What Are You Buying?

This is the third time I’m posting an article where I ask readers what their near-term purchases might be. I’m keen on making sure this blog is an interactive experience. I really enjoy sharing ideas with you readers out there as mutually learning from one another is one of the main purposes I commit myself to this blog.

The market has experienced quite a run-up lately. The S&P 500 is up 13.58% over the last month which leads me to believe that a downdraft in the market might be just around the corner. I’m certainly hoping there is, anyway. A lot of the stocks I keep on my watch list, which includes my own portfolio, are up quite a bit and a few of them are simply priced out of my buy range right now. But, one of my mantras is to purchase dividend growth stocks every single month with the funds that are left over after paying my expenses. This is my form of forced savings and dollar cost averaging. I do try, however, to purchase more when the market is down and less when the market is up. I do believe that in any market one is able to find attractively valued businesses relative to the overall market as I do not believe in the efficient-market hypothesis.

The list I’m going to present includes stocks that I’m currently interested in adding to the Freedom Fund. I’ll receive my commission check early next month and will make a purchase sometime after that, the time frame of which depending on how the market responds. This list is in order of what I’m most interested in buying at the top.

Here’s my short watch list:

Raytheon Company (RTN)

Per Morningstar:

Raytheon is a major United States defense contractor with nearly $25 billion in annual sales that operates through six segments: integrated defense systems, intelligence and information, missile systems, network-centric systems, space and airborne systems, and technical services. Sales to the U.S. government account for more than 88% of the company’s total sales. Waltham, Mass., based Raytheon employs 72,000 people.

Raytheon was listed on my last article article where I shared what I was interested in. The reasons I was interested then still remain. It’s a defense stock, and being such has been beaten down due to fears over the reduction in defense spending. Overall, I think there is value here with a solid entry yield to boot. It trades for a P/E ratio of 8.58 and has a pretty decent entry yield of 3.95%. It has 7 years of dividend growth behind it with a 5-year DGR of 10.8%. It has a solid balance sheet and a debt/equity ratio of 0.4. It has a low payout ratio of just 33.9%.

*Morningstar values RTN at a 4/5 star valuation.
*S&P rates RTN as a 3-star Hold.

Medtronic Inc. (MDT)

Per Morningstar

One of the largest medical device companies, Medtronic develops and manufactures therapeutic medical devices for chronic diseases. Its implantable products include pacemakers, defibrillators, heart valves, stents, insulin pumps, and spinal fixation devices. The company markets its products to health-care institutions and physicians in the United States and overseas. Foreign sales account for about 41% of the company’s total sales.

Medtronic is a solid health care play, in my opinion. It’s been on my watch list for some time now and I think even though it’s had a pretty solid run-up lately, being up 6.74% over the last month, it’s still a pretty solid value for a long-term purchase. It’s a global leader in its space and is committed to global growth in key emerging markets. It’s trading for an attractive 12.37 P/E ratio with an entry yield of 2.73%. It has 34 years of dividend growth behind it, with a 5-year DGR of 19%. It has a debt/equity ratio of 0.5. The payout ratio is 33.4%, which leaves a lot of room for continued dividend growth.

*Morningstar values MDT at a 4/5 star valuation.
*S&P rates MDT as a 3-star Hold.

Kinder Morgan Inc. (KMI)

Per Morningstar:

Kinder Morgan Inc. owns the general partner, incentive distribution rights, and an approximate 11% interest in the limited partner units outstanding of Kinder Morgan Energy Partners. It also owns a 20% stake in NGPL, a major interstate natural gas pipeline. 

This one might be an interesting play. It’s hard for me to completely value KMI, as they own the general partner of the master limited partnership of Kinder Morgan Energy Partners. MLP’s are a bit difficult for me to totally value, and they operate under different circumstances from normal corporations. KMI was taken public earlier this year, after being taken private back in 2007. Now that it’s back on the market there are a lot of investors really interested in this play as they have a large interest in KMP, one of the largest pipeline operators in the world, with over 37,000 miles of pipelines. One of my readers, Joe, and a fellow blogger Dividend Growth Investor have peaked my interest in this company. It has an attractive entry yield of 4.12%, and the dividend growth of KMP ensures solid growth with KMI.

*Morningstar values KMI at a 4/5 star valuation.
*S&P currently has no rating for KMI.

General Dynamics Corporation (GD)

Per Morningstar:

Falls Church, Va.-based General Dynamics manufactures ships, armored vehicles, defense-oriented information technology systems, and business jets. The firm gets around 72% of revenue from the Department of Defense and the rest from foreign sales and Gulfstream business jets. In 2010, the firm generated $32.4 billion in sales and $2.6 billion in earnings. 

General Dynamics is a solid industrial play, in my opinion. They are one of the largest defense companies in the world, and as with RTN, the projected and assumed slowdown in defense spending has left shares with GD under performing the overall market. GD shares currently trade for a P/E ratio of 9.12 with an entry yield of 2.87%. It has 20 years of dividend growth behind it already with a 5-year DGR of 16%. The debt/equity ratio is 0.2. Currently, the payout ratio is 26%, which leaves a lot of room for future dividend growth. I think this is a solid defense stock, but I like RTN a bit better as the entry yield is higher and the fundamentals are similar. I’m interested in both, however.

*Morningstar values GD at a 4/5 star valuation.
*S&P rates GD as a 3-star Hold.

That’s my list. What are you buying?

Full Disclosure: None.

Thanks for reading.

Comments

  1. says

    Hi there mantra,

    How do you determine if KMI’s is sustainable long term? I have a difficult time analyzing pipeline and utility companies due to their high capex and debt. I just don’t understand, please enlighten me cause it’s driving me crazy!

    As for purchases, I like MDT, DE, MSFT, & QCOM.

  2. says

    Henry,

    To look at the ability of KMI to stay sustainable, you must look at the ability of KMP to stay sustainable, which is highly likely given the business they are in. KMI doesn’t have any debt, but KMP does. I think KMI, overall, is probably a good long-term play. I do understand their business and I think it’s a great business, but it’s my lack of experience with this type of business that has kept me on the sidelines up until now. We’ll see.

    I like your buy list. I’m surprised to se DE up there, as you don’t like debt and I think they have a relatively high amount of it. Their debt/equity ratio is 2.1. MSFT becomes more and more interesting, but I do like INTC better on the tech side. MSFT hasn’t had as much a run-up over the last month as INTC has though.

    Let me know how your buys go!

  3. says

    Mantra,

    It’s true, I do not like debt. There are several companies in my portfolio: CL, PM, IBM, CAT, DE & YUM with debt/equity over 1.0. But they all have high operating cash flow, enough to cover any short term debt due.

    I’m still confused about KMI. Last I checked, they had $15 billion in total debt. KMI’s business model is fantastic, they’re basically a toll road. Like you, I don’t fully understand the business so I’m hesitant to make an investment. As for sustainable, I meant the dividend. How do you go about analyzing that? Thanks!

    - Henry

  4. says

    Henry, when you look at the balance sheet of KMI, less than 3B of the debt is owned by KMI (the rest is on KMP balance sheet). It isn’t a straight forward investment like typical corporate common stock.

    The real kicker for KMI is the incentive distribution rights (IDR). The 11% ownership entitles KMI to 45% of the distributable income. This means that KMI can increase its dividends faster than KMP. Here’s a clip from a recent Morningstar valuation report which mentions the growth opportunity:

    Valuation
    Our fair value estimate for Kinder Morgan Inc is $33 per share. This reflects an 80% chance that the merger goes through, in which case our estimate would increase by a dollar. Our standalone fair value estimate is $27 per share. In our base merger case, we model all of El Paso’s pipes dropped down to KMP and EPB by 2015, and assume that two thirds of the assets go to KMP. Based on our numbers we see cash inflows from KMP accounting for roughly 57% of 2012 cash flows and increasing to 70% of cash inflows by 2015. On average we expect El Paso’s contribution to KMI to be roughly a billion a year, whether counted as dividends from EP before its assets are fully dropped down, or from KMI’s ownership of EPB and its general partner. We think KMI can afford to increase its dividend at an average annual rate of 13%, and is likely to declare $1.38 per share in 2012 compared to an annualized $1.20 currently.

  5. says

    For my part, I bought some NYSE:AT today. Pretty boring, a electric utility that pays an 8% dividend monthly. Management says its going to increase it 5% before the end of the year.

  6. says

    Henry,

    sfi said it better than I can. Thanks for adding that value added comment, sfi. The incentive distribution rights are very important here when reading into the sustainability of dividend growth.

    This is certainly not the usual straightforward investment, and it would be a bit outside my normal comfort zone, which tends to be pretty conservative. I’m keeping my eye on this one.

    sfi: Interesting choice there. A monthly dividend paying 8%. Pretty nifty!! That’s a pretty aggressive investment, no?

    Thanks for stopping by!

  7. says

    Rene,

    Great choice. I’ve looked at NUE a few times recently. It’s an interesting choice, and good exposure to steel but the declining (negative) earnings scare me a bit. It is, of course, a cyclical business. I know there are fans out there, and D4L comes to mind, but I just haven’t felt compelled on this one.

    What’s your thoughts on NUE going forward? They have had a long history of dividend growth, despite their extreme cyclical nature.

    Take care!

  8. says

    Thanks Mantra & SFI,

    I’ll continue to look into KMI. However, I still don’t fully understand the general partner set up so KMI is a pass for now. There are plenty of quality dividend companies to buy. Maybe we’ll all get to do some Black Friday shopping in the market this month!

  9. says

    Henry,

    I agree that if an investment is not totally understood then it’s a good idea to stay away. I’m becoming more comfortable as I continue to study KMI, but it’s definitely different from what I’m used to, and a bit more aggressive.

    I hope you’re right about some Black Friday specials!!!

    Take care!

  10. Anonymous says

    Hey D Mantra,

    Interesting potential choices. I’m looking at RTN n LMT in the defense sector. Although I do think there will eventually be some defense cuts (given the deficit situation), I think this has already been priced into the stocks. And as is usual in these situations where the market overrated to legit concerns, these stocks are probably underpriced.

    I still have INTC on my watchlist but might have missed the boat as I watched to purchase @ $ 20-22.

    I recently bought RY-N. I’m bullish on banks North of the Border as they’ve avoided the shenanigans that caused problems for the big US banks. Their conservative balance sheets and Canada’s tighter banking rules make them divvy positions I can sleep well with at nite.

    Take care.

    -Rock the Casbah

  11. Anonymous says

    Sorry typos to above. “overreacted” instead of “overrated” and “wanted” instead of “watched”. Getting too tired.

    -Rock the Casbah

  12. Max says

    Hey Mantra!
    Greetings from Germany! I enjoy reading your blog. I am about your age and my income and portfolio have about the same size as yours.
    I am investing in big dividend paying companies but my main focus is on the European market. I also like small German companies with perfect balance sheets which is a bit more risky.
    One recommendation to you would be Munich Re, the biggest reinsurer in the world. This year is terrible for them (Japan, New Zealand, Greece,…). They have already written down the entire Greek sovereign debt in their investment portfolio. Hopefully, there are no more surprises… They have a low market to book ratio (0,86) and a high dividend (>6%, payout ratio normally ~45%). Dividend growth rate 5years is 23,52%. They want to keep the dividend steady despite all the problems. Warren Buffett is Munich Re`s biggest shareholder with more than 10% of the company.
    Max

  13. Anonymous says

    Mantra,
    My statregy is to purchase stocks with a yield over 2.5% which have a high dividend value score, which is basically yield times earnings divided by the sum of price and debt per share. My portfolio is weighted to match the dividend value score. I am still in the accummulation stage to fill out the weighting. My next purchase is Microsoft.
    Ken

  14. says

    Rock,

    I agree. I think a lot of the anticipated defense cuts are already priced into these stocks. I think there is limited downside by purchasing at current levels, especially with the high yields they’re offering. LMT has an especially high yield, but I’m a little concerned about debt/pension issues as well as their high price/book ratio.

    I hear ya on INTC. That one ran away from quite a few people, but I still think it’s a good value…just not as good as it is around $21-22/share.

    I agree with you on the Canadian banks. There’s a lot of solid picks up there with the solid balance sheets.

    Thanks for stopping by!

  15. says

    Max,

    Thanks for stopping by. That’s really great that we are both in the same age range as well as income/portfolio size. It sounds like you’re doing a great job and I wish you all the best.

    On Munich Re, the problem is that it’s not available on an American exchange as an ADR…at least not that I’m aware. Purchasing stocks from foreign markets directly adds a bit more risk than I’m willing to take on at this time, but it does sound like a great investment opportunity.

    Best wishes for you in the future and please keep in touch! Thanks for your support.

  16. says

    Ken,

    Interesting system you have there. Is that your own? I’ve never heard of that one before. Pretty good stuff. What, in your portfolio, currently has the highest dividend value score?

    On MSFT, I have in the past not been a fan. But, it seems that they are becoming more and more dividend friendly and they will likely be a large player in the cloud market. This one has become more interesting and there have been some positive reviews lately from D4L and The Dividend Pig. They have a ton of cash and have been generous with dividend increases. I see quite a few opportunities right now and have limited capital, but this one looks good.

    Thanks for stopping by!

  17. Anonymous says

    Mantra,

    I developed the dividend value score to reflect a desire to own stocks that have a nice yield and are relatively cheap. Price to earnings ratio is the typical value parameter, so I modified it to reflect that earnings must also service debt. The score also includes dividend growth and return on investment to extrapolate past dividends and earnings into the future. Of course, I also look at companies qualitatively.

    Having a score is most useful for deciding which stock to purchase each month out of my 25 stock portfolio. I look for the largest difference between the target investment based on the dividend value score and the actual amount invested for each stock. I believe this procedure provides diversity while insuring stocks are bought when they a relatively cheaper.

    The top five stocks in my portfolio by dividend value score are in order Lily, Intel, Chevron, Microsoft, and ConocoPhilips.

    Ken

  18. says

    Ken,

    Thanks so much for the response. I agree with you that maintaining the ability to service debt and keep it low for valuation purposes is important. I also agree that it’s important to look at companies qualitatively as well.

    That’s an interesting way to come up with a valuation. I’ll have to try that out!

    Top 5 doesn’t surprise me too much. Low valuations in oil, as is historically true and the big tech stocks are also trading low valuations.

    Thanks so much for sharing. I can agree with you that MSFT seems to be a compelling purchase right now in the tech space.

    Best wishes!

  19. says

    Im buying Philip Morris this month. Some reasons:
    * Volumebased taxsystems create pricefloor and prevents lowprice competition.
    * Tobaccomarketing is forbidden in many channels. This makes it hard for new competitors to enter (again they cant compete on price)
    * Static demand, priceincreases gives little effect on volume.

    In the US tobaccoconsumtion has been decreasing for decades but tobacco companies has been doing fine thanks to price increases. Pricing power is nice since it doesnt demand new machines or any other cost. This means big effect on bottom line.

  20. says

    Sure there is regulatury and healthawareness risks. But its not like tobacco was unaffected by these factors earlier. Altria has been the best stock the last 50 years. Despite public realisation of dangers. Despite entrance of warningsigns and despite big tobaccotaxes.

  21. says

    defensiven,

    Great pick. I’m very long on PM as one of my largest holdings. It’s one of the only companies in the world I’d invest in that has the debt/equity ratio it has. It’s a cash machine, so I’m ok with that.

    I look at it like this. Altria has been the best performing stock on our market for the last 50 years, experiencing a lot of growth here in the U.S. PM will experience a lot of growth in emerging markets where cigarettes are still a fraction of what they cost here. It seems like “a little bit of history repeating”.

    I like PM, but I do prefer getting in at the mid-$60′s or so when I can. I can see PM being an outrageous performer over the next 20 years or so. I’d like to keep it at a high percentage of my overall portfolio, and would probably target as high as 7% long-term, even as I grow my total positions. Great yield, large margins, inflation-proof, wide moat, lack of competition, market leader in almost every market they compete in…what’s not to like?

    Best wishes!

  22. Anonymous says

    Be careful about any defense contractors, particularly RTN. When the cuts come, it’ll be mostly in R&D not O&M, so if you’re a company developing systems vice providing bombs and bullets, you in for a number of lean years.

  23. says

    Anonymous,

    Thanks for stopping by and commenting.

    Don’t forget that RTN produces missiles.

    I have actually been looking a little stronger in the direction of LMT. I have, in the past, not been a fan due to the debt load and the unfunded pension issues, but the high yield and F-35 contract does provide interest.

    Also, by purchasing them in November I’ll receive a dividend at the end of December. RTN won’t pay out until next year. We shall see.

    Thanks again for stopping by.

    • Anonymous says

      Based on my understanding of price to earnings value I feel T is a good buy now.

      I also don’t think that people will be giving up their smart phones anytime soon. S

      Do you concure?

      Chris

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