I update fair value estimates for every DG stock in my portfolio and look for undervalued stocks suitable for further investment. Similarly, I look for overvalued stocks and determine if it makes sense to hold the stock or to sell it.
Yield channel charts are great visual tools for DG stock valuation. I create yield channel charts for stocks that appear to be undervalued or overvalued. As long as the stock price remains inside the yield channel, no immediate action is needed.
But if the stock price moves outside the yield channel, some action may be needed.
If the stock price moves outside the yield channel to the downside, the yield is high, historically, and the stock is undervalued. Buying more shares may be appropriate.
Conversely, if the stock price moves outside the yield channel to the upside, the yield is low and the stock becomes overvalued. Selling the stock and replacing it with an undervalued stock may be appropriate.
Recap
In last month's edition of DivGro Pulse, I looked at yield channel charts for Altria (MO), Northrop Grumman (NOC), Comcast (CMCSA), and Pfizer (PFE). Here is a recap of my conclusions:
- Based on the stock's 5-year yield history, MO would trade at an undervalued yield of 5.49% if the stock drops below $51 before August 2018.
- The 5-year yield channel chart confirmed that NOC was significantly overvalued. I closed my position for an annualized gain of 46%.
- CMCSA's 5-year yield channel chart suggested that the stock is trading at an undervalued yield. On 22 March, I bought 150 shares of CMCSA at $33.60 per share for an initial yield on cost of 2.26%.
- If PFE trades below $29.50 before August 2018, the stock would trade at an undervalued yield of 4.61%. Again, that is based on the stock's 5-year yield history.
Quality Stocks
To estimate fair value for DG stocks in my DivGro portfolio, 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 finbox.io.
As mentioned earlier, I added CMCSA to DivGro last month at $33.60 per share for an initial yield on cost of 2.26%. The stock dropped a bit and now yields 2.30%.
Only one other stock, CVS, is trading at s significant discount to fair value. I'm not interested in adding to CVS at this stage, though. The company indicated that it would not be increasing its dividend in the foreseeable future.
This month, six stocks earned 7-star ratings, while the other four top ten ranked DG stocks each earned a 6-star rating. Generally, I consider stocks rated 5-stars or better worthy of further consideration.
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 my DivGro portfolio for April 2018:| Comcast (CMCSA) | • Discount | 18.4% | • rank #1 • ✭✭✭✭✭✭✭ |
| 3M (MMM) | • Premium | 8.5% | • rank #2 • ✭✭✭✭✭✭✭ |
| General Dynamics (GD) | • Premium | 11.9% | • rank #3 • ✭✭✭✭✭✭✭ |
| Unitedhealth (UNH) | • Discount | 0.3% | • rank #4 • ✭✭✭✭✭✭✭ |
| T. Rowe Price (TROW) | • Premium | 3.6% | • rank #5 • ✭✭✭✭✭✭✭ |
| CVS Health (CVS) | • Discount | 23.6% | • rank #6 • ✭✭✭✭✭✭✭ |
| Hormel Foods (HRL) | • Premium | 4.1% | • rank #7 • ✭✭✭✭✭✭✩ |
| Texas Instruments (TXN) | • Discount | 1.3% | • rank #8 • ✭✭✭✭✭✭✩ |
| Nike (NKE) | • Premium | 12.2% | • rank #9 • ✭✭✭✭✭✭✩ |
| Cummins (CMI) | • Premium | 2.9% | • rank #10 • ✭✭✭✭✭✭✩ |
As mentioned earlier, I added CMCSA to DivGro last month at $33.60 per share for an initial yield on cost of 2.26%. The stock dropped a bit and now yields 2.30%.
Only one other stock, CVS, is trading at s significant discount to fair value. I'm not interested in adding to CVS at this stage, though. The company indicated that it would not be increasing its dividend in the foreseeable future.
This month, six stocks earned 7-star ratings, while the other four top ten ranked DG stocks each earned a 6-star rating. Generally, I consider stocks rated 5-stars or better worthy of further consideration.
Discounted Stocks
| CVS Health (CVS) | • Discount | 23.6% | • rank #6 • ✭✭✭✭✭✭✭ |
| Altria (MO) | • Discount | 19.0% | • rank #23 • ✭✭✭✭✭✭✩ |
| Comcast (CMCSA) | • Discount | 18.4% | • rank #1 • ✭✭✭✭✭✭✭ |
| AT&T (T) | • Discount | 15.6% | • rank #33 • ✭✭✭✭✭✩✩ |
| Omega Healthcare Investors (OHI) | • Discount | 15.3% | • rank #46 • ✭✭✩✩✩✩✩ |
| Qualcomm (QCOM) | • Discount | 14.7% | • rank #41 • ✭✭✭✭✩✩✩ |
| Walgreens Boots Alliance (WBA) | • Discount | 13.7% | • rank #13 • ✭✭✭✭✭✭✩ |
| Verizon Communications (VZ) | • Discount | 11.3% | • rank #37 • ✭✭✭✭✩✩✩ |
| Dominion Resources (D) | • Discount | 10.8% | • rank #40 • ✭✭✭✭✩✩✩ |
| Realty Income (O) | • Discount | 10.5% | • rank #44 • ✭✭✭✩✩✩✩ |
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):
Last month, 23 DG stocks traded at a discount to fair value, versus 26 stocks this month.
Position Sizes
From time-to-time, I like to look at the relative 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.
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.
Raytheon (RTN), Valero Energy (VLO), and Lockheed Martin (LMT) are all trading closest to their respective 52-week highs. In contrast, Procter & Gamble (PG), D, and OHI 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.
Three stocks stand out on this chart, VLO, Nvidia (NVDA), and TROW. These stocks have performed exceptionally well in the past year compared to their annualized 5-year performances. On the other hand, MO and WBA have performed rather poorly in the last year.
The reason I consider recent performance is two-fold. Stocks like VLO, NVDA, and TROW may be significantly overvalued, presenting an opportunity to trim or even close the positions. Conversely, stocks like MO and WBA may be undervalued or troubled and I'd like to be alerted about that. In that case, I can dig deeper to understand the reasons for the share price decline.
Positions to Boost?
WBA is a Dividend Champion with a track record of 42 years of higher dividend payments. The stock yields 2.48% at $64.60 per share and has a 5-year dividend growth rate of 9.2%.
At 1.22% of total portfolio value, WBA is a relatively small position. The stock is ranked #13 this month and trades at a discount of about 14% to my fair value estimate.
In the past year, WBA has performed poorly compared to its annualized performance over the past five years. Only MO performed worse in this regard.
Let's consider WBA's yield channel chart to see if the stock is trading at undervalued yield levels:
The chart covers a 9-year timeframe and includes an overlay of the 5-year undervalued yield as a dotted line. WBA's stock is trading near the 5-year undervalued yield line of 2.53%.
Given the stock's annualized dividend of $1.60, a share price of $63.24 would yield 2.53%. But WBA is trading a little above $63.24 presently.
The 9-year yield channel is wider and suggests an undervalued yield of 3.25%.
My conclusion is that WBA would be a buy below $65 and a strong buy below $51.50 through August 2018. These price targets are based on the expected 5-year and 9-year undervalued yields on 31 August.
Positions To Close?
After closing my NOC position, I don't see any reason to close other positions in my portfolio at this time.
NVDA, Microsoft (MSFT), and RTN are trading well above fair value:
| Nvidia (NVDA) | • Premium 31.8% | • rank #25 • ✭✭✭✭✭✭✩ | |
| Microsoft (MSFT) | • Premium 24.8% | • rank #12 • ✭✭✭✭✭✭✩ | |
| Raytheon (RTN) | • Premium 19.2% | • rank #24 • ✭✭✭✭✭✭✩ |
But these stocks are performing very well and each has a 6-star rating.
I'm own NVDA because of the stock's growth prospects (certainly not for its anemic yield!), particularly in the areas of autonomous cars, artificial intelligence, and cloud computing. The stock's 5-year dividend growth rate is 50%, but I'd be very happy with low double-digit percentage increases going forward. The 1-year and 3-year DGRs are 17.5% and 18.8%, respectively.
Microsoft is one of only two companies to hold the coveted AAA credit rating from Standard & Poors. The other company is Johnson & Johnson (JNJ). MSFT is a quality DG stock with a streak of 16-years of higher dividend payments. It yields 1.76% and has a 5-year dividend growth rate of about 14%.
Even though RTN is trading near its 52-week high, I wouldn't want to get rid of another Aerospace/Defense stock so quickly after closing my NOC position. The stock seems to have bullish momentum and with increased defense spending by the Trump administration, I think the upward trend will continue.
The other potential candidate for removal is Hannon Armstrong Sustainable Infrastructure Capital (HASI), a real estate investment trust that provides capital and services to the energy efficiency, renewable energy, and other sustainable infrastructure markets in the United States. Recently, HASI's management announced a dividend freeze, opting instead to focus on fixing debt levels and reducing interest rate risk. Also, I quite like the high yield of 6.86% and I'm not willing to give that up right now!
New Positions?
My latest top ten list of DG stocks contains six stocks that I don't own. These stocks all have low payout ratios, high credit and financial strength ratings, and strong dividend safety and growth ratings. The stocks are high-quality dividend growth stocks and if you haven't seen my article, I think it's worth taking a look!
Here, I want to focus on one of those stocks, Snap-on (SNA). The company is based in Kenosha, Wisconsin, and manufactures and markets tools, equipment, diagnostics, repair information, and systems solutions.
SNA ranked #5 on my top ten list:
In the table, Yrs are the years of consecutive dividend increases, Payout is the EPS payout ratio and Debt is the ratio of debt to equity. 5-Yr DGR is the dividend growth rate over a 5-year period, while Standard & Poor's Credit Rating and Value Line's Safety and financial strength (Fin. Strength) ratings also are provided. I've added Safety and Growth scores (out of 100) from Simply Safe Dividends and my own estimate of Fair Value.
Here is a yield channel chart for SNA:
SNA's stock is trading near the 5-year undervalued yield line of 2.14%. Given the stock's annualized dividend of $3.28, a share price of $153.27 would yield 2.14%. SNA closed at $147.39 per share, so, in fact, the stock is trading at undervalued levels relative to its 5-year dividend yield history.
I'll be doing a stock analysis of SNA soon to see if I want to open a position in DivGro.
Concluding Remarks
In my DivGro Pulse articles, I focus on the strategy of dividend growth investing as it pertains to my portfolio, DivGro. I monitor the health of DG stocks in DivGro, 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 be helpful in guiding sell decisions.
Thanks for reading and take care, everybody!
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