DivGro Pulse: July 2018

In my regular DivGro Pulse articles, I focus on strategy and monitor the health of my portfolio of dividend growth stocks. My aim is to reduce portfolio risk, to further diversify my holdings, and to improve the balance of my holdings.

To identify undervalued or overvalued stocks in my portfolio, I perform an extensive fair value analysis and update the fair value estimates of every dividend growth stock in my portfolio. Undervalued stocks are suitable for further investment, while overvalued stocks are candidates for selling.

I create Yield Channel Charts for stocks that appear to be undervalued or overvalued. These charts show market valuation relative to historical yield patterns, creating a fair value or "safety" zone for the stock price. As long as the stock price stays within the safety zone of the yield channel, no immediate action is needed. But if the stock price moves outside the yield channel, I want to be alerted.

Should the stock price move outside the yield channel to the upside, the yield is low and the stock becomes overvalued. Replacing the stock with an undervalued stock may be appropriate. On the other hand, should the stock price move outside the yield channel to the downside, the yield is high, historically, and the stock becomes undervalued. Buying more shares may be appropriate.

Recap

Last time I looked at yield channel charts for Comcast (CMCSA), Nike (NKE), and TJX (TJX).

• I deemed CMCSA a strong buy relative to historical yield patterns. On 29 May, I added 50 shares at $31.49 per shares, increase my total position to 200 shares and lowering my average cost basis to $33.07. 
• Since looking at NKE's yield channel chart, the stock has made a new 52-week high of $81. This is close to the $84 price I identified as overvalued based on historical yield patterns. NKE now trades below $78 per share, so I'm happy to continue holding my shares. 
• When I looked at TJX's yield channel chart, the stock traded about 2% above the undervalued line. Nevertheless, I decided to open a position and on 29 May, I bought 100 shares at $88.42 to secure an initial yield on cost of 1.76%. My purchase was timely as TJX now trades above $97 per share!

I did not write a pulse article in June as we took some time off to spend with my sister and her family visiting from South Africa. Nevertheless, June was a busy trading month as I expanded DivGro to 72 positions. For details, see my portfolio page. 

In this month's edition, I'll take a look at the newly expanded list of 56 dividend growth stocks in my portfolio.

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, Finbox.io, and F.A.S.T. Graphs.

A byproduct of the evaluation process is a 7-star rating and a score that I use to rank the dividend growth stocks in my portfolio. Here are the top ten ranked dividend growth stocks for July:

Comcast (CMCSA)	• Discount	15.38%	• rank   #1 •  ✭✭✭✭✭✭✭
TJX (TJX)	• Premium	12.43%	• rank   #2 •  ✭✭✭✭✭✭✭
Ross (ROST)	• Premium	9.66%	• rank   #3 •  ✭✭✭✭✭✭✭
CVS Health (CVS)	• Discount	31.61%	• rank   #4 •  ✭✭✭✭✭✭✩
Texas Instruments (TXN)	• Premium	7.64%	• rank   #5 •  ✭✭✭✭✭✭✩
UnitedHealth (UNH)	• Premium	4.06%	• rank   #6 •  ✭✭✭✭✭✭✩
Lowe's (LOW)	• Premium	1.16%	• rank   #7 •  ✭✭✭✭✭✭✩
Cummins (CMI)	• Discount	18.31%	• rank   #8 •  ✭✭✭✭✭✭✩
Illinois Tool Works (ITW)	• Discount	1.95%	• rank   #9 •  ✭✭✭✭✭✭✩
Hormel Foods (HRL)	• Premium	3.01%	• rank #10 •  ✭✭✭✭✭✭✩

This month, three stocks earned 7-star ratings, while the other top 10 ranked stocks each earned 6-star ratings. Generally, I consider stocks rated 5-stars or better worthy of further consideration.

Three stocks trade at least 10% below my fair value estimates.

CMCSA continues to trade at discounted levels, even though the stock price has recovered a bit to above $35 per share. I'm not planning to add more shares at this time.

CVS Health (CVS) is trading about 32% below my fair value estimate. The company recently bought Aetna (AET) and indicated that it would not be increasing its dividend until the balance sheet leverage is down to 3x. If CVS declares an unchanged dividend of 50¢ per share in September, the stock will no longer be deemed a dividend growth stock. I'm planning to hold my shares, but I'm not interested in adding any shares at this time.

After making an all-time high of $194.18 in January, Cummins (CMI) has taken a beating! The stock is down 29% and seems to be struggling to reassure nervous investors. One concern is emissions issues, another is uncertainty surrounding newly enacted trade policies and import tariffs. Nevertheless, I'll be looking at the stock's yield channel chart in this article to see if adding to my position would be timely and appropriate.

Discounted Stocks

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

CVS Health (CVS)	• Discount	31.61%	• rank   #4 •  ✭✭✭✭✭✭✩
Kite Realty Trust (KRG)	• Discount	23.94%	• rank #56 •  ✭✭✩✩✩✩✩
AT&T (T)	• Discount	22.76%	• rank #38 •  ✭✭✭✭✭✩✩
Cummins (CMI)	• Discount	18.31%	• rank   #8 •  ✭✭✭✭✭✭✩
Altria (MO)	• Discount	18.19%	• rank #23 •  ✭✭✭✭✭✩✩
Walgreens Boots Alliance (WBA)	• Discount	16.54%	• rank #25 •  ✭✭✭✭✭✩✩
Comcast (CMCSA)	• Discount	15.38%	• rank   #1 •  ✭✭✭✭✭✭✭
Omega Healthcare Investors (OHI)	• Discount	15.13%	• rank #54 •  ✭✭✩✩✩✩✩
Starbucks (SBUX)	• Discount	13.80%	• rank #11 •  ✭✭✭✭✭✭✩
Verizon Communications (VZ)	• Discount	12.32%	• rank #42 •  ✭✭✭✭✩✩✩

All ten of the top discounted stocks are discounted by at least 10%.

Due to their low ratings, I'm not interested in adding to Kite Realty Trust (KRG),  Omega Healthcare Investors (OHI), or Verizon Communications (VZ) at this time.

I already mentioned CVS, CMI, CMSA.

AT&T (T) now yields 6.44% at about $31 per share. In May and June I added a total of 80 shares to increase my position to 280 shares. My average cost basis is $33.05, so I'll consider adding more shares to lower my cost basis.

Based on the yield channel chart of Altria (MO) presented in the March edition, I'd like to see the stock price below $51 before adding more shares. MO is trading above $57 per share, presently.

I doubled my Walgreens Boots Alliance (WBA) position in May, adding 100 shares at $63.09 per share. This reduced my average cost basis to $65.18. WBA now trades above $68, so I'm not interested in adding more shares at this time. 

Finally, Starbucks (SBUX) made a new 52-week low of $47.37 recently. The stock now trades at $52.59 and yields 2.75%. I'll look at the yield channel chart of SBUX next month. 

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


Last month, 31 dividend growth stocks traded at a discount to fair value, versus 24 stocks this month.

Position Sizes

I like to look at the relative size of positions in my portfolio because 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 dividend growth 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.


I consider positions with weights less than 1% as underweight positions and therefore good candidates for further investment. In the chart above, the underweight positions are shaded light green.

Another way to look at position sizes is by proportional yield, which gives a completely different perspective! OHI dominates with more than 6% of DivGro's yield, followed by Main Street Capital (MAIN) and Qualcomm (QCOM).

In the next few months I'd like to reduce DivGro's overall risk profile, and addressing the imbalance of yield contribution is one way to reduce overall risk.

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% level orange. These are stocks with poor recent performance.


Microsoft (MSFT), Medtronic (MDT), and Apple (AAPL) are all trading near their respective 52-week highs. In contrast, T, Illinois Tool Works (ITW), and CMI 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 in this chart, Ross (ROST), T. Rowe Price (TROW), and Valero Energy (VLO). These stocks have performed exceptionally well in the past year compared to their annualized 5-year performances.

On the other hand, MO, NVIDIA (NVDA), Hannon Armstrong Sustainable Infrastructure Capital (HASI), and CMCSA have performed rather poorly in the last year.

The reason I consider recent performance is two-fold. Stocks like ROST, TROW, and VLO may be significantly overvalued, presenting an opportunity to trim or even close those positions.

Conversely, stocks like MO, NVDA, HASI, and CMCSA may be undervalued or troubled and I'd like to be alerted about that possibility. That way, I can dig deeper to understand the reasons for the share price decline.

Positions to Boost?

CMI is a Dividend Challenger with a track record of 12 years of higher dividend payments. The stock yields 3.28% at $138.96 per share and has a 5-year dividend growth rate of 18.5%. The stock is trading at a discount of about 18% to fair value.

At 0.92% of total portfolio value, CMI is a relatively small position. The stock is ranked #8 this month and earned a 6-star rating. In the past year, CMI has performed poorly compared to its annualized performance over the past five years. In fact, it is one of the worst performers among my dividend growth stocks in this regard. Additionally, the stock is trading only about 9% above its 52-week low.

Let's consider CMI's yield channel chart to see if the stock is trading at undervalued yield levels:


The chart covers a 7-year timeframe and includes an overlay of the 5-year undervalued yield as a dotted line. The chart shows a 7-year undervalued yield of 3.87% and a 5-year undervalued yield of 4.02%.

With CMI yielding about 3.28%, the stock is not yet trading at undervalued levels relative to historical yield patterns. If CMI trades below $120 per share, I would consider the stock a strong buy.

For now, I'm going to wait for the stock price to drop a little more before adding to my position.

Positions to Trim?

MSFT is a Dividend Challenger with a track record of 16 years of higher dividend payments. The stock yields 1.56% at $107.68 per share and has a 5-year dividend growth rate of 13.9%. MSFT is trading at a premium of about 13% to my fair value estimate.

At 2.32% of total portfolio value, MSFT is one of my larger positions. The stock is ranked #19 this month and earned a 5-star rating. In the past year, MSFT has performed well compared to its annualized performance over the past five years. In fact, it is one of the best performers among my dividend growth stocks in this regard. Additionally, the stock is trading only about 1% below its 52-week high.

Let's consider MSFT's yield channel chart to see if the stock is trading at overvalued yield levels:


The chart covers a 9-year timeframe and shows an overvalued yield of 1.74%. It is clear that MSFT is trading in overvalued territory relative to historical yield patterns.

MSFT is DivGro's seventh home-run stock and, with total returns of more than 280%, one of my top performers! Annualized total returns are 55%!

It feels difficult to sell a winner like MSFT, but my yield channel chart suggests it would be a good time to do so. Since I own 140 shares, I'll sell 40 shares now and ride the upward trend as long as it lasts.

New Positions?

In my monthly 10 Dividend Growth Stocks series, I identify 10 CCC stocks for further research. This month's top 10 list contains two 6-star stocks that I don't own, Franklin Resources (BEN) and Home Depot (HD).

BEN is a Dividend Champion with a dividend increase streak of 38 years. The stock yields 2.84% at $32.45 and has an impressive 5-year dividend growth rate of 17%. The company has relatively low debt levels and a dividend payout ratio that leaves ample room for future dividend increases.

However, BEN's earnings growth rate is quite flat at 3%, as illustrated in the following F.A.S.T. Graphs chart. That does not impress me!


On the other hand, HD's F.A.S.T. Graphs chart is very impressive!


HD's earnings growth rate is about 17%! The stock yields 2.09% at $197.14 per share and has a spectacular 5-year dividend growth rate of 25%. With a payout ratio of 51%, the stock also has some room for future dividend increases.

It is clear, though, that HD is trading at a premium to fair value. In my estimation, HD is trading about 10% above fair value. The following yield channel chart confirms this fact, as HD's price line is closer to the overvalued yield line (red) than the undervalued yield line (green):


We can use the 5-year undervalued yield of 2.41% to calculate a suitable entry point. Given HD's annualized payout of $4.12, a price point of $171 per share would indicate a buy based on a 5-year yield history. That's about 13% below HD's current share price.

Concluding Remarks

My DivGro Pulse articles are strategy-focused. I update fair value estimates and identify undervalued stocks suitable for further investment or overvalued positions that should be trimmed or closed. I also look at candidate stocks for new positions. 

MSFT is overvalued and I'm planning to sell 40 shares (about 29% of my position).

CMI is not yet trading at undervalued levels relative to historical yield patterns, but I'll consider adding to my position if the stock drops a little further.

HD looks interesting, but the stock is a little expensive for my taste at this time.

Thanks for reading and take care, everybody!