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| Dividend Valuation Model |
General Mills (GIS) is up 22% over the last twelve months. A questioner wants to know what our dividend valuation model is signaling about the stock's prospects for the coming year. In addition, several questioners have asked if we are a pure "buy and hold" manager, or if we take profits under certain conditions.
In answering the second question first, we are not a "buy and hold" investment manager. We are a "buy undervalued and sell overvalued" manager. We find that our average holding time of a stock is about 5 years.
Let's use our Dividend Valuation chart above of General Mills (click to enlarge) to look more closely at the buy and sell signals we believe have the most validity.
First a cursory looks reveals that over the past 20 years there has been a reasonably tight fit between the movement of GIS's price (red line) and its projected valuation (blue bars), as calculated by our Dividend Valuation model. Indeed, the R2 is near 90%. It is important to remember that the Dividend Valuation model calculates a single formula that is used for all years, with the only difference from year to year being the inputs of dividend growth and changes in interest rates.
So how do we read GIS's prospects for the coming year? The checkerboard bar at the far right is the model's calculation of the predicted price using our projections of GIS's dividend growth over the next twelve months and the change in the yield of a 30-year US Treasury bond. That predicted price is approximately $40 per share. If we include GIS's dividend, that would produce an approximate total return over the coming year of near 12%.
As a reminder, while our model has done a good job of predicting value over the last 20 years, the model is based on historical relationships and, thus, is not a guarantee that GIS's predicted price of near $40 per share will be met. You probably knew that already.
Let's look more broadly at GIS's valuation chart to see the various buy and sell signals it has made. Remember the actual price is the red line and the model's predicted price is the blue bar. Thus, simplistically, when the red line intersects a blue bar in a particular year, that would mean that price is below value, and it would signal that the stock is undervalued and a buy candidate. Conversely, if the red price line is higher than the top of a blue bar it is considered overvalued, and a sell candidate if owned.
According to the model, GIS was undervalued between 1993 and 1998, in 2000, 2005, 2009, and 2010. Simply speaking, if we were following the model without other considerations, we would have bought the stock in 1993 and sold it in 1999. We would have bought again in 2000 and sold in 2001; repurchased it in 2005 and sold again in 2006. Finally, we would have bought in 2009 and we would still be holding the stock.
In actual practice, we follow a more rigorous standard for buying and selling. In the case of a stock like GIS, we require that the stock be at least 10% undervalued or overvalued to trigger buy and sell signals. We find this provides about the same rate of return with far less turnover and capital gains taxes.
We do not currently own General Mills in any of our Rising Dividend models. We have looked at it many times over the years, but other stocks appeared to be more undervalued each time. Indeed, its current 12% undervaluation is not exceptional. Our models are suggesting that the average stock is nearly 25% undervalued. GIS is an outstanding company, and if it retreats in price or begins to grow its dividend at a higher rate than our model now projects, we would become much more interested in buying it.
We'll be tackling some of the questions about the economy and the Federal Reserve next week.
The author does not own General Mills.
