Mr. Market was in a bad mood during the past few days, with major stock market indices declining by about 3% since Tuesday. Many reasons have been cited for the sell-off, such as negative reaction to the U.S. election results, fears about the looming fiscal cliff, and lousy economic news from Europe. While these macro-level issues are important, I think it is also important for investors to stay calm, maintain a long-term view, and consider taking advantage of Mr. Market's pessimism. As a dividend growth investor, I view these sell-offs as great opportunities to invest in high-quality dividend growth stocks that are trading at attractive valuations. The hard decision is not whether to buy, but what to buy, especially given my limited cash. I ultimately decided to increase my position in one of the most undervalued stocks in my portfolio.
Today I bought shares of Norfolk Southern (NSC), a major North American railroad company. This is the fourth time I have added to my position in NSC this year, with previous purchases occurring in January, March, and September.
NSC has declined over 20% in the past two months, mainly due to poor quarterly earnings (driven by a decline in coal volumes) and negative market sentiment. Today the stock fell another 2%, setting a new 52-week low. The company is undoubtedly going through a rough patch right now and analysts expect headwinds to persist into the first half of 2013. However, I continue to have a favorable view of the company's long-term growth prospects.
I also think the market has overreacted to recent events, pushing NSC even further into undervalued territory. The stock now has a P/E of 10.5 (its 5-year average P/E is 14.4), P/S of 1.7, and PEG of 0.9. Its current yield of 3.45% is well above the 5-year average of 2.40%. Using a Dividend Discount Model with a projected dividend growth rate of only 8% (which is below historic averages) and a discount rate of 11%, I calculate a fair value of $72 for NSC. Morningstar gives NSC a 4-star rating with a fair value of $85. S&P gives NSC a 4-star rating with a fair value of $67.60 and a 1-year price target of $85. Using the lowest of those estimates, NSC is currently undervalued by at least 14%.
I bought 25 shares of NSC at the price of $57.90 per share, giving me a total of 95 shares at an average price of $67.00 per share and a 2.97% yield on cost. My previous cost basis was $70.25 per share, so this purchase reduced it by 4.63%, which is a great instance of averaging down. At the current dividend rate, I can expect to receive quarterly dividends from NSC of $47.50, which is $12.50 more than before this purchase. NSC will now contribute a total of $190.00 to my annual dividend income, which is $50.00 more than before. This purchase makes NSC the largest position in my portfolio, with a weight by market value of 8.9%, which is about as large as I feel comfortable having it. Incidentally, my forward 12-month dividend total is now $2,000.
I will be sitting on the sidelines for the rest of November because I have insufficient cash for another purchase. For the next few months I anticipate being able to make only one purchase per month. On the one hand, it is unfortunate that I cannot put more money to work immediately. (In case you are wondering, if I did have more cash right now, then I would probably buy KMI and MCD.) On the other hand, it forces me to stagger my purchases over time, which could be advantageous if better opportunities arise later. Regardless, I think the most important thing is to stay disciplined by investing in good opportunities at regular intervals.
Good post! I have similar problems right now: a) don't know what to buy since nearly all long positions have been slashed down in the last couple of weeks and b) we have reached the contribution limits for our Roth IRAs for this year. We wondered whether we should put any new cash into the taxable brokerage account, but decided against it and are putting the money into our car fund now so we can reach the required amount for our new ride a few months ahead of time.
ReplyDeleteSouthbay Consulting: Thanks for your comment. It can indeed be a challenge to decide where to put new cash. Your decision to put extra money toward your new car fund sounds reasonable.
DeleteNice grab. I initiated into NSC on their last dip around $62. I would totally double down right now. I just wish I had the extra cash. I would be scooping up NSC, INTC, KMI and LNCO.
ReplyDeleteThe Dividend Warrior
Dividend Warrior: Thanks! I also wish I had more cash -- a lot of good opportunities are cropping up now, such as the stocks you mentioned.
DeleteGreat job averaging down. Dropping your cost basis by over 4.5% is a great feeling. I'd like to pick up some more to continue averaging down but I built my position in my Roth and want to keep it together in there. My Roth is expended for the year and I'm done for at least another week or so in my FI portfolio. I know its a pain when the capital is limited trying to decide what to buy whens the markets drop as they're doing now but its a good problem to have.
ReplyDeletePassive Income Pursuit: Thanks! It felt great to average down by a considerable amount. I agree that the challenge of choosing among several attractive opportunities is a "good" problem to have. I'd much rather be in this situation than in one where I am struggling to find opportunities.
DeleteDGM,
ReplyDeleteGreat buy here. I can't see much further downside. It's sitting at not only new 52-week lows, but also multi-year lows.
I also have a favorable view of the company over the long-term, but short-term headwinds may persist due to reduction in coal volumes. It does seem Obama's re-election, and his unfavorable view of coal, is a boon to long-term investors as the market is punishing NSC right now.
Congrats on getting forward annual dividends to the $2k mark. That's awesome man!
I joined you in averaging down on NSC. I feel comfortable with where it's at now, but couldn't resist.
"I think the most important thing is to stay disciplined by investing in good opportunities at regular intervals." - I couldn't agree more. That holistic approach is an absolute cornerstone of the strategy I put forth for myself right from the beginning. It's one I will continue until I'm finished investing.
Best wishes!
Dividend Mantra: Thanks, I appreciate the feedback. I agree with your views on NSC and I am glad to see you also took advantage of the opportunity to average down. Once these short-term headwinds subside I think we will see a rebound in the company's operating results and stock price.
DeleteI was a bit surprised that I was able to reach the $2k forward dividend mark so soon. It is always nice when reality exceeds prior expectations!
It is great that we are both making solid progress in our investing. Best wishes as we near the end of 2012!
Nice move. Initiated a position in NSC on Friday. The stock is being punished big time! I'm thinking of adding more if it dips below $55 or $56. Sit tight; looks like MCD is coming down too. It's interesting how a simple quarterly earnings miss causes stocks to drop so much.
ReplyDeleteAverage Dividend Yield: Thanks, and nice move yourself! NSC is quite a bargain at the moment. I have also been watching MCD, which is becoming very attractive. If it continues to decline over the next few weeks, then I might look to increase my position once I have new capital.
DeleteHow big is your acceptable 'Margin of Safety'?
ReplyDeleteAnonymous: I don't look for a specific number when it comes to margin of safety, but I do like it when my percent estimate is in the double digits (as is the case with NSC). More generally, the margin of safety is just one factor among many that I consider when deciding on a purchase.
DeleteGreat move, NSC is being punished by the market right now. I like the idea of reducing the cost basis. I would probably add more myself but I already own 100 shares, and NSC represents my largest holding.
ReplyDeleteI'm also monitoring KMI and MCD right now. Would like to add MCD and hoping it drops even further due to the recent bad news lingering for awhile.
FI Fighter: Thanks for your comment. With NSC also being my largest holding now, I will be a bit more hesitant about additional purchases. My rule of thumb is not to have any single position represent more than 10% of my portfolio, and NSC is at 8.9% now, so my next few purchases will most likely be other stocks. For example, if MCD does indeed drop further, then I would be willing to increase my position in it.
DeleteI think we can all agree that NSC is very attractively priced at the moment.
ReplyDeleteThe thought of buying more is a struggle in my mind. I'm already happy with the size of my NSC position and really don't want it being any larger. But the value is there and staring at me right in the face! I also worry that cheap nat gas is here to stay and could be a long term problem for coal producers and transporters. Can they find other business to replace coal? Would they need to build new track and change routes? Can new customers be put on the same lines? I'm not so sure this is a short term problem. Man, NSC and INTC run circles in my head. Tough decisions!
Anyways I'm a fellow NSC shareholder and think it will work out in the end. I'm willing to ride it out but not sure if I want to up the ante. I might change my mind though, I seem to do that fairly often.
Thanks for the write up it was a good read!
Compounding Income: Thanks for your comment.
DeleteRegarding coal: This past winter was one of the warmest on record, which is the main reason for the sharp decline in coal volume. Unless this marks a sudden and permanent change in climate, going forward we are likely to see regression toward the mean (i.e., "average" winters). This would imply a bottoming out and potentially an uptick in coal volume, at least in the short term.
However, this rides on top of a gradual, long-term decline in domestic coal use as utilities eventually transition to alternative energy sources, such as natural gas. This does not mean that coal will disappear overnight, but it is unlikely to drive much growth for the railroads in the distant future.
That said, I think the decline in domestic coal could be partially offset by an increase in export coal to various emerging market economies, where strong economic growth and larger populations will produce greater energy needs. Railroads are the primary means of transporting coal to terminals for overseas shipping.
Regarding non-coal business: There continues to be an increase in intermodal shipping for the railroads that will likely be the main driver of growth going forward. As the U.S. population increases, more raw materials and finished products will need to be moved around the country, but this will put considerable strain on the Interstate highway system -- not just due to more trucks on the road, but also more people traveling in general. Railroads will be beneficiaries of highway congestion and there could be a gradual shift from trucking to railroad transportation in some areas. Moreover, railroads have the additional advantages of being more fuel efficient and able to transport heavier loads than trucks. Thus, I see intermodal shipping becoming a larger component of railroad revenues, perhaps large enough to offset what happens with coal.
Those are some of my thoughts concerning railroads. I could be wrong about future trends, but I take some solace in the fact that people like Warren Buffett see a bright future for railroads (otherwise I doubt he would have spent over $40B to acquire BNSF). Of course, I will monitor how things progress over the years, so if at some point it looks like railroads are no longer attractive long-term investments, then I can always restructure that aspect of my portfolio.
I, too, used the recent pullback to increase my NSC position. It is now at a full position size, with an avg cost of $61.47. I am wondering what your and other commenters' opinions are on the upcoming dividends. Do you think that there will be an increase from the $0.50/share dividend for the next dividend in March 2013 to coincide with the recent two time/year increases? I have been searching and cannot find much on this. Thanks.
ReplyDeleteG2K: Thanks for your comment. Although I would like to see NSC continue to increase its dividend every two quarters, the recent drop in earnings might lead management to be more conservative and do a single increase in 2013 (perhaps in August). I think it will depend a lot on earnings over the next few quarters.
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