Sunday, October 21, 2012

Book Review: Markets Never Forget (But People Do)

Markets Never Forget (But People Do) (2011) by Ken Fisher

This book can be considered a sequel to the author's previous book, Debunkery, which I read and reviewed earlier this year. The main thesis of this book is that people tend to forget about (or ignore) market history, which results in misconceptions and improbable projections about the relationship between market performance and various economic and political factors. To give some examples from the book:
  • In the past few years there has been plenty of talk about the risk of a "double-dip recession," even though it is an improbable event, reflecting less than 10% of past recessions.
  • People tend to forget that major drops in the market are often followed soon after by strong rebounds, producing a V-shaped pattern.
  • Even though the market's average annual return has been around 10%, it is actually rare for the return in a given year to be around 10%.
  • If you are a perma-bear, then you will be wrong more often than right because the market has positive annual returns about two-thirds of the time.
There is also discussion of the market in relation to volatility, government debt, politics, globalization, and other issues. I disliked the chapter on politics; even though I agree with some of the author's views, he expresses them in a harsh and unprofessional manner that drags the book down to a lower level. Putting that aside, I think the book shows that a knowledge of market history can be useful for dispelling some of the misconceptions and improbabilities promulgated by the media and pundits.

Note: I read this book in September 2012.

Saturday, October 20, 2012

Revisiting Black Monday After 25 Years

Yesterday marked the 25th anniversary of Black Monday (October 19, 1987), when world stock markets plunged and the Dow Jones Industrial Average fell by 22% in a single day. Nightly Business Report has posted the video of that night's broadcast on their website. It provides a fascinating historical look at what happened that day and how people reacted.

Wednesday, October 17, 2012

Dividend Increase: KMI

Kinder Morgan, Inc. (KMI) is increasing its quarterly dividend by 2.9%, from $0.35 to $0.36 per share. Its dividend has been increased every quarter in 2012, resulting in an overall increase of 20% compared with the last quarter of 2011. Given that I own 40 shares of KMI, my quarterly dividend increases from $14.00 to $14.40, which will add an extra $1.60 to my annual dividend income. This dividend increase also boosts my yield on cost to 4.11%. Thus far this year, there have been dividend increases for 23 of the 25 dividend growth stocks in my portfolio.

Dividend News: ABT

There has been some uncertainty about what will happen to the dividend of Abbott Laboratories (ABT) once the company splits at the end of this year. Some clarification was provided on today's earnings call:
The dividend has always been an important component of Abbott's investment identity. We had previously indicated that we expected to combine dividend of the 2 companies to be at least equal to Abbott's pre-separation annual dividend. And we expect AbbVie to be even more focused on shareholder returns in the pharma dividends, paying a larger portion of the dividend.

With this in mind, today, we're announcing that we expect AbbVie to pay an annual dividend of $1.60 per share, starting with the quarterly dividend to be paid in February. This, like all dividends, will be subject to approval by the future AbbVie board in January 2013. We're also announcing that we expect the new Abbott dividend to be $0.56 per share, in line with its peer group and growth prospects, again, starting with the dividend to be paid in February and again, subject to approval by the Abbott board.

In the end, this combined annual dividend rate of $2.16 for the 2 companies exceeds the current annual dividend rate of $2.04. And this increase is expected to be implemented one quarter earlier than in past years.
Assuming those dividend rates are approved, the combined dividend increase will be 5.9%, which is rather modest, but it will come a quarter earlier than usual. Note that AbbVie will trade under the ticker ABBV.

Tuesday, October 16, 2012

Dividend Growth Analysis: Rate Versus Length Of Streak

A new article of mine has been published on the investing website Seeking Alpha. The article is entitled Dividend Growth Analysis: Rate Versus Length Of Streak and it looks at the relationship between dividend growth rate and length of the dividend growth streak.

Thursday, October 11, 2012

Stock Bought: INTC

Today I bought shares of Intel (INTC), the world's largest semiconductor chip maker. I wrote about INTC last month when I started a position in the stock. Its price has continued to trend down over the past few weeks, making the stock even more undervalued than before. The company reports its quarterly earnings on October 16, but I do not like to guess how the market will react to earnings, so I deemed it best to take advantage of the buying opportunity already in front of me.

I bought 50 shares of INTC at the price of $21.70 per share, giving me a total of 115 shares at an average price of exactly $22.22 per share (some nice symmetry there) and a 4.03% yield on cost. At the current dividend rate, I can expect to receive quarterly dividends of $25.88, which is $11.25 more than before this purchase. INTC will now contribute a total of $103.52 to my annual dividend income, an increase of $45.00.

My three purchases this week used up all my cash, so I will be waiting on the sidelines until I have new capital at the start of November. On the one hand, this means I will not be able to take advantage of any dips due to earnings that "miss" analyst estimates in the coming weeks. On the other hand, desirable dips might not happen (such was the case in July) and the opportunities that resulted in my recent purchases might be gone by the end of the month. I am continuing to teach myself that it is better to capitalize on good opportunities when they are present than to speculate about future opportunities that may not come to fruition.

Wednesday, October 10, 2012

Stock Bought: CMI

For my second purchase today I bought shares of Cummins (CMI), a world leader in the design and manufacture of diesel and natural gas engines. The company is at the forefront of developing better engine technology that meets stricter emission standards and is poised to take advantage of the increasing use of natural gas as a fuel source for vehicles.

I recently posted a quantitative comparison of CMI with one of its competitors in the heavy machinery industry, arguing that it is undervalued despite having solid fundamentals. Here is a recap:
  • Its 5-year historic growth rates for revenue and earnings are 9.70% and 21.87%, respectively, with low double-digit earnings growth expected over the next few years.
  • The company has a great balance sheet, with debt/capital of 9.60%, debt/equity of 12.34%, a current ratio over 2, and ample interest coverage.
  • The company has increased its dividend for 7 consecutive years, with an impressive 5-year dividend growth rate of 32.10% and a payout ratio of just 20%. This year's dividend increase was 25%.
  • CMI has a P/E of 8.74 (its 5-year average P/E is 15.10), P/S of 0.91, and PEG of 0.76. Using a Dividend Discount Model with a below-average dividend growth rate of 10% and a discount rate of 12%, I calculate a fair value of $110 per share, which implies a 20% margin of safety at the current stock price.
The stock price of CMI is near its 52-week low (and more than 30% off its 52-week high), dipping by more than 3% today after the company lowered its full-year revenue guidance and announced plans for 1,000 to 1,500 layoffs. The company attributes its actions to a slowdown in the global economy that has led to customers delaying capital expenditures. While this is not good news, I think it reflects short-term problems possibly linked to uncertainty regarding the fiscal cliff. In my opinion, Cummins has strong prospects for long-term growth.

I bought 15 shares of CMI at the price of $88.00 per share, giving me a 2.26% yield on cost. At the current dividend rate, I can expect to receive quarterly dividends of $7.50, which will add a total of $30.00 to my annual dividend income. Cummins is now the 25th stock in my portfolio. I had been waiting for an opportunity to initiate a position in CMI below $90, so I was glad to get it today. The company reports its quarterly earnings on October 30, which could lead to more price action at the end of the month. If the stock is still trading around the current level in early November (when I will have new capital), then I would consider increasing my position.

Stock Bought: KMI

For my first purchase today I bought shares of Kinder Morgan (KMI), the third-largest energy company in North America. The company operates an extensive network of pipelines for transporting natural gas, crude oil, and petroleum products. Its business model is similar to a toll road in that the company collects volume-based fees for transporting raw materials, with limited exposure to the fluctuating prices of those commodities. This results in stable and growing cash flows as energy needs increase over time, and the company's massive asset footprint will likely help it dominate the midstream energy industry for many years to come.

The Kinder Morgan group of companies has an interesting corporate structure. The General Partner (GP) is Kinder Morgan, Inc. (KMI), which pays dividends based on distributions it receives from two Limited Partners (LPs). The first LP is Kinder Morgan Energy Partners, which is represented by two entities that differ only in that KMP gives cash distributions (similar to dividends) and KMR gives share dividends. The second LP is the recently acquired El Paso Pipeline Partners, which is represented by a single entity, EPB, that gives cash distributions. KMP and EPB are examples of Master Limited Partnerships (MLPs), which often have high yields but come with some tax complications. KMI is a C-corporation that provides a way of investing in MLPs without the extra tax issues. Moreover, because of its Incentive Distribution Rights as GP, KMI should be capable of greater dividend growth over time than the LPs.

KMI became a publicly traded stock in early 2011, so it does not have much of a dividend history at this point. However, the company has increased its dividend in 4 of the past 5 quarters and management has expressed a commitment to dividend growth. In fact, management is targeting a dividend growth rate of at least 10% for the next several years, which is not unrealistic given the 14% distribution growth rate for KMP over the past 16 years. In addition, Richard Kinder (the CEO) and other management own about 28% of KMI stock, so it is in their interest to maintain a solid dividend.

It is difficult to come up with a valuation for KMI because of the unique characteristics of the MLPs for which it is the GP. In addition, its balance sheet is difficult to assess because the company still has to "drop down" assets from its purchase of El Paso Pipeline Partners. However, using a Dividend Discount Model with a dividend growth rate of 10% (matching their target) and a discount rate of 14%, I calculate a fair value of $38.50 per share, which is slightly above the current stock price.

I bought 40 shares of KMI at the price of $34.85 per share, giving me a 4.00% yield on cost. (I set my limit price with the goal of getting that YOC.) At the current dividend rate, I can expect to receive quarterly dividends of $14.00, which will add a total of $56.00 to my annual dividend income. The stock will go ex-dividend later this month, so I will receive my first dividend payment in November. Kinder Morgan is now the 24th stock in my portfolio, adding some nice diversification in the energy sector.

Friday, October 5, 2012

Examining Another Dividend-Growth Large-Cap Fallacy

A new article of mine has been published on the investing website Seeking Alpha. The article is entitled Examining Another Dividend-Growth Large-Cap Fallacy and it looks at the relationship between market capitalization and dividend growth rate among dividend growth stocks.

Tuesday, October 2, 2012

Stock Thoughts: CMI vs. CAT

In my ongoing quest to find undervalued dividend growth stocks I have focused recently on two industrial companies that manufacture and distribute heavy machinery: Cummins (CMI) and Caterpillar (CAT). Cummins designs and produces diesel and natural gas engines, as well as various engine-related components. Caterpillar also builds engines, but it has a more diverse product array that includes construction/mining machines and industrial gas turbines.

The purpose of this post is to organize, compare, and share some of the quantitative information I have compiled on the two companies. It is intended to be a quick, side-by-side numerical snapshot rather than a comprehensive analysis. I will start with some stock price information (as of October 2):

Both stocks are trading more than 25% below their 52-week highs, suggesting they have fallen out of favor recently. This becomes more evident upon examination of various price ratios:

The current P/E, P/S, and P/B ratios are below their 5-year averages, indicating that both stocks are undervalued. It seems as though the market has historically given a higher valuation to CAT than to CMI. This observation, coupled with the PEG ratios and various fair value estimates I have seen, suggests that CAT might be slightly more undervalued than CMI. The next table shows recent growth rates:

Here we see that CMI has had superior revenue and earnings growth in recent years, but CAT is expected to have higher growth going forward (which is a reason for its lower PEG ratio). However, it is notoriously difficult to accurately predict future growth, so I consider the projections to be in the same ballpark for both companies. Next are some measures of management effectiveness:

ROA and ROE are acceptable for both companies. The comparison becomes more interesting when you look at some balance sheet details:

CMI has a strong balance sheet with low debt, a high current ratio, and excellent interest coverage. In contrast, CAT has a mediocre balance sheet with a considerable amount of debt. Given that these companies operate in a cyclical industry, I place great weight on the balance sheet. As a dividend growth investor, I also give a lot of weight to the dividend:

The yields and payout ratios are similar, but CMI has had much stronger dividend growth in recent years, although CAT has a much longer dividend growth streak. I find myself more impressed by the recent dividend growth from CMI.

Summary and Conclusions: This purely quantitative comparison shows that CMI and CAT are similar in many respects, the main one being that both stocks are undervalued. Using a Dividend Discount Model with a 10% dividend growth rate and 12% discount rate, I get a fair value of $110 for CMI and $114 for CAT. These values imply there is a margin of safety of at least 15% at current prices.

Even though I did not show any historical trend data, both companies recovered quickly from the recession and seem to be doing well. However, CAT recently lowered its guidance out to 2015, which may hint at some future earnings instability (CMI reduced its short-term guidance earlier this year). Despite near-term economic pressures, I think both companies would represent suitable long-term investments, especially when worldwide economic growth picks up.

That said, if I were to choose just one of them as an investment, then I would probably go with CMI. From a quantitative perspective, I like its strong balance sheet and recent dividend growth. From a qualitative perspective, I like the company's leadership in developing better engine technology that meets stricter emission standards. The increasing use of natural gas as a fuel source should also benefit the company. For these reasons, I am considering CMI as a potential addition to my portfolio.

Monthly Review: September 2012

Here is a review of what happened in September:

Dividends: I received a total of $134.48 in dividends from the following stocks:
  • ADM: $10.50
  • BDX: $11.25
  • CVX: $18.00
  • JNJ: $21.35
  • MCD: $35.00
  • NSC: $25.00
  • UTX: $13.38
This was a pretty good month for dividends. I now have a year-to-date total of $1,149.67, which puts me 88.4% of the way toward my goal of receiving $1,300 in dividends for 2012. I am on track to achieve my dividend goal in November.

Dividend Increases: I was pleased to see dividend increases announced for two of my stocks (click on each stock to see my post about the increase):
  • PM: 10.4% increase, $16.00 more in annual dividend income
  • MCD: 10.0%, $14.00
These are my two largest dividend payers, so I am happy to get double-digit percent increases. Thus far this year, there have been dividend increases for 20 of the 23 dividend growth stocks in my portfolio. I expect increases for the remaining three stocks (ADM, BDX, and UNP) to be announced in November.

Savings: This month I saved $1,668 (56.1%) of my net income, which results in year-to-date savings of $12,648. I achieved my goal of $12,000 in savings for 2012! When I set the goal at the start of the year, I did not have a reliable estimate of how much I could save each month. It feels great to know that I was able to save more than I anticipated. I am curious to see how much my total savings will be at the end of the year.

Transactions: I bought two stocks this month (click on the transactions to see my posts about them): As discussed in my posts, I consider these to be good purchases from a valuation standpoint. The first purchase increases my position in NSC, making the railroad stock the third-largest position in my portfolio. The second purchase is my first new position in several months and I think a high-quality technology stock such as INTC adds some nice diversification to my portfolio. These purchases will increase my annual dividend income by $98.52. I did not sell any stocks for the 9th consecutive month.

Portfolio: My portfolio currently consists of 23 stocks and has a market value of $60,437.16 (including cash), which is a 2.4% increase over last month's value. About 72% of the increase came from new capital and the rest was due to capital gains and dividends.

Seeking Alpha: I published one new article on the investing website Seeking Alpha (click on the title to go to the article): Curiously, this turned out to be my least popular article in terms of page views, even though it seemed to get a good reception in the comment section. Oh well! In September I earned a total of $44.37 from this article and additional page views of my previous articles. My Q3 total is $235.66 (which will be paid in October) and my year-to-date total is $579.60.

Looking Ahead: October will be a decent month for dividends, only slightly less than what I received in September. My savings rate should be good. My two recent purchases used up a modest amount of cash, but once I add the new capital from my September savings, I will have enough cash to make two purchases. A lot of earnings will be reported in the second half of October, so I am tempted to wait and see which stocks dip on "disappointing" earnings. However, if a good opportunity comes up between now and then, I might take advantage of it.