The New Nifty Fifty, Part 3: Dividend Growth Ideas And Valuations

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Includes: AAPL, ACN, ADP, AFL, AVA, BAX, BDX, CAT, CL, CLX, COP, COST, CVX, D, DE, DIS, EMR, GE, GIS, GPC, HCP, HSY, IBM, JNJ, KHC, KMB, KMI, KO, LMT, MA, MAIN, MCD, MDT, MKC, MMM, MO, MSFT, NEE, NOC, NSC, O, OHI, PEP, PG, PM, QCOM, RTN, SBUX, SJM, SO, T, TGT, UTX, V, VZ, WBA, WEC, WELL, WFC, WMT, XOM
by: Mike Nadel

Summary

After two articles about the top DGI portfolio picks from my 10 panelists, I reveal my choices.

Many companies are overvalued, but there do seem to be some opportunities.

COST, BAX, TGT, LMT and MAIN are among the names discussed in detail.

Having carried me these last two weeks, my Dividend Growth Investing colleagues must have aching backs by now. It's finally time for me to pull my own weight and reveal my New Nifty Fifty and Top 10 lists.

In the process, I will talk about some companies that might present buying opportunities and others that are more expensive than the 12-carat diamond I have tucked away in the glove box of my Lamborghini. (Just kidding about the diamond. And the Lamborghini. But my Hyundai does have a glove box, and I'll fight anyone who says otherwise!)

With enormous help from respected Seeking Alpha contributors and commenters Chowder, David Crosetti, David Fish, Eli Inkrot, Eric Landis, Tim McAleenan, Miz Magic DiviDogs, ScottU, David Van Knapp and Bob Wells, Part 1 and Part 2 of this series have been amazingly well-received. The two articles have generated tens of thousands of pageviews and about 1,000 comments.

Obviously, we love to discover, digest, debunk, discuss and debate, and we all benefit from the exchange of ideas. Here's hoping everybody is ready for more, because now it's my turn.

Fifty Ways To Weave A Winner

I'm not sure if I am boring or just "by the book," but 39 of the 50 companies I selected ended up being part of the panel's consensus:

3M (NYSE:MMM), Altria (NYSE:MO), Apple (NASDAQ:AAPL), AT&T (NYSE:T), Automatic Data Processing (NASDAQ:ADP), Baxter International (NYSE:BAX), Becton Dickinson (NYSE:BDX), Chevron (NYSE:CVX), Coca-Cola (NYSE:KO), Colgate-Palmolive (NYSE:CL), ConocoPhillips (NYSE:COP), Deere (NYSE:DE), Exxon Mobil (NYSE:XOM), General Mills (NYSE:GIS), HCP (NYSE:HCP), Hershey (NYSE:HSY), Johnson & Johnson (NYSE:JNJ), Kimberly-Clark (NYSE:KMB), Kinder Morgan (NYSE:KMI), Kraft (KRFT), Lockheed Martin (NYSE:LMT), McCormick (NYSE:MKC), McDonald's (NYSE:MCD), Microsoft (NASDAQ:MSFT), NextEra Energy (NYSE:NEE), Omega Healthcare (NYSE:OHI), PepsiCo (NYSE:PEP), Philip Morris (NYSE:PM), Procter & Gamble (NYSE:PG), Qualcomm (NASDAQ:QCOM), Realty Income (NYSE:O), Southern (NYSE:SO), Starbucks (NASDAQ:SBUX), United Technologies (NYSE:UTX), Verizon (NYSE:VZ), Visa (NYSE:V), Walgreen (WAG), Wal-Mart (NYSE:WMT), Wisconsin Energy (NYSE:WEC).

Here are the 11 companies I selected that didn't make the New Nifty Fifty:

COMPANY

SYMBOL

YRS

YLD

MR Inc

VL

PRICE

M*FVE

Accenture

(NYSE:ACN)

10

2.56

9.68

1

79.55

81.00

Avista

(NYSE:AVA)

12

3.64

4.10

2

34.92

NA

Costco

(NASDAQ:COST)

11

1.08

14.52

1

131.93

125.00

Health Care REIT

(HCN)

11

4.59

3.92

3

69.21

69.00

Main Street Capital

(NYSE:MAIN)

4

6.44

7.26

NA

31.67

NA

MasterCard

(NYSE:MA)

3

0.58

83.33

2

75.99

82.00

Medtronic

(NYSE:MDT)

37

1.82

8.93

1

67.04

63.00

Norfolk Southern

(NYSE:NSC)

13

2.06

5.56

2

110.68

105.00

Northrop Grumman

(NYSE:NOC)

11

2.06

14.75

1

135.66

110.00

Raytheon

(NYSE:RTN)

10

2.38

10.00

1

101.66

97.00

Walt Disney

(NYSE:DIS)

4

0.96

14.67

1

89.53

84.00

YRS is consecutive years of dividend growth according to David Fish's CCC list; YLD is dividend yield as of 10/29/14; MR Inc is most recent dividend increase percentage; VL is Value Line's Safety score (1 highest, 5 lowest); PRICE is at market close 10/29/14; M*FVE is Morningstar's Fair Value Estimate.

My favorite from that group is Costco, which has a brilliant business model and superb management. So why don't I own my No. 1 retailer, a company I far prefer to Wal-Mart? Because every time I look at it - which is almost every day the market is open, and sometimes on weekends! - it is overvalued.

Morningstar lists its trailing P/E ratio at 28.2, compared to 18.1 for the industry and 24.5 even for its own lofty five-year standard. Costco's forward P/E is 25.4. I could use my wife's 401(k) brokerage account to average into it over time, but doing so would annoy the cheapskate in me!

COST certainly isn't the only overvalued name in those 11. I own HCN and Avista but I wouldn't buy them today. As the panelists discovered when putting together their lists, there isn't a whole lot of value out there among the kind of companies most of us want to own for the next decade or more.

Medtronic and Accenture are leaders in their industries and are just about fairly valued. Either would reduce my overall portfolio yield, however, so I am looking for more attractive entry points. MDT needs to get below $60 and ACN under $70 for me to start paying real attention. I might have a long wait.

MasterCard also carries a high multiple but Morningstar and other analysts say it is undervalued. I was surprised that while six panelists selected Visa, not a single one picked MasterCard, which has a similarly deep moat. Because its yield is so low, it would be a capital-appreciation play now, but it could be a Dividend Aristocrat one day.

Main Street is the only business development company I own, and it's just 1% of my stock portfolio. Often regarded as best of breed, MAIN is internally managed by an outstanding team, distributes income monthly and regularly pays special dividends. With so many positives, it almost always trades at a premium to its peers. Although BDCs sometimes are considered risky because they lend money to companies that can't get loans from banks, MAIN's losses during the 2007-09 recession weren't as deep as the S&P 500's.

Not Quite Nifty Enough

These 11 New Nifty Fifty companies were not on my list: AFLAC (NYSE:AFL), Caterpillar (NYSE:CAT), Clorox (NYSE:CLX), Dominion Resources (NYSE:D), Emerson Electric (NYSE:EMR), General Electric (NYSE:GE), Genuine Parts (NYSE:GPC), IBM (NYSE:IBM), J.M. Smucker (NYSE:SJM), Target (NYSE:TGT) and Wells Fargo (NYSE:WFC).

GE actually is one of my largest holdings. As documented in a recent article, I bought it in June 2008 and held it through the recession. I keep GE because I'd rather not dump it now that it is aggressively growing its dividend again, but I doubt I would initiate a position today. It gets a 3 Safety rating from Value Line, it infamously slashed its dividend in 2009 and management still hasn't fully regained my trust.

I own Target, too, having bought it before the credit breach and botched Canada rollout exposed some problems. The Canada screw-up was particularly disturbing because it smacked of incompetence and hubris at the executive level. Even after the fall in share price, TGT has a significantly higher P/E than Wal-Mart. I continue to hold because of the dividend, and I am hopeful some new management hires can turn things around.

I used to have AFLAC, having bought it at $41 in July 2012 and sold it at $63 in September 2013. While I obviously am happy about the 54% gain in 14 months, AFL since has stagnated and has offered unimpressive dividend hikes. Many DG investors argue it is a great buy, but it gets Value Line's 3 Safety score, and I remain concerned about its ties to Japan's economy.

I considered IBM last year, but couldn't shake the feeling that its best days are behind it. Fellow contributor Chuck Carnevale made a compelling case for IBM recently, though the article's comment stream was filled with rational arguments against it. If one sees IBM as a viable investment, it certainly is nicely valued, but I simply have too many questions about it to be comfortable owning it.

As for the other seven "New Nifties" I didn't choose, I would consider any of them for my portfolio if they offered good entry points and continued sound fundamentals. So why aren't they in my 50? Hey, you can't pick 'em all! Even Exxon Mobil, PepsiCo and General Mills weren't unanimous choices by the panel.

Some Nifty Values

Going back to the 39 New Nifties that the panel and I agreed upon, I consider AT&T, Baxter, Chevron, ConocoPhillips, Exxon Mobil, Qualcomm and United Technologies to be the best valued right now.

Baxter is my top choice. Not only is it an innovative, well-managed healthcare company, but it also is offering investors a 3% yield. At $70.41, it is priced 16% below Morningstar's Fair Value Estimate of $84. Some express concern about the impending spin-off of its biopharmaceutical operations, but management has given no reason to be wary. If BAX is still trading near $70 when funds become available in November, I probably will top off my already solid position.

CVX, COP and XOM are tricky because they are so dependent upon oil prices and because the Middle East and Russia are even more volatile than usual. Each company pulled back pretty significantly from its high and each recently offered an attractive entry point, but I already own so much of all three that I am insisting upon bargain-basement prices that have yet to arrive.

I couldn't resist topping off T when it reached the 5.5% yield mark ($33.45) last week. The company is now one of my dozen largest annual income producers.

Of those I don't yet own, QCOM tempted me most during the market dip; I'm still holding out for at least a 2.5% yield, which would mean $67.20 per share. Although UTX started looking good at under $100, I'm patiently waiting for the 2.5% mark ($94.40) there, too. If neither QCOM nor UTX falls to me, my portfolio is fine without them.

As you'll notice in the preceding several paragraphs, I'm not giving "stock tips" because I am not comfortable in that role. I talk about my own circumstances, which might be totally different from others' situations, and I urge potential investors to do thorough research.

One More Top 10

Here again is the DGI Dozen from Part 2, a list decided by a tally of the panelists' Top 10 picks: JNJ, PG, O, CVX, KO, MO, CL, KMI, MCD, T, PEP, PM.

Now here is mine:

COMPANY

YRS

YLD

MR Inc

VL

PRICE

M* FVE

3M

56

2.26

34.65

1

151.01

131.00

Chevron

27

3.65

7.00

1

117.14

132.00

Costco

11

1.08

14.52

1

131.93

125.00

Exxon Mobil

32

2.92

9.52

1

94.59

109.00

General Mills

11

3.22

7.89

1

50.90

52.00

Johnson & Johnson

52

2.65

6.06

1

105.56

99.00

Lockheed Martin

12

3.22

12.78

1

186.43

141.00

Philip Morris

7

4.55

6.38

2

87.91

90.00

Procter & Gamble

58

2.97

7.00

1

86.54

93.00

Wisconsin Energy

11

3.23

7.96

1

48.29

38.00

Like many panelists, I haven't necessarily chosen my 10 "favorite" companies. Nor am I recommending that everybody run out and buy these names.

What I have tried to do is select top brands representing a variety of sectors - companies I believe will thrive and grow their dividends for years to come.

The Philip Morris/Altria choice might as well have been a coin flip. I went with PM because of its international exposure, but both companies are core holdings in my portfolio.

I am a third of the way through my three-year mission to build a Lockheed Martin position via its DRiP. LMT seems overvalued here, but I am making two new purchases every month and therefore will take advantage of any pullbacks, too. (You might have noticed Northrop Grumman and Raytheon in my 50. Hey, we might as well profit from our country's never-ending willingness to drop bombs somewhere.)

Aside from CVX and XOM, it's hard to say any of my Top 10 are undervalued. One could make a case for GIS, JNJ, PM and PG being priced fairly now, but only if one agrees that premium companies merit premium valuations.

Conclusion

I once again would like to thank the 10 panelists who took part in this project and the many other folks whose comments have provided insight and support.

Although this concludes the series, it isn't the last you will see of the New Nifty Fifty or the DGI Dozen. Within the next couple of months, I plan to create model portfolios and start tracking them.

Despite evidence to the contrary, there are still some skeptics who view the original Nifty Fifty as a failure. It wasn't, at least not for the buy-and-hold investor, and I believe this new version will stand the test of time even better.

Disclosure: The author is long AVA, BAX, COP, DE, GE, GIS, CVX, HCN, JNJ, KMI, KO, KRFT, LMT, MAIN, MCD, MMM, MO, O, OHI, PEP, PG, PM, SO, T, TGT, VZ, WAG, WEC, WMT, XOM.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.