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The pharmaceutical juggernaut Abbott Laboratories looks reasonably cheap these days. Its shares have been going down for the past few weeks and it's a good buying opportunity in my opinion. Here's why.
Consistent Dividend Growth
Abbott has grown dividends consistently for over 25 years. It's part of the Dividend Aristocrats index maintained by S&P. Not only that, but ABT has grown dividends an annualized 9.33% over the last 11 years. On average, the year-over-year dividend growth has also been around the same ballpark, 9.45% (the average and the annualized 11-year return can differ in case most of the growth was in one or just a few years as opposed to consistent over time. When they match, it's a sign the growth has been sustained over time).
Consistent Earnings Growth
A consistent dividend growth needs to be accompanied by a consistent earnings growth too or the dividend is not sustainable. Over the same last 11 years, ABT has had an annualized earnings growth of 9.31%, which comes in very close to its annualized dividend growth. This means that dividend growth is supported by earnings growth directly, which is a good sign. It means the company is passing through all of its extra earnings back to shareholders via dividend increases.
Some people prefer to see earnings growth slightly surpass dividend growth to be on the safe side. But by doing so, it means the company is increasing its cash reserves and I would want to understand why. It could mean an acquisition is coming up or the company is expecting to have higher expenses going forward (patent disputes, lawsuits, etc). So, higher earnings growth per se is neither good or bad, but must be understood. In the case of Abbott, for the past 11 years earnings and dividend growth have matched, which can only mean the company is growing smoothly and not becoming lopsided in anyway, neither increasing cash reserves nor depleting it, hence a very good sign in my opinion.
Consistent Sales Growth
Just because earnings growth have been consistent during this time does not necessarily mean the company is actually generating more cash since earnings can be so easily manipulated. However, 11 years is a long time, especially when the earnings can be seen in form of dividends during this time (it's a lot harder to fake real cash in your pocket than it is on an income statement). Nonetheless, let's see how Abbott fares in sales growth, which is a more direct way of assessing where growth is coming from.
For the past 10 years, sales have grown an annualized 8%. This is only slightly less than the 9% earnings growth, which indicates that for the most part sales have kept pace with earnings. It also indicates that the company has been aggressive at cutting costs at a rate of 1% per year. In the long run I'd expect earnings and dividend growth to slow down to catch up to sales growth. Still, 8% is a good growth rate to have.
Dividend Yield is Moderately High
At a price of approximately $45.50 and with an annual dividend of $1.76, ABT sports a dividend yield of 3.8%, which is pretty decent in today's market. When factoring in a 8-9% growth, it means investors can expect a return of 11-13% on their investment going forward, minus inflation and plus any share price appreciation.
Implied Price using Dividend Discount Model
Treating a share of ABT as a bond and investing in it just for the dividend using the Dividend Discount Model, I came up with a price range for ABT of between $59 and $44. This means that ABT is undervalued at the time of writing. My assumptions were a 10-11% discount and 7% dividend growth, which, given the track record of sales growth of 8% is still a little conservative.
Other Considerations
Other things to consider before investing: why is ABT going down in the past several weeks? No single news piece accounts for this decline, but a more thorough investigation is warranted.
One a price-to-earnings basis, ABT looks fairly valued with a tailing P/E of about 15. However, its forward P/E is only 10, since ABT expects to earn between $4.54 and $4.64 per share in 2011.
Conclusion
All things considered, ABT looks cheap to me. I'm buying shares of Abbott (ABT) at the time of writing. Please do your own analysis before buying.
Disclosures: I own shares of ABT at the time of writing.
Showing posts with label dividends. Show all posts
Showing posts with label dividends. Show all posts
2011-01-31
2011-01-18
S&P 500 Fair Value: What to Expect in 2011
About two years ago I posted my mathematical assessment of the market's fair value. It's still a widely-referenced article. Given your interest and my own curiosity as I prepare my investment route for 2011, I thought I'd repeat that study using more recent data.
But this time, I'll use both a dividend discount model and an earnings growth model.
S&P 500 Fair Value from a Dividend Perspective
Using the Dividend Discount Model here's a quick summary of the market today and what is in store for 2011, if history helps.
If we treat a stock as a bond and nothing else, we're expecting to get in the future our model for dividends that we got in the past, plus some growth. This is one of the most conservative ways I know to value a stock and hence why I'm using it here to value the index.
Here are the numbers:
Here are the numbers:
But this time, I'll use both a dividend discount model and an earnings growth model.
S&P 500 Fair Value from a Dividend Perspective
Using the Dividend Discount Model here's a quick summary of the market today and what is in store for 2011, if history helps.
If we treat a stock as a bond and nothing else, we're expecting to get in the future our model for dividends that we got in the past, plus some growth. This is one of the most conservative ways I know to value a stock and hence why I'm using it here to value the index.
Here are the numbers:
- All-Time Dividend Growth. Since 1960, the S&P 500 has grown dividends an average of 5.04% per year (note: variance is large, meaning some years this number is much higher, others much lower).
- 10-Year Dividend Growth. The last 10 years have seen a lower dividend growth, just 3.58% annually.
- Today's Fair Value. Assuming a 5% growth ad infinitum a 7.5% discount rate based on an estimated dividend for 2011 of $24.28, today's fair value is 971, meaning the market is overvalued by 33%.
Modeled value vs. real value for S&P 500 using DDM.
S&P 500 Fair Value from an Earnings Perspective
Earnings provide another way to assess the fair value of an index. By looking at historical growth and current earning yield, we can put a fair price on the index. However, earnings are a secondary measure of what one can get out of an index, since not all earnings flow to the investor as dividends.
While earnings can give us a good feel for how the market is doing, it can't tell us what the companies will do with their earnings nor how they will return them to us investors. Dividends can be cut, but earnings are flakier, given that they're not usually thought as belonging to shareholders, which is a shame, but quite true of most companies.
Here are the numbers:
- All-Time Earnings Growth. Since 1960, S&P 500 earnings have grown an annualized 6.81%.
- 10-Year Earnings Growth. For the trailing 10 years, earnings have grown 4.07%.
- Today's Fair Value. Assuming 2011 earnings of 87.84 and applying a P/E multiple of 15, the S&P would be valued at 1318 today, meaning the market is undervalued by 1.7%.
Modeled value vs real value for S&P 500 using earnings.
Conclusion
Whether you choose to believe the DDM is more accurate or the earnings approach is more accurate, both currently indicate that the S&P is anywhere from fairly-valued all to the way to grossly overvalued.
However, this numerical assessment assumes a smooth continuation of history without taking into account all that is going on with the economy, international affairs and expectations of inflation/deflation. Use this to help you make informed decisions, but do not rely entirely on it.
The source of raw data is still here (no affiliation with the authors or their institutions).
Disclosures: I own SPY and many other whole market-tracking indices at the time of writing.
2011-01-08
Portfolio Returns for 2010
2010 is now history and it's time to update my portfolio returns to check on my progress so far.
In 2010, my US portfolio, which excludes real estate and foreign accounts, returned (including dividends) approximately 11.3%. Comparing with the S&P 500, which returned (including dividends) approximately 15.1%, my returns are not great.
But my results don't bother me at all, because my portfolio has less risk than the S&P and does better than the S&P in down years. Let's see why. But first, let me define risk.
Risk
I don't consider risk to be equal to beta or the Sharpe ratio. That's because I don't mind price swings (which increase beta) as long as I believe that in the long run, my buying power will be maintained or increased versus inflation.
In other words, I consider risk to be the degree with which I may lose principal, either via loss of capital (due to bankruptcy, long-term loses in the underlying companies, etc) or inflation.
With that, let's dissect my portfolio a bit to understand where I trailed the market and why I should not worry about it.
Portfolio Drag
Looking at my holdings and the weights they play on my overall allocation, I found out that the main reason for underperformance in 2010 was due to my bias towards large value companies. These are mainly blue chips that pay steadily-growing dividends such as HD, WMT and JNJ.
Let's look at a couple of those:
Johnson & Johnson (JNJ). The BandAid maker opened the year at $64.41 and closed it at $61.55, hence returning -4% in share price appreciation. When adding the 3.2% dividend, JNJ's total return was a negative 0.8%.
Walmart (WMT). The world's largest retailer opened the year at $53.45 and closed it at merely $54.09, thus returning 1.19% in share price. When adding its dividend of 2.2%, WMT's total return was 3.39%.
Home Depot (HD). The home-improvement retailer opened the year at $28.93 and closed at $30.21, thus returning 4.4% in share price. Adding its 3.3% dividend, HD's total return was 7.7%.
Therefore, my over-reliance on these big names caused my portfolio to lag behind the larger market.
However, as I've mentioned before, I believe my capital will be preserved better if I stay with these stocks for the long-run, as opposed to rotating in and out growth or "story" stocks throughout the year.
Goals, Restated
For the largest part of my portfolio, my goal is on dividend growth and capital preservation. As such, I believe these companies will continue doing the job. All three have been increasing dividends over the years (HD did pause for a while though, but I believe they will resume soon) and as long as my capital is safe with them, I will reap the benefits of the increasing dividends over time.
To recap my investing approach: When I invest, I look for companies with a history of sustainable dividend growth. Then I factor in this growth and current share price to determine a price I should pay now that will yield at least 11-12% dividend return over many years, with a margin of safety of between 10 and 15% (depending on various fundamental and historical factors).
For this reason, I'm quite happy with my returns so far. I will lag the S&P in good years, but I will do better in the down years (like I did in 2008).
Disclosures: I own every stock mentioned above at the time of writing.
In 2010, my US portfolio, which excludes real estate and foreign accounts, returned (including dividends) approximately 11.3%. Comparing with the S&P 500, which returned (including dividends) approximately 15.1%, my returns are not great.
But my results don't bother me at all, because my portfolio has less risk than the S&P and does better than the S&P in down years. Let's see why. But first, let me define risk.
Risk
I don't consider risk to be equal to beta or the Sharpe ratio. That's because I don't mind price swings (which increase beta) as long as I believe that in the long run, my buying power will be maintained or increased versus inflation.
In other words, I consider risk to be the degree with which I may lose principal, either via loss of capital (due to bankruptcy, long-term loses in the underlying companies, etc) or inflation.
With that, let's dissect my portfolio a bit to understand where I trailed the market and why I should not worry about it.
Portfolio Drag
Looking at my holdings and the weights they play on my overall allocation, I found out that the main reason for underperformance in 2010 was due to my bias towards large value companies. These are mainly blue chips that pay steadily-growing dividends such as HD, WMT and JNJ.
Let's look at a couple of those:
Johnson & Johnson (JNJ). The BandAid maker opened the year at $64.41 and closed it at $61.55, hence returning -4% in share price appreciation. When adding the 3.2% dividend, JNJ's total return was a negative 0.8%.
Walmart (WMT). The world's largest retailer opened the year at $53.45 and closed it at merely $54.09, thus returning 1.19% in share price. When adding its dividend of 2.2%, WMT's total return was 3.39%.
Home Depot (HD). The home-improvement retailer opened the year at $28.93 and closed at $30.21, thus returning 4.4% in share price. Adding its 3.3% dividend, HD's total return was 7.7%.
Therefore, my over-reliance on these big names caused my portfolio to lag behind the larger market.
However, as I've mentioned before, I believe my capital will be preserved better if I stay with these stocks for the long-run, as opposed to rotating in and out growth or "story" stocks throughout the year.
Goals, Restated
For the largest part of my portfolio, my goal is on dividend growth and capital preservation. As such, I believe these companies will continue doing the job. All three have been increasing dividends over the years (HD did pause for a while though, but I believe they will resume soon) and as long as my capital is safe with them, I will reap the benefits of the increasing dividends over time.
To recap my investing approach: When I invest, I look for companies with a history of sustainable dividend growth. Then I factor in this growth and current share price to determine a price I should pay now that will yield at least 11-12% dividend return over many years, with a margin of safety of between 10 and 15% (depending on various fundamental and historical factors).
For this reason, I'm quite happy with my returns so far. I will lag the S&P in good years, but I will do better in the down years (like I did in 2008).
Disclosures: I own every stock mentioned above at the time of writing.
2011-01-01
Two High-Yield Funds To Consider In 2011
In my quest for high returns, high yield is an obvious candidate. It's also a tricky one for the same reason: if it's so obvious, it probably won't last long or is very risky.
Nonetheless, a little bit of research can help mitigate these things a bit. Research won't guarantee anything -- nothing is ever guaranteed in investing. But I digress.
Here are the two funds that may help boost a small part of your portfolio the same way they're boosting a small part of mine (emphasis on small).
CEF Income Composite (PCEF)
The PowerShares* Closed-End Fund Income Composite (ticker: PCEF) is a fund of closed-end funds seeking high current income. It tries to achieve this by rotating in and out of closed-end funds when they offer a discount to NAV (net asset value) and good risk-reward prospects based on PowerShares proprietary trading technology. It currently yields about 8% and pays out monthly dividends. It has a very steep fee: 1.81% (0.50% for the ETF and the rest as per the underlying funds).
What I like about this fund is in part derived from what I like about CEFs (Closed-End Funds): they often trade at a discount to NAV and attract less attention than other funds. CEFs are often leveraged and they use long and short strategies to boost performance (and thus increase risk). The subject of closed-end funds is very interesting, but long. I'll reserve the details for another post.
With PCEF in particular, the yield and the monthly payouts are very nice. I looked at the top 5 funds that compose this ETF and they are reasonable funds with the typical risk profile of CEFs: some leverage (20-30%), a good diversifications of securities and most are not managed payout funds, which in my opinion are horrible funds (managed payout funds are those that make a distribution whether or not they have gains, which means that in lean times they will return capital to shareholders, which is a waste of time). Sadly, out of the top five funds, two are returning capital to shareholders.
Here is the breakdown of investment of PCEF, according to PowerShares:
High Yield Bond Fund (DHY)
The Credit Suisse** High Yield Bond Fund (ticker: DHY) is a simple CEF, not a fund of funds. It invests primarily on US corporate "junk" bonds. These are bonds rated "below investment grade" by the credit agencies. What this means is that these securities are less likely to re-pay their debts than the theoretically safest bond out there: US treasury bonds. In reality, no company wants to default on their bonds, which would imply having to file for bankruptcy protection and possibly liquidate the company. But in practice, this does happen, so the credit rating is important. Just keep in mind that low doesn't mean investors won't get paid. It means investors should demand higher yields.
DHY offers a monthly "dividend" (treated as regular income at tax time) that yields about 11% annualized. The underlying portfolio has a medium duration -- 4.75 years -- which means that the portfolio is not super sensitive to interest rate changes like, say, a 30-year bond. But it is not immune either.
The fund is leveraged, about 29% and has an expense rate that is very steep: 2.65%. Typically, I don't invest in funds with high fees, but in the case of CEFs I allow a few exceptions when I can get the funds at a discount.
This fund in particular is offering about 1-2% discount to NAV right now (it was 1.1% when I bought it). But it recently traded at a large premium (see graph below), which means that an attentive investor may capture outsized returns.
It has, however, traded at significant discounts to NAV in the previous 3 years, which means this is a short-term play only.
Conclusion
I consider both of these investments to deviate from my value strategy. First, they are expensive and leveraged and second, at least DHY is a short-term investment only given its long history of premium/discount. So, consider yourself warned. However, the yields are decent and given that inflation is pretty much staying under wraps for a short while (at least until the Fed hits again with QE3), these two funds can offer a nice current yield.
Have a profitable 2011 everyone.
Disclosures: I own both of these funds at the time of writing.
* I'm not affiliated with PowerShares in anyway. Moreover, I usually don't endorse their dynamic way of portfolio construction and higher fees. This is one of the exceptions.
** I'm also not affiliated with Credit Suisse either.
Nonetheless, a little bit of research can help mitigate these things a bit. Research won't guarantee anything -- nothing is ever guaranteed in investing. But I digress.
Here are the two funds that may help boost a small part of your portfolio the same way they're boosting a small part of mine (emphasis on small).
CEF Income Composite (PCEF)
The PowerShares* Closed-End Fund Income Composite (ticker: PCEF) is a fund of closed-end funds seeking high current income. It tries to achieve this by rotating in and out of closed-end funds when they offer a discount to NAV (net asset value) and good risk-reward prospects based on PowerShares proprietary trading technology. It currently yields about 8% and pays out monthly dividends. It has a very steep fee: 1.81% (0.50% for the ETF and the rest as per the underlying funds).
What I like about this fund is in part derived from what I like about CEFs (Closed-End Funds): they often trade at a discount to NAV and attract less attention than other funds. CEFs are often leveraged and they use long and short strategies to boost performance (and thus increase risk). The subject of closed-end funds is very interesting, but long. I'll reserve the details for another post.
With PCEF in particular, the yield and the monthly payouts are very nice. I looked at the top 5 funds that compose this ETF and they are reasonable funds with the typical risk profile of CEFs: some leverage (20-30%), a good diversifications of securities and most are not managed payout funds, which in my opinion are horrible funds (managed payout funds are those that make a distribution whether or not they have gains, which means that in lean times they will return capital to shareholders, which is a waste of time). Sadly, out of the top five funds, two are returning capital to shareholders.
Here is the breakdown of investment of PCEF, according to PowerShares:
(source: PowerShares.com)
High Yield Bond Fund (DHY)
The Credit Suisse** High Yield Bond Fund (ticker: DHY) is a simple CEF, not a fund of funds. It invests primarily on US corporate "junk" bonds. These are bonds rated "below investment grade" by the credit agencies. What this means is that these securities are less likely to re-pay their debts than the theoretically safest bond out there: US treasury bonds. In reality, no company wants to default on their bonds, which would imply having to file for bankruptcy protection and possibly liquidate the company. But in practice, this does happen, so the credit rating is important. Just keep in mind that low doesn't mean investors won't get paid. It means investors should demand higher yields.
DHY offers a monthly "dividend" (treated as regular income at tax time) that yields about 11% annualized. The underlying portfolio has a medium duration -- 4.75 years -- which means that the portfolio is not super sensitive to interest rate changes like, say, a 30-year bond. But it is not immune either.
The fund is leveraged, about 29% and has an expense rate that is very steep: 2.65%. Typically, I don't invest in funds with high fees, but in the case of CEFs I allow a few exceptions when I can get the funds at a discount.
This fund in particular is offering about 1-2% discount to NAV right now (it was 1.1% when I bought it). But it recently traded at a large premium (see graph below), which means that an attentive investor may capture outsized returns.
(source: CEFConnect.com)
Conclusion
I consider both of these investments to deviate from my value strategy. First, they are expensive and leveraged and second, at least DHY is a short-term investment only given its long history of premium/discount. So, consider yourself warned. However, the yields are decent and given that inflation is pretty much staying under wraps for a short while (at least until the Fed hits again with QE3), these two funds can offer a nice current yield.
Have a profitable 2011 everyone.
Disclosures: I own both of these funds at the time of writing.
* I'm not affiliated with PowerShares in anyway. Moreover, I usually don't endorse their dynamic way of portfolio construction and higher fees. This is one of the exceptions.
** I'm also not affiliated with Credit Suisse either.
2010-07-10
Building a Strong Dividend Growth Portfolio
When it comes to indexing I usually have two views: it's a great tool if one doesn't have the time or inclination to analyze stocks, but it's also a wide catch-all net that brings in the tuna along with the catfish.
So, what should a time-constrained investor do if one doesn't want to invest in the entire market or a sector at once and get the chaff along with the wheat? Answer: Buy the strongest dividend payers from selected industries. And to find out who these dividend payers are one can do their own detailed analysis or read this blog.
Selected pharmaceutical index
The list below is a non-diversified list of strong pharmaceutical companies that have a history of paying dividends. Not all are cheap, but the point of indexing a sector is to get the benefit of the industry as a whole without having to guess or investigate which company has the best pipeline, the best strategy or the best cash position to go after acquisitions.
If one believes, like I do, in the future of the pharmaceutical industry -- which is home to great companies, many international, and robust dividend payers -- then buying the strongest companies is a wise strategy.
Dividend yield-based weighting
Should one buy an equal-weighted index of these companies? Well, first, if by equal-weight one means same number of shares, the answer is no. Share price is too dependent on number of shares, which is arbitrary and as such this index would be arbitrary as well. If one buys an equal number of dollars per company, that's a more suitable strategy but it would still assume that all companies are equivalent, which is not a good assumption.
A better way to index is to use a dividend yield-based indexing: buy more dollars worth of companies with higher dividend yields. This approach has two benefits: 1) one buys more of the higher-dividend companies which in turn boosts the yield of the portfolio and 2) higher yielding companies in the same industry are typically considered cheaper than peers since the yield is higher because the price is lower, so one ends up buying more of the cheaper companies.
However, this pure yield-based approach also has drawbacks: 1) high yielding companies can be cheaper for a reason, and a thorough investigation of these reasons defeats the purpose of this lazy indexing approach; and 2) high current yields could mean the companies have little growth ahead of them and as such the dividend may not keep up with inflation or growth elsewhere.
So, what's the alternative?
Dividend growth-based index
Factoring in current dividend yield as well as dividend growth should provide a much better index because current yield plus dividend growth equals total dividend returns. So, this indexing method is equivalent to saying "buy more of the companies that will return more money to you in form of dividends".
Of course, dividend growth involves making predictions about future dividends. However, armed with fundamental analysis and a long history of dividend growth one can make informed assumptions about future growth and thus minimize the risk of making a bad call.
With this, here's my dividend growth-based index of pharmaceutical companies based on 10-year historical growth rates and current yield and their respective weights.
Putting it all together
The "weight" column in the table above indicates a dollar multiplier for each ticker. That means one should buy 2.36 times more Novartis (NVS) than Merck (MRK).
If one has a budget of $10,000 to allocate to this index, and rounding the number of shares to their nearest whole number, one should buy $1783.8 (36 shares) worth of NVS and only $762.3 (21 shares) of MRK.
The final portfolio worth approximately $10,000 in today's prices would look like this:
Of course, one should only follow this approach if one doesn't have time to do a thorough due-diligence fundamental analysis and after consulting with their financial advisor.
Disclosures: Long JNJ at the time of writing.
So, what should a time-constrained investor do if one doesn't want to invest in the entire market or a sector at once and get the chaff along with the wheat? Answer: Buy the strongest dividend payers from selected industries. And to find out who these dividend payers are one can do their own detailed analysis or read this blog.
Selected pharmaceutical index
The list below is a non-diversified list of strong pharmaceutical companies that have a history of paying dividends. Not all are cheap, but the point of indexing a sector is to get the benefit of the industry as a whole without having to guess or investigate which company has the best pipeline, the best strategy or the best cash position to go after acquisitions.
If one believes, like I do, in the future of the pharmaceutical industry -- which is home to great companies, many international, and robust dividend payers -- then buying the strongest companies is a wise strategy.
Dividend yield-based weighting
Should one buy an equal-weighted index of these companies? Well, first, if by equal-weight one means same number of shares, the answer is no. Share price is too dependent on number of shares, which is arbitrary and as such this index would be arbitrary as well. If one buys an equal number of dollars per company, that's a more suitable strategy but it would still assume that all companies are equivalent, which is not a good assumption.
A better way to index is to use a dividend yield-based indexing: buy more dollars worth of companies with higher dividend yields. This approach has two benefits: 1) one buys more of the higher-dividend companies which in turn boosts the yield of the portfolio and 2) higher yielding companies in the same industry are typically considered cheaper than peers since the yield is higher because the price is lower, so one ends up buying more of the cheaper companies.
However, this pure yield-based approach also has drawbacks: 1) high yielding companies can be cheaper for a reason, and a thorough investigation of these reasons defeats the purpose of this lazy indexing approach; and 2) high current yields could mean the companies have little growth ahead of them and as such the dividend may not keep up with inflation or growth elsewhere.
So, what's the alternative?
Dividend growth-based index
Factoring in current dividend yield as well as dividend growth should provide a much better index because current yield plus dividend growth equals total dividend returns. So, this indexing method is equivalent to saying "buy more of the companies that will return more money to you in form of dividends".
Of course, dividend growth involves making predictions about future dividends. However, armed with fundamental analysis and a long history of dividend growth one can make informed assumptions about future growth and thus minimize the risk of making a bad call.
With this, here's my dividend growth-based index of pharmaceutical companies based on 10-year historical growth rates and current yield and their respective weights.
| Ticker | 10-yr div. growth | Curr yield | Curr Price | P/E | Weight |
| NVS | 13.74% | 3.93% | 49.55 | 12.07 | 2.36 |
| JNJ | 12.84% | 3.57% | 60.54 | 12.72 | 2.19 |
| LLY | 7.86% | 5.57% | 35.17 | 9.07 | 1.8 |
| ABT | 9.26% | 3.66% | 48.03 | 14.08 | 1.73 |
| PFE | 7.87% | 4.87% | 14.77 | 11.89 | 1.7 |
| GSK | 5.53% | 5.28% | 34.84 | 10.2 | 1.45 |
| BMY | 3.73% | 5.00% | 25.6 | 14.71 | 1.17 |
| MRK | 3.29% | 4.19% | 36.3 | 7.57 | 1 |
The "weight" column in the table above indicates a dollar multiplier for each ticker. That means one should buy 2.36 times more Novartis (NVS) than Merck (MRK).
If one has a budget of $10,000 to allocate to this index, and rounding the number of shares to their nearest whole number, one should buy $1783.8 (36 shares) worth of NVS and only $762.3 (21 shares) of MRK.
The final portfolio worth approximately $10,000 in today's prices would look like this:
| Shares | Cost $ | |
| NVS | 36 | 1783 |
| JNJ | 27 | 1634 |
| LLY | 38 | 1336 |
| ABT | 27 | 1296 |
| PFE | 86 | 1270 |
| GSK | 31 | 1080 |
| BMY | 34 | 870 |
| MRK | 21 | 762 |
| Total | $10,031 |
Disclosures: Long JNJ at the time of writing.
2010-07-04
Preparing a Shopping List for Bad Times Ahead
Several pundits online and on mainstream media are calling for another "leg down" or plain depression in the markets soon.
I don't react to predictions, forecasts, star readers or fortune tellers. I will see when it happens. However, it's always good to be prepared for anything -- up markets, down markets, neutral markets -- at all times. As such, I have my shopping list ready in case the forecasters turn out to be right.
Because it's a long shopping list and it's mostly still far from my entry prices, I will just pick those that have been approaching my entry price recently. Many of these are names I already own and am looking to buy more of. Some are new.
Shopping list for the next "leg down"
PAYX (Paychex) - Buy range: $25-21, Current: $25.47
COP (ConocoPhillips) - $47-38, Current: $48.82
PFE (Pfizer) - $13-11, Current: $14.14
RDS.A (Shell) - $48-42, Current: $50.01
CINF (Cincinnati Financial) - $23-21, Current: $25.53
ETR (Entergy) - $75-60, Current: $70.70
Note 1: These are all dividend payers that have been around for a while and paying dividends for a while.
Note 2: Entry prices were based on my model of discounted dividend analysis and a qualitative assessment of earning power. The entry prices typically entail a total return from dividend plus dividend appreciation to 11 to 12%. Any share price growth is extra icing on the cake (and was not factored in the price).
Note 3: There are two oil companies on the list. This is a good thing, because when governments in developed countries start to print money seriously, oil, gas and tanker and pipeline companies will benefit. It's best to own the companies behind these commodities than own the commodities outright for various reasons that are beyond this article's point right now.
Note 4: I started buying Shell a little ahead of my entry price and am looking into buying more significantly when it does enter the buy range.
Note 5: I haven't bought Entergy yet because I haven't had time to investigate their price drop and read their latest 10Qs. As soon as I find out they're still in as good a shape as when I first priced my buy range, I will pull the trigger.
Disclosures: I own shares of PAYX and RDS.A at the time of writing.
I don't react to predictions, forecasts, star readers or fortune tellers. I will see when it happens. However, it's always good to be prepared for anything -- up markets, down markets, neutral markets -- at all times. As such, I have my shopping list ready in case the forecasters turn out to be right.
Because it's a long shopping list and it's mostly still far from my entry prices, I will just pick those that have been approaching my entry price recently. Many of these are names I already own and am looking to buy more of. Some are new.
Shopping list for the next "leg down"
PAYX (Paychex) - Buy range: $25-21, Current: $25.47
COP (ConocoPhillips) - $47-38, Current: $48.82
PFE (Pfizer) - $13-11, Current: $14.14
RDS.A (Shell) - $48-42, Current: $50.01
CINF (Cincinnati Financial) - $23-21, Current: $25.53
ETR (Entergy) - $75-60, Current: $70.70
Note 1: These are all dividend payers that have been around for a while and paying dividends for a while.
Note 2: Entry prices were based on my model of discounted dividend analysis and a qualitative assessment of earning power. The entry prices typically entail a total return from dividend plus dividend appreciation to 11 to 12%. Any share price growth is extra icing on the cake (and was not factored in the price).
Note 3: There are two oil companies on the list. This is a good thing, because when governments in developed countries start to print money seriously, oil, gas and tanker and pipeline companies will benefit. It's best to own the companies behind these commodities than own the commodities outright for various reasons that are beyond this article's point right now.
Note 4: I started buying Shell a little ahead of my entry price and am looking into buying more significantly when it does enter the buy range.
Note 5: I haven't bought Entergy yet because I haven't had time to investigate their price drop and read their latest 10Qs. As soon as I find out they're still in as good a shape as when I first priced my buy range, I will pull the trigger.
Disclosures: I own shares of PAYX and RDS.A at the time of writing.
2010-02-12
Bracing for Inflation
I'm no economist. Neither I have a crystal ball. Nonetheless, all I hear is talk about inflation. I don't know where it is, but from all I've read and thought about, one thing is clear: the US dollar will continue to lose value (as has been the case in the last 40 years or so since coming off of the gold standard), and it is likely to lose value faster than in the last ten years.
Again, I'm no economist. I don't know that there isn't a perfectly acceptable magic way out of this. But economists too have predicted seven of the last three recessions...
Anyway, it doesn't take much understanding about money to figure out that the USD is toast. With 30% of GDP compromised as debt and with the Greenspan-Guidotti rule out-of-the-whack the picture doesn't look rosy for Uncle Sam.
So what's an investor to do?
Well, by and large, nothing much one wouldn't do in normal times: buy undervalued, dividend-paying stocks. In the long run, if anything is going to hold value, it's a well run company with valuable assets (physical or intellectual) with a strong franchise.
Ok, but there might be something else investors can do to tweak their portfolios a bit: they should move their cash away from the USD and bonds and into:
TIPS is not an unreasonable option, but being a taxable security and being tied to the official inflation rate (which is computed by those devaluing the currency), I tend to leave them as a distant fourth option.
Foreign currencies
I've discussed the role of foreign currencies before. So I'll just add that there's no reason to completely avoid emerging markets. The Brazilian Real is old news. But the Mexican Peso (FXM) pays a reasonable interest and I don't see it defaulting or going into hyper inflation anytime soon.
Physical assets
My beef with commodities and physical assets in general is their lack of dividends, lack of internal growth rate. Nonetheless, it doesn't hurt to have some as a backup plan.
My favorite commodity would be oil, given its importance as an industrial raw product and its finite production. Also, gold tends to do well in uncertain times like now.
But my favorite physical asset is really real estate. With real estate, one can obtain dividends (rent) and increase its value over time, through proper maintenance, and upgrades.
More stocks
As you may have guessed, investing in businesses is still my favorite option, be them your own business (assuming you're competent and are in a good industry) or someone else's, under the same assumptions, plus the condition that these companies trade for a discount and/or pay juicy, growing dividends.
However, there's no telling what will happen with the US or the USD. If the country defaults, we lose. If we go to war, we lose (as Phillip Fisher said in his book, "War is always bearish on money. To sell stock at the threatened or actual outbreak of hostilities so as to get into cash is extreme financial lunacy. Actually just the opposite should be done") and if do nothing, well, nothing will be resolved.
Disclosures: Long brazilian Real and global real estate.
Again, I'm no economist. I don't know that there isn't a perfectly acceptable magic way out of this. But economists too have predicted seven of the last three recessions...
Anyway, it doesn't take much understanding about money to figure out that the USD is toast. With 30% of GDP compromised as debt and with the Greenspan-Guidotti rule out-of-the-whack the picture doesn't look rosy for Uncle Sam.
So what's an investor to do?
Well, by and large, nothing much one wouldn't do in normal times: buy undervalued, dividend-paying stocks. In the long run, if anything is going to hold value, it's a well run company with valuable assets (physical or intellectual) with a strong franchise.
Ok, but there might be something else investors can do to tweak their portfolios a bit: they should move their cash away from the USD and bonds and into:
- Diversified baskets of foreign currencies
- Physical assets (commodities, oil, gold)
- More stocks, favoring global companies with business presence in large foreign markets.
TIPS is not an unreasonable option, but being a taxable security and being tied to the official inflation rate (which is computed by those devaluing the currency), I tend to leave them as a distant fourth option.
Foreign currencies
I've discussed the role of foreign currencies before. So I'll just add that there's no reason to completely avoid emerging markets. The Brazilian Real is old news. But the Mexican Peso (FXM) pays a reasonable interest and I don't see it defaulting or going into hyper inflation anytime soon.
Physical assets
My beef with commodities and physical assets in general is their lack of dividends, lack of internal growth rate. Nonetheless, it doesn't hurt to have some as a backup plan.
My favorite commodity would be oil, given its importance as an industrial raw product and its finite production. Also, gold tends to do well in uncertain times like now.
But my favorite physical asset is really real estate. With real estate, one can obtain dividends (rent) and increase its value over time, through proper maintenance, and upgrades.
More stocks
As you may have guessed, investing in businesses is still my favorite option, be them your own business (assuming you're competent and are in a good industry) or someone else's, under the same assumptions, plus the condition that these companies trade for a discount and/or pay juicy, growing dividends.
However, there's no telling what will happen with the US or the USD. If the country defaults, we lose. If we go to war, we lose (as Phillip Fisher said in his book, "War is always bearish on money. To sell stock at the threatened or actual outbreak of hostilities so as to get into cash is extreme financial lunacy. Actually just the opposite should be done") and if do nothing, well, nothing will be resolved.
Disclosures: Long brazilian Real and global real estate.
2009-11-01
Dividend Discount Model in Action -- LLY Stock Analysis
Recently, I noticed a stock on my watch list that hasn't returned to its pre-financial-crisis level: Pharmaceutical company Eli Lilly (LLY). Here's my analysis.
For a mature dividend aristocrat such as LLY, the dividend discount model is usually a good start in valuing the stock.
LLY has raised its dividend for over 25 years. Over the last 10 years, LLY has raised its dividend a compound 7.86%. Year-over-year, the minimum raise has been 4%, the maximum 13% and the average raise was close to 8%.
Meanwhile, earnings per share (EPS) growth has only compounded by 1.65%. So the growth in dividend is probably not sustainable without further improvements to the bottom line, such as cost cutting or acquisitions.
If we assume a 1% growth in dividends (to match the growth in EPS) in perpetuity, and tag it with a 9% discount (my minimum expected return from solid stocks), the dividend growth model yields a price of $25.
LLY currently trades at around $34, has a forward P/E of 7.8 due to analysts-expected EPS of about $4.25 for 2009.
LLY's 10-year average EPS is only $2.00, though. The growth expected this year and next is attributed to a strong drug demand, the acquisition of ImClone and cost cutting. The company's own EPS guidance for 2009 suggests EPS between $4.20 and 4.30. It's unclear how sustainable this new EPS level is.
Historically, LLY P/E ratio has been quite high: the average low P/E was around 22 while the average high P/E was 34. Counting on market euphoria to bring the P/E back to its historical lofty levels is never a good idea. My comfort range of P/E for a large and mature company such as LLY is between 10 and 15. Using LLY's average 10-year earnings of $2.00, we get a price tag of between $20 and $24.
Looking at dividend and EPS growth and checking the P/E ratio is only part of the analysis. I said earlier that it's usually a good start because mature companies such as LLY often have stable earnings, growth, debt load and share count. But a further look at the balance sheet is always helpful. Consider the trends in the graph below.
Looking at various balance sheet indicators as a percentage of sales can help spot worrisome trends. In this case, it's encouraging to see that both research and development (R&D) and accounts receivable have been moving inline with sales. Inventory had a run up in the past that warrants further investigation, but doesn't appear to be out of control. Selling, general and administrative expenses (SG&A) have been growing slightly faster than sales, which might indicate that LLY is not as efficient as it used to be 10 years ago. Nonetheless, the trend is not sky-rocketing either.
Overall, these trends are somewhat reassuring that the dividend discount model is meaningful as it shows the fundamentals are not quickly deteriorating.
Conclusion: from a purely dividend discount valuation and a check against a conservative P/E multiple and a conservative EPS estimate, my initial fair value for a share of LLY is between $20 and $25. Further investigation into drugs in the pipeline, patent expiration and integration of acquisitions is necessary to further determine earnings power and hence fair value.
Disclosures: No shares of LLY held at the time of writing.
For a mature dividend aristocrat such as LLY, the dividend discount model is usually a good start in valuing the stock.
LLY has raised its dividend for over 25 years. Over the last 10 years, LLY has raised its dividend a compound 7.86%. Year-over-year, the minimum raise has been 4%, the maximum 13% and the average raise was close to 8%.
Meanwhile, earnings per share (EPS) growth has only compounded by 1.65%. So the growth in dividend is probably not sustainable without further improvements to the bottom line, such as cost cutting or acquisitions.
If we assume a 1% growth in dividends (to match the growth in EPS) in perpetuity, and tag it with a 9% discount (my minimum expected return from solid stocks), the dividend growth model yields a price of $25.
LLY currently trades at around $34, has a forward P/E of 7.8 due to analysts-expected EPS of about $4.25 for 2009.
LLY's 10-year average EPS is only $2.00, though. The growth expected this year and next is attributed to a strong drug demand, the acquisition of ImClone and cost cutting. The company's own EPS guidance for 2009 suggests EPS between $4.20 and 4.30. It's unclear how sustainable this new EPS level is.
Historically, LLY P/E ratio has been quite high: the average low P/E was around 22 while the average high P/E was 34. Counting on market euphoria to bring the P/E back to its historical lofty levels is never a good idea. My comfort range of P/E for a large and mature company such as LLY is between 10 and 15. Using LLY's average 10-year earnings of $2.00, we get a price tag of between $20 and $24.
Looking at dividend and EPS growth and checking the P/E ratio is only part of the analysis. I said earlier that it's usually a good start because mature companies such as LLY often have stable earnings, growth, debt load and share count. But a further look at the balance sheet is always helpful. Consider the trends in the graph below.
Looking at various balance sheet indicators as a percentage of sales can help spot worrisome trends. In this case, it's encouraging to see that both research and development (R&D) and accounts receivable have been moving inline with sales. Inventory had a run up in the past that warrants further investigation, but doesn't appear to be out of control. Selling, general and administrative expenses (SG&A) have been growing slightly faster than sales, which might indicate that LLY is not as efficient as it used to be 10 years ago. Nonetheless, the trend is not sky-rocketing either.
Overall, these trends are somewhat reassuring that the dividend discount model is meaningful as it shows the fundamentals are not quickly deteriorating.
Conclusion: from a purely dividend discount valuation and a check against a conservative P/E multiple and a conservative EPS estimate, my initial fair value for a share of LLY is between $20 and $25. Further investigation into drugs in the pipeline, patent expiration and integration of acquisitions is necessary to further determine earnings power and hence fair value.
Disclosures: No shares of LLY held at the time of writing.
2009-09-10
Don't Let Your Investment be Diluted
This article originally appeared on The DIV-Net on 2009-09-02
High return on equity (ROE) and a reasonably high dividend yield are good things to have in stock investment. But investors focusing on just these two metrics (or any other few metrics) might be surprised to discover they are losing money.
This is the case of CenterPoint Energy (CNP), a utility company with interests in electricity, natural gas distribution and pipelines. Since 1999, CNP has returned $8.78 per share to shareholders via dividends. The average annual dividend yield since then has been between 3.11% and 6.83%.
The return on equity has been solidly between 10.3 and 34%, with the average just over 21%, which is pretty good considering that an average business gets less than 12% and utilities are lucky to strike above 8% ROE.
But long-term investors received little for holding the stock for the last 10 years. In fact, they lost money after inflation, through equity dilution.
An investor who was lucky to buy a share of CNP in 1999 at the lowest recorded price for that year ($22.75) and held on until the very peak price in 2008 ($17.35), would have gotten a total cumulative return of around 8%, including dividends, which translates to 0.89% annualized. That's less than inflation.
Even if we consider that in 1999 the market was very inflated and in 2008 it was really low overall, this exercise assumed an investor was lucky enough to buy at the trough and sell at the peak. Most investors won't get these prices.
But let's exclude 1999 as it was a local market peak and also 2008 since it was an abnormally depressed year. Let's continue to assume our investor was lucky and bought at the lowest point in 2000, collected dividends until the top of 2007 and sold at that high price.
Even in this scenario, the cumulative return amounts to only 24% or 3% annualized, barely keeping up with inflation.
The table below summarizes why.
CNP has been diluting shareholders returns via stock options and outright sale of stock and at the same time maintaining or increasing its debt. These management actions proved to be unfriendly to shareholders and thus investors should continue to shun this stock.
Dilution of shares and high debt are characteristics of capital-intensive companies with high fixed charges. Careful investors should be on the look out for such companies and invest only when it makes sense to do so.
Value investing is not only about finding bargains. It's about finding wonderful businesses at reasonable prices.
Disclosure: no position in CNP at the time of writing.
High return on equity (ROE) and a reasonably high dividend yield are good things to have in stock investment. But investors focusing on just these two metrics (or any other few metrics) might be surprised to discover they are losing money.
This is the case of CenterPoint Energy (CNP), a utility company with interests in electricity, natural gas distribution and pipelines. Since 1999, CNP has returned $8.78 per share to shareholders via dividends. The average annual dividend yield since then has been between 3.11% and 6.83%.
The return on equity has been solidly between 10.3 and 34%, with the average just over 21%, which is pretty good considering that an average business gets less than 12% and utilities are lucky to strike above 8% ROE.
But long-term investors received little for holding the stock for the last 10 years. In fact, they lost money after inflation, through equity dilution.
An investor who was lucky to buy a share of CNP in 1999 at the lowest recorded price for that year ($22.75) and held on until the very peak price in 2008 ($17.35), would have gotten a total cumulative return of around 8%, including dividends, which translates to 0.89% annualized. That's less than inflation.
Even if we consider that in 1999 the market was very inflated and in 2008 it was really low overall, this exercise assumed an investor was lucky enough to buy at the trough and sell at the peak. Most investors won't get these prices.
But let's exclude 1999 as it was a local market peak and also 2008 since it was an abnormally depressed year. Let's continue to assume our investor was lucky and bought at the lowest point in 2000, collected dividends until the top of 2007 and sold at that high price.
Even in this scenario, the cumulative return amounts to only 24% or 3% annualized, barely keeping up with inflation.
The table below summarizes why.
|
CNP has been diluting shareholders returns via stock options and outright sale of stock and at the same time maintaining or increasing its debt. These management actions proved to be unfriendly to shareholders and thus investors should continue to shun this stock.
Dilution of shares and high debt are characteristics of capital-intensive companies with high fixed charges. Careful investors should be on the look out for such companies and invest only when it makes sense to do so.
Value investing is not only about finding bargains. It's about finding wonderful businesses at reasonable prices.
Disclosure: no position in CNP at the time of writing.
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