As a DGI investor, I'm a bit torn when it comes to the general market's recent thirst for yield and how this has affected me as a self directed investor. First of all, I have to admit that I am very pleased with the capital appreciation performance of my portfolio. The majority of my positions are out performing the broad indexes and this is not something to pout about. However, this widespread interest in typical dividend growth names has not only pushed up stock prices of the high yielding dividend aristocrats that I like to own, but their valuations as well. You see, these stock price gains weren't necessarily correlated with revenue and/or earnings growth. Rather, investors seem to have piled into typical DGI names due to yield and yield alone. This leaves investors like me whose sole focus isn't yield, but value and margin of safety as well, in an uncomfortable position. With many of the companies I own trading with historically overvalued premiums, attractive opportunities to put new capital to work are few and far between. This is cause for concern for me; I worry that investors who are now putting hard earned cash to work in many of the so called "defensive" sectors aren't buying defensive assets at all, but instead participating in a growing yield related bubble that is poised do pop once the market realizes its valuation related folly.
With interest rates so low, it's becoming increasingly difficult to rationalize fundamental valuations, especially when it comes to high yielding equities. Even Buffett talks about how equity valuation should change in relation to the yield curve, so I know these prices aren't completely unjustified. Though, I believe the general idea is that when rates are so low there should be solid growth in the world markets (or, at the very least, in domestic ones) and although I'm not a doom and gloom recession guy, I don't see overly exciting growth on the horizon either. On a historical basis it seems rather clear to me that things have become over heated in the dividend growth space. In an atmosphere of slowing global growth premiums should theoretically be lower than the long-term historical average. However, due to ZIRP and or NIRP policies, investors large and small must go somewhere to generate yield and this has proven to be equity markets. I think it's wrong to assume the risk of equities as bond proxies in pursuit of fixed income like returns. However, whether I believe it is wrong or not, this is the path that the market has chosen.
Because of this I've decided to do something I don't usually do here on Seeking Alpha: write a series of bearish pieces, focusing on very high quality companies with very unattractive fundamental valuations in the present. I am not advocating that investors sell their shares if they happen to own a company that I highlight under a bearish lens; I am not a professional by any means and I'm not making recommendations. Although, I do think it's prudent for individual investors to spend time thinking about the valuation of their holdings and the margin of safety (or lack thereof) that they offer after the current run up in DGI names.
So, the first company that I will be focusing on is the oil king of the dividend aristocracy: Exxon Mobil (NYSE:XOM). XOM shares are yielding 3.23%; significantly more than what can be achieved with U.S. Government paper. XOM has paid an annually increasing dividend for 34 consecutive years, adding to the argument that this investment could be potentially better than one in bonds. I understand this that has been a wonderful company over the years in terms of its ability to generate wealth for its long-term shareholders. However, the way I see it, other than those two statistics this company has very little else to offer investors in the present day.
Now, before anyone gets hot and bothered by me talking negatively about this well respected company, please note that I realize my opinion is a minority one (drastically so) with XOM trading less than 2% off its recent 52 week high and has a meager short interest of 1.16%. But, I don't follow the markets closely just so I can follow the herd. I'm not long the stock, I don't have any plans to buy shares anytime soon, nor do I have any sort of short position here. Frankly put, I'm an objective observer who, as mentioned before, is concerned that so many are apparently running to this blue chip name as a flight to safety in today's highly volatile market.
Before I mentioned XOM's tremendous dividend growth streak as a positive aspect of the stock. And, without a doubt, it is so. Although, I think many income investors are taking that dividend for granted these days with massive pressure on the company's earnings. XOM is a well managed company with a strong balance sheet. The company will be able to support its current dividend over the short term with its cash pile, by raising low interest debt, or by further reducing its capex; however, if earnings, and more importantly free cash flow doesn't pick back up I don't foresee the famous streak lasting much longer. I'm sure that management will prioritize its prized dividend, although I think too many investors have become complacent, assuming the storm will pass when, in my opinion at least, the signs are pointing towards a lower for longer scenario with regard to the price of oil.
As you can see, the falling oil prices have done massive damage to XOM's earnings over the last year. This graph doesn't paint a pretty picture:
|Free Cash Flow/Share||$3.57||$0.98||$0.70|
|Long-term Debt (millions)||$11,653||$18,687||$29,568|
Just looking at these numbers, without knowing which balance sheet they belonged too, I would assume that the company would be trading with weakness and a diminished premium being that it is but a shade of its former self. However, this isn't the case with XOM. As you can see here, XOM shares are trading significantly above their long-term historical average.
Source: F.A.S.T. Graphs
The last time shares spent prolonged time above this normal P/E line was late 2003. Shares have maintained a much higher relative premium throughout 2016 than they did during the down years of the great recession even. Because of all of this, XOM investors must be supremely confident in the company's short term future outlook, otherwise, it could take years and years of slow growth for the valuation to begin to make sense.
Source: F.A.S.T. Graphs
Before I mentioned that shares were just off their 52 week highs. As you can see below, since the end of Q3, 2015, XOM shares have been on a strong rally. This rally began has maintained a slight correlation to the price of oil since early February when oil bottomed; however, as you can see below, XOM shares have demanded a huge premium to the underlying material that it does the majority of its business with. I cannot justify this premium, especially when, as stated before, I believe the related metrics regarding supply and demand in the oil patch point to long-term over supply issues which should cap the price of a barrel around $60. Sure, you'll easily find other, likely more qualified, opinions out there that suppose oil will continue its rise and cruise right past that barrier to the halcyon days of supply balance and $100 oil. But, I believe either assumption is surrounded by a significant amount of speculation and really isn't worth discussing in depth here being that I don't have a crystal ball for the price of oil. Your guess is as good as mine.
What I do think is worth focusing on are the fundamentals, which are eroding before our eyes. As conservative income investors, XOM shareholders must ask themselves whether or not this speculation, alongside historically high valuations and therefore, miniscule margins of safety, is truly worth the risk in search of a 3.25% yield?
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.