Scalper1 News
Volatility is the subject of the week. Investors have the opportunity, even the responsibility, to determine how to manage volatility. Using my investment club as an example, an 80/20 filter applied to the DJIA analyzes how the index weathered the week and identifies the top six components for investment consideration. A record-setting week is over. Industry experts are still debating what actually happened and why. Yet, the advice seems to be consistent – expect the volatility to continue. With volatility comes an opportunity, even responsibility, to understand your personal price points. At what point would you sell? At what point would you buy? It’s probably a fair statement that even if one had limit orders set, the odds were small of actually having enough cash to cover all of one’s desirable trades or actually seeing all the orders execute. But, that doesn’t mean the exercise to determine buy points or sell points would be fruitless. I rarely construct an article based wholly on my investment club. But, this article inspired me to start laying a foundation with the members – just in case a bear market is here or around the corner or down the road. I realized the volatility described in the article would fit perfectly with the club’s 2015 goals. At the beginning of the year, we set a theme for 2015 of “Why don’t we?”. We’ve been a club for nearly a decade. It was time to ask the question: “Why don’t we own X or Y or Z?”. For example, why haven’t we invested in the businesses from where we purchase our gasoline, drive through for our snacks or drinks, do our Christmas shopping or to where we pay those expensive insurance premiums? That’s not to say every business would warrant an investment. But, we should at least do the analysis and know the reasons why we were waiting on or eliminating the option. So, with the club in mind, this week provided a prime opportunity to muse over the thirty components of the DJIA (Dow Jones Industrial Average). The club doesn’t currently have an investment in each component for a variety of reasons. In some cases, we’ve truly opted to pass. In others, we’ve not yet done the work. Since hindsight is supposedly 20/20, if this week were to repeat, which components should capture our attention? What would be our buy point? To begin consideration of the DJIA components in the past week, the primary questions centered on how they weathered the storm. How far did they fall? Did they recover? This wasn’t to be an exercise in analyzing each component but rather an exercise in narrowing the focus. Like most individuals, we don’t have an abundance of cash sitting and waiting to be invested. After all, we are an investment club not a savings club. Therefore, using the 80/20 rule, it seemed wisest to determine on which six (20%) of the DJIA to focus. Choosing the six means (hopefully) eliminating twenty-four based on reasonable criteria. Many industry experts say that a true correction requires a pullback of at least 10%. In this case, the question is a pullback from what? One could use the closing price from August 21st. The problem is that some stocks had already started a correction pattern. One could use a stock’s 52 week high. But, there are a variety of reasons why a stock may have pulled off its high. For example, the energy-related stocks are well off their highs. The fairest starting point for each stock seemed to be its 50-day moving average. Returning to the concept that there are companies well off their 52-week highs, there are logical reasons why now or the near future may not be a good time for investing in those companies. A reasonable rule of thumb seemed to be that it’s not time to invest in a company whose 50-day moving average was more than 25% from its 52-week high. This guideline eliminated Caterpillar (NYSE: CAT ), Chevron (NYSE: CVX ), E.I. Du Pont (NYSE: DD ), Intel (NASDAQ: INTC ), Wal-Mart (NYSE: WMT ) and Exxon Mobil (NYSE: XOM ). Component 50-Day Moving Average 52-Week High 50-Day From 52-Week AAPL $118.85 $134.54 13.20% AXP $77.86 $94.89 21.87% BA $142.00 $158.83 11.85% CAT $78.37 $109.73 40.02% CSCO $27.73 $30.31 9.30% CVX $86.57 $129.53 49.62% DD $55.22 $76.59 38.70% DIS $111.93 $122.08 9.07% GE $25.89 $28.68 10.78% GS $202.66 $218.77 7.95% HD $116.40 $123.80 6.36% IBM $158.29 $195.00 23.19% INTC $28.67 $37.90 32.19% JNJ $98.74 $109.49 10.89% JPM $67.46 $70.61 4.67% KO $40.76 $45.00 10.40% MCD $98.04 $101.88 3.92% MMM $149.69 $170.50 13.90% MRK $57.75 $63.62 10.16% MSFT $45.81 $50.05 9.26% NKE $112.86 $117.72 4.31% PFE $34.78 $36.46 4.83% PG $77.04 $93.89 21.87% TRV $104.45 $110.49 5.78% UNH $120.64 $126.21 4.62% UTX $100.33 $124.45 24.04% V $72.82 $76.92 5.63% VZ $46.73 $51.73 10.70% WMT $70.97 $90.97 28.18% XOM $78.56 $99.67 26.87% Next, using the “rule” that a correction requires a decrease of 10%, American Express (NYSE: AXP ) and Traveler’s Companies (NYSE: TRV ) were both eliminated. Component 50-Day Moving Average August 24th Low Low From 50-Day AAPL $118.85 $92.00 29.18% AXP $77.86 $71.71 8.58% BA $142.00 $115.14 23.33% CSCO $27.73 $23.03 20.41% DIS $111.93 $90.00 24.37% GE $25.89 $19.37 33.66% GS $202.66 $172.10 17.76% HD $116.40 $92.17 26.29% IBM $158.29 $143.00 10.69% JNJ $98.74 $81.79 20.72% JPM $67.46 $50.07 34.73% KO $40.76 $36.56 11.49% MCD $98.04 $87.50 12.05% MMM $149.69 $134.00 11.71% MRK $57.75 $45.69 26.40% MSFT $45.81 $39.72 15.33% NKE $112.86 $94.50 19.43% PFE $34.78 $27.51 26.43% PG $77.04 $65.02 18.49% TRV $104.45 $95.21 9.70% UNH $120.64 $95.00 26.99% UTX $100.33 $87.17 15.10% V $72.82 $60.00 21.37% VZ $46.73 $38.06 22.78% Likewise, if a company recovered to within 10% of its 52-week high, it doesn’t seem that company would be offering a “bargain” opportunity. That’s not to say the company is not fairly valued. However, if the goal is to take advantage of volatility, there may be companies with more room left to run. This filter eliminated Home Depot (NYSE: HD ), McDonald’s (NYSE: MCD ), Nike (NYSE: NKE ), United Healthcare (NYSE: UNH ) and Visa (NYSE: V ). Component August 29th Close 52-Week High Current to 52-Week AAPL $113.29 $134.54 18.76% BA $133.24 $158.83 19.21% CSCO $26.00 $30.31 16.58% DIS $102.48 $122.08 19.13% GE $25.16 $28.68 13.99% GS $187.75 $218.77 16.52% HD $117.52 $123.80 5.34% IBM $147.98 $195.00 31.77% JNJ $95.17 $109.49 15.05% JPM $64.13 $70.61 10.10% KO $39.45 $45.00 14.07% MCD $96.25 $101.88 5.85% MMM $144.21 $170.50 18.23% MRK $55.37 $63.62 14.90% MSFT $43.93 $50.05 13.93% NKE $112.50 $117.72 4.64% PFE $32.66 $36.46 11.64% PG $71.21 $93.89 31.85% UNH $117.28 $126.21 7.61% UTX $93.24 $124.45 33.47% V $72.46 $76.92 6.16% VZ $46.07 $51.73 12.29% Speaking of recovering, if a company’s share price did not “bounce” back this week, that may suggest weakness. It seemed reasonable to expect at least a 50% bounce or recovery from Monday’s lows. Filtering for components with a recovery of less than 50% eliminated International Business Machines (NYSE: IBM ) and United Technologies (NYSE: UTX ). Component August 24th Low August 29th Close 50-Day Moving Average Percentage Recovered AAPL $92.00 $113.29 $118.85 79.29% BA $115.14 $133.24 $142.00 67.39% CSCO $23.03 $26.00 $27.73 63.19% DIS $90.00 $102.48 $111.93 56.91% GE $19.37 $25.16 $25.89 88.80% GS $172.10 $187.75 $202.66 51.21% IBM $143.00 $147.98 $158.29 32.57% JNJ $81.79 $95.17 $98.74 78.94% JPM $50.07 $64.13 $67.46 80.85% KO $36.56 $39.45 $40.76 68.81% MMM $134.00 $144.21 $149.69 65.07% MRK $45.69 $55.37 $57.75 80.27% MSFT $39.72 $43.93 $45.81 69.13% PFE $27.51 $32.66 $34.78 70.84% PG $65.02 $71.21 $77.04 51.50% UTX $87.17 $93.24 $100.33 46.12% VZ $38.06 $46.07 $46.73 92.39% The club has a predominant goal of a 10% annual return for our portfolio. With total shareholder return as the focus, it’s natural to look at the dividend yield of the components. The current average yield of the DJIA is 2.86%. Of the remaining fifteen components, Disney (NYSE: DIS ) and Goldman Sachs (NYSE: GS ) are not offering a yield at half that mark. Therefore, both were moved to the eliminated bucket. Component August 29th Close Dividend AAPL $113.29 1.84% BA $133.24 2.73% CSCO $26.00 3.23% DIS $102.48 1.29% GE $25.16 3.66% GS $187.75 1.38% JNJ $95.17 3.15% JPM $64.13 2.74% KO $39.45 3.35% MMM $144.21 2.84% MRK $55.37 3.25% MSFT $43.93 2.82% PFE $32.66 3.43% PG $71.21 3.72% VZ $46.07 4.78% At this point, seventeen of the thirty components have been eliminated. In theory, the list now contains thirteen companies with room left to run and a yield tallying at least half the average of the index. Specifically for my club, we already own four companies on the remaining list. It would be easy to just focus on the nine that are left. But, the wiser option would be to include them and evaluate whether any of our four merit a reinvestment. Focusing on the total potential for return aligns with our club goal of 10% annual return. In ten of the thirteen remaining components, the one-year target exceeds the 52-week high. Only 3M (NYSE: MMM ), Procter & Gamble (NYSE: PG ) and Verizon (NYSE: VZ ) have one-year targets below their respective 52-week highs. For the sake of being conservative, when calculating the potential growth for share price appreciation for each of the thirteen, the lower of the 52-week high or the one-year target is used. Calculating the remaining growth from share price appreciation equates to a range of 10.1% to 19.2%. It would be easy to simply eliminate the lowest five companies. However, the company with one of the lowest growth potential rates, Verizon, also happens to offer the best dividend yield at 4.78%. Therefore, it is prudent to add the potential growth for share price appreciation to the dividend yield. In order to achieve a 10% annual return, the club typically targets potential returns of 20%. Thus, even if a company achieves just half its goal, the club hits its target. As shown, at current prices, three of the components offer a potential return over 20% – Procter & Gamble, Boeing (NYSE: BA ) and Apple (NASDAQ: AAPL ). Cisco (NASDAQ: CSCO ) also comes very close. Ironically, these are the four companies in which the club already has positions. Thus, all four companies will be considered for reinvestment when prices are near the August 28th closing price. Component August 28th Close 52-Week High or One-Year Target Potential Growth Dividend Potential Total Return PG $71.21 $84.50 18.66% 3.72% 22.38% BA $133.24 $158.83 19.21% 2.73% 21.94% AAPL $113.29 $134.54 18.76% 1.84% 20.59% CSCO $26.00 $30.31 16.58% 3.23% 19.81% JNJ $95.17 $109.49 15.05% 3.15% 18.20% MRK $55.37 $63.62 14.90% 3.25% 18.15% GE $25.16 $28.68 13.99% 3.66% 17.65% KO $39.45 $45.00 14.07% 3.35% 17.41% MMM $144.21 $164.31 13.94% 2.84% 16.78% MSFT $43.93 $50.05 13.93% 2.82% 16.75% VZ $46.07 $51.42 11.61% 4.78% 16.39% PFE $32.66 $36.46 11.64% 3.43% 15.06% JPM $64.13 $70.61 10.10% 2.74% 12.85% For the purpose of considering new positions in the next six companies on the list above, Johnson & Johnson (NYSE: JNJ ), Merck (NYSE: MRK ), General Electric (NYSE: GE ), Coca-Cola (NYSE: KO ), 3M, and Microsoft (NASDAQ: MSFT ), the club would have to take advantage of volatility and market pullbacks. A buy point must be determined which fulfills the goal of a potential return of at least 20%. As prices fall, the dividend yield will rise as will the potential growth in share price appreciation. The next table establishes buy points based on these changes. Component Buy Point 52-Week High or One-Year Target Potential Growth Dividend Potential Total Return JNJ $93.74 $109.49 16.80% 3.20% 20.00% MRK $54.51 $63.62 16.71% 3.30% 20.01% GE $24.66 $28.68 16.30% 3.73% 20.03% KO $38.60 $45.00 16.58% 3.42% 20.00% MMM $140.34 $164.31 17.08% 2.92% 20.00% MSFT $42.74 $50.05 17.10% 2.90% 20.00% Since the club is already familiar with four of the top six components, this exercise actually identified the top 33% (10) of the DJIA components relative, primarily, to weathering the week. The next step for my investment club is to determine if any of the next six companies kindle an interest. If so, our buy points are established. Disclosure: I am/we are long AAPL, BA, CSCO, DIS, INTC, NKE, PG, V. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
Scalper1 News