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Valuing Mike Nadel's Dividend Growth 50 +113

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In this article, I intend to go through how I use Fastgraphs to value stocks. I'll apply the process to the stocks featured in Mike Nadel's recent "Dividend Growth Series," an excellent series of articles which any DGI investor needs to read.

Although Mike's total list covers 163 stocks, if you remove the names for which only one panelist voted for, (I consider these "outliers," and with the exception of Tim's pick of BBL, none of them are either on my watch list or are stocks which I currently own.) So, to reduce the volume of data, which will allow us to concentrate mentally on the so called "prime suspects," I'm going to exclude those 70 stocks, and only work with the 93 stocks that two or more panelists suggested. These 93 stocks left basically encompass every stock universally accepted as a "high quality company" by the Dividend Growth community. While some are no doubt currently overvalued, the chances of you kicking yourself in a decade or two because you bought a "piece of junk" stock when you were a beginning investor are greatly reduced if you stick to this list.

In thinking about valuation, the best advice I've found was from Chuck Carnevale (aka Mr. Valuation) that explained how valuation can be thought of in terms of housing. I invested (if you can call losing several hundred thousand dollars investing) in housing for several years before becoming interested in and learning about stocks. Many things about real estate are very concrete. You can see these things, and touch them in real life. I know exactly what a square foot is and what it looks like. For this reason, it really helps me to take stock investing "concepts" and somehow relate them to similar "real life" concepts in real estate.

I can't seem to find Chuck's explanation now, but from what I can remember, he basically said this: Let's say you build two identical houses. They both have the same materials in their construction, the same amount of lumber, drywall, etc. So their cost is identical. But one of the houses is in Beverly Hills and the other is in Detroit. Even though they cost the same to build and have exactly the same money invested in materials, obviously the one in Beverly Hills is going to sell for a lot more money.

If you were trying to value these two houses, you could choose many different ways to do it. The first would be to take every house for sale in the country, look at the price, and divide it by the square footage. This would give you an idea of how much the average square foot of a house in the country is selling for. Of course, this is going to include thousands of houses in cities you don't know or care about. It's going to include beachfront property, mountain cabins, and lots of other properties which have nothing in common with your two houses. Then, once you got an average price per square foot, you could compare it to what your two houses are selling for per square foot, and while you might get some broad idea, it's going to be a pretty inaccurate way of determining the value of your specific two houses. This is equivalent to what people are doing when they say "the market" is high or low, or whatever they think "the market" is valued at, at the time.

The second way would be to take every house within the specific city you are looking at, and figure out what people are paying for square foot within that specific city. This is better than the above approach, however you still might be comparing a mansion to a shack, just because they are in the same city. This is equivalent to looking at what the P/E ratio of other companies in the same sector are selling for.

A third way would be to just list pricing of the houses, from cheapest to most expensive. But this doesn't really tell you much either, since it doesn't take into account what people have historically been willing to pay. The house in Detroit might be selling for $50,000, and be overvalued, while the house in Beverly Hills might be selling for $500,000 and be undervalued. Sure, 50K might seem a good bit "cheaper" than 500K, but is it? This is equivalent to just listing the P/E ratios of all the stocks on your watch list from low to high. Sure, lower is generally better, but if it's always been super low, and now it's just low, then it's probably actually overvalued.

So what is the best way? What if your property had actually been sold several times over the years, and you had access to what the ACTUAL sales price of YOUR SPECIFIC HOUSE was? (Let's assume you are adjusting it for inflation, just to take that factor out of our theoretical situation here.) Then you could figure the EXACT price that people had historically been willing to pay per square foot for your house, and simply compare it to the current price. If the current price is lower, you're probably getting a deal. If the current price is higher, you're probably paying a premium. In this case, how much you pay per square foot of your house is analogous to P/E, or how much you pay per every dollar the company earns. So, this is what we are trying to do here, the key is that we are comparing the current price to what people have been willing to pay in the past for the exact same thing.

I subscribe to the "basic" version of Fastgraphs which costs $9.95/month and is some of the best money you will ever spend as a self directed investor. My local newspaper costs $9.95 a month. I cancelled it. I'd rather buy stock with the money. My wife and mother have, on occasion referred to me as "the cheapest man in the world." Truth be told, I'm not cheap, but frugal. I must receive a lot of value in something to feel good about spending money on it. I feel good about spending $9.95/month on Fastgraphs.

So, onto the actual process of how I do it. With the "basic" version of Fastgraphs, you get three "portfolios." So, the first thing to do is either type or "cut and paste" the tickers of the 93 names we are working with. Obviously, with 93 names it takes just a few seconds to cut and paste, so that is strongly preferred over typing each one by hand.

I had already "cut and pasted" the entire list of all 163 stocks from Mike's article into Excel so that I could color code them and do other sorting that helps me to keep track of them, so it was easy to simply highlight the column in Excel with the ticker names and then paste them into the "edit tickers" window on the portfolios page of Fastgraphs.

Now, on Mike's list, the tickers are listed with the exchange first, then a colon, and then the actual stock ticker. For some reason for stocks which are traded on the Nasdaq, Fastgraphs uses the symbol "NasdaqDS" instead of just "Nasdaq" so it won't recognize them. The easiest way around this is to delete the first part of the name which includes the exchange, so there is only the name of the stock ticker itself. Then Fastgraphs will automatically find the correct exchange and take care of the problem for you.

Now that you have the portfolio setup, you can click on the "review" button. Fastgraphs will generate the review tables which give you lots of great info about each stock. For the purposes of what we are doing here, we are only looking at three things. As far as valuation is concerned, the main things we are looking at is the "normal P/E" (what P/E people have been historically, "normally" willing to pay for the company), and the current P/E, which is pretty self explanatory.

The third is the amount of time for which we want to look at the data. Near the top, there's a drop down menu which says: "Max Years Used for Hist Columns," and allows you to select the years for which you want to include in the data.

Selecting different time periods is going to give you different results. For instance if you select data which includes the dot com boom, your normal P/E's on many companies are going to be higher, since many companies were bid up to ridiculous P/E's during this period. However, the great recession also saw many P/E's that were ridiculously low, so I just select 21 years (the longest for which data is available) and hopefully the two cycles will work to help cancel each other out. In the future, I have thought about doing separate reports for different time periods (such as maybe 5, 10 and 20 year periods), then using Excel to average the numbers together to get a "blended" number which will give you an overall valuation taking all three time periods into consideration.

Then, click on the "select headings for report below" button, and you can select which data you want to be displayed in the tables. While there are many useful heading you can select such as Div Yield, Market Cap, for the purposes of this exercise, we're just going to select "Company name" as column 1 (for obvious reasons), Normal P/E as column 2, and Current P/E as column 3. Then click on the "Re-generate Portfolio Review" button and Fastgrahs will re-draw the page with the new tables.

Now, when Fastgraphs draws the tables, it doesn't make all the stocks in one big table. It actually draws separate tables with 10 stocks each. That's ok.

Now comes the fun part. Scroll down the bottom right corner of the last table, click and hold the mouse, and highlight ALL of the tables all the way up to the top left cell in the top table, where you can release the mouse. I do this on a PC where I have good control of the mouse, it would probably be a lot harder to do on an Ipad or equivalent.

Then, open up a blank Excel spreadsheet, and paste the data into Excel. Because you copied all of these individual tables, now you have to manually delete the header and footers from each table, which will essentially make one large table in Excel, with one stock for each line number. I also usually set the column width and height at this time, just to make the table look better.

At this time, you should have three columns. The "A" column is the Stock name, "B" is the 21 year normal P/E and "C" is the current P/E. So, for the "D" column, we're going to enter a simple formula. In the D1 cell, type in: =C1-B1. This will subtract the current P/E from the normal P/E and give you a numerical reference as to how overvalued or undervalued the company is. Of course, undervalued companies will have a negative number and overvalued companies will have a positive number.

Then, position your mouse over the lower right hand corner of the D1 cell, and click and hold, then drag downward all the way to the bottom of the table. This will apply this formula to all the other stocks as well. Now you can highlight the "D" column, and go to "sort and filter" and select "sort smallest to largest." Once you do this, it will ask you if you want to "expand the selection," click on "yes." This will list all the companies from most undervalued to most overvalued.

Like anything, there's always some issues. For some reason, Fastgraphs is coming up with a current P/E of 0 for Nestle, so that's not going to be accurate. Also, Reits need to be valued based on FFO (Funds from operations,) so any Reits should be deleted from the list. Because of this, Reits tend to show up near the bottom of the list anyway, and I'm really only concerned with companies at the top of the list (undervalued) so it doesn't bother me.

Of course, valuations change on a daily basis as stock prices and earnings reports change, so here are the results of the this exercise which I have done on 2/13/2015. Changing time periods for the data is really where the "art" of valuation comes in, and where Fastgraphs can be really a great tool. Hope this is helpful! If you have any comments with suggestions or other feedback, please don't hesitate to leave them.

Company Name:

Normal P/E:

Current P/E:

Difference:

QUALCOMM Incorporated

35.6

13.6

-22

Microsoft Corporation

26.3

16.6

-9.7

Medtronic plc

26.9

18.7

-8.2

Diageo plc

26.4

18.8

-7.6

International Business Machine

16.4

9.6

-6.8

The Coca-Cola Company

26.9

20.7

-6.2

Starbucks Corporation

38.4

32.4

-6

General Electric Company

20.9

15

-5.9

AFLAC Inc.

15.5

10.1

-5.4

Baxter International Inc.

19.9

14.6

-5.3

Apple Inc.

22.3

17.5

-4.8

Pfizer Inc.

20.3

15.6

-4.7

Wal-Mart Stores Inc.

21.9

17.2

-4.7

Johnson & Johnson

20.5

16.4

-4.1

Deere & Company

15.6

11.5

-4.1

Gilead Sciences Inc.

16.1

12.2

-3.9

Franklin Resources, Inc.

17.7

14.4

-3.3

Emerson Electric Co.

18.7

15.5

-3.2

Kellogg Company

19.1

16.2

-2.9

Royal Dutch Shell plc

13

10.1

-2.9

Wells Fargo & Company

16.2

13.3

-2.9

Aqua America Inc.

24.6

21.8

-2.8

The Boeing Company

19.9

17.3

-2.6

JPMorgan Chase & Co.

13.5

11.1

-2.4

AT&T, Inc.

16.2

13.8

-2.4

Exxon Mobil Corporation

15.4

13.3

-2.1

HCP, Inc.

23.1

21.1

-2

Caterpillar Inc.

15.2

13.5

-1.7

Walgreens Boots Alliance, Inc.

25

23.4

-1.6

Chevron Corporation

13.4

11.8

-1.6

Verizon Communications Inc.

16.2

14.6

-1.6

Pepsico, Inc.

23.2

21.6

-1.6

GlaxoSmithKline plc

17

15.8

-1.2

Main Street Capital Corporatio

15

13.9

-1.1

McDonald's Corp.

19.1

18.6

-0.5

The Home Depot, Inc.

25.1

24.9

-0.2

Target Corp.

18.3

18.1

-0.2

United Technologies Corporatio

17.5

17.5

0

U.S. Bancorp

14.4

14.6

0.2

Colgate-Palmolive Co.

23.5

23.8

0.3

General Mills, Inc.

18.5

18.8

0.3

The Procter & Gamble Company

20.7

21

0.3

Norfolk Southern Corporation

16.6

17.1

0.5

The Walt Disney Company

22.3

22.9

0.6

Southern Company

15.9

16.6

0.7

Enterprise Products Partners L

23

23.9

0.9

Illinois Tool Works Inc.

19.7

20.6

0.9

Lockheed Martin Corporation

16.4

17.4

1

Philip Morris International, I

15.5

16.9

1.4

Stanley Black & Decker, Inc.

15.7

17.1

1.4

McCormick & Company, Incorpora

20.2

21.8

1.6

Kimberly-Clark Corporation

18.1

19.9

1.8

3M Company

20.1

21.9

1.8

Avista Corp.

15.7

18.1

2.4

CSX Corp.

16.3

18.8

2.5

Waste Management, Inc.

19.1

21.7

2.6

The J. M. Smucker Company

17.5

20.2

2.7

Abbott Laboratories

19.8

22.6

2.8

ConocoPhillips

11.2

14.1

2.9

Omega Healthcare Investors Inc

19.9

22.8

2.9

Rogers Communications Inc.

11.1

14.2

3.1

Hasbro Inc.

16.5

19.6

3.1

Kraft Foods Group, Inc.

17.7

20.9

3.2

Unilever plc

19.5

22.9

3.4

Union Pacific Corporation

17.4

21.2

3.8

Automatic Data Processing, Inc

25.3

29.2

3.9

The Hershey Company

22.6

26.5

3.9

The Clorox Company

20.2

24.3

4.1

Wisconsin Energy Corp.

15.4

19.7

4.3

Becton, Dickinson and Company

18.2

22.5

4.3

Genuine Parts Company

16.3

20.8

4.5

NextEra Energy, Inc.

14.9

19.7

4.8

Lowe's Companies Inc.

21.5

26.8

5.3

Dominion Resources, Inc.

15.8

21.3

5.5

Hormel Foods Corporation

17.8

23.4

5.6

Magellan Midstream Partners LP

17.8

23.5

5.7

Church & Dwight Co. Inc.

21.2

27.4

6.2

Visa Inc.

22.1

28.4

6.3

Nike, Inc.

20.7

27.1

6.4

Ross Stores Inc.

15.4

22.1

6.7

Cracker Barrel Old Country Sto

15.2

22.2

7

Costco Wholesale Corporation

22.6

30.2

7.6

Air Products & Chemicals Inc.

17.5

25.2

7.7

Altria Group Inc.

13.4

21.4

8

V.F. Corporation

14.4

22.8

8.4

Berkshire Hathaway Inc.

10.7

21.5

10.8

W. P. Carey Inc.

19.6

33.6

14

Kinder Morgan, Inc.

36.8

50.9

14.1

National Retail Properties, In

18.5

35.8

17.3

Ventas, Inc.

24.2

45.4

21.2

Realty Income Corporation

25

57.5

32.5

Health Care REIT, Inc.

26.7

64.6

37.9