Submitted by
Fast
Graphs
as part of our
contributors program
.
This is the fourth in a series of articles designed to counter a
pervasive attitude that common stocks are expensive today.
Furthermore, we would agree with those that contend that we have
been in a stealth bull market for the last 18 months or more.
However, would also contend that stocks were so cheap prior to this
stealth bull-run that even though they have risen, there are still
many stocks that remain fairly priced and even many that are
undervalued. Blue-chip Dividend Aristocrats represent one of the
best examples of our thesis.
A second, but very important additional theme of this series of
articles focuses on the reality that it is, in truth, a market of
stocks and not a stock market. Therefore, we argue that
investors and their portfolios are best served by focusing on
specific companies they may be interested in investing in, in lieu
of worrying about the general levels of broad markets and/or the
economy, etc. Links to our previous articles can be found here:
Part 1
,Part 2 andPart 3 .
Blue-Chip Dividend Aristocrats - Many Attractive Buying
Opportunities
The equity asset class that many believe is overvalued is the
high-quality dividend growth stock. This perception has been
created in part because many of these stocks have performed well
lately. However, as we will illustrate later, many in this
group were so undervalued that even after their prices rose they
have only become fairly valued, while some still remain
undervalued.
The prestigious Standard & Poor's Dividend Aristocrat list
is comprised of 50 companies that have increased their dividends
for 25 or more years in a row. Thanks to the almost effortless
efficiency of theF.A.S.T. Graphs™ fundamentals analyzer software
tool, it has been an easy task to run through this list of 50
quality dividend growth stocks one at a time. Therefore, a
clear perspective of the valuation on each constituent was easily
and quickly accomplished. We believe this is far superior to
relying on a vague idea about valuations based on notions of the
markets at large, or pre-judgments about a large group.
This exercise empowered us to organize the Standard & Poor's
Dividend Aristocrat list into four simple groups based on
valuation. With so many investors perceiving stocks as
generally overvalued, the results were quite gratifying. Of the 50
Blue-chip Dividend Aristocrats, we found 23 that were fairly valued
to undervalued, 16 that were moderately overvalued, only 8 that we
felt were dangerously overvalued, and finally, 3 that we felt had
fundamental issues. The following tables and individual
examples will be presented in reverse order, starting with the most
overvalued and moving on to where we see the best valuations.
Dangerously Overvalued Dividend Aristocrats
The label "dangerous overvaluation" refers to Dividend
Aristocrats whose prices have risen far enough above rational
earnings justified valuations that short to intermediate-term price
movements could result in temporary losses of 20% or greater.
However, because of the quality of these names and their long-term
consistent records of earnings and dividend growth, each of these
eight names are still expected to generate positive long-term total
returns in spite of today's overvaluation.
Therefore, the real message here is that we believe investors
would be best advised to wait patiently for what we believe will be
inevitable corrections, representing better entry points. In
concert, this would also imply that current owners might want to
consider either lightening up on these positions or even outright
sales of the total position. Moreover, the reader should
recognize that this is primarily a valuation recommendation,
because most of the companies on this list are superb businesses
with great long-term operating records. In other words, we
like the stocks, but not their current prices.
The following table lists the eight dangerously overvalued
Dividend Aristocrat constituents by order of highest expected
future return to the lowest. As a valuation measurement, we believe
the highlighted column "EPS Yld%" provides important insight into
valuation. A preponderance of historical evidence has led us
to conclude that a minimum earnings yield of 6.5% to 7% is required
for fair value to be present. Therefore, the reader will
notice that all of the names on this list possess earnings yields
below 5%. In other words, this suggests that the company's
earnings and cash flows do not adequately compensate investors for
taking the risk of owning the equity.
Sherwin-Williams Co. (
SHW
): A Clear Picture Of Overvaluation
A quick glance at the following earnings and correlated F.A.S.T.
Graphs ™ on Sherwin-Williams vividly displays how the company's
stock price has currently deviated from its intrinsic value.
Moreover, it is clear that this is completely unsupported by
historical precedent. Furthermore, it's important that we focus on
the fact that Sherwin-Williams was very reasonably priced at the
beginning of 2004, and essentially stayed that way until
inexplicably price started deviating in late 2011.
We believe the Sherwin-Williams' example illustrates one of the
great dangers of relying on statistical data when looking for
investment candidates. The 10-year track record of this
high-quality dividend aristocrat that has produced a compounded
annual return in excess of 19% per annum could easily entice
investors into believing that it is an excellent investment
choice. However, we would argue that the proper view would be
that Sherwin-Williams was an excellent investment choice in
2004. On the other hand, we believe the picture above clearly
illustrates that this company is dangerously overvalued today.
Even looking to the future, and acknowledging that
Sherwin-Williams is expected to have accelerated earnings growth in
excess of 15%, still does not justify today's high valuation.
Consequently, we feel that now would be an excellent time to
lighten up on, or even completely sellout of, this high-quality
Dividend Aristocrat. We believe it would even be prudent to hold
the cash with a parentheses around it that says "this money is
earmarked to be returned to Sherwin-Williams when its valuation
inevitably comes back in alignment with earnings." However,
there are not many investors that possess this kind of discipline
or rational thought.
Moderately Overvalued Dividend Aristocrats
When we examine the 16 moderately overvalued Dividend Aristocrat
constituents, we are presented with an interesting challenge.
Even though past and present operating results play an important
role in the valuation decision, we believe that the greatest weight
should be given to the forecasts of the future operating potential
of each company. The challenge that this presents rests with
the accuracy of the forecasts. For example, if the estimated
future earnings growth is too low, then these companies may not be
overvalued after all, and vice versa.
Nevertheless, looking at an earnings and price correlated
F.A.S.T. Graphs ™ provides a great deal of information and insight
that can be useful in regards to making this kind of determination.
Furthermore, if we accept the consensus forecasts provided by
leading analysts, we discover that our earnings yield, although
below are 6.5% to 7% threshold, is closer to fair value than we saw
with what we designated as the dangerously overvalued group.
McDonald's Corp. (
MCD
) - Moderate Overvaluation?
McDonald's Corp. represents a classic example of moderate
overvaluation. Technically, the current PE of 17 is supported
by the company's normal PE ratio since calendar year 2009 (post
recession). On the other hand, since McDonald's is currently
trading at a PE ratio greater than 15, which would be the earnings
justified valuation calculation of intrinsic value, it is
technically moderately overvalued. Furthermore, even when
viewing this chart, that only provides 4 years and 10 months of
actual history (note that estimates for calendar year 2013 are
included on this graph), we see several times where McDonald's
stock price was touching the orange line representing fair
value. Consequently, the patient investor may be wise to wait
for an entry point when McDonald's is firmly in value.
In other words, this could imply that a patient investor might
get the opportunity for a more attractive entry price. On the
other hand, buying it today might not be so terrible either. This
is the conundrum that moderate overvaluation presents. More
simply stated, we would not consider McDonald's Corp. dangerously
overvalued by any stretch of the imagination. Perhaps, the
term fully valued would be more appropriate, and might also apply
to most of the other 15 examples in this moderately overvalued
group.
Fundamental Issues
- Dividend Aristocrats
There were 3 of the 50 Dividend Aristocrats that cause us
concern based on what we would call real or potential fundamental
issues. Ironically, two of these three, Pitney Bowes Inc. (
PBI
) and Chubb Corp. (
CB
) show earnings yields that are significantly greater than our 6.5%
to 7 % threshold. On the other hand, both of these companies have
operating histories that, at the very least, make us question the
reliability of future growth. Perhaps even more ironically,
we might favor Leggett & Platt (
LEG
) over the other two, yet it is the only one with an earnings yield
below our threshold.
We believe this simply validates our belief that there is no
substitute for comprehensive research. On the other hand, we
believe that powerful tools such as F.A.S.T. Graphs ™ can certainly
make that effort easier and more efficient. Statistics alone
will often mislead investors if they don't have a clear picture of
what is really transpiring within a given business.
Pitney Bowes Inc (
PBI
): A Clear Picture of Deteriorating Earnings
Companies that are found on prestigious lists such as the
Standard & Poor's Dividend Aristocrats or
David Fish's Dividend Champions
would imply strong companies based on their long-term histories of
raising their dividends each year for at least 25 consecutive
years. And frankly, and even for the most part, those
implications would prove true. However, deeper research can
often indicate otherwise. Pitney Bowes Inc. appears to be a company
that deviates from the strong company assumption.
A quick glance at the earnings and price correlated graph below
shows that earnings have been in a freefall since the great
recession of 2008. However, a more cursory look at the
current dividend yield of 11% on a Dividend Aristocrat that has
increased its dividend every year for 25 years seems quite
alluring. Consequently, we offer this as a prime example of
how simple statistics like dividend yield and even Pitney Bowes'
low PE ratio of 6.6, looked at in isolation, can be misleading.
When you review Pitney Bowes' price performance over the past 15
years there are two issues that need to be considered. First
of all, this company was clearly massively overvalued at the
beginning of 1999. Then, stock price appropriately tracked
earnings up to and including the great recession. Since that
time both earnings and stock price have been in a freefall.
But perhaps the most telling factoid indicating a red flag is that
dividend growth has slowed to a crawl over the past three
years.
However, in all fairness to Pitney Bowes, we would suggest that
prospective investors should look much deeper into what is
currently happening with this company. If the last few years
are any indication, then this company may be on the threshold of
becoming a fallen angel. Currently, only a few analysts are
following the company and are forecasting zero growth going
forward. Finally, Pitney Bowes' high debt load represents
another caveat. Finally, the primary learning point here is
that you can't rely on statistical representations of valuations
based on measurements such as average PE ratios or even earnings
yield, without seeing all these facts in relation to each
other. In other words, a picture is truly worth 1000
words.
Dividend Aristocrats: Good Values - Good
Buys
A quick run through of the individual earnings and price
correlated graphs on the 23 Dividend Aristocrats that appear to be
attractively valued, validate that they are. Of course, some
are more favorably valued than others, and one name, Family Dollar
Stores (FDO), could have easily been included with our moderately
overvalued group. In other words, there are ranges of
valuation and no absolute or precise calculation applies to
all.
Furthermore, some of the names on this list have had good
run-ups recently, but continue to be fairly valued or even
undervalued based on our earnings yield criteria. And,
although each of these are Dividend Aristocrats (and Dividend
Champions), some are more attractive for their growth, others for
their yield, and others for a combination of both. In other
words, their attractiveness will depend on the investment
objectives of the respective individual investor considering
them.
Emerson Electric Co. (EMR): A Premium Valuation Legacy
Currently on Sale
Emerson Electric is an example of a Dividend Aristocrat that the
market has typically priced at a premium valuation. However, the
great recession of 2008 changed that dramatically as the price fell
below its earnings justified valuation. However, it's
interesting that the market price (valuation) returned to its
normal premium PE of 18.7 so quickly. Then, apparently
because we have a flattening of earnings expected this year, the
stock is now uncharacteristically trading at its earnings justified
fair valuation (the orange line).
Perhaps the most interesting fact regarding Emerson Electric, is
that the consensus of analysts following the company expect future
earnings growth to be almost double the company's historical
earnings growth. If this turns out to be true, then today's
reasonable valuation, coupled with its above-average current yield,
indicates that this blue-chip dividend growth stock is currently on
sale, or at least reasonably priced.
Valuation Is A Relative Concept
In order to assist us in solidifying our thesis that many
blue-chip dividend growth stocks are still attractively valued,
even though their stock prices have risen recently, we will turn to
Target Corporation (TGT). We have recently seen a comment
suggesting that since Target was trading at a 52-week high, it
surely must be overvalued. However, our analysis utilizing the
earnings and price correlated graph below provides a clear
illustration that this is an erroneous assumption.
It is a fact that Target is trading at a 52-week high, it is
also a fact that Target's stock price has turned in a strong
performance since June of 2011. However, what those facts do
not reveal is how undervalued Target was in 2011. Consequently,
this recent strong performance has only brought the company back to
its earnings justified valuation level (the orange line).
Moreover, the graph also shows that Mr. Market has historically
placed a premium valuation on this blue-chip retailer.
Therefore, it's arguable at least, that Target could even be
considered undervalued if you were to rely on the market's
historical pricing precedent.
Furthermore, by running an earnings and price correlated graph
since calendar year 2009 (post recession) we discovered that Mr.
Market appeares to be pricing Target at more rational fundamentally
based levels since the great recession. This is a recent fact
that should be factored into the decision process.
Nevertheless, Target appears to be reasonably priced under this
more rational scenario.
Summary and Conclusions
We believe there is a lot of value in this market.
Moreover, we believe there is especially a lot of value to be found
in the blue-chip dividend growth stocks. This is important,
because many people believe that these stocks have become
overvalued as a result of some good performance recently. We
hope that this article put some of those fears to rest.
However, it's important to add that our position is based on being
long-term shareholders of the businesses.
In other words, there is always a possibility that Mr. Market
could drive many of the shares of the companies discussed in this
article lower over the short run. On the other hand, we
believe that although it's impossible to hit a perfect bottom (or
top), buying a great business at a sound valuation is a long-term
winning strategy.
Finally, we hope this article provides additional insights into
the importance of making investment decisions one company at a
time, over having vague general notions. As we have often
stated, in every market, whether it's a bull market or bear market,
there will always be fairly valued, undervalued and overvalued
individual companies to be found. The prudent investor
understands this, and we believe, should always be willing to
separate the wheat from the chaff. In that vein, we feel
there is a lot of wheat in the equity asset class dividend growth
stocks.
Disclosure:
Long MCD, AFL, WAG, ADP, KO, MDT, JNJ, ABT, GPC, MKC, ITW, BCR,
MHP, T, KMB, SYY, CLX, PEP, PG at the time of writing.
Disclaimer:
The opinions in this document are for informational and
educational purposes only and should not be construed as a
recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies
discussed may not continue and the companies may not achieve the
earnings growth as predicted. The information in this document is
believed to be accurate, but under no circumstances should a
person act upon the information contained within. We do not
recommend that anyone act upon any investment information without
first consulting an investment advisor as to the suitability of
such investments for his specific situation.