We are dividend investors and lost among all the talk about dividend investing is the subject of valuation. We say that dividends are important for two reasons: 1. They have represented almost 50% of the total rate of return of stocks over the last 50 years; and 2. In many cases dividend growth is highly correlated with price growth.
We can conclude from these two facts that correlation modeling can reveal the "normative" value of a stock at any point in time. This of course does not mean that these normative valuation models can predict the future, nothing can do that; but it does give us a good idea of how the market has valued a company's dividend profile in the past. That coupled with the fact that dividends have been approximately one-third as volatile as earnings over the long-term, in our judgment, gives us the best guess possible about the approximate value of a company.
The "unknowns" have been winning the battle against the "knowns" in the economy and the markets in recent months. In this environment, it is not surprising that the Processed Food Industry group has flourished. Not only is the group defensive in nature, but also with such a weak economy, investors are betting that more meals are being eaten at home than away from home. Thus, the Processed Food group has been riding high.
Our dividend valuation models, however, suggest that the group may now be discounting all the good that is likely to come over the next twelve months.
The two charts above are of Kellogg (K) and General Mills (GIS), two leaders in the Processed Food category. The red lines are the anual price movements of the two stocks and the blue bars are the annual dividend valuations based on a multiple regression of their stock prices versus dividend growth and interest rates.
The picture is nearly the same for both stocks. They ain't cheap. The price lines are now above their current dividend valuations, but more importantly, their current prices are above their projected growth in dividends and valuations (the striped bars) over the next 12 months. In short, to our way of thinking, these two stocks, and many others in the group are not cheap.
Oddly enough, the Household Products group, not shown here, which includes Procter and Gamble (PG) and Colgate (CL), is still selling far under its dividend valuation. We'll be watching for a shift away from the Processed Food group to the Household Products group in the weeks and months ahead.
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