Dividend Stocks To Consider In An Overbought Market

Includes: CSCO, CSX, DOV, IBM
by: Dividends For The Long Haul

Economic and news reports continue trickling in week by week and month by month indicating the U.S. economy is slowly and gradually growing, but not at an extent great enough to justify the advance of the U.S. stock market so far in 2012. Economic data for the year to date has disappointed as GDP has grown by 1.3% and 2.0% in Q1 and Q2 respectively. Personal incomes have remained relatively flat, and the U.S. has a trade gap of roughly $40 billion a month. While economic data has been less than impressive, over this same time period the S&P 500 has climbed nearly 16%.

In addition to the slow growth the economy has seen this year, additional challenges will be present in months and years ahead. Economic growth is expected to remain low in the quarters and years ahead. Uncertainty is affecting the future economic growth in Europe, and restricted government spending will further stress the economy in years ahead. In light of all of this, the market as a whole appears to be overbought. During times when the markets are overbought, investors must be careful and cautious when evaluating stocks, however as Chuck Carnevale has said, " ... Valuation needs to be evaluated on a company-by-company basis. This is simply an extension to the concept that it is a market of stocks, rather than a stock market ..." Even in overbought markets, opportunities to purchase quality companies at a great valuation can be found.

International Business Machines, Inc. (NYSE:IBM)

On October 16th, IBM reported earnings per share of $3.63 for Q3 2012, which was generally in line with analyst expectations. While earnings per share did meet expectations, total revenue fell 5% year on year to $24.75 billion, and management issued full-year EPS guidance of at least $15.10, below the analyst consensus of $15.14. In the wake of a lackluster earnings report and weak full-year guidance, shares fell to roughly $200. Based upon the full-year 2012 earnings guidance, IBM shares sport a 2012 P/E ratio of 13.5, just above the five-year average P/E of 13.1. IBM currently sports a 1.7% yield, and pays an annual dividend of $3.40/share.

IBM is a Warren Buffett approved dividend growth stock, and it appears poised to be a sound investment for years to come. The company expects earnings growth of roughly 10% over the next five years, and should continue to reward investors with capital gains in the years to come. In addition to solid capital gains, IBM has significant room to grow its dividend thanks to its EPS growth, and low payout ratio. While IBM may not be able to grow dividends at the 16% CAGR it has over the past five years, high single and low double-digit dividend growth is not out of the question. IBM is expected to face some pressure from reduced government spending in the years ahead, but federal contracts make up less than 2% of IBM's total revenue. As the economy continues to stabilize, and businesses begin increasing capital spending, IBM should see increasing sales and revenue. I believe that IBM is a great company, and possibly a better stock for dividend growth investors in the years to come.

Cisco Systems, Inc. (CSCO)

Cisco is a market leader in the world of designing and selling Internet Protocol based networking and other communications equipment. CSCO has a market cap of nearly $100B, on TTM revenue of $46B. CSCO shares currently trade at $18.64, with a TTM P/E ratio of 12.7, well below the company's five year average P/E of 16.59. Over the past 12 months CSCO shares have risen by 7.8% as earnings per share have grown by 28.4%, and over the next five years CSCO expects to maintain a CAGR of 7.85%.

CSCO initiated dividend payments in 2011, and made three quarterly dividend payments (Q1, Q3, and Q4) of $0.06. Currently, CSCO shares are paying an annualized $0.56 dividend, which at today's trading price equates to a 3.06% dividend yield. With a current payout ratio of just 18.67%, CSCO appears to have significant room to continue growing the dividend.

Cisco shares appear to be significantly undervalued at this time. Cisco expects just moderate growth in the years ahead, but could out perform analyst expectations as businesses begin investing in network enhancements. While the economic recovery has been slow, any uptick in economic activity should benefit CSCO investors. Investors who purchase the stock now or in the weeks ahead would obtain a strong company at a great valuation with significant ability to grow the dividend in the years ahead.

CSX Corp (CSX)

CSX is one of two of the east coast's large rail companies [Norfolk Southern Corp. (NSC) is the other]. On October 16th, CSX reported earnings per share of $0.44 for Q3 2012, which beat analyst estimates by one cent. While the company was able to beat on earnings, revenue came in $40 million below estimates, at $2.98 billion. The drop in revenue was largely attributable to decreases in coal shipments, which fell 16% year on year. Total volume for CSX dropped 1.2% for the quarter, although excluding coal shipments, volume increased 3.5%.

Despite reporting solid earnings, CSX shares dropped 1.2% to $21.37 on October 17th. Following the share price drop, shares of CSX can be purchased at a P/E ratio of 12, below the five year average P/E of 14.2. With long term EPS expected to grow by 13.4% and nearly a 30% operating margin the only concern is the balance sheet. The company solid cash flow, and pays out 30% of earnings in the form of dividends yielding 2.6%. Over the past five years CSX has managed an annual dividend growth rate of just under 23%.

Management made it clear that CSX is still dealing with a soft economy, and has been significantly impacted by the decrease in coal shipments. While decreasing coal shipments and revenue hurts CSX, the effects of these decreases have been priced into the stock already. CSX has seen coal shipments declining all year, and shares were punished in September when Norfolk Southern issued guidance lowering their outlook on weak coal demand. In the years ahead, as fuel prices continue to rise, efficient rail and intermodal shipping will continue to grow shipment volumes as the economy continues to grow and recover. Despite the negatives surrounding coal for CSX the stock is vastly undervalued, and investors who buy in at this level should see significant capital appreciation and dividend growth in the high single or low double digits over the next five years.

Dover Corp (NYSE:DOV)

The Dover Corporation owns a portfolio of specialized industrial and manufacturing companies. The company is focused on developing equipment, components, and solutions in its four main operating segments (Communication Technologies, Energy, Engineered Systems, and Printing & Identification). Dover reported Q3 earnings per share of $1.32, which beat by $0.04, but missed on revenue by $50 Million.

After reporting solid earnings, DOV shares fell 2.3% on October 17th to trade for $55.83. At this price, DOV is off significantly from its 52-week high of $67.20. Shares have a TTM P/E ratio of 12.6, below the five year average of 14.0. Dover expects to grow earnings just under 10% over the next five years. Dover has a long history as a dividend growth stock with 57 consecutive annual dividend increases. Paying an annualized $1.40 in dividends, DOV shares currently yield 2.45%. The company has been able to grow the dividend by 11.8% over the past five years with a current payout ratio of just 28%.

DOV appears to be an attractive stock for dividend growth investors at its current share price. Dover shares are currently trading at a favorable valuation for long term investors, as they are below the five year average P/E. With a low payout ratio, solid dividend growth, and a decent current yield investors should look closely at DOV. DOV's dividend should continue to grow rapidly in the years ahead. In addition patient shareholders will see the share price rise as well, given the company's expected earnings growth near 10%. This well established company has room to continue growing at its current share price, and as manufacturing activity in the U.S. increases DOV shareholders should benefit greatly. Investors have the opportunity to purchase shares of a high quality company, at a favorable valuation, that will provide steady returns for years to come.


Markets may be overbought (overvalued) or oversold (undervalued) as a whole, but opportunities within the market always remain. During undervalued markets investors can easily identify lots of opportunities to purchase quality companies at favorable valuations, but during over bought markets investors must be more prudent in their analysis to identify favorable investments. Regardless of market conditions dividend growth investors can find investments that can help solidify and develop their dividend growth portfolios.

Disclosure: I am long CSX. 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. Investors should conduct their own analysis prior to entering any position