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Wed. Sep. 16, 2009

Finding Dividend Stock Gems In An Overbought Market *

Last week I wrote about how dividend stocks were getting expensive and the number of stocks that my model identified as a buy were diminishing. After another week of the market rallying, the number of stocks identified as a buy fell to 4 stocks from 7. So what do you do if you are over-allocated in the four stocks that are a buy?

If you practice asset allocation and dollar cost averaging, as I do, having cash set aside to purchase stocks with no clear buy from an allocation standpoint certainly presents a quandary. When I am faced with this situation, I evaluate what is most important to me and continue to look for that.

In evaluating a dividend stock there are some items that I will not compromise on, such as:

  1. NPV MMA Differential: It must be positive and greater than $500.
  2. Free Cash Flow Payout + Debt To Total Capital < 100%: Cash is the life blood of dividend increases. If a company, is paying out most of its cash as dividends and/or is carrying high levels of debt, a dividend cut is very likely.
  3. Dividend Yield: Too high or too low of a dividend is risky. Too high and the company has a hard time maintaining it; too low and the company will have a hard time growing it at high enough rate to make the numbers work.

That leaves price available for compromise. As a dividend and value investor I want to have it all, but sometime that is not an option. I take heart that even the best investor in America has been where I am at. Consider his quote:

It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. — Warren Buffett

With that in mind I currently categorize stocks that are potential purchases into two tiers:

Tier I: Four and five Star stocks that are trading below my calculated fair value with a yield above my preset minimum. These are the stocks I categorize as “buy” stocks.

Tier II: Four Star stocks that are trading less than 5% above my calculated fair value with a yield above my preset minimum. These are my “wonderful stocks at a fair price.”

Sure I would like to buy them below fair value, but that is not always possible. If your holding period is forever, will an extra 5% make a lot of difference in 20 years? Consider these stocks I currently categorize as Tier II stocks:

Genuine Parts Co. (GPC) – Analysis
Genuine Parts Co is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products.
- Calculated Fair Value: $34.27
- Recent Price: $35.59

Emerson Electric Co. (EMR) – Analysis
Emerson Electric Co. primarily makes backup power equipment for telecom and Internet providers and users, climate control components, and electric motors.
- Calculated Fair Value: $38.39
-  Recent Price: $39.38

Procter & Gamble Co. (PG) – Analysis
The Procter & Gamble Company (P&G) is focused on providing branded consumer goods products. The Company markets its products in more than 180 countries.
- Calculated Fair Value: $55.27
- Recent Price: $55.64

It is important to remember that just a few short months ago everyone was looking for a bottom.  There will be other opportunities to buy great companies at a large discount.

Full Disclosure: Long GPC, EMR, PG. See a list of all my income holdings here.

(Photo: Steve Woods)


6 Responses to “Finding Dividend Stock Gems In An Overbought Market *”

  1. Mike says:

    Hi, Nice article, short and to the point. And I love the Buffet quote as well. I’m in the process of putting together a new dividend stock portfolio for my father and would love your insight. I posted about it on my blog. If you get a chance to look at it and give some comments, I’d really appreciate it. I have a few of the stocks from your portfolio under consideration, ie EMR

  2. Mike: Nice looking portfolio. I actually own several of the stocks you have selected (SYY, EMR, MMM, LLY). Some are on my watch list, while others I have excluded for various reasons.

    Best Wishes,
    D4L

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