Tuesday, March 06, 2007

The True Value of Rising Dividend Stocks

By Greg Donaldson and Mike Hull In recent days, we wrote two blogs that addressed the issues surrounding the sharp fall in stock prices. We were reminded today by a friend and client in New Jersey that we may have missed an opportunity to highlight the true power of Rising Dividend Investing: the sell off has not decreased the income our portfolios produce, neither has it damaged their "true value." As most of you realize, falling or rising stock prices do not affect dividends. Companies set dividend policy on a per share basis, thus the dividends per share our companies were paying a week ago are the same as the ones they are paying today, regardless of the changes in the price of the stock; likewise the income from our bonds and preferred stocks is unchanged. The stocks in our Cornerstone style of management have increased their dividends an average of 17 consecutive years. We fully expect that all 27 companies will increase their dividends in 2007. All of our bonds and preferred stocks are investment grade and most have risen in price since the sell off began. Falling stock prices often cause a flight to safety, and our fixed income securities are considered safe, so they have risen, although not enough to completely offset the sell off in stocks. So from the perspective of our clients' portfolios, what has the sell off meant? We don't think very much. Their portfolios' incomes are the same as a week ago, and we have not adjusted any income growth forecasts. In this regard, our portfolios' "true values" are still rising because we expect dividends to grow and interest rates to remain relatively constant. That being the case, the sell off is like a spell of bad weather -- it may get a lot of headlines, but it isn't going to change our clients lives. Another bit of good news is that the sell off is giving us a chance to nibble on some of our favorite stocks at bargain prices. After all, if a company's "true value" is rising and for some reason its price falls, then, well, you know the rest . . . . Here is the bottom line on Rising Dividend Investing as we practice it: Today's price is not the final arbiter of what a stock is worth. The true value of a stock is a function of the current dividend and future dividend growth, and how these two variables compare to interest rates on riskless securities (US Treasury bonds). These variables exert a kind of "gravitational" pull on the selling price of the stock towards its "true value." Our research shows that the prices of stocks that qualify to be called Rising Dividend Stocks flow back and forth across their "true value" or equilibrium price about every three years. As of Tuesday March 6th, the stocks in our Rising Dividend Models, on average, were nearly 15% undervalued. That means that if our companies continue to pay their current dividends, which we believe is a near 100% certainty, and raise their dividends in line with our estimates, near 10%, that the best estimate we have is that their total return in the coming 12 months should be about 15%. It is not a guarantee, but history shows us few stocks that do not eventually reach their "true value" as long as dividends are secure and growing and interest rates stay relatively tame. That would mean if we do not get our 15% this year, it will be tacked on to next year. In times of high volatility, when the headlines are full of worrisome market news it may seem almost heretical to say that the market sell off is not so much financial news, as news about the weather. But if you have watched the action of Rising Dividend Stocks for as long as we have, you see that it is almost always price that reverts to "true value" not the other way around. If we were judging our investment decisions solely on prices, we would be just as worried as many of the long faces we see on financial television. But we learned a long time ago that today's market action has very little to do with what a stock or the overall market will be selling for a year or two years from now. We believe the best predictor of future performance for Rising Dividend Stocks is, well, you guessed it. Thanks Randy, for the heads up.