will be paid well. The Hoya Capital High Dividend Yield ETF (RIET) pays monthly dividends and yields more than 10%. Just make sure you get the stock symbol right!
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Is the bottom for stocks in? That’s the question I will address in this week’s first edition of the Hidden Profits Report. The Fed has a lot to say about both the current level of stock prices, and no matter how much you may hate the Fed or wish we did not have a fiat