The concept of fair value is really quite simple. Given a few select inputs such as dividends, dividend growth, holding period, discount rate and few others, one can easily calculate the fair value of a stock. As with most simple things, the devil is in the details – the inputs must be correct to calculate a reasonable fair value, otherwise, garbage in, garbage out.
As mentioned in last week's article, most Dividend Growth Stocks are currently trading on the pricey side based on their historical metrics and on their dividend fundamentals. A bull market is not the friend of an investor that is in the accumulation mode. Advancing stocks makes us feel good today, while cheap stocks will make us feel good in the future.
That is not to say that all dividend stocks are overvalued today. There are still bargin-priced dividend stocks available. However, to find them we may have to dig and scratch more to uncover them. A little time and diligence will reward the patient investor.
As a starter, here is a list of several dividend growth stocks that are trading below my calculated fair value:
Colgate-Palmolive Company (CL) is a major consumer products company that markets oral, personal and household care, and pet nutrition products in more than 200 countries and territories.
Fair Value: $95.10 | Recent Price: $84.11 | Yield: 2.7%
Microsoft (MSFT) is the world's largest software company, develops PC software, including the Windows operating system and the Office application suite.
Fair Value: $27.44 | Recent Price: $23.91 | Yield: 2.7%
McDonald's Corporation (MCD) is the largest fast-food restaurant company in the world, with about 32,500 restaurants in 117 countries.
Fair Value: $94.95 | Recent Price: $80.54 | Yield: 3.0%
The Procter & Gamble Company (PG) is a leading consumer products company that markets household and personal care products in more than 180 countries.
Fair Value: $80.22 | Recent Price: $65.43 | Yield: 3.0%
Intel Corporation (INTC) is the world's largest manufacturer of microprocessors, the central processing units of PCs, and also produces other semiconductor products.
Fair Value: $28.47 | Recent Price: $21.73 | Yield: 3.6%
Wal-Mart Stores, Inc. (WMT) is the largest retailer in North America and operates a chain of discount department stores, wholesale clubs, and combination discount stores and supermarkets.
Fair Value: $70.69 | Recent Price: $53.66 | Yield: 2.7%
Abbott Laboratories (ABT) is a diversified life science company and is a leading maker of drugs, nutritional products, diabetes monitoring devices, and diagnostics.
Fair Value: $68.81 | Recent Price: $51.08 | Yield: 3.7%
I calculate Fair Value weighing the Mid-2 Price and the NPV MMA Price. The weight depends on where we are in the cycle. The Mid-2 Price considers four fair value calculations, Avg. High Yield Price, 20-Year DCF Price, Avg. P/E Price and Graham Number, the highest and lowest fair values are excluded and the remaining two calculations are averaged to calculate the Mid-2 price. The NPV MMA Price is where the NPV MMA value equals the NPV MMA target. See Fair Value for more detailed information.
The above list is a starting point for additional due diligence. A successful dividend growth investor is not solely focused on valuation. We must also consider dividend fundamentals and dividend growth sustainability. When a stock appears to be under-valued it could mean the market has lost confidence in it. If the market is wrong and we are not too fearful to buy, a handsome reward is likely to come our way.
Full Disclosure: Long CL, MCD, PG, INTC, WMT, ABT. See a list of all my income holdings here.