What To Do When A 'Not So Good Quarter' Blows Up A Stock's Share Price

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Includes: MSFT, SBUX, V
by: The Dividend Bro

Summary

Short-term events like a so-so quarterly earnings report can cause a stock's share price to take a nose dive.

If you still believe in the company, this can provide you with an attractive entry point.

Price declines in Microsoft, Starbucks and Visa have brought these companies much closer to our price targets.

Three companies that my wife and I have in our portfolio and would like to add to got clobbered after reporting earnings this week. Visa (NYSE:V) dropped 2.12%, Starbucks (NASDAQ:SBUX) lost 5.62% and Microsoft (NASDAQ:MSFT) got hammered to the tune of 6.69% the day after their quarterly earnings reports came out. All three companies are flat or down since the beginning of the year. If you were an investor that only cared about capital gains, you probably would not be too happy with the price action of these stocks.

If you are a dividend growth investor, however, your emotions might be the exact opposite. All three of these companies are dominant in their sectors of the economy. All three have shown that they are willing to pay and raise dividends to shareholders. And all three have had impressive gains in share price over the last year. If you are a dividend growth investor, the following table might interest you:

Company

Current Div Yield

5-Year Div Growth

# of Yrs of Div Growth

1-Year Price Gain

Microsoft

2.78%

18.6%

14

24.42%

Starbucks

1.39%

30.5%

6

21.12%

Visa

0.71%

30.7%

8

22.80%

Click to enlarge

Each company has had impressive dividend growth over the past five years. While Starbucks and Visa are relatively new to the dividend game, they both have 30%+ average dividend growth over the past five years. Even Microsoft, which has been paying a dividend for most of the past century, has attractive dividend growth of close to 20% over the previous five years.

In the table, I also included each company's return for the previous year. Even with yesterday's drop, each company has an impressive gain in share price over the last twelve months. This doesn't even account for dividends received. Since all of these companies have had a run up in price, you may have thought that they were too expensive to add to. Each of these companies suffered losses because their most recent quarters weren't as good as expected. In other words, they were priced for perfection. If you are a long-term investor like us, the sharp drop in share price might be a buying opportunity. While quarterly reports give you an insight into a company's current financial decision, they can often cause investors to overreact either positively or negatively to the current news.

Using that overreaction to your benefit can help you acquire shares at attractive prices. I use a shopping list to identify what target price I have for each company that I follow. That way, when the market knocks them down, I can attempt to remove emotion from my investments and buy more shares at the prices I want. Let's take a look at my target prices for Microsoft, Starbucks and Visa. For a recap of our investment guidelines, click here.

Microsoft

S&P Capital 12-month price target

S&P Capital Fair Value

Morningstar Fair Value

$55

$54

$61

F.A.S.T Graphs Current P/E

F.A.S.T Graphs 5-Year Avg P/E

Price Target

19.4

12.7

$50

Click to enlarge

As previously stated, the technology giant has had a nice share price appreciation. I've purchased two lots of shares at an average price of $41.23 and have been looking for the stock to trade lower so I could add to the position. Shares of Microsoft ended the week at $51.78. F.A.S.T. Graphs has a five-year average P/E ratio of 14.2 and the current P/E ratio is 19.4. That is a steep 26.8% premium. S&P Capital has a twelve-month price target of $55 and a current fair value of $54, which is a 6.22% and 4.29% discount, respectively.

Morningstar is much more bullish as they see fair value at $61, almost 18% higher from Friday's close. Averaging the metrics together, I see Microsoft as 0.38% undervalued. With 10+ years of dividend growth, I would be willing to pay a 5% premium for shares of Microsoft. Currently, Microsoft would be considered a buy.

One reason I might hesitate to pull the trigger at these prices is that the current P/E is really out of whack compared to the five-year average.

If you use the F.A.S.T. option to look at the three-year performance of Microsoft, you see the three-year P/E ratio is 16.3, just 16% overvalued. This is a tad easier to swallow even if it doesn't fit my guidelines exactly. Because the other metrics show the company is undervalued, I would be willing to purchase more shares under $50.

Starbucks

S&P Capital 12-month price target

S&P Capital Fair Value

Morningstar Fair Value

$68

$48

$65

F.A.S.T Graphs Current P/E

F.A.S.T Graphs 5-Year Avg P/E

Price Target

32.9

29.1

$55

Click to enlarge

The coffee giant wasn't hit nearly as hard as Microsoft, but it still saw a significant loss in share price. We've bought shares of Starbucks twice at the split adjusted price of $39.26 and $50.77, so we are sitting on a solid 32.44% total gain. Starbucks has been on a tear in recent years, but Friday's drop in price brought the company back to earth just a little bit. This loss also brought the company into a slightly better valuation. S&P Capital says fair value is $48, 17% lower from Friday's close of $57.68. However, they see shares trading at $68 or 17.89% higher from here in April of 2017.

Morningstar finds that the company is currently 12.69% undervalued. F.A.S.T. Graphs says the current P/E ratio of 32.9 is only a 3% premium to the five-year average P/E ratio of 31.9. All told, Starbucks is 2.69% undervalued by our criteria. With six years of dividend growth, I would like Starbucks to be at least fairly valued. In a previous article, I stated I would like to own more shares at $55. I will maintain that same price target.

Visa

S&P Capital 12-month price target

S&P Capital Fair Value

Morningstar Fair Value

$80

$72

$104

F.A.S.T Graphs Current P/E

F.A.S.T Graphs 5-Year Avg P/E

Price Target

29.3

22.3

Click to enlarge

The largest credit card company in the world was tagged with a loss of under 3% on Friday. Visa held up better than both Starbucks and Microsoft. The valuation metrics I use are all over the place on the company. F.A.S.T. Graphs five-year P/E ratio is 24.2 and the current P/E ratio is 29.3. This metric says Visa is trading at a 17% premium. S&P Capital fair value is $72, 9% lower than the closing price of $79.11. S&P Capital's twelve-month price target is $80, which is just 1% higher from where the stock ended on Friday. Morningstar, on the other hand, is extremely bullish and says fair value is $104. If the stock were to reach this level, it would be a 31% gain.

Combined, the metrics say Visa is 1.55% under fair value. I've only managed to purchase Visa once at a price of $73 so I am eager to add more shares. With eight years of dividend growth, I am willing to buy shares as long as they are not more than 5% overvalued by our criteria. At $75, Visa is within that range for each metric outside of F.A.S.T Graphs P/E ratio. At this price, shares of the company would be 6% undervalued on our combined metrics.

Conclusion

Microsoft, Starbucks and Visa are dominant players in their part of the economy. They have all shown the willingness to pay and raise dividends. In retirement, these dividends will cover our expenses. While we are primarily concerned with dividends and dividend growth, we do care about acquiring shares at a reasonable valuation. We are eager to add to these holdings and all three of these companies are close to reaching our target price.

Disclosure: I am/we are long MSFT, SBUX, V.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are not investment professionals. Please do your own research before making any investment decision.