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.
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Coho Capital commentary for the second quarter ended June 30, 2020. Q2 2020 hedge fund letters, conferences and more Dear Partners, Coho Capital returned 46.6% during the first half of the year compared to a loss of 3.1% in the S&P 500. Many of our holdings, such as Netflix, Amazon, and Spotify, were perceived beneficiaries Read More
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 on Abbott Labs clearly illustrates the consistent and currently above-average dividend growth this blue chip has generated. Once again we see impeccable operating performance resulting in inexplicable poor price-performance.
Although Abbott Labs has generated above-average shareholder returns, the current low valuation of stock price has temporarily muted the company’s potential. However, dividend growth has remained consistent throughout this time period.
The estimated earnings and return calculator shows that Abbott Labs’ stock price sits on the lowest rung of the valuation corridor. Therefore, this blue chip appears to be undervalued at today’s prices.
VF Corp. (VF)
VF Corporation is a global leader in branded lifestyle apparel with more than 30 brands, including Wrangler®, The North Face®, Lee®, Vans®, Nautica®, 7 For All Mankind®, Eagle Creek®, Eastpak®, Ella Moss®, JanSport®, lucy®, John Varvatos®, Kipling®, Majestic®, Napapijri®, Red Kap®, Reef®, Riders® and Splendid®.
The logarithmic graph on VF Corporation illustrates a very consistent and slightly above-average growth rate. However, the market has typically undervalued their shares based on the historical normal PE ratio plotting below the orange earnings justified valuation line.
The standard scale graph on VF Corporation (VFC) depicts a solid record of earnings growth with only one hiccup in 2009. Also, the company started out undervalued based on its earnings record, and appears ever so slightly overvalued based on historical results.
The associated performance results on VF Corporation illustrate how powerful returns can be when the quality company is purchased at a below valuation level. Even though their historical earnings growth rate is the second lowest of this group, thanks to valuation moving from low to moderately high, VF Corp. offered the strongest total shareholder returns.
The estimated earnings and return calculator on VF Corp. shows that the company is fairly priced based on an estimated 12% future earnings growth. However, prospective investors should at least consider that the market has historically undervalued shares. This doesn’t mean that the company is a bad buy now, only that it’s not as inexpensive as it often can be.
United Technologies Corp. (UTX)
Based in Hartford, Connecticut, UTX is a diversified company that provides high technology products and services to the aerospace and building industries worldwide.
The logarithmic graph on United Technologies Corp. (UTX) depicts a company that the market has typically priced in almost perfect concert with its operating results. Clearly, the ideal time to buy this company was when the market was undervaluing it during the great recession of 2008 and 2009.
The standard scale graph on United Technologies (UTX) shows that this aerospace and defense company remained profitable during the recession, even though earnings fell slightly. However, the company’s dividend continued to increase thanks to a strong balance sheet and cash flow generation.
The associated performance results on United Technologies illustrates how earnings and rate of return will correlate when the market appropriately prices a company.
Estimated earnings and return calculator on United Technologies show that the company is very reasonably priced. This is especially true considering that of this group of five dividend growth stocks, United Technologies is expected to grow the fastest.
Stryker Corp. (SYK)
Stryker (SYK) is one of the world’s leading medical technology companies and is dedicated to helping healthcare professionals perform their jobs more efficiently while enhancing patient care. The Company offers a diverse array of innovative medical technologies, including reconstructive, medical and surgical, and neurotechnology and spine products to help people lead more active and more satisfying lives.
The logarithmic graph on Stryker Corp. (SYK) depicts a company that the market had once overvalued but has more recently priced this blue chip company in line with earnings growth. Most importantly, here we have an example of a company whose operating performance continued to grow while stock price fell.
The standard scale graph on Stryker Corp. shows that this company is morphing into a dividend growth stock from a pure growth stock. Clearly, the payout ratio depicted by the light blue shaded area has been steadily increasing.
The associated performance results on Stryker Corp. show above-average shareholder returns thanks to strong earnings growth even though valuation started off high. Also, the dividend growth rate has been very high thanks to a combination of strong earnings growth and an increasing payout ratio.
The estimated earnings and return calculator on Stryker Corp. shows the company to be very attractively valued at today’s prices.
PepsiCo Inc. (PEP)
PepsiCo (PEP) offers the world’s largest portfolio of billion-dollar food and beverage brands, including 19 different product lines that generate more than $1 billion in annual retail sales each. PepsiCo’s main businesses — Quaker, Tropicana, Gatorade, Frito-Lay, and Pepsi Cola — also make hundreds of other enjoyable foods and beverages that are respected household names throughout the world.
The logarithmic graph on PepsiCo shows very consistent earnings growth right through the great recession of 2008 and 2009. However, this graph also illustrates a more pessimistic attitude regarding their stock price notwithstanding their continued its strong operating performance.
The standard scale graph on PepsiCo (PEP) shows that the market has been pricing the company in line with its earnings growth since calendar year 2009. This does show a change in investors’ attitudes, as this blue chip has typically been awarded a quality premium prior to the great recession.
The associated performance results on PepsiCo Inc. shows that solid operating performance in the consistent dividend growth rate rewarded shareholders since calendar year 2006. The shareholder returns were achieved in spite of a change in investors’ attitudes regarding evaluation of their shares.
The estimated earnings and return calculator on PepsiCo shows the company to be perfectly valued at today’s levels based on analyst consensus estimates. This can especially be a good time in accumulate the shares if one believes that the market may once again apply a premium valuation to this blue chip’s shares.
The F.A.S.T. Graphs™ pictorial review of these five attractively valued blue-chip dividend growth stocks clearly illuminates the dual performance records that companies possess. Price-performance is not always indicative of a company’s True Worth value ™. The second performance measurement, operating results or earnings growth, which most leading investors consider the most important, is also mostly ignored. However, we are hopeful that this article illustrates the value that a clear perspective of both performance measurements provides. Which is why I contend: “measuring performance without simultaneously measuring valuation is a job half done.”
Although the graphic presentation provided by this article provides essential fundamentals at a glance, the reader is encouraged to look deeper into each of these six dividend growth selections. Importantly, since each of these companies will soon be (or already has) reporting earnings, a special emphasis should be placed on those reports. However, most importantly, we encourage the reader to measure the actual results against any hype and or hysteria that may manifest as a result of these companies’ earnings announcements. Any stock price volatility that may occur could represent an excellent opportunity to build positions in these selections. On the other hand, if the earnings announcement stimulates a significant increase in price, caution would be in order.
Disclosure: Long INTC,ABT,VFC,UTX,SYK,PEP
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.