I always liken the stock market to any other kind of market out there. In a bazaar you’ll have goods that are bought and sold by a manic crowd, and as such you’re likely to find expensive and cheap merchandise alike. The same goes for the stock market; however, as evidenced by the S&P 500’s meteoric run over the last few years, the odds of finding cheap merchandise that is high in quality is significantly less than it was just a few years ago. Good deals on great stocks are hard to come by, but that doesn’t mean you stop looking or buying.
I started buying equities back in early 2010 as I decided to start living well below my means and take every penny of excess capital and invest that money in high-quality dividend growth stocks. This journey has served me well thus far, but to be honest I’d be happier if the market hadn’t run up so much in the last few years. Cheaper stocks means my limited capital goes further, and with it the future dividend income I’m buying with today’s dollars would be larger. But wishing for events that have not come to pass won’t get me anywhere; I try to take any situation and make the best out of it.
As such, I’ve been combing for opportunities over the last week or so, trying to find the best deals I can. One might think high-yielding securities are especially expensive right now, as many investors flock to the income they provide in the face of still-low interest rates present in many other asset classes like bonds and CDs. However, I think there are still some opportunities out there to be had, and today I’m going to discuss two in particular.
BP Plc (BP)
This oil giant still appears cheap, and has been cheap now for a number of years as it continues to deal with legal overhang after the unfortunate and disastrous Deepwater Horizon oil spill back in early 2010. I’m not going to go too in-depth about the legal proceedings as they currently stand, as I’ve done that before. However, what we can see here is a much smaller BP than what existed before the spill as they’ve sold off $38 billion in assets (with another $10 billion in divestments to be completed by the end of 2015) to fund the paying of fines and settlements relating to the disaster, and have focused on the best assets they can keep. Just like I would focus on my best assets if I had to sell off part of my personal wealth, BP has done the same. In particular, after some realignment, they now own almost 20% of Rosneft, one of the world’s largest oil producers. However, as Rosneft is majority owned by the Russian government, this adds unique risk to BP – especially in view of the recent tensions regarding Ukraine.
As a smaller, but more fit BP that focuses on higher-margin projects, absolute growth will take a back seat to quality. The company is only predicting 1% annual production growth through 2015, yet it also sees itself increasing operational cash flow by 50% from 2011-2014, assuming $100/barrel oil. BP has had 11 major projects started up since 2011, with an increased focus on safety. Furthermore, BP is back to a strong presence in the Gulf of Mexico after a drilling moratorium was lifted in late 2012.
The company remains committed to returning cash to shareholders. An $8 billion share buyback program that was initiated after the sale of TNK-BP to Rosneft couldn’t come at a better time as shares are cheap here. And the company remains committed to the dividend, and it has extended multiple raises since resuming its dividend in early 2011. Its raised the dividend three times since, with the last raise being 5.6%.
S&P Capital IQ predicts $6.12 EPS per ADR share in 2014, which puts the forward P/E ratio at 8 since shares are currently trading hands for just under $49/share. The yield on shares right now is 4.54% based on a $0.57 quarterly dividend per share. While 4.54% might not seem all that lucrative, there are few other equities out there that yield this high while also having the potential for so much dividend growth and capital appreciation. BP is currently a large holding for me, and I plan on buying at opportune times, depending on capital availability .
Philip Morris International Inc. (PM)
The world’s largest publicly traded cigarette company leaves little to be desired. The current yield, at 4.52%, is almost the same as BP, and also shows a lot of promise for continued dividend growth. While there are risks involved in a company that manufactures a product that is so heavily taxed and regulated around the world, the large moat around an addictive product is unlikely to abate anytime soon.
Shares in PM have not performed well lately, down some 4.5% YTD. But this should serve as opportunity for long-term holders, and I personally added to my position in late January, and PM is now my second largest holding behind Johnson & Johnson (JNJ). And this is for good reason. There are huge competitive advantages here with PM, as they have massive economies of scale, marketing and selling their products across the globe, while also spreading the risk of regulation out across multiple markets. Their crown jewel in Marlborough is the #1 cigarette brand across the world, and the company owns seven of the world’s top 15 international brands. Excluding the People’s Republic of China, the company holds an estimated 28.2% of the world’s cigarette market share.
The company has managed six consecutive years of dividend growth, after being spun-off from Altria Group Inc. (MO) in 2008. They have a dividend growth rate of 28.4% over the last five years, which is impressive. While unlikely to continue at that rate, high-single-digit growth is certainly sustainable, and really all that’s necessary to make this a suitable long-term holding. And I anticipate that growth rate to be sustainable due to new opportunities in reduced-risk products and e-cigarettes, which PM is developing platforms in rather aggressively. Furthermore, the company sees additional growth in both traditional cigarette and new products in four major markets – China, India, Bangladesh, and Vietnam- where it has little to no current exposure. These four markets account for approximately 40% of global cigarette consumption, so the potential is staggering.
Shares in PM are currently trading hands for a P/E ratio of 15.8 – which is in line with its 5-year average. However, to be able to pick up shares in a global powerhouse at 5-year average prices considering the market is priced at all-time highs is, in my opinion, an incredible opportunity. The yield is there, and so is the value and growth. I’m a big fan of PM at today’s prices, and if it weren’t already such a huge position for me I’d be buying even more.
Overall, I view the two companies above at above-average in terms of growth potential and yield, while also being below-average in terms of valuation, in consideration of where the overall market is at right now. As a long-term investor I’m currently happily invested in both of these companies and look forward to continued dividend growth on the back of profit growth from the underlying businesses.
However, risks should not be taken lightly. BP still continues to face risk in the ongoing litigation regarding the 2010 spill, as well as commodity pricing risk; if oil falls significantly from here, that could impact profitability, and their plans significantly. PM faces regulation and taxation risk, and illicit trade in counterfeit cigarettes is on the rise. And while these risks are significant, all investments include risk. I simply feel here that the potential reward at today’s prices more than compensates for the risk profiles inherent in these companies based on all known information.
Full Disclosure: Long BP, PM, JNJ, MO
How about you? A fan of these stocks at today’s prices?
Thanks for reading.
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