When investing in common stocks, there is no one strategy that fits all investors. Some investors are focused on investing for income, some for capital appreciation and others for various combinations of both. Additionally, there is the issue of risk tolerance. Some investors are willing and capable of assuming greater risk if they believe it will lead to greater returns, while others are more risk adverse. These are just but a few of the many variations that apply to the individual investor’s own unique goals and characteristics.
Therefore, I have initiated this series of articles with the hopes of providing fairly valued stock research candidates that potentially offer something for everyone. In part 1 I introduced the series and provided a few examples of each specific equity class that I would cover in the series. In part 2 I covered high-growth stocks, which I consider the most aggressive, but perhaps potentially the most profitable equity class. In this part 3, I offer a review of what appear to be fairly valued growth and income stocks. Consequently, this category contains selections that may be appropriate for investors in the accumulation phase of building their retirement portfolios.
Similar to high-growth stocks, but ideally in a more conservative fashion, the primary focus of my growth and income selections is total return. Therefore, I offer this group of research candidates to those investors desirous of building and accumulating long-term wealth, through investing in high quality blue-chip dividend paying stocks for the purpose of generating an above-average rate of total return through the combination of capital appreciation, dividend income, and in many cases a growing dividend income stream.
Therefore, each candidate that will be found in this article will pay a dividend. However, the current yields available may not meet the needs or objectives of those retired investors currently seeking income. On the other hand, this article will be reviewing candidates that I believe provide the opportunity for generating double-digit future long-term total returns. Moreover, many of these selections are poised with the potential to deliver long-term total returns that are the equivalent, or close to it, of many of the high growth candidates covered in part 2.
Total Return: The Capital Appreciation Component + The Income Component
Very simply stated, for common stocks the total return is comprised of the two primary components of return; the capital appreciation (growth) component and the income (dividends) component. When investing in pure growth stocks (stocks that pay no dividends), total return is comprised only of capital appreciation. However, with dividend paying stocks the investor still receives the capital appreciation component but also receives additional return from the income component. These two returns together make up the total return received on a dividend paying growth stock.
Although this is a very straightforward calculation, it is not void of controversy or debate. There are those that would argue that dividend income does not provide additional return. For example, these individuals argue that since the company’s stock price is reduced on the ex-dividend date by the precise amount of the dividend, the dividend itself provides no additional return. Although this is technically correct, I would argue that it’s much ado about nothing. I am not alone on this position. In his excellent and newly released book titled Top 40 Dividend Growth Stocks For 2014, author David Van Knapp has this to say on the subject. First, on pages 23 and 24, David explains the ex-dividend date as follows:
“Ex-dividend date: “Without-dividend date.” The first day that a newly purchased share of stock comes without the right to receive the next dividend. If you purchase a stock on or after the ex-dividend date, you will not receive the next dividend. In order to be entitled to the next dividend, you must buy prior to the ex-dividend date.
From the seller’s point of view, the ex-dividend date is the first day on which you can sell the shares and nevertheless be entitled to receive the next dividend. The ex-dividend date precedes the payment date by a few days or weeks.
Before the market opens on the ex-dividend date, stock exchanges usually adjust the previous day’s closing price downward by the amount of the dividend. This price adjustment reflects the fact that the cash to pay the next dividend will not be retained by the company, as it is earmarked to pay the dividend. For most stocks, that adjustment in price soon gets lost in the noise of the next day’s trading.”
Then, later on pages 57 and 58, Dave goes on to further explain why he does not consider this temporary dividend reduction a big issue:
“10. Stock prices drop by the amount of the dividend
This is not really a disadvantage either, although some people view it as one.
Stock exchanges follow a long-standing practice. When a company declares a dividend, it sets the record date. Under exchange rules, the ex-dividend date is thereby established a few days prior to the record date. That ex-date becomes the first day on which new buyers of the stock will not receive the upcoming dividend.
Before the opening of trading on the ex-dividend date, the exchange reduces the quoted price of the stock by the exact amount of the declared dividend.
The idea is that this money will not be received by new buyers, so they should pay that much less for the stock.
Because of this price adjustment, shareholders who owned the stock before the ex-dividend date, and who hold on straight through, see the price of their stock momentarily lowered by the amount of the dividend. In practice, as soon as trading opens on the ex-dividend date, market participants establish the actual price of the stock. The exchange’s price adjustment is usually hard to detect after an hour or two of trading. There certainly is no long-term impairment to the price of the stock.”
Moreover, I wrote extensively on the subject in a previous article found here. However, since this article is focused on total return I thought it would be useful to elaborate on how total return is comprised, calculated and produced. Since a picture is worth 1000 words, I will utilize the F.A.S.T. Graphs™ Fundamentals Analyzer Software Tool to illustrate how total return on a common stock is accomplished. I will use a few quintessential examples of companies that are included on my list of fairly valued growth and income candidates that will be produced later in the article.
Stanley Black & Decker Inc: (SWK)
Stanley Black & Decker, Inc. provides power and hand tools, mechanical access solutions, and electronic security and monitoring systems and products and services for various industrial applications.
The following 15 calendar year graph on Stanley Black & Decker plots its monthly closing stock price (the black line) and earnings (the orange line). Notice how the stock price tracks and closely correlates to earnings. Additionally, notice what happens when the price line disconnects from earnings and moves either above the orange line or below it. Inevitably, it moves back into alignment. This relationship of price-to-earnings is what establishes the capital appreciation component of total return.
In sophisticated terms, this represents how the market sets the company’s stock price by capitalizing earnings. By