Friday, December 02, 2005

UTX -- Of Horses and Hoods

I'm going to provide a look under the hood of one of our stock valuation models using United Technologies (UTX) as an example. Since 1988 the combination of UTX's dividend growth and the change in interest rates on a 10 Year US T-bond have explained 92% of the annual price movement of the stock. That model currently estimates that the current fair price range should be between $60 and $70 per share, with $65 being the midpoint of the range. UTX is now selling for $55 per share. At today's price that puts UTX at as great a discount from expected value as at anytime in the last decade. But does that mean it is a table-pounding buy? Yes and no. The expected price range is well above UTX's current selling price, but a look at UTX's history shows that it has had periods of under and over valuation lasting up to 3 years. I fully expect UTX will reach $65 per share over the next few years, thus the question in my mind is not if, but when. If UTX reaches $65 in the next year, it will produce a total return of approximately 18%; if it takes two years, we will make a little less than 9%. The reason I believe the odds favor UTX reaching $65 sooner rather than later is because UTX has already been undervalued for the past 12 months, so the averages are in our favor. I just spoke to the company last week and tried to pry out of them what their dividend hike in 2006 might look like. They were noncommittal, except to say a dividend hike was likely in the first quarter. I told them they had enough free cash flow to choke a horse, and I thought their shareholders would applaud, another big dividend hike and a public statement about future hikes. The company representative with whom I spoke was so used to talking with Wall Street analysts, who completely ignore dividends, that he seems a bit startled when I told him I would rather have the dividend hike than share buy backs. I mentioned that I had read where the company was disappointed that its stellar 2005 results had largely been ignored by the market, I suggested that a commitment to a dividend payout ratio of 35% would do wonders for the stock price. He was a very pleasant man and said he would pass on my suggestion. Let's put this one on our radar and see what the next dividend hike looks like. UTX is in our Rising Income Portfolio. Illinois Tool Works, which has a very similar story, is in our Blue Chip Growth Portfolio. I'll review it next.