Dividends4Life: Stock Gems In An Overbought Market

Stock Gems In An Overbought Market

Posted by D4L | Sunday, September 20, 2009 | | 4 comments »

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)

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4 comments

  1. VLT // September 20, 2009 at 9:54 PM

    What is your take on DWX?

  2. Dividends4Life // September 21, 2009 at 2:28 PM

    VLT: I have not spent any time looking at DWX. However, I am moving my income investments away from ETFs and international stock. Both tend to have erratic dividends. I prefer consistent and growing dividends.

    Best Wishes,
    D4L

  3. DJ // September 21, 2009 at 9:46 PM

    D4L - Would a dividend investor be better off putting cash to work immediately in a fairly priced company thus starting the dividend reinvestment process? Or is the better value proposition to hold cash in the hope of better prices, but delay receiving those dividends in the interim. Also I would be interested in your thoughts on how fully invested you think a dividend investor should be in dividend stocks vs. cash, money market funds, or bond ETFs that are waiting to be deployed back into dividend stocks at better prices. Thanks for great site.

  4. Dividends4Life // September 24, 2009 at 7:03 AM

    DJ: I am a believer in asset allocation and dollar cost averaging. To sit on cash and wait on a better entry point is a form of market timing and I have never been good at that. I look to my asset allocation model to determine where my next investment needs to go, then I try to find the best buy in that category.

    Best Wishes,
    D4L

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