Earlier this month, Standard & Poor's downgrade of U.S. debt caused a stir on Wall Street and in the political world. And that wasn't the only poor review that the credit rating agency handed out. S&P also downgraded the debt of a handful of major insurers, and issued negative outlooks on some others.
The downgrades and changes in outlook were the latest part of a lengthy trend. Back in the early 1980s, about 60 U.S. companies had triple-A credit ratings; by 2000, the number was down to about 15. Today, only four remain: Microsoft Corp., Exxon Mobil Corp., Johnson & Johnson, and Automatic Data Processing Inc.
S&P offered some good news for those companies, reiterating their triple-A ratings. It also affirmed its strong double-A-plus ratings for General Electric and W.W. Grainger Inc., saying these six companies wouldn't be impacted by the U.S. downgrade.
In Canada, too, only a handful of stocks get top-notch credit ratings. Moody's Investors Service Inc., another of the major credit rating groups, has long-term outlooks on 68 Canadian companies with "investment-grade" corporate debt. Only 20 or so get any type of A rating for the long term.
All the credit rating talk got me wondering if the stocks of the highest-rated firms in the U.S. and Canada look as good as their bonds. I used my "Guru Strategies" – each of which is based on the approach of a different investing great – to analyze the six U.S. firms mentioned above, and the publicly-traded Canadian companies that get any type of A rating from Moody's.
I found a mixed bag. In the U.S., four of the six get solid scores; in Canada, only a few of Moody's A-level companies are publicly traded on Canadian exchanges, and those that are – like Canadian National Railway – don't excite my gurus' models. ADP, Exxon, Suncor and CNR all fell short, largely because of weak earnings growth or share valuations that were too high.
Here's a look at the four U.S. firms that are both at the top of the credit heap and appear to have attractive shares.
Microsoft: Bill Gates's software behemoth doesn't get much love from Wall Street, but it should, according to a couple of my models.
My Peter Lynch-based strategy considers it a "stalwart," the type of big, steady firm that holds up well in recessions, thanks to a moderate earnings-per-share growth rate of 15.9 per cent and high sales (nearly $70-billion U.S. per year).
My Warren Buffett-based model, meanwhile, likes Microsoft's earnings consistency, manageable debt and 27.9-per-cent average return on total capital over the past decade, a sign of the "durable competitive advantage" Mr. Buffett looks for.
Johnson & Johnson: This New Brunswick, N.J.-based health-care giant ($176.9-billion market cap) is one of the largest companies in the world, and also one of the steadiest. Spanning 60 countries, it has increased adjusted earnings in 27 straight years and dividend payouts in 49 straight years.
It's a favourite of my James O'Shaughnessy-based value model, which looks for large firms with strong cash flows and high dividend yields. J&J certainly has the size, and it's also generating $5.34 in per-share cash flow, which is more than four times the market mean of $1.29. Plus, it's offering a solid 3.6-per-cent yield.
My Buffett-based model also gives the stock solid marks. It likes the fact that the firm has increased EPS in all but two of the past 10 years, has enough annual earnings that it could pay off all its debt in a little over a year, and has a 23.1-per-cent average return on total capital over the past decade.
W.W. Grainger: Based in Lake Forest, Ill., Grainger offers more than a million products designed to keep facilities up and running, ranging from adhesives to motors to lighting to security systems. It has two million business and institutional customers in more than 150 countries, and has a $9.6-billion market cap.
My Buffett-based model likes Grainger, which has increased EPS in all but two years of the past decade. The firm is also conservatively financed, with annual earnings that are nearly three times its debt, and it has averaged a solid 16.3-per-cent return on equity over the past decade.
General Electric: With origins that stretch back 120 years ago to Thomas Edison, this Fairfield, Conn.-based light bulb pioneer has grown into a diversified giant, with operations in more than 100 countries and more than $150-billion in annual sales. The firm, which is active in the energy, health, transportation, financial, and infrastructure arenas, is a favourite of my O'Shaughnessy-based value model, thanks to its size, $2.27 in cash flow per share, and strong 3.8-per-cent yield.
Disclosure: I'm long Microsoft and GE.
John Reese