DivGro Pulse: April/May 2017

I decided to combine the April and May editions of DivGro Pulse, as we'll be taking a vacation break in mid-May when I usually publish pulse articles.

Pulse articles are strategy focused. I update fair value estimates for every stock in my portfolio and use the information to identify undervalued stocks suitable for further investment.

Additionally, I review the recent performance of stocks in my portfolio to see if any of them are performing poorly. If so, I need to take appropriate action.

Updating the fair value estimates for every stock in my DivGro portfolio is a process that takes several hours to complete. I perform a multi-stage Dividend Discount Model analysis, a Gordon Growth Model analysis, and an analysis of dividend safety. I also consider fair value estimates and price targets available elsewhere, such as those from Morningstar, finbox.io, and S&P Capital IQ.

Position Sizes

While I prefer to see equal weights for positions in my portfolio, it is difficult to achieve because of my desire to sell covered call options. To sell covered calls, I need to own 100 shares for each option sold. Quite naturally, therefore, my portfolio will not be ideally weighted.

 

The red dashed line represents my average position size (1.78%). I consider stocks with weights less than 1% as underweight and suitable for further investment. 

In April, I doubled my position in Ford Motor Company (F) to reduce my cost basis and to sell additional covered calls. Ford is a great stock for selling covered calls. 

My positions in The Walt Disney Company (DIS), Ford, and Qualcomm Inc (QCOM) are the largest positions in DivGro. I have open covered call positions on each of these stocks. The DIS options, which expire in June, are deep in the money and my DIS shares can be called away at any time. 

Main Street Capital (MAIN) is the fourth largest position. The stock pays monthly dividends yielding 5.6% at $40 per share, but my average yield on cost (YoC) is 7.55%. I have unrealized annualized returns of 33% on MAIN!

Discounted Stocks

I prefer to buy stocks at discounts of at least 10%. To determine if stocks are available at a discount, I estimate the fair values for every stock in my portfolio. As part of the analysis, I also rank my stocks and assign a 7-star rating. In general, stocks rated 5-stars or better are worthy of further consideration. Here are the ten DivGro stocks with the largest discounts to fair value, as of 2 May 2017. In addition to the stock's discount and its 7-star rating, I include the stock's rank out of 48 stocks:

CVS Health Corporation (CVS)	• discount  18.9%	• rank #  2 • ★★★★★★☆
Gilead Sciences, Inc (GILD)	• discount  18.7%	• rank #25 • ★★★★★☆☆
Qualcomm Inc (QCOM)	• discount  18.0%	• rank #  3 • ★★★★★★☆
AbbVie Inc (ABBV)	• discount  13.5%	• rank #32 • ★★★★☆☆☆
Ford Motor Company (F)	• discount  10.9%	• rank #33 • ★★★★☆☆☆
Valero Energy Corporation (VLO)	• discount  10.1%	• rank #  7 • ★★★★★★☆
Pfizer Inc (PFE)	• discount    8.3%	• rank #42 • ★★★☆☆☆☆
AT&T Inc (T)	• discount    5.2%	• rank #39 • ★★★★☆☆☆
Target Corporation (TGT)	• discount    5.2%	• rank #10 • ★★★★★☆☆
Verizon Communications (VZ)	• discount    3.1%	• rank #37 • ★★★★☆☆☆

The first six stocks trade at discounts of at least 10%. However, I'm not interested in adding shares to positions rated 5-stars of less, so only CVS, QCOM, and VLO are candidates. CVS is the smallest position of the three.

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

Only 15 of my stocks are trading at a discount to fair value.

Quality Stocks

Here are the top ten ranked stocks in DivGro for April/May 2017:

Hormel Foods Corporation (HRL)	• premium   2.5%	• rank   #1 •  ★★★★★★☆
CVS Health Corporation (CVS)	• discount  18.9%	• rank   #2 •  ★★★★★★☆
Qualcomm Inc (QCOM)	• discount  18.0%	• rank   #3 •  ★★★★★★☆
T. Rowe Price Group, Inc (TROW)	• discount    1.3%	• rank   #4 •  ★★★★★★☆
Nike Inc (NKE)	• premium   2.6%	• rank   #5 •  ★★★★★★☆
General Dynamics Corporation (GD)	• premium   6.3%	• rank   #6 •  ★★★★★★☆
Valero Energy Corporation (VLO)	• discount  10.1%	• rank   #7 •  ★★★★★★☆
3M Company (MMM)	• premium 12.7%	• rank   #8 •  ★★★★★★☆
Johnson & Johnson (JNJ)	• premium   5.0%	• rank   #9 •  ★★★★★★☆
Target Corporation (TGT)	• discount    5.2%	• rank #10 •  ★★★★★☆☆

None of the top ten ranked stocks earned a 7-star rating. MMM is trading at a healthy premium to fair value, so I'm not interested in adding at this time. Any of the other 6-star stocks are candidates for further investment, either by buying more shares or by selling puts at strike prices below fair value.

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 that trade below the 50% mark (those in orange) are potentially undervalued.

Another way to look at recent performance is to compare a stock's recent returns to its annualized returns over a longer time frame. The following chart compares 1-year returns to annualized 5-year returns for all DivGro stocks. The returns exclude dividends:


In the past year, GILD, CVS, TGT, HRL, and NKE have performed poorly when compared with their annualized 5-year returns. In contrast, Apple Inc (AAPL), Cummins Inc (CMI), Microsoft Corporation (MSFT), MAIN and STAG Industrial, Inc (STAG), have performed well when compared to their annualized 5-year returns.

Positions To Close

I have not yet pulled the plug on STAG Industrial, Inc (STAG), which remains my lowest ranked stock with only one star:

STAG Industrial, Inc (STAG)

• premium   8.0%

• rank #48 •  ★☆☆☆☆☆☆

STAG's annualized return is 34% (including dividends), so the stock continues to perform very well.

I'm starting to question my ranking system with respect to REITs (real estate investment trusts) and BDCs (business development companies), so I decided to hang on to my STAG position until I have a chance to revisit my ranking system.

Positions To Boost

Considering that CVS is one of my smaller positions, I'll be looking into adding shares. The stock is ranked #2 out of the 48 DivGro positions and is discounted by nearly 19%.

New Positions?

I'll be looking into Magma International Inc (MGA) and TJX Companies Inc (TJX), the stocks ranked #5 and #6 in my top 10 ranked stocks for April:

 

Of the two candidates, MGA seems to be trading at the largest discount to fair value.

Thanks for reading and take care, everybody!