Wednesday, September 16, 2009

* Finding Dividend Stock Gems In An Overbought Market

Last week I wrote about how dividend stocks were getting expensive and the number of stocks that my model identified as a buy were diminishing. After another week of the market rallying, the number of stocks identified as a buy fell to 4 stocks from 7. So what do you do if you are over-allocated in the four stocks that are a buy?

If you practice asset allocation and dollar cost averaging, as I do, having cash set aside to purchase stocks with no clear buy from an allocation standpoint certainly presents a quandary. When I am faced with this situation, I evaluate what is most important to me and continue to look for that.

In evaluating a dividend stock there are some items that I will not compromise on, such as:
  1. NPV MMA Differential: It must be positive and greater than $500.
  2. Free Cash Flow Payout + Debt To Total Capital < 100%: Cash is the life blood of dividend increases. If a company, is paying out most of its cash as dividends and/or is carrying high levels of debt, a dividend cut is very likely.
  3. Dividend Yield: Too high or too low of a dividend is risky. Too high and the company has a hard time maintaining it; too low and the company will have a hard time growing it at high enough rate to make the numbers work.
That leaves price available for compromise. As a dividend and value investor I want to have it all, but sometime that is not an option. I take heart that even the best investor in America has been where I am at. Consider his quote:
It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. -- Warren Buffett
With that in mind I currently categorize stocks that are potential purchases into two tiers:

Tier I: Four and five Star stocks that are trading below my calculated fair value with a yield above my preset minimum. These are the stocks I categorize as "buy" stocks.

Tier II: Four Star stocks that are trading less than 5% above my calculated fair value with a yield above my preset minimum. These are my "wonderful stocks at a fair price."

Sure I would like to buy them below fair value, but that is not always possible. If your holding period is forever, will an extra 5% make a lot of difference in 20 years? Consider these stocks I currently categorize as Tier II stocks:

Genuine Parts Co. (GPC) - Analysis
Genuine Parts Co is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products.
- Calculated Fair Value: $34.27
- Recent Price: $35.59

Emerson Electric Co. (EMR) - Analysis
Emerson Electric Co. primarily makes backup power equipment for telecom and Internet providers and users, climate control components, and electric motors.
- Calculated Fair Value: $38.39
- Recent Price: $39.38

Procter & Gamble Co. (PG) - Analysis
The Procter & Gamble Company (P&G) is focused on providing branded consumer goods products. The Company markets its products in more than 180 countries.
- Calculated Fair Value: $55.27
- Recent Price: $55.64

It is important to remember that just a few short months ago everyone was looking for a bottom. There will be other opportunities to buy great companies at a large discount.

Full Disclosure: Long GPC, EMR, PG. See a list of all my income holdings here.

(Photo: Steve Woods)

Tags: [EMR] [GPC] [PG]