Due to reader requests, I've decided to break up my weekly "Best Dividend Stocks To Buy This Week" series into two parts.
One will be the weekly watch list article (with the best ideas for new money at any given time). The other will be a portfolio update.
To also make those more digestible, I'm breaking out the intro for the weekly series into a revised introduction and reference article on the 3 rules for using margin safely and profitably (which will no longer be included in those future articles).
To minimize reader confusion, I will be providing portfolio updates on a rotating tri-weekly schedule. This means an update every three weeks on:
- My retirement portfolio (where I keep 100% of my life savings).
- The best dividend aristocrats to buy now including the best opportunistic buys of each week based on F.A.S.T. Graphs.
- My new "What I'm Buying Next" series, which explains what companies are on my immediate buy watch list from which I make all weekly retirement portfolio buys.
I've also decided to remove the "Why Valuation ALWAYS Matters" intro to this series since that makes it more cumbersome to read for loyal followers of this series.
Why A Trade Deal Is Not Likely Anytime Soon
After China vowed to retaliate against Trump's August 1st tweet warning of 10% tariffs on all remaining Chinese imports ($300 to $340 billion worth of goods), there was a lot of uncertainty of what the retaliation might look like.
That has now been answered with China canceling imports of US agricultural goods and devaluing the Yuan, which is pegged to the dollar each morning by the People's Bank of China.
According to Paul Christopher, the head of global market strategy for Wells Fargo Investment Institute, these actions bode poorly for any trade deal being achieved soon.
“We think China’s moves today signal that they are prepared to use a variety of measures and push these negotiations well into 2020... There’s not going to be an easy deal here for the U.S.” - Wells Fargo (emphasis added)
I personally think the odds of a trade deal being reached at all to end the US/China trade war next year are looking very slim. And I'm not the only one. According to Ryan Sweet of Moody's Analytics:
"Our baseline assumption, with odds of 35%, is that the current tariffs plus the 10% on the remaining $300 billion in Chinese imports, scheduled for September 1, remain in place through Trump's first term. We assign a 25% likelihood that there is further escalation in the form of 25% tariffs on all Chinese imports. The likelihood of a full-blown trade war, which includes 25% tariffs on all Chinese imports and tariffs on imported vehicles and parts, have risen to 25%. The best-case scenario is a sustained de-escalation in the trade war, but those odds are only 20%." - Moody's (emphasis added)
Moody's thinks the tariffs will remain in place for all of 2020, and given that no trade talks are scheduled before September 1st (and now none might happen at all), I consider Moody's probability estimates, that a trade deal is a 20% probability event, reasonable. That's not a guarantee, of course, as Moody's itself admits. "As we have seen over the past couple of years, these odds can change quickly."
And as for the President's famous penchant for reacting to the market, Moody's explains that the "Trump Put" isn't likely to happen yet, nor likely result in a deal anytime soon.
"In the past, Trump has either delayed tariffs or sounded upbeat about trade negotiations, likely in an effort to put a floor under the stock market. If the past is any guidepost, a 7% to 10% drop in the S&P 500 could trigger the Trump put. Currently the S&P 500 is not near that threshold. Further declines in the stock market will catch the Trump administration's attention, but this could only lead to a delay in the implementation of the September 1 tariffs, not a truce. The odds of a deal are very unlikely." - Moody's (emphasis added)
The latest pullback from the 4th escalation of the trade war (which always occurred at market highs) has been 6% so far. Stocks have recovered about half of that as of Thursday's close. The 1.8% rally that day was due to better than expected Chinese export data as well as China's central bank pegging the Yuan/Dollar ratio lower than expected (somewhat easing fears of a currency war).
However, the fact remains that the trade war is likely to get worse before it gets better. While the US economy continues to grow faster than all our developed rivals, I'm closely watching the weekly data for signs of deterioration.
I track several economic models, including those from the Cleveland, New York, and St. Louis Fed, plus Jeff Miller's excellent weekly meta-analysis of several models to estimate three-month and 9-month recession risk.
But to confirm what those models say (highest recession risk in 10 years), I look at the aggregate facts, specifically 19 leading indicators and where they sit relative to their historical baseline. That's where David Rice's Baseline and Rate of Change or BaR grid comes in. I consider it the best single snapshot of the current health of the US economy.
Thus far, none of the indicators, not even industrial production (the most affected by tariffs), have indicated contraction, just slowing growth. For Q3, the economist consensus is for 1.9% GDP growth, the Atlanta Fed estimates 1.9% and the New York Fed 1.6%. That's down from 2.1% in Q2 and 3.1% in Q1. I expect 10% tariffs to knock that down to 1.5% and raising those to 25% would likely mean 1.0% to 1.5% growth in 2020.
That's because enough indicators are still indicating expansion to indicate that no recession is likely in 2019 or likely 2020.
This is the most important table I use to determine recession risk (which I use to tweak the percentage of my monthly savings going into defensive/cyclical stocks vs. bonds/cash).
It's updated every two weeks, and as of August 2nd, the mean of the coordinates or MoC (average of all the indicators) was 27.2% above baseline. The recent trend was showing that the MoC was likely to go above 30% until the 10% tariff threat was made.
Now it's likely that economic fundamentals will weaken in the coming weeks. The good news is that, according to Mr. Rice, who has maintained this grid for many years, it would likely take 18 months before the MoC falls to recessionary levels (sub 5% above baseline).
Using the 2001 and 2007 recessions as historical baselines, we can see that, as long as the average of these 19 leading indicators stays above 20%, there is very little chance that a recession is coming within 12 months, and virtually no chance that we're in one already. That's an alarmist claim I've seen the media peddling in recent weeks, and the facts absolutely do not back that up.
However, it's also true that new tariffs, that will roughly increase tariffs on China by 50%, are almost certainly going to slow growth, though not necessarily enough to cause a recession.
(Source: FactSet Research)
That's because, unlike in the mid-50s, when manufacturing and industrial sectors made up 65% of US GDP, today services dominate and the most trade sensitive parts of our economy account for just 25% of aggregate US economic output.
(Source: FactSet Research)
Industrial production has kept growing, but at a rate that's been steadily slowing for the past nine months. Note that in 2016, during the peak of the second-worst oil crash in 50 years, industrial production growth reached -5%, yet the US didn't experience a recession. This shows the resilience of America's highly diversified $22 trillion economy, where strong consumer spending and service sectors can pick up the slack even when industrials and manufacturing are suffering a mild recession.
(Source: FactSet Research)
But the bad news is that the manufacturing outlook is getting steadily worse, not just in America, but in all developed economies. US manufacturing has stalled and France's is on the verge of a mild recession. Germany, Italy, the UK, Canada, and Japan are already in a manufacturing recession.
The first US tariffs against China began in January 2018, and have steadily gone up. It's highly likely that this is the reason that global manufacturing recently dipped into a mild recession, after 20 months of steady declines.
But the good news is that global growth is not expected to turn negative either in 2019 or 2020.
As FactSet Research's Sarah Potter explains:
"While most of the indicators we have available to measure the industrial economy are flashing red, it's not clear whether these will prove to be accurate predictors of a broader economic contraction. We only have to look back three years to find evidence to question the connection between the industrial sector and the overall economy. However, one can also argue that the various segments of the economy are more intertwined than ever before — both domestically and on a global basis — and industrial output remains an important area to watch." -FactSet Research (emphasis added)
But slower growth could very well result in flat corporate earnings growth in 2019 and 2020, rather than the 2% and 11% growth analysts expected for those years, respectively, before the trade war escalated for the 4th time.
So what should investors worried about more trade war pullbacks, corrections, or in a worst-case scenario, a bear market do? A sleep well at night or SWAN portfolio begins with the proper asset allocation or the mix of stocks/bonds/cash you own.
3 Good Bond ETFs That Are Likely To Stay Flat/Go Up During Corrections/Bear Markets
If you will need to withdraw principal from your portfolio within the next three to five years (like retirees using some form of the 4% rule), you likely need to own some bond/cash equivalents.
Since 1945 in 94% of years the S&P 500 closes down, bonds stay flat or go up, even during periods of double-digit inflation (highly unlikely in the foreseeable future).
This is because, unlike what the media might lead you to believe, stocks and bonds are NOT the same. They are in fact, nothing alike other than that they both generate income.
High-quality bonds (like sovereign debt) tend to have negative correlations with stocks, explaining why they tend to move in opposite directions during periods of high stock market fear.
- PIMCO Enhanced Short Maturity Active Exchange-Traded Fund (MINT): Morningstar 5-star, gold-rated cash equivalent ETF, 2.7% yield net of expenses (paid monthly)
- Schwab U.S. Aggregate Bond ETF (SCHZ): 4-star silver rated intermediate bond ETF (which will benefit from future Fed bond buying), 2.8% net of expenses (paid monthly)
- SPDR Portfolio Long Term Treasury ETF (SPTL): 4-star rated long-term US treasury ETF, 2.4% yield net of expenses (paid monthly)
These are the three bond ETFs Dividend Kings uses (10% equal allocation to each) for our $1 Million Retirement Portfolio. We also have 10% allocation to Preferred REIT shares and 60% in undervalued high-yield blue chips which is how we managed to build a retirement portfolio with a weighted safe yield of 4.7% and that's expected to deliver about 4.4% long-term income growth (and approximately 11% CAGR total returns).
These are the highest quality bond ETFs I was able to find (according to Morningstar).
An equally weighted bond portfolio of MINT, SCHZ, and SPTL, rebalanced annually, would have suffered a peak decline of just 6.1% during the last eight years (moderate rate sensitivity, duration 7.9). Its beta (volatility relative to S&P 500) was -0.25, serving the purpose of having non-correlated assets (relative to stocks) to buffer your portfolio during pullbacks and corrections.
33% MINT/SCHZ/SPTL vs. S&P 500 During Months When Stocks Fell 5+% Since 2012
|Month||S&P 500 Decline||MINT Return||SCHZ Return||SPTL Return||DK Bond ETFs (Equally Weighted)|
(Source: Portfolio Visualizer)
Nothing works every time, and sometimes bonds will fall when stocks freak out. But during the last eight years, during the average monthly pullback, these three bond ETFs averaged a 1.9% gain vs. the market's 6.6% decline.
And over entire corrections, they also did their job of staying flat or rising modestly, thus smoothing out portfolio returns, providing assets to sell if needed (without realized losses), and generally helped conservative investors sleep at night.
Late 2018 Correction
During the worst correction in 10 years, these three ETFs held up very well, especially during the final three weeks, when the S&P 500 fell 17% over 15 trading days.
In late 2015, the market plunged 10% within a matter of days, and these bond ETFs did what was expected of them, especially SPTL, which rises the most when stocks crash (flight to safety and very long duration).
As you can see, the longer the duration of the bond ETF (SPTL's is 17), the more it rises when stocks fall. The reason we went with equal allocations in each is because of the uncertainty regarding a 2020 or 2021 recession (12-month recession risk is 42% right now if current economic fundamentals persist).
If we avoid recession (the most likely outcome), then interest rates will recover (Moody's expects that in 2021) and long duration bonds will decline modestly. Since Dividend Kings makes data-driven/high probability decisions, we thought it prudent to hedge against either scenario, a recession or merely a temporary slowing of US growth (that will abate when the trade war eventually ends).
The right bond allocation for most people is between 30% and 50%, depending on your individual circumstances. You can weight the duration of bonds any way you wish, depending on your needs and how bullish/bearish you are about the short- to medium-term state of the economy.
So that's my view of the trade situation, and how Dividend Kings is approaching our bond allocations. But here are the best defensive stocks for new money today, based on our approach.
The Dividend Kings Approach To Valuing And Recommending Stocks
See this article for an in-depth explanation of how and why the Dividend Kings values companies and estimates realistic 5-year CAGR total return potentials.
In summary, here is what our valuation model is built on.
- 5-year average yield
- 13-year median yield
- 25-year average yield
- 10-year average PE ratio
- 10-year average P/Owner Earnings (Buffett's version of FCF)
- 10-year average price/operating cash flow (FFO for REITs)
- 10-year average price/free cash flow
- 10-year average price/EBITDA
- 10-year average price/EBIT
- 10-year average Enterprise Value/EBITDA (factors in debt)
These metrics represent pretty much every company fundamental on which intrinsic value is based on. Not every company can be usefully analyzed by each one (for example, EPS is meaningless for REITs, MLPs, yieldCos, and most LPs). But the idea is that each industry appropriate metric will give you an objective idea of what people have been willing to pay for a company.
We line up the expected and realistic growth rates of companies with time horizons of similar growth, thus minimizing the risk of "this time being different" and overestimating the intrinsic value of a company.
4 Great Defensive Investing Ideas From The Dividend Kings Master Valuation/Total Return Potential List
Here are four great defensive dividend ideas from the Dividend Kings Master Valuation/Total Return Potential List.
|Investment Type||Company||Ticker||Current Price||Historical Fair Value||Yield||Discount To Historical Fair Value||5-Year F.A.S.T Graphs Estimated Total Return Potential|
|Highest Defensive Safe Yield||British American Tobacco||(BTI)||$38||$50||7.1%||25%||20% to 25%|
|Undervalued Defensive Dividend Aristocrat||AbbVie||(ABBV)||$66||$121||6.5%||46%||20% to 28%|
|Undervalued Defensive Dividend King||Altria||(MO)||$47||$62||6.9%||25%||14% to 22%|
|Defensive Super SWAN (11/11 Quality)||Johnson & Johnson||(JNJ)||$132||$128||2.9%||-3%||7% to 11%|
(Sources: F.A.S.T. Graphs, Google Finance, Management Guidance, Analyst Consensus) - prices as of August 9th
Altria is expected to raise its dividend for the 50th consecutive year in August (adjusted for spin-offs). While it won't technically be a dividend king, we're not going to let technicalities stand in the way of sound investing advice. That's especially true when Coca-Cola (KO) is the second most undervalued defensive dividend king, and nearly 10% overvalued.
Note that historical fair value is NOT a "12-month price target" but merely my best estimate of what a company is worth in 2019 (using this year's consensus results) based on valuation multiples investors have paid in the past, during which fundamentals (like growth rates) were similar. Total return potentials are based on realistic growth rates and a return to historical valuations within 5+ years.
If you're looking for more great long-term investing ideas, then this is where the rest of this article comes in.
Morningstar Is A Good (But Not Perfect) Place To Start Looking For Good Ideas
Morningstar is typically (though not always) a good starting location for blue-chip income investing ideas. That's because they are 100% focused on long-term fundamentals, rather than 12-month price targets like most sell-side analysts (the ones that issue "buy, sell, hold" recommendations). Most of their fair value estimates are reasonable (though not always, more on this in a moment). So, here are all my blue-chip watch list stocks that Morningstar estimates are at least 20% undervalued.
(Source: Morningstar) data as of August 9th "q" = quantitative (non-analyst) model estimate
But you can't just look at any one analyst's fair value estimate and know if it's a good buy. That's because every company has its own risk profile, and differing business models mean that a 20% discount to fair value of a highly cyclical company (like commodity producers) isn't the same for one with very stable and recession-resistant cash flow (like a consumer staples company).
This is where looking at Morningstar's star ratings is a good next step. These ratings, which correspond to buy, strong buy, and very strong buy recommendations, factor in a company's risk profile, industry trends, management quality, and Morningstar's definition of "Moatiness" (which I sometimes disagree with but are for the most part on the money when it comes to corporations).
Morningstar's moat definition is based on their belief that a company can maintain returns on invested capital above its weighted cost of capital (using their assumptions plugged into the CAPM model) for 20 years or longer (wide moat) and 10 years or more (narrow moat). I look for competitive advantages that allow returns on invested capital above the industry norm and above the cash cost of capital (what matters more to the ability to grow dividends over time).
Here are my watch list companies that Morningstar consider 4 or 5 star buy and strong buy ratings.
(Source: Morningstar) data as of August 9th "q" = quantitative (non-analyst) model estimate
You'll note that there a lot more 4 and 5 star stocks than ones trading 20% or below Morningstar's estimates fair value. That's because Morningstar is adjusting for quality, safety, and overall cash flow stability (via their uncertainty ratings). This is why a Magellan Midstream (NYSE:MMP) is a 4-star stock despite being just 10% undervalued (per their estimate).
However, while a 4 or 5 star Morningstar stock is USUALLY a good long-term investment, it's important to remember that some of the company's recommendations can be far off the mark. Dividend Kings uses a 100% pure F.A.S.T. Graphs powered historical valuation method that only looks at historical and objective data and sometimes disagrees with Morningstar.
Typically, these disagreements are minor. Sometimes, they are not. For example,
|Company||Morningstar Fair Value||Dividend King's Historical Fair Value|
|Home Depot (HD)||$170||$199|
|Simon Property Group (SPG)||$195||$206|
Morningstar usually has similar estimates as us for most sectors, but popular momentum stocks (like many tech names) they often appear to try to justify rich valuations. For example, they assume much faster growth at Microsoft will justify a 40% multiple expansion, which implies that Microsoft's growth rate in the future will be 14% CAGR (not impossible but on the upper range of probable).
For Nike, Morningstar straight up assumes a DOUBLING of the historical PE, despite growth rates that are merely in line with its historical norms. Dividend Kings lines up realistic future growth rates (based on fundamentals, management guidance, and analyst consensus) with time periods in which the company's fundamentals and growth rates were similar to what's likely, and then assumes the same average valuation multiples will apply to this year's expected results (since the fundamentals and growth rates are similar).
How can you tell whether or not Morningstar's valuation estimates and star ratings are reasonable or totally off the mark (other than becoming a Dividend King member and looking at our exclusive company valuation/total return potential lists)? One good way is to look at objective valuation metrics, which is where we turn to next.
Price-To-Earnings Vs. Historical Norm
While no single valuation method is perfect (which is why DK uses 10 of them), a good rule of thumb (from Chuck Carnevale, the SA king of value investing and founder of F.A.S.T. Graphs) is to try not to pay more than 15 times forward earnings for a company.
This is because PE ratios are the most commonly used valuation metric on Wall Street and 15.0 PE being a reasonable price for quality companies is based on Mr. Carnevale's 50 years of experience in asset management valuing companies. He bases that on an earnings yield of 6.7% (inverse of a 15 PE) being roughly equal to the 200-year return of the stock market.
Chuck's historical P/E valuation approach has made him a legend on Seeking Alpha and, according to TipRanks, one of the best analysts in the country when it comes to making investors money.
(Source: TipRanks) - data as of August 9th, note the stock market's historical 1-year return is 9.1% and 60% is considered a good success rate for analysts.
Chuck usually compares companies to their historical valuation ratios, and he's ranked in the top 1.5% of all analysts tracked by TipRanks (based on the forward 12-month total returns of his recommendations). While 12 months is hardly "long term," the point is that Mr. Carnevale is a fantastic value investing analyst and his historical valuation-driven approach is beating 98.5% of all bloggers/analysts, including 5,200 that work on Wall Street.
Here are dozens of blue-chip companies with forward P/Es of 15 or less AND their five-year average PEs. Note that some industries are naturally prone to lower multiples (such as financials) due to more cyclical earnings. Which is why you want to compare their current PEs to their historical norms (Morningstar offers 5-year average PEs, but 10 years is better for factoring in industry/sector downturns).
Keep in mind, P/E ratios for MLPs, REITs, and YieldCos are not a good indication of value since high depreciation results in lower EPS. Price/cash flow is the better approach with such pass-through stocks.
(Source: Morningstar) - data as of August 9th
But as I just said, PE is not appropriate for some stocks, such as REITs, YielCos, MLPs, and LPs. Similarly, you want to make sure that the historical PE ratio makes sense. For pharma like ABBV, Bristol-Myers (NYSE:BMY), Amgen (NASDAQ:AMGN), and Pfizer (NYSE:PFE), adjusted earnings are more appropriate, and the 5-year average PE is skewed by large one-time charges. Similarly, cyclical companies like Halliburton (HAL) can appear more undervalued than they really are, because recent industry recessions can cause average PE ratios to be crazy high.
Notice also how some industries naturally have lower PEs, like Canadian Imperial Bank of Commerce (CM). Its 8 PE looks great, but the 5-year average is 10.8, indicating it's likely moderately undervalued (Morningstar estimate is 18%). In other words, PE vs. historical PE is just another step in the process of valuation, and not necessarily a "be all and end all" way to decide what stocks to buy.
And of course, since income investors like their MLPs and REITs, price to cash flow vs. historical norm is also something you want to check to make sure a stock you are interested in is trading at a reasonable valuation.
Price/Cash Flow Vs. Historical Norm
While earnings are usually what Wall Street obsesses over, it's actually cash flow that companies run on and use to pay a dividend, repurchase shares, and pay down debt. Thus, the price/cash flow ratio can be considered a similar metric to the P/E ratio but a more accurate representation of a company's value. Chuck Carnevale also considers a 15.0 or smaller price/cash flow ratio to be a good rule of thumb for buying quality companies at a fair price. Buying a quality company at a modest to great cash flow multiple is a very high probability long-term strategy.
Again, comparing a company's price to cash flow against its historical norm can tell you whether it's actually undervalued. Dividend Kings uses 10-year average cash flows and Morningstar only offers 5-year averages. For cyclical companies, sometimes that can cause skewed results (which is why we use longer time periods and as many of our 10 valuation metrics as are industry-appropriate).
Here are all the companies on my watch list with price/cash flow of 15.0 or less.
(Source: Morningstar) - data as of August 9th
You want to use several valuation metrics in concert to ensure that any false signals are eliminated (which is why DK uses up to 10). For example, Emerson Electric (EMR) is a dividend king with 62 consecutive years of dividend hikes to its name. The price to cash flow of 13 looks like it's much lower than the five-year average of 19. But Dividend Kings estimates EMR is worth $66, or just 9% more than it currently trades for. It's a good buy, but not necessarily a great one like this single metric comparison might indicate.
Or take the example of NextEra Energy (NEE), a level 11 Super SWAN, one of the greatest dividend stocks on earth, and hands down the best-regulated utility in America. NEE trades at 15 times cash flow, which might seem like it fits with the Chuck Carnevale/Ben Graham rule of thumb.
NextEra's intrinsic value, based on what people have actually paid for its dividends, earnings, and cash flow is between $133 and $179, with $154 being a reasonable single figure we use. This means that NextEra is 40% historically overvalued, the 5th most overvalued Super SWAN (out of 44 that exist). Buying it today means 0% to 4% CAGR five-year total returns are likely, a bond like return from this wonderful company because it's so overpriced.
PE/Growth Ratio (Growth At A Reasonable Price)
According to Benjamin Graham, Buffett's mentor and the father of value investing, a company with stable cash flow but zero growth prospects is fairly valued at a PE of about 8. If you just go off the PE ratio alone, you may actually not be getting a good deal, because companies with fast growth are naturally worth higher multiples. This is where the PE/Growth or PEG ratio comes in.
While this method is limited by what growth assumptions you use, it's a quick and dirty way to screen for potentially attractive dividend growth investments, when used in conjunction with other methods. The S&P 500's PEG ratio is currently 2.6 to 2.8 (depending on the growth estimates you use). A PEG of 1.0 or less is generally excellent, but 2.0 or less is likely to deliver good returns IF you're buying a quality company with a stable business model. Here are my watch list stocks with PEGs of 2.0 or less, as estimated by Morningstar's forward growth forecast.
(Source: Morningstar) - data as of August 9th
PEG is a good way to strive for "growth at a reasonable price" or GARP. However, the obvious flaw is that it's based on forward projections that can be wrong. All valuation metrics have their limitations, which is why you shouldn't rely on just one.
Screening a company via all of these approaches can minimize the chances of overpaying for a quality name (make sure to check that earnings and cash flow are growing so you don't buy a value trap by mistake). For example, AbbVie clears all screens making it a great deep value buy.
- Dividend King's Historical Discount To Fair Value: 46%
- Morningstar estimated discount to fair value: 36%
- Morningstar star rating: 5 (very strong buy)
- PE: 7.5 (vs. 14.5 average since 2013 spin-off)
- P/cash flow: 8.0 vs. 13.4 average
- PEG: 1.2 (low end of a reasonable growth rate of 5% to 10%)
Buying AbbVie today, a company that has beaten and raised its own full-year guidance for 14 out of 26 quarters it's been a publicly traded company and is on track for three more years of double-digit growth, is a high-probability/low-risk investment right now. It's also...
- spin-off rule dividend aristocrat;
- the highest yielding dividend aristocrat;
- a defensive (recession-resistant business model) aristocrat; and
- a level 8/11 (above average) quality company.
Quality Stocks At 52-Week Lows Are Great Screening Candidates
(Source: Google Sheets) data as of August 9th, bolded companies are within 5% of 52-week lows
I maintain a watch list that takes every company I track and applies an 11-point quality score based on dividend safety, the business model, and management quality. All dividend stocks can be ranked 3-11, and my watch list (about 200 companies) only includes those with quality scores of 8 and higher.
- 8: Above average quality company, seek 15% discount to fair value or better, limit to 5% to 10% of invested capital.
- 9: Blue-Chip company, limit to 5% to 10% of invested capital and seek 10% discount to fair value.
- 10: SWAN stock, buy with confidence at 5% or greater discount to fair value or better, limit to 5% to 10% of invested capital.
- 11: Super SWAN (as close to an ideal dividend stock as you can find on Wall Street), fair value or better, limit to 5% to 10% of your invested capital.
I've programmed that watch list to track prices and use the 52-week low as a means of knowing when a blue-chip or SWAN stock is within 5% of its 52-week low and potentially a Buffett-style "fat pitch" investment. This means a quality company is:
- Trading near its 52-week (or often multi-year) low;
- Undervalued per other valuation methods; and
- Offers a high probability of achieving significant multiple expansion within 5 to 10 years and thus delivering double-digit long-term total returns over this time period.
Another method you can use is to target blue chips trading in protracted bear markets, such as sharp discounts to their 5-year highs. Buying a company at multi-year lows is another way to reduce the risk of overpaying and boost long-term total return potential.
(Source: Morningstar) - data as of August 9th
In the above table, I've set it up to show all the methods we've discussed today. You can thus see that most of the above companies are potentially fantastic long-term buys, based on many important valuation metrics, including Morningstar's qualitative ratings (of management quality, moat, and margin of safety).
This is what I mean by "fat pitch" investing, buying them when they are at their least popular ("be greedy when others are fearful"). It doesn't mean buying some speculative, small company, with an untested business model in hopes it becomes the next Amazon (AMZN).
The goal is simply to buy quality blue chips, whose fundamentals are firmly intact, and whose valuations are so ridiculously low, that modest long-term growth can deliver 15% to 25% CAGR total returns as the market realizes its mistake.
Mind you, it can take a long time for coiled springs like these deep value blue-chips to pop (sometimes five to 10 years), but as long as their business models remain intact and they keep growing cash flow and dividends, they eventually will which is why seven of the nine best investors in history have been value investors.
Bottom Line: The Market Has ALWAYS Faced Uncertainty But Smart Investors Can Use Reasonable Approaches To Minimize The Pain During Future Downturns
Global trade uncertainties currently include:
- The US/China conflict which isn't likely to get better anytime soon.
- Possible US/EU conflict over auto parts (also 25% tariffs).
- Japan/South Korea trade war (recently got worse).
- October 31st Brexit deadline looming.
Media reports of global economic policy uncertainty recently hit a 30-year high (highest ever recorded since this index was created). Combined with computer high-frequency algo trading (which can account for 90% of daily volumes), this might lead to higher short-term volatility.
Investors should trust their long-term strategies, tailored to their specific goals/risk tolerances/time horizons, rather than market timing during periods of high volatility and scary headlines (like the return of CNBC's "Markets in Turmoil" series).
No dividend stock is a true bond alternative, and if you need short-medium-term asset sales to meet expenses (such as retirees or those approaching retirement), then you need to own sufficient bonds/cash equivalents (proper asset allocation).
For the stock portion of your portfolio, less risk-tolerant investors might consider a marginal defensive strategy for new money they are putting to work, such as by buying BTI, ABBV, MO or JNJ today.
These are all level 8+/11 quality companies (above average to Super SWAN) which are sufficiently undervalued enough that they are likely to outperform during future market downturns. This does NOT mean they will go up, but rather play a defensive role by falling less, helping you sleep at night, and when combined with the right allocation to bonds/cash, provide some ballast to your portfolio.
Never forget that all investing is probabilistic. There is no way to tell what the future will bring with certainty (always think in terms of probabilities). Thus, the proper way to plan for an uncertain future is to stick to a long-term plan that is reasonable and has the best chance of achieving your long-term goals no matter what happens over the next year or two.
Dividend Kings makes it easy to know the best safe dividend stocks to buy at any given time via our valuation/total return potential lists. Membership also includes
- Access to our four model portfolios (Fortress, Deep Value Blue-Chip, High-Yield Blue-Chip, $1 Million Retiree Portfolio)
- over 24 exclusive articles per month
- Our Weekly Podcast
- 20% discount to F.A.S.T Graphs
- real-time chatroom support
- an exclusive database of 650 preferred stocks
- exclusive weekly updates to David Fish's (now run by Justin Law) Dividend Champion list
Click here for a two-week free trial so we can help you achieve better long-term total returns and your financial dreams.
Disclosure: I am/we are long ABBV, MO, JNJ, BTI. 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.