- Introduction to my industry reviews series and a brief review of rules I use in selecting candidates for my watch list.
- Update of my review on Nu Skin and my current recommendation.
- Update of my review on Inter Parfums and my current recommendation.
- Invitation to consider my low cost hedging strategy for equity portfolios.
By Mark Bern, CPA CFA
If you are new to the series and would like to start at the beginning, just follow this link to "The Dividend Investors' Guide to Successful Investing." In the initial article I provide a description of my selection process and explanations of all the metrics I use. I am currently in the process of providing annual updates to the original industry articles.
I would like to reiterate some of the simple rules that I use as filters to find prospective companies for my master list. Companies must pay a dividend and increase it regularly. I prefer dividend yield above 2.5% but will consider slightly lower yields if yields are growing much faster than the average rate for the industry. Companies that have cut the dividend within recent years or have a history that includes multiple cuts will not make the list. I require a positive cash flow that includes the ability to pay long-term debt coming due within the next five years. This is to provide certainty of viability in case the credit markets freeze up again as happened in 2008 and 2009. Companies that post losses in earnings from ongoing operations will not be considered. I also do not like stocks of companies that tend to fall further than the broad market index, S&P 500.
The purpose of these rules, as well as the other metrics that I use, is to identify companies that are well positioned to weather recessions without worry of bankruptcy. I like to hold for the long term and collect an ever-increasing stream of dividend income. Market corrections give us opportunities to add good companies to our portfolios at bargain prices. I also do not follow companies that experience significant volatility in earnings. I do remove non-cash accounting entries and one-time gains so that I am analyzing operations. But when companies have too many one-time adjustments, especially when the adjustments result in losses, it often means that management has made bad capital allocation decisions. Those companies do not make my list either.
On June 25, 2012 I wrote an article reviewing the Toiletries and Cosmetics industry with an analysis of two companies that passed my metrics and made it onto my watch list. My watch list is comprised of nearly 80 companies that I periodically review and consider to be the leaders of each respective industry. When I prune my portfolio or have a stock called away I immediately look to my watch list for the stock that offers me the best value at the time to put my funds back to work earning a rising stream of dividends. The two companies from this industry that made the cut for inclusion on my watch list were: Inter Parfums (NASDAQ:IPAR) and Nu Skin (NYSE:NUS). Had one invested an equal amount into each of these two shares on the day of the previous article the return as of Friday, March 29 (close), including dividends, would have been 98.4 percent. And that is after NUS recently dropped by over 40 percent from its 52-week high. Now it is time to review these two companies again and decide what to expect from the shares in the future.
I will look at NUS first, since there is far more controversy surrounding these shares. The huge drop in share price from over $138 to Friday's close of $83.06 (up 91% since recommended at $43.50 on June 25, 2012) is due to an investigation conducted by the Chinese government into the company's sales practices in China. The result is a much smaller fine than investors anticipated amounting to $781,000. NUS representatives are resuming sales in China and the company is taking corrective steps to avoid similar problems in the future. The share price surged higher by 18 percent on March 24 on the news. I expect NUS shares to remain very volatile for a few more months (as evidenced by a more than 3% drop last Friday) until investors begin to see actual post-investigation results from the June 2014 quarter. Until then I suspect we are witnessing an opportunity to enter a position at a reasonable price.
While I am not a big fan of multi-level marketing companies' business model I am able to appreciate the potential this group has in expanding throughout emerging markets across the globe. I also expect that growth in the very important China market may weaken for NUS in the current and next few quarters as the company has work to do in improving its image there. But this should be a temporary setback as the company continues to develop and successfully launch new products to its sales force of over 50,000 and deriving nearly 90 percent of revenue from outside the U.S. The balance sheet remains strong as the company has $525 million in cash and only $181 million in total debt as of December 31, 2013.
I have moved my five-year target price to $145 on NUS. It has been 21 months since the original article when my five-year target was a mere $73 per share. Revenue and earnings literally took off in 2012 and 2013, increasing at rates far higher than I had been expecting. I still believe that management can continue to grow but at a more moderate pace. Dividends have increased by 73 percent since the previous article and I believe we can expect additional gains in the future. However, here too I expect more moderated improvements. In all, I now expect a total average ROI of 16.6 percent from NUS over the next five years.
Moving on to IPAR, the shares closed last Friday at $36.42 from the original recommended price of $16.52 per share (up over 120% since my June 25, 2012 recommendation) and the dividend has increased by 50 percent to $0.48 per share to yield 1.3 percent. The yield remains low but the rate of increase is excellent. However I expect things to slow down considerably in the future.
My projection for EPS growth is 9.5 percent and I expect dividends to grow annually by an average or about 12.7 percent. I have raised my five-year target price from $28 to $48, accounting for the growth since the last 21 months. If my target price is attained investors can expect an average compounded average ROI of 7.7 percent from IPAR. The trailing 12-month P/E ratio is us to 28.7 compared to my expected future P/E to average no more than 18. I suggest waiting for the price to get under $24 as a much more desirable entry point. The stock fell 42 percent during the 2011 market correction so I do believe this entry point to be within the realm of possibilities. IPAR remains a quality company but overpaying for quality is still overpaying and usually has negative consequences.
The current bull market will soon be the fourth longest in duration since 1929. If you are considering hedging your equity portfolio and would like to consider an inexpensive strategy please consider my series, "Protecting Your Equity Portfolio for Less" series.
As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other's experience and knowledge.