Finding Value In This Market

It’s good to be back! Echoing some of the sentiment I noticed in the comments on this blog recently, it seems that us dividend growth investors have been hesitant to deploy capital over the last few months. I share those circumstances, albeit not totally because of expensive stocks. It seems that if any time was a good time to take a break from frugality and investing, the last few months were that time.

The DJIA is up over 1,000 points over just the last two months. At the beginning of June, the Dow Jones was sitting just above 12,000. As of this past Friday, the DJIA closed at 13,208. That’s quite a climb, and if you missed the occasional dip due to eurozone concerns or stories of slowing growth you now find yourself in the precarious position of sitting on some cash with limited opportunities to invest it. I certainly don’t have a giant warchest due to some decisions over the last couple months that I regret, but I do find myself with a little capital.

Valuation is extremely critical when considering whether or not to purchase a specific stock. It determines your overall performance on your investment including your total return and yield on cost. To be a successful dividend growth investor, one must not only consider company fundamentals, dividend security, yield, dividend growth metrics, sector allocation and the like before purchasing a stock but must also strongly consider the price you’re going to pay for that stock. Even the best companies in the world can be too expensive, and if you pay too high a price, even for high quality, you will suffer for it in the way of reduced yield and a low overall return.

I believe in purchasing stocks in high and low markets, on a monthly basis as I receive capital from my day job. This has been my modus operandi since I started this journey, and will continue to be until I’m finished. I believe in just about every market there are overvalued securities and undervalued securities. I don’t believe the market is completely efficient, and there will always be under-loved and under-followed stocks. When CNBC is clamoring for Wal-Mart Stores, Inc. (WMT) and interviewing the CEO and runs daily segments on what a wonderful stock it is, then you probably know that it’s not a great time to purchase WMT. On the other hand, if you can’t remember the last time anyone mentioned Archer Daniels Midland Company (ADM), then maybe it’s a good time to review the company one again and re-familiarize yourself with its fundamentals.

I plan on deploying some capital either late this month or early in September as my cash balance grows to the point where I can make meaningful purchases. Some of the stocks that I currently find value in, even in this expensive overall market, are as follows:

Aflac Incorporated (AFL)

Aflac is a supplemental life and health insurance company that operates in the U.S. and Japan. It was beaten down tremendously over the course of the summer of 2011 and hasn’t fully recovered since then. Being a financial stock in a post Great Recession world doesn’t help, but the tsunami in Japan and concerns over its bond portfolio are the primary factors for its weakness over the last year. I believe this is a solid stock as a long-term holding, and if I didn’t already have a healthy position in AFL, I would be adding at these levels. It currently trades for a P/E ratio of 8.39 and has a solid entry yield of 2.88%. The balance sheet is stellar and they have been engaging in moves to de-risk the bond portfolio in light of eurozone concerns.The 5-year dividend growth rate is 17.5%, which is very strong.

Archer Daniels Midland Company (ADM)

Archer Daniels Midland is one of the largest agricultural commodity companies in the nation. Its massive size gives it a strong distribution network, which helps the company create value for its shareholders. ADM currently trades at a P/E ratio of 14.14 and has a pretty decent entry yield of 2.70%. Although the yield isn’t fantastic, they are due for a dividend increase for November’s payout. ADM is highly exposed to any shifts in commodity pricing, so that makes them a little vulnerable. Overall, at $26 a share I’d be a buyer here. The debt/equity ratio at 0.4 is pretty strong and over time the size and scale of the business should allow room for organic growth and larger market share. This looks like a solid long-term holding. The 5-year DGR is 10.4%.

McDonald’s Corporation (MCD)

McDonald’s operates as one of the largest restaurant chains in the world. Through large economies of scale and strong growth opportunities abroad I feel there is plenty of great days ahead for MCD. Trading for a P/E ratio of 16.57, it isn’t dirt cheap but it’s a solid value for a brand name multinational business. The entry yield right now at at just over $88 per share is 3.17%. MCD has been growing dividends for 35 years, longer than I’ve been alive. The 5-year DGR is 20.4%, which is obviously very high. This is one of those companies I love to own a piece of because not only do I believe in them long-term, but I use their products often and it puts a smile on my face to know that I’m contributing to the success of one of my investments.

What about you? Where do you find value in this market?

Full disclosure: Long AFL, MCD, WMT

Thanks for reading.

Photo Credit: FreeDigitalPhotos.net

Comments

  1. says

    Great to see you back in the saddle. I’m looking forward to hear the juicy details about your hiatus. Frugality has been very good to me, but I too have had some big ticket items (plane tickets to family, an unfortunate lease situation with my apartment) that have been regrettable but I will just bite the bullet for now and keep my eye on the ball.

    Completely agree with ADM. I bought at around 26 myself. Agri will only become more necessary in the coming decades and they are investing marvelously in their international infrastructure, buying that port in Brazil and the facility in Poland. I like that stuff. Plus as you mentioned, you get a raise pretty soon which bumps your forward yield to probably over 3%.

    Happy Sunday.

    • says

      Joe,

      Haha. There isn’t many juicy details to speak of. Simply me not being very smart. But, now I am more dedicated than ever and truly believe down to my core in what I’m doing here.

      ADM seems solid here and it has surprisingly moved near the top of my watch list. Not a particularly exciting business, and certainly not an investment that will make you wealthy overnight…but seems like a solid value play right now. The exposure to commodities could be troubling, but certainly most large international companies have some commodity risk in some fashion.

      This one may be my next buy.

      Best wishes!

    • says

      Squeezer,

      It’s not a loss unless you sell. You picked up MCD at a strong price if you’re thinking about the long-term. It won’t matter all that much that you paid $92 per share instead of $89 per share when it’s 2040 and you’ve made your investment back twice over.

      Valuations are important, but it’s also important to remember to get an attractive price and hold for the long-term and not try to focus on getting the absolute cheapest price possible.

      Best wishes!

    • says

      $25,000,

      Great price there and good buy. MCD is very high on my list of potential purchases right now. There are few brand names out there bigger and better than Mickey D’s.

      I’m with you as well on averaging down. If it drops further from here then that just gives one a better price on a high quality company and would allow one to build the position further.

      Take care.

  2. says

    just sold my JPM which I picked up a couple of months back after the stock took a hit
    on their big trading losses. I was looking for a nice bounce back, but it was only a little one. still a profit and the risk/reward was starting to look more like risk.

    • says

      jlcollinsnh,

      Nice move there on making a little money off of JPM’s woes. Bank stocks are still a little iffy for me right now, but getting in and out quickly might be the way to go if banks are up your alley. WFC and USB look okay here and are the only big banks I track. I own SBSI, a small bank in Texas.

      I hear you on the risk/reward profile leaning more towards risk. Nice move on making your profit and getting out.

      Best wishes!

  3. says

    I’m about to publish a stock report on Aflac on Monday. The conclusion is: risky but undervalued. I wouldn’t call the balance sheet stellar, because really the only downside to the whole company is their balance sheet problem, which is European debt exposure. $5.6 billion in exposure is still a problem. But, it’s on my watch list now and I might pick up some shares.

    As for McDonald’s, I definitely agree. For that level of safety and growth, the stock price looks good. I would increase my exposure at current prices.

    • says

      Matt,

      Excellent point there. I should have clarified my stance on the balance sheet in regards to debt to finance operations instead of the debt exposure as part of the investment portfolio. Insurance companies can be a little tricky there.

      I just read your report on AFL and it was excellent. If I didn’t have a fairly large position (for me) which I purchased when it was in the low $30’s, I’d be buying here…even with the risk from PIIGS bond exposure.

      I’m with you on MCD as well. Safety and growth, with value and a pretty strong entry yield…it’s hard to find all those wonderful qualities wrapped up in one pretty package.

      Best wishes!

  4. says

    Welcome back Dividend Mantra! I was very happy to see you posting again.

    I believe you can find undervalued stocks in almost any market conditions. The market can do what it wants, I focus on specific stocks and wait patiently for them to become undervalued.

    • says

      Kanwal,

      Thanks for the kind welcome back!

      I’m with you. Mr. Market presents the patient and smart investor with opportunities all the time. I think that while the overall market right now is a little pricey, there are values to be found as I discussed above.

      Take care!

  5. says

    Nice post, DM. I agree that those three stocks represent pretty good value in the current market. I am considering adding to my positions in ADM and MCD. I am also watching AFL, but my general aversion to financial stocks will likely keep me away from it for the time being.

    Given the recent market rise that you mentioned, I am hesitant to deploy any cash right now, so I may just stay on the sidelines for the rest of August. However, I suppose it all depends on what Mr. Market offers me in the coming weeks.

    • says

      deedubs,

      MCD and ADM are both pretty strong values right now, in my opinion. I pulled the trigger on one of them today…which I’ll discuss very soon. It was a close call!

      I hear you on being hesitant to deploy cash. Even though the above list of stocks represent strong value, even they will fall further if the overall market takes a significant dip. Of course, that’s the risk that equity investors face every day.

      Best wishes.

  6. says

    Welcome back!

    I was actually going to write a blog post myself about the current market conditions and why I haven’t been making many new purchases as of late. Seems like you have that well covered here!

    I’ve also been looking at AFL, and am kind of kicking myself for not pulling the trigger when it dipped below $40 a few months back. Although the market does currently seem kinda pricey, I agree that you can probably still find value in it. I suppose this time around I’ll try and be a little more patient and wait for that ever anticipated next dip.

    Happy hunting!

    • says

      FI Fighter,

      Hey, you can still write that article. I look forward to reading it if you do!

      Great job on your budgeting, by the way.

      AFL still represents value here. If I didn’t already purchase my lot in the low $30’s, I’d be all over it.

      Patience will serve you well. I’m patient as well, but at the same time I like to pick my spots throughout the month when I feel confident about a company and how it fits in my Freedom Fund.

      Stay in touch!

  7. says

    I have no formal Education in Finance / Economics. Therefore I look at Screener
    “Undervalued Predictable Companies – Discount Cash Flow And Discount Earnings”.
    AFL is @ top in the list. I study Value Investment Newsletters to improve my understanding about businesses. I am an Option Trader but work exclusively with Stock Fundamentals with VALUE. Therefore I am a Value Investor but with A Trader Twist. I buy the Undervalued Predictable Stock (LEAP Call Option) & sell it after market makes improvement in Value towards Normal. This creates price improvement & therefore Profit. I am Long AFL in profit. Thanks a million for demonstrating your wisdom to us (Newbies) & creating the Blog.

    • says

      Sunil Singh,

      Great strategy there. It sounds like you basically try to purchase a stock when it’s trading below its intrinsic value and then sell when it reaches a pre-determined price (value). Certainly a great strategy that many value investors have used over the decades, and you mix options in there.

      Good to hear that AFL made it to the top of your value screener. I also find a lot of value in that name right now.

      Thanks for stopping by and offering up that bit of wisdom on your value-based strategy I hope you stick around.

      Best wishes.

  8. MCM says

    How does it feel to be mentioned with the greats who came out of retirement to dominate? Michael Jordan, Lance Armstrong, Jay-Z and Dividend Mantra…

    • says

      MCM,

      Wow! I think that’s one of the most awesome things anyone has ever said to me. I really appreciate it. I guess I’ll try to bring back #23!

      Thanks again, that was really awesome. Made my day.

      Best wishes!

  9. says

    Welcome back. I had missed reading some of your posts. I like your three picks as well. I actually added MCD to my portfolio this morning and sold some ADM puts last week. All 3 are solid companies to own long-term IMO. If I didn’t already own TWGP I’d be looking for pickup AFL at some point in the near future.

    • says

      austinbroker,

      Thanks for the kind words. I also stop by your blog as well and you’re doing great!

      It sounds like we’re on the same page with MCD and ADM. I don’t follow TWGP very closely, but maybe I need to start now.

      I look forward to continuing to follow your journey.

      Take care!

  10. says

    Dividend Mantra–A question if I may.

    I’m almost age eligible to remove monies from my Roth IRA. Could I take some of those monies, buy a rental property, and then the monies I receive in rent be tax free?

    Thanks in advance.

    • says

      Michael,

      That’s a great question. I’m far from any type of expert on real estate, but once you take the money out of your ROTH, it’s yours free and clear and you can do what you wish with it. Now, what you do may create a taxable event. Rental income, as far as I understand it, is a taxable event but how much, if any, will also depend on your state.

      I would suggest a tax expert on that one. I hope that helps.

      Best wishes!

  11. says

    Wow, it’s good to see you’re back! awesome

    I’ve also been looking at ADM, it seems to me that if you want to own the company now would be a pretty good time to get in. I think the dividend increase might be smallish this year because of the drought. It’s just a hunch. MCD is tempting as well.

    • says

      CI,

      Thanks for that. It’s great to be back!

      I agree. ADM does present some pretty solid value right now. It’ll be interesting, as you point out, exactly how much the drought will affect them. Definitely something to watch.

      Take care!

    • says

      Mike,

      Thanks so much. Very, very kind of you. I’m glad you decided to keep checking and stay in touch. I was wondering how many people would stop by after I started posting again. I’m really glad to see that I still have loyal and passionate readers. It means a lot to me!!

      I hope your journey is going great!

      Take care.

  12. says

    Mantra,

    Not only did you come back, but you came back with a bang!! What a great post.

    I completely agree with you in this post. Although I would have preferred to purchase equities in May, averaging in those positions over the long run is the way to go. In fact I found myself sitting with a wack of cash in my RRSP (like your 401K) and wonderin what on earth to buy – but the big U.S. Blue Chips looked oh so expensive. SYY was certainly on the list, and wish I bought 125 shares last week. Instead I just averaged into my existing positions, which actually is a good thing as it really builds up my DRIPs.

    Had I known KO was going to split, I would have waited and bought 100 shares. ;)

    Keep up the good work Mantra, nice to have you back.

    Cheers
    The Dividend Ninja

    • says

      Ninja,

      Thanks so much for stopping by and your support is much appreciated, as always!

      SYY was fourth on the list and I started writing about it, but had to cut the article off at some point. The thing that concerns me about SYY is the FCF payout ratio. I think it’s a fine company that will prosper long-term, but the FCF issues are still there. It had a nice pop recently.

      I’m glad to see you still doing a great job with the blog. Keep up the great work!

      Best wishes!

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  14. says

    I find that the best indication of how undervalued a stock is is the price to sales ratio or what is commonly referred to as market cap.

    Simply stated. If a company does 1 billion in annual sales but it has a market cap of 100 million dollars than the price to sales ratio is ten to one. In other words the market is valuing a company that does 1 billion dollars in annual sales at just 100 million dollars. But what does this mean. It means everything if you are a classic value investor.

    Here is a perfect example of why the price to sales ratio is so very important if you are a value investor in stocks. If our 1 billion dollar company is breaking even that is they are not making a profit nor losing money. Lets say the company has 250 millon dollars in long term debt and 80 million dollars in cash. We will say they are in the food business they make a wide aray of food products. Maybe the company did a buyout of another company a few years ago that did not work out as well as expected. So thats why the company is having trouble making a profit but things now seem to be moving in the right direction. If I purchase shares in the company for say 10 dollars. And over a five year period the company improves their earnings performance to the point where their now earning say 60 million dollars on sales of one billion two hundred million dollars. Thats a profit margain of 5%. If the stock were to now trade at twenty times earnings that would now mean that the price of the stock would be at 120 dollars a share or another way to put it the marketcap is now one billion two hundred million instead of 100 million.

    The problem for me is not that this investment method is not effective it works great. I purchased seaboard stock back in 2000. I think it was for 190 dollars a share around that. I following the exact method I describe above. I sold my shares about five years later for 2500 dollars yes thats correct 2500 dollars or more than twelve times what I paid for the shares. Seaboard was profitable when I bought it and profitable when I sold it. The stock was just a great undervalued stock that was overlooked by investors.

    Like I was saying before the problem is not with this investment method. Its that stocks like seaboard are very rare indeed theirs just not a whole lot of quality companies out their selling a very low price to sales ratios. Another issue that I have been having is when a company of decent quality trades at a very low price to sales ratio its not long before a private equity firm or the family of a family owned company takes notice and usually makes a low bid for the shares and takes the company private preventing me from realizing the enormous gains that mght have been possible had I not been forced to sell my shares out to a party that was making a very unfairly low offer for the shares of the company.

    Another thing to keep in mind when it comes to value stocks that have a low price to sales ratio that could give the buyer a tremendous advantage is this.

    I mentioned earlier that are food company had 80 million dollars of cash on their balance sheet now if the company choose to they could buy back a large chunk of their stock maybe 30 million dollars worth of the shares outstanding it would only cost them 30 million dollars they still would have 50 million dollars of cash left on their balance sheet. This means that under the positive earnings outlook for the company the stock price could even be much higher than 120 dollars a share. If the company were to retire a large percentage of their exsisting shares in a stock buyback.

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