Two Reasonably Valued Blue Chips

When I talk about “blue chip” stocks, I’m typically referring to shares in very high quality companies that have excellent, long-standing reputations for profitability during all economic cycles. A more narrow definition could be described as stocks that are tracked by the Dow Jones Industrial Average (DJIA). The two companies I’m going to profile below fit both definitions, and are trading for reasonable valuations despite the fact that they are really high quality companies with global scale and wide economic moats behind their businesses. I mainly invest in blue chips because I plan on living off the dividend income my portfolio spits out for decades, so I don’t want to have to worry about whether or not some of the companies I’m investing in will be bankrupt tomorrow. While there have been some blue chips over the last century that have gone bust (like Eastman Kodak Company), they are relatively few and far between and generally the decline is rather slow and painful rather than an overnight bankruptcy.

While both of these businesses are reasonably valued at today’s prices, keep in mind that one should still remain cautious about the broader market’s modest overvaluation, and due to this overvaluation prices could come down in the short-term on these two stocks and many other stocks in the market. However, I’m a long-term investor so I try to pay less attention to macroeconomic events and more attention to the individual quantitative fundamentals inherent with each company along with qualitative aspects that give me confidence in the ability for a company to continue operating profitably well into the future.

Wal-Mart Stores, Inc. (WMT)

Wal-Mart needs no introduction. Or at least I hope it doesn’t. This is a $240 billion global retailer juggernaut, with over 10,000 stores under it’s banner. With a P/E of just 14.33, I believe an investor has an opportunity to buy into one of the world’s best, and biggest businesses. The entry yield is just 2.56% at today’s prices, but that relatively lackluster yield is backed by 39 years of dividend growth and a 10-year dividend growth rate of 18.1%. Furthermore, the dividend payout ratio is under 37%, so there is plenty of room for further dividend growth. The balance sheet is attractive and stable, with a debt/equity ratio of 0.6.

Earnings per share have a compound annual growth rate of 10.58% over the last nine years, and I think WMT has plenty of growth ahead. Remember how they operate more than 10,000 stores worldwide? Well, only 393 of these are located in China. The most populous country on the planet. And try only 20 in India. That’s the other country with over 1 billion people. So, while they have saturated the domestic market to a degree, international growth is really in its infancy. So, the growth they’ve experienced, while phenomenal, is relatively handicapped by the fact that they haven’t yet taken full advantage of the company’s potential. While e-commerce is a threat, as are small retailers like the dollar stores, I feel that Wal-Mart is well positioned to counter e-commerce with the favorable deals they’ve been able to strike with suppliers which has led them to be a low-cost leader, and they also own a chunk e-commerce via their web sales. As far as small dollar stores go, WMT has been focusing on smaller stores to enter key markets they weren’t able to before. The sheer scale of this company makes me a believer, even though the history of retail is littered with companies that lost their former glory. I am currently invested in this company and interested in increasing my ownership stake if the price stays near today’s price of under $74 per share.

*Morningstar currently rates WMT as a 3/5 star valuation with a Fair Value estimate of $74.00.
*S&P Capital IQ currently rates WMT as a 4/5 star Buy with a Fair Value calculation of $81.30.

International Business Machines Corp. (IBM) 

While I’m admittedly not a big fan of the technology sector, I think IBM deserves merit and consideration here. It currently trades with a P/E of 13.18, and at a price not too far above where Warren Buffett bought a stake worth over $11 billion. He bought a large portion of his stake back in late 2011, but has been intermittently adding to it since. His purchase price has been estimated to be around $173 based on the trading range of the stock during the second and third quarters of 2011, and you have IBM shares currently trading for about $185 right now. Not too often do you get an opportunity to buy a stake in a company near what Warren Buffett paid. The entry yield stands at a fairly low 2.05%, but the 10-year DGR is 18.8% and IBM has raised it’s dividend for 18 consecutive years. With a payout ratio of just 27%, I believe dividend growth will remain strong for the foreseeable future. The balance sheet is slightly leveraged, however, with a debt/equity ratio at 1.5. EPS has a CAGR of 14.23% over the last nine years, which is extremely strong and no doubt helped by the large share buyback program IBM has long had in place.

IBM is a solutions company. They take problems that businesses have and create IT-based solutions for those problems. And that’s where IBM is a bit unique, and I think why Warren Buffett, traditionally extremely tech-shy himself, decided to take such a big bite out of this company. IBM has been able to create a moat around it’s business simply based around the fact that they are the best in the world at solving big problems for big businesses and once they implement their solutions, be it hardware and/or software, it’s hard to switch to competitors. And so, IBM has been able to dig a substantial moat based around high switching costs which were created because of unique business intelligence properties. IBM is also one of the best companies out there at putting long-term operational plans in place, most recently with the 2015 road map which dictates $20 EPS in 2015. Certainly there are risks here because technology evolves much quicker than other industries, but IBM has been a leader for decades even while the tech landscape has changed dramatically. They were able to switch from a low-margin hardware business to a higher-margin software and solutions company many years ago, so they are able to adapt. Overall, I feel IBM is one of the best picks in the tech sector and I’m currently interested in initiating a position over the next month or two if the price can stay relatively stable.

*Morningstar currently rates IBM as a 4/5 star valuation with a Fair Value estimate of $208.00.
*S&P Capital IQ currently rates IBM as a 4/5 star Buy with a Fair Value calculation of $229.20.

How about you? Interested in either of these high quality companies with high dividend growth?

Full Disclosure: Long WMT

Thanks for reading.

Photo Credit: pakorn/FreeDigitalPhotos.net

Comments

  1. says

    Well I bought some IBM on Friday so I guess you could say I’m interested. Bought some more WMT earlier this year as well. While IBM’s debt/equity is very large around 1.5 it’s not really as bad as it looks since they’ve started financing purchases for their customers so their own debt for the company is really about 1/7th of their total debt and the rest is debt by their customers. At least that’s the way I understand it from checking through some more reliable resources that have better knowledge of analyzing balance sheets and other financial statements. Revenue has been fairly flat over the last decade and EPS & DG have been propped up by the huge buyback program, so eventually something will have to give. Revenue needs to grow faster or EPS/DG will have to slow. One of the truly amazing things I discovered when analyzing the company is that their FCF after dividends (OCF – CAPEX – Div) has averaged over $11.9 billion over the last 5 FY’s.

    I’m tempted to scale back my INTC position a bit and redeploying the capital into IBM to get a balance between the two.

    • says

      Pursuit,

      Nice buy. I guess great minds think alike. :)

      Great point on the balance sheet. They are like CAT in that the balance sheet looks worse than it is because of financing operations. GE as well. Although I still prefer a more streamlined operation less financing if/when I can get it.

      Yeah, the revenue has been surprisingly stagnant over the last five years. Looking out over the last 10 years paints a slightly better picture, but not much. EPS has been supercharged by the buybacks, which is okay because it increases ownership percentages among existing shareholders and allows dividend growth to continue on a static revenue basis, but sales will have to pick up at some point. A lot of big businesses have been cutting back and IT spending isn’t immune, so I hope that IBM’s sales pick up as spending increases with a less anemic overall economy.

      I hope to join you as a shareholder soon!

      Best wishes.

    • says

      I know this doesn’t relate to WMT or IBM, but what’s your take on VOD? I know you have a pretty sizeable stake in them and I’m curious to see how you feel about them going forward. I had read through some comment streams on SA about management hinting at freezing the dividend, but haven’t gotten the chance to listen to the conference call. I can probably deal with a frozen dividend but what do you think about a cut on the way?

    • says

      Pursuit,

      Well, VOD hasn’t mentioned anything about a dividend cut and I don’t feel that one is on the way. But, they have had some struggles in the European market. What management recently stated in regards to the dividend is that they’ll look to at least keep it the same YOY, which is different language than they were using before, which was to raise it at least 7%. So, this appears to be opening the door for static dividend payouts. We’ll see. If that’s what happens then I’ll likely look elsewhere for a similar yield but better growth prospects.

      I hope that helps. :)

      Best wishes.

    • says

      Hey Pursuit,

      I’ve also sold my INTC position and I entered into WMT. Since then, I’m down 7% on my trade but that’s ok. WMT will continue to sell goods in 10 years, I can’t bet $10 INTC will sell computer chips though!

  2. Anonymous says

    I added more IBM on Tuesday and established a position June. An interesting pick. I wondered if IBM might make your portfolio.

    The first Wal-Mart shares found their way to my account in late January this your. Love the moat on this business.

    Like you, I intend to add to both position this your barring any surges in price.

    • says

      Anonymous,

      Great stuff! I certainly agree with you on buying at these levels. I’m not a huge fan of tech in general, but I think IBM fits well as a services company with high switching costs. Similar to ADP in that regard.

      I hope you found some value in the article, and glad to have you as a fellow shareholder in WMT. E-commerce is a threat, but I’m confident that WMT can thwart some of these issues with distribution, scale and e-commerce sales of their own.

      Take care!

  3. Spoonman says

    I’ve been adding heavily to my WMT position, especially after the recent pullback. WMT is as solid a company as they come, with earnings that nearly monotonically increase over time.

    The yield on IBM has simply never been high enough for my tastes. If it gets up to 2.4% or 2.3%, then I’ll probably add it to my porfolio.

    In any case, it’s good to know that the market is finally giving us more options to choose from. It has been a very challenging year overall, so opportunities like these should be cherished.

    • says

      Spoonman,

      I hope to add WMT very soon to my own portfolio as well. I’m long from a position I started quite a while ago, and am anxious to improve on that at what I consider to be an attractive valuation. Glad to hear that you agree. :)

      I hear you on IBM’s yield. It’s also what has largely kept me away. However, if they can keep up that tremendous growth rate the YOC can rise pretty quickly. That will either mean the price has risen as well, reflecting a still-low yield, or the yield has risen to the point to where adding more is a great idea. Either way, it’s a win.

      Hope you’re enjoying your weekend!

      Best regards.

  4. says

    Count me in with WMT. This name is near the top of my list for potential September purchases. I’m not sure about IBM though. If I had to explain how they make money I couldn’t do it. I’m not ready to own IBM stock at this time, but have never looked at it closely.

    • says

      Compounding Income,

      WMT is also high on my list for a September purchase. We just have to keep our fingers crossed that the price stays the same, or even better – goes down. :)

      I hear you on IBM. As far as technology companies go, IBM is actually one of the easier to understand. I think if you took the time to take a look at some of their reports you’d get pretty familiar. Plus, they’re not some dot-com upstart. They’ve been around for over 100 years. The biggest detractor for me is the low yield, however.

      Thanks for stopping by!

      Take care.

  5. says

    DM,great picks you propose here. Own 70 shs of WMT and will add to them very soon. I do not think the Price of WMT can go very much lower, although I Would sell them only if they’d remain too long under th 67 level.

    As to IBM, I was the happy owner until last year when I sold them around 195 or so, as I thought they would languish for some years, but after Reading your post, checked the Price target and ROR and decided now to buy them straight away on Monday. Target this year or next is around 250. I think near the 52 WL is a real good spot to be once more the happy part-owner. Was very impressed with their cáncer or other disease diagnostic software that if I remember well has a rate of 80% success for determining the right drugs to administer (doctors got only 50%).Thanks for all your work that pushes me not to fall asleep in my quest. Good to you. Aspenhawk

    • says

      Aspenhawk,

      Nice position with WMT! That’s about double mine. Good stuff!

      I really like both companies at today’s prices. If both stay the same or see continued weakness I’ll be interested in both for September. I’m hoping we see some further weakness in the broader market, which would likely drive the prices on these shares down even further. :)

      Best wishes!

  6. says

    I like both of the companies that you listed. But at present I find their starting yields too low for my tastes. But if their prices slide downwards and bring the yield up to at least 2.75% or so, I might consider buying one. I’ve been wanting to be a WMT owner for the longest time, but the stock has always eluded me.

    • says

      MFIJ,

      I’d love to get WMT at 2.75%. With a broader market pullback, it’s quite possible we get there. I’d be a happy investor at that level.

      Not quite so sure we see that kind of yield on IBM anytime soon, however. But if we do, again I’ll be very happy!

      The dividend growth behind the relatively low entry yield is obviously the attraction behind these names. I think a portfolio would be best served by diversifying between the low yield/high growers, medium yield/medium growers and high yield/low growers, where the sweet spot (and most of the action) is in the medium yield/medium growers. You get a little bird in the hand and bird in the bush with those.

      Cheers!

    • says

      Wallet Engineers,

      Glad to hear you’re a young investor. This gives you a lot of time to compound your wealth. If time is on your side, you’re sitting in a great spot. Good for you!

      I think younger investors like yourself are probably served best by the equities that have lower entry yields but higher growth rates, because you have the time necessary to let that investment compound over time.

      Best of luck to you. :)

      Take care!

  7. Anonymous says

    Took2summit here,

    Curious with people’s opinion of WMT vs TGT. the financials are very similar, the dividend yields are very similar, the growth in dividends has been similar, the valuation is very similar.

    Given all the above, I tend to favor towards TGT. The only reason is I feel 10x more clean when I walk into a target vs a walmart. I’m happy to shop in a target but while in a walmart I feel disgusting and like I’m in a third world country. Walmart has neglected their branding and the shape of their stores is severly lacking and meanwhile there are brand new, clean, up to date targets popping up everywhere.

    Out of the two companies, Target is definitely for me as I think the future growth also favors Target. Target is a $40b company while Walmart is a $240B company and Walmarts extra $200B in market cap doesn’t offer them any pricing advantage, Target has already reached any kind of economy of scale that Walmart can enjoy. Infact, in my opinion, Walmart’s extra $200B in market cap only hurts them due to the law of large numbers. I know this business is one where size matters, but as I said above Target is already receiving any economy of scale that Walmart is seeing.

    My 2 cents.

    • says

      Took2summit,

      I like Target too, however not as much WMT. Remember, TGT has been in business way longer than WMT has and WMT has been kicking their butts for the last 30 years. There has been nothing stopping TGT from growing faster (due to their lower market cap), and yet they haven’t.

      I like both retailers, and I think they both offer something a bit unique. As far as store quality, I think they’re very similar in that regard. The Super Targets that I’ve been in have been very similar to Wal-Mart Supercenters in terms of cleanliness and available merchandise. But WMT was markedly cheaper from my experience. Now, the smaller “core” Target stores have been cleaner than many Wal-Mart Supercenters, but there isn’t nearly the same type of traffic, employees or merchandise volumes. It’s comparing apples to oranges.

      Again, I like both. I wouldn’t mind investing in Target at today’s prices. But, I don’t think they are somehow inherently better than WMT simply because they’re smaller, and would actually take the opposite stance on that regard. Plus, WMT is just getting started in international expansion.

      Overall, I like both but would not feel compelled to favor the smaller Target because that smaller size has not been an advantage over the last 100 years they’ve been in operation.

      Best regards!

    • says

      I haven’t mentioned it online but I work for Wal-Mart Realty, setting up new small format stores. You should check out one of our neighborhood markets or a Wal-Mart express, you wouldn’t even think you were in a Wal-Mart store.

      I cannot disclose specific numbers, but I can tell you our small formats division growth is explosive and is going to have a greater impact on the company year after year.

    • says

      Investing Early,

      Wow! Thanks for that information. That’s really awesome. I’m so glad to hear that the smaller stores are going so well. I see one of the Marketplace stores on the north side of town and it appears to compete very, very well with a dollar store right across the street. Wal-Mart is getting pretty good at filling out the niche stores in small neighborhoods while still dominating with the Supercenters.

      I really like the word “explosive” when thinking about growth and our investments. I get amped up when I hear words like that. :)

      Thanks again for stopping by and sharing. Great, great stuff!

      Take care.

  8. Pursuing Financial Freedom says

    DM,
    I enjoy reading your blog and agree very much with your analysis of WMT. I am a young investor myself and enjoy reading about your thought process and overall journey. Since I have a long time horizon, I have focused on buying what is under or fair valued at the moment. (AFL,CVX,etc) I am very excited to start a position in WMT very soon. What are your thoughts on Visa? I like their history of dividend growth, love their business model and with the recent debit fiasco I see a great buying opportunity. The yield is low now, but the long term growth is what I’m after. I like the 20%-50% increases every year in my income to go along with the KO, JNJ single digit increase of late. Passive Income Pursuit has just done a great analysis of Visa on his blog. I would appreciate your insight as well. Lastly, I am very interested in Express Scripts (ESRX). There are rumors of a possible dividend strategy soon. I utilize FAST Graphs for due diligence and man do they look like a great buy at the moment!

    • says

      PFF,

      Thanks for stopping by. Always great to hear from another young investor.

      I like Visa, but it currently falls outside of many of the criteria I use as a value investor. The pricing is a tad high, which is obviously due to the expected growth ahead of V. The yield is also very low for me, as I generally don’t consider anything less than 2%. With a yield below 1%, it would take consistent huge increases YOY to get the YOC high enough to make sense. From a total return perspective, however, V has a lot to offer.

      To be quite honest I profiled V on this blog back when it was around $95/share or so, and it made one of my watch list posts. It was a top three buy for me, but I ended up passing on it. It was much cheaper back then both in price and valuation, and I regret that.

      I think a portfolio is well served by having a mixture of low yield/higher growth, medium yield/medium growth and high yield/lower growth holdings. I’ve been focusing on the third category a bit lately because REITs have been more attractive than in the recent past, but the two stocks highlighted above fit well in the first category. I don’t really favor any of them because they all have something unique to offer, but one could argue the middle category offers that elusive “sweet spot” that offers the best of both worlds (yield and growth). Of course, that’s where you find a lot of premium valuations as well.

      Best wishes!

  9. says

    I like WMT at these prices. It is one of my core long holdings that I will continue to add to. With international expansion still in its infancy and domestic growth coming in the form of smaller market stores I believe there is plenty of growth left in big blue. I like TGT as well, know a few people that work there and invest in it also, but WMT has honestly out performed them over decades. If I can make the exact same purchase at a WMT for less than that at TGT I will continue to do so. The difference will be invested into equities like WMT. I have a free commission trade to use and I was thinking about adding to CVX or increasing my KO exposure. KO is nearing 3% yield at $37 and some change and I think I’m pretty light on that stock. IBM has also been on my radar, good analysis, but for now I will be staying away from the tech sector.

    Cheers

    • says

      RXSKI,

      I agree with you in regards to WMT. I think there is plenty of growth ahead for this company, which would be impressive considering the growth it has already had over the last 20+ years.

      KO is nearing that 3% yield mark. I noticed that. I may have to add to my Coca-Cola exposure in September if the broader market continues this downtrend. I’m getting very excited about what the next week or so looks like! :)

      Cheers!

  10. Anonymous says

    DM,
    Fan of the blog, been plowing through it the past few days. I have a question that I hope you can answer. I am not trying to challenge your stance, but just want your viewpoint and opinion.
    Why are you investing in dividend stocks as opposed to rental homes? Do you feel that you can achieve faster independence through dividends than rental homes?

    • says

      Anonymous,

      I am not a fan of investing in rental homes. I will admit that you’ll likely see higher returns overall, but there is a lot less diversification there and a lot more work/input. Whereas dividend growth investing can be considered mostly passive once you’re actually living off the dividend income and you’re no longer in the accumulation phase, having a handful of rental homes will likely require quite a bit more of your time.

      I’ll be honest. I’m not handy. I have no desire to get a call about a broken toilet or an issue with a window or stains on carpet. I just have way too many things I want to accomplish and activities I want to engage in once I’m financially independent. I just don’t have the time or desire to deal with stuff like this.

      If you’re really looking for higher cash returns (higher yield) than most dividend growth stocks will provide while still getting a good chance at a raise that roughly matches inflation and you don’t mind having most of your eggs in one basket, investing in a bunch of REITs would almost do the same thing with a lot less work.

      Just my $0.02.

      Best wishes.

  11. says

    Just wanted to cheer your IBM consideration on. IBM is actually my very first equity position ever (gifted to me) and my first real DGI experience. Great growth, I recently added at 184.

    • says

      RO,

      Glad to have your approval! I’m strongly considering IBM here. It’s sitting below $183 right now. I think there is some fairly strong value in this name and I might just go ahead and buy before the end of the month. However, that would mean my capital for any September purchases would be really light and it’s hard for me to put myself in that situation. So many stocks, so little capital! :)

      Thanks for stopping by.

      Best regards!

    • says

      rb40,

      I can understand your aversion to buying any IBM seeing as how I’m pretty confident you have a sizable position in your former employer. I think I’d do the same in your position.

      WMT looks very good here. Both look fairly attractive from a valuation/growth standpoint. I’m excited! :)

      Best wishes.

    • says

      Anonymous,

      That calculator does not included reinvested dividends. I don’t have the time to add up 13 years of dividends and manually reinvest them, but I’d be willing to bet that the return is likely at least double what you see.

      Besides that, the S&P 500 is up only about 12% before dividends during that time period, and the cumulative dividends in a broad S&P 500 index are probably pretty similar to the cumulative dividends from WMT during that time.

      The last 13 years have not been kind to equity investors, overall. During this period you were just coming out of the dot-com bubble burst, a recession and the Great Recession. Some stocks performed better than others, as is always the case. Diversification is key! :)

      Best regards.

  12. says

    I once owned IBM when it was selling for 40-ish a share. Since I sold it for a small profit of 3 bucks or so a share I am kicking my butt for not sticking with this stock. But back then I was stupid and naive.

    I just started purchasing my favorite stocks via Motif Investing, so I too bought a fraction of shares of WMT recently. I am excited about it because it allows me to buy all those companies at once.

  13. Anonymous says

    I continue to own the 200 or so shares of IBM that I accumulated while while working there in the early 2000s. I spent many late nights and many many weekends hunched over a computer screen just to keep up with the work.

    The crazy thing? IBM continues to send me a paycheck even though I don’t show up for work. It is a lot smaller and only arrives once a quarter, but the dividend check that I receive is a small bonus for my sacrifice 10 plus years ago.

    Good luck!

    Roger H

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