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Introduction

In one of Chuck Carnevale's latest article (here) he offers up a summary of the positions that he has written about for Seeking Alpha readers over the years. The title could have been "Nailing It!", "I Told You So," or any other cleaver title and we all would have read it for the same conclusion. Purchasing at sound valuation gives the greatest opportunity for investors to make a fair return on the risk that they each take when investing.

I currently am sitting on a higher percent of cash than I would like, but I cannot find any investment that I feel represents the characteristics that I am looking for in investments. I know that some of you support paying a premium for quality companies like Wal-Mart (WMT). In reading Chuck's article, it made me interested in reviewing the differences that purchasing quality stocks at fair valuations make on dividend growth. As a DGI, I am particularly interested in how much dividend income I give up by purchasing quality companies at a premium valuation. I will review Pepsi (PEP), Wal-Mart and Procter & Gamble (PG) for the valuation premiums from 2005/2006 (based on their fiscal year) to 2013 vs. the equivalent pricing of fair value. The focus is on how much dividend to I give up to buy now verse waiting for fair value.

Wal-Mart

It is hard to argue that Wal-Mart is a poor investment. Over the years we all know that Wal-Mart has done fantastic for investors. That does not mean it is worth a premium. If I review the stock in terms of a purchase in 2006, I am curious how much of my dividend that I must give up to pay for the 'Premium' in the valuation between 2006 and 2013. The idea is that I am buying the premium clip of future earnings and expect to be reward for that purchase.

The table below shows that in January 2006, WMT was trading at a P/E of 17.2, which is a premium of 15% over the average of the next 8 years. I have highlighted two numbers. The first is the difference between the price at the purchased P/E and the average P/E. The second is the cumulative dividends earned on one share. Note, it would take 6 years of dividends to earn back the premium paid on the earnings.

Of course this is not the only part of the puzzle to think about it, but it puts the P/E premium in context of what us DGI's like the most - dividends. Are you willing to risk 6 years of dividends to start the stream today? Buying at fair valuation would be a better use of your capital to generate income.

WMT

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

EPS (Diluted)

2.68

2.71

3.13

3.39

3.70

4.47

4.52

5.02

Stock Price

46.11

47.69

50.74

47.12

53.43

56.07

61.36

69.95

P/E

17.2

17.6

16.2

13.9

14.4

12.5

13.6

13.9

Average P/E

14.9

Price @ Average

40.0

Difference

6.1

Dividends Per Share

0.6

0.67

0.88

0.95

1.09

1.21

1.46

1.59

Dividend Cumulative

0.6

1.27

2.15

3.1

4.19

5.4

6.86

8.45

Source: GuruFocus

Pepsi

Again, another great company that needs no introduction. The soda/snacks company has proven a great investment for many DGI's out there over the years. Again, that does not mean that it is worth purchasing at a premium.

The table below shows that in December 2005, PEP was trading at a P/E of 24.7, which is a premium of 32% over the average of the next 8 years. I have highlighted two numbers. The first is the difference between the price at the purchased P/E and the average P/E. The second is the cumulative dividends earned on one share. Note, it would take until September 2013 or 8 years of dividends to earn back the premium paid on the earnings.

PEP

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

EPS (Diluted)

2.39

3.34

3.41

3.21

3.77

3.91

4.03

3.92

Stock Price

59.08

62.55

75.9

54.77

60.8

65.33

66.35

68.43

P/E

24.7

18.7

22.3

17.1

16.1

16.7

16.5

17.5

Average P/E

18.7

Price @ Average

44.7

Difference

14.4

Dividends Per Share

1.01

1.16

1.43

1.65

1.78

1.89

2.03

2.13

Dividend Cumulative

1.01

2.17

3.6

5.25

7.03

8.92

10.95

13.08

Source: GuruFocus

Procter & Gamble

Adding to the list of premium brands above, P&G also needs limited introduction to this group. P&G is a multinational consumer goods company. P&G owns brands such as Oral-B, Tide and Puffs; among many others. The company estimates its products to be used by over 99% of American households.

The table below shows that in June 2006, PG was trading at a P/E of 21.1, which is a premium of 22% over the average of the next 8 years. I have highlighted two numbers. The first is the difference between the price at the purchased P/E and the average P/E. The second is the cumulative dividends earned on one share. Note, it would take until June 2012 or 6 years of dividends to earn back the premium paid on the earnings.

PG

Jun-06

Jun-07

Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Jun-13

EPS (Diluted)

2.64

3.04

3.64

4.26

4.11

3.93

3.66

3.86

Stock Price

55.6

61.19

60.81

51.1

59.98

63.57

61.25

76.99

P/E

21.1

20.1

16.7

12.0

14.6

16.2

16.7

19.9

Average P/E

17.2

Price @ Average

45.3

Difference

10.3

Dividends Per Share

1.15

1.28

1.45

1.64

1.8

1.97

2.14

2.29

Dividend Cumulative

1.15

2.43

3.88

5.52

7.32

9.29

11.43

13.72

Source: GuruFocus

Conclusion

As mentioned in the introduction, Chuck nailed it in his article. Paying a premium to purchase quality names is a tough decision to make and each of us needs to consider our objectives as well as strategy before we invest. For me, even though I still have plenty of years to go, I cannot get over the hurdle of paying more for a company than is reasonable. Using between 5 and 10 years of dividends to compensate for my lack of patience is unacceptable. Purchasing at sound valuation gives the greatest opportunity for investors to make a fair return on the risk that they each take when investing. I will continue to look for fair valued companies as part of my screening process.

Source: Why I Support Chuck Carnevale's Preference For Valuation