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.