The 12 Highest Quality Blue Chips You Can Buy Right Now (2024)

(Source: Imgflip)

Short-Term Economic Outlook Turns Very Dark... But There Is Light At The End Of The Tunnel

In each of my articles, I start by summarizing the latest developments of the fast-moving pandemic/global recession which is now all but certain to happen.

Right now we're 10 hours away from March 19's daily close on new cases.

• 240,648 cases
• 21,840 new cases today

At some point, new cases will peak and stabilize as global containment efforts start working. When that is we can't know, but it generally takes 2 to 4 weeks after lockdowns are initiated.

Italy locked down on March 9, and France and Spain soon after. So within the next week, we will hopefully see Italy peak and begin drifting lower, as has occurred in South Korea and China.

However, as tragic as the deaths of 9,953 people and counting are, what has the market freaking out on a daily basis is the economic ramifications of beating this virus.

The latest economic forecasts are now in from Bank of America (BAC) and JPMorgan (JPM).

The economists forecast that US gross domestic product will collapse in the second quarter, falling 12% on a seasonally adjusted annual rate basis - the biggest quarterly decline in post-war history - after growing only 0.5% in the first quarter of 2020. For the full year, the bank is forecasting a contraction of 0.8%...

One positive factor going forward that Bank of America expects is that the economy will return to growth in the third quarter of the year. "- Business Insider (emphasis added)

Bank of America's model is in line with JPMorgan's, and JPMorgan is even more frightening, though there is also good news there as well.

• China Q1 growth: -40% YOY, worst in 50 years in any country
• Global economy Q1: -12% (due to China)
• Global economy Q2: -1% (China bounces back)
• US Q2: -14%
• Europe Q2: -22%
• UK Q2: -30%
• US Unemployment rising from 3.5% to 6.3% in Q2, falling to 5.3% by the end of the year

If a normalization in activity from depressed levels takes hold midyear alongside building policy stimulus, the depth of the current downturn can be seen as a springboard for a strong snapback in growth," Kasman said."- CNN

JPMorgan's model is the most pessimistic thus far. Goldman Sachs (GS) is expecting -5% growth in Q2 GDP and the current blue-chip consensus (updated weekly) is for -2%.

(Source: MarketWatch)

The consensus forecast is likely going to get worse, given that JPMorgan happens to be one of the 16 most accurate economic teams that make up the blue-chip consensus.

Obviously, we need to confirm these models with actual data but that's not looking promising so far.

David Rice is one of Seeking Alpha's top economic gurus and runs the BaR economic grid.

• Follow These Indicators To Know If, And When, A Recession Will Occur

The coming weeks could be an ugly one for econ nerds like me. It's a veritable minefield of potentially disappointing news.

Joshua Brown, CEO of Ritholtz Wealth Management, put it plainly a few days ago.

You must be fully prepared for both foreboding news about the contagion’s spread and, yes, even the death rate. You must also be prepared for how bad the March economic numbers are going to be relative to February. Some of these comps are going to be so astounding that they’ll look like typos. And it’s highly doubtful that anything turns sharply higher in April" - Joshua Brown (emphasis added)

Goldman Sachs estimates 2.4 million new jobless claims are coming this week. Bank of America estimates the number at 3 million, Morgan Stanley (MS) 3.4 million and Citigroup (C) 4 million. The following week may be worse since 23% of the nation's population was locked down after that data was collected.

Things are going to suck and in a big way, in the coming months. There is no denying this, so we must be prepared for the horrifying economic reports that are coming.

(Source: quote fancy)

So if we are facing an ugly quarter of growth, then why am I still invested? Why am I writing articles recommending companies to buy now?

I am not recommending anyone ever go "all in" because that's market timing. I'm saying have a watchlist of quality names that fit your needs and buy in stages, nibbling, not gulping, stocks opportunistically.

Proper asset allocation, meaning the mix of cash/bonds you own as well as stocks, is often a great source of dry powder, as well as helping you sleep well at night.

Bonds have always acted as a shock absorber to stock market declines.

Bonds can provide dry powder to rebalance into the stock market or pay for current expenses when the stock market inevitably goes through a nasty downturn." - Ben Carlson, Ritholtz Wealth Management, (Emphasis added)

So now that you're aware of the latest developments, hopefully, you are prepared to take advantage of the incredible bargains we have available today.

(Source: quote fancy)

The 12 Highest Quality Dividend Stocks You Can Buy Right Now

As always, I begin by screening out the companies on the Master List that are above fair value.

• 326 companies fair value or better

Next, we must define what we mean by quality. There are several objective and subjective metrics I use.

• quality score (dividend safety + business model + management quality)
• dividend safety (especially important right now with fundamentals severely impacted temporarily)
• credit rating: vitally important in a global liquidity crunch
• return on capital: Joel Greenblatt's favorite proxy for quality/moatiness
• dividend growth streak: Ben Graham considered 20+ years a sign of high quality

Some of these metrics are obvious to many. Others are new to some readers.

Companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above-average profits." - Joel Greenblatt

Joel Greenblatt defined return on capital as annual pre-tax profit (EBIT) divided by operating capital, the total money invested into anything needed to run the business.

For example, if a company has $10 million in plant, equipment, offices, and working capital, and generates $5 million per year in pre-tax profit then its return on capital is 50%.

What's a good return on capital? That will depend on the industry but here are the summary stats on the entire Master List.

• the average return on capital: 84% = 81st industry percentile (top 19% of industry peers) = VERY high quality
• average 13-year median ROC (smooths out industry cycles): 96% = very high quality
• average 5-year ROC trend: +1% CAGR (wide and stable moat/quality)

ROC doesn't work well in some sectors or industries, such as REITs, energy, utilities, and some financials (banks and insurance companies). But for most corporations, it's a great way to compare the quality of a company within its industry.

Next, there's Ben Graham, the father of modern security analysis, value investing, and Buffett's mentor.

One of the most persuasive tests of high-quality is an uninterrupted record of dividend payments going back over many years. We think that a record of continuous dividend payments for the least 20 years or more is an important plus factor in the company’s quality rating.” - Ben Graham, The Intelligent Investor (emphasis added)

Note that Graham doesn't actually consider it necessary for a company to have a dividend growth streak of 20 years, just pay uninterrupted dividends for two decades or more.

But any company that can not only continue paying dividends across an average of two recessions or more, but raise them each year in all market/economic/industry conditions is not just high quality, but very high quality.

So let's take the 326 reasonably to attractively priced companies we have remaining and next select for quality and safety.

• 224 companies are 9+/11 blue chip or better quality
• remove the five energy names due to likely downgrade in this week's update: 219 remaining.
• remove anything without a 5/5 very safe dividend: 181 companies remain

Next, we have to consider credit ratings because the credit markets are starting to tighten as a result of the recession.

(Source: S&P)

A actually refers to the range of A- to A+ and an A-rated company has about 3.6% 30-year default risk. Since bonds are the most senior in the capital stack, an A-rated company is something income investors can take comfort in during troubled economic times.

• eliminate anything not A-rated or better: 90 companies remain

Now let's apply the 20+ year dividend growth streak, which Ben Graham says is a sign of not just good quality, but very good quality.

• 37 companies with 20+ year dividend growth streaks + 9/11 or higher blue-chip quality+ 5/5 very safe dividends + A-credit ratings

Finally, let's apply Greenblatt's return on capital screens

• eliminate anything with returns on capital not in the top 25% of its industry: 21 companies

Now we have a collection of world-class dividends stocks, at reasonable to attractive valuations.

So let's rank them by return on capital and select the 12 highest.

(Source: Dividend Kings valuation tool) green = potential good buy, blue = potential reasonable buy

The 12 highest quality companies you can buy at a reasonable or good price are

• Automatic Data Processing (ADP)- 242% Return on capital = 95^th industry percentile
• Alibaba (BABA)-230% ROC = 98% percentile
• General Dynamics (GD)-125% ROC = 97% percentile
• Colgate (CL)-94% ROC = 97% percentile
• Medtronic (MDT)-73% ROC = 92% percentile
• Diageo (DEO)-68% ROC = 86% percentile
• Stryker (SYK)-66% ROC = 89% percentile
• Novo Nordisk (NVO)-65% ROC = 96% percentile
• Roche (OTCQX:RHHBY)-55% ROC = 93% percentile
• Pepsi (PEP)-53% = 90% percentile
• (SWK)-50% ROC =94% percentile
• Ecolab (ECL)-39% ROC = 90% percentile

Alibaba isn't a dividend stock, but the goal here was the highest-quality companies and even dividend portfolios can include a few pure growth names (I own Amazon (AMZN)).

Fundamental Stats On These 12 Companies

• average quality: 10.4/11 SWAN quality vs. 9.7 average dividend aristocrat and 7.0 average S&P 500 company
• average dividend safety: 5/5 very safe = 4.7 average aristocrat and 3.0 S&P 500 average
• average yield: 2.4% vs. 2.4% S&P 500 and 2.6% most dividend growth ETFs
• average valuation: 19% undervalued (good buy) vs. S&P 15% undervalued = good buy
• average dividend growth streak: 36.1 years = dividend aristocrat
• average 5-year dividend growth rate: 8.5% CAGR
• average analyst long-term growth consensus: 9.7% CAGR vs. 6.3% S&P since 2000
• average forward P/E ratio: 16.7 vs. 13.9 S&P 500
• average PEG ratio: 1.72 vs. 1.64
• average return on capital: 97% = 93rd industry percentile (very high-quality by Greenblatt's definition)
• average 13-year median ROC: 99% (relative stable moats/quality)
• average 5-year ROC trend: +0% CAGR (improving moats/quality)
• average credit rating: A+ (very strong balance sheets, very high-quality)
• average annual volatility: 21% vs. 15% S&P 500, 26% Master List Average, 22% average aristocrat
• average market cap: $119 billion mega-cap
• average 5-year total return potential: 2.4% yield + 9.7% growth +4.4% CAGR valuation boost = 16.5% CAGR (12% to 21% CAGR with 25% margin of error)

These 12 stocks collectively combine to form a portfolio that yields the same as the S&P 500, but is expected to grow faster, is slightly more undervalued and is objectively much higher quality.

Thus, it should be no surprise that it's expected to deliver superior long-term returns to the S&P 500.

(Source: F.A.S.T. Graphs, FactSet Research)

As Ben Graham explained, over the long term, the market always correctly "weighs the substance of a company." Thus the ultimate determination of quality comes from long-term returns.

Highest Quality Stocks Since 2004 - Annual Rebalancing

(Source: Portfolio Visualizer)

• yield in 2004: 1.6%
• 2019 yield on cost: 13.3%
• 15.3% CAGR dividend growth over 15 years

Since 2004 this portfolio would have beaten the market by 50% annually while delivering slightly lower annual volatility. Thus the excess total returns/negative volatility or Sortino (reward/risk) ratio was 69% better.

What's more exciting is that today these 12 companies are collectively more undervalued than back in 2004, allowing long-term investors to expect similar if not slightly better returns.

Of course, right now the market is terrified and so let's consider the volatility of these stocks.

(Source: Portfolio Visualizer)

Other than Pepsi, none of these stocks is less volatile than the market (15% annual standard deviation). Combine them together, however, and you get a less volatile portfolio with superior long-term results.

But the fact is that negative volatility is the cost of doing business on Wall Street. Anyone who can't stomach sharp drops in stock prices is too heavily exposed in equities and needs more cash/bonds.

Highest Quality Stocks Peak Declines Since 2004

(Source: Portfolio Visualizer)

Normally, bonds go up when stocks fall. But nothing is ever guaranteed on Wall Street in any given downturn or in the short term.

This is why these 12 companies should be owned as part of a diversified and properly risk-managed portfolio. That means a reasonable asset allocation, the mix of stocks/bonds/cash that will let you enjoy the gains but survive the declines too.

As the saying goes "stocks let us eat well, bonds let us sleep well."

Here are some great cash equivalents you can own that did not break down like those that owned significant amounts of corporate bonds.

• SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL)
• Goldman Sachs Treasury Access 0-1 year ETF (GBIL)
• Schwab Strategic Trust - Schwab Short-Term U.S. Treasury ETF (SCHO)
• Vanguard Short-Term Treasury ETF (VGSH)

Cash Equivalents That Do What They Are Supposed To In A Crisis

(Source: YCharts)

Let's build a balanced portfolio to show you can a reasonable allocation to bonds and cash can combine with the highest quality companies to generate strong long-term income and wealth compounding.

• 10% BIL (CASH)
• 10% iShares Core U.S. Aggregate Bond ETF (AGG) - intermediate bonds
• 10% SPDR Portfolio Long Term Treasury ETF (SPTL) - long maturity US treasuries

Highest Quality Balanced Portfolio Since 2008 (Great Recession) - Annual Rebalancing

(Source: Portfolio Visualizer)

This portfolio was 10% more in stocks since 2008, near the market peak in October 2007. Yet, thanks to owning superior quality companies, it experienced the same overall volatility as a 60/40 stock/bond portfolio.

(Source: Portfolio Visualizer)

This is what I mean by a "diversified and risk-balanced portfolio." This balanced portfolio fell 24% during the Great Recession, beating a 60/40 balanced portfolio by 7% and falling 33% less than the S&P 500.

This is what I mean by sleep well at night bunker retirement portfolio. You can't avoid a decline during a bear market. But you can ride out the downturn because the cash will keep you liquid and fund expenses during periods when both stocks and bonds are falling.

During normal recessions, bonds are also rising, so once you're out of cash, you start selling those at a profit (or at least breakeven) rather than stocks.

The Bigger The Decline The Higher The Future Returns

(Source: Michael Batnick)

Why do you put up with bear markets? Because the bigger the decline the stronger the recovery.

Bonds and cash are your ballast and store of value. They are there to hedge and minimize volatility, helping you sleep at night and fund expenses.

Stocks are what generates the most income over time (bond interest payments never grow) as well as the strongest returns.

Bottom Line: The Best Time To Buy Quality Stocks Is During Market Panics Like This

The more frightening the market, the richer the returns, across all time frames.

Owning stocks means you own a real piece of an actual business.

The stock prices on your screen say nothing about what these companies are worth...I promise you one thing: The value of your companies doesn’t change 8% a day, day after day."- Vitaliy Katsenelson, CEO of asset management firm IMA (emphasis added)

With ADP, BABA, GD, CL, MDT, DEO, SYK, NVO, RHHBY, PEP, SWK and ECL you can buy some of the objectively highest quality companies on earth.

They are now available at reasonable or attractive valuations, some for the first time in many years. As Nick Maggiulli, a data scientist for Ritholtz Wealth Management pointed out, if you aren't willing to buy these companies after a bear market crash, when will you buy them?

It's cash/bonds and proper asset allocation that is the core of sound risk management.

These are the guidelines I use in my retirement portfolio and all the portfolios I manage. They are meant to be sound and reasonable for most people but feel free to alter them for your specific needs. What matters is having a plan you can realistically stick to, even when the market panics as it is now.

The point is that you can't know what tomorrow will bring, only have a general idea of what will happen over the next 5+ years.

(Source: Imgflip)

I can't promise you stocks will be up in a few months, but what I can tell you is that it's extremely likely they will be much higher in 5+ years. How likely? About 87.5% probability.

Those are the kind of low-risk/high probability recommendations I love making, especially when the best quality companies are on sale.

As Greenblatt said, "Buying good businesses at bargain prices is the secret to making lots of money."

I need everyone reading this to understand what's coming next is going to be historic, a generation-defining moment in history.

I proudly served our nation in the Army Medical Services Corps during the global war on terror. Now I am being asked to serve my country, and indeed the very world, in another capacity.

The next few months are likely to be some of the most painful economically that any of us will ever experience. The global war against this virus must be won, and it will be won, with the determination of all the people of the world.

It's only a matter of time, resolve, and a relentless determination to not give in to fear, panic, or despair.

The rebuilding process after COVID-19 has passed will be historic, will likely take years, but if we all come together as a nation, and a planet, then we will surely get through this crisis as we have overcome literally every other challenge that has stood before generations past.

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