3 'Wonderful Dividend Stocks at a Fair Price'

Last week I wrote about how dividend stocks were getting expensive and the number of stocks that my model identified as a buy were diminishing. After another week of the market rallying, the number of stocks identified as a buy fell to 4 stocks from 7. So what do you do if you are over-allocated in the four stocks that are a buy?

If you practice asset allocation and dollar cost averaging, as I do, having cash set aside to purchase stocks with no clear buy from an allocation standpoint certainly presents a quandary. When I am faced with this situation, I evaluate what is most important to me and continue to look for that.

In evaluating a dividend stock there are some items that I will not compromise on, such as:

1. NPV MMA Differential: It must be positive and greater than $500.
2. Free Cash Flow Payout + Debt To Total Capital < 100%: Cash is the life blood of dividend increases. If a company is paying out most of its cash as dividends and/or is carrying high levels of debt, a dividend cut is very likely.
3. Dividend Yield: Too high or too low of a dividend is risky. Too high and the company has a hard time maintaining it; too low and the company will have a hard time growing it at a high enough rate to make the numbers work.

That leaves price available for compromise. As a dividend and value investor I want to have it all, but sometimes that is not an option. I take heart that even the best investor in America has been where I am at. Consider Warren Buffett's quote:

It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

With that in mind I currently categorize stocks that are potential purchases into two tiers:

Tier I: Four and five Star stocks that are trading below my calculated fair value with a yield above my preset minimum. These are the stocks I categorize as “buy” stocks.

Tier II: Four Star stocks that are trading less than 5% above my calculated fair value with a yield above my preset minimum. These are my “wonderful stocks at a fair price.”

Sure I would like to buy them below fair value, but that is not always possible. If your holding period is forever, will an extra 5% make a lot of difference in 20 years? Consider these stocks I currently categorize as Tier II stocks:

Genuine Parts Co. (GPC) – Analysis
Genuine Parts Co is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products.
- Calculated Fair Value: $34.27
- Recent Price: $35.59

Emerson Electric Co. (EMR) – Analysis
Emerson Electric Co. primarily makes backup power equipment for telecom and Internet providers and users, climate control components, and electric motors.
- Calculated Fair Value: $38.39
- Recent Price: $39.38

Procter & Gamble Co. (PG) – Analysis
The Procter & Gamble Company (P&G) is focused on providing branded consumer goods products. The Company markets its products in more than 180 countries.
- Calculated Fair Value: $55.27
- Recent Price: $55.64

It is important to remember that just a few short months ago everyone was looking for a bottom. There will be other opportunities to buy great companies at a large discount.

Full Disclosure: Long GPC, EMR, PG. See a list of all my income holdings here.

Comments

[Dotcom:]

Thank you.

Sep 17 02:10 PM

[Dotcom:]

For future article - I would like to know when the market is being evacuated, for whatever reason (e.g. end of 2008, March of 2009), should you sell your Dividend paying stocks to try to avoid serious negative NAV impacts and buy back in later or just hang on? Thanks in advance for considering this topic.

Sep 17 02:18 PM

[genemerk:]

i have been div investor for many years but like many i am sure item 2 and 3 went over my head. need articles that average guy can understand

Sep 17 02:46 PM

[mbkelly75:]

Actually 2 & 3 were clear to me - it was Point 1 that confused me.
For Point 3: The Golden Ratio of Dividends = 3.1%-3.8%. This is the percentage return that gives a nice return while still allowing the company to grow and re-invest in itself. More can work and so can less, but that range is the ideal. Compounding this by re-investing the dividend can have huge returns over time.

Sep 17 03:13 PM

[Bert Mariani:]

So the title of the article says "dividend" in it. For the 3 stocks you mention you fail to give the current dividend amount and the resulting yield at the current price.

How do you calculate "fair" value ?

Sep 18 11:31 AM

[Mark Divy:]

Do you ever consider higher risk stocks? Would be interesting to see what you might consider as future buys, but currently not paying or recently lowered payout companies that should recover in the near term (6-12 months). This is a riskier effort, but one that could proivde upside on the price when a pick regains its payout.

Sep 18 12:29 PM

[Avooch:]

This is a good beginning analysis. I like to add my screening the expected long term dividend return imputed by the current Market price.

For example, Emerson's imputed LT return is 6.37%.

----------------------...

Don't Get Massacred !

Gudovac1941

Sep 18 01:57 PM

[Alan Young:]

Why pump dividend stocks without mentioning what the dividend yield is?

Sep 18 03:06 PM

[Domino412:]

I think T is the best dividend stocks out there. I don't see it mentioned too much, but the daily volume is huge. I play T over and over swing trading and dividend capture. It has treated me well. I dont want it to get too much hype since it is fair priced. Hopefully it will stay "hidden" and not get overbought like the rest of the market. It was up .68 on 9/17 and the yield is around 6.5.

Sep 20 09:48 AM

[untrusting ...:]

Hmmmm 3.1-3.8% is ideal? Compared to what?
1) Almost any tax-advantaged stock such as REIT's or CanRoy's pays significantly more in dividends than that.
2) Any preferred stock or any preferred stock EFT pays more than that.
3) Any bond fund or bond fund EFT pays more than that.

Common stock dividends in the 3% range are historically quite low compared to previous stock market periods of prior decades. If one recalls correctly, 4% and up was the norm prior to the 90's and as such it accounted for a significant part of total return in prior market days.

Investing for dividend returns in the 3% range is really more like saying, gamble on most of your returns coming from price appreciation and capital gains, in our view. And the truth is stocks have a negative appreciation even in nominal terms, let alone real terms, over the past decade. By way of comparison, we have a LT bond fund in one of our retirement accounts and it has a compound annual return of over 7% for well over the past decade.

In our view, the investment approach to the stock market (equities) has fundamentally changed since the late 1990's. In essence the equities market has essentially become a trader's market. Works great if your an astute trader, not so great if your a LT investor looking for stable growth and stable returns.


On Sep 17 03:13 PM mbkelly75 wrote:

> Actually 2 &amp; 3 were clear to me - it was Point 1 that confused
> me.
> For Point 3: The Golden Ratio of Dividends = 3.1%-3.8%. This is the
> percentage return that gives a nice return while still allowing the
> company to grow and re-invest in itself. More can work and so can
> less, but that range is the ideal. Compounding this by re-investing
> the dividend can have huge returns over time.

Sep 20 02:14 PM

[Moon Kil Woong:]

Either you invest for divedend yield or you invest for stock appreciation. Trying to play both sides is complicated and often suffers simply because the stock market doesn't reward higher divendends (they want better growth) and conservative investors tend towards flat dividend yield (thus any cut in dividends to support growth punishes the stock even if it is fundamentally sound and the stock suffers both from rising rates as well as slower economic growth).

Dividendsforlife's article is a good attempt for trying to find good value looking at both sides of the coin, but generally I think it's best to either go pure play dividends or stock appreciation for each stock you pick. If you want both values buy 2 seperate stocks thus the profile is more straightforward. Trying to get both in one stock just muddies the water.

Sep 20 11:48 PM