Monday, October 21, 2013

Undervalued Dividend Stocks I purchased in the past week

In the past week I made a few stock purchases in my Roth IRA and for my taxable account. Today I am going to discuss the purchases I made in my taxable account.

I usually scan the list of dividend champions and achievers at least two times per month, in order to uncover quality that sells at cheap prices. I also have a list of stocks I own in Yahoo Finance, which I monitor each morning for headlines. Based on monitoring companies I owned with small allocations to my portfolio, and based on their relative valuation, I decided to add to them. The companies whose shares I acquired included International Business Machines (IBM) and American Realty Capital Properties (ARCP).

International Business Machines Corporation (IBM) provides information technology (IT) products and services worldwide. This dividend achiever has managed to raise distributions for 18 years in a row.

Back on Thursday, I noticed that IBM stock was unduly punished to a 52 week low after supposedly missing analyst revenue growth expectations. The issue with IBM is that revenue has been growing very slowly over the past decade. However, as an investor in a business all I care about is the earnings per share that this business earns. This is because rising earnings per share provide the cornerstone behind future dividend growth. The thing I like about IBM is that its goal is to grow shareholder value, and not just chase meaningless revenues that would not translate into higher profits. As part of the company’s 2015 vision plan, it aims to earn $20/share by 2015. So far the company has been on track to achieve those goals.

IBM has also managed to consistently repurchase stock for 19 years in a row. It has reduce shares outstanding through its regular share repurchases from 2.34 billion at the end of 1994 to 1.10 billion by 2013. Further, this dividend achiever has increased distributions for 18 years in a row. Over the past decade, IBM has managed to increase dividends by 18.80%/year. If the stock price continues languishing for several years, that is good news for IBM shareholders, because that would mean that the dollars allocated for share repurchases would buy out a greater number of shares outstanding.  One of the largest investors in IBM is Berkshire Hathaway (BRK.B), which is the holding company controlled by legendary investor Warren Buffett.

The stock has a low dividend above 2%, but is really cheap at 12 times 2012 earnings and 10.30 times forward 2013 earnings. Given the cheap valuation, and prospects for very good dividend growth, it is no surprise I added to my IBM position. Check my analysis of IBM.

American Realty Capital Properties, Inc. (ARCP) owns and acquires single tenant, freestanding commercial real estate that is net leased on a medium-term basis, primarily to investment grade credit rated and other creditworthy tenants. I originally purchased shares of this REIT after selling my position in National Retail Properties early in the year.

This REIT has been public for less than two years. However, it has managed to raise its monthly dividends several times since going public in 2011. This indicates potential for shareholder friendly management. There are several things I look for in a REIT, as described in my REIT checklist.

The REIT has been rapidly expanding its portfolio of triple-net leased properties, and acquiring American Realty Capital Trust IV, a lot of other freestanding properties and is in the process of acquiring CapLease (LSE). This is a lot of M&A for one year, but it is all expected to be accretive to Funds from Operations per share. In fact, AFFO/share is expected to come at 1.14 – 1.18/share, which is substantially above the annual dividend of 94 cents/share. Based on forward valuation, this REIT is a steal at current prices.

In my checklist for REITs, I look for plans for growth, and American Realty Capital Properties does have the drive to reach the critical mass of Realty Income (O). It’s top 10 tenants account for less than one third of revenues, which are diversified across 48 states. It is surprising to find that the REIT has an almost 100% occupancy rate.

The one risk I see is that ARCP grows too quick too fast. This means that a company that grows too fast, might end up leveraging itself too much, and if the world throws it a curveball, it could derail plans for world domination. Typically when different companies are acquired or merged, there is the possibility for clash of cultures. I am not saying that this would happen, but one of the possible reasons for the cheap valuation on this REIT is that it still has a relatively unproven track record in comparison with Realty Income (O) or National Retail Properties (NNN).

That being said, it offers a yield of 7.30% that seems to be well covered from forward FFO/share. The distribution is paid monthly, and the tenant base seems pretty stable and respectable, which lowers the chance of occupancy declining.

Full disclosure: Long IBM, ARCP, O

Relevant Articles:

Five Things to Look For in a Real Estate Investment Trust
Are we in a REIT bubble?
Warren Buffett’s Dividend Stock Strategy
Dividends versus Share Buybacks/Stock repurchases
Two dividend payers I recently purchased for my taxable accounts

6 comments:

  1. Regarding IBM, you said, "revenue has been growing very slowly over the past decade. However, as an investor in a business all I care about is the earnings per share"

    I don't understand. How can you not care about revenues? You can't have a sustainable growth in earnings without growth in revenue. You can increase EPS through cost-cutting, but isn't there a point where that's no longer do-able?

    ReplyDelete
  2. You don't want to pursue revenues for revenues sake. All you should care about is profit. If you mindlessly grow revenues, without taking into account profits, you can bankrupt the company.

    A company can increase earnings per share through buybacks ( shares are perennially undervalued), and focusing on higher margin activities.

    Revenues have increased from 89 to 104 billion over the past decade, profit increased from 7.5 to 16.6 billion.

    Basically, the company has been very smart about optimizing its mix of revenues, and focusing on profitability. They are increasing margins and focusing on items that can deliver earnings. They are essentially being very smart for taking the most profit possible first - check how margins have increased in the past decade. As a partial business owner, this is the type of business management you should be focusing on.

    If IBM repurchases 4% of outstanding shares, gives you a 2% dividend, and manages to grow revenues and earnings by a mere 3%, you should be able to earn a total return of 9%. Otherwise said, with earnings growth of 3%, added to EPS growth through buybacks of 4%, you can expect dividend growth of at least 7%. Given low payout ratio, they can probably afford to increase it at a slightly higher rate for next decade

    ReplyDelete
  3. DGI,

    I saw that you mentioned picking up IBM in you ACN post. Buying a blue chip at a 52 week always feels good. With many similarities in services to ACN, I think IBM is a more diversified pick because of their enterprise hardware business, and their proprietary software businesses (Rational suite for example). Where ACN doesn't have that. I love the buy back, and the divesture of their PC business in hindsight was brilliant.

    I work with IBM on a very large US Gov contract and they have a stranglehold on the Gov because they've integrated all of their machines and software into the project. They make money on the hardware, software, and services, and they won't lose the long term contract because of it.

    ReplyDelete
  4. It's amazing how far apart one analysis can be from another. This was posted today from another blogger. For him it's overvalued at this time and there are other metrics that make this not so attractive.

    Is it ok to post a link from another site?


    http://feedproxy.google.com/~r/Dividends4life/~3/XyC3Jb_GQMQ/international-business-machines-corp.html?utm_source=feedburner&utm_medium=email

    ReplyDelete
  5. RBD,

    I think IBM is a formidable force in their business segments. I am still watching ACN, as I have experience in interacting with their teams. I think they have a strong brand in management consulting.

    Paul,

    So someone else has a different "opinion"? So what?

    So did the person that sold me their IBM stock on Thursday. Am i bothered from this?

    Not at all!

    ReplyDelete
  6. One should not never others opinions influence their decisions, particularly if they have done the work needed to have their initial conviction in the first place.

    If you have done the work, someone who doesn't agree with you should not have an impact on your decision. In fact, some of my best bets have been at a time when the majority of investors disagreed with me. Actually, since 2009, it seemed that almost everyone disagreed with me on buying stocks.

    Now, if I found out new and material information about my investment, I should evaluate whether it impacts my analysis or not. But if you let random people's opinions influence your decisions, then you are not doing a good analysis.

    ReplyDelete

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