The Best Dividend Stocks To Buy Before The Christmas Rally

Summary

• Stocks are up 3.5% in December, 8% in the last three months and 31% YTD.
• Yet, the six trading days following Christmas historically bring 0.75-1.5% further gains, about 1,000% greater than any other six-day period of the year.
• With the S&P 500 now 16% historically overvalued, pullback/correction risk is highly elevated and it's more important than ever to allocate your savings reasonably and prudently.
• Carnival Corp., FedEx and Expeditors International are three quality dividend stocks that are trading at reasonable to attractive valuations and should deliver both steady dividend growth over time as well as 10+% CAGR long-term total returns.
• The rest of this article walks you through a prudent method of screening quality dividend stocks for valuation, so you can always know the best companies to entrust your hard-earned savings at any given time.
• Looking for a portfolio of ideas like this one? Members of The Dividend Kings get exclusive access to our model portfolio. Get started today »

(Source: imgflip)

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 6 Best Dividend Aristocrats And Kings To Buy In December.
• My "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.

The Santa Claus Rally Is A Real Thing...

With the stock market up so strongly over the past three months, many investors consider this a "Santa rally".

(Source: YCharts)

Actually, as Mark Hulbert points out in this article, the Santa rally is a statistical anomaly in which the six trading days following Christmas are about 50% more likely to see stocks advance.

That probability will fluctuate between 70% and 85%, depending on whether or not the market is up in December (it's up 3.5% this December). What's more, the historical gains of the Santa rally are 1000% greater than those in any other six-day period.

The stock market normally goes up (75% of all years since 1926), but the probability of stocks going up in any six-day stretch is 55%. 70-85% probability of stocks going up is statistically significant, and thus why investors generally enjoy stronger gains during the time right after Christmas.

... But It Doesn't Mean You Should Abandon Prudent Investment Principles

It's important to remember that investing is all about probability, and while the Santa rally is a real thing, it's not something prudent investors should trade around, as Mark Hulbert explains:

Regardless, only for very short-term traders would the existence of a genuine Santa Claus rally be the basis for a new trade. The average Dow gain in all Santa Claus rallies since 1896 is 1.49%, for example, and 0.74% in years in which the Dow’s before-Christmas December gains are positive. While that’s significantly better than the 0.13% average six-trading-day return over the rest of the year, it may not be sufficiently better to pay for transaction costs."

- Mark Hulbert (emphasis added)

The average Santa rally since 1896 has seen stocks rise 1.5% during this six-day stretch and half as much in years when the market was up in December (this year). Is that statistically significant compared to the average rolling six-day gain of 0.16% for the rest of the year? You bet.

Should reasonable and prudent long-term investors rush to blindly buy stocks before Christmas trying to make a quick buck? Absolutely not.

The nature of finance is risk management and probabilities. Right now:

• The S&P 500 is trading at a forward P/E of 18.8 vs. 16.2 25-year average
• S&P 500 is about 16% historically overvalued, according to JPMorgan Asset Management (using six different metrics)

(Source: CNN)

CNN's fear and greed index is at 92, one of the highest levels seen over the last three years.

On January 26th, the market had a forward P/E of 18.7 and the fear and greed index was at 80. We're now above both levels.

So does that mean it's time to sell everything and wait for an imminent pullback/correction? Heck, no.

Over 12 months' valuation explains just 10% of stock returns. That rises to 46% over 5 years and 90% over 10+ years, according to Bank of America and Princeton.

Short-term stock movements are impossible to predict consistently, even for hedge funds backed by an army of quants and supercomputers. The only thing I can say with certainty is that pullback/correction risk is highly elevated and a 5+% downturn or two is highly likely in 2020.

Bank of America analyst Michael Hartnett believes the market is “primed for Q1 2020 risk asset melt-up,” and according to CNN:

Hartnett expects the 2020 gains to be "front-loaded... that carries the S&P 500 to 3,333 by early March "a point underlined by BofA's year-end target of 3,300 for the S&P 500."

(as of November 11th)

(Source: YCharts)

Is the market really going to 3,333 by March? I have no idea, as I'm not a technical analyst nor am I short-term speculator. What I can tell you is that even with the market potentially melting-up now and the bull market now the longest and most profitable in US history, quality dividend stocks are still available at reasonable or attractive valuations.

My Approach To Valuing And Recommending Stocks

See this article for an in-depth explanation of how and why I value companies and estimate 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 P/E 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. 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.

I 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.

I maintain 10 total valuation lists, covering:

• 49 level 11/11 quality Super SWANs (the best dividend stocks in America which collectively have tripled the market's annual returns over the past 25 years)
• All the Dividend Kings
• All the Dividend Aristocrats
• All safe (level 8+ quality) midstream MLPs and C-corps
• All safe monthly dividend-paying stocks
• All DK model portfolio holdings
• Our Top Weekly Buy List
• Our Master Valuation/Total Return Potential List (323 companies and counting)

It's from these lists that I present four potentially excellent long-term dividend growth opportunities that smart investors can buy despite the currently elevated market multiples and short-term pullback risk.

3 Great Dividend Stocks Smart Investors Can Buy For Christmas

Carnival Corp. and FedEx are Dividend Kings' Deep Value Portfolio and High-Yield Blue Chip Portfolio holdings.

Company	Ticker	Quality Score (Out Of 11)	Yield	Historical Fair Value	Current Price	Discount To Fair Value	5-Year CAGR Total Return Potential
Carnival Corp.	(CCL)	8 - above average	4.0%	$74	$40.5	33%	14-26%
FedEx	(FDX)	8 - above average	1.8%	$179	$148	17%	19-29%
Expeditors International	(EXPD)	11- Super SWAN-Dividend Aristocrat in 2020	1.3%	$79	$77	3%	8-15%

Click to enlarge

(Sources: F.A.S.T. Graphs, FactSet Research, Reuters, YCharts, Dividend Kings Master Valuation List, management guidance, analyst consensus, Gordon Dividend Growth Model)

Carnival Corp.: Still A Bargain Even After A 7% Post-Earnings Rally

Carnival is soaring as I write this due to reporting earnings that beat both expectations for the current quarter and adjusted EPS guidance for Q1 2020 at $0.49, which was 22.5% above consensus expectations.

(Source: F.A.S.T. Graphs, FactSet Research)

What's more, CCL reported adjusted EPS of $4.40 in 2019, compared to $4.26 that analysts were expecting. 3.3% growth in 2019 might not seem like a lot, but keep in mind three things:

• 2019 S&P 500 EPS growth is expected to be about 0.4%
• Analysts expected zero growth
• CCL was trading at about 10 times earnings, compared to its historical 15-18 P/E, which is how the market values this business when it's growing between 5% and 22% CAGR over time.

Over the long term, CCL has a strong growth runway created via its 19 ships being delivered by 2023. Even with that extra supply, demand for cruising is expected to outpace new ship construction because both young and old all over the world love the experiential nature of what Carnival Corp. is offering consumers.

Carnival Growth Profile

• FactSet long-term growth consensus: 8.7% CAGR
• Reuters 5-year EPS growth consensus: 5.0% CAGR
• YCharts long-term growth consensus: 10.5% CAGR
• Historical growth rate: 4.9% CAGR over the last 20 years
• Realistic growth range: 5-11% CAGR
• Historical fair value: 15-18 P/E

Note that the actual total return potential is 2% CAGR lower due to CCL's earnings beat rally of 9%.

(Source: F.A.S.T. Graphs, FactSet Research)

Even if CCL grows at the lower end of its expected range and trades at the low end of historical fair value, it could double your investment over the next five years.

Compare that to the 2-7% CAGR that most asset managers expect from the S&P 500 over the coming years or the 4-6% CAGR that the Gordon Dividend Growth Model estimates is likely.

(Source: F.A.S.T. Graphs, FactSet Research)

If CCL grows at the upper end of its expected range and returns to the high end of fair value, then it could deliver 26% CAGR total returns.

All while delivering a safe 4% yield that's more than double that of the broader market and likely to grow faster over time.

FedEx: Opportunistic Buying Opportunity After Earnings Miss Crash

FDX crashed 10% after missing earnings and reducing guidance for fiscal 2020 to -30% adjusted EPS growth.

The causes of the miss were a perfect storm of factors, including:

• Negative 1.6% growth in global trade (tariff conflict is starting to ease for the first time in 20 months)
• Amazon contract ended in August (tough comps)
• Ongoing investments into logistics and supply (including new jets) that are necessary for FedEx to profit from the global growth in e-commerce around the world
• The timing of Black Friday/Cyber Monday (that revenue was pushed into December)

These negatives caused operating margins to fall to 3.9%, which management is confident will recover to the "teens" by the end of fiscal 2020. FDX has always been a cyclical company, and the best time to buy it is during industry downturns like we're now experiencing.

Here's why the Dividend Kings bought more FedEx after that 10% crash.

FDX Valuation Matrix

Metric	Historical Fair Value	2020	2021	2022
Earnings	17.7	$193	$226	$255
Operating Cash Flow	8.2	$157	$204	$235
EBITDA	6.4	$185	$201	$216
EBIT	11.2	$175	$197	$219
EV/EBITDA	6.4	$185	$201	$216
Average		$179	$206	$228

Click to enlarge

(Sources: F.A.S.T. Graphs, FactSet Research, Reuters, GuruFocus)

Analysts have updated their 2020 consensus estimates for FDX's fundamentals, and it appears those deliver a fair value of $179 this year, rising rapidly in the coming years as the trade conflict ends, global growth accelerates and FedEx's huge cost-cutting initiatives come on-line.

Here is the medium-term FactSet consensus for FedEx's operating earnings.

• -30% EPS growth in 2020
• 17% growth in 2021
• 13% growth in 2022
• 8% growth in 2023

FedEx Growth Profile

• FactSet long-term growth consensus: 11.5% CAGR
• Reuters 5-year EPS growth consensus: -2.0% CAGR (not a long-term forecast, includes -30% growth in 2020)
• YCharts long-term growth consensus: 12.0% CAGR
• Historical growth rate: 8.3% CAGR over the last 20 years
• Realistic growth range: 7-12% CAGR
• Historical fair value: 16-18 P/E

Even after the big earnings miss, the analyst consensus for FDX's long-term growth remains virtually unchanged (it fell about 1%).

(Source: F.A.S.T. Graphs, FactSet Research)

Even if the company grows half as fast as expected, that would still justify its historical fair value range. The low end of which, when combined with 5% growth, could deliver nearly 20% CAGR total returns.

(Source: F.A.S.T. Graphs, FactSet Research)

If FDX grows at 12% and returns to the upper end of fair value, then it could deliver nearly 30% CAGR total returns.

That's the power of combining an undervalued above-average quality company that's capable of double-digit growth or roughly double the market's historical earnings growth rate.

Expeditors International: The Newest Super SWAN Is A Good Buy For 2020 And Far Beyond

In 2020, EXPD will become a Dividend Aristocrat when it hits 25 consecutive years of dividend growth.

EXPD is one of the world's largest freight logistics coordinators, with 250 offices on six continents. The company's specialty is North America to Asian ocean and air cargo, which explains why its medium-term growth has taken a beating from the tariff conflict.

• 2019 consensus growth: 1%
• 2020 growth: 5%
• 2021 growth 7%
• 2022 growth 7%

But over the long term, EXPD, though a combination of 5-6% revenue growth, margin expansion (better automation and economies of scale) and buybacks (2.7% CAGR historically), should be capable of high-single digit or low-double digit earnings, cash flow and dividend growth.

M&A is also a growth catalyst because freight logistics is a very fragmented industry where the largest players absorb their smaller rivals. While M&A is always tricky to pull off well, EXPD management has an exceptional track record of well-executed, strategic M&A, and they almost never overpay for such deals.

Economies of scale make this a wide-moat industry because EXPD's customer base, numbering in the thousands, gives it strong buying power with shippers. This allows the company to offer its clients lower cost, while maintaining a reputation for some of the most reliable service in the industry.

Expeditors Growth Profile

• FactSet long-term growth consensus: 10.0% CAGR
• Reuters 5-year EPS growth consensus: 5.3% CAGR
• YCharts long-term growth consensus: 4.1% CAGR
• Historical growth rate: 12.9% CAGR over the last 20 years
• Realistic growth range: 4-10% CAGR
• Conservative fair value: 22-24 P/E

(Source: F.A.S.T. Graphs, FactSet Research)

Even if EXPD grows at the lower end of the analyst forecast, it's likely to match or beat the broader market over the next five years.

(Source: F.A.S.T. Graphs, FactSet Research)

If it grows in the double digits, as FactSet expects, then it could double your investment over the next five years. That would continue a long tradition of strong double-digit returns that most Super SWANs are famous for. Collectively, the Super SWANs have tripled the market's annual returns (15% vs. 5%) over the past 25 years.

EXPD Total Returns Since 1991

(Source: Portfolio Visualizer) portfolio 1 = EXPD

My base case is 7% long-term growth and the mid-range of the company's historical P/E, generating 10% CAGR long-term return potential.

(Source: F.A.S.T. Graphs, FactSet Research)

That's the power of a modestly fast-growing Super SWAN bought at fair value based on its 2020 consensus fundamentals.

What if CCL, FDX and EXPD don't fit your needs? That's where the rest of this article comes in. So, let's walk through a prudent way to screen quality dividend stocks for valuation, so you can always make reasonable choices with your hard-earned savings.

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 December 20th)

Even with the market near all-time highs, you can see that, at least according to Morningstar, there are plenty of quality names available at bargain prices. We disagree with some of these valuations (Imperial Brands (OTCQX:IMBBY) is just 29% undervalued, for example), but for the most part, these are quality companies trading at attractive valuations.

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 a reasonable buy, good 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 its belief that a company can maintain returns on invested capital above its weighted cost of capital (using its 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 (which matters more to the ability to grow dividends over time).

Here are my watch list companies that Morningstar considers 5-star Strong Buys.

(Source: Morningstar, data as of December 20th) "q" = quantitative (non-analyst) model estimate

Note that Morningstar's discount to fair value estimates for 5-star stocks can vary widely, from its 50% estimates margin of safety for 7/11 average quality Imperial Brands to just 20% and 18% for 11/11 Super SWAN quality EPD and 9/11 blue-chip quality LNC, respectively.

Morningstar's approach to valuing companies is similar to my own, where quality is taken into account.

Quality Score (Out of 11)	Example	Good Buy Discount To Fair Value	Strong Buy Discount	Very Strong Buy Discount
7 (average quality)	AT&T (T), IBM Corp. (IBM)	20%	30%	40%
8 above-average quality	Walgreens (WBA), CVS Health Corp. (CVS)	15%	25%	35%
9 blue-chip quality	Altria (MO), AbbVie (ABBV)	10%	20%	30%
10 SWAN (sleep well at night) quality	PepsiCo (PEP), Dominion Energy (D)	5%	15%	25%
11 (Super SWAN) - as close to a perfect dividend stock as exists on Wall Street	3M (MMM), Johnson & Johnson (JNJ), Caterpillar (CAT), Microsoft (MSFT), Lowe's Companies (LOW)	0%	10%	20%

Click to enlarge

To me, a Super SWAN dividend king like 3M is more attractive 20% undervalued than a lower-quality company like IBM that's 35% undervalued. But at the right price, even an average-quality company that has a safe dividend that's likely to grow at all is a potentially attractive investment, at least for some people's needs.

However, while 5-star Morningstar stock is usually a good long-term investment, it's important to remember that some of its recommendations can be far off the mark. I use 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 Kings 2019 Historical Fair Value
3M	$176	$188
Microsoft	$155	$100
Apple (AAPL)	$220	$167
Nike (NKE)	$102 (increasing by low single digits following earnings)	$66
Home Depot (HD)	$170	$199
Simon Property Group (SPG)	$189	$206
UnitedHealth Group (UNH)	$310	$214 in 2019, $239 in 2020
Merck (MRK)	$104	$76
American Water Works (AWK)	$93	$80

Click to enlarge

(Sources: Morningstar, Dividend Kings valuation/total return potential lists)

Morningstar usually has similar estimates as us for most sectors, but for popular momentum stocks (like many tech names), it often appears to try to justify rich valuations. For example, here are the P/E multiples it uses to determine fair value for Super SWANs Nike, Microsoft and UnitedHealth.

• Nike: 36 P/E = Morningstar fair value (historical P/E range 22-26)
• Microsoft: 29 P/E = Morningstar fair value (historical P/E range 16-20)
• UnitedHealth: 21 P/E = Morningstar fair value (historical P/E range 14-18)

(Source: F.A.S.T. Graphs, FactSet Research)

The purple line is Morningstar's fair value P/E ratio for Nike, which Morningstar is valuing based on a P/E of 36 and an EV/EBITDA of 26.

(Source: F.A.S.T. Graphs, FactSet Research)

Fair value means that investors can expect to fully participate in a company's future growth, with dividends and long-term growth delivering total returns unhindered by valuation mean reversion.

That's according to the Gordon Dividend Growth Model, which has been forecasting stock market returns with relative accuracy for 5+ year periods since 1956. It's what Brookfield Asset Management (BAM) uses, Vanguard founder Jack Bogle swore by it, and it's what the Dividend Kings have used for years or decades.

Nike is currently expected to growth 15% CAGR over time, per FactSet. That's close to the 14% CAGR 20-year growth rate when it averaged a 21.6 P/E.

(Source: F.A.S.T. Graphs, FactSet Research)

If Nike were truly fairly valued at a 36 P/E, investors should expect about 16% CAGR long-term returns. In reality, 5% CAGR is more realistic, because Nike is absolutely overvalued today.

The "fair value" multiples that Morningstar's analysts sometimes use are not just objectively too high, but fly in the face of what real investors risking real money have valued each company's earnings and cash flows at.

(Source: imgflip)

Valuation can't be known with exact precision, but ultimately, a company's earnings, dividends and cash flows are worth what investors have paid for them over periods of similar fundamentals.

How can you tell whether Morningstar's fair value estimates are reasonable or just plain crazy? By looking at objective metrics like P/E ratios.

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. That's the same rule of thumb that Ben Graham, the father of value investing, considered a reasonable multiple to pay for a quality company.

This is because P/E ratios are the most commonly used valuation metric on Wall Street, and 15.0 P/E 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 P/E), being roughly equal to the 200-year return of the stock market.

Chuck also considers 15 times cash flow to be prudent for most companies, as do all the founding Dividend Kings.

Here are dozens of blue-chip companies with very low forward P/Es and their five-year average P/Es. 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 P/Es to their historical norms. (Morningstar offers 5-year average P/Es, but 10-20 years is better for factoring in industry/sector downturns.)

(Source: Morningstar, data as of December 20^th)

Don't forget that 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 a better approach with such pass-through stocks.

Historical P/E and a 15.0 rule of thumb are not perfect. 5-year average P/Es can give a false reading if something extreme happened, like a bubble or industry crash, causing the energy P/E ratio averages to become absurd.

Energy Transfer's P/E ratio is meaningless, and so, I don't even look at it (yield, price/OCF, P/EBITDA, EV/EBITDA and P/EBIT are what I consider for that stock).

Another important metric to check is price-to-cash flow, which replaces the P/E ratio for REITs, yieldCos, MLPs/midstreams and many LPs.

Price-to-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-to-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-to-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. I use 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 the companies on my watch list with the lowest price-to-cash flows.

(Source: Morningstar, data as of December 20^th)

Again, historical price-to-cash flow estimates are not perfect. TerraForm Power (TERP), a level 8/11 quality yieldCo, was run into the ground and nearly bankrupted by its former sponsor SunEdison (which did go bankrupt). Brookfield Asset Management rescued it and turned it into a great high-yield dividend growth stock, which justifies a much higher valuation.

Or consider Southwest Airlines (LUV), a 10/11 quality SWAN stock that is currently 13% undervalued and a Strong Buy.

(Source: F.A.S.T. Graphs, FactSet Research)

Free cash flow is operating cash flow minus capex. Since airlines are a cyclical industry and the timing of new plane deliveries is variable, LUV's FCF is extremely volatile. As a result, the stock doesn't actually track FCF very well.

(Source: F.A.S.T. Graphs, FactSet Research)

Operating cash flow is operating income before depreciation minus taxes and adjusted for changes in working capital. Basically, the money that's left over after running the business but excluding investments to fund future growth or maintenance capex.

Look how well LUV's share price tracks its historical 8.2 operating cash flow average. Southwest's normal price-to-operating cash flow multiple is 7-9 over the last 20 years when its operating cash flow grew between 10% and 30% CAGR. Based on the consensus OCF/share for 2020, LUV is worth about $65 based on this metric, about 20% more than it is today.

(Source: F.A.S.T. Graphs, FactSet Research)

When looking at EV/EBITDA (on a per share basis), meaning market cap + debt - cash/EBITDA (the acquirer's multiple), we can see that the market doesn't value Southwest at 15 but around 9. That's during a period of 9% CAGR EBITDA growth, which is what analysts expect to continue over the long term.

In 2020, the consensus EV/EBITDA estimate says LUV is worth $74 per share, 37% more than it is today.

Notice how I use many fundamental metrics looking at relevant fundamentals. That's because any one metric might give an outlier estimate that could lead you to invest in a bubble stock and expose yourself to massive valuation and volatility risk.

Looking at up to 10 metrics (if they all apply to the company) and excluding outliers is the best way I know to reasonably estimate what a company's fundamentals are actually worth in any given year.

P/E-to-Growth Ratio (Growth At A Reasonable Price) And Putting It All Together

According to Chuck Carnevale and Ben Graham, Buffett's mentor and the father of value investing, a 15 P/E is prudent for most companies, even slow-growing ones. But if a company is able to grow especially fast (over 15% over time), it deserves a higher multiple. That's because the compounding power of time means a company that grows at a faster rate can generate many times greater wealth and income for you.

How Much Your Money Will Grow Based On Company Growth Rate And Time Period

Long-Term Growth Rate	10 Years	20 Years	30 Years	40 Years	50 Years
5%	1.6	2.7	4.3	7.0	11.5
10%	2.6	6.7	17.5	45.3	117.4
15%	4.0	16.4	66.2	267.9	1,084
20%	6.2	38.3	237.4	1,470	9,100
25%	9.3	86.7	807.8	7,523	70,065
30%	13.8	190.0	2,620	36,119	497,929
35%	20.1	404.3	8,129	163,437	3,286,158
40%	28.9	836.7	24,201	70,038	20,248,916
45%	41.1	1,688	69,349	2,849,181	117,057,734
50%	57.7	3,326	191,751	11,057,332	637,621,500

Click to enlarge

Note that this table is simply meant to illustrate a point. It's not actually possible for any company to grow 50% annually for 50 years, which would mean earnings and cash flow growing nearly 1 billion-fold (it would have to literally take over the world).

Most investors, depending on their needs (and ideal asset allocation), can likely achieve 5-10% returns over time. Warren Buffett is one of the greatest investors in history, with about 21% CAGR returns over 54 years.

Since 2000, the S&P 500's earnings growth has been about 5.5% CAGR, which is why a company that can realistically grow much faster may be worth a higher-than-normal P/E (or price-to-cash flow). This is where the P/E-to-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 about 3.1 (18.8 forward PE/6% long-term EPS growth).

Here are my watch list stocks with PEGs of close to 1, as estimated by Morningstar's forward growth forecast (some of those growth estimates are likely to be proven wrong).

(Source: Morningstar, data as of December 20^th)

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.

For example, FedEx is a great company trading at a nice discount, which is why the Dividend Kings Deep Value portfolio has opportunistically bought it four times.

(Source: F.A.S.T. Graphs, FactSet Research)

But its PEG is not 0.45, which implies about 30% long-term growth (7-12% is realistic).

Here are the PEG ratios of some of these companies, using FactSet data and consensus growth estimates.

• FedEx: 8.9 forward PE/11.5% long-term growth = 0.77
• Delta Air Lines (DAL): 9.5 forward PE/10.9% long-term growth = 0.87
• ViacomCBS (VIAC): 7.5 forward PE/8% long-term growth = 0.94
• Imperial Brands Plc: 6.7 forward PE/3.5% long-term growth = 1.9
• Bristol-Myers Squibb (BMY): 13.9 forward PE/14% long-term growth = 0.99

(Source: F.A.S.T. Graphs, FactSet Research)

BMY is a company I own in my retirement portfolio that Deep Value bought twice right near the bottom. But because the company's cash flow is going to grow so rapidly in 2020, its fair value for next year is about $109.

Metric	2020 Consensus Growth	2021 Consensus Growth	2022 Consensus Growth
EPS	46%	18%	7%
Operating cash flow/share	59%	86%	6%
EBIT (pre-tax profits)/share	131%	17%	9%
EBITDA/share	123%	13%	NA

Click to enlarge

(Sources: F.A.S.T. Graphs, FactSet Research)

BMY Valuation Matrix

Metric	Historical Fair Value	2019	2020	2021
5-Year Average Yield	2.69%	$61	$67	$68
13-Year Median Yield	3.12%	$53	$58	$59
25-Year Average Yield	3.44%	$48	$52	$53
Earnings	19.3	$84	$123	$145
Operating Cash Flow	19.1	$63	$101	$188
EBITDA	14.0	$68	$152	$172
EBIT	16.1	$72	$166	$194
EV/EBITDA	14.0	$68	$152	$172
Average		$65	$109	$131

Click to enlarge

(Source: F.A.S.T. Graphs, FactSet Research)

Note how I look at several valuation methods to estimate what a company's fundamentals are worth.

For example, CCL passes several of these valuation screens.

• Historical Discount-to-Fair Value: 33% (Strong Buy based on quality)
• Forward P/E: 10.0 (vs. historical 15-18 fair value P/E range)
• Price-to-Operating cash flow: 6.1 vs. 7-10 historical norm
• PEG: 10.0/8.7% long-term consensus growth = 1.15

First, you need to know what companies are worth owning (Dividend King's motto is "quality first, valuation second and proper risk management always"). That's where a good watchlist is useful. Next, you need to know what a company's worth today. That involves looking at several fundamental valuation metrics, such as dividends, earnings and cash flow.

When you find a company that is both above-average quality and trading at a below-average valuation, you have truly found a powerful tool that can help to achieve your long-term financial goals.

Quality Stocks At 52-Week Lows Are Great Screening Candidates

(Source: Google Sheets, data as of December 20^th) Bolded companies are within 5% of 52-week lows

Note that like any valuation screening tool, 52-week lows are not sufficient but a place to begin your research.

(Source: F.A.S.T. Graphs, FactSet Research)

If Nike fell to $68, it would be at its 52-week low. Based on 2020's expected results, it would merely be approaching a "reasonable" buy price.

(Source: F.A.S.T. Graphs, FactSet Research)

Ventas (VTR) has crashed from overvaluation and is now mean-reverting as it has always done, and is likely to keep doing as long as its fundamental thesis remains intact. It's now about 7% undervalued, making the stock a good buy.

(Source: F.A.S.T. Graphs, FactSet Research)

Simon has been in a bear market for three years, and so, is about 20% undervalued for next year. It's a very strong buy, while Ventas is merely a good buy, and Nike, if it were to crash 35%, would merely be approaching "reasonable" buy levels.

I maintain a master list that takes every company I track for Dividend Kings and applies an 11-point quality score based on dividend safety, the business model and management quality.

• 7: Average quality, seek 20% discount to fair value and limit to 2.5% of invested capital or less
• 8: Above-average quality company, seek 15% discount to fair value or better, limit to 5-10% of invested capital
• 9: Blue-chip company, limit to 5-10% 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 5-10% 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 5-10% of your invested capital

A score of 7 is average quality, which means a 2% or smaller probability of a dividend cut during a recession, based on how much S&P 500 dividends have been cut in past economic downturns (2% was the highest average cut during the 1990 recession, all other recessions were less).

(Source: Moon Capital Management, NBER, Multpl.com)

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
• Offers a high probability of achieving significant multiple expansion within 5-10 years, 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 December 20^th)

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).

It's important to remember that no single valuation metrics or screening tool is sufficient on its own. It's just a source of ideas for further due diligence. Only if a stock is attractively valued via many methods is it a true bargain.

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 the hope that it becomes the next Amazon (AMZN).

The goal is to buy quality blue chips whose fundamentals are firmly intact and whose valuations are so ridiculously low that modest long-term growth can deliver 15-25% 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 5-10 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: Smart Investors Remain Disciplined And Follow A Reasonable And Prudent Plan No Matter What The Market Is Doing

(Source: imgflip)

I'm not a market timer and can't tell you with certainty where the market will go next. What I can tell you is that pullback/correction risk is now highly elevated, and in 2020, we're likely to see one or two 5+% declines from record highs.

(Source: Guggenheim Partners, Ned Davis Research)

That's the historical average since 1945, but just because stocks are due to for pullback doesn't mean it's time to sell everything and hide under the bed.

Pullbacks and corrections are healthy parts of the market cycle and last an average of one and four months respectively. The time to recover to new highs is also one and four months, and reasonable and prudent investors, who use appropriate risk management, have nothing to fear from 2020 or any given year.

Here are the risk management rules that run the Dividend Kings' portfolios and my retirement portfolio as well.

Today, CCL, FDX and EXPD all represent quality dividend growth stocks you can safely buy for the long term, even with the market trading at such lofty levels.

If you don't like those three, then feel free to screen your personal watchlist by P/E vs. historical norm, price-to-cash flow and PEG. Using several time-tested valuation methods in concert is how you can minimize valuation risk and maximize the probability of achieving your long-term financial goals.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.