DivGro Pulse: September 2017

I've been rather busy this month, so September's edition of my monthly pulse article series is a little later than usual.

In these pulse articles, I focus on strategy and I monitor the health of DivGro, my portfolio of dividend growth stocks. I update the fair value estimates of stocks in DivGro and use the information to identify undervalued stocks suitable for further investment.

Additionally, I review the recent performance of stocks 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 portfolio takes several hours. I perform a multi-stage Dividend Discount Model analysis, a Gordon Growth Model analysis, and an analysis of dividend safety. My final fair value estimate also considers fair value estimates and price targets available elsewhere, such as those from Morningstar, finbox.io, and S&P Capital IQ.

Recap

In last month's pulse article, I mentioned that CVS Health (CVS) remained under my radar and that I wanted to sell a short-term put option on CVS. So far, I haven't identified a suitable trade.

Instead, I sold two put contracts on Hormel Foods (HRL), a multi-month top-ranked stock in my 10 Dividend Growth Stocks series:

• Sold to Open 2 Contracts of Option HRL Dec 15 2017 32.50 P

HRL again topped my September list, a position the stock has held since April 2017. With HRL trading below $32, there's a chance that the puts will be assigned and that I'll be buying 200 shares on or before 15 December 2017. See my lastest options update for transaction details. If assigned, I'll pay those shares at an effective cost basis of $31.50 per share.

CVS dropped from #3 to #5 this month, so the stock is still worth considering.

Last month, I also mentioned International Business Machines (IBM). The stock is trading 20% below its 52-week high. IBM's 4% yield is attractive, but is the stock becoming a value trap? IBM's earnings revenue has fallen for 21 straight quarters:

Chart by Mike Nudelman/Business Insider/Statista

I'm still contemplating what to do with my relatively small IBM position, though I'm not in any rush to close my position...

Position Sizes

From time-to-time, I like to look at the size of my DivGro positions. Stocks that are underweight are good candidates for further investment. While I prefer to see a more balanced portfolio, I sell covered calls on a selection of my DivGro stocks. To do so, I need to own 100 shares or multiples of 100 shares, so some of my DivGro positions are larger than those not involved in covered calls.

The red dashed line represents the average position size (1.75%) in my portfolio. Stocks with weights less than 1% is underweight are good candidates for further investment.

Quality Stocks

To determine if stocks I own are trading at a discount, I estimate the fair value of stocks in my portfolio. A byproduct of the evaluation process is a 7-star rating per stock and a score that I use to rank the stocks in my portfolio.

Here are the top ten ranked stocks in DivGro for September 2017:

Hormel Foods (HRL)	• premium 20%	• rank   #1 •  ★★★★★★☆
CVS Health  (CVS)	• discount  19%	• rank   #2 •  ★★★★★★☆
International Business Machines  (IBM)	• discount  16%	• rank   #3 •  ★★★★★★☆
Nike (NKE)	• premium   3%	• rank   #4 •  ★★★★★★☆
T. Rowe Price (TROW)	• discount    1%	• rank   #5 •  ★★★★★★☆
Altria Group (MO)	• premium   4%	• rank   #6 •  ★★★★★★☆
Cummins (CMI)	• premium   9%	• rank   #7 •  ★★★★★☆☆
General Dynamics (GD)	• premium 12%	• rank   #8 •  ★★★★★☆☆
Walgreens Boots Alliance (WBA)	• discount  15%	• rank   #9 •  ★★★★★☆☆
Target (TGT)	• fair value  0%	• rank #10 •  ★★★★★☆☆

The top six ranked stocks each earned a 6-star rating. Generally, stocks rated 5-stars or better are worthy of further consideration.

Notice that only four of the top ten ranked stocks are trading at a discount to fair value, but TROW essentially is trading at fair value.

I already mentioned CVS and IBM. At a discount of about 15%, Walgreens Boots Alliance (WBA) looks interesting, though its 2% yield is a bit low for my liking. Any of the other stocks trading near fair value are suitable for put selling, so I'll be looking for opportunities soon.

Discounted Stocks

I prefer to buy stocks when they're discounted by at least 10%. Here are the ten DivGro stocks with the largest discounts to fair value, as of 25 September 2017. In addition to the stock's discount and its 7-star rating, I include the stock's rank out of 50 DivGro stocks:

CVS Health (CVS)	• discount  19%	• rank #  2 • ★★★★★★☆
International Business Machines (IBM)	• discount  16%	• rank #  3 • ★★★★★★☆
Walgreens Boots Alliance (WBA)	• discount  15%	• rank #  9 • ★★★★★☆☆
Valero Energy (VLO)	• discount  12%	• rank #12 • ★★★★★☆☆
Qualcomm (QCOM)	• discount  10%	• rank #25 • ★★★★★☆☆
Pfizer (PFE)	• discount    5%	• rank #42 • ★★★☆☆☆☆
AT&T (T)	• discount    5%	• rank #36 • ★★★★☆☆☆
Starbucks (SBUX)	• discount    4%	• rank #29 • ★★★★☆☆☆
Ford (F)	• discount    1%	• rank #32 • ★★★★☆☆☆
T. Rowe Price (TROW)	• discount    1%	• rank #  5 • ★★★★★★☆

I'm not really interested in adding to positions of stocks rated 5-stars or less. Valero Energy (VLO) looks promising, though, so I'll take another look at VLO.

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):


Please note that I created this chart two days after completing my fair value analysis, so the order of stocks (see the green bars) are somewhat different than the table of discounted stock presented above.

Only thirteen of my stocks are trading at a discount to fair value, versus twenty stocks that traded at a discount last month. It is getting harder to find good value in quality dividend growth stocks, it seems.

Positions To Close

With the exception of possibly IBM, I'm not targeting any positions in my portfolio for closing. As mentioned last month, the poor relative performance of stocks like IBM, GE, F, XOM, and QCOM could be warning signs or great opportunities. So even in the case of IBM, I'm undecided about next steps. While Warren Buffet has sold one third of Berkshire Hathaway's stake in IBM, the selling has stopped around $160 per share. Perhaps that level is a good indication of what Buffet thinks IBM is worth now?

I'm still busy with the thorough analysis of my portfolio I mentioned last month. My goal is to see how DivGro can be strengthened, especially from a risk-reward perspective. I'm using the portfolio analysis tools available at Simply Safe Dividends, TipRanks, finbox.io, and Simply Wall St for this purpose. Stay tuned!

Positions To Boost

As mentioned earlier, I'm still looking to sell a short-term put option on CVS. Meanwhile, I've added 10 shares at $81.52 to increase my CVS holding to 50 shares. I have also added a few shares of VLO, WBA, and Intel (INTC).

I'm also considering adding to my positions in Omega Healthcare Investors (OHI) and Nvidia (NVDA). In both cases, these will be relatively small additions.

OHI is trading at a small premium to my fair value estimate (about 2%), although the this F.A.S.T. Graphs chart indicates a discount based on a correlation of price to AFFO (adjusted funds from operations):

My NVDA position is by far the smallest one in DivGro. The stock yields only 0.32%. It is wildly overvalued (with a P/E of about 50) and certainly is not a typical dividend growth stock. I consider NVDA, along with small positions in the so-called FANG stocks, guilty pleasures. 

New Positions?

I have one new position in mind: Texas Instruments (TXN).

The stock is a regular in my monthly list of top 10 ranked dividend growth stocks. In September's list, TXN is ranked sixth:

Of the top 10 ranked stocks I don't own, TJX Companies (TJX), Lowe's Companies,(LOW), The Cheesecake Factory (CAKE), and Snap-on (SNA) are trading below fair value.

TJX and LOW are solid dividend growth stocks with long histories of dividend increases. Both stocks look interesting, though I'll probably look at TJX first, as I have open short puts on LOW.

Returning to TXN, while the stock is trading at a premium of about 9% to my fair value estimate, I believe the stock has more room to run. What is particularly intriguing about TXN is management's favorable view on returning shareholder value. Last week, the company announced an impressive dividend increase of 24% and increased authorization to repurchase up to $6 billion of its own stock over time. This amount is in addition to about $4.6 billion of previously authorized repurchases that remained at the end of June 2017.

Earlier I sold a $75 put contract on TXN with a January 2018 expiration date. With TXN trading near $89, I've captured most of the value now and I'll probably close the position early. I'm thinking about opening a new position in TXN, albeit a small one, even with TXN trading at a premium. I suspect the company will continue to do well in the foreseeable future.

Thanks for reading and take care, everybody!