I’m confounded lately. The S&P closed at an all-time high this past Friday – finishing at 1,759.77. An incredible run so far in 2013 has the index up 23.4 percent YTD. Although the broader market’s valuation doesn’t necessarily impact my investment decisions directly, a rising market has a way of lifting all boats within the tide. So I’m faced with a portfolio of high quality assets that are currently trading for prices a bit frothier than what I’d be willing to pay if I had to buy them today. I’m glad I started investing in 2010!
However, back to my state of mind. I’m confounded because while I’m a bit leery of investing any fresh capital right now due to my cautious outlook in light of where the broader market is at, I’m also confronted with the fact that my overarching goal of achieving financial independence by 40 years puts me in a position where I’m inclined to keep purchasing high quality equities as often as I can which keeps my compounding snowball of wealth rolling downhill at the fastest pace I can muster.
And so I recently chose to add just a little snow to that fairly substantial snowball. A broader market pullback may melt a little off the top, but I’ll just pack in fresh snow flakes and keep on rolling. Besides, the larger the snowball gets the more snow showers I can expect in the future via dividend income; bring on the clouds!
As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.
This purchase comes not long after I initiated a position in Baxter at the end of September – for $66.60 per share. The fact that BAX declined a bit since I initiated that position even while the S&P 500 is up gave me a nice chance to average down and add to my burgeoning position with this global healthcare company.
Baxter is a diversified, global healthcare company. It manufactures and markets medical products for hemophelia, immune disorders, kidney disease, infectious diseases and other conditions. They operate in two segments: BioScience and Medical Products. The BioScience segment accounted for 44% of sales in 2012, while the rest was attributed to Medical Products. They sell products in over 100 countries which are used by hospitals, nursing homes, rehab centers, kidney dialysis centers, research centers, etc,. and continue to focus on medically necessary products and therapies.
Not much has changed since I initially invested in Baxter. The company released third quarter results on October 17 (read the transcript here), and it was a nice quarter from where I’m standing. Earnings were adjusted downward because of a $0.20 charge for costs related to the acquisition of Gambro AB. Factoring that out, EPS was $1.19 – up from $1.06 a year earlier. Sales rose 9%, in line with expectations.
I can’t figure out why the market continues to punish BAX, but I’m glad it’s occurring. Factoring in dividends, BAX is basically flat for the year. When you have a high quality, diversified and global health care company underperforming the market by a margin that wide the value investor in me is sure to take notice.
Fundamentally, the company remains extremely sound. From 2003-2012, revenue has grown by a compounded annual rate of 5.3%, while EPS has a CAGR of 11.9%. The dividend has also grown in spectacular fashion, and BAX sports a 5-year dividend growth rate of 16.4%. Not too shabby. On top of that, BAX is also committed to returning value to shareholders via the share buyback program: they spent $1.5 billion on shares in 2012. The balance sheet also looks good, with a debt/equity ratio of 0.8.
I think BAX stands to do well from here. The fact that many of their products focus on life-threatening and chronic medical concerns means that demand should remain strong for what the company manufactures, even as healthcare reform takes hold. Demographic changes also provides a tailwind for the company, as does continued international exposure. Overall, I’m quite pleased with being able to pick up additional shares in BAX at today’s prices – especially in light of the otherwise lack of value in the market. Of course, risks include potential liability from malfunctioning products and increased competition.
BAX currently trades for a P/E ratio of 16.55. Looking at the future growth of the company, I think today’s price represents fairly decent value. S&P Capital IQ predicts a three-year compounded annual growth rate of EPS to be 8%. I valued the shares using my typical Dividend Discount Model analysis and used a 10% discount rate and a 7% long-term dividend growth rate. This gave me a fair value of $69.91. I’m happy receiving a small margin of safety on a low-risk company with an outstanding track record.
The dividend appears to be sustainable with a payout ratio of 49.5%, and I anticipate the company will continue growing it from here. The entry yield on my purchase is 3%.
This purchase adds $39.20 to my annual dividend income based on the current quarterly payout of $0.49.
My portfolio still has 42 positions, as this was an addition to an existing investment.
Some current analyst opinions on my recent purchase:
*Morningstar rates BAX as a 4/5 star valuation with a fair value estimate of $80.00.
*S&P Capital IQ rates BAX as a 4/5 star Buy with a fair value calculation of $74.30.
I’ll update my Freedom Fund in early November to reflect my recent addition.
Full Disclosure: Long BAX
How about you? Deploying any capital in today’s expensive market?
Thanks for reading.
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