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Saturday, October 22, 2016

DivGro Pulse: October 2016

Last month I started a new monthly article series in which I'll be monitoring the health of DivGro, my portfolio of dividend growth stocks. These pulse articles will be strategy focused. I'll provide updated fair value estimates and compare those estimates to current market prices. I'll also provide various charts to visualize recent performance. My goal is to help inform investment decisions.

In contrast, my monthly review articles present a summary of the past month's activities along with a snapshot of DivGro's current state, including metrics such as projected annual dividend income (PADI), average yield on cost (YoC), percentage payback and projected annual yield.

Discounted Stocks

Stocks in my portfolio that trade at a discount to fair value are candidates for further investment. Before I buy more shares, though, I'd want to analyze the stock to see if I still like the fundamentals. Conversely, if a stock is trading at a premium to fair value, I'd want to avoid buying more shares. Doing so would increase the average cost basis and reduce the average YoC.

The following chart shows the percentage discount to fair value of all the stocks in my portfolio. Green bars represent discounts, and red bars represent premiums (or negative discounts):

I like to buy stocks trading at discounts of 10% or better. According to the chart above, nine stocks are trading more than 10% below fair value. But are these stocks suitable for further investment?

As a first past test, I rank the stocks based on fundamentals and assign a 7-star rating to each stock. Stocks that earn at least five stars are suitable for further analysis:

Gilead Sciences, Inc (GILD) • discount  32% • ★★★★★☆☆
PennantPark Investment (PNNT) • discount  27% • ☆☆☆☆☆☆
AbbVie Inc (ABBV) • discount  27% • ★★★★★★
Ford Motor Company (F) • discount  21% • ★★★★★★
Valero Energy Corporation (VLO) • discount  19% • ★★★★★★
Pfizer Inc (PFE) • discount  14% • ★★★☆☆☆☆
Main Street Capital (MAIN) • discount  13% • ★★★★☆☆☆
Wells Fargo & Company (WFC) • discount  11% • ★★★★★☆☆
Target Corporation (TGT) • discount  11% • ★★★★★★

Of these discounted stocks, I've invested less than 1% of available capital in TGT and WFC. For comparison, the average position size in DivGro is 1.64%.

I have an open short put option on TGT. If shares trade below $65 on or before 20 January 2017, the chances are that I'll get to buy 100 shares at a cost basis of less than $62 per share (when accounting for the option premium).

As for WFC, I'm not convinced that I want to increase my position after the revelation that bank employees committed fraud as part of an incentive scheme. In fact, it looks like the fallout will impact business negatively for a long time to come.

The other 6-star stocks look quite attractive. I already own 600 shares of F, and I'm already leveraging that position through covered calls. I could execute the same strategy for ABBV, as I own 100 shares. Another possibility would be to sell a put option at a suitable strike price. Doing so would allow me to collect an option premium and perhaps increase my position in ABBV at a favorable entry price.

Finally, increasing my position in VLO at the current market price would lower my cost basis and simultaneously raise YoC. VLO yields 4.3%.

Quality Stocks

As I mentioned last time, sometimes it is appropriate to add shares to an existing position even if the stock is trading at fair value or a small premium. This is certainly true for great dividend growth stocks.

Here are the ten highest ranked stocks in DivGro for October. Only one stock earned 7-stars this month. The rest are all 6-star stocks:

T. Rowe Price Group, Inc (TROW) • discount     7% • ★★★★★★★
General Dynamics Corporation (GD) • premium    6% • ★★★★★★
Valero Energy Corporation (VLO) • discount   19% • ★★★★★★
3M Company (MMM) • premium  14% • ★★★★★★
Nike Inc (NKE) • premium    7% • ★★★★★★
Target Corporation (TGT) • discount   11% • ★★★★★★
AbbVie Inc (ABBV) • discount   25% • ★★★★★★
Cisco Systems, Inc (CSCO) • discount    7% • ★★★★★★
Qualcomm Inc (QCOM)• premium    3% • ★★★★★★
Johnson & Johnso (JNJ)• premium    6% • ★★★★★★

The premium on MMM shares is too high for my taste. Of the remaining stocks, I've invested less than 1% of available capital in GD, NKE, and TGT (as mentioned earlier).

GD is my top performing stock with an annualized total return of 37%. GD is also DivGro's first home run stock. NKE currently yields 1.24%, way below what I normally require. However, the company's dividend growth rate is impressive, and with a dividend payout ratio below 30%, NKE could afford to continue growing its dividend at a healthy pace.

TROW, CSCO, and QCOM made my list of 10 Dividend Growth Stocks for October 2016. TROW placed second after a stock I don't (yet!) own. CSCO and QCOM placed ninth and tenth, respectively.

Recent Performance

One way to assess a stock's recent performance is to plot the current price relative to its 52-week trading range:

Stocks trading below the 50% mark potentially are undervalued. The chart hides the magnitude of the trading range, but a quick check confirms that both GILD and NKE performed rather poorly over the past 52 weeks. GILD is down 28% and NKE is down 21%:
 Source: Google Finance

Another way to look at a stock's recent performance is to plot current yield relative to the 52-week yield range. For consistent dividend payments, a stock's yield rises when the stock price drops, and vice versa. Dividend growth investors often look at current yield relative to average yield over a time frame. A higher current yield suggests that a stock may be undervalued.

Because of the inverse price-yield relationship, the chart essentially reverses the order of the stocks. It is not an exact reversal, though. The reason is many stocks have experienced dividend increases over the past year.

Finally, I like to compare recent returns compare to annualized returns over a longer time frame. Doing so allows me to get a sense of each stock's recent performance. The following chart compares 1-year returns to annualized 5-year returns for all my DivGro stocks. Note that dividends are not accounted for in this chart:

The chart confirms that GILD has been the worst performer over the past year, this time compared with its annualized performance over five years. In contrast, CAT is performing quite well relative to its annualized 5-year performance.

Positions To Close

I plan to sell the following stocks if conditions are right:

BHP Billiton (BBL)
With an annualized loss of 11%, BBL is the worst performer of my long-term positions. It is rated 2-stars and ranked #48 out of 49 stocks. The company has cut the dividend twice in the past year, so BBL now yields only 1.99%. My plan is to sell BBL by year's end and to offset capital gains. The stock is in an uptrend, so I'm waiting to see if I can reduce my losses a bit!

Helmerich & Payne Inc (HP)
HP is rated 4-stars and ranked #38 out of 49 stocks. While HP yields an impressive 4.21%, I'm concerned about dividend safety in light of the company's near-term outlook and the collapse of energy resource pricing. I'm close to breakeven, and if the stock price continues to improve, I should be able to sell my shares for a small profit before year's end.

• PennantPark Investment (PNNT)
I'm happy to see a small profit in my PNNT position. In August, I confessed to significantly increasing my PNNT position in an attempt to recover past losses. With an unsustainable yield of nearly 15%, I don't see PNNT as a long-term holding. It is ranked #49 out of 49 stocks in DivGro and is my only 1-star stock. PNNT just declared another 28¢ dividend, so I'll hang onto my shares a little longer...

• Caterpillar Inc (CAT)
I think it is time to depart ways with CAT. The stock has made a decent comeback in the past 52-weeks despite a 15% drop in revenue. I rate the stock 4-stars, but it is ranked #36 out of 49 stocks, and I'm concerned about the company's near-term future. Revenue is expected to drop in 2017, and now the CEO has resigned after 43 years with the company. My CAT position shows annualized profits of 6%.

Positions To Boost

Based on the information presented here, I consider several stocks to be suitable for further investment. Please note that I'm not recommending these stocks. Readers should do their due diligence!

In the following descriptions, the yield is calculated on closing prices on 21 October 2016, payout is the EPS (earnings per share) payout ratio, and debt is the stock's debt to equity ratio. I also include Morningstar's moat rating and Standard and Poor's credit rating. Value Line's safety and financial strength ratings round things out.

T. Rowe Price Group, Inc (TROW)
streak 30 years | 5-year growth rate 14% | yield 3.27% @ $65.96 | payout 52% | debt 0% | moat wide | credit rating N/A | safety 2 | financial strength A+

Dividend Champion TROW is the top-ranked stock in my portfolio and the only 7-star stock. Trading at a 7% discount to fair value, I like the stock's yield, dividend growth rate, and it's zero debt. S&P Capital IQ gives TROW a Quality Ranking of A-.

• Qualcomm Inc (QCOM)
streak 14 years 5-year growth rate 20% yield 3.12% @ $55.76 payout 62% debt 38% moat narrow credit rating A+ safety financial strength A++

Although QCOM is trading at a slight premium of 3% to my fair value estimate, the stock looks very attractive. I own 100 shares, but those shares are in one of my FolioInvesting accounts and not eligible for options trading. I'm thinking about writing a put option to see if I can buy additional shares below fair value. Alternatively, I could just go for a straight covered call trade.

Cisco Systems, Inc (CSCO)
streak 6 years 3-year growth rate 32% yield 3.45% @ $30.15 payout 49% debt 45% moat narrow credit rating AA- safety financial strength A++
CSCO is trading at a 7% discount to my fair value estimate. In August I bought 300 shares when put options I had sold got exercised. My effective buy price of $30.31 was well below fair value at the time. Subsequently, I wrote covered calls on these shares. One call option was exercised earlier this month when CSCO briefly traded above the $31 strike price. The other two put options expired worthless yesterday. I'm looking to replace the 100 shares I gave up and write more covered calls.

• Target Corporation (TGT)
streak 49 years | 5-year growth rate 21% yield 3.52% @ $68.23 payout 47% debt 110% moat none credit rating A- safety 1 financial strength A
I already mentioned my open short put option on TGT. With the stock trading 11% below fair value, I'm thinking about writing additional put options. TGT is ranked #6 out of 29 DivGro stocks, and has a 6-star rating. I like the stock's dividend history and, of course, its dividend yield and growth rate.

• Valero Energy Corporation (VLO)
streak 36 years 5-year growth rate 56% yield 4.30% @ $67.93 payout 39% debt 36% moat narrow credit rating BBB safety financial strength A+
I continue to like VLO for its attractive dividend yield and excellent dividend growth rate. The stock trades at a discount of 19% to my fair value estimate and is ranked #3 out of 49 DivGro stocks. While the stock's credit rating is on the low side and Value Line's safety rating is a 3, the payout ratio of only 39% provides ample room to continue aggressive dividend growth.

Thanks for reading and take care, everybody!


  1. I like this "pulse" feature. This is a pretty involved analysis to be doing on a monthly basis! As always, I appreciate the detail.

    I have 3 comments:

    1) I can't argue with any of those "positions to boost". All five are great names at very reasonable prices.

    If you haven't already, you might want to take a look at the options market for VLO...the share price is all over the place, which means premiums are juicy!

    2) I've also decided against taking any further long positions in WFC. At first I wasn't too upset about the fake account struck me as more dumb than evil.

    But then it came out that they were retaliating against whistle blowers:

    Sorry but that doesn't work for me. You want to have impossible sales goals, fine...most sales goals are. But retaliating against whistle blowers is bad juju. Count me out.

    3) HP is a tough one isn't it? I'm a little bit more optimistic than you about the safety of the dividend. They used the boom years to make massive investments in new equipment, so going forward, they should be able to run on a pretty lean capex budget. Plus they made all those investments without stretching the balance sheet, so they're not burdened with a bunch of debt. As long as the decline in their term contracts stabilizes (it should as the oil price stabilizes), I think the dividend is actually quite safe.

    Like many things in the oil patch, this one isn't for the faint of heart. The share price moves around A LOT.

    But then, those wild price swings make for a pretty interesting options market. My current plan with HP is to sell puts to try and initiate a position in the $50-$55 range.

    1. Hi catfishwizard -- I apologize for not responding earlier. Things have been hectic, lately.

      (1) Thanks for your suggestion on VLO options -- I'll take a look.

      (2) The retaliation against whistleblowers is EXACTLY what made me change my mind about further investment. Thanks for those links! As a Wells Fargo customer, it really irked me to hear that reaction of the bank I had been a customer of for 14 years. My wife and I discussed, but have not yet acted, on transferring our accounts to another bank.

      (3) HP is getting closer to my target exit price of $72. The stock closed at $70.23 on 23 November and is making new 52-week highs. If I sell now, I'll get out with a small profit (when taking dividends into account). All the best with your HP option trades. Looks like your $50-$55 puts are quite safe!

      Thanks for your great comments!

  2. I love this series. Really useful information here Ferdi and the way you present it is easy to understand. I have a few puts sold on some of the companies you've listed here as boost candidates.

    1. Hi Investment Hunting -- thanks for your kind words. I'm so glad that other DGI's are getting into options to boost dividend income. It is great to cross-check ideas!

  3. As a "big" shareholder of WFC, I was disappointed about the practice and the news that come about recently. As WFC's customers, I'm pretty happy with their services over BAC.
    I'm probably going to hold on to WFC, as I bought it at $33, then sold for a huge profit, then buy it back at $41, sold for a huge profit. Bought it at $49 it got up close to $60 which I did not sell, now's it's at $45, a little disappointed, but the 3% dividend isn't bad. :) I'm going to collect dividend until the stock recover from all the bad press, and settlements.

    1. Hi vivianne -- We're long time Wells Fargo customers and I've certainly not experienced any negatives or sales pressure type interaction at my local branch. I am disappointed, though, to hear that this practice has been going on for a long time, and also to hear management's response to the matter. The fallout seems worse than anticipated. As far as the stock goes, it popped nicely with Trump's election. I might just get out of the position while the getting out is good. As for remaining a customer (we're 14 year customers), the jury is still out on that!

  4. Very nice way to review your portfolio! Where do you get the "fair value" from? I'd love to make something like this for my portfolio.

    1. Hi DivRider -- My fair value estimate is a fairly complex calculation. I start with a multi-stage Dividend Discount Model, but also use the Gordon Growth Model and a Dividend Safety Rating to determine an initial fair value estimate. I corollate my results with similar fair value estimates from sources like Morningstar, S&P Capital IQ,, and more.


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