After a bull run of more than 10 years, many stocks have very attractive long-term financials. Value investing over the past decade, for example, for the most part, has not been needed. Why? Because as there have not been any significant economic downturns over the past decade, many companies have been able to grow earnings through debt instead of equity. This is something Wall Street turns a blind eye to also. Earnings rule the day on the street irrespective of whether those earnings have grown from debt or equity. If a company can turn debt into profit at a faster clip than it has to pay the interest back, then one could say it makes sense to borrow aggressively in a roaring bull market.
One company that has very impressive financials over the past decade, for example, is Aqua America, Inc. (WTR). The numbers impress me because they have been very stable. For example, revenues have grown by almost 3% on average over the past decade per year and earnings by almost 7%. These are not ultra-elevated numbers, but there is an element of predictability about them. Furthermore, the firm has kept the balance sheet in check, which we like.
However, we would not be interested in Aqua America for a long-term hold. Yes, the firm pays a nice 2.5% dividend, which has grown for 11 years, but we would see this stock as more of a short-term play at present than anything else. Let's explain why.
If we look at the daily chart, we can see that shares rallied (along with the market) out of its December low. The S&P 500 printed its own daily cycle low on Friday last and has been rallying aggressively every trading day since then. However, Aqua America has not gotten in gear yet, which brings short-term opportunity. For example, trading in Aqua America today (13th of March) was weak before there was a brief rally into the close. The share price still ended up down $0.19 cent for the day. The short-term play here (assuming Aqua America will follow the market once more like December) is a swing trade until the stock's momentum technical indicators get overbought. When they do, this would be our signal to take profits.
The beauty of swing trading is that valuation and fundamentals do not carry the same weight as a long-term buy and hold. They are not important over the short term. The goal here would be for shares to get overextended on a short-term basis. The risk is just over $0.50 a share or 1.4%. These are the type of numbers we like.
Consequently, though, why wouldn't Aqua America interest us a long-term play? Two reasons. Its cash flow statement and valuation. Although we mentioned that the firm's key financials were trending in the right direction over the past decade, we cannot state the same with respect to how capex spend has been affecting the bottom line. For the past 5 years, for example, capex spend has been more or less on par with operational cash flow. In fact, in '17 and '18, capex spend came in much higher than operational cash flow. This, over time, can put a lot of pressure on the growth of the dividend. Normally, we look for capex spend to take up no more than 40% of the company's net income. This is not what we have here.
The firm's earnings multiple of 33.1 and sales multiple of 7.6 are also well ahead of the averages in this industry as well as Aqua America's 5-year averages. For a long-term dividend growth play, the best time to enter into a long play is when shares are trading below their historical average valuation. This gets compounding working in the investment much faster if those increasing dividends are aggressively reinvested.
To sum up, investors need to take heed of the reported dividend payout ratio as it is calculated from net income. However, cash pays dividends, not earnings. Furthermore, the firm's valuation is too lofty for us at present to consider a long-term dividend growth play.
However, there is opportunity as a short-term swing play. As long as one honors stops, the risk/reward setup is definitely skewed towards being a buyer here.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WTR over the next 72 hours. 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.