BY: Chuck Carnevale, F.A.S.T. Graphs, Inc.
Investors today have instant access to minute by minute changes in the stock prices of their portfolio holdings in real time. Since stock prices tend to fluctuate wildly from one day to the next, I for one do not feel that this information overload is a good thing. What makes matters even worse is how wildly the value of a stock can change from one day to the next. It’s not uncommon to see a stock rise or fall by 10% or more on any given trading day. Yet common sense would dictate that the intrinsic value of a large publicly traded company could not possibly change that much that quickly.
Price swings, like those mentioned above, are most likely to happen on the day the company reports earnings. Minor misses or beats with their earnings estimates can often instigate apparently insane reactions with their share prices. But you can’t count on what those reactions might be. Sometimes an earnings beat will cause the stock to rise, and sometimes it will cause it to fall, and vice versa. There just doesn’t seem to be any rhyme, reason or logic behind what the market might do to the company’s stock price on earnings day. The bottom line is that short-term price volatility is rarely a valid indicator of the company’s intrinsic value.
The world’s leading investors have long understood that current stock price is not always the best indicator, and certainly not the only indicator of a company’s True Worth™. These experienced investors acknowledge and understand that market prices can overvalue or undervalue a company at any given point in time. These astute investors will take advantage of overvaluation as an opportunity to sell, and conversely, exploit fear-based undervaluation as an opportunity to buy. Smart investment decisions are made based on the prudent practice of calculating a company’s intrinsic value based on fundamentals, primarily earnings and cash flows.
Therefore, most investors will take their lead from the stock price movement that is occurring every minute of every trading day, and in today’s age of technology, often after-hours as well. On the other hand, most astute investors see this as noise and recognize that they only get true knowledge-based information on any company they follow four times a year. It’s only when the company presents its quarterly earnings report that facts are separated from fiction. Therefore, my motto is: “measuring performance without simultaneously measuring valuation is a job half done.” But, you can only truly measure performance when the fundamental information is at hand.
The following six dividend growth stocks will be reporting earnings over the next couple of days. The following table lists these companies in order of highest potential total annual rate of return to lowest, based on the consensus of leading analysts five-year earnings estimates. Each of these six companies has raised their dividend every year since 2006, a period of time that includes the great recession of 2008. But most importantly, each of these six companies is currently trading at a reasonable valuation, and in a couple of cases, a low valuation based on the next five years of expected earnings growth.
Six Dividend Growth Stocks – Price Performance and Fundamental Valuation
The following pictorial review utilizing our F.A.S.T. Graphs™, fundamentals analyzer software tool, looks at each of our six reasonably valued dividend growth stocks based on the correlation between price and fundamental valuation. We will offer four graphs on each selection. The first two graphs will be based on the last five years of history, where earnings and stock price are correlated. The first graph is logarithmic and looks at price, earnings and the historical price earnings ratio for each company. The second graph is standard scale and shows dividends stacked on top of earnings (the light blue shaded area). The third graph calculates the performance associated with both the price and earnings correlated graphs. Notice how an instantaneous perspective of how well each company has performed on an operating basis is illuminated.
The fourth graph is a forecasting calculator based on the consensus of leading analysts reporting to FirstCall. The dark orange line on this graph represents an earnings justified valuation multiple. In other words, this dark orange line represents fair value. The two lighter orange lines above and the two lighter orange lines below the darker orange line provide a value corridor of reasonableness. In other words, if the stock price falls between those five lines the stock is considered reasonably valued based on the associated earnings estimates allowing for reasonable margin of error. All six of these examples show stock prices within the valuation corridor.
Intel Corp. (INTC) and Abbott Labs (ABT) appear undervalued, VF Corporation (VFC) and United Technologies (UTX) appear to fall into the high side of the valuation quadrant, while Stryker (SYK) and PepsiCo (PEP) appear to be precisely fairly valued. Given these modest gradations, each of these companies could be prudently purchased assuming the consensus estimates are accurate.
When reviewing the associated performance results for each company notice the effect that beginning valuation has on the long-term returns on each company. I also suggest that each reader focus on the dividend cash flow table noticing how each company has increased their dividend every year since 2006.
However, the most important take-away that the F.A.S.T. Graphs™ illuminate, are the two performance calculations that every company possesses. First, price performance, which almost every investor focuses exclusively on, and second, the operating performance represented as earnings and/or dividend growth which are mostly ignored.
Intel Corp. (INTC)
Intel (NASDAQ: INTC) is a world leader in computing innovation. The company designs and builds the essential technologies that serve as the foundation for the world’s computing devices.
The logarithmic graph on Intel shows that the company is not as cyclical as some believe. I’ve always considered the company quasi-cyclical with longer-term characteristics of growth.
With the standard scale earnings and price correlated graph we add dividends, the light blue shaded area stacked on top of, but paid out of the green shaded area earnings.
When reviewing the associated performance graph for Intel we discover that current undervaluation based on earnings negatively impacted shareholder returns. However, Intel does meet the criteria to be considered a dividend growth stock since the dividend has increased every year.
The estimated earnings and return calculator shows that Intel is currently priced below the valuation corridor (five orange lines) which indicates that this stock is extremely undervalued based on consensus analyst estimates. In other words, our price performance has been poor in spite of the fact that operating performance has been and is expected to continue to be strong.
Abbott Laboratories (ABT)
Abbott (NYSE: ABT) is a global, broad-based health care company devoted to the discovery, development, manufacture and marketing of pharmaceuticals and medical products, including nutritionals, devices and diagnostics. The company employs nearly 90,000 people and markets its products in more than 130 countries.
The logarithmic graph on Abbott Labs (ABT) shows that this company is a paragon of consistency regarding earnings growth. Therefore, we see almost perfect operating results that are currently being imperfectly priced by the market.
When viewed at standard scale, the graph