Investing And Uncertainty

Humans don't like ambiguity. This is demonstrated in the experiment Hersh Shefrin discusses where subjects are offered either a guaranteed $1000, or a 50/50 chance at $2000. Consistently, fewer than 50% of respondents prefer the gamble for $2000, even though the expected values (i.e. the average value of the result if it were conducted many times) of both offers are the same.

What if the 50/50 odds in the above experiment were instead unknown? This adds even further uncertainty to the situation, and results in even fewer people willing to gamble on the $2000.

Shefrin calls this phenomenon "aversion to ambiguity", and on Wall Street it results in downward pressure on the prices of securities with uncertain outlooks. In order to avoid uncertainty/ambiguity, humans will stay away, even if the odds are favourable (i.e. downside risk is low, upside potential is high).

In his book, Shefrin argues that this ambiguity aversion is the reason for government intervention, even when it is not needed. What would have happened had the government not bailed out the banks? Nobody really knows, but the fact that the outlook was uncertain made the government want to intervene, even at a high cost, in order to avoid the uncertain situation.

As Mohnish Pabrai notes in his book, risk is not the same as uncertainty. Uncertainty can drive down the prices of assets/securities, even if downside risk is low. By capitalizing on situations where uncertainty is high, but risk is low, the investor can put himself in a position to earn above-average returns.

Disclosure: Author would roll the dice on the $2000 as long as the odds were 50%+

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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Stock Analysis: Leggett & Platt Inc. (LEG)

Linked here is a detailed quantitative analysis of Leggett & Platt Inc. (LEG). Below are some highlights from the above linked analysis:

Company Description: Leggett & Platt Inc makes a broad line of bedding and furniture components and other home, office and commercial furnishings, as well as diversified products for non-furnishings markets.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

1. Avg. High Yield Price
   
2. 20-Year DCF Price
   
3. Avg. P/E Price
   
4. Graham Number
   

LEG is trading at a discount to only 3.) above. Since LEG's tangible book value is not meaningful, a Graham number can not be calculated. The stock is trading at a 62.8% premium to its calculated fair value of $13.08. LEG did not earn any Stars in this section.

Dividend Analytical Data: In this section there are three possible Stars and three key metrics, see page 2 of the linked PDF for a detailed description:

1. Free Cash Flow Payout
   
2. Debt To Total Capital
   
3. Key Metrics
   
4. Dividend Growth Rate
   
5. Years of Div. Growth
   
6. Rolling 4-yr Div. > 15%
   

LEG earned three Stars in this section for 1.), 2.) and 3.) above. A Star was earned since the Free Cash Flow payout ratio was less than 60% and there were no negative Free Cash Flows over the last 10 years. The stock earned a Star as a result of its most recent Debt to Total Capital being less than 45%. LEG earned a Star for having an acceptable score in at least two of the four Key Metrics measured. The company has paid a cash dividend to shareholders every year since 1939 and has increased its dividend payments for 38 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:

1. NPV MMA Diff.
   
2. Years to > MMA
   

LEG earned a Star in this section for its NPV MMA Diff. of the $563. This amount is in excess of the $500 target I look for in a stock that has increased dividends as long as LEG has. The stock's current yield of 4.88% exceeds the 3.98% estimated 20-year average MMA rate.

Other: LEG is a member of the S&P 500 and a member of the Broad Dividend Achievers™ Index.

Conclusion: LEG did not earn any Stars in the Fair Value section, earned three Stars in the Dividend Analytical Data section and earned one Star in the Dividend Income vs. MMA section for a total of four Stars. This quantitatively ranks LEG as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $21.97 before LEG's NPV MMA Differential decreased to the $500 minimum that I look for in a stock with 38 years of consecutive dividend increases. At that price the stock would yield 4.73%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $500 NPV MMA Differential, the calculated rate is 1.6%. This dividend growth rate is less than the 2.0% used in this analysis, thus providing a margin of safety. LEG has a risk rating of 1.50 which classifies it as a low risk stock.


A sign of a well managed company is the ability to increase cash flow in the face of falling sales and earnings. LEG's sales and earnings peaked in 2006. However, free cash flow per share has doubled since that time. 2010 should not be any different with S&P forcasting LEG's customer markets recovering late this year and moving to positive sales growth. Earlier this month I initiated position in LEG in spite of the fact it was trading well in excess of my $17.94 fair value price. Since then, LEG has appreciated an additional 5%. For additional information, including the stock's dividend history, please refer to its data page.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I was long in LEG (1.2% of my Income Portfolio). See a list of all my income holdings here.

Recent Stock Analyses:

• Stock Analysis: Meridian Bioscience Inc. [VIVO]
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This article was written by Dividends4Life. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below. [RSS] [Email] [Twitter]

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Weekend Reading Links - March 14, 2010

For your weekend reading pleasure, the articles listed below contain some of the best dividend and value investing insights found on the web. They were written by various members of the Dividend Investing and Value Network over the past week:

Articles From DIV-Net Members

• Dividends Value presented Increasing Dividend Yield Part II: REITs
  
• The Dividend Guy presented Essential Tips For the Struggling Investor – Making Decisions
  
• Dividend Growth Investor presented Seven Dividend Increases in the news
  
• Barel Karsan presented When The Company Values Itself
  
• Buy Value presented Anticipating Dividend Increases
  
• Disciplined Approach to Investing presented Bullish Investor Sentiment Rises, But...
  
• Old School Value presented EPS Affected by Tax Rate Changes
  
• Triaging My Way To Financial Success presented The Ultimate Wrap Mutual Fund
  
• BuyLikeBuffett.com presented The First Million Is The Hardest To Make
  
• 40percent 20years presented Time to combine with Dividends Value Investing
  
• EPIC INVESTOR presented Invest in ethics
  
• Value Walk presented My Reporting From The Columbia Investment Management Conference

There are some really good articles here, please take time and read a few of them.

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Abbott Laboratories (ABT) Stock Analysis

Abbott Laboratories engages in the discovery, development, manufacture, and sale of health care products worldwide. It operates in four segments: Pharmaceutical Products, Diagnostic Products, Nutritional Products, and Vascular Products. The company is a component of the S&P 500 and the dividend aristocrat indexes. Abbott Laboratories has increased dividends for 38 years in a row. Most recently Abbott raised its quarterly dividend payment by 10% to $0.44/share. Dividend author Dave Van Knapp has included the company in his most recent book "The Top 40 Dividend Stocks for 2010".



For the past decade this dividend stock has delivered a total return of 7.3% annually.

At the same time the company has managed to increase earnings per share by 8.40% on average since the year 2000. For fiscal years 2010 and 2011, analysts expect EPS to increase to $4.24 and $4.77. This would be a nice increase from the $3.69 in earnings per share that the company booked for FY 2009. Analysts also expect an over 7% increase in sales for FY 2010 to 33 billion dollars, excluding the recently completed acquisition of Belgium based Solvay’s pharmaceuticals unit. This deal would add $0.10/share in FY 2010 and $0.20/share in FY 2011. I like the strong product pipeline of Abbott, as well as the potential for new launches. There could be some generic competition for some of Abbott’s products but overall the forecast for future revenue increases is quite rosy. Last year’s acquisition of Advanced Medical Optics exposes the company in the rapidly growing market for LASIK and Cataract procedures.
The company also delivers a little over half of its sales from international markets. Almost 18% of its sales come from the drug Humira, which treats rheumatoid arthritis and psoriatic arthritis. This drug is expected to continue delivering strong sales growth in the next few years for Abbott Labs. In June 2009, a federal jury has returned a verdict of $1.67 billion against Abbott Laboratories in a patent infringement suit. The other party to the suit was Johnson & Johnson (JNJ). Abbott Labs (ABT) is currently appealing the verdict.


The ROE has largely remained between 12% and 28% after falling from its 2000 highs over 34%.

The company has managed to increase its annual dividend by 8.60% on average over the past decade. A 9% increase in dividends translates into the dividend payment doubling every 8 years. Since 1986 Abbott Laboratories has managed to double its dividend every 6 years on average.

The dividend payout ratio has largely remained above 50% over the past decade, with spikes in 2001 and 2006 caused by lower earnings. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings. Currently the dividend payout ratio is below 50%.

Overall Abbott Laboratories (ABT) is attractively valued currently, trading at a P/E of 15, dividend yield of 3.20% and an adequately covered dividend. While I don't expect to earn as much as this early Abbott Labs (ABT) investor, I still believe that there is room for substantial total returns in this position. I would consider be adding to this position.

Full Disclosure: Long ABT

Relevant Articles:

- Four notable dividend increases
- Dividend Growth beats Dividend Yield in the long run
- Dividends Stocks versus Fixed Income
- Not all dividend stocks are overvalued

This article was written by Dividend Growth Investor. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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Calibration

In a previous post, we saw how humans have an overconfidence bias, and how that can play havoc on financial forecast estimations. What is not immediately clear, however, is the increasing role overconfidence plays the more knowledge one acquires. That is, as expertise rises, so does overconfidence, resulting in the fact that the people with the most knowledge are likely to be the most miscalibrated, which can result in detrimental effects.

But knowledge alone does not doom someone into being overconfident. James Montier argues that it's a lack of feedback that pushes people to be overconfident. To demonstrate this, Montier cites a study performed by Scott Plous that compares the calibration of weathermen against that of doctors. Weathermen were asked to predict the weather, while doctors were asked to diagnose patients (based on case notes). Both were asked to provide confidence intervals, so that their calibrations could be measured.

Interestingly, weatherman were well calibrated, while doctors were very poorly calibrated. Montier argues that this is because weather forecasters benefit from the fact that they receive immediate evidence of their abilities as forecasters, while doctors do not.

While one may be inclined to believe that financial analysts should be like weathermen in that they can see whether their forecasts came true, similar calibration tests appear to show that analysts are calibrated to a similar extent as doctors! As a result, the industry is glowing with overconfidence. Further testing confirmed the opening hypothesis: experts in finance are more overconfident than lay people, as they apply too narrow a band around their estimates as compared to the general public.

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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Stock Analysis: Meridian Bioscience Inc. (VIVO)

Linked here is a detailed quantitative analysis of Meridian Bioscience Inc. (VIVO). Below are some highlights from the above linked analysis:

Company Description: Meridian Bioscience Inc. develops, makes and sells disposable diagnostic test kits and related products used for the rapid diagnosis of infectious diseases.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

1. Avg. High Yield Price
   
2. 20-Year DCF Price
   
3. Avg. P/E Price
   
4. Graham Number
   

VIVO is trading at a discount to only 3.) above. The stock is trading at a 28.8% premium to its calculated fair value of $17.94. VIVO did not earn any Stars in this section.

Dividend Analytical Data: In this section there are three possible Stars and three key metrics, see page 2 of the linked PDF for a detailed description:

1. Free Cash Flow Payout
   
2. Debt To Total Capital
   
3. Key Metrics
   
4. Dividend Growth Rate
   
5. Years of Div. Growth
   
6. Rolling 4-yr Div. > 15%
   

VIVO earned two Stars in this section for 2.) and 3.) above. The stock earned a Star as a result of its most recent Debt to Total Capital being less than 45%. VIVO earned a Star for having an acceptable score in at least two of the four Key Metrics measured. Rolling 4-yr Div. > 15% means that dividends grew on average in excess of 15% for each consecutive 4 year period over the last 10 years (2000-2003, 2001-2004, 2002-2005, etc.) I consider this a key metric since dividends will double every 5 years if they grow by 15%. The company has paid a cash dividend to shareholders every year since 1990 and has increased its dividend payments for 19 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:

1. NPV MMA Diff.
   
2. Years to > MMA
   

VIVO earned a Star in this section for its NPV MMA Diff. of the $6,457. This amount is in excess of the $1,600 target I look for in a stock that has increased dividends as long as VIVO. If VIVO grows its dividend at 15.0% per year, it will take 3 years to equal a MMA yielding an estimated 20-year average rate of 3.98%. VIVO earned a check for the Key Metric 'Years to >MMA' since its 3 years is less than the 5 year target.

Other: VIVO is a member of the Broad Dividend Achievers™ Index.

Conclusion: VIVO did not earn any Stars in the Fair Value section, earned two Stars in the Dividend Analytical Data section and earned one Star in the Dividend Income vs. MMA section for a total of three Stars. This quantitatively ranks VIVO as a 3 Star-Hold.

Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $38.46 before VIVO's NPV MMA Differential decreased to the $1,600 minimum that I look for in a stock with 19 years of consecutive dividend increases. At that price the stock would yield 1.77%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $1,600 NPV MMA Differential, the calculated rate is 10.4%. This dividend growth rate is less than the 15.0% used in this analysis, thus providing a margin of safety. VIVO has a risk rating of 2.00 which classifies it as a medium risk stock.

VIVO is an integrated life science company that manufactures, markets and distributes a broad range of innovative diagnostic test kits, purified reagents and related products. These products provide for early diagnosis of common medical conditions, such as gastrointestinal, viral, urinary and respiratory infections. VIVO's diagnostic products are used outside of the human body and require little or no special equipment. The company has strong market positions in the areas of gastrointestinal and upper respiratory infections, serology, parasitology and fungal disease diagnosis. VIVO markets its products to hospitals, reference laboratories, research centers, veterinary testing centers, physician offices and diagnostics manufacturers in more than 60 countries around the world. Although the stock is currently trading above my $17.94 fair value price, I view it as a company with a lot of potential; thus I have added it to my watch list. For additional information, including the stock's dividend history, please refer to its data page.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I held no position in VIVO (0.0% of my Income Portfolio). See a list of all my income holdings here.

Recent Stock Analyses:

• Stock Analysis: The Coca-Cola Company [KO]
  
• Stock Analysis: Walgreen Co. [WAG]
  
• Stock Analysis: RLI Corp. [RLI]
  
• Stock Analysis: Cardinal Health Inc. [CAH]
• More Stock Analyses

This article was written by Dividends4Life. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below. [RSS] [Email] [Twitter]

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Weekend Reading Links - March 7, 2010

For your weekend reading pleasure, the articles listed below contain some of the best dividend and value investing insights found on the web. They were written by various members of the Dividend Investing and Value Network over the past week:

Articles From DIV-Net Members

• Dividends Value presented Increasing Dividend Yield Part I: Utilities
  
• The Dividend Guy presented Added 3 New Canadian Dividend Stocks to My Portfolio
  
• Dividend Growth Investor presented The ten year dividend growth requirement
  
• Barel Karsan presented Paving The Way To Success
  
• Buy Value presented Buffett Gets a Bullseye
  
• The Div Guy presented February Dividend Income Update
  
• Disciplined Approach to Investing presented Dividends Will Be A Company's Renewed Focus?
  
• Old School Value presented ROE ROIC and CROIC
  
• BuyLikeBuffett.com presented Secret Millionaire Donates Her Fortune
  
• 40percent 20years presented Ask Warren Buffett - Last Long Interview
  
• EPIC INVESTOR presented Beat Warren Buffett
  
• Value Walk presented Jacob Wolinsky Interviews Famous Value Investor Whitney Tilson

There are some really good articles here, please take time and read a few of them.

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Is now the time to start looking at US ETF REITs?

Every industry faces periods of rise and periods of decay. The last few years have, not surprisingly, been a period of decay in the REIT Area. But like nuclear stocks after 3 mile island, or banks after the savings and loan scandle, or bonds after the junk bond era, after a sector has been desimated what is often left are the high quality well managed companies that will rise to dominate the sector in the future. Is now the time for REITs?

For those not familiar with REITs they are otherwise known as Real estate invest trusts. The basic rule that governs their operations is that they give 90% of all revenues from a period back to shareholders in the form of a dividend. There are three key classes:

• Equity REITS: Invest in property and gain revenues from collecting rent. 
• Mortgage REITS: Loan money for mortgages or buy and sell mortgage backed securities.
• Hybrid REITS: You guessed it, they do both.

I am not a big fan of Mortgage REITs, in my opinion they partake in the buying and selling of paper. Paper that is difficult if not impossible to assess its true value. For those more in the know these types of investments may make sense. I follow Buffett's advise when it comes to these matters, if you can't understand it then don't buy it.

So that leaves us with Equity REITs. These REITs employee people who specialize in real estate industry they understand the simple formula (rent - upkeep) > mortgage. With housing prices depressed all across the US those companies that are still alive in this sector are starting to gather steam and acquire great properties. Regardless of what happens over the next few years people will still need properties to rent. Unless you believe that housing prices have a significant way to fall yet this is certainly an interesting sector to examine.

To further diversify there are several ETFs that deal with REITS if we look at each of these compared with the S&P over a two year and five year periods the industry is quite depressed from its highs.

To be clear I am not advising you date the REIT sector, but if you are looking to diversify your portfolio and hold a stock or ETF for 10 years it might be a good time to look at this sector.

This article was written by buyingvalue. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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