March Shopping List: Realty Income, Chevron And Dominion Resources

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Includes: CVX, D, O
by: The Dividend Bro

Summary

After selling Southwest Airlines and adding new capital to our portfolios, we should be able to make two purchases this month.

For March, I focused on higher yielding companies Realty Income, Chevron and Dominion Resources.

Purchasing either Realty Income or Chevron would make full positions in those stocks.

Buying Dominion Resources would give us our first utility stock.

Each month I write about stocks that I am considering for purchase in mine and my wife's dividend growth portfolio. This month we should be able to make several purchases, because on Friday we sold our Southwest Airlines (NYSE:LUV) holding. When I buy a stock, I hope to never have to sell it. Over the past few years I have only made the decision to sell a stock a handful of times. I originally bought Southwest Airlines on 12/11/2015 for $45.15. My wife and I love to travel and we almost always use Southwest Airlines because of their no checked bag fee and low fares. Almost every airline I know of charges a fee for a checked bag and when I compare Southwest's fares with other companies I often can't find a better price. The company, while sporting a less than 1% dividend yield, also offers attractive dividend growth. In fact, the company raised the dividend in May of 2016 by 33%.

So if I like the company's product and dividend growth, why did I sell? I don't have a problem with holding a low yielding company. In fact, we have big positions in several companies that yield less than 2%. When Southwest Airline's stock price tumbled earlier this year, I wasn't inclined to add to our holdings because the yield hardly broke 1%. If a company isn't going to offer me much income, then I want it to be a dominating player in its industry. The issue is that there is so much competition in the airline space that there isn't much brand loyalty when it comes to low airfares. If costumers find a different price on a flight with American Airlines (NASDAQ:AAL), they will most likely choose to take that flight. Because of this, Morningstar says that the airline industry has no moat. If I am going to own a low yielding company, I want a wide moat. Visa (NYSE:V) and MasterCard (NYSE:MA) combined dominate the credit card space. People who like Starbucks (NASDAQ:SBUX) are extremely loyal to the brand. Same goes for Nike (NYSE:NKE) and their position as the #1 seller of shoes and athletic apparel. Disney's (NYSE:DIS) ability to monetize media, movies and theme parks makes them a major player in the entertainment sector. Each of these companies has a wide moat, which is what I am looking for in companies with lower dividend yields. I'm happy to have fairly large positions in these types of companies because their position in each of their sectors makes it likely that they will continue to churn out profits and higher dividends. With the airline industry, I'm not so confident that can happen. For these reasons, I sold our Southwest Airlines position at $53.68. We made 19% on the trade.

Now on to this month's shopping list.

Realty Income (NYSE:O)

Current Yield

# Years div growth

5 Year Div Growth Rate

4.23%

24

6.60%

S&P Capital 12-month price target

S&P Capital Fair Value

Morningstar Fair Value

$65

N/A

$51

F.A.S.T Graphs Current AFFO

F.A.S.T Graphs 5 Year Avg AFFO

Price Target

20.5

19

Under $62

Last month I wrote The Monthly Dividend Company is one of the stocks I would be willing to break my investing rules to buy. Much of what I said then remains true today except that the Fed raised interest rates on Wednesday. Some investors fear that in a rising interest rate environment, Real Estate Investment Trusts might have trouble borrowing money to make acquisitions that fuel their growth. Check out the company's website and you'll see that since 1992, their lowest occupancy rate was 96.8%. This occurred in 2009. As I said in a previous article, if the worst recession since the Great Depression can't really hurt Realty Income, my guess is that a few rate hikes won't cause much pain either. In addition, when the company leases their properties to drug stores, fitness clubs, movie theaters and discount chains, the renters are responsible for the maintenance, taxes and insurance. Realty Income is simply a land lord collecting rent.

Realty Income has paid a dividend every month for the past 24 years. The average annual raise over the past 5 years is 6.6%. Considering the current yield is over 4.2%, I'm more than satisfied with the dividend growth. One more batch of shares and I would consider Realty Income to be a full position for us. Let's see if the company is a good value based on my investment criteria.

F.A.S.T. Graphs list the current adjusted funds from operation as 20.5. The average AFFO over the past 5-years is 19. This metric has shares as more than 7% overvalued. S&P Capital has a 12-month price target of $65. Based on Friday's closing price of $59.86, shares are undervalued by 8.6%. The most recent S&P Capital report that Fidelity shows doesn't list a fair value for shares. Morningstar says fair value is $51. By this measure, shares are almost 15% overvalued. Average these numbers out and I see Realty Income as 4.51% overvalued. This is almost at my limit of paying 5% over fair value for a core position, but because of the company's ability to pay and raise dividends through good and bad economic times, I'm fine with paying a heftier price for this company. Realty Income is at the top of my watch list for this month.

Chevron (NYSE:CVX)

Current Yield

# Years div growth

5 Year Div Growth Rate

4.01%

29

6.8%

S&P Capital 12-month price target

S&P Capital Fair Value

Morningstar Fair Value

$114

$106.40

$95

F.A.S.T Graphs Current PE

F.A.S.T Graphs 5 Year Avg PE

Price Target

64.1

13.9

Under $111

Many investors feared that energy giant Chevron would have to cut its dividend when the price of oil dropped to $27 a barrel. Kinder Morgan (NYSE:KMI) and Conoco Phillips (NYSE:COP), two energy companies that we used to own, did just that. Instead, Chevron raised their dividend at the end of last October. Sure, the dividend raise was a paltry 0.9%, but this raise is better than a cut and it maintained Chevron's dividend growth streak. The average raise over the past 5 years is just under 7%. With almost three decades of dividend growth behind it, the energy company has shown that they are dedicated to maintaining the dividend.

As you might expect with a low price of oil, earnings have really taken a hit. F.A.S.T. Graphs sees a current price to earnings ratio of 64.1. The 5-year average PE is 13.9. Ouch. Most people would stay away from a stock that has a price to earnings ratio that high above the average. I consider Chevron to be a core holding and feel that the company has weathered a significant drop in the price of oil rather well. Because earnings should bounce back with higher energy prices, I am of the mind to believe that this elevated PE isn't forever. By the time the earnings ramp up and the price to earnings multiple is more in line with the average PE, the stock will have mostly risen from current levels. Because I feel large integrated oil companies are the safest bet in the energy sector, I am willing to ignore this measurement for Chevron.

Let's examine how Chevron fares with my other investment criteria. S&P Capital has a 12-month price target of $114, which would be a 6% gain from Friday's closing price of $107.68. S&P Capital have a fair value of $106.40. Based on the most recent trading session, the stock is just a little more than 1% overvalued. Morningstar has a fair value of $95, showing that shares of Chevron are currently almost 12% overvalued. Average just these numbers out and I see shares of Chevron as 2.37% overvalued. Yes, the PE multiple is concerning, but like I said, I consider Chevron a core holding and as such, I am willing to overpay for shares. Chevron is almost a full position for us and I would have no problem adding to shares at these levels.

Dominion Resources (NYSE:D)

Current Yield

# Years div growth

5 Year Div Growth Rate

3.92%

14

7.30%

S&P Capital 12-month price target

S&P Capital Fair Value

Morningstar Fair Value

$75

$65.70

$76

F.A.S.T Graphs Current PE

F.A.S.T Graphs 5 Year Avg PE

Price Target

20.5

19.3

Under $76

Dominion Resources has been on my watch list a number of times, but I have yet to add them to our dividend growth portfolio. With the Fed raising rates and pointing towards more as the economy continues to improve, conventional wisdom would think that utility stocks might be hurt. What happened after rates were raised? Dominion Resources, along with other utility stocks, jumped. Dominion gained 1.87% on Wednesday, with much of the gain coming after the Fed's announcements. It should be noted that the stock gave back some of the gains on Thursday and Friday, ending the week about where it was when the rate increase was announced. This price action tells me that investors were expecting the rate increase and nothing in the Fed's announcement surprised them. We don't yet own a utility, but I would like to add one and Dominion Resources, with a current yield of almost 4% and an average dividend growth rate of more than 7% over the last 5 years, is at the top of my list in the utility sector.

F.A.S.T. Graphs says the current PE is 20.5 and the 5-year average is 19.3. This would mean that shares are currently about 6% overvalued. S&P Capital has a fair value of $75, which means that Dominion is almost 3% overvalued based on Friday's closing price of $77.12. S&P Capital lists a fair value of $65.70, which would put shares at 15% overvalued. Morningstar gives a fair value of $76, which would have the stock about 1.5% overvalued. Average these numbers out and I find shares of Dominion Resources to be about 6.22% overvalued. With 14 years of dividend raises, I would be willing to pay 5% overvalued for the stock. To get into my buy range, the stock would have to drop a single dollar. With 20+ years until retirement, I am not going to worry too much about a single dollar. Utility companies often hold up better in recessions because people are going to do everything they can to pay their electric bills. When money becomes available later this week, I feel that Dominion Resources is close enough to my price target to buy.

Conclusion

I have tried to spend the first part of 2017 adding to mine and my wife's current holdings. I want to get as many holdings as possible to a ¾ths or full position. Purchasing either Realty Income or Chevron this month would bring both of those positions to full positions. If I wanted to expand our portfolio and finally add a utility company to our accounts, Dominion Resources would be a good addition. What do you think of my watch list? Which would you buy?

Disclosure: I am/we are long CVX, O, V, MA, DIS, NKE, SBUX.

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: We may initiate a position in Dominion Resources in the next week or so. We are not investment professionals. Please do your own research before making an investment decision.

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