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Wednesday, March 28, 2018

DivGro Pulse: March 2018

Welcome to another edition of DivGro Pulse, a series of articles that focus on the strategy of dividend growth investing. I monitor the health of my DivGro portfolio, update fair value estimates, and determine undervalued stocks suitable for further investment.

After founding DivGro in January 2013, I've focused almost exclusively on dividend growth (DG) investing. I say "almost exclusively", because my portfolio includes some closed-end funds, exchange-traded funds, and stocks that do not pay or regularly increase dividends.

Pulse articles exclusively focus on the DG stocks in my portfolio. I hope to reduce DivGro's overall risk profile, continue to increase diversification, and improve the balance of my holdings.

As mentioned in January's pulse article, I'm considering a subscription service for DG investors that will focus on strategy, fair value analysis, and portfolio management. Since these are the topics of my DivGro Pulse articles, once the subscription service is launched, I no longer will publish pulse articles on my blog.


I missed writing a pulse article in February because of work commitments. We're in crunch time finishing up Incredibles 2, but things should start to quiet down in April.

In January, I presented several Yield Channel Charts of DG stocks worthy of consideration.

Yield channels are safety zones for stock prices. As long as the stock price remains in the yield channel, the stock can be considered fairly valued. If the stock price moves outside the yield channel to the upside, the yield is low, historically, and the stock becomes overvalued. Conversely, if the stock price moves outside the yield channel to the downside, the yield is high and the stock becomes undervalued.

In January I looked at yield channels for Hormel Foods (HRL), CVS Health (CVS), T Rowe Price (TROW), and TJX Companies (TJX). Here is a recap of my conclusions:
  • HRL is a buy if the stock trades below $30.75 before 1 July 2018.
  • CVS is undervalued if the stock yields more than 2.72%. 
  • TROW is a sell if the stock trades above $135 before 1 July 2018.
  • If TJX trades below $70.50 before 1 July 2018, the stock would be undervalued relative to its 12-year dividend yield history.
CVS now yields 3.2%, so the stock is significantly undervalued relative to its 7-year dividend yield history. However, the company has frozen its dividend following the purchase of Aetna (AET), so CVS won't be raising its dividend or repurchase stock for some time. I'm holding my position and won't be increasing it in the foreseeable future.

HRL and TJX are trading well above the abovementioned target prices, while TROW is trading below $110 after pulling back about 9% from its 52-week high.

This month, I'll focus on a few stocks identified in 10 Dividend Growth Stocks For March 2018:

Specifically, Altria (MO) is now the top-ranked DivGro stock, while Comcast (CMCSA) and Pfizer (PFE) are candidates for new positions. Northrop Grumman (NOC) appears to be trading at a significant premium, so I'll look at the defense contractor as well.

Quality Stocks

To estimate fair value, I perform a multi-stage Dividend Discount Model analysis, a Gordon Growth Model analysis, and an analysis of dividend safety. My final fair value estimates also consider fair value estimates and price targets available elsewhere, such as from Morningstar and

A byproduct of the evaluation process is a 7-star rating for each stock and a score that I use to rank the DG stocks in my portfolio.

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

Altria  (MO) • Discount16.38%  • rank   #1 •  ✭✭✭✭✭✭✭
CVS Health  (CVS) • Discount29.53%  • rank   #2 •  ✭✭✭✭✭✭✩
Hormel Foods  (HRL) • Discount  1.69%  • rank   #3 •  ✭✭✭✭✭✭✩
Walgreens Boots Alliance (WBA) • Discount12.66%  • rank   #4 •  ✭✭✭✭✭✭✩
Aflac  (AFL) • Discount  2.31%  • rank   #5 •  ✭✭✭✭✭✭✩
AT&T  (T) • Discount19.06%  • rank   #6 •  ✭✭✭✭✭✭✩
T. Rowe Price  (TROW) • Premium  1.55%  • rank   #7 •  ✭✭✭✭✭✭✩
General Dynamics  (GD) • Premium  6.45%  • rank   #8 •  ✭✭✭✭✭✭✩
Texas Instruments  (TXN) • Premium  6.12%  • rank   #9 •  ✭✭✭✭✭✭✩
Travelers  (TRV) • Premium  5.23%  • rank #10 •  ✭✭✭✭✭✭✩

This analysis was done after the market closed on 26 March, a day the Dow Jones soared 669 points. Not surprisingly, the rankings of my DG stocks changed a little since I published March's top 10 list. For example, while MO and CVS remained at #1 and #2, HRL now slots in at #3 while AT&T (T) dropped to #6.

This month, MO earned a 7-star rating while the other nine DG stocks each earned a 6-star rating. Generally, I consider stocks rated 5-stars or better worthy of further consideration. 

Discounted Stocks

I prefer to buy stocks when they're available at discounts of at least 10%. Here are the top ten discounted DG stocks in my portfolio:

CVS Health  (CVS) • Discount29.53%  • rank   #2 •  ✭✭✭✭✭✭✩
AT&T  (T) • Discount19.06%  • rank   #6 •  ✭✭✭✭✭✭✩
Abbvie  (ABBV) • Discount16.97%  • rank #27 •  ✭✭✭✭✭✩✩
Altria  (MO) • Discount16.38%  • rank   #1 •  ✭✭✭✭✭✭✭
Verizon Communications  (VZ) • Discount14.52%  • rank #25 •  ✭✭✭✭✭✩✩
Walgreens Boots Alliance (WBA) • Discount12.66%  • rank   #4 •  ✭✭✭✭✭✭✩
Hannon Armstrong Sustainable
Infrastructure Capital (HASI)
 • Discount12.13%  • rank #47 •  ✭✭✩✩✩✩✩
Omega Healthcare Investors (OHI) • Discount12.13%  • rank #46 •  ✭✭✩✩✩✩✩
Qualcomm  (QCOM) • Discount12.06%  • rank #42 •  ✭✭✭✭✩✩✩
Dominion Resources (D) • Discount  7.89%  • rank #40 •  ✭✭✭✭✩✩✩

I'm not really interested in adding to positions of stocks rated 5-stars or worse, so the only candidates worth considering are CVS, T, MO, and WBA.

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

In January, only six DG stocks traded at a discount to fair value, versus 23 stocks this month!

Position Sizes

From time-to-time, I like to look at the size of my holdings. Stocks that are underweight are good candidates for further investment. While I prefer to see a more balanced portfolio, I sell covered calls on select DG stocks. To do so, I need to own 100 shares or multiples of 100 shares, so several positions are larger than those not involved in covered call trading.
The red dashed line represents the average position size (1.43%) of the DG stocks in my portfolio. Stocks with weights less than 1% is underweight are good candidates for further investment.

Recent Performance

One way to assess a stock's recent performance is to plot the current price relative to its 52-week trading range. I color stocks trading below the 50% orange. These are stocks with poor recent performance.

NOC, Raytheon (RTN), and Nvidia (NVDA) are all trading close to their respective 52-week highs. In contrast, MO and Procter & Gamble (PG) are trading near their respective 52-week lows.

Another way to look at recent performance is to compare recent returns to annualized returns over a longer time frame. The following chart compares 1-year returns to annualized 5-year returns:

Please note that the returns exclude dividends.

Two stocks stand out on this chart, TROW, and NVDA. Both have performed exceptionally well in the past year compared to their annualized 5-year performances. On the other hand, MO has performed rather poorly in the last year.

The reason I consider recent performance is two-fold. Stocks like TROW and NVDA may be significantly overvalued, presenting an opportunity to trim or even close the position. I'd like to know when that happens and consider my options. Conversely, stocks like MO may be undervalued or troubled and I'd like to know about that also. Of course, merely looking at the chart won't tell me if MO is presenting a great opportunity or if the stock is in trouble. I'll have to dig deeper to understand the reasons for the share price decline.

Positions to Boost?

MO is a Dividend Champion with a track record of 48 years of higher dividend payments. The stock yields 4.43% at $59.60 and has a 5-year dividend growth rate of 8.3%.

MO is one of the smaller positions in my portfolio at just 0.85% of total portfolio weight. The stock is ranked #1 this month and trades at a discount of 16% to my fair value estimate.

Based on these factors, it seems to be a good time to boost my MO position. But let's look at MO's yield channel chart. First, here's the nine-year chart:

Interestingly, the yield channel chart shows two occasions when it would have been appropriate to reduce or close my MO position. In March 2017 and in June 2017, MO's stock price moved outside the yield channel to the upside and the stock became overvalued based on historical yield patterns.

The yield channel chart also shows an inflection point, indicating that a shorter timeframe might be more appropriate. Here is the five-year chart:

The 5-year yield channel is narrower, particularly on the undervalue yield side (5.49% versus 7.64%).

Based on the narrower yield channel chart, my conclusion is that now would not a great time to boost my MO position. Should MO's share price drop to $50.50 or lower before August 2018, I'd consider MO a buy based on historical yield patterns.

MO would have to trade 15% lower to reach the 5-year undervalue yield level of 5.49% by August 2018.

Positions To Close?

NOC is trading at a 30% premium to my fair value estimate and yields only 1.24% at $355.23 per share. However, the stock has an impressive 5-year DGR of 12.6%.

NOC is ranked #32 of 47 DG stocks in DivGro and earns a 4-star rating:

Northrop Grumman  (NOC) • Premium 29.8% • rank #32 •  ✭✭✭✭

The stock's relatively poor ranking is mostly due to its premium price, but there are some other concerns to note. See the following summary of financial highlights, courtesy of

Values of concern are visible at a glance, as these are colored red. For example, NOC has uncomfortable debt levels and a rather high price to book ratio, while the company's latest quarterly EPS dropped 8% from the prior quarter.

Let's consider the nine-year yield channel chart:

Based on historical yields, NOC is trading at overvalued levels.

Notice that the chart has an inflection point in early 2013. Looking at the five-year yield channel chart instead, the overvalued yield is 1.28% while the undervalued yield is 3.01%. As mentioned earlier, NOC yields 1.24% at current levels.  

NOC is one of DivGro's best-performing stocks. In fact, it is DivGro's ninth home run stock, a designation I give to any position in my portfolio that crosses the 100% mark in total returns.

It feels difficult to sell a winner like NOC, but my yield channel chart suggests it would be a good time to do so. And that's what I'll do.

New Positions?

I mentioned earlier that I want to look at CMCSA and PFE. These are the only stocks on my latest top ten list of DG stocks that I don't own.

First, let's see what the yield channel chart of CMCSA shows:

CMCSA is a Dividend Contender with 11 years of higher dividend payments. The stock yields 2.27% at $33.54, so it is not yet trading at an undervalued yield, at least based on the nine years of yield history.

If we consider the five-year chart instead, things look different:

Here, the channel tightens to 1.50% (overvalued) and 1.99% (undervalued). So based on more recent history, CMCSA is trading at undervalued yield levels.

In my view, it would be worthwhile to do a thorough stock analysis of CMCSA and I hope to do so soon.

Finally, let's consider PFE, a drugmaker with a history of eight years of higher dividend payments:

The stock is trading in the middle of its eight-year yield channel, which makes it seem to be an inappropriate time to buy shares. However, consider the five-year chart:

While PFE is still not trading at undervalue yield levels, the tighter range based on only five years of dividend yield history is telling. Here's my conclusion: If PFE trades below $29.50 before August 2018, I would consider the stock a buy based on historical yield patterns. At that price, PFE would yield a very attractive 4.61%.

Concluding Remarks

My DivGro Pulse articles are strategy-focused. I monitor the health of my DivGro portfolio, update fair value estimates, and determine undervalued stocks suitable for further investment. I also look at candidates for new positions.

Using yield channel charts helps me to determine potential buy and sell levels based on the historical dividend yield patterns of individual stocks. These charts seem to be a great tool for identifying undervalued stocks. Similarly, I think yield channel charts can help guide sell decisions.

Thanks for reading and take care, everybody!

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