Thomas Doerflinger

Long only, growth, growth at reasonable price
Thomas Doerflinger
Long only, growth, growth at reasonable price
Contributor since: 2012
Thank you for an informative article, but you may need to re-think your approach to valuation. Just because the stock is more expensive than the S&P 500 and more expensive than its historical median does not necessarily mean it is overvalued. It is growing much faster than the S&P 500, which is unlikely to grow EPS more than 6% per year over the next few years. (SPX EPS will be flat this year.) If you wait for the PE of Visa to drop to 21x, you may never own this high-quality fast-growing company.
You will probably have to wait a long time for a 2-year CD to get to 5%. I agree many high yield equities look particularly expensive.
I agree 1.5 is not dirt cheap. But if you sell everything that looks expensive you end up paying a lot in taxes and commissions.
You can come up with pro forma EPS for the S&P 500 by aggregating the pro forma figure for each company, which are available on First Call, IBES, Bloomberg, etc., and dividing by the index divisor. That is how the "bottom-up estimate" for the S&P 500 EPS is calculated.
CAPE is of dubious value because it is based on GAAP EPS which no one on Wall Street looks at when valuing individual companies. GAAP EPS includes goodwill write-downs, which may reflect temporary economic phenomena such as weak commodity prices but does not reflect increases in goodwill as companies develop brands, franchises, distribution networks, etc.. I prefer to look at the PE on pro forma S&P 500 EPS. The index now trades at 15.9x trailing pro forma EPS, versus an average of 16.3x, 2005-2006, when interest rates were much lower. Stocks look quite reasonably valued but are no longer cheap. We may get some PE expansion as investors buy equities for yield; the dividend payout ratio is still low at 32% and dividends are likely to rise faster than earnings. However most of the equity return will come from earnings growth of about 6%, not from PE expansion.
I agree with your premise that dividend growth stocks are an attractive investment, but PG is a very poor example, in my opinion. To gauge the economic and financial health of a company, it is much better to look at earnings and revenue growth, not DPS growth. PG has produced poor earnings growth in recent years, 1.4% annually from 2008 through 2012, which is why it has attracted activist investors like Bill Ackman who want to shake up management. Dividend growth was faster than EPS growth because the company raised its payout ratio to 58%, which is high not low (the S&P 500 is around 30%). There is little reason to think the company can raise its DPS 8% annually in the future.
Stocks with strong EPS growth as well as decent dividend yields.
Robert, Thank you for your comments. In looking for attractive dividend-paying stocks, I prefer not to use an approach (Dividend Aristocrats) that rules out entire sectors of the market, including most tech companies, most banks, and younger companies in general. As I said, the Aristocrats are indeed an interesting "shopping list" but one needs to look elsewhere as well.
I don't follow the logic of your first comment. If for ABC Corp. EPS growth will not lead to a rise in share price, then if ABC pays a dividend that WILL improve total return because at least the investor is receiving a dividend. Total return will equal the dividend yield, instead of being zero.
On your second point, of course a few companies cut or eliminate dividends during a recession. But even in the last recession S&P DPS fell 21%, which means 79% of the pre-crisis dividend continued to be paid and could be reinvested when stocks were cheap. The decline in share buy-backs was much greater. And the 2008-2009 recession saw an exceptionally big drop in S&P DPS; in most recessions the decline is more like 2-4%. So if you hold a well-diversified portfolio you will in fact have decent cash flow to reinvest in stocks at attractive prices during a recession.
On your third point, while there will be times when dividends are cancelled or cut, they are much more transparent than share buy-backs. When was the last time your saw a press release from a company saying, "Even though our board has announced a buy-back program, last quarter we did not buy back any shares, and our share count crept higher due to exercising of employee stock options"? Never.
Thanks for the advice. I agree there is a lot of good content on SA. We have to keep in mind that the division between "dividend paying" and "non-dividend paying" stocks is not fixed. Knowing that investors are keen to buy dividend-paying stocks, Wall Street will provide more dividend-paying product to investors, some of it over-priced. And the valuations of some dividend payers have become excessive. So going forward it will be harder to succeed in "dividend growth" investing over the next years than the past few. That is one reason why it is risky to focus too much on dividends as opposed to the overall quality of the business and its valuation.
Thanks for the feedback. In the article, I didn't discuss my approach to stock picking in much detail. Basically I look for a decent yield, fairly high return on capital, and sustainable growth in EPS and DPS. I also favor stocks whose consensus EPS forecasts are rising; this will be a particularly useful metric over the next year as overall profit growth weakens or even disappears.
Excellent article. In addition to the stocks discussed, I would look to younger, more dynamic companies (including a few tech stocks) that pay meaningful dividends which are likely to grow rapidly over the next few years. The problem with some "dividend aristocrats" -- including certain staple and healthcare stocks which look fairly expensive now -- is that they have illustrious pasts but problematic futures.