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The Part-time Investor
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I am a medical professional who has been dabbling in investing for many years. DGI seems to be the best way for me to invest for my retirement while being able to sleep at night.
  • How To Buy Great Companies At Fair Prices 4 comments
    Jul 21, 2013 5:07 AM | about stocks: BDX, KO, MCD, MDT, UTX, WBA

    "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." --- Warren Buffet

    I like to keep things simple, and I can't think of anything simpler (in the world of investing) then buying a great company with a stellar dividend growth record, and holding it forever, only selling it if it freezes or cuts its dividend. Of course the process of deciding which companies to invest in is not always simple, but once I've bought a company, I plan on holding it "forever", meaning well into my retirement. And as a dividend growth investor I often say that the stock price doesn't matter to me. I will claim that I don't watch the market because market changes don't matter to me. In fact I do check the market every day (I can't help myself), but I will not sell my stocks based on changes in their prices, whether up or down. I am investing for income, and as long as my stocks continue to pay me an ever increasing stream of dividends, and the rate of increase satisfies my requirements, I am happy.

    But my statement that the stock price doesn't matter to me is not completely accurate. What I should say is that ONCE I HAVE PURCHASED THE STOCK I'm not worried about the stock price. But the actual purchase price is very important. Even if I have identified a great company which I would love to own I still have to make sure not to pay too high a price for it.

    Warren Buffet was taught by Benjamin Graham to purchase stocks only if he could buy it for below intrinsic value. To look for a margin of safety. But later in his career, as he was influenced by Charlie Munger, he came to believe it is just as worthwhile to buy great companies at a fair price. Conversely, even a wonderful company should not be bought at a bad price. The key is buying the company for fair value (or, if you get lucky, below value). Even if you are buying a wonderful company with a great dividend, if you pay too much your returns will suffer.

    There are many ways to value a company, but, again, with my desire to keep it simple, I just go to FAST Graphs. One of my criteria for buying a stock is that it must not be over priced based on its FAST Graph. FAST Graphs shows you whether or not the stock price is above or below True Worth (Chuck's term). You can read the FAST GRAPH ARTICLES by Chuck Carnevale to learn more about FAST Graphs, but basically the orange line shows the True Worth of the company based on its earnings. And if you make sure you don't buy a stock that is trading over its True Worth line, and that stock continues to be a solid DGI stock, then your returns should be pretty good.

    To show what I'm talking about here are some examples of some great dividend growth companies, and the returns they gave if you had bought when they were over valued, or fairly valued, based on their FAST Graph. All of the values shown below are with all their dividends reinvested .

    Coca-cola (NYSE:KO)

    (click to enlarge)

    Coke is one of the great dividend stocks of all time. And over the past 15 years Coke has increased its earnings at an annual rate of 8.80%, and it's dividend at a rate of 8.62% per year. But back in 1999 KO was trading well above its True Worth (TW) line (The orange line on the FAST Graph). If you had bought Coke at that time you would have had to pay about $34 for it (post-split), but the FAST Graph TW was only around $13. If you had held it through present time a $10,000 purchase would have turned into only about $16,300. Your annual return over that time period, including reinvested dividends, would only be 3.51%. So even though Coke's earnings and dividend grew at better then an 8% rate, your return would have been significantly less. Yes, your dividends would have increased at 8.62%, but your over all return would have suffered.

    Now compare that to Oct 2004. Although KO is still over its TW line it is at least much closer. It could have been bought for about $20, while the TW was about $15. A $10,000 purchase would have turned into about $24,500 by now, with an annual return of 11.08%.

    Date Purchased

    Stock price

    True Worth

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $34.00

    $13.00

    $16,320.66

    3.51%

    $2,986.55

    11/1/04

    $20.70

    $15.00

    $24,545.35

    11.08%

    $3,505.10

    For those interested strictly in dividend income, and not total return, it is interesting to note that you would have collected more in dividends if you had waited until KO was closer to TW in 2004, then if you had bought when it was over priced in 1999, even though you were collecting dividends for 5 less years.

    Some more examples

    Medtronic (NYSE:MDT)

    (click to enlarge)

    Once again you can see that in 1999 MDT was selling for well over its TW of about $16. MDT has increased its earnings at a rate of 10.63%, and it's dividend at a rate of 14.29% over the past 15 years. And yet if you had bought MDT in 1999 a $10,000 purchase would have turned into only $17,300, with reinvested dividends, a total annual return of 3.85%.

    MDT did not return to, or even come close to, its TW until about Oct of 2008 when both the price and the TW were about $40. A $10,000 purchase at that time would have turned into about $14,500 now, a total annual return of about 8.4%. Much closer to the long term earnings and dividend growth rate.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $35.78

    $12.00

    $17,336.25

    3.85%

    $2,023.51

    11/3/08

    $39.81

    $40.00

    $14,677.18

    8.45%

    $814.59

    Walgreens (WAG)

    (click to enlarge)

    Another great dividend stock, but in 1999 WAG was selling for about $30 while TW was around $12. WAG has increased its earnings at a rate of 12.22%, and its dividend at a rate of 14.8% since then, and yet if you had bought WAG in 1999 a $10,000 investment would have turned into only $21,100, an annual rate of only 4.60%.

    However, by waiting until Sept 2008, when both the price and TW were around $31, you would have improve your annual return to about 17%, above WAG's historical earnings and dividend growth rates.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $27.00

    $10.00

    $21,118.76

    4.60%

    $2,028.60

    10/6/08

    $23.22

    $23.00

    $23,227.16

    17.16%

    $1,366.90

    Becton Dickson (NYSE:BDX)

    (click to enlarge)

    Here is a stock that was selling for over TW in 1999, around $40, while TW was around $25, so it too was over priced. But it soon fell back down to its TW, and traded along its TW for quite a while. BDX has increased its earnings at a rate of 9.75%, and it's dividend at a rate of 12.63% over the past 15 years. Had you bought in 1999 $10,000 would have turned into about $29,200, an annual return of 7.93%. Not too bad, but this still would have trailed the earnings and dividend growth rate. But if you had waited until the end of 1999 and bought it when it was closer to the TW line your return would have increased to 11.49% and $10,000 would have turned into $42,700.

    And look at the dividends you would have collected. Had you bought early in 1999 you would have collected $3047 over the next 15 years. But had you waited for BDX to return to its TW you would have collected $4360. That is $1300 more, over a shorter period of time.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $40.97

    $25.00

    $29,235.10

    7.93%

    $3,047.92

    11/1/99

    $27.81

    $25.00

    $42,699.00

    11.49%

    $4,360.53

    McDonald's (NYSE:MCD)

    (click to enlarge)

    MCD has increased its earnings at a rate of 10.26%, and it's dividend at a rate of 20.93% over the past 15 years. Just like BDX, MCD was trading for a premium to TW in 1999, but soon afterwards its price dropped back down to TW. In 1999 its price was about $40, compared to TW of about $20. A $10,000 purchase at that time would have turned into $32,780, an annual return of 8.69%. But by Sept of 2002 it had fallen to its TW price of about $18, and a $10,000 purchase would have turned into $74,000 today, an annual return of 20.70%! This is much closer to its DGR.

    You would have collected $4800 in dividends if you had bought in 1999, when it was over True Worth, but that would have increased to $10,500 if you bought it when it dropped to its TW.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $40.25

    $20.00

    $32,780.72

    8.69%

    $4,816.81

    9/30/02

    $17.50

    $20.00

    $74,044.45

    20.70%

    $10,535.41

    United Technology (NYSE:UTX)

    (click to enlarge)

    Finally, we have UTX. UTX has been trading at, or below, TW almost continuously for the past fifteen years. During that time UTX has increased it's earnings at a rate of 10.88%, and it's dividend at a rate of 12.70%. Of the six stocks mentioned in this article only UTX was trading for about its TW at the start of 1999, and buying a fairly valued UTX, rather then any of the others over valued stocks, would have been a wise move. $10,000 worth of UTX bought in early 1999 would have turned into almost $42,000, with an annual return of 10.48%, consistent with its earnings and dividend growth rate. Just three months later UTX was over TW, and if you bought at that time your results would have been worse. $10,000 would have turned into $36,000, an annual return of 9.58%. But be patient and wait for UTX to fall back to TW in early 2000 and your annual return, if purchasing it then, would have improved back up to 12.19%.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $28.67

    $26.00

    $41,898.34

    10.48%

    $5,861.80

    4/5/99

    $32.94

    $24.00

    $36,015.90

    9.58%

    $5,011.89

    1/31/00

    $25.80

    $26.00

    $35,675.87

    12.19%

    $6,318.40

    Comparing the dividend income, out of the three scenarios, the one that was bought when UTX was above TW is the one with the worst income.

    Conclusion:

    As I said above I am an income investor, and I look to increase my dividend income year after year. But that doesn't preclude me from caring about total return. Capital gains still matter to me, and although I don't invest with the purpose of achieving capital gains, I know that over time it will make up a significant part of my return. Therefore poor total returns achieved due to buying stocks at too high a price is relevant, even to a DGIer like me.

    It is better to find stocks that are around, or below, their true worth, as shown on FAST Graphs, rather then reaching for the over priced ones. Although not over paying for a stock seems like an obvious idea, the actual effect it can have on returns can be striking, and these examples can help to really drive home the point. Some looking at my examples might say "All you're showing is that if you buy at a lower price you'll do better. DUH!" But that, of course, is not what I'm saying. It's not that simple. MDT, bought in 2008, would have given you a better annual return then MDT bought in 1999, even though the 2008 price was higher. What I'm trying to show is that all these stocks, stellar as they may be, can become over valued, and reach a price where they are too expensive. And if you over pay for these stocks, even if they continue to provide excellent earnings and dividend growth, your total return will suffer.

    But what I'm also showing is that you can still achieve excellent returns if you pay full but fair value. Every one of the stocks I mentioned, when bought at its True Worth, returned excellent results. You do not have to invest only in stocks trading at a discount their true worth.

    Thank you for reading my article. I welcome your comments and criticisms.

    Disclosure: I am long MCD, MDT, UTX, WAG, BDX. 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: I am not an investment advisor. Nothing I write should be considered to be a recommendation to buy any particular stock. I am simply discussing and explaining the methods I use and some studies I have done. Every investor should do their own due diligence.

    Stocks: BDX, KO, MCD, MDT, UTX, WBA
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Comments (4)
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  • maybenot
    , contributor
    Comments (6719) | Send Message
     
    PTI -- I enjoy your writing. Well laid out article. Good history to look at.

     

    Good points in your conclusion.

     

    I'm always (aren't we all!) trying to find a quality company to buy at True Worth.

     

    Now, if I only knew the future -- so I can buy on the dips/corrections/etc. -- to get some of these quality companies at their True Worth.

     

    Hey, also, I am sure you will get some comments of "well, where are the graphs of quality companies showing one should buy them NOW?!?".

     

    I would kinda, sorta agree -- hey, we are all greedy :) for easy info!
    But I would also agree that your article had a focus and you showed it quite well.

     

    Long KO & MCD
    21 Jul 2013, 01:31 PM Reply Like
  • The Part-time Investor
    , contributor
    Comments (3284) | Send Message
     
    Author’s reply » Maybe,

     

    Thank you very much for your comment.

     

    I doubt I'll get many comments, since this wasn't accepted as a premium article, so not many people will read it. Oh well.

     

    I've been looking for some companies to put on a "buy now" list, and will hopefully write an article to that effect. But taking a quick look at the CCC list there aren't many, if any, companies selling below TW. I'll have to pick out some that are at TW. ie. "wonderful companies at fair prices"

     

    21 Jul 2013, 02:40 PM Reply Like
  • Eric Landis
    , contributor
    Comments (3283) | Send Message
     
    Nice work on the article, it really hammers home the point that entry price matters when starting a position.

     

    Sorry for you in not getting this one published. I know the feeling of disappointment when putting so much work into something and then having the editors "not get it".

     

    Anyways, keep up the good work!
    22 Jul 2013, 10:09 AM Reply Like
  • The Part-time Investor
    , contributor
    Comments (3284) | Send Message
     
    Author’s reply » Thanks for the kind words Eric. I'm sure I'll try again with another article with a similar theme. It's a very valuable lesson.
    22 Jul 2013, 02:31 PM Reply Like
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