7 DGI Value Research Candidates Found At The Intersection Of The Chowder Rule And Reversion To The P/E Mean

by: DGI Guy

Summary

The Chowder Rule is a popular Seeking Alpha DGI Metric.

Using historic P/E ratios is a way to identify value opportunities.

Using the CCC Champions List, I have identified 7 potential research candidates.

Introduction

One of the things that is often daunting for an investor is deciding how to get from the entire universe of stocks down to a manageable number of research candidates. Doing this requires an investor to understand the risk/reward trade-off that he or she is willing to take. Then, once determined, converting that information to rules that can be applied on a stock screener.

One of the articles I wrote with the most page views suggested that value investors could find opportunities by reviewing the gap between the historic P/E ratio and current P/E ratio (here). Many comments suggested that each individual stock may or may not follow this logic. There are reasons that a stock might be in one category or the other -- for example, it was a growth stock and now it is slowing or a large organization spun off a portion of its business. One option to review that protects the interest of the dividend investor is finding a company that has a reasonable P/E and qualifies under the Chowder Rule. For those of you unfamiliar with the Chowder Rule, you can find out more information here (link).

Data

As a DGI, I want to make sure that the companies that I purchase are of the highest quality. I want to hold on to them for twenty-plus years. For me, this means finding companies that have been paying dividends through every business cycle known to man. To start, I filter the list of potential stocks from the Champions portion of the David Fish's CCC list (here). One of the advantages of David's work is the ability to get fundamental details on many stocks quickly. For this analysis, the Chowder Rule value was taken directly from his list. Please note, I have modified the Chowder Rule slightly for this article. The data below ignores the current yield relative to S&P yield portion of the Chowder Rule. Every investor is different, and this model was intended to not look at current income but rather look at value investing within the constraints of dividend growth investing.

The second part of the argument is to find companies that are priced at a discount to their historic P/E. As I am interested in looking across every economic environment, I used a 20-year timeframe for the average P/E. This covers a wide range of markets including the build-up to the tech boom, the downfall from the tech boom and the recession in 2008/2009. The P/E information was recorded from the FAST Graphs (here). As the core of the argument revolves around P/E, I have removed all REITs to avoid any non-comparable information. I have also removed a handful of outliers that impact the visualization of the chart below.

Chart

The chart below shows the information from above. The Chowder Rule is displayed on the Y-axis. A line at Chowder Rule = 12 has been added to show the minimum qualification. The X-axis shows the Discount/Premium P/E value calculated as discussed above. The upper left quadrant is thus the intersection of a high Chowder Rule and a discount to the historic P/E.

7 Research Candidates

From the list, there are 7 candidates who qualify in both buckets. They are:

Ticker

P/E Discount

Chowder Rule

MDT

-29.6%

13.21

WMT

-22.5%

16.35

WAG

-20.0%

25.21

DOV

-18.0%

12.09

XOM

-17.8%

12.73

CVX

-17.0%

12.96

MCD

-2.6%

17.45

Below is a snapshot from FAST Graphs' Portfolio feature of the 7 companies.

Is there a best?

Looking at the list, WAG looks like it is the best. WAG currently has a P/E of 20 and shows a discount of 20% to its historic P/E. This means the historic P/E would have been 25! While their growth is impressive, that type of P/E would only be reserved for the best of the best that is growing quickly. You can quickly see that the historic P/E suffers from an overvaluation of the stock in the early years of the comparison period.

Looking at the chart at a different time period changes the picture. Moving from a 20-year to a 15-year view, this shows a historic P/E of 23.6 and thus a 3.6 point discount. The overvaluation is still apparent.

The last view shows the 10-year picture of WAG. This shows a historic P/E of 18 and thus a 2-point premium is currently being charged. The result is that WAG appears to be slightly overpriced today relative to historic value.

So, who has the best-looking chart?

The chart that looks the best to me is actually DOV. Below is a series of the 10-, 15- and 20-year charts. The 15- and 20-year charts show good relative discount to historic P/E. The 10-year shows a slight discount of 0.1 point to its historic P/E. It is important to note here that the starting yield is a bit lower than some of you may consider at 2.1%.

10-Year

15-Year

20-Year

Conclusion

Utilizing this new method, I was able to determine that opportunities exist within the discount to a 20-year time horizon. Digging in a bit deeper, a few of the stocks that made the final cut suffer from time period error. Finding the right time period to review is always going to be up to the bias of the individual investor. Based on your individual goals, each stock on the list may warrant additional investigation.

Disclosure: The author is long MCD, WMT.

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.

Additional disclosure: The author has no positions in any other stocks mentioned, and no plans to initiate any positions within the next 72 hours.