Monday, August 19, 2013

Your best ideas might already be in your circle of competence

In a previous article I outlined the difficulties I am having in allocating new cash to my portfolio. However, I mentioned that I am comfortable holding the companies I own. This is because I believe that the companies in my dividend portfolio have excellent business prospects, and also have favorable business economics.
I have spent thousands of hours poring through annual reports, press releases, analyst reports, looking at financial trends, and trying to understanding each respective business. As a result I am relatively familiar with the companies I own. While I monitor positions frequently, I am not pulling the sell trigger unless there is a dividend cut. I do reserve the right to sell if other activities happen, that could cause me to question the business prospects for the company. For example, I have sold companies before, when I found comparable securities at much better valuations. In those occasions, I have traded up either by obtaining better growth prospects, or better yields.

Of course, if the securities I sold became attractive again, I would purchase them at the lower valuations. Unfortunately, great securities are typically close to being fairly valued, and quite often stay overvalued for extended periods of time. As a result, it is fairly rare to find comparable securities with similar business characteristics, while selling at better valuations.

This exercise helped me reach a Eureka moment: My best ideas are already in my portfolio It is true that some of them are overvalued, and not worth adding to at current prices. However, I am perfectly fine holding on to these stocks and doing nothing for 20 – 30 years. My second “a-ha” moment was that for many of the companies I do not own, but would consider to be “best ideas”, I am already familiar with them.

For many of the companies I own, I would welcome the next recession as a buying opportunity. Other than that, the problem I would be facing is that fresh capital will be accumulating whether I contribute money or not. As a result, I would have to find more uses for the capital. Luckily, I am well-versed in the components of the Dividend Champion and Dividend Achiever lists. I keep scanning them for opportunity, and learning about each business that I find appealing. For me, an appealing business is one that I expect to be around in 10 -20 and even more than 30 years.

For example, I believe that Hershey (HSY) would be around for the next 30 years (and beyond), while delivering a product that customers associate with quality that they are willing to pay a rising price for. This pricing power will deliver rising profits and dividends for the company’s shareholders. Unfortunately, while holding on to this cash machine could be a smart long-term strategy for existing investors, the stock is overvalued at 25.70 times forward earnings for new investors. However, I would keep monitoring the company, and would love to initiate a position at the next hiccup of the enterprise or during the next recession.

I also believe that the products of Brown-Forman (BF.B) would be around for at least 30 years from now. The stock price is overvalued at the moment at 23 times forward earnings. However, I am not seeing a comparable alternative that is substantially cheaper, to make it worthwhile my time and effort to replace Brown-Forman with it. The other company needs to be comparable from a quality perspective, but from a valuation perspective needs to be both cheaper and also meet my entry criteria.

A few companies I already own, which I find attractively priced today include:

ConocoPhillips (COP) explores for, produces, transports, and markets crude oil, bitumen, natural gas, liquefied natural gas, and natural gas liquids on a worldwide basis. This dividend achiever has raised distributions for 13 years in a row. Over the past decade, it has raised dividends by 15.10%/year. Currently, the stock trades at 11.20 times earnings and yields 4.10%. Check my analysis of ConocoPhillips.

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend achiever has raised distributions for 26 years in a row. Over the past decade, it has raised dividends by 9.60%/year. Currently, the stock trades at 9.70 times earnings and yields 3.30%. Check my analysis of Chevron.

Dr Pepper Snapple Group, Inc. (DPS) operates as a brand owner, manufacturer, and distributor of non-alcoholic beverages in the United States, Canada, Mexico, and the Caribbean. This company has raised distributions since 2010. Currently, the stock trades at 15.30 times earnings and yields 3.20%. Check my analysis of Dr Pepper.

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. This dividend champion has raised distributions for 36 years in a row. Over the past decade, it has raised dividends by 28.40%/year. Currently, the stock trades at 17.40 times earnings and yields 3.20%. Check my analysis of McDonald’s.

Wal-Mart Stores, Inc.(WMT) operates retail stores in various formats worldwide. The company operates in three segments: Walmart U.S., Walmart International, and Sam's Club. This dividend champion has raised distributions for 39 years in a row. Over the past decade, it has raised dividends by 18.10%/year. Currently, the stock trades at 14.60 times earnings and yields 2.50%. Check my analysis of Wal-Mart.

Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has raised distributions for 46 years in a row. Over the past decade, it has raised dividends by 18.60%/year. Currently, the stock trades at 16.10 times earnings and yields 2.50%. Check my analysis of Target.

Full Disclosure: Long BF-B, COP, CVX, DPS, MCD, TGT, WMT

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  1. When I get more cash, going to be buying WMT. The price is coming down, which means time to buy :)


  2. I agree. Added to my position in KO this week.

  3. I agree Dividend Investor. While I'm always interested in learning about new companies, I find I have a select group of companies where I am very familiar and the most comfortable investing in for the long term. I have picked out a group of 35 companies that I want to build my portfolio with. Unless any of these companies give me reason to change my mind in the future (which I'm sure some will as change is inevitable) I feel no need to keep finding more and more companies to want to add to my portfolio. The only exception would be if I find an absolutely great company at an absolutely great valuation that I hadn't been looking at before.

  4. Hi DGI,

    an alternative for BF.B could be the british stock Diageo (DEO). It's slightly cheaper and has a nice product portfolio. I do own both. :-)


  5. There are a handful of very high quality businesses with consistent earnings and strong dividend histories. Diversifying for the sake of adding something else doesn't necessarily strengthen your portfolio, you could end up substituting diluting your earnings and dividend quality for the sake of diversification

  6. They always say the majority of your returns will come from 20% of your holdings. Just have to pick the right ones. Happy investing.


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