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LOWE’S Company - Stock Analysis for Dividend Growth Portfolio

LOWE’s Company (LOW) is a home improvement retailer. It focuses on retail do-it-yourself (DIY) customers and do-it-for-me (DIFM) customers who utilize LOW's installation services, and commercial business customers. Its product lines include products and services for home decorating, maintenance, repair, remodeling, and the maintenance of commercial buildings. It has approximately 1650 retail stores in US and Canada.

LOW is member of Dividend Aristocrats, Mergent’s Broad Dividend Achiever Index, and S&P500 Index. The most recent dividend increase was in July 2009.

Trend Analysis
Here I am looking at trends for past 9 years of company’s revenue and profitability. These parameters should show consistently growth trends. The trend charts is shown in image below.

  • Revenue: In general, a growing trend since 2000. The average revenue growth for last 9 years has been approximately 14 (std dev of 6.8%). Growth has slowed down in last few years and expected to be negative in 2009.
  • Cash Flows: Overall, until 2008, a growing trend of operating cash flow. It is above net income. The free cash flow is consistently less than net income.
  • EPS from continuing operation: In general, it had an increasing trend until 2007. Negative since 2008 and it is reflection of economic downturn.
  • Dividends per share: Very slow anemic, albeit growing trend.

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 1.43. This is a low risk category as per my 3-point risk scale. Other than negative EPS growth, all other parameters are positive.

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 49% (stdev. 15%) is more than average EPS growth rate of 20% (stdev. 16.4%).
  • Duration of dividend growth: Consecutive dividends growth for more than 25 years.
  • 4 year rolling dividend growth rate for past ten years: Less than 10%.
  • Payout factor: It has been less than 25% since 2000.
  • 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 1.5%; and (b) MMA yield is 2.9%. With my projected dividend growth of 8.2%, the dividend cash flow is 1.41 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $14.1 (i.e. yield 2.2%)
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: $26.0
  • Average high yield price calculated based on past 10 years: $26.8
  • Pricing based on past 10 year relative price-to-earnings ratio. $39.0
  • Pricing based on price-to-earnings ratio of 12: $22.3
  • Graham number: $22.7
The range of fair value is calculated as $24 to $27.3.

Qualitative Analysis
LOW is a founded in 1952 and is the second largest retailer in home improvement segment. Its growth model consists of growing market share by expanding more markets.
  • Its revenue is pretty much focused in US markets (with some presence in Canada and Mexico).
  • It continues to have very stable gross and operating margins. It continues to generate operating cash flows.
  • One would expect that with housing market crash, LOW’s earnings would also crash (similar to financial sector banks). However, it was not the case, and it indicates the strength of its business model.
  • Even though the housing market is grim, I believe the repair and maintenance segment will continue to generate revenue and income for LOWs.
  • The risk factor is that continued slackness in housing market.

Conclusion
Lowe’s Corporation is a stable and slow growing company in long term. It is expected to continue to have a sustainable cash flow over next few years. One issue with Lowe’s is that, historically, it has had a very low dividend yield of less than 2%. At such a low yield, it is less attractive relative to any high yield bond or CDs. However, LOW shares bought at fair value or below would make up of the lack of dividends. In addition, the low payout factor and low dividend risk provides stability for dividend cash flow. The current pricing of $23.4 is less than my buy range. I would continue to add to my existing position based my allocation levels.

Full Disclosure: Long on LOW.

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Protection From High Debt

Before delving into a full analysis, investors will often take a quick look at a company's balance sheet to get an idea of its financial position. Armed with information about the nature of the company's business, the investor can get a good idea of whether the company is "safe" from a solvency point of view. Since value investors value the protection of capital above all else, a company with a high debt level will often be immediately discarded from further analysis. Sometimes, however, a high debt load is not a threat to solvency at all!

Consider Asta Funding (ASFI), a firm that purchases consumer receivables from companies that offer credit to their customers (e.g. credit card companies, telephone companies). For the quarter ended September 30th, the company shows consumer receivables of $208 million against senior debt of $123 million, for a difference of $85 million.

Note that this is not the same thing as an asset of $85 million against no debt, because of the uncertainty of the value of the asset and the magnification of this uncertainty that results from leverage. To illustrate with an example, if the value of the asset is overestimated by 20%, the levered book value drops by almost 50% from $85 million to $43 million (208 * 0.8 - 123) whereas the value of the unlevered asset would only drop to $68 million ($85 million * 0.8).

In the case of Asta, the value of the assets is rather uncertain. The company purchases its receivables for pennies on the dollar, as the companies selling the accounts have already tried and failed to collect from these customers. Adding to the uncertainty is the fact that high unemployment levels have made it more difficult for Asta to collect on its receivables: the company has written down $184 million of its receivables in the last four quarters.

As such, an investor scanning only the balance sheet might take a look at these numbers and run. However, Asta is a lot safer than it looks. The reason for this comes down to the fact that most of its debt is secured by one particular asset, and only one particular asset. Should that asset (currently carried at $121 million) not perform, the loan of approximately $100 million does not have to be paid from the company's other assets! This is an interesting situation which increases the safety of Asta significantly.

The company trades at just 2/3 of its book value despite the fact that most of the debt is non-recourse. Aaron Stackhouse discusses the company's situation in further detail here, for those interested in further analyzing this company.

Looking at a company's balance sheet can give an investor a good idea of the company's debt level. However, only with a careful reading of the notes to the financial statements can an investor uncover items that significantly alter an investor's perception of how solvent a company may be.

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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Socially Responsible Investing

Socially responsible investing, also known as socially-conscious or ethical investing, describes an investment strategy which seeks to maximize both financial return and social good. For example, if you are vehemently opposed to smoking, you can decide to avoid investing in companies that manufacture and sell cigarettes or other tobacco products. In this video, the Benefits and Pensions Monitor explains in detail what SRI is and how to implement it in your portfolio.


Personally, I do not consider SRI in my investment decisions. That does not mean that you should not. You need to take a stand on what you believe in and ensure that your investment choices reflect that.

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


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Stock Analysis: Harleysville Group Inc. (HGIC)

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

Company Description: Harleysville Group Inc. is a regional holding company for property and casualty insurance companies that operates in 32 states, primarily in the eastern half of the U.S.

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
HGIC is trading at a discount to 1.), 3.) and 4.) above. The stock is trading at a 7.5% discount to its calculated fair value of $34.88. HGIC earned a Star in this section since it is trading at a fair value.

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%
HGIC 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%. HGIC 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 1986 and has increased its dividend payments for 22 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
HGIC earned a Star in this section for its NPV MMA Diff. of the $2,081. This amount is in excess of the $1,300 target I look for in a stock that has increased dividends as long as HGIC has. The stock's current yield of 3.87% exceeds the 3.72% estimated 20-year average MMA rate.

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

Conclusion: HGIC earned one Star 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 four Stars. This quantitatively ranks HGIC as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $38.49 before HGIC's NPV MMA Differential decreased to the $1,300 minimum that I look for in a stock with 22 years of consecutive dividend increases. At that price the stock would yield 3.25%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $1,300 NPV MMA Differential, the calculated rate is 6.7%. This dividend growth rate is less than the 8.4% used in this analysis, thus providing a margin of safety. HGIC has a risk rating of 1.25 which classifies it as a low risk stock.

HGIC underwrites property and casualty insurance policies and offers commercial automobile, workers' compensation, and multiperil insurance, as well as personal automobile and homeowner's insurance. The company markets its policies through almost 2,000 insurance agencies, and maintains offices in about a dozen states. On October 27, 2009, HGIC agreed to assume Delta's book of Delta Lloyds Flood Insurance Business effective November 1, 2009. This is a company that I have watched for some time. It has very little debt and its free cash flow payout is relatively low. HGIC is attractively trading below my buy price of $34.88. It is a stock I will give strong consideration to in the future as my asset 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 held no position in HGIC (0.0% of my Income Portfolio). What are your thoughts on HGIC?


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Weekend Reading Links - December 27, 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 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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Buying a House But Not for an Investment

We all do not need to be told that US economy is passing through a turbulent phase. Talk to any individual who has slightest interest in economy and/or investment process, they will tell you the housing is the root cause of our economic malaise. One would imagine that everybody would learn from past mistakes (i.e. particularly mortgage practices) and hopefully do not do repeat it. Sometimes I do not get that feeling, and many times who will feel stakeholders have different objectives and hence knowingly they keep repeat it.

I am looking to buy my first house and hunting for good mortgage rates. I am surprised how there is no change is predatory practices. My wife and I have an excellent credit history, zero debt, and have decided to put down payment of up to 40% total house price. Every lender and real estate broker is attempting to project buying house as an investment. It is being projected to me that it will be part of my wealth. We are being encouraged to not put more than 10% (in some cases no more than 20%) as down payment for the house. There is one lender who is willing to provide load upto 95% i.e. only 5% down payment. Intriguing!

I may not be an smart investment banker, but I just cannot understand how a house (primary place for living) can be considered an investment or part of my wealth. In my view, owning a house as primary dwelling is more of our responsibility to family. It is our current expenses, which we need to manage using good quality of earnings (like good quality of dividends). Even if we did not own a house, we would still need a place to live. It is highly likely that for similar standard or quality of living, one would probably end up paying same level of rent.

The most interesting part is, almost all of them run the same tape record that once you fully pay the mortgage, it will be your asset. Over time, housing increases in value. Think over it for a minute. Assuming the value of house increases, what does it really mean? If I want to live at another place, I will have to probably end up paying similar high amount for same standard of living. Where is the value for me? Where is my wealth?

So why brokers and lenders want to lend more? So that they can get PMI and they can get higher commission. The higher the loan amount they sell, based on fixed percentage commission, they can get higher fees and commission. They do not seem to be interested in providing you a good value. They are more interested in squeezing higher amount of loans and higher commission from themselves.

At best, buying a house using mortgage is preserving value of your money. The rental amount is lost forever. However, in case of mortgage, you are keeping it with you. Sometime is future, you will not have to pay the rent. Finally, how can you measure the intangible benefits like enjoying house with your family and friends, the quite and peaceful sleep that you have day in day out, etc. You work hard to live and have fun. Can you really put an ROI to it?

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Fixing The Average

When estimating a company's earning power, it's important to look at its annual earnings over the past business cycle, rather than assuming that its current earnings are representative of future earnings. In Security Analysis, Ben Graham and David Dodd discussed the need to smooth out fluctuations in annual earnings, and we have looked at some reasons for why that is the case. Sometimes, however, properties of a company have changed, and current earnings may actually be a better gauge of a company's earnings prospects going forward.


Consider Dover Downs Gaming (DDE), a hotel/casino/track operator in Delaware. In addition to corporate tax rates that are already quite high, the state government has been increasing the company's gaming fees and taxes. The fee changes are not minimal, and are not recorded as taxes, and therefore show up as increased operating expenses. Consider the following statement from the recent 10-Q:

Gaming expenses increased by $1,082,000, or 2.4%, primarily as a result of increased gaming taxes and slot machine fees that resulted from legislation passed in May of 2009 that became effective on May 28, 2009. The impact of this legislation resulted in an increase in our gaming taxes and slot machine fees of approximately $3,600,000 in the third quarter of 2009.

This $3.6 million per quarter of increased fees is not a trivial amount. It represents about 6% of the quarter's revenues, and as such results in taking a huge chunk out of the company's profit margin. These new fees eat up about $14 million on an annualized basis, compared to the company's operating earnings of around $40 million per year or so in the last four years!

The new fees had such an impact, that the company cancelled plans to expand:

We had previously completed architectural and engineering work related to a Phase 7 casino expansion that would have included, among other things, a new sports book facility and a parking garage. Given the recent decision by the US Court of Appeals for the Third Circuit to limit the extent of sports wagering in Delaware and the higher gaming tax rates that were recently legislated, we decided not to proceed with this project. During the third quarter of 2009, we wrote off $2,177,000 of capitalized costs related to these expansion projects.

While averaging past earnings do smooth out temporary fluctuations in annual earnings, the investor must still keep an eye out for recent changes to the business that render operating earnings obsolete. Adjustments to averaged earnings that take recent changes into effect will often need to be made to improve their predictability of future earnings power.

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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Your Mutual Fund May Be Ripping You Off

Bargaineering is a great personal finance blog and has done a series of videos about personal investing that I find very enlightening. In this particular post Jim talks about mutual fund fees and how your mutual fund may be in fact ripping you off.


As I have said before, it is extremely important that all investors keep track of the fees we pay. Mutual funds can be a big source of those excess fees. Go now and check the websites for each and every fund you own and check the MER. If it is high then plan your next steps right away.

This article was written by The Dividend Guy. To learn more about dividend investing, please follow my RSS feed or Twitter account.


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Stock Analysis: Emerson Electric Co. (EMR)

Linked here is a detailed quantitative analysis of Emerson Electric Co. (EMR). Below are some highlights from the above linked analysis:

Company Description: Emerson Electric Co. primarily makes backup power equipment for telecom and Internet providers and users, climate control components, and electric motors.

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
EMR is trading at a discount to 1.) and 3.) above. The stock is trading at a 13.0% premium to its calculated fair value of $36.97. EMR 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%
EMR 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%. EMR 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 1947 and has increased its dividend payments for 52 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
EMR earned a Star in this section for its NPV MMA Diff. of the $637. This amount is in excess of the $500 target I look for in a stock that has increased dividends as long as EMR has. If EMR grows its dividend at 6.4% per year, it will take 3 years to equal a MMA yielding an estimated 20-year average rate of 3.72%. EMR earned a check for the Key Metric 'Years to >MMA' since its 3 years is less than the 5 year target.

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

Conclusion: EMR 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 EMR as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $44.74 before EMR's NPV MMA Differential decreased to the $500 minimum that I look for in a stock with 52 years of consecutive dividend increases. At that price the stock would yield 2.95%.

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 5.7%. This dividend growth rate is less than the 6.4% used in this analysis, thus providing a margin of safety. EMR has a risk rating of 1.25 which classifies it as a low risk stock.

EMR has a strong competitive position within its major product categories and a reputation for providing consistent returns to investors. EMR's advantages include globally branded platforms, new products in the pipeline, a strong balance sheet and free cash flow. The stock is currently trading above my buy price of $36.97, but given its strong dividend fundamentals, I will give it consideration as my asset 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 EMR (3.7% of my Income Portfolio). What are your thoughts on EMR?

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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.


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Weekend Reading Links - December 20, 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 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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The Year that was

As the year winds down in these final weeks I have had opportunity to think back on the year that was. For some I know this has been a terrible year, for myself it has financially been one of the best. While we do publish a fair number of stock reviews throughout the year only a limited few actually translate into actual recommended buys, but almost everything we touched this year turned to gold.

We started the year with a buyout of Puget Power (PSD) that netted a nice return, then on to a quick buy and sell of Ford (F) that provided a fabulous return. Then on with Methanex (MX) whose 6% dividend and 62% increase in share price has been quite enjoyable. Our next big move was into Brystol Myers (BMY) who also promises us a nice 6% and whose shares have increased 37% since our posted article.

While others have done better I feel good about the risk and return garnered in these trades.

Loose, but don't loose the lesson

The year was not completely full of winners; our early positions in the small unknown NSEC before the credit crunch really kicked into high gear are still haunting us with a 30% loss. When the company cut it's dividend the share price dropped off the wall and has only recently somewhat rebounded. In this case the mistake was twofold, too small of a company, and it had too little liquid cash onhand to support the dark days of the credit crunch. The lack of cash caused the cut of the dividend and the small nature of the business turned a leak into a mass exodus.

If you can't decide then don't

This has been probably one of the quietest years for shear buys and sells. It has been hard to keep the finger off the trigger with some of the ridiculous prices that have been available for quality companies. With the constant appearance of books chock full of intangibles assets though finding the true value of a company has been laborious and kept me on the sidelines. While I hope to close out the year with a one more buys I've been more than happy to put the money to work in more reliable places while awaiting the perfect opportunity.

Best of the season to you, hoping your new year will be profitable and rewarding.

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Changes in the Dividend Aristocrats

The dividend aristocrats list includes companies which have increased dividends for over 25 years in a row. It is equally weighted and re-balanced once an year.

The companies which were added to the index include:

BROWN-FORMAN -CL B (BF.B )

CINTAS CORP (CTAS)

I expected that these two companies could be good additions to the index in The New Dividend Aristocrats.

The companies which were removed from the index include:

Avery Dennison Corp (AVY) (analysis)

BB&T Corp (BBT) (analysis)

Gannett Co (GCI) (analysis)

General Electric (GE) (analysis)

Johnson Controls (JCI) (analysis)

Legg Mason (LM) (analysis)

M & T Bank (MTB) (analysis)

Pfizer (PFE) (analysis)

State Street (STT) (analysis)

Us Bancorp (USB) (analysis)

In 2008 the dividend aristocrats’ index outperformed the S&P 500 by 15.50 percent. The dividend aristocrats lost 21.55% in 2008 versus the 37.00% loss for the S&P 500. So far in 2009 ( as of December 11) the S&P Dividend Aristocrats index is up 27.24%,, which is better than the 25.38% performance of S&P 500.To view the full list of Dividend Aristocrats in 2009, check out Standard and Poors website.

Full Disclosure: Long MTB

-Dividend Stocks to Avoid

-More Dividend Stocks to Avoid

-High-Yield Dividends at Risk

- Why do I like Dividend Aristocrats?


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Graco Inc., - Stock Analysis for Dividend Growth Portfolio

Graco Inc. (GGG) and its subsidiaries, provides fluid handling systems and components. Its products are used to move, measure, control, dispense, and spray a wide range of fluids in Industrial, Contractor and Lubrication applications. The company was founded in 1926 and has headquarters in Minneapolis, Minnesota.

GGG is part of S&P Mid-Cap 400 Index and has been increasing dividends for last 10 years (including the latest one). The most recent dividend increase of 5.0% was in December 2009. In last 10 years, the annual dividends have increased from $0.13 per share to $0.80 per share.

Trend Analysis
Here I am looking at trends for past 9 years of company’s revenue and profitability. These parameters should show consistently growth trends. The trend charts are shown in images below.

  • Revenue: Growth until 2006, flat since 2006. The average revenue growth for last 9 years has been approximately 9.3%. Year 2009 revenues are expected to be lesser by more than 25%.
  • Cash Flows: Overall, until 2008, a growing trend of free cash flow and operating cash flow. Most of the time FCF is more than net income.
  • EPS from continuing operation: In general, it had an increasing trend until 2007, drop in 2008, and expected drop more in 2009.
  • Dividends per share: Growing trend.

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 2.14. This is a medium risk category as per my 3-point risk scale. High payout factor, significant reduction in operating margin, and negative EPS growth makes this medium risk dividend stock. It is very close to being a high risk to dividend stock.

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 12.5% (stdev. 23.65%) is similar to average EPS growth rate of 12.1% (stdev. 14.3%).
  • Duration of dividend growth: 10 years of consecutive dividends growth.
  • 4 year rolling dividend growth rate for past ten years: Since 2001, it is 10 or more%.
  • Payout factor: It has been less than 37%. But expected to close to 90% for 2009.
  • 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 2.9%. With my projected dividend growth of 9.3%, the dividend cash flow is 1.54 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $19.15 (i.e. yield 4.0%)


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: $22.7
  • Average high yield price calculated based on past 10 years: $26.4
  • Pricing based on past 10 year relative price-to-earnings ratio. $40.4
  • Pricing based on price-to-earnings ratio of 12: $25.9
  • Graham number: $10.3

The range of fair value is calculated as $19.8 to $25.1.

Qualitative Analysis
GGG intends to focus of its core competency of solutions/components for fluid management systems. Its strategy for growth consists of expanding in emerging markets and value added acquisitions.

  • Its revenue is diversified in Americas (55%), Europe (29%), and Asia/Pacific (16%). In addition, its also has diversified revenue stream from industrials (55%), contractor equipments (33%) and lubrication equipments (11%).
  • It continues to have stable to growing cash flows.
  • It has also taken a bit of debt. If the growth plans do not materialize, servicing debt will be challenge.
  • More than half of its revenues come from industrial sector. However, its presence in growing industrial sector of emerging markets (i.e. China and India) is week. It needs to expand in these markets. This will be risk factors to its growth.


Conclusion
Graco Inc. has enjoyed a stable and slow growth for last nine years. It has a well defined growth strategy around its core competency. It continues to have a positive cash flow. The present dividends seems to be covered, however, a continued weakness is end market (i.e. US and Europe) can affect dividend growth in near future. The stock’s current risk-to-dividend rating is 2.14 (medium risk), which is very close to being a high risk. I would continue to watch for any changes w.r.t lower dividend risk and or falling into my fair pricing range.

Full Disclosure: No position at the time of this writing.

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Shareholder Rights? Not So Much

Sometimes, managements will adopt so-called Shareholder Rights Plans that "protect" shareholders from hostile takeovers. Often, however, such plans have negative effects for shareholders. In such cases, these plans are designed to protect managements rather than shareholders. Consider events last year at LCA-Vision (LCAV), a stock we've discussed as a potential value play.

The founders of LCAV (who left the company a few years ago) started buying up a significant number of shares, bringing their total to 11.4% of the company. Often, this type of activity suggests a takeover offer for the remaining shares may soon follow. In order to entice remaining shareholders to tender their shares, a takeover offer will ordinarily be at a price well above the current share price. Because the market anticipates an offer, the shares tend to trade higher than they otherwise would. Good for current shareholders, right? It was, until a "Shareholder Rights Plan" was adopted by management (management's description of how the plan works is available here).

The plan makes it more difficult for a group to successfully bid for and acquire the company. But even if an offer is made, shareholders are under no obligation to accept it. If they deem the offer to be unfair, they have the option to reject it. So essentially management is eliminating that shareholder option with a shareholder "rights" plan, forcing shareholders to wait until the next annual general meeting to vote the plan down.

In Security Analysis, Ben Graham asserts that shareholders do not protect themselves from managements as much as they should. This appears to be an example where management has protected itself at the expense of shareholders. Beware the Shareholder "Rights" Plan...it is usually designed to protect management, not shareholders.

Disclosure: Author has a long position in shares of LCAV

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10 Books I am Reading on my Kindle

I have always enjoyed reading, but I never thought I would be reading as much as I am now. What has changed? The Amazon Kindle 2 and the ease and ability to carry around a bunch of books at once. This device is amazing. Compared with the Apple iTouch, iPhone, or even the Sony Reader, the Kindle is about as ugly as a rhino but it is hard to dispute the impact the ease of getting books delivered wirelessly is. This fact alone has me reading more books than I have ever done before.

The real beauty is that an investor has access to personal finance and investing books through the Kindle store. I now can satisfy my crazy appetite for investing books without having to carry them around. I travel a lot so having these books in one little device has been good for my back! Here are some that are on my Kindle right now, and some I will add as I make my way through those (note - not affiliate links as Amazon does not allow that):

1. The Investor's Manifesto
2. The Little Book of Main Street Money
3. The Perfect Portfolio
4. The Bogleheads' Guide to Retirement Planning
5. The New Coffeehouse Investor
6. The Four Pillars of Investing
7. The Ultimate Dividend Playbook
8. The Intelligent Investor
9. The Dhandho Investor
10. Your Money and Your Brain

Please note these are not affiliate links as Amazon does not allow that for Kindle books. However, if you are interested in a Kindle, please feel free to click here:






 Don’t get me wrong - there are a lot of things that need to be improved about the Kindle. Especially the fact that not all books are available, due in part to publishers unwillingness to publish Kindle versions ahead of hardcopy versions. In addition, depending on which region you live in, not all books will be available for you. Reminds me of the MPAA and their protectionist attitudes with mp3’s. The MPAA has lost that war, and I suspect that book publishers will too as pirated versions of eBooks are becoming available.  I have not gone down that route as there are just enough available in my region to satisfy my appetite.   In an event, I believe ebooks are here to stay and the experience will only get better as we all figure this out.

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Stock Analysis: Nucor Corporation (NUE)

Linked here is a detailed quantitative analysis of Nucor Corporation (NUE). Below are some highlights from the above linked analysis:

Company Description: Nucor Corporation is engaged in the manufacture and sale of steel and steel products. As the largest minimill steelmaker in the U.S., Nucor has one of the most diverse product lines of any steelmaker in the Americas.

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
NUE is trading at a discount to 1.) and 2.) above. The stock is trading at a 46.4% premium to its calculated fair value of $28.85. NUE 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%
NUE 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%. NUE 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 (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%. The company has paid a cash dividend to shareholders every year since 1973 and has increased its dividend payments for 36 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
NUE earned a Star in this section for its NPV MMA Diff. of the $9,612. This amount is in excess of the $500 target I look for in a stock that has increased dividends as long as NUE has. If NUE grows its dividend at 15.0% per year, it will take 1 years to equal a MMA yielding an estimated 20-year average rate of 3.72%. NUE earned a check for the Key Metric 'Years to >MMA' since its 1 years is less than the 5 year target.

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

Conclusion: NUE 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 NUE as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $119.43 before NUE's NPV MMA Differential decreased to the $500 minimum that I look for in a stock with 36 years of consecutive dividend increases. At that price the stock would yield 1.17%.

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 5.2%. This dividend growth rate is less than the 15.0% used in this analysis, thus providing a margin of safety. NUE has a risk rating of 1.50 which classifies it as a low risk stock.

NUE has a solid share of the markets in which it competes, a very low ratio of total debt to assets, and a very diverse product mix. The company's relatively flexible cost structure (pay-for-performance) and low-cost operations have helped mitigate weak demand in the most recent downturn. Recently, the company announced a 2.9% dividend increase. This was much less than the last several years' increase, but speaks well to management's confidence in the company's ability to perform. The stock is currently trading well above my buy price of $28.85. 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 NUE (3.5% of my Income Portfolio). What are your thoughts on NUE?


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Weekend Reading Links - December 13, 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 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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Google maps for property assessment

Having been on a recent trip to the southern US I was awestruck with the prices of property there. Being out of my element in a new city I simply wasn't comfortable with the idea of investing though. With proper preparation trips of this type can be quite rewarding and one of your best tools is often overlooked- Google Maps.

With a simple browse of an area in Google maps you can learn all of the following:

  • How far away is the local hospital, school, police station, prison, garbage dump, shopping mall. All of these can increase or dramatically decrease your long term value.

  • What is the wealth of the area- do you see cars in people's yards, do the roofs look old, are there pools, does your neighbour have a garbage dump running in his back yard?

  • What is the zoning like? Are newer houses quite close together indicating you will likely be able to demo and build two houses on a lot in the near future.

  • Is there any major road development occurring? How do you think things will develop based on how they are currently setup? Will a house be demolished and a new road collected to your quite street? Or maybe a street widening to turn your two lane into a four lane.

  • Where are the major roads? Are they close to the house? Roads tend to get more busy rather than less over time leading to poor air quality, busy streets and an overall negative environment.

  • What types of businesses are nearby? If you see dump trucks parked in back lots this is a bad sign. Greenhouses down the street means 24/7 lights and the constant sound of trucks.
Take it all in and Happy hunting!

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Stanley Works (SWK) Stock Analysis

The Stanley Works manufactures tools and engineered security solutions worldwide. The company, which has raised dividends for 42 consecutive years, is a member of the S&P Dividend Aristocrats index.

Since 1999 this dividend stock has delivered an average total return of 8.10% annually.

The company has managed to deliver a 6% average annual increase in its EPS between 1999 and 2008. Analysts expect Stanley Works to earn $2.42 share next year, followed by an increase to $3.06/share in the year after that. Back in November 2009, Stanley Works announced its intent to acquire Black & Decker (BDK) in an all stock deal subject to regulatory and shareholder approvals. The combined companies could realize significant synergies and enjoy a wider product base with little overlap between the two businesses. In addition to that the company is in the process of eliminating 10% of its staff, which could help offset weaker sales this year.

Return on Equity has fluctuated widely between 9% and 21% over the past decade. This indicator has spend of the time in the high teen’s however. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Annual dividends have increased by an average of 4.20% annually since 1999, which is much slower than the growth in EPS. A 4 % growth in dividends translates into the dividend payment doubling every eighteen years. If we look at historical data, going as far back as 1968, Stanley Works has actually managed to double its dividend payment every ten years on average.

The dividend payout ratio has consistently remained below 50% over the past five years. 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 Stanley Works is overvalued at 22 times earnings, yields 2.70% and has an adequately covered distribution payment. Although the Black & Decker acquisition could be accretive to EPS, it could jeopardize the already weakened growth in distributions for Stanley Works such that the company freezes its payment for a few years. If it keeps raising distributions however I would look to enter a small position in Stanley Works (SWK) on dips below $44.

Full Disclosure: None


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Index Investing in the Context of Exposure to a Market

In last couple of years, Exchange traded funds (ETFs) as an investment vehicle has gained momentum among individual investors. In addition, we can also see never ending queue of new ETF based funds either being launched or waiting in the wings. There are few key aspects such as low expenses, trading ability during normal market hours, and relative transparency. Let us take an example of S&P500. We expect that buying S&P500 based ETF fund will provide us exposure to US economy.

  • S&P500 is market cap based index. The top 28 companies have 40% contribution to the index, while top 45 companies provide 50% contribution, and top 180 companies provide 80% contribution. As an investor it really does not help to invest in index hoping to have exposure to US economy.
  • In S&P500 index, the bottom 320 companies have only 20% contribution. As an investor, do I really need to be part of 320 companies for only 20% exposure?
  • The top 10 companies in S&P500 index (which have approx. 20% weightage) earn close to 40% of the revenue from foreign and/or emerging markets. If we take the full gamut of 500 companies, it is likely (and probably safe to assume) that more than 50% of the revenue comes from markets outside US. So as an investor it does not seem to provide exposure to the US economy.
  • The index consists for array of companies who weightage is based on market capitalization. In case of S&P500, the top 10 has a significant contribution to the index and it can sway it performance even with small change. However, a set of 10 companies on the bottom rung, will not impact S&P500. Even if these 10 companies are doing good and maintaining consistency performance, profitability, and good financial management, there will be no visible impact on the index. As an investor, the value of our investments will be at the mercy of large companies.
  • The index is an attempt to capture a wider base of business in the economy; it is difficult to have all good quality companies. Index will have good quality and bad quality companies. Even though we as an investor may not like a company, we get exposure to it by default.
This is quite intriguing. It may be good indicator for the economy and provide a ‘relative’ comparison tool in different time periods. However, as an investor, its applicability and use in our portfolio is limited to structure.

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Shareholder Rights? Not So Much

Sometimes, managements will adopt so-called Shareholder Rights Plans that "protect" shareholders from hostile takeovers. Often, however, such plans have negative effects for shareholders. In such cases, these plans are designed to protect managements rather than shareholders. Consider events last year at LCA-Vision (LCAV), a stock we've discussed as a potential value play.

The founders of LCAV (who left the company a few years ago) started buying up a significant number of shares, bringing their total to 11.4% of the company. Often, this type of activity suggests a takeover offer for the remaining shares may soon follow. In order to entice remaining shareholders to tender their shares, a takeover offer will ordinarily be at a price well above the current share price. Because the market anticipates an offer, the shares tend to trade higher than they otherwise would. Good for current shareholders, right? It was, until a "Shareholder Rights Plan" was adopted by management (management's description of how the plan works is available here).

The plan makes it more difficult for a group to successfully bid for and acquire the company. But even if an offer is made, shareholders are under no obligation to accept it. If they deem the offer to be unfair, they have the option to reject it. So essentially management is eliminating that shareholder option with a shareholder "rights" plan, forcing shareholders to wait until the next annual general meeting to vote the plan down.

In Security Analysis, Ben Graham asserts that shareholders do not protect themselves from managements as much as they should. This appears to be an example where management has protected itself at the expense of shareholders. Beware the Shareholder "Rights" Plan...it is usually designed to protect management, not shareholders.

Disclosure: Author has a long position in shares of LCAV

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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Use Index Funds, Not Mutual Funds and Save 80% In Fees

I would hope at this point it is very common knowledge that mutual funds can be, and often are, more expensive than index funds. However, my gut tells me that there is still work to do to inform the layperson investor that fees do matter and there are simple things that can be done to minimize the impact of those fees on your portfolio. Here is a video that explains just that.


Pretty simple but powerful message - you can save a good chunk of your hard-earned money by using low cost index funds. Check your mutual funds today and take a look at the management expense ratio. If it is higher than a index fund, then you have some action to take.

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


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Stock Analysis: Cincinnati Financial Corp. (CINF)

Linked here is a detailed quantitative analysis of Cincinnati Financial Corp. (CINF). Below are some highlights from the above linked analysis:

Company Description: Cincinnati Financial Corp. markets primarily property and casualty coverage; it also conducts life insurance and asset management operations.

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
CINF is trading at a discount to 1.), 2.) and 4.) above. The stock is trading at a 17.2% discount to its calculated fair value of $30.77. CINF earned a Star in this section since it is trading at a fair value.

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%
CINF 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% and it 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 1954 and has increased its dividend payments for 49 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
CINF earned a Star in this section for its NPV MMA Diff. of the $921. This amount is in excess of the $500 target I look for in a stock that has increased dividends as long as CINF has. The stock's current yield of 6.16% exceeds the 3.72% estimated 20-year average MMA rate.

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

Conclusion: CINF earned one Star 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 four Stars. This quantitatively ranks CINF as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $30.77 before CINF's NPV MMA Differential decreased to the $500 minimum that I look for in a stock with 49 years of consecutive dividend increases. At that price the stock would yield 5.10%.

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 negative (1.5%). This dividend growth rate is slightly less than the 0.6% used in this analysis, thus providing a very small margin of safety. CINF has a risk rating of 1.75 which classifies it as a medium risk stock.

CINF was founded by independent insurance agents in order to better service their needs by providing them preferential treatment when picking an underwriter. The company primarily sells commercial property-casualty insurance with a smaller personal lines exposure marketed through a select group of about 1,100 independent insurance agencies. Like most financial services companies, CINF has seen its share of struggles. Although, the stock is trading slightly below my buy price of $30.77, its Free Cash Flow payout of 78% gives me pause. Before seriously considering initiating a position in this stock, I plan to wait a few more quarters and watch for a decline in the FCF Payout. 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 CINF (0.0% of my Income Portfolio). What are your thoughts on CINF?


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