Significant Price Run-up Distorting Dividend Fundamentals
When you buy a dividend stock at a depressed level it will eventually return to its norm. However, at its normal level the dividend fundamentals could be so bad that you would be better off putting the money to work somewhere else. For this evaluation, my primary indicator is the NPV MMA Differential. When this metric goes negative, it in effect is saying you are better off putting the into a money market account for the next 20 years. When this occurs I look for a way to exit the position and retrieve my original investment, leaving the portion attributable to capital appreciation. Examples of stocks that I hold with these characteristics (or close to it) are:- 3M Co. (MMM) | Yield: 2.60% | NPV MMA Diff: (117)
- Emerson Electric Co. (EMR) | Yield: 2.87% | NPV MMA Diff: (108)
- Genuine Parts Company (GPC) | Yield: 3.82% | NPV MMA Diff: 302
- Illinois ToolWorks Inc. (ITW) | Yield: 3.09% | NPV MMA Diff: 317
Dividend Freeze Leading to Poor Dividend Fundamentals
When a company fails to raise its dividend (dividend freeze), the dividend fundamentals quickly deteriorate if its yield is low. It is easier to be patient when the yield is higher and the stock is still earning its way. However, as dividend growth investors, ultimately we expect our dividends to grow: Below are several stocks that failed to raise their dividends at the expected time:- Paychex Inc. (PAYX) | Yield: 4.89% | Dividend Flat Since: 07/2008
- Eli Lilly & Co. (LLY) | Yield: 5.74% | Dividend Flat Since: 02/2009
- Progress Energy Inc. (PGN) | Yield: 5.88% | Dividend Flat Since: 01/2009
- Integrys Energy Group, Inc. (TEG) | Yield: 5.56% | Dividend Flat Since: 02/2009
Historical Performance Is Not Indicative Of Expected Results
Sometimes historical results are indicating the stock is a good investment, but something just doesn't seem right. In situations like this there is probably a reason for the uneasiness and it is in our best interest to understand why we feel that way. Usually we know something that is not reflected in the financials.This recently occurred with my AFLAC Inc. (AFL) position. I had been closely watching AFL since the time it first failed to raise its dividend. For a stock with a yield as low as AFL, dividend growth is paramount for its long-term success. My model's calculated dividend growth rate was higher than what I expected going forward, at least for the near term. Its annual dividend growth has been declining since 2008, with 2010 growth only 3.6% (considering 2 dividends at $0.28 and two at $0.30). This was the only single digit increase in the last 10 years. When considering AFL's most recent increase, the NPV MMA differential is under-performing its target. AFL has a large exposure to hybrid bonds (particularly European banks) and exposure to European sovereign debt. This makes them more risky than many other Financial Services companies. I have been looking to reallocate a portion of my financial Financial Services holdings (currently in excess of 10%) and I considered AFL one of my weaker financial stocks, so I sold it.
Substantial Change In The Business
Sometimes the world changes and what you were selling yesterday at a premium you can't give away today. This phenomenon has been played out since the beginning of time. Rock gathers were replace with club makers who were replaced with spear makers who were replaced with arrow makers who were replaced with musket makers who were replaced with rifle makers, and so on. We see this happening today with the print media. Companies like Courier Corporation (CRRC) that publishes, prints and sells books, and Gannett Co., Inc. (GCI) an international media company that owns USA Today have struggled recently as people have moved from print media to online. Both companies were unable to continue the string of consecutive dividend increases.Other times a catastrophe will shake a company to it very foundation. This has been most evident with the recent oil disaster in the Gulf. BP (BP) was not prepared for a situation like it faced. As the damage claims mounted, investors lost confidence in management to stop the oil flow and began to sell off the stock. A dividend cut soon followed.
Buy-And-Hold Not Buy-And-Forget
All investors need to be vigilant and keep a close watch on their investments. There are few certainties in an uncertain world. Things change and adjustments must be made. Buy-and-hold is a successful investment strategy; buy-and-forget is a recipe for disaster.Full Disclosure: Long MMM, EMR, GPC, ITW, PAYX, LLY, PGN, TEG. See a list of all my income holdings here.
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