effect of buying stocks on sale usually leads to the necessity of dealing with future overvaluation. This side effect has currently manifested itself in my portfolio at present time. Therefore, in lieu of offering generalizations about what to do with overvaluation, I would like to share my own deliberations of what I might do on several currently overvalued holdings. The key here is that my decisions will be based on the specific situations regarding each holding. However, and as a reminder to the reader, the underlying principles based on the lessons of the masters referenced above will remain at the forefront of my mind at all times.
As usual, I will utilize the fundamentals analyzer software tool F.A.S.T. Graphs™ to articulate my thinking regarding each example I will present. I have marked each graph with a green dot illustrating when the stock was purchased, and the yellow line indicates cost basis. For new readers, the orange line represents a calculated earnings justified fair valuation. The black line on the graph represents monthly closing stock prices. The light blue shaded area illustrates dividends paid out of earnings, and the dark blue line illustrates the normal price earnings ratio that the market has historically applied.
What Do I Do With My Two Utilities With Moderate Overvaluation?
My first two examples will examine two utilities, SCANA Corporation (NYSE:SCG), and NextEra Energy, Inc. (NYSE:NEE) (formerly Florida Power & Light). In both cases, these were purchased because they offered a current yield at time of purchase of more than 4%. In my mind, I saw these as quasi bond alternatives. In other words, my objective for owning them was their high yield, and low betas (approximately .5 for each), and not because I expected any significant capital appreciation. Consequently, since both were purchased for their income, I have no intention of selling either as long as their dividends remain intact.
Based on the earnings and price correlated graphs on each, both were purchased when they were undervalued, and both are currently modestly overvalued. However, I do not believe the downside potential from overvaluation on either sample warrants a sell. On the other hand, I should also add that I do not believe that either company is a sound purchase at today’s overvalued levels.
Essentially, this decision is based on the fact that finding a suitable replacement trading at fair value or below, low betas and with a similar yield and quality, is not readily available in today’s marketplace. Furthermore, these are typical low growth utilities, and my low cost basis provides me a margin of safety that would be hard to replicate. In these cases, I take the lead of Warren Buffett where inactivity strikes me as intelligent behavior.
NextEra Energy, Inc. (NYSE:NEE)
SCANA Corporation (NYSE:SCG)
When The Sell Decision Is Made For Me
As a general statement, there are usually only two reasons why I will ever sell a common stock when I am in control of the decision. The first and most common reason is dangerous overvaluation. I define overvaluation as dangerous when it is at a level that would take years for me to recover my current profits if the stock were to move into fair value range. It’s important to add here that it needs to be understood that a precise calculation of fair value is nebulous at best. Consequently, I am reticent to act unless overvaluation is so high as to be too obvious to ignore.
My second reason would be a permanent deterioration in the fundamentals of the company. It’s important to emphasize here that a few bad quarters, or even a down year or two, may not indicate a permanent fundamental deterioration. Nor would a modest change in the company’s growth rate indicate permanent deterioration, especially if it was considered temporary.
However, there is a third reason that is out of my control. My next example, H.J. Heinz Company (NYSE:HNZ) represents a stock that Warren Buffett and a consortium have purchased outright. Consequently, this decision is easy, I will simply either wait until I receive the cash as follows: “At the closing of the transaction, Heinz shareholders will receive $72.50 in cash for each share of common stock they own, in a transaction valued at $28 billion, including the assumption of Heinz’s outstanding debt.”
H.J. Heinz Company (NYSE:HNZ)
Perhaps in sympathy with the Heinz transaction, Campbell Soup Company (NYSE:CPB) has experienced a similar spike in valuation. Consequently, I have added Campbell Soup to my candidates-for-sell list. Thanks to the great recession, I was fortunate to have the opportunity to acquire this blue-chip at a discount to its fair value. However, at its current quotation I believe the stock’s valuation has become extended.
Campbell Soup Company (NYSE:CPB)
