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Wed. Aug. 5, 2009

Five Dividend Stocks With Different Reasons Not To Buy *

Sometimes good companies aren’t good buys, and this is not always a bad thing. Often it is a result of the market over reacting in a positive direction. The stocks simply become overvalued, but their underlying fundamentals remain excellent. Below are a couple of companies that fall into this group:

Illinois Tool Works Inc. (ITW) – Yield: 3.06% – 2 Stars – Analysis
Illinois ToolWorks Inc. is a diversified manufacturer operates a portfolio of about 750 industrial and consumer businesses located throughout the world. As you can see for the information below, price is all that is keeping ITW from being a 4 Star stock:

  • Recent Price: $40.00
  • 3 Star Price: $38.99
  • 4 Star Price: $36.20

3M Co (MMM) – Yield: 2.89% – 2 StarsAnalysis
3M Co. is a diversified technology company with a presence in various businesses, including industrial & transportation, healthcare, display & graphics, consumer & office, safety, security & protection services, and electro and communications. Like ITW above, price is all that is keeping MMM from being a 4 Star stock:

  • Recent Price: $72.00
  • 3 Star Price: $57.44
  • 4 Star Price: $44.43

I was fortunate to purchase both of the stocks above when their prices were much lower, so I can’t complain that they are no longer 4 Star buys. However, for other companies the road to fewer stars is not as appealing. Instead of a significant run up in their share price, the run up may have occurred in their debt or dividend payout percentage, or both. Here are some dividend companies and the challenges they are facing:

BP Plc (BP) – Yield: 6.50% – 1 Star
This supermajor integrated oil company (formerly BP Amoco p.l.c.) is based in London and is the world’s second largest publicly owned oil company and the fourth largest U.S. refiner. With Debt to Total Capital at an acceptable level and Free Cash Flow Payout at an undesirable level, a 3 Star rating is the best BP could earn at any price.

  • Debt to Total Capital: 27%
  • Free Cash Flow Payout: 69%
  • Recent Price: $50.00
  • 3 Star Price: $1.00

SUPERVALU Inc. (SVU) – Yield: 4.67% – 0 Stars
SUPERVALU INC. is one of the largest U.S. food wholesalers, this company is also one of the biggest supermarket retailers in the U.S. With Debt to Total Capital at an undesirable level and Free Cash Flow Payout at an acceptable level (but with some years negative), a 3 Star rating is the best SVU could earn at any price.

  • Debt to Total Capital: 73%
  • Free Cash Flow Payout: 42%
  • Recent Price: $15.00
  • 2 Star Price: $14.75
  • 3 Star Price: $1.00

The Hershey Company (HSY) – Yield: 2.89% – 0 Stars
The Hershey Company engages in the manufacture, marketing, distribution, and sale of various types of chocolate and confectionery, refreshment and snack products, and food and beverage enhancers in the United States and internationally. With both Debt to Total Capital and Free Cash Flow Payout at undesirable levels, a 2 Star rating is the best HSY could muster at any price.

  • Debt to Total Capital: 83%
  • Free Cash Flow Payout: 88%
  • Recent Price: $40.00
  • 2 Star Price: $1.00

Of the three, I believe BP stands the best chance of recovery. Though BP recently froze its dividend at $0.84/share (ADR), higher oil prices should lead to higher FCF and a dividend increase, it could easily add a fourth Star and once again enter the buy zone. I don’t have a lot of confidence in the other two.

Before buying a stock with hopes things will soon improve, it is a good idea to run some sensitivities to see where, or if, the stock can make a recovery. Modeling is cheap, selling an undesirable stock usually isn’t.

Full Disclosure: Long ITW, MMM, BP. See a list of all my income holdings here.


9 Responses to “Five Dividend Stocks With Different Reasons Not To Buy *”

  1. Monevator says:

    Interesting angle, to look at companies you shouldn’t buy, rather than those you should. A nice mental exercise.

    I tend to think most stocks are fairly priced, even dividend payers (i.e. that the higher dividend is making up for either lower growth prospects or more risk).

    With this mindset, you’re less likely to get confused by mistaking a good company for a good opportunity, just as you say at the start.

    That said, I’ve been thinking of investing in one of your rejects – BP. It takes two to make a market. ;)

  2. Monevator: I was disappointed that BP froze their dividend at $0.84/share (ADR), but with the rising oil prices, I think the company will be ok.

    Best Wishes,
    D4L

  3. doug says:

    Any stock or ETF that is any good is over priced now. If it isn’t the market already tells us to stay away due to the lack of oarticipation in this historic rally. So, we wait for a pullback that may not come or we hold our noses and buy.

  4. Mike says:

    I have several questions – specifically about BP.
    You state BP’s Free Cash Payout is too high – where do you find this info?

    What is your strategy about buying more shares of BP?
    Do you analyze your metrics (like FCFPayout) and buy when the numbers meet your criteria – regardless of share price?

    I am new at this – so bear with me.
    I thought the idea was to buy good companies – like BP – periodically – and then hold for a long time.

    What is the reason for not buying BP at this time?
    Are you not buying BP now because you think the shares might come down in price?

    THanks,
    Mike.

  5. Interesting way to show how your model works, not to mention test it in real time. I’ve found it’s a good use of time to pick through an unappealing company’s fundamentals. Reverse cognition works, sometimes as well as reverse psychology.

  6. Mike: I calculate Free Cash Payout from data on Morningstar. Free Cash Flow = Operating Cash Flow – Capx. The FCF payout id the dividend/share divided by FCF/share.

    I look at everything together, including share price. In addition, BP competes with all other viable stocks. When I make an investment decision, I look for the best place to put my money to work based my allocation and the specific factors each company brings to the table. Though, I wait at least 3 months between purchasers, I will not buy just because time has passed.

    Currently, BP is overpriced based on my model. Also, it has froze its dividend – which is the first step to a sell. BP may end up being ok, but right now I am seeing warning signs, so I will wait and watch.

    Best Wishes,
    D4L

  7. Daniel: A good model will point out the buys and let you know when not to buy.

    Best Wishes,
    D4L

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