Concentrate On Finding Value To Succeed In Dividend Growth Investing

Includes: ABT, JNJ, WMT
by: Clay King

Given enough time, any investor can be successful through the ups and downs of the market. One only needs to view a long term chart of the Dow Jones with its steady upward trend to verify the truth of long term investing. Market timing aside, few-- if any-- have accomplished this with much success, and would be better off turning their efforts to find good stocks at good prices. Earlier I wrote an article using the I-GARP (Income Growth At a Reasonable Price) as an investment method of selecting stocks. In that article I made a comparison between a stock with little growth and value to one with good growth and value as an illustration of the process. The investment strategy behind this requires more than running a screen, reading a random research report, or waiting for a "hot" tip. It requires time, effort, and the necessary data.

I maintain a large universe of stocks that I monitor for value. One of the set-ups that I seek is formed by a range bound stock, which continues to grow earnings and dividends, while the measures of valuation increase in favor of the investor. The father of fundamental analysis, Benjamin Graham, called value a margin of safety, meaning price matters. Quite simply, it is buying great companies when most of the price risk is removed from the stock. To reach this level of valuation requires that the fundamentals increase more than the offsetting price increase. For instance, if earnings of Company A grow at a 20% rate over the course of a year, but the price of the shares only increase by 10%, then valuation has improved.

My search for these equity candidates is manual, as I know of no other way to do it. I use a charting program that plots price and earnings to find issues where price has remained sideways (a line in technical jargon) and earnings have steadily grown. In this article I outline three current examples, all of which qualify as current prospects for purchase.

The first stock covered is Wal-Mart (NYSE:WMT). Most dividend investors might find that Wal-Mart does not yield high enough for purchase, but the shares are a perfect example of achieving the margin of safety. The period covered in the shaded box is the price and earnings growth which qualifies as the long period with earnings growth. During the long range bound period, the earnings of the company have climbed from $1.20 for 1999 to $4.18 TTM.

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The next chart is the PE and current yield in the same time frame. The shares started the period with a PE in the 50s that was at all time highs. During this period of growth the PE has declined to just a tad over 11. The yield has increased from a just 0.5% to the 2.8% level. Have the shares reached the point of maximum valuation? We will only know the answer to that question some time in the future, but I feel quite confident that the eventual outcome will benefit the investor that is long Wal-Mart.

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The next stock is Johnson & Johnson (NYSE:JNJ), which offers another example of our lost decade trading range. As outlined in the shaded box below, we see that the shares of JNJ were stuck in a long range between 50 and 70 while the earnings rose from $1.54 to $4.76 TTM.

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Below are graphs of the PE and yield of JNJ over the same time frame. The PE dropped from levels in the mid 30s to a current print of 15. The yield has climbed from 1%, which is a level that most-- if not all-- dividend growth investors would have never purchased. Today, after the long period of valuation repair, it is a favorite choice among many income investors.

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Next we examine the shares of Abbott Labs (NYSE:ABT). Once again we have a stock that has been range bound, which in this case is between the low 40s to the 60 level. The 10 year period saw earnings increase from $1.64 in 1999 to $4.27 TTM. Note the period in the mid 1990s where the stock price traded well below the earning trend and the subsequent rally from this period of under valuation. Note the position today.

In the valuation chart below we see the same set-up as the two preceding stocks. Here the PE for Abbott has declined from the mid 30s to the 15 level today. The yield has climbed from a low of less than 1.5% to today's 3.8%. Value has reversed making this a stock for dividend income investors. In 1999, it wasn't on the radar screen of income investors. Today it is on the radar screen of dividend investors, or in their portfolios.

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This is a strategy to find value. With value comes the "margin of safety" popularized by the late and great Benjamin Graham. I'll leave it to the individual investor to determine if he or she has more interest in chasing yield or seeking value. Value makes seeking alpha easier to obtain.

Disclosure: I am long WMT, JNJ, ABT.