Wednesday, December 5, 2012

Market Declines: An Opportunity to Acquire Quality Dividend Stocks

In a previous article I argued that entry price matters to investors. Even the best quality dividend growth stocks like Coca Cola (KO) or Wal-Mart (WMT) are not worth owning at any price. In fact, investors who purchased these stocks in the early 2000’s, saw lackluster returns for over a decade. While earnings and dividends were growing at a fast pace throughout that period, it took almost a decade before the low initial yields became noticeable and before the valuations appeared attractive again. In fact, despite the rise in earnings over the past decade, stock prices for these two companies didn’t have much to show for it.


On the other hand however, purchasing dividend stocks at attractive valuations can help investors lock in an accidentally high yield. I usually find at least 15 -20 attractively valued dividend stocks ready to be bought at any time in my monthly screening process. However, I also typically uncover some rapidly growing companies, which increase distributions at a double digit pace, but trade at high valuations. As a disciplined income investor, I monitor these securities on a regular basis and add mental entry points should they reach undervalued territory. In order to reach my long term dividend goals, it really does make a difference whether I purchase a company growing earnings and distributions at 7% when its yield is 2% or 3%. In the first case, after one decade, my yield on cost will be 4%. In the second case, my yield on cost would be 6%.

Once or twice per year however, markets tend to get upset about something. It could be the US sub-prime mortgage crisis in 2008 – 2009 or the fiscal cliff in August and September 2011. Once markets get upset about something, investors start selling off fearing the worst. Business news commentators flash warning signs that the economy is about to collapse, earnings will plummet, unemployment will skyrocket and how humanity would revert back to living in caves very soon. This leads to decreases in share prices, because market participants now see stocks as inherently riskier than before. Many companies that previously traded at above-average valuations will now become fairly valued.

This is the point when regularly monitoring the market will pay off for long-term dividend investors. If they had done their homework, and have confidence in their analysis that the attractively valued income stock will maintain and increase earnings power over time, then they will have the chance to buy it at bargain prices. This will be a very difficult decision, since the investor will be seemingly going against everyone else’s warning of economic decline. For example, I was able to purchase several stocks between September 2008 and February 2009 at super attractive valuations. It was a very scary period in my investment career, as I feared that this time the economy will collapse. Nevertheless, I kept to my plan to regularly investing in dividend stocks though despite all the gloom. I did have to sell a few of my dividend holdings in the period however, since they cut or eliminated distributions. I replaced these stocks with other companies that were fairly valued at the time.

For a company with a stable business model characterized by recurring revenue streams, a decrease in price by 50% doubles its dividend yield.  If the dividend is well covered by earnings, then chances are that it won’t be cut, which makes the investment attractive to income seeking individuals. For example, Aflac (AFL) traded in the high $50’s in 2008. However, during the general decline in all financial stocks, I was able to snap some at approximately $25/share in early 2009.  At the same time, the quarterly dividend was increased from 24 cents/share in last quarter of 2008 to 28 cents/share for the first quarter or 2009. The same company that yielded 1.50% less than a few months earlier was now paying a higher dividend and yielded more. I liked the fact that the company was expanding in Japan, and was building its brand in the US simultaneously, in addition to its attractive valuation.

Another quality company I was able to purchase at low valuations included Altria Group (MO). In September 2008 the stock was trading around $20/share, and paid a quarterly dividend of 29 cents/share. By December 2008, Altria was trading at $15/share, and the dividend had been increased to 32 cents/share. The yield had thus increased from 5.80% to 8.50%. I liked the fact that people are more likely to keep habits such as smoking even in tough economic times, in addition to the ridiculously low valuation.

The reason why this paid off for me was the fact that I held a diversified portfolio consisting of over 30 individual components. Each of these companies kept business as usual, as their customers kept buying products or services on a daily basis. These products or services are everyday essentials that consumers or businesses need in order to operate. For example, just because we are in a recession, people still brush their teeth, use electricity or shave every morning. The other thing that helped most of the companies I owned was the fact that they were and still are riding the long term trend where millions of consumers from emerging markets are entering middle class for the first time. This increases their customer base tremendously, and will likely do so for the next several decades.

A few attractively valued dividend stocks to consider after the recent declines include:

McDonald's (MCD) is attractively valued at 16 times earnings and yields 3.70%. The company has managed to raise dividends for 36 years in a row, and over the past decade has managed to boost them by 27.40%/year. Check here for a more detailed analysis of the stock.

Medtronic (MDT)  is attractively valued at 12 times earnings and yields 2.50%. The company has managed to raise dividends for 35 years in a row, and over the past decade has managed to boost them by 15.80%/year. Check here for a more detailed analysis of the stock.

Walgreen (WAG)  is attractively valued at 13.50 times earnings and yields 3.40%. The company has managed to raise dividends for 37 years in a row, and over the past decade has managed to boost them by 18.90%/year. Check here for a more detailed analysis of the stock.

5 comments:

  1. As usual, thanks again for your excellent blog - it has been very helpful to me.

    Yet, the biggest challenge I find from your analysis is deciding which stocks to focus on rather than simply buying all of them.

    I know that you suggest keeping about 30~40 stocks yet should one want to run 'lean and mean' and keep it at 10, 15, or 20 stocks tops for the DG portion of his/her portfolio, which would you recommend focusing on?

    Naturally, those stocks would be diversified across various sectors yet would you insist on (1) picking ones that have been paying dividends for the longest,(2) picking ones with the greatest moats,(3) ones with the highest rate of dividend growth over the past decade,(4) ones with the highest divyield,(5) highest earnings growth,(6) lowest PE and/or (7) highest Beta?

    Additionally, when the market drops like in March 2009, some stocks will drop a lot (and then rise) more than others. From stocks I follow, Exxon and Monsanto are up barely ~20~40% While with others like Ford, Apple, TWX, CAT and News Corp, you would have multiplied your money by at least 3x (CAT,NEWS), 5x (TWX) and 10x or more in the cases of Apple and Ford.

    Would you agree it's important to focus on these stocks during the next market decline?

    In conclusion, when you mention "I would consider adding to my position in the stock subject to availability of funds." I would find it helpful for you to rank or grade just how badly you want to buy that stock (vs other ones you've indentified)...

    I look forward to your thoughts!

    ReplyDelete
  2. Hello dear reader,

    First of all, thank you for your comment. I would caution you against blindly following analyses on this site. Just because a stock makes sense for me, does not mean that it would make sense for you. You have to examine your investment goals and go with what is right for you. I cannot offer individual investment advise as well. Sorry.

    To answer your question, I find it impossible to keep DG investing "lean" to 15 - 20 stocks. There are the usual suspects ilke JNJ which are always there to be purchased if extra funds are available. But there are also these stocks which are always overvalued, but if you monitor them long enough you might get the opportunity to snap them up at reasonable valuations once share prices drop.

    As far as stocks I tend to pick.. I use a mixture of (1) through (7). To be honest, after looking at many stocks for many years, and getting acquainted with some for certain periods of time, I tend to buy the things I understand at what I find to be attractive valuations. I do not look at just one criteria when i analyze a stock. I try to blend a few and try to come up with an estimate of what will work going forward, and what I am comfortable with.

    I do like to pick companies that have a history of raising dividends for one decade, and the average annual raise has been above 3%. Ideally a company growing distributions at/above 6%/year would be a nice one to invest for me. Dividend growth is of course limited by the yield you get today. a 6% yielder would have a much harder time growing distributions at 6% than a 3% yielder. I also try to select companies that have some sort of a moat. I don't care about beta/alpha delta or gamma. The most important thing i believe is to pick reasonably priced shares ( Think P/E that is below 20, if not even lower), which have the capacity and a very high probability of raising earnings per share over time. Even if DPS is not increased as quickly as EPS, the market will end up rewarding you for this investment. I also look at payout ratios.

    I would say that investing for dividends is more of an art than science. Sometimes i also think that many investors lose in this game because they are trying to impose their own way of thinking or rules onto the market, rather than let the market/companies guide them.

    Imposing your own rules on dividend investing is similar to attempting to understand running water by putting water in a bucket.

    Market drops are a great opportunity to purchase quality stocks at attractive valuations. For Ford, the reason why price went up so much is because stock was beaten down as GM and Chrysler went bankrupt. Ford was really lucky for not going under.

    Some co's are going to go up a lot after a bear market, while others are going to not go up as much. That's why one needs a diversified portfolio.

    ReplyDelete
  3. We're listening out here DGI. Your postings serve to educate and enlighten, whether we always agree with you or not. Keep the postings coming, you are a weekly read around here!

    I would truly like to know how you get some of your information. Frequently, you post a list of recently announced dividend increases. It would be great to know the mechanics of how you get this information, since it has alerted me to interesting stocks in the past that I had never heard of before. Whether or not I buy any of these, it's helpful to know how to get them on the radar screen in the first place.

    Keep up the good work and Happy Holidays to you and yours!

    ReplyDelete
  4. DGI,

    How do you only have 30 or so stocks? Every time I do my calcs starting with the Dividend Champion list I end up with a 20 or so watchlist which I then buy one or two lots during the month. I have only been doing this for 18 or so months but my holdings are probably 20 or so diff companies already!

    ReplyDelete
  5. I just use screeners on google to let me find dividend increases.

    Evan,

    I have been doing dividend investing for a LONG time now. Some of the stocks I own have not been in my buy range for many years. I own over 45+ individual stocks, although I would say 30 or so cover the majority of my portfolio. I am often bombarded with ideas I like, but unfortunately my income limitations make me unable to buy more than 1 - 2 stocks/month.

    ReplyDelete

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