Monday, July 29, 2013

Looking for dividend bargains in an overheated market

With prices on many stocks I follow reaching new highs, it is getting more difficult to find attractive places for my investment dollars. Because of the above factors, I have ventured into modifying my entry criteria slightly, in order to adapt to the current environment in 2013. I definitely feel out of step with the current market however.

I usually screen the list of dividend champions and dividend contenders about once every month using my entry criteria, in order to find attractively valued securities. In addition, I also review dividend increases every week, in order to uncover hidden dividend gems.

After I come up with a list of cheap companies, I try to perform a more detailed review of financials, business prospects and competitive strengths, in order to gain a more thorough understanding of the company’s business model.

In most cases however, chances are that I have analyzed before the companies on the dividend champions and dividend contenders lists. As a result, I just check the last time anything material happened between my analysis time and the purchase date. The beauty of dividend investing is that knowledge is cumulative – if you understood the business model of Coca-Cola in 2011, along with risks and opportunities, your knowledge is most likely still relevant. Things could change over time of course, as Coca-Cola (KO) acquired North America bottling operations from CCE in 2010. For most of your dividend champions, there are not going to be changes in the business model over several years. By reviewing the annual reports, one can easily keep up with any other annual changes like new markets, new products as well as obtaining information about the most recent trends in fundamentals.

Unfortunately, most of the companies I usually focus on have been overpriced. For the companies that I find attractively priced today, I already have an above average allocation to them. Unfortunately, my principles of holding a diversified portfolio prevent me from concentrating my holdings too much. For example, I find Phillip Morris International (PM) and Chevron (CVX) to be attractively priced today. Unfortunately, all two of these companies are in the top five of my holdings. As a result, I would need to look elsewhere for opportunities.

There are also many opportunities with the oil and gas majors these days, many of which trade under 10 times earnings, and offer above average yields. However, investors should avoid concentrating portfolios too much in a given sector. This is because oil and gas companies earnings could suffer if commodity prices dropped from here. If your income portfolio has more than 15 - 20% in a given sector, chances are you might be overly concentrated to it.

Another attractive factor behind dividend investing however is that once you select a great company at a good price, you can simply hold on to it. You can choose to perform small portfolio tweaks here and there, but even if you don’t you should still do just as well doing little. Monitoring your positions is important as well however, as things do change over time.  If I were retired and living off my portfolio, I would not really care whether stocks are up or down, as long as fundamentals are intact and companies are showering me with cash on a recurring basis. As an investor in the accumulation phase however, the problem is that while you would benefit from dividend growth, you would fail to turbocharge your income growth because you are not reinvesting your pile of growing dividend payments.

I have been able to identify several companies with low price/earnings ratios, adequate dividend coverage and yields, which have good long-term business and dividend growth prospects:

Aflac Incorporated (AFL), through its subsidiary, American Family Life Assurance Company of Columbus, provides supplemental health and life insurance products. The company has raised distributions for 30 years in a row, and has a five year dividend growth rate of 10.90%/annum. Currently, the stock is trading at 9.70 times earnings and yields 2.30%%. Check my analysis of Aflac.

Ameriprise Financial, Inc. (AMP), through its subsidiaries, provides a range of financial products and services in the United States and internationally. The company has raised distributions for 9 years in a row, and has a five year dividend growth rate of 20.60%/annum. Currently, the stock is trading at 17.20 times earnings and yields 2.40%. Check my analysis of Ameriprise Financial.

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. The company has raised distributions for 26 years in a row, and has a five year dividend growth rate of 9.20%/annum. Currently, the stock is trading at 9.60 times earnings and yields 3.10%. Check my analysis of Chevron.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised distributions for 5 years in a row, and has a five year dividend growth rate of 13.10%/annum. Currently, the stock is trading at 17.30 times earnings and yields 3.80%. Check my analysis of Philip Morris International.

Target Corporation (TGT) operates general merchandise stores in the United States. The company has raised distributions for 46 years in a row, and has a five year dividend growth rate of 20.50%/annum. Currently, the stock is trading at 16.80 times earnings and yields 2.40%. Check my analysis of Target Corporation.

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The company has raised distributions for 39 years in a row, and has a five year dividend growth rate of 13.50%/annum. Currently, the stock is trading at 15.40 times earnings and yields 2.40%. Check my analysis of Wal-Mart Stores.

ConocoPhillips (COP) explores for, produces, transports, and markets crude oil, bitumen, natural gas, liquefied natural gas, and natural gas liquids on a worldwide basis. The company has raised distributions for 13 years in a row, and has a five year dividend growth rate of 13.10%/annum. Currently, the stock is trading at 10.70 times earnings and yields 4.20%. Check my analysis of ConocoPhillips.

McDonald’'s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. The company has raised distributions for 36 years in a row, and has a five year dividend growth rate of 13.90%/annum. Currently, the stock is trading at 18.20 times earnings and yields 3.10%. Check my analysis of McDonald’'s.

In modifying my entry criteria, I can accept a shorter streak of dividend increases, and even a lower current yield. However, I would never sacrifice on company quality, and I would not purchase shares trading above twenty times earnings.

Full Disclosure: Long AFL, CVX, PM, TGT, WMT, COP, APD, KO

Relevant Articles:

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  1. Sorry that you are altering your entry dividend level to make a purchase. Mine is 3%. When the market is setting new highs causing yields to fall it tells me the market needs a correction. I trimmed a few stocks to lock in 35-45% gains Friday, 5-7 years of dividends. I will wait until the entry prices come back to me.
    Thanks for your articles.

  2. I'm wondering if LO or BTI would be a better choice for someone who has no tobacco stocks? Both have higher dividends, LO has growth while BTI has no witholding tax?

  3. I was just looking over my watch list considering my next purchase. I'm probably considering adding to either my Chevron (CVX) or Wells Fargo (WFC) positions. I really like Aflac (AFL) but it's currently my largest position. I'm also considering adding a completely new position of Darden Restaurants (DRI) for diversification purposes. Not quite sure what I'll do yet. Guess it depends how I'm feeling next week when I'm ready to make the move.

    I think the market is fairly high right now but there are still some ok buys out there worth considering.

  4. You listed some excellent companies, but though their balance sheet looks good and their P/E is fair, some of those are very near their 52 week high. Would that not be contrary to your earlier article, which talked about locking in higher yields by buying at lower valuations?

    I realize in the short term, you would have cash sitting around not earning you dividends. If you are like me though and have 25-30 years until retirement, holding onto unallocated dividend cash for even a few years would have no long-term disadvantage.

    There would probably be at least one sector that flucuates offering a better value during that time anyways.

  5. I agree that it is probably better to sit on cash than to purchase something overvalued. Why would you purchase something that doesn't fit your original criteria now?

  6. First Anonymous,

    I am trying to focus on quality, although I try to avoid overpaying for it. Time will tell if I was successful in that. Unfortunately, I find it difficult to sit in cash - I always seem to find bargains. However, some of these bargains are already over-weight in my portfolio.


    I have not looked at those companies. BTI is a UK company, so therefore, no withholding tax.


    Stay tuned for a post on the specific stocks I bought last week..

    Second Anon,

    I usually pay more attention to earnings in relation to price. If a stock is undervalued, I have no problem buying it at an all time high. In fact, I expect that most of the companies I buy will earn more over time, and therefore reach 52 weeks highs multiple times during my investing career.

    To paraphrase Buffett" Price is what you pay, value is what you get"

    In the article you reference, I was saying that preferably, I would buy stocks at a deep discount. Unfortunately, those are once in a lifetime opportunities.. I doubt we would see another one over the next decade.

    I cannot afford to have cash sitting around waiting for "perfect setup". If you are psychologically ready to wait for that, even if it means stock prices go up 100- 200% from here, then go for it.

    Third Anonymous,

    Of the companies mentioned above, most fit my entry criteria at the time the article was written last week. The thing to understand is that investing is not a black or white process, but is more art than science. It is good to have rules, but it is also important to know when to override rules. That's why the richest investor is Warren Buffett, and not a computer system.

  7. DGI, any thoughts on DE? Seems to be undervalued at the moment. Still sort of new to this but i'm hunting around as well.


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