Through my 40-years of investing, I have seen bull markets and bear markets, and one thing I have learned is markets do not go straight up. However, if this is your first year of investing you might be saying, "yes markets do go straight up", and I would have to agree, it does seem that way this year. With about a month to go in 2013, the S&P 500 is up 27.9%, which is an approximately 1% gain every two-weeks. This year's return is on top of a 13.9% return in 2012.
Declines in 2013 have been almost non-existent, only two small pullbacks of approximately 5% have occurred. Markets declined slightly in the May-June period and again in August. Other than those small declines, it has been almost straight up.
Currently, the S&P 500 index trades at 17 times reported earnings, the highest valuation in more than three years. In addition, many of the dividend growth stocks that I prefer to invest in have risen to prices that I believe leave little room for future growth.
I accumulate funds for investing by raising cash through various means and adding it to my quarterly dividends. I then take those funds and add shares to one of my current holdings, or start a new position. I do this, roughly, on a quarterly basis. However, I am currently sitting on some cash, but find all the stocks I am interested in expensive. Thus, I have chosen to wait until I see a better opportunity. Below, I will share the four stocks I am most interested in and why I am waiting to purchase them.
Procter & Gamble (PG) - Procter & Gamble needs no introduction, it is one of the worlds largest consumer goods companies. P&G has numerous billion dollar brands such as Tide, Bounty, Crest, Head & Shoulders, Pampers, and Dawn, just to name a few. P&G has been a dividend growth investors dream stock with a steadily rising stock price and consistently growing dividends. I would like to own P&G, but I do not want to own it at the current price.
P&G closed Friday, near its all-time high, at $84.95 and is up 24.7% in the last 12-months. At Friday's closing price, P&G has a P/E of 21.59 and PEG (Price to Earnings Growth) of 2.38. Those numbers are not off the chart expensive, but they are not cheap either. Given P&G's recent slow earnings growth, I would prefer to wait until the price fell back to the mid-70's. The chart below shows P&G's recent earnings and operating income growth.
|Year||Diluted Net Earnings||Operating Income (in millions)|
As you can see, earnings and operating income have declined as competition has increased and consumers have traded down to lower priced products. Although I still consider P&G a great company, I have to acknowledge growth has slowed and thus, wait for a better opportunity. Paying almost 22 times earnings, for a company that has seen net earning decline over the last 5-years, is, in my opinion, not a smart investment.
In a previous article, I wrote this about P&G.
"I believe the return of A.G. Lafley, continued cost reduction, an improving world economy, continued innovation, greater emphasis on emerging markets and a world population that will continue to grow by the hundreds of millions will lead to decades of mid-single digit growth. I also believe P&G's long history of dividend growth and share buy-backs will continue."
I still feel all that is true and I believe P&G will make a smart investment at the right price. That price is in the mid-70's, so I will wait for that price.
Realty Income (O) - Realty Income is a 44-year old publicly traded real estate company that likes to refer to itself as the "Monthly Dividend Company." It has a yield of over 5% and pays its dividend monthly. With a recent acquisition of American Realty Capital Trust, Realty Income has over 3,800 properties located in 49 states. The majority of tenants are retail, but O has been trying to diversify and retail now makes up less than 80% of its revenue.
I currently have a small position in Realty Income, but do not intend to purchase any additional shares until the rise in interest rates stabilizes. I believe rates will stabilize once the Federal Reserve announces the start of "taper". The chart below shows the 10-year Treasury Rate and the stock price of O, during the past 6-months.
|Date||O Stock Price||10-Year Treasury Rate|
As you can see in the chart, when interest rates jumped in the May to June period, Realty Income's stock price fell. When rates briefly sunk again in the September to October period, O's stock price climbed slightly, but recently fell again as rates have risen.
When valuing REIT's, normal valuation measures like P/E do not apply. My determination that O is expensive, is based on the stock price correlation with interest rate movement. In my opinion, interest rates are going to rise in 2014, therefore, I believe Realty Income will fall in price. I love Realty Income, but will not add any shares to what I currently own until I believe interest rates have stabilized.
Coca-Cola (KO) - As everyone knows, KO is the world's largest beverage company. Coca-Cola sells beverages, including sodas, juices, teas, sports drinks, energy drinks and water. Beverage products have been consumed by the world's population for decades and will continue to be consumed for decades. In 2009, the company unveiled its 2020 Vision; this long-range plan calls for doubling sales to over 3 billion by 2020 (here).
I own KO, the position size, although large, is not as large as several other companies I own. I have for some time been looking to add to KO, but have not found the right entry price. The majority of my KO position was purchased in the late 2009, early 2010 period when Coke was selling in the low to mid-50's (pre-split). Although I want to add KO shares, I want to add when they present a good value, which they currently do not.
Currently, KO has a P/E of 21 and a PEG ratio of 2.63, like PG not extremely expensive, but not a value either. In the most recent 3rd quarter earnings report, KO reported net revenues declined 3% in the 3rd quarter and 2% year to date. Operating income declined 12% in the 3rd quarter and 6% year to date. Year-to-date earnings per share are down 2%, although comparable earnings per share (without currency effects) are up 4%. Unless KO has a huge 4th quarter, earnings for the year will grow in the low single digits. I do not believe paying 21 times earnings for a company growing in the low single digits is a wise move.
I have always said Coca Cola is the greatest business in the world, selling a simple product, refreshment, to the world. Coca Cola will be around for a long time and I want to increase my shares, but I will wait until the share price provides a better value. If KO were to fall back to the $35.00 range I would be willing to add shares.
Microsoft (MSFT) - The last stock I will discuss is MSFT. The story here is a little different, in that I do not think the stock is overvalued. In fact, I think it presents an excellent long-term value, which is why I began a position on October 8th at a price of $32.97. However, I believe there is some short-term risk in the stock price if Alan Mulally is not selected as the new CEO.
When news broke Steve Ballmer was retiring as MSFT CEO, the stock had a nice pop. When it was reported Alan Mulally was being considered for the job, the stock had another nice gain. The stock is up 42% for the year and 8% in the last few months. Although MSFT had a nice 3rd quarter, many of the gains, are in my opinion, based on speculation. Speculation that Mulally will be named CEO and speculation that the new CEO will sell-off some divisions like Xbox and Bing. If either of those two things do not happen, I believe the stock will drop in price. Because the news on the new CEO will occur relatively soon, I am willing to wait and see how the news breaks and how the stock reacts before investing any more money.
If the news disappoints investors, I will be happy to buy the shares they are selling as I believe MSFT is in the middle of a transformation that will lead to years of growth. Using Yahoo finance we see the current P/E for MSFT is 14 and the PEG rate is 1.94. We also see MSFT has cash of over $9.00 per share on its balance sheet and has healthy profit margins of 28.17% and operating margins of 34.58%. Those economic indicators are very good. The payout ratio on the dividend is a low 34% so a stock holder can be assured that dividend raises are forthcoming. In the case of MSFT, I believe a little patience may provide a better investment opportunity.
I believe one of the keys to successful investing is having a good entry point. The greatest business in the world can be a poor investment if you overpay for it. The market as a whole has had a great run, many individual stocks have also had great runs. It may not seem like it now, but at some point the market will pull-back. Perhaps it will be news that the Federal Reserve will start tapering. Perhaps it will be some unexpected geo-political event. Whatever it is, at some point, the market will decline.
My process for investing involves researching companies looking for the four attributes I want. These four things are: a sustainable product, meaning no fad investments (I want a company to have a product that will still be here in 20 years); a wide moat (the company must dominate its business in such a way that competition is minimal and the barriers to entry into the business are huge); a rising dividend of at least 2%; and the price must be reasonable.
The reasonable price factor is critical to the success of the investment. Most companies that have the attributes I want carry a premium price. The Coca-Cola's, Johnson & Johnson (JNJ), and Procter & Gambles of the world are seldom cheap. However, there are times their valuations are more reasonable than others and I have learned to wait for those times.
The four stocks I have discussed are all wonderful businesses, all dominate their business sector in some manner, but for various reasons all of them, in my opinion, are overpriced. I want to buy a great business at a fair price, therefore, for now, I will wait for a better price before buying any of the four companies I mentioned.