Sunday, May 31, 2009

Weekend Reading Links - May 31, 2009

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 (DIV-Net) over the past week:

Articles From DIV-Net Members

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

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Saturday, May 30, 2009

Fad Investing

crocsAbout two years ago I was speaking to a friend who was very excited about an investment opportunity. "This company is a sure thing, my kids all have these and I saw Oprah was wearing a pair of them last week so they are going to have a huge quarter." He was right and saw his money double, and then a year later fall 20% below what he had paid for it.

So what went wrong? My friend is a huge advocate of the buy what you know adage made popular by P
eter Lynch. He looked at his own life and picked products that he saw his family using. He coupled this with some stingy investment criteria that the company was undervalued in relation to the upcoming sales. All good things. What he forget was that he was fad investing.

Fad investing is the process of investing in a company because of a product; not because of the company. This happens every year with companies like Potash, and Krocks. There are some simple ways to avoid fad investing:


  • Look at the stable. What else does the company have, is this one of 20 products they produce?

  • Check the weight. What percentage of revenue is going to be absorbed by one product line. If it were to dry up how would this impact the business?

  • Looks for Sustainable Competitive Advantage. I've written about this Buffet criteria before. The company that is producing this great product, is there something that would prevent others from making this product cheaper or slightly better?

  • Think about need. In economies like the present, having a product that doesn't make people's lives better/easier/more efficient is a dangerous dance.

Remember too that few companies rise to greatness on the backs of one great idea.
Starting a company with a great idea might be a bad idea. Few visionary companies began life with a great idea. Furthermore, regardless of the founding concept, visionary companies were less likely to have early entrepreneurial success than the comparison companies in our study.
p.7 Built to Last James C. Collins

So if you are in for the long haul then invest in a company not in a fad.

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Friday, May 29, 2009

Colgate-Palmolive Stock Analysis

Colgate-Palmolive Company, together with its subsidiaries, manufactures and markets consumer products worldwide. It operates in two segments, Oral, Personal, and Home Care; and Pet Nutrition. The company is a Dividend Achiever and a Champion. Colgate-Palmolive has paid uninterrupted dividends on its common stock since 1895 and increased payments to common shareholders every year for 46 years.


From the end of 1998 up until December 2008 this dividend growth stock has delivered an annual average total return of 5.90% to its shareholders. While the stock has largely remained flat for the majority of the past decade (except for the breakout in the stock price in 2007) most of the returns came from reinvested dividends.

At the same time company has managed to deliver an impressive 10.70% average annual increase in its EPS since 1999.

The ROE has consistently remained high, ranging between 57% and 475% over the past decade.

Annual dividends have increased by an average of 11.40% annually since 1999, which is slightly higher than the growth in EPS.
An 11 % growth in dividends translates into the dividend payment doubling almost every six and a half years. If we look at historical data, going as far back as 1977, Colgate Palmolive has actually managed to double its dividend payment every eight years on average. Just a few weeks ago Colgate Palmolive boosted its dividend by 10% for the 46th year in a row. The dividend is very well covered at the moment.

The dividend payout has ranged between a high of 51% in 2006 and a low of 33% in 2002. One positive fact is that the payout ratio has consistently remained below 50%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Despite the low dividend payout ratio and low P/E ratio, I require a dividend yield of at least 3% in order to initiate a position in Colgate Palmolive. Currently the yield is at 2.80%, and price earnings ratio is 17.

In comparison Procter & Gamble (PG) trades at a P/E multiple of 12 and yields 3.40%, Kimberly-Clark (KMB) trades at a P/E multiple of 13 and yields 4.70%, while Clorox (CLX) trades at a P/E multiple 14 while yielding 3.60%.
I would consider initiating a position in Colgate Palmolive on dips below $58.66.

Full Disclosure: Long PG, KMB and CLX
Related Articles:


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Thursday, May 28, 2009

BDX – Stock Analysis for Dividend Growth Portfolio

Becton, Dickinson and Company (BDK) is a medical technology company that serves healthcare institutions, life science researchers, clinical laboratories, industry and the general public. BD operates in three different market segments viz. medical supplies and devices, laboratory equipments, and diagnostic products. BD is headquartered in the United States and has offices in nearly 50 countries worldwide.

BDX is a dividend achiever and has been paying growing dividends for last 10 years. In one of my earlier post, I listed few companies that may have potential for dividend growth investments. I had shortlisted BDX for more analysis. Keeping with that, my objective here is to analyze if BDX is a good dividend growth stock and how it will rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 8 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

  • Revenue: Consistently growing revenue. The average revenue growth for last 8 years is 8.6% (with 2.8% standard deviation).
  • Cash Flows: In general, an increasing trend for operating cash flow (except a dip in year 2006). The free cash flow is generally close to net income.
  • EPS from continuing operation: Consistently growing earnings.
  • Dividends per share: Consistently growing dividends.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.14. This is a low risk category as per my 3-point risk scale.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

  • Dividend growth rate: The average dividend growth of 16.0% (stdev. 15.7%) is less than average EPS growth rate of 18% (stdev. 12.3%). The dividends seem to be well covered and consistent with earnings growth.
  • Duration of dividend growth: 10 years.
  • 4 year rolling dividend growth rate for past ten years: Less than 10% for past 8 years. More than 12% for last six years.
  • Payout factor: In the past 8 years, it has been in the range of 20% to 30%. There is room for growth in payout factor.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.0%; and (b) MMA yield is 3.4%. Considering the last 8 year average dividend growth rate of 16%, the stocks dividend cash flow at the end of 10 years is 1.65 times MMA income. However, with my projected dividend growth of 8.6%, the dividend cash flow is equal to 0.91 times MMA income. For MMA income to be equal to dividend cash flow, the yield has to be 2.4%, and price has to be at $56.00

Fair Value Calculation
This section determines what price I should pay to buy a given stock

  • Net present value (NPV) price based on 15 year DCF: $46.5
  • Average high yield price calculated based on past 10 years: $67.5
  • Pricing based on past 8 year relative price-to-earnings ratio. $74.7
  • Pricing based on price-to-earnings ratio of 12: $50.7
  • Graham number: $38.2

The range of fair value is calculated as $48.0 to $55.5. This is determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value). This fair value is also very similar to the requirement for MMA income equal to dividend cash flow.

Qualitative Analysis
BDX’s history can be traced back to 1897. It has survived all the major ups and downs in the recent history of United States. This demonstrates that it keeps adapting to changes in the market place.

  • Contrary to widespread belief, my viewpoint is it operates in an industry with high barriers to entry. The quality and reliability requirements for end products in this industry are among the stringent ones. BDX’s has consistently showing that it can meet those requirements in profitable way.
  • Current financial turmoil does not seem to have had a game changing effect on its businesses. The company does not have excessively high debt levels. It does not depend upon the credit markets.
  • BDX generated more than half of its sales from outside of US. This allows individuals investor like me to hedge against dollar decline and exposure to international markets.
  • The area of concern for BDX is the regulatory driven constraints which may change the spending patterns of hospitals and clinics.
  • Another area of concern is recession driven likely reduction in expenditure from community hospitals and other life science customers.
  • Like any other company, I expect BDX to face short-to-intermediate term challenges due to recession driven slow down.

Conclusion
BDX is a dividend achiever and has been raising dividends for last 10 years. The stocks current risk-to-dividend rating is 1.14 (low risk). This is a low yield dividend stock with dividend cash flow being equal to MMA cash flow after 10 years (at price of $56). This analysis shows that BDX continues to be a good stock for potential dividend growth investment. I will be willing to open a long position when the stock prices falls within my fair value range.

Full Disclosure: No position at the time of writing. I may initiate a long position in near future.

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Wednesday, May 27, 2009

Reducing Risk

The mainstream finance industry defines a company's riskiness by its stock price's volatility. For value investors, there is no such short cut; a company's riskiness is defined by a slew of factors that can affect the business. A few weeks ago, we considered some items that can affect risk on the cost side. Today's post will discuss some items relevant to risk on the revenue side.


First of all, a company's revenue can have varying degrees of cyclicality. What this means is, during recessions, certain industries are hurt more than others. Conversely, these industries tend to do better when the economy is strong. Nevertheless, there is higher risk involved in a cyclical business, since poor conditions can persist and cause companies to be unable to meet their obligations. For a more detailed discussion of this topic, see this article.

Secondly, risk is lower when a company has a "moat" (as coined by Buffett) that essentially protects it from competition. In these instances, revenues are more stable, thereby reducing downside risk. Of course, companies with strong moats are hard to come by.

Revenue risk is also reduced when a company is not depedent on one product, as having multiple lines serve to diversify a company's risk should a competitor make inroads or should a product become obsolete. Having a diverse array of customers also helps, since that way a company's fortunes are not tied to the health of companies outside of its control. (This was an important factor when we answered a reader's question on auto parts suppliers a few months ago.)

Finally, it's important to understand how persistant current revenues are. Does the company need to keep innovating just to hold revenues steady, or has it already done most of the work? As an example, contrast Walmart with Apple. Apple's earnings are only as good as its latest products, and it must make sure to keep producing products that customers value, which won't be easy over the long-term. On the other hand, Walmart already has a presence where it can sell the products customers value, without having to innovate anew!

While it's impossible to predict the future, investors can better protect themselves from unforeseen events by choosing companies which are less susceptible to revenue declines. By considering the factors discussed above, downside risks can be reduced.


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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Tuesday, May 26, 2009

Small-Cap Is An Important Component in a Portfolio

I have owned some form of small-cap equity assets in my portfolio for some time now. The reason is simple - they have offered good returns over the years and have made a nice impact on my overall portfolio. This additional return comes with some risk. Small-caps come with more risk than larger cap equity and can swing widely. This is why I have chosen to use only index funds as my investment of choice for this asset class. My investment money is spread over a large number of small-cap stocks so that the individual security risk is reduced significantly.

To highlight the importance of small-caps in a portfolio, especially at specific times in the market like coming out of a bear market, there is a video put out by Soundinvesting.com that I think is worth watching. It offers some interesting advice in a straightforward and simple approach.



Let us know how you manage small-caps in your own portfolio - use the comment section below.


This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.


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Monday, May 25, 2009

Stock Analysis: AFLAC Inc. (AFL)

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

Company Description: Aflac Incorporated engages in the marketing and sale of supplemental health and life insurance plans in the United States and Japan.

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
AFL is trading at a discount to 1.) and 3.) above. If I exclude the high and low valuations and average the remaining two, AFL is trading at a 10.2% discount. AFL earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.
AFL earned three Stars in this section for 1.), 2.) and 3.) above. 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 (1999-2002, 2000-2003, 2001-2004, etc.) I consider this a key metric since dividends will double every 5 years if they grow by 15%. AFL has paid a cash dividend to shareholders every year since 1973 and has increased its dividend payments for 27 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
AFL earned both of the available Stars in this section. The NPV MMA Diff. of the $45,186 is in excess of the $2,500 minimum I look for in a stock that has increased dividends as long as AFL has. If AFL grows its dividend at 16.7% per year, it will take 2 years to equal the cumulative earnings from a MMA yielding an estimated 20-year average rate of 3.64%. AFL earned a Star since its Years to >MMA of 2 is less than 5 years.

Other: AFL is a member of the S&P 500, a Dividend Aristocrat and a member of the Broad Dividend Achievers™ Index. AFL has a solid balance sheet with debt to total capital of 24% in the most recent interim reporting period. In addition, the company generates significant free cash flows with a free cash flow dividend payout of only 11%. It has a strong market position and proven management with a consistent track record for share repurchases and dividend increases. AFL mainly invests in high-quality corporate debt and has no subprime holdings. Risks include investment losses, unfavorable movements in the yen/dollar exchange rate, lower premium growth and difficulties recruiting agents.

Conclusion: AFL earned one Star in the Fair Value section, earned three Stars in the Dividend Analytical Data section and earned two Stars in the Dividend Income vs. MMA section for a net total of six Stars. Since my scale tops out at five, this quantitatively ranks AFL as a 5 Star-Strong Buy.

Using my D4L-PreScreen.xls model, I determined the share price could increase to $85.38 before AFL's NPV MMA Differential fell to the $3,000 that I like to see for a stock with 27 consecutive years of dividend increases. At that price the stock would yield 1.31%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the needed $3,000 NPV MMA Differential, the calculated rate is 6.1%. This dividend growth rate is well below the below the 16.7% used in this analysis, thus providing a significant margin of safety. AFL has a risk rating of 2.00 which classifies it as a medium risk stock.

AFL is an interesting stock. Quantitatively it has everything an income investor looks for in a company: low debt, strong cash flows, low dividend payout ratio and a long history of increasing its dividend. However, it is a financial company and has a large exposure to other financial services companies, particularly European banks via hybrid bonds. I see this more as a limiting factor of near-term share price appreciation, not its ability to continue growing its dividend. I will continue to add to my position when the stock is trading below its $38.42 buy price and as my allocation allows. 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 AFL (2.0% of my Income Portfolio).

What are your thoughts on AFL?

Recent Stock Analyses:
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Sunday, May 24, 2009

Weekend Reading Links - May 24, 2009

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 (DIV-Net) over the past week:

Articles From DIV-Net Members

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

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


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Saturday, May 23, 2009

Competitive Paralysis

overtheshoulderAugust 4th, 1954 two world record holding sprinters Bannister and Landry squared off in a one mile race at Commonwealth Stadium. The two men had a close race with Landry leading coming into the final few lengths. Knowing that Bannister was sure to be close, Landry looked over his inside shoulder to check his position. Bannister, following closely behind, saw the move and used Landry's shoulder check as an opportunity to pass on the outside and ultimately win the race.

In reading some recent business releases from market leaders I was surprised to see how much time was dedicated to talking about strategies for dealing with smaller competitors. Essentially, doing this very same type of shoulder check.
Ignorance of your competition is most certainly a mistake; a company can often learn to improve itself by looking at what others in the same market are doing. Trying to run a race forward by constantly looking back is though a guaranteed formula for failure. A company who follows this course of action will end up, at best, only as good as its weaker competition.

Visionary companies focus primarily on beating themselves. Success and beating competitors comes to the visionary companies not so much as the end goal, but as the residual result of relentlessly asking the question- How can we improve ourselves to do better tomorrow than we did today.
P. 10 Built to Last- Successful Habits of Visionary Companies

Thoughts on Reading Financial Statements

When you read company financial statements you should think about this:
  • Does this market leading company understand how it got in front and what it needs to do to stay in front?

  • Are they trying to beat their previous performance or are they simply trying to do the minimum required to lead.

  • Are they on the offense: trying to grow customer bases, develop new products, reach new markets, and improve on current products. Or, are they purely on defense trying to fend off a competitor and are therefore letting this competitor set the tempo.
Leading companies don't check their competition; they stay appraised of their condition but ultimately they run their own race as hard and as fast as they can regardless of what the competition may be doing.

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Friday, May 22, 2009

MLPs for tax-deferred accounts

Master Limited Partnerships are very good investment vehicles for individuals looking for high current dividend income. There are some tax issues with reporting MLP income in a taxable account, which led me to explore investing in MLPs through an IRA or ROTH IRA account.



In a taxable account, most of the distributions are considered a return of capital, and thus you do not pay taxes on that portion. This tax deferral does decrease your cost basis however, which could mean higher capital gains or ordinary income taxes if you sell. Because of the supposedly complicated tax returns from MLPs, some investors are shunning MLPs as a class althogether. Others are considering simply purchasing those MLPs in a tax advantaged account, and forget about them.
For non-taxable accounts however, there is a gray area from a tax perspective whether or not one could hold MLPs there. The distributions that an individual that holds a master limited partnership in an individual retirement account receives could be considered unrelated business taxable income subject to taxation. As long as the UBTI from all MLPs in an IRA does not exceed $1000 in a given year, your partnership distributions won’t be taxed.
If the UBTI does exceed $1000 however, the custodian that holds your IRA would have to file a form 990T to the IRS. The tax is paid out of the IRA on the net income from your MLP distributions, which are taxed at the corporate rate.
The UBTI has generally been a non-issue for most MLPs over the past few years, but this isn’t guaranteed. Some like Kinder Morgan (KMP) have even had a negative UBTI in some years, which could be offset against any positive UBTI amounts from other MLPs. Kinder Morgan is one of my Best High Yielding Stocks for 2009.
I do believe however that paying a small tax out of your MLP distributions in an IRA shouldn’t be a big hassle, since distributions are rich and taxed at the corporate rate. One should check with their IRA custodian however in order to asses the amount of fees that the IRA has to pay if the UBTI threshold is exceeded.
If you do not feel comfortable putting ordinary master limited partnerships in a tax-deferred account but feel that you might be missing out, there are still workarounds for this situation. There is an easy way to invest in two MLPs without worrying about taxes too much – Kinder Morgan (KMP) and Enbridge Energy Partners (EEP). They pay their distributions directly as additional shares, which is similar to automatic dividend reinvestment. If you choose to invest in KMP or EEP in an IRA, consider investing in KMR and EEQ.
KMR and EEQ are great vehicles for taxable accounts as well since their distributions are not taxable when received, and thus shareholders are not issued an annual 1099 tax form. You would pay taxes only when you sell your units.
The taxation characteristics of your investments are just one part of the investment puzzle. Always make sure to investigate the company’s fundamentals and do your homework before investing in stocks.

Several publicly traded closed end funds such as Tortoise Energy Infrastructure Corporation (TYG), Tortoise Energy Capital (TYY), Tortoise North American Energy Corp. (TYN), and Kayne Anderson MLP Investment Company (KYN) provide a proper diversification within the MLP sector. They are suitable for IRAs since they send out Form 1099-DIV instead of K-1, which also makes it easier for investors with taxable accounts to file their annual tax returns. In most cases the dividends received are treated as a return of capital, which reduces your cost basis. In such cases the distributions are not treated as taxable income. Investors would only have a tax liability when they sell their closed end fund.
These closed end funds also do not generate any unrelated business taxable income (UBTI). The main disadvantage of these closed end funds are their steep annual management fees.

Tortoise Energy Infrastructure Corporation (TYG) has an annual management fee of 0.95% plus a 0.19% charge for other expenses for a total annual expense ratio of 1.14%.Tortoise Energy Capital (TYY) has an annual management fee of 0.95% plus a 0.25% charge for other expenses for a total annual expense ratio of 1.20%.Tortoise North American Energy Corp. (TYN) has an annual management fee of 1.00% plus a 0.71% charge for other expenses for a total annual expense ratio of 1.71%.

Kayne Anderson MLP Investment company (KYN) spots an annual management fee of 2.50% in addition to other fees of 3.40% for a total expense of 5.90%.
Because of high expense ratios, I would think twice before investing in those closed end funds. One thing that is certain in the investment world is that higher fees are not necessarily indicative of superior investment performance. If you cut your costs to the bone, you are much more likely to at least track your index benchmark.

Full Disclosure: Long KMR

Relevant Articles:

- Master Limited Partnerships (MLPs) – an island of stabiliity for dividend investors
- Kinder Morgan Energy Partners (KMP) Dividend Analysis
- Best High Yield Dividend Stocks for 2009
- General vs Limited Partners in MLP's

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Thursday, May 21, 2009

TROW – Stock Analysis for Dividend Growth Portfolio

T. Rowe Price Group (TROW) is a publicly owned corporation, a holding group, and an investment manager. The firm provides its services to corporations, corporate, public, and Taft-Hartley retirement plans, foundations, and endowments. It is modeled as an asset manager.

TROW is a dividend achiever and has been paying growing dividends for last 10 years. In one of my earlier post, I listed few companies that may have potential for dividend growth investments. TROW was one of them I had shortlisted for more analysis. Keeping with that, my objective here is to analyze if TROW is a good dividend growth stock and risk of dividends associated with it.


Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. I have discussed this in more detail at Dividend Tree. The risk number for risk-to-dividends is 2.14. This is a medium risk category as per my 3-point risk scale.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.
  • Dividend growth rate: The average dividend growth of 25.2% (stdev. 8.34%) is more than average EPS growth rate of 17.8% (stdev. 22%). The two years where EPS were negative, has effect this calculation. If we remove the two negative years, the dividends seem to be well covered. The low payout factors allow for this flexibility and help cover for dividends.
  • Duration of dividend growth: In recent times, dividends have grown only since last 10 years.
  • 4 year rolling dividend growth rate for past ten years: More than 10%.
  • Payout factor: In the past 10 years, it has been consistently less than 50%. In 2008 it increased to 53%. This is an indicator to keeping watch for dividends reduction.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.6%; and (b) MMA yield is 3.4%. Considering the last 10 year average dividend growth rate of 25.2%, the stocks dividend cash flow at the end of 10 years is 4.27 times MMA income. However, with my projected dividend growth of 15.3%, the dividend cash flow is equal to 2.04 times MMA income.

Fair Value Calculation
This section determines what price I should pay to buy a given stock
  • Net present value (NPV) price based on 15 year DCF: $20.4
  • Average high yield price calculated based on past 10 years: $48.5
  • Pricing based on past 10 year relative price-to-earnings ratio. $45.6
  • Pricing based on price-to-earnings ratio of 12: $24.5
  • Graham number: $19.1
The range of fair value is calculated as $24.5 to $31.6. This is determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value).

Qualitative Analysis
TROW’s strength is its business model of asset managements. It manages money for individuals, high net worth individuals, pension funds, corporate funds, and endowments’. It is considered as one of the conservative asset management company.
  • The company does not have any debt, does not need for credit for its operations, or does not need credit for its growth. This is a significantly good characteristic.
  • Since it operates as an asset manager, it is relatively a stable industry i.e. less cyclic.
  • It is likely to be beneficiary of the baby boomer driven demographic shift needing money management services. It has an excellent positioning to reap benefits from this segment.
  • Current financial turmoil does not seem to have had a game changing effect on its businesses. However, it has experienced slow down.
  • I expect it to face short-to-intermediate term challenges due to recession driven slow down.


Conclusion
The dividend cash flow is twice that of MMA income based on current yield of 2.6% and conservative estimate of dividend growth (15.3%). The stocks current risk-to-dividend number is 2.14 (medium risk category). TROW is a dividend achiever and has been raising dividends for last 10 years. In addition, this analysis is showing that TROW continues to be potentially good dividend growth stock with medium risk to dividends. I will be open to initiate a long position when the stock price falls within my fair value range.

Full Disclosure: No position at the time of writing. I may open long position in near future.

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


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Wednesday, May 20, 2009

Dorel's Advantage

As we've discussed before, it is much easier to predict a company's operating earnings than it is its net income, due to changes in debt levels, interest rates, non-operating earnings, and one-time tax items which all affect the latter but not the former. When attempting to value a company using these estimates of operating earnings, however, care must be taken to avoid blanketing each company with the same general tax rate.

Since most North American companies face a tax rate of around 35%, it is tempting to apply this estimate blindly when running a back-of-the-envelope valuation of a company under consideration. However, due to certain credits, tax treaties, and subsidiary jurisdictions, companies can have very different tax rates, which can wildly throw off a valuation.

Consider Dorel (DII.B), a diversified manufacturer of juvenile products and furniture. Because its foreign subsidiaries operate in low-tax jurisdictions, its effective tax rate is only around 15%! Dorel's 2008 income before tax was $132 million, but thanks to its low tax rate this is equivalent to income before tax of $170 million (for a company with a 35% tax rate to have the same after tax earnings as Dorel)...a massive difference!

For an even more extreme example of how a company's tax rate can affect its valuation, read what we wrote about Gildan Activewear (GIL), a company that has managed to reduce its tax rate to practically zero!

For a more detailed discussion of Dorel as a possible value investment, see this article.

Disclosure: Author has a long position in shares of DII.B

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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Monday, May 18, 2009

Stock Analysis: Eli Lilly and Co (LLY)

Linked here is a detailed quantitative analysis of Eli Lilly and Co (LLY). Below are some highlights from the above linked analysis:

Company Description: Eli Lilly and Company discovers, develops, manufactures and sells prescription drugs that offers a wide range of treatments for neurological disorders, diabetes, cancer, and other conditions. The company also sells animal health products.

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
LLY is trading at a discount to 1.) and 3.) above. If I exclude the high and low valuations and average the remaining two, LLY is trading at a slight discount. LLY earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.
LLY earned one Star in this section for 3.) above. LLY has paid a cash dividend to shareholders every year since 1885 and has increased its dividend payments for 42 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
LLY earned both of the available Stars in this section. The NPV MMA Diff. of the $10,982 is in excess of the $2,500 minimum I look for in a stock that has increased dividends as long as LLY has. LLY's current yield of 5.74% exceeds the 3.64% estimated 20-year average MMA rate.

Other: LLY is a member of the S&P 500, a Dividend Aristocrat and a member of the Broad Dividend Achievers™ Index. Like all pharmaceutical companies, LLY faces generic challenges to the its branded patents. The company must continuously development new drugs and face regulatory risks. LLY has a robust pipeline and a diverse drug portfolio with limited near-term patent expirations. Risks include competitive pressures and failure of new drugs to perform.

Conclusion: LLY earned one Star in the Fair Value section, earned one Star in the Dividend Analytical Data section and earned two Stars in the Dividend Income vs. MMA section for a net total of four Stars. This quantitatively ranks LLY as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price could increase to $52.55 before LLY's NPV MMA Differential fell to the $3,000 that I like to see for a stock with 42 consecutive years of dividend increases. At that price the stock would yield 3.73%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the needed $3,000 NPV MMA Differential, the calculated rate is -2.2%. This dividend growth rate is negative and well below the below the 4.3% used in this analysis, thus providing a margin of safety. LLY has a risk rating of 2.00 which classifies it as a medium risk stock.

Looking at the attached PDF, the first thing the grabs your attention are the graphs showing LLY's 2008 earnings and cash flow. The company realized record cash flows while earnings plummeted. This is usually a result of the company recording a non-cash accounting charge. In LLY's case, the company completed its acquisition of ImClone Systems Inc., resulting in a significant charge of $4.69 billion ($4.46/share) for acquired in-process research and development (IPR&D) and reached resolution on government investigations related to its past U.S. marketing and promotional practices for Zyprexa®, resulting in an additional charge of $1.48 billion. I recently added to my position and will consider future additions below my $34.70 buy price. 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 LLY (3.8% of my Income Portfolio).

What are your thoughts on LLY?

Recent Stock Analyses:
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Sunday, May 17, 2009

Weekend Reading Links - May 17, 2009

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 (DIV-Net) over the past week:

Articles From DIV-Net Members

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

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Saturday, May 16, 2009

Bristol-Myers Squibb Review

bms1This week we are reviewing Bristol-Myers Squibb as a possible stock acquisition. To do so we will use the Buffett four filters we discussed in a previous article.

About the Company

Bristol-Myers Squibb Company (BMS) is engaged in the discovery, development, licensing, manufacturing, marketing, distribution and sale of pharmaceutical and nutritional products. The Company had two segments: Pharmaceuticals and Nutritionals. The Pharmaceuticals segment is made up of the global pharmaceutical and international consumer medicines business. The Nutritionals segment consists of Mead Johnson Nutritionals (Mead Johnson), primarily an infant formula and children’s nutritionals business. In January 2008, the Company completed the divestiture of Bristol-Myers Squibb Medical Imaging (Medical Imaging) to Avista Capital Partners L.P. In June 2008, BMS acquired Kosan Biosciences, Inc., a developer of oncology products. In August 2008, the Company completed the divestiture of its ConvaTec business to Cidron Healthcare Limited, an affiliate of Nordic Capital Fund VII and Avista. In December 2008, BMS completed the sale of its brand business in Egypt to GlaxoSmithKline.

Filter 1: Recent Insider Buying

Sigal Elliot EVP, CSO & President R&D
Huet Jean-Marc EVP & CFO

Filter 1 Conclusion

Strong insider buying by key roles in the company- very positive signs.

Filter 2: Graham Fundamental

Metric, Actual
P/E, 12.92
Book Value, 17311.00
Price to Book 3.04
Current Ratio, 2.32
EPS Growth Rate, -0.04 over 5 yrs
Revenue, $5,015M
Consistent Dividend, Yes
Dividend Yield, 6.20%
Earnings in all of last 10 yrs, Yes

Filter 2 Conclusion

Strong on main Graham valuations, EPS Growth Rate is weak meaning they have underperformed in their ability to generate growing earnings over the last 5 years. Compared to the sector that is achieving 5.22% they are not performing well.

Price to book is also inflated meaning we are paying a premium for the value of the company. In comparison to its competition in the sector that is 2.11 they are overpriced.


Filter 3: Sustainable Competitive Advantage

Patents are the main area of advantage for a drug company so it is worth looking at some short hand notes about the largest drugs that Bristol carries, and when the patents expire.

Plavix

Plavix is marketed worldwide in nearly 110 countries, with sales of US$5.9 billion in 2005. It had been the 2nd top selling drug in the world for a few years as of 2007 and was still growing by over 20% in 2007.

In 2006, generic clopidogrel was briefly marketed by Apotex, a Canadian generic pharmaceutical company before a court order halted further production until resolution of a patent infringement case brought by Bristol-Myers Squibb. The court ruled that Bristol-Myers Squibb's patent was valid and provided protection until November 2011.

Generic clopidogrel is also produced by several pharmaceutical companies in India at significantly lower retail prices, up to 1/30th of the price.

Counterfeit Plavix is in circulation, as with many popular medicines.
Wikipedia Link

Abilify

The patent on aripiprazole expires on October 20, 2014; however, due to a pediatric extension, a generic will not become available until at least April 20, 2015. Barr Laboratories initiated a patent challenge under the Hatch-Waxman Act in March 2007. This challenge is still in court as of 11 December 2008.
Wikipedia Link

Reyataz

Patent Expiration Sep 30, 2011
source

Sustiva

Patent Expiration Aug 7, 2012
source

Baraclude

Patent Expiration Feb 21, 2015
source

Filter 3 Conclusion

Diverse solid products. As with many drug companies they sell their product at a premium and once patents expire generics are quick to rush in. 2011 a number of these patents expire so there will likely be an infusion of R&D over the next few years to get new products to the market place to replace older ones.

Filter 4: Able and Trustworthy Managers

James M. Cornelius: Chairman of the Board, Chief Executive Officer

“We’ve recast our business portfolio to focus on medicines for serious disease. We’ve addressed our cost structures to be a leaner, stronger, more effective company, and we’ve accelerated innovation through our string of pearls business development execution”
… “we continue to make headway against our goal of improving our gross margins, pre-tax margins, and net income margins, and again in the quarter, we saw improvement in all three.”

source

Lamberto Andreotti : President, Chief Operating Officer, Director

“We are retaining the scope and resources of a traditional pharmaceutical company and adopting the agility of a biotech company,” says Lamberto. “We are creating an environment that puts a premium on innovation and speed. One of the biggest changes is our shift to a business model that embraces partnerships and opportunities that don’t fit within the traditional pharma model. This means we’re less focused on doing everything on our own. Instead, we’re selecting those things that we need to do ourselves, and doing them better and differently. In the process, we’re accelerating the things that make us very competitive in this changed environment.”

source

Jean-Marc Huet : Chief Financial Officer, Executive Vice President

“We had broad-based growth in the first quarter across the entire portfolio driven by Plavix, Abilify, our virology business, as well as our newer products.”
source

Filter 4 Conclusion

It is tough to get a sense of the management at this point. They do appear to understand the investor/management relationship and do seem to understand how to set a strong corporate direction. Are they trustworthy- hard to say at this point.

Final conclusions- what are your thoughts?

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Friday, May 15, 2009

The Sweet Spot of Dividend Investing

The following is a guest post from Dave Van Knapp, the author of The Top 40 Dividend Stocks for 2009. Make sure to check his site from this link.

In long-term dividend investing, one needs to control risk in many areas. Risk comes in many forms: selecting unsound companies; purchasing companies whose dividends are in peril; creating a portfolio that is insufficiently diversified; and so on.

Two important areas of risk to a long-term dividend strategy are the initial yield and expected growth rate of the dividend itself.
If you start out with too low a yield, it will take many years for the dividend to grow to where it provides a worthwhile return on your original investment. On the other hand, if you start out with too high a yield, it may well be that the dividend is unsustainable and in peril.
If the company typically increases its dividend at too slow a rate, again the dividend will take too long to grow into a desirable return. On the other hand, if you anticipate too fast a growth rate, the company may not achieve it.Plotting these two characteristics against each other--initial yield and anticipated dividend growth rate--gives us a diagram of the "sweet spot" in dividend investing.



On this diagram, the left (vertical) axis represents the dividend’s likely growth rate. It ranges from very slow (say less than 3 percent per year) to very high (say 20 percent per year or more). The bottom (horizontal axis) represents the initial dividend yield, from very low (less than one percent) to very high (greater than 10 percent).

The red area represents four places you don’t normally want to be. Here’s why:

The left edge of the chart is where the stock’s yield is simply too low to be attractive. I seek initial yields of 3 percent or more. Fortunately, because of the long bear market, a lot of quality stocks that formerly would not have cleared this hurdle now offer yields over 3%.
The lower edge is where dividend growth is too slow. Generally seek a growth rate of at least 4 to 5 percent per year. Even in this slow economy, many quality dividend companies have increased their dividends in 2009 by attractive amounts. Examples would be Abbott Labs (ABT, 11%); Coca-Cola (KO, 8%); Chubb (CB, 6%), Procter & Gamble (PG, 10%), Colgate-Palmolive (CL, 10%), and PepsiCo (PEP, 6%).
The top edge is labeled “Growth Traps.” This is where the dividend’s growth rate is probably unsustainable because it is too high. It’s a “trap,” because a high dividend growth rate is usually an attractive quality in a dividend stock. But when the growth rate is too fast, it usually cannot be continued. The very high growth rate may be a red flag that the company is over-extended in its dividend policy and will need to pull back. The risk in stocks with a high dividend growth history is that continuation of a very high rate of dividend growth is unlikely. Many value investors (including Warren Buffett) consider annual earnings growth of 15 percent to be about the maximum sustainable for long time periods.
The right edge is labeled “Yield Traps.” Again, a high yield is a good thing, up to a point. But extremely high yields often point to a problem. The reason the yield is very high is probably because the stock’s price cratered. While that could simply be the byproduct of the bear market of 2007-2009, it could also be a reflection that the company is in serious difficulty and will need to cut its dividend soon. In 2008 and early 2009, we have seen this time and again, especially among financial firms. It should go without saying that the very finest dividend stocks suitable for a long-term dividend strategy are not in danger of cutting their dividends.

The green area in the middle is the sweet spot: Initial dividend yields of between about 3% and 9%, combined with dividend growth rates of about 4% to 17%. Those are generally sustainable numbers, and it is where we will find most of the best dividend stocks for long-term investing.

Relevant Articles:

- 10 by 10: A New Way to Look at Yield and Dividend Growth
- Yield on Cost Matters
- The Dividend Edge
- My Dividend Growth Plan - Strategy


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Thursday, May 14, 2009

When to Initiate a Position ?

If you are like any other do-it-yourself individual investor, you would have been through this dilemma. When should I initiate a position? As per our individual investing style, criteria and risk profile, we have done our due diligence and come up with price that we are ready to pay. Now if we are in bull market, we do not hesitate and take a plunge. However, if we are in the bear market (like these days), then we hesitate to initiate our position. We start contemplating, should we wait a little bit more? This dilemma is more in case of dividend investors because YOC is sensitive to initial yield.

I have been through this dilemma quite often. Let is think this through with some rational reasoning.

  • It is just not possible to predict stock prices. If it were possible, everybody would rich and nobody would be losing money.
  • Any type of fundamental analysis that is done is based on past data, based on past economic environment, and based on how past managements have performed. A great company in past, can end up in mess with new management. Do we need to go through any examples?
  • Any type of technical analysis or chartists theories claims to predict short term movements in next few days or in some cases next few weeks. These are typically 5% to 10% differentials. If I am investing for long term with 10years, 15years, or even more, than these differentials are of no consequence.
I have made mistakes and learnt my lessons. The key is to learn, adapt, evolve, and move on. The well defined investment process based on principles of risk management helps me get over this dilemma. No amount of analysis (fundamental or technical) will save me from losses, if my process of evaluating an investing opportunity is wrong, or if my investing process has shortcomings, or if I do not have ability to stick with my risk criteria’s. If I am listening to market chatter, and continuing to wait for a stock to go down for higher initial yield, then I am deviating from my process. I am listening to folks who themselves have no clue what they are taking about or it may not be relevant to you.

What do I do?
Like any other do-it-yourself investor, I spend quite a bit of time to analyze a company and come up with fair value range. This fair value range is based on my personal risk profile (and not necessarily a fair value in absolute terms). I do not make any one time stock purchase for any given opportunity. In general, I spread it over a period of time. When the stock price falls in my fair price range, I initiate a small position equivalent to 30% of final expected allocation. I then continue to watch for six months or more. In this way, I can minimize my downward losses due to falling knife (note – I cannot avoid, only minimize). The next two installments are kept of future depending upon when there is next opportunity. If it is in fact a falling knife, then it will be obvious. If it is in fact an opportunity to invest, I add to my position, and hence help averaging down.

The message is, ignore the market chatter, identify a process for yourself, and stick to it. There is no investing process which is based on zero risk methodology. Accept the fact that we will incur short term losses.

In a well defined investing process, these short term differentials (loss or profit) will not have any noticeable impact in your longer term objectives.

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


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Wednesday, May 13, 2009

Of Swine And Men

For an analyst, the phrase "long term" appears to mean next quarter rather than this one. Indeed, it is difficult to find analysts who are focused on a company's long term prospects. For a most recent example, consider the analyst response to the recent swine flu outbreak.

While the Center for Disease Control and Prevention has certified that people cannot get swine flu from eating pork or related products, that has not prevented cautious consumers and global trade partners from holding off on their pork purchases for the time being. A classic temporary occurrence, right? Surely, this should have a minimal impact on the long-term value of pork producers.

Not so, according to many analysts, who have slashed their target prices of many affected companies. For example, Christopher Bledsoe of Barclays reduced his target price for Smithfield Foods (SFD), from $24 to $6, despite the fact that he acknowledges the company's products are not affected:

"The fact that pork is deemed safe to eat when properly cooked is likely to be ignored initially by enough consumers and governments globally to impact (Smithfield's) profit recovery."

Apparently, this profit recovery impact slices the SFD's worth by 75%!

Value investors are cautioned not to fall prey to such herd mentalities. Rather than selling when others are selling and buying when others are buying, long term investors have the opportunity to take advantage of such price swings in order to buy companies at a discount to their intrinsic values.

For other recent examples of analyst folly, see articles here and here.

Disclosure: None

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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Tuesday, May 12, 2009

The World is Bigger than Canada and the U.S.

I have been extremely fortunate this year. My employer has posted my in Norway, away from my home in Canada and it has given my family and I the most amazing opportunity to travel easily throughout Europe. As I write this, I am sitting in the Barcelona airport awaiting our flight home after a weeks cruise up the coast of Italy and France. As usual, I have thought of the linkages of this trip to my investment plans and have confirmed something I have always know.

Simply put, there is a whole other world outside of the U.S. and Canada with large well developed markets with large well established companies. As such, I am more convinced now more that ever that I need to have maximum international diversification in my portfolio. Without that, I would be missing out on massive markets and massive companies spread out across the world.

I am not talking about the Coca-Cola's and McDonald's or the world. These companies seem to be everywhere, especially Coca-Cola which is one reason I own it. I am talking about other large companies such as Popular which is a well know dividend paying Spanish bank. There are telecommunications companies, airlines, vacation and travel companies, clothing companies, technology companies to name a few. If I invested only in the U.S. and Canada I would be missing out on these markets.

To invest internationally, I do not invest in individual stocks. Instead, I use international index ETFs to do the work for me. I am not close enough or have enough time to keep track of these companies from afar. Index ETFs work very well for me and give me access to these markets in a cheap and easy fashion. In my opinion, based on what I have seen directly, if you are investing in only U.S. and Canadian stocks then you are missing out on huge markets with great growth potential.

This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.


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Monday, May 11, 2009

Stock Analysis: Illinois Tool Works Inc (ITW)

Linked here is a detailed quantitative analysis of Illinois Tool Works Inc (ITW). Below are some highlights from the above linked analysis:

Company Description: Illinois ToolWorks Inc. is a diversified manufacturer operates a portfolio of about 750 industrial and consumer businesses located throughout the world.

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
ITW is trading at a discount to only 1.) above. If I exclude the high and low valuations and average the remaining two, ITW is trading at a 28.8% premium. ITW had a Star deducted for trading at a premium in excess of 5%.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.

ITW earned one Star in this section for 3.) above. ITW has paid a cash dividend to shareholders every year since 1933 and has increased its dividend payments for 46 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
ITW earned both of the available Stars in this section. The NPV MMA Diff. of the $3,245 is in excess of the $2,500 minimum I look for in a stock that has increased dividends as long as ITW has. If ITW grows its dividend at 5.1% per year, it will take 1 year to equal the cumulative earnings from a MMA yielding an estimated 20-year average rate of 3.64%. ITW earned a Star since its Years to >MMA of 1 is less than 5 years.

Other: ITW is a member of the S&P 500 and a member of the Broad Dividend Achievers™ Index. ITW has a strong balance sheet with a relatively low debt and generates high levels of free cash flow relative to net income. Looking ahead, ITW should continue to grow EPS via acquisitions and share repurchases. Risks would include a continued downturn in industrial activity and/or capital spending, integration of acquisitions and continued escalation of raw material costs.

Conclusion: ITW lost one Star in the Fair Value section, earned one Star in the Dividend Analytical Data section and earned two Stars in the Dividend Income vs. MMA section for a net total of two Stars. This quantitatively ranks ITW as a 2 Star-Weak stock.

Using my D4L-PreScreen.xls model, I determined the share price could increase to $35.34 before BRC's NPV MMA Differential fell to the $3,000 that I like to see for a stock with over 25 consecutive years of dividend increases. At that price the stock would yield 3.51%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the needed $3,000 NPV MMA Differential, the calculated rate is 4.8%. This dividend growth rate is slightly below the 5.1% used in this analysis, thus providing a small margin of safety. ITW has a risk rating of 1.75 which classifies it as a medium risk stock.

2009 will likely be a difficult year for ITW due to the slowing global economy, along with reduced activity in the automotive and construction industries. ITW is a good company, but currently selling at a premium. Given its near-term prospects, we will likely see entry points closer to my buy price of $26.92. For additional information, including the stock's historical dividend information, 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 ITW (2.8% of my Income Portfolio).

What are your thoughts on ITW?

Recent Stock Analyses:
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