DivGro Pulse: October 2017

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

I also review the recent performance of every stock to see if any of them are performing poorly. If so, I need to take appropriate action. In the near future, I'm planning to use a new tool to assess performance, so-called yield channel charts. These charts allow dividend growth investors to assess market valuation relative to historical yield patterns. Yield channels can be seen as safety zones for stock prices. As long as the stock price stays within the yield channel, the stock is fairly valued.

Updating the fair value estimates for every stock in my portfolio is quite involved. 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 identified Texas Instruments (TXN) as a new position target. I wrote:

... 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.

So, I decided to buy shares of TXN even though the stock was trading at a premium to fair value

• 2017-09-26: Bought 50 shares of TXN at $87.71 per share

I'm happy I acted swiftly — the stock is now trading above $96 per share!

Additionally, I mentioned several existing holdings that seemed suitable for further investment. I reported on these trades in my September monthly review:

• CVS Health (CVS) — added 10 shares; increased position to 50 shares
• Intel (INTC) — added 30 shares; increased position to 570 shares
• NVIDIA (NVDA) — added 10 shares; increased position 20 shares
• Omega Healthcare Investors (OHI) — added 100 shares; increased position 400 shares
• Valero Energy (VLO) — added 8 shares; increased position 180 shares
• Walgreens Boots Alliance (WBA) — added 36 shares; increased position 80 shares

Finally, I reiterated some concerns with International Business Machines (IBM). While the stock's 4% yield remains attractive, I wondered if IBM was becoming a value trap. I noted that I have a relatively small position in IBM and that I'm not in any rush to close my position.

Below, I'll give an update on my IBM position.

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 for each stock and a score that I use to rank all the stocks in my portfolio.

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

Hormel Foods (HRL)	• premium   3.9%	• rank   #1 •  ★★★★★★☆
CVS Health (CVS)	• discount  15.1%	• rank   #2 •  ★★★★★★☆
Walgreens Boots Alliance (WBA)	• discount  17.5%	• rank   #3 •  ★★★★★★☆
T. Rowe Price (TROW)	• premium 23.0%	• rank   #4 •  ★★★★★★☆
Nike (NKE)	• premium  11.2%	• rank   #5 •  ★★★★★★☆
Altria Group (MO)	• premium   4.1%	• rank   #6 •  ★★★★★★☆
Texas Instruments (TXN)	• premium 20.1%	• rank   #7 •  ★★★★★☆☆
General Dynamics (GD)	• premium   9.3%	• rank   #8 •  ★★★★★☆☆
Target (TGT)	• premium   5.4%	• rank   #9 •  ★★★★★☆☆
Cummins (CMI)	• premium 13.6%	• rank #10 •  ★★★★★☆☆

The top six ranked stocks each earned 6-star ratings. Generally, stocks rated 5-stars or better are worthy of further consideration. Notice that only two of the top ten ranked stocks are trading at discounts to fair value.

Discounted Stocks

I prefer to buy stocks trading at discounts of at least 10%.

Here are the ten DivGro stocks with the largest discounts to fair value, as of 26 October 2017. In addition to the stock's discount and its 7-star rating, I include the stock's rank out of 51 DivGro stocks:

Walgreens Boots Alliance (WBA)	• discount  17.5%	• rank #  3 • ★★★★★★☆
CVS Health (CVS)	• discount  15.1%	• rank #  2 • ★★★★★★☆
AT&T (T)	• discount  14.2%	• rank #33 • ★★★★☆☆☆
Valero Energy (VLO)	• discount    6.0%	• rank #24 • ★★★★★☆☆
General Electric (GE)	• discount    4.9%	• rank #47 • ★★★☆☆☆☆
Verizon Communications (VZ)	• discount    4.7%	• rank #36 • ★★★★☆☆☆
Qualcomm (QCOM)	• discount    3.4%	• rank #29 • ★★★★☆☆☆
National Retail Properties (NNN)	• discount    3.2%	• rank #50 • ★★★☆☆☆☆
Pfizer (PFE)	• discount    2.5%	• rank #43 • ★★★☆☆☆☆
Gilead Sciences (GILD)	• discount    1.0%	• rank #37 • ★★★★☆☆☆

I'm not really interested in adding to positions of stocks rated 5-stars or less.

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 twelve of my stocks are trading at a discount to fair value, versus thirteen stocks that traded at a discount last month. It is challenging to find good dividend growth stocks trading at or below fair value.

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 several of my DivGro positions are larger than those not involved in covered calls.

The red dashed line represents the average position size (1.59%) in my portfolio. Stocks with weights less than 1% is underweight are good candidates for further investment.

Positions To Close

Last month I mentioned that I'm still contemplating what to do with my relatively small IBM position.

Meanwhile, IBM reported 2017-Q3 results with both revenue and earnings beats. Furthermore, the company is forecasting diluted operating EPS for the 2017 fiscal year of at least $13.80, compared to $13.75 consensus. Notably, IBM's revenue from its strategic imperatives businesses grew 10%, and cloud revenue itself was up 20% year-over-year.

Is this enough evidence that the turnaround finally is happening? I'm not yet convinced, but I've decided to hold my position and wait for clarity — either way.

Positions To Boost

October's top 10 list of includes three DivGro stocks and, notably, my newest holding TXN:
MO is consolidating after dropping about 10% in July with an FDA announcement of plans to explore lowering the nicotine allowed in cigarettes to non-addictive levels:
MO is one of my smaller holdings, currently only 0.96% of DivGro's market value. 

MO is a DivGro home run stocks, a designation I give to any holding that crosses the 100% mark in total returns. I own 75 shares of MO and perhaps it is time to add to my position. I'll probably look at selling a secured put option first, perhaps near my fair value estimate of $63.

New Positions?

Of the seven stocks in October's top 10 list that I don't own, AmTrust Financial Services (AFSI), Lazard (LAZ), Chico's FAS (LOW), Legg Mason (LM), and Cheesecake Factory (CAKE) are trading below fair value.

LAZ and LM look quite interesting. Both stocks have zero debt, offer decent yields, and are trading at discounts of at least 10%. They also have excellent 5-year dividend growth rates of about 20%.

Unfortunately, I don't have a lot of cash available to establish new positions. I'll need to build some cash reserves first. Nevertheless, if a stock analysis produces favorable results, I'll consider selling out-of-money puts to initiate a position. 

Thanks for reading and take care, everybody!