3 Under-Priced And 3 Over-Priced DGI Stocks

 |  Includes: CL, DE, MSFT, NKE, PAYX, QCOM
by: The Part-time Investor

"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." --- Warren Buffett

When evaluating which stocks to buy for my portfolio I like to keep things simple. I use only 6 criteria in my screen, as discussed in one of my previous articles. They are all concrete measures, easily understandable, with no interpretation as to whether the stock passes the criteria or not. If a stock passes all six criteria it can be added to my portfolio. If it fails any one of them then I will not buy it. But since there are so few criteria it makes each of them extremely important. And possibly the most important one is valuation. No matter how great a company is, no matter how good the yield is, no matter how long it has been paying a dividend and no matter what the dividend growth rate is, if I over pay for the stock then I expect my over-all results will suffer.

Once I have purchased a stock, what happens to its price doesn't matter to me, as long as it continues to pay me a good dividend with a good growth rate. But the actual purchase price is very important! Even if I have identified a great company which I would love to own, I still have to make sure not to pay too high a price for it. Warren Buffet was taught by Benjamin Graham to purchase stocks only if he could buy them for below intrinsic value. To look for a margin of safety. But later in his career, as he was influenced by Charlie Munger, he came to believe it is just as worthwhile to buy great companies at a fair price. But conversely we must understand that even a wonderful company should not be bought at too high a price. The key is buying the company for fair value or, if I get lucky, below value. Even if I am buying a wonderful company with a great dividend, if I pay too much my returns will suffer.

There are many ways to value a company, but, again, with my desire to keep it simple, I don't spend time studying the PE, P/B, P/S, PEG, or any other ratio. I simply go to FAST Graphs. One of my criteria for buying a stock is that it must not be over priced based on its FAST Graph. You can read the FAST Graph articles by Chuck Carnevale to learn more about FAST Graphs, but basically the orange line on the graph shows the True Worth (Chuck's term) of the company based on its earnings. FAST Graphs shows you whether or not the stock price is above or below True Worth. If I make sure I only buy stocks trading at or below their True Worth line, and those stocks continue to be solid DGI stocks, then my returns should be excellent.

To show what I'm talking about, here are some examples of some great dividend growth companies, and the returns they produced if they had been bought when they were over valued based on their FAST Graphs. All of the returns shown below are with all their dividends re-invested.

Lets take Coca-Cola (NYSE:KO) as an example. KO has been a DGI mainstay for many years. It has produced an annual return of 8.9% for the past 21 years, and during that time its dividend growth rate has been 10.6%. Does that mean that at any time during the past 21 years I could have bought KO and made 8.9% a year? Of course not. From (approximately) 1996 through 2002 KO's price had risen so high that had I bought it at that time I would have achieved mediocre returns, at best. The returns would have been below 5% most of that time, and as low as 2% if I bought in the middle of 1997. This just shows that no matter how great the company is, if I pay too much for the stock my results will suffer.

Here is the FAST Graph of KO from 1993 through 1997:

Had I looked at KO's FAST graph in 1997 (although I don't know if FAST Graphs existed back then) this is what I would have seen. The orange line shows the True Worth of KO based on its earnings. In 1995, as the stock price moved above $15, it became more and more over valued. This visual representation makes it very obvious that KO, no matter how great a company it was (is), or how good a dividend history it has, should not have been bought at that time. If I had, my return over the past 16 years would have been only about 3% a year. Here is the rest of the FAST Graph up through present day.

Click to enlarge

Even though KO has almost always traded above its fair value line, you can see that from 1996 through 2002 the stock price (the black line) was even further above its fair value than usual. A wise investor would have stayed away.

Another example.

As shown by the orange line in the FAST Graph below, Medtronic (NYSE:MDT) has been increasing its earnings year after year without fail since 1993. But as you also can see, from about 1997 through 2005 MDT was trading way over its True Worth line.

Even though MDT raised its dividend an average of 16.6% per year since 1997, had I bought it at that time I would have achieved an annual return of less than 6%. As you can see from the rest of the graph MDT is still increasing its earnings and dividend every year. But the price, even now, is still only around $53, the same price that it was back in the year 2000. Conversely, to show that I can make good returns if I do pay attention to the True Worth line, and how important it is to buy below, or at the stocks fair value, had I bought MDT back in 1993, when the price was about at the level of the True Worth line, even though the price has basically stalled for the past 13 years I still would have achieved a return of 14.8%.

Click to enlarge

Now, here are some stocks that are trading below their True Worth, as shown by their FAST Graphs, and therefore could be considered to be a buy right now. Disclosure: I already, in fact, own all three of these stocks.

Deere & Co (NYSE:DE).

Deere is the world's largest maker of farm tractors and combines, and a leading producer of construction equipment.

Deere's yield is 2.46%. The payout ratio is 25.09%, and the Chowder number is 18.9. S&P gives DE a Quality Rating of "A". The Dividend Growth rate for DE for the past 21 years was 8.9% and the annual return during that time was 12.4%. The most recent dividend increase was 10%. The EPS forecasts are $8.84 for FY 13, compared with $7.63 posted in FY 12.

Click to enlarge

Deere's FAST Graph shows that DE is priced well below its True Worth line, and except for a short time at the end of 2007-beginning of 2008, has been under valued. I consider DE to be a buy right now.

Microsoft (NASDAQ:MSFT)

Microsoft is the world's largest software maker, primarily as a result of its near monopoly position in desktop operating systems and its Office productivity suite.

MSFT has a yield of 3.40%, a payout ratio of 35.5%, and a Chowder number of 18.0. S&P gives it a Quality Rating of "A-". It has shown a DGR of 27.2% since it started paying a dividend in 2003. The Most recent increase, just this past month, was 22%. MSFT has returned only 5.2% since it started paying a dividend, due to a contraction of its PE ratio, but, as shown in the FAST Graph below, this has brought MSFT to a point where it is trading well below its True Worth. In FY 13, MSFT reported EPS of $2.65. Consensus estimate EPS of for FY 14 is $2.74 and $3.07 in FY 15.

Click to enlarge


Qualcomm designs, develops, manufactures, and markets digital telecommunications products and services. It provides integrated circuits and system software solutions to top wireless handset and infrastructure manufacturers.

QCOM has a yield of 2.17%, a payout ratio of 37.23%, and a Chowder number of 14.5. S&P gives it a Quality Rating of "A-". QCOM has had a DGR of 34.3% since it started paying a dividend in 2003, and an annual total return during that time of 13.9%. The most recent increase was 40%. S&P forecasts revenue increases of 30% in FY 13, 11% in FY 14, and 8% in FY 15. It estimates that operating EPS will increase to $3.98 in FY 13, $4.31 in FY 14, and $4.68 in FY 15.

As the FAST Graph below shows QCOM has been trading well below its True Worth level since about 2009, and continues to do so today.

Click to enlarge

Now, to show how to use FAST Graphs to figure out which stocks to stay away from, the following are some examples of stocks that FAST Graphs show are presently over priced.


Nike Inc. is the world's largest supplier of athletic footwear, with an estimated 50% of this $20 billion market (at wholesale). Sports apparel and equipment are also sold under the Nike banner, and the company's other segment houses its affiliated brands, Converse, Hurley, and Nike Golf.

NKE has a yield of 1.4%, a payout ratio of 28%, and a Chowder number of 15.2. S&P gives it a Quality Rating of "A+". NKE has had a DGR of 14.71% over the past 21 years, and has produced an annual return of 18.2% during that time. The most recent increase was 16.67%. S&P sees revenues from continuing operations reaching $27.13 billion in FY 14, driven by growth in North America and emerging markets.

NKE earned $2.67 in 2013. Consensus estimate for 2014 is $3.02.

Click to enlarge

As shown in the FAST Graph NKE is trading well above it's True Worth line, just like KO and MDT were trading in the past. I believe that the low yield and high price indicate that it would be wise to stay away from NKE for now.


Paychex is a leading provider of payroll processing, human resources and benefits services. The company was founded in 1971, and began by serving the payroll accounting services of businesses with fewer than 200 employees. It currently has more than 100 locations and serves over 570,000 clients throughout the U.S.

PAYX's yield is 3.5%. The payout ratio is 84%. S&P gives QCOM a Quality Rating of "A". PAYX has had a DGR of 24.6% over the past 21 years, and has shown an annual return of 15.5% during that time. But the most recent dividend increase was only 3.0% and the Chowder number is under 12. In FY 13 the EPS was $1.60. Consensus EPS for FY 14 is $1.69.

The FAST Graph shows that PAYX, although trading close to its True Worth at times during 2009-2011, has risen significantly since that time and now appears to be over priced.

Click to enlarge

Colgate-Palmolive Co. (NYSE:CL)

Colgate Palmolive is a leading global consumer products company that operates in the oral, personal and household care and pet food markets. The company's oral care products include toothbrushes, toothpaste and pharmaceutical products for oral health professionals. CL's personal care products include bar and liquid soaps, shampoos, conditioners, deodorants, antiperspirants, and shave products. The home care business produces major brands such as Palmolive and Ajax soaps.

CL's yield is 2.27%. The payout ratio is 56.9% and the Chowder number is 14.0. S&P gives QCOM a Quality Rating of "A+". CL produced a DGR of 10.3% over the past 21 years, and during that time its annual return was 13.8%. The most recent dividend increase was 9.68%. In 2013 S&P looks for sales to increase about 3%, to $17.6 billion, from the $17.1 billion reported for 2012. The consensus estimate for 2013 EPS is $2.83, up 6% from $2.68 in 2012.

CL last traded around its True Worth during 2009-2011. Since that time the price has moved well above its True Worth, and now appears to be over priced.

Click to enlarge


The determination of a company's value is one of the most important exercises we must do when deciding whether or not to buy a company. It can often be very difficult to figure out whether or not a company is properly valued, but it is essential not to over pay for ANY company. Fortunately FAST Graphs has done the work for us, and presents the valuation in a very easy to understand form. I think that by using FAST graphs in their investment decisions many people will be able to find great companies at fair prices, and improve their results.

Thank you for reading my article. I welcome your comments and criticisms.

Disclosure: I am long MDT, DE, MSFT, QCOM, NKE, PAYX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.