Investing in Dividend Champions or Aristocrats at sound valuations is a prudent strategy for retirees seeking income and capital appreciation. Since these are companies that have increased their dividends every year for at least 25 consecutive years, their blue-chip status is practically a given. However, notwithstanding the impeccable quality that most Champions or Aristocrats possess, prospective investors should still never ignore sound valuation.
Whenever you invest in any common stock at sound valuation, your odds of long-term success are greatly enhanced. My 40+ years of experience, analyzing and investing in stocks have taught me not only the importance of sound valuation, but also the incredible benefits this practice provides investors. First and foremost, investing at sound valuation greatly mitigates overall risk. I'm not saying it eliminates risk altogether, but I do believe it significantly minimizes long-term risk.
Secondly, and perhaps of equal importance, investing at sound valuation also provides the opportunity to earn above-average returns. Moreover, if you invest at below sound valuation, you provide yourself the opportunity to earn returns that exceed the company's operating performance (earnings growth rates). In other words, you are in a position to achieve the natural leverage that undervaluation provides.
However, it's also important for investors to realize that they can overpay for even the best companies. Moreover, if and when they do overpay, they not only increase their risk they simultaneously reduce their total return potential. But most importantly of all, my experience has taught me that you don't have to overpay for even the best companies. With a little patience, coupled with the proper understanding of sound investing practices, I can confidently state that finding even the most wonderful businesses at fair valuation is an inevitability. It just requires the patience to wait for attractive value to inevitably manifest.
In addition to having my last statement validated over my many years of personal investing experience, this principle was also taught to me by reading Peter Lynch's classic book One Up On Wall Street. On page 159 in chapter 10 titled Earnings, Earnings, Earnings Peter Lynch stated:
"You can see the importance of earnings on any chart that has an earnings line running alongside the stock price… On chart after chart the 2 lines will move in tandem, or if the stock price strays away from the earnings line, sooner or later it will come back to the earnings."
Fortunately, I was blessed to possess precisely the type of charting program that Peter Lynch referred to in his classic work. Consequently, after running many thousands of companies via the earnings and price correlated F.A.S.T. Graphs™ research tool, I was able to confirm the truth behind his statements. In the short run, the price of any common stock can become overvalued (or undervalued), but in the long run price will inevitably return to fair value. I feel very fortunate to learn, and embrace, this vital principle at a very early stage of my investing career. Simply stated, Peter Lynch is correct.
Sound Valuation: What It Is How It Works
The concept "sound valuation" is also known by many names to include fair value, intrinsic value, true worth value, etc. However, in the context of this article I am referring to sound valuation as a concept where the price you are paying provides an earnings yield that represents an attractive enough return to compensate you for the risk you are taking. Furthermore, although I believe it is one of the most important considerations that investors need to focus on before investing their money, I further believe that it is also an often misunderstood notion.
First and foremost, sound valuation, at least in my opinion, is never a perfectly precise number or value. Instead, I believe sound valuation represents a range of valuation levels that always include a certain level of uncertainty associated with it. The uncertainty stems from the fact that as investors we must always realize that we are in fact buying the future and not the past. Therefore, implicit in any calculation of sound valuation is the necessity to forecast. Moreover, we should additionally always realize that forecasting can never be a game of perfect. On the other hand, I do believe that forecasting can be accomplished within a reasonable enough range of accuracy to be of great value.
The primary point I'm trying to stress here is that sound valuation should be approached with an attitude of common sense and logic. Since sound valuation is a concept, I believe it should be looked at conceptually. Therefore, I always think of valuation, as I previously stated, as a range of possibilities and probabilities. In other words, when I'm considering investing in a common stock, my mind is automatically thinking of a price point that is plus or minus an actual number.
However, another critical aspect of sound valuation is the realization that it won't necessarily protect you from the possibility of short-term loss or stress. Mr. Market truly is, as Ben Graham tried to teach us, a manic-depressive entity. His famous allegory from The Intelligent Investor goes as follows:
"Imagine you had a partner in a private business named Mr. Market. Mr. Market, the obliging fellow that he is, shows up daily to tell you what he thinks your interest in the business is worth.
On most days, the price he quotes is reasonable and justified by the business's prospects. However, Mr. Market suffers from some rather incurable emotional problems; you see, he is very temperamental. When Mr. Market is overcome by boundless optimism or bottomless pessimism, he will quote you a price that seems to you a little short of silly. As an intelligent investor, you should not fall under Mr. Market's influence, but rather you should learn to take advantage of him.
The value of your interest should be determined by rationally appraising the business's prospects, and you can happily sell when Mr. Market quotes you a ridiculously high price and buy when he quotes you an absurdly low price. The best part of your association with Mr. Market is that he does not care how many times you take advantage of him. No matter how many times you saddle him with losses or rob him of gains, he will arrive the next day ready to do business with you again."
Therefore, I believe that Ben Graham's lesson is that we should be prepared for the potentiality of short-term stock market irrational behavior. Consequently, even when we do invest at sound valuation, it doesn't necessarily follow that the stock price cannot go lower in the short run. In fact, in many cases it might in fact be what happens. Bargains (stocks at sound valuation or below) are rarely found in companies that are currently popular.
Instead, our best buys will usually come from stocks that are currently unpopular. And, since they don't ring a bell at the tops or bottoms of a market, we should be prepared for anything over the shorter run. Therefore, my best advice is to be long-term oriented with a focus on the business behind the stock while simultaneously ignoring short-term price volatility. Investing at sound valuation is straightforwardly a long-term strategy. Therefore, don't allow the short run which is often based on emotion (fear or greed) deter you from wise and prudent action. Instead, like a good Boy Scout, be prepared.
However, to conclude this section I offer the following advice. Personal experience and analysis has proven to me that stock price will eventually and inevitably reflect sound valuation. Sometimes the adjustment process when a stock is misappraised will happen quickly, and other times it may take longer than we are comfortable with. However, in the long run the price of a public company's stock will predictably reflect sound valuation at some point in future time. I trust that, and believe that every investor should also trust it.
My Own Record on Writing about Valuation
I have been extensively writing and publishing articles about the importance of valuation on Seeking Alpha since 2009. So much so, that fellow Seeking Alpha author David Van Knapp felt it appropriate to anoint me with the title "Mr. Valuation." I'm quite proud of that recognition because I fervently believe that only being willing to invest in a stock when you believe it is priced at a sound valuation is both prudent and important. Moreover, I believe that this principle is crucial for retired investors seeking safety and a growing income stream from their retirement portfolios.
Additionally, in my humble opinion, based on the quality of the companies comprising the Dividend Champions list developed by another fellow Seeking Alpha author David Fish, are among the most appropriate candidates for dividend seeking retirees to choose from. However, even when considering the impeccable quality of the companies comprising the Dividend Champions list, it does not logically follow that they are always sound investments. As I previously stated, even the best of companies can become overvalued by Mr. Market. When they do, then I believe that investors should realize that their attractiveness and soundness is greatly reduced due to overvaluation. Therefore, it is possible that investing in Dividend Champions that are overvalued can be an unsound strategy.
On the other hand, when you can find Dividend Champions that are simultaneously fairly valued or better yet undervalued, then both the safety associated with owning them and the potential long-term rewards (dividend growth and total return) are greatly enhanced. With this in mind, I thought it might be interesting to review the results of all the Dividend Champions that I have written about on Seeking Alpha since 2009 when I believed they were either fairly valued or undervalued.
Therefore, I offer the following comprehensive review of every fairly valued Dividend Champion that I wrote about over my entire tenure with Seeking Alpha. However, before I present this record there are a couple of important clarifying remarks that must be made. First of all, I have not included every company that I have written about on Seeking Alpha. Instead, what follows are only every Dividend Champion that I contended was fairly valued or undervalued when I wrote about them. Even more importantly, I did not buy them or personally invest in them at the time the articles were written. Instead, I offered all of them merely as attractive candidates for further research and/or due diligence.
With that said, I found the exercise and the experience quite illuminating on several fronts. First and foremost, this process further solidified my beliefs and views on the importance of sound valuation. Admittedly, the timeframe is rather short and the period of time when I started writing about these Dividend Champions was very opportune. However, I would add that investor pessimism was at an especially heightened state in 2009 and 2010. But to my own credit, because valuations were low due to general investor pessimism, it was also a time when I felt very confident about investing in America's best dividend paying blue-chip stalwarts.
The Results Are Fascinating to Review
At this point I would like to describe my writing record on Dividend Champions by utilizing the F.A.S.T. Graphs™ research tool to illustrate the up-to-date results achieved by the Dividend Champion companies that I believed were fairly valued at the time I wrote the articles. In order to accomplish this task, I present current historical Earnings and Price Correlated Graphs on each Dividend Champion that I previously wrote about.
Then I utilized the Edit B/S (edit buy/sell) function on a portfolio I created comprised of all the Champions I wrote about in order to place a green dot representing the previous day's closing price on the day the article was written. Next, I copied all Estimated Earnings and Return Calculator (forecasting graphs) that was presented in the original article, if any. I did this to illustrate how the forecasts being made at the time the article was written worked out to current time. I have highlighted the actual earnings that each company achieved on the current historical graphs in light green shading.
Likewise, I highlighted the consensus earnings estimates in green that were forecast at the time the articles were originally written. Therefore, the reader can evaluate how accurately the consensus estimates turned out to be. As I previously stated in this article, you will find that the forecasts were not perfect. However, I feel that they did fall within the reasonable range of probability that I discussed earlier. I will provide brief commentary on each company relative to the accuracy of the forecasts. Finally, I included a link to all the original articles for anyone interested in reading the original works.
As you review each of the following historical graphs, I suggest paying close attention to the pink line plotting each company's dividends each year prior to being paid out of earnings. Remember, these are Dividend Champions that have increased their dividends for 25 consecutive years in a row regardless of short-term price volatility.
Automatic Data Processing (NASDAQ:ADP) is an example of a Dividend Champion that, for whatever reason, historically commanded a premium valuation. However, the Great Recession brought stock price close to theoretical fair value creating what I thought was a rare opportunity to invest in Automatic Data Processing at sound valuation. However, also note that price has once again moved back to premium valuation (the blue normal P/E ratio line).
Note that earnings estimates are based on fiscal year ending June 30th and not calendar years. In this example estimates for the first couple of years were very close.
I wrote two articles on Aflac (NYSE:AFL) one in November of 2011 and one in July of 2012. In both cases, I suggested that Aflac represented an undervalued opportunity. Note that the price was slightly lower when I wrote my second article than it was when I wrote my first. However, both cases represented an attractive opportunity to invest in Aflac.
Although I did not include a forecast graph in my first article on Aflac, I did in the second as follows: Note that estimated earnings for 2012 and 2013 were in excess of actual results as seen in the historical graph. However, earnings were still strong enough, and valuation low enough, to support a rising stock price. Estimates do not have to be perfect to be of value.
In spite of the fact that Becton Dickinson did not achieve the consensus earnings estimates, you can see that its valuation on January 19, 2012 was low regardless. However, a resurgence in earnings growth apparently stimulated the stock price upward. Nevertheless, dividends were increased in both 2012 and 2013.
Once again, we see that earnings estimates were optimistic on January 19, 2012 when the article was published. However, earnings were still positive enough to support the rising dividend. Therefore, I argue that Becton Dickinson was at a minimum fairly valued on January 19, 2012.
Clorox Company (NYSE:CLX) is another example of a blue-chip that historically commanded a premium valuation. However, and once again, the Great Recession brought share price into almost perfect alignment with fair value (the orange earnings justified valuation line).
In spite of the fact that Clorox missed consensus estimates, September 20, 2010 represented an excellent opportunity to buy their shares below their historical normal P/E ratio valuation (the blue line).
Like most major oil companies, Chevron Corp (NYSE:CVX) has a history of what I call quasi cyclical operating results. However, cash flows support their growing dividend as evidenced by the pink line on the graph. Therefore, in spite of the cyclicality of earnings, Chevron was available at a low relative valuation on February 9, 2011, the date I published the article.
When I published the article on Dover Corp (NYSE:DOV) on July 19, 2011 I pointed out its semi cyclical earnings history. Note that Dover was technically moderately overvalued on that date. But more importantly, note that price fell below the orange earnings justified valuation line twice subsequent to the day I published the article. However, in both cases, price moved back into alignment and beyond. As a side bar, I personally feel that Dover is moderately overvalued currently.
Although Dover did not meet the consensus estimates for 2011, 2012 and 2013, earnings did grow at an above-average rate of 20%, 7% and 15% respectively.
When I wrote the article on Genuine Parts (NYSE:GPC) on August 11, 2010, the company appeared to be fairly valued at the time. But most importantly, earnings growth was very strong subsequent to publishing the article.
Although Genuine Parts' earnings estimates were optimistic at the time I published the article, this company's actual results exceeded those estimates. Consequently, performance has been strong and highly correlated with its actual earnings growth. Notice the pattern of price moving back into alignment with earnings each time that it rose above the orange earnings justified valuation line as it is now.
Illinois Tool Works (NYSE:ITW) appeared fairly valued on the August 3, 2011 when I published the article. However, note that stock price initially fell in the short run, but has risen strongly ever since. However, I believe that Illinois Tool Works is currently overvalued today.
Illinois Tool Works did not achieve the consensus estimated earnings growth expected on August 3, 2011. However, with a P/E ratio of 13.9, current earnings did provide an attractive earnings yield at the time.
With a legacy of premium valuation, Johnson & Johnson (NYSE:JNJ) appeared reasonably valued on September 30, 2009 when I wrote about it. The steady increasing dividend supported its stock price then and now.
Even though Kimberly-Clark Corp (NYSE:KMB) does not have a history of above-average earnings growth, earnings have been very consistent. Consequently, the opportunity to invest in Kimberly-Clark when price was below the orange earnings justified valuation line appeared attractive based on a high current and growing dividend yield.
Kimberly-Clark did not meet optimistic consensus earnings growth, however, earnings and dividends did grow consistently since the article was published.
Coca-Cola Co (NYSE:KO) is one of the most highly regarded blue-chips on the planet, and a Warren Buffett favorite. However, note that Coca-Cola was available below its historic premium valuation (the blue line) at the time I published the article. Consequently, the stock has done well since the article was published.
I published two articles on McDonald's (NYSE:MCD). The first in March of 2010 when I considered the stock fairly valued. However, the second time I wrote about McDonald's (see article link below) was at a time that I felt that the stock was fully valued to moderately overvalued. Therefore, I think it's interesting to see that price appreciation has been very strong subsequent to the first article. However, even though the dividend has continued growing since the second article, price appreciation has been flat to slightly down.
I produced the following forecasting graphs in both articles I published on McDonald's. The first graph just below corroborated McDonald's fair valuation.
The second forecasting graph on the article published on January 31, 2012, indicated the moderate overvaluation I was writing about at the time.
I also published two articles on Medtronic (NYSE:MDT) suggesting in the first article that Medtronic was fairly valued and in the second article I suggested it was undervalued. It's interesting to note that immediately following the publishing of both articles that share price initially fell, as I warned about earlier in this article. However, it's also interesting to note that current share price supports my contention and Peter Lynch's contention that price will inevitably move back to fair value, as it has today.
I only included a forecasting graph on Medtronic in the second article published on February 16, 2011, which indicated undervaluation. Once again, actual results did not meet consensus forecasts. However, earnings did grow strongly enough to move the stock price higher today than it was when the article was published.
Note that McGraw-Hill changed their stock symbol after selling off their education division. However, the core company remains essentially the same although the symbol is different than when I first published the article.
It's interesting to note that the new McGraw Hill has generally exceeded the consensus estimates except for 2012 that were offered when the article was published.
Much like many of the other Dividend Champions, PepsiCo (NYSE:PEP) had traded at a premium valuation until the most recent recession. During this time along with the preceding years, PepsiCo stayed in line with its justified valuation around 15 times earnings. However, as of late the price has rebounded to a more historic level.
A forecast chart was not provided in my previous article; however, one can see that earnings have been growing. Despite a small decrease in EPS last year, it is apparent that the dividend payout has continued to increase.
Procter & Gamble (NYSE:PG) is perhaps the quintessential example of waiting for a great company to come to a reasonable valuation. While I admired the company for years - decades even - I waited to make a purchase decision only when the price reflected an attractive entry point. Some are willing to pay up for quality, yet even in this respect I am fastidious about valuation.
In my follow-up article, I went on to describe the value proposition being offered by Procter & Gamble. Today price has climbed back to a more "normal" P/E range; sadly it appears that I am once more obliged to wait for this dividend stalwart to retreat back to a better valuation.
As demonstrated in the graph below, I penned three articles referencing Sysco (NYSE:SYY) as a reasonable investment. My first article came in 2010 detailing how the combination of a sound valuation, solid growth prospects and a rising dividend can make for an attractive investment.
While Sysco did not end up meeting the robust growth set out by analysts, the dividend has kept on increasing year after year.
When I wrote the second article referencing Sysco, growth expectations had slowed. While matching the first year of expectations, Sysco once again has trailed the estimated growth forecasts. Yet much like the first example, that particular entry point still appears reasonable for the long-term investor.
Finally, in the third Sysco article, growth estimates had dropped by more than 10% to 6.8%. Interestingly, this would have been one of the best times to purchase Sysco in the last year and a half. Today, growth estimates have picked up and the valuation is a bit steeper.
The performance results of V.F. Corp. (NYSE:VFC) since my last article have truly been spectacular. At the time of that article I concluded that V.F. Corp. was attractively valued; today its valuation has reached the upper level of fair value.
Wal-Mart (NYSE:WMT) represents an example of how irrational Mr. Market can be. I waited years for the stock price to come back to fair value. Over that time the stock clearly went sideways, but steadily down. Finally, I felt I saw an opportunity to re-examine Wal-Mart once fair value was manifest.
Investing in a great company like Wal-Mart when valuation makes sense is both sound and profitable. Their business had never faltered, it was only excessive valuation that hurt shareholder returns.
Summary and Conclusions
I hope the reader enjoyed this review of my entire history of Seeking Alpha published articles on Dividend Champions that I considered fairly valued at the time. Personally, I found it fascinating how sound and reasonable valuations produced solid results in terms of both capital appreciation and an increasing dividend on these blue-chip dividend paying stalwarts. Moreover, I feel that it's extremely important to point out that fair valuation judgments were primarily based on current operating earnings at the time the articles were written. Therefore, even though earnings estimates were not as good as forecast on most of these companies, current fair valuation produced solid results.
In my opinion, the results speak loudly to the principle of sound valuation mitigating risk. To put this point into perspective, since forecasting future earnings is both difficult and tenuous at best, overpaying for even the finest blue-chip dividend paying stocks clearly increases risk. However, if you are disciplined to only invest when valuations appear reasonable, risk is minimized and attractive performance still attainable. Finally, I think it's important to repeat that fair valuation is first a function of current earnings. Future estimates do not have to be precisely accurate in order to make a sound and profitable long-term investment in dividend paying blue-chips.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.