Unloved Stocks Outperform?

(I originally posted the following article on The DIV-Net on July 13,2008)

As they often say about real estate investing, one does not make money in real estate when it is sold, but when the real estate is purchased. The point in this statement is the profit is really determined based on the price paid for the real estate. In other words--don't over pay. Many real estate investors are finding this axiom true today. Well, what about stocks that are unloved by the so called investing experts?

The CXO Advisory Group website highlighted findings from a research report titled Stocks of Admired Companies and Despised Ones by Deniz Anginer, Kenneth Fisher and Meir Statman. In short, the study's authors tested whether the top companies in Fortune magazine's list of America's Most Admired Companies underperformed the companies that ranked in the bottom of the list. The following table taken from the study summarizes some of the findings.

Difference between the return of Industry-Adjusted Despised and Admired
portfolios during the ten years: April 1983 – March 2006.

Source: Stocks of Admired Companies and Despised Ones

In short, the CXO Advisory article notes:

...the stocks of companies least admired by the ostensibly well-informed may well outperform the stocks of the companies most admired.

More detail from the above noted study is outlined in the CXO Advisory article.

As Old School Value's post last Saturday noted, All Intelligent Investing IS Value Investing,

Value investing...revolves around paying less or a fair amount to [a company's] real value, referred to as intrinsic value...

I think Charles Kirk of The Kirk Report recently said it best in his post titled Your Comfort Zone:

"High achievers (in life and in the market) frequently step outside their comfort zone. That’s the way they learn and make progress. At the same time, they also expect to fail (more often than not), but do not see failure or mistakes they make as problems, but as educational experiences.

The natural instinct of all of us is to seek safety and shelter, unfortunately at the exact same time when we should be aggressive and risk tolerant. Those who do well in the market understand this natural human tendency and they consistently work against it when others are doing the exact opposite.

The key for today is to first understand what your comfort zone is and then take a step outside of it. Remember, the market doesn’t reward comfort and decisions that “feel” good to make. That’s the law of nature and it is true of this market like any other."

Source:
Buy Stocks of Companies Experts Hate?
CXO Advisory Group, LLC
February 14, 2007
http://www.cxoadvisory.com/blog/external/blog2-14-07/

Stocks of Admired Companies and Despised Ones
By: Deniz Anginer, Kenneth Fisher and Meir Statman
February 2007
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=962168#PaperDownload

Your Comfort Zone
The Kirk Report
By: Charles Kirk
July 8, 2008
http://www.thekirkreport.com/2008/07/your-comfort-zo.html

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Risk Tolerance And The Estate Plan

The recent sell off in the stock market has investors reevaluating their investment risk tolerance. Beyond ones investment risk tolerance, all investor should ensure they include this evaluation within an overall financial plan. A key aspect of the financial plan is establishing a comprehensive estate plan.

Setting up an estate plan can be a difficult undertaking because some aspects of the estate plan deal with events that take place upon ones death. A recent article in the American Association of Individual Investors, Reassessing Your Risk Tolerance? Don't Overlook Estate Planning, notes:

[estate planning] provides peace of mind that your assets will pass according to your wishes at the least cost and administrative burden. Whatever one's reasons for taking the risk of not planning, there is no doubt that it is a risk that one should not take.

A key aspect of an estate plan is having a properly executed will. The will identifies how some assets are transferred upon ones death. Not having a will can result in the state determining how your assets are distributed after your death. Not many people want the state involved in these type of personal decisions. Additionally, assets can be transferred outside of a will via stipulations in assets like IRAs, 401(k)s and life insurance contracts.

The AAII article details six simple questions one can address in constructing an estate plan:

Identify the goals,

Gather the data and make assumptions,

Evaluate the feasibility of your goals,

Develop your strategies,

Implement the decisions, and

Review your progress.

The conclusion of the AAII article notes, "once you have recognized the risks of not having an estate plan, and how relatively simple it can be to establish one, then perhaps you will be motivated to go through the process outlined above. At a minimum, a will and powers of attorney, coordinated with the proper titling of assets and beneficiary designations, can help you to administer your assets during life and at death..."

To find out more detail on an overall financial plan, I wrote a post mid year last year, Financial Planning Toolkit from CCH, that highlights a free website with information on overall financial planning. Included in the CCH website is the topic of estate planning.

Source:
Reassessing Your Risk Tolerance? Don't Overlook Estate Planning
American Association of Individual Investors
By: Ellen J. Boling, CFP
2008
http://www.aaii.com/includes/DisplayArticle.cfm?Article_Id=2327&digit=219

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Stanley Works Tacks On Another Dividend Increase

Stanley Works (SWK) announced a 3.2% increase in the company's third quarter dividend. The new quarterly dividend will be 32 cents per share versus 31 cents per share in the same quarter last year. This represents the fifth year in a row the quarterly dividend has been increased by a penny. This increase represents the company's 41st consecutive annual dividend increase.

• The estimated payout ratio is expected to equal 31% versus the 5-year average payout ratio of 46%. In 2003 the company reorganized certain business including exiting the Mac Tools retail channel. Consequently, the dividend payout ratio was 90% in 2003 due to some non-cash charges in that year.

• SWK is one of S&P's Dividend Aristocrats.

• The company has a Standard & Poor's Quality Ranking of B+.

(click on table/chart for larger image)

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BB&T Comes Through With Dividend Increase

In June, BB&T (BBT) affirmed its intention to increase its quarterly dividend. Well, Thursday the company came through on its intention and announced a 2.2% increase in the company's quarterly dividend. The rate of increase is below its 10-year average dividend growth rate of 10%.

• The new quarterly dividend increases to 47 cents per share versus 46 cents per share in the same period last year.

• The estimated payout ratio will equal 65% based on December 2008 estimated earnings of $2.89. The 5-year average payout for BBT is approximately 54%.
  

• The company has a S&P Quality Ranking of A-.

(click on table/chart for larger image)

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Bullish Investor Sentiment Ticks Higher But Bull/Bear Spread Remains Unchanged

The American Association of Individual Investors reported this week's investor bullish sentiment rose to 25% versus last week's reading of 22.17%. The bull/bear spread remained unchanged at a negative 33% due to an increase in bearish sentiment to 58.14% versus last week's level of 55.17%. The 8-period moving average of bullish sentiment trended lower to 30% versus 33% last week.

(click on chart for larger image)

Data source: American Association of Individual Investors

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Wells Fargo Increases Dividend Nearly 10% And Stock Price Moves Higher By 33%

Wells Fargo (WFC) announces a 10% increase in its third quarter dividend earlier today and the stock rockets higher by nearly 33%! The stars seemed to be aligned this morning for the market as WFC announces the dividend increase and the SEC is taking a shot at naked short selling. Could it be that a large number of shorts were covering today in light of potential SEC action? Whatever the case I will enjoy the move higher by most financial sector stocks today.

In Well's case, the company is increasing its quarterly dividend to 34 cents per share versus 31 cents per share in the same quarter last year. The approximate payout ratio is 64% based on 2008 estimated earnings per share of $2.11. This compares to the 5-year average payout ratio of 45%. The company has an S&P Quality Ranking of A.

(click on table/chart for larger image)

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Investing Carnival #3: The Bear Market Edition

Welcome to the July 15, 2008 edition of investing carnival. I was fortunate to draw this week's Carnival following a tough week in the market. One could really say the weeks have been tough since October of last year.

Since the markets have not been too kind to investors, I thought the first post should be from one of our doctors. Maybe this will provide the medicine for a better week ahead. So with that enjoy the following submissions from this past week.

Retirement Planning

Jose DeJesus MD presents Drawing on Your Retirement Funds posted at Physician Entrepreneur. Some useful tips if one is nearing retirement.

Ben Dinsmore presents The Roth 401K Can Accelerate Your Retirement Savings posted at Trees Full of Money, saying, "We should all be so lucky, but if you are among the few who routinely “max out” their yearly 401k contributions, you definitely need to know about the Roth 401k."

Dividend Investing

Dividend Growth Investor presents McDonald's Corporation (MCD) Dividend Analysis posted at Create Rising Passive Income From Dividend Paying Stocks, saying, "I think that MCD is currently overvalued at a P/E of 27 and a payout ratio of over 75%. The only positive is the solid dividend yield and above average dividend growth. I would consider initiating a long position in MCD on dips below $40."

Dividends4Life presents Stock Analysis: Exxon Mobil Corp (XOM) posted at Dividends 4 Life, saying, "Stock Analysis of Exxon Mobil Corp (XOM)"

Bullish Dividends presents Dividend Stock Analysis: Great-West Lifeco Inc (TSE: GWO) posted at Traders Corner, saying, "A Stock analysis of Great-West Lifeco Inc (TSE: GWO) to see if it's a good dividend based investment."

Slackerwealth presents Procter and Gamble, A Case for Going Long posted at A Slacker's Quest for His First Million, saying, "A bullish case for dividend stalwart Procter & Gamble."

Stockaholic presents Advantage Energy Income Fund (TSE: AVN.UN) posted at Traders Corner, saying, "Stock Analysis for Advantage Energy Income Fund"

Investing Screens

The Dividend Guy presents Stock Screens are not Buy Screens posted at The Dividend Guy Blog, saying, "Using stock screen as a stock buy generator is not a good idea. Here are my thoughts on the subject."

Sean presents The Best Free, Online ETF Screener? posted at Financial Ramblings.

Investing

Declan Fallon presents Where to start? posted at Fallond Trade history.

Steve Faber presents - Stock Market Terms – The Top10 Market Terms You Need to Know (Part 1) posted at DebtBlog.

The Shark Investor presents I'd Be The Growlingest Bear on the Internet If Only I Were a Bear posted at The Shark Investor.

Geoffrey presents Want to Hold Foreign Currencies Instead of US Dollars? posted at Wealth Monkeys.

Declan Fallon presents Strategy lab: Buy 2% gap - Sell on 10% gain posted at Zignals blog.

Investing Angel presents The 2008 Election And The Stock Market » Free Stock Market Investing Tips posted at Stock Tips, saying, "Your investment decisions right now may largely depend on who
you think will win the 2008 election."

Wealth Accumulation

Silicon Valley Blogger presents Help Your Kids Get Rich: Invest Early posted at The Digerati Life.

Dorian Wales presents Teach Your Kids Basic Finance and Economics with Monopoly - 11 Valuable Lessons posted at The Personal Financier, saying, "11 lessons to teach our kids drawn from a monopoly game I just finished"

Larry Russell presents Living Expense Tracking Methods posted at Pasadena Financial Planner.

Real Estate

Joe Manausa presents Understanding Trends In Real Estate posted at Tallahassee Real Estate Blog, saying, "Actual inventory trend analysis helps us to understand the overall movement of our residential inventory over a period of time. Of all the trends in real estate that we study, inventory trends are the most important. The longer the period of time that we study, the less that “noise” affects our view."

Alternative Investments

Neelakantha presents Top 50 Useful Financial Apps for Your iPhone or Blackberry posted at Currency Trading.net. With the introduction of the second generation iPhone maybe this article is for you. If you truly need to stay connected in the wireless world, some of the applications may benefit you.

David presents If I Was Going To Start Up A Day Spa posted at Sugar Salon, saying, "For several years, I dreamt of opening my day spa. I would spend hours in my 10×10 cubicle planning the service menu, the decor, the marketing theme, the perfect location. I spent zero hours thinking of managing staff, bookkeeping, dealing with plumbing issues."

That concludes the third carnival edition. Submit your blog article to the next edition of Investing Carnival using our carnival submission form. Past posts and future hosts can be found on The DIV-Net's blog carnival index page.

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Paychex Increases Dividend 3.3%

On Monday, Paychex (PAYX) announced a 3.3% increase in the company's quarterly cash dividend. The new quarterly dividend increases to 31 cents per share versus 30 cents per share in the same quarter last year. The estimated payout ratio is 75% based on year end May 2009 earnings per share estimate of $1.65. The 5-year average payout ratio is approximately 53%. Paychex has an S&P Quality Ranking of A+.

(click on table/chart for larger image)

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Relating Company Fundamentals To The Dividend Discount Model

(I originally posted the following article on The DIV-Net on July 6, 2008.)

Before I describe how to apply the Dividend Discount Model (DDM) to other fundamental company factors like, price to earnings, price to book and return on equity, following is a brief overview of the DDM.

The usefulness of valuing a stock using the Dividend Discount Model is the fact the formula provides an investor a price he/she can expect to receive from the specific stock investment. The investor receives all dividends on an ongoing basis plus the value of the stock when it is sold. In order to value the shares using the DDM, an investor calculates the present value of all the future cash flows. The constant DDM formula is:

The DDM can be used to relate the value of a stock to a company's fundamentals.

Price Earnings Ratio

To get to the P/E or price to earnings ratio, both sides of the constant DDM equation need to be divided by earnings per share. The resulting formula is:

Then looking at the above formula, an investor can tell:

• increase the dividend payout then the P/E increases
• increase the required rate of return, r, the P/E decreases
• increase the growth rate, g, the P/E increases.
  

Required Rate of Return

As noted below, the DDM formula can be rearranged so an investor can ascertain that the required rate of return, r, is comprised of the dividend yield and the rate of growth.

Price of a Stock

Finding the relationship between price of a stock to the book value, return on equity, required rate of return, growth rate and dividend payout ratio involves rearranging the DDM formula as follows:

If B₀ is the current book value and ROE is return on equity, one knows:

E₀=(B₀)(ROE₀) since ROE₀=E₀/B₀.

Therefore,

As a result, the price of a stock, P₀, is related to:

• book value--------------->increases B₀ result in increase in P₀
• ROE--------------------->increase ROE results in an increase in P₀
• dividend yield-----------> increase D₀/E₀ results in increase in P₀
• expected growth rate---->increase g results in an increase in P₀
• required rate of return--->increase r results in a decrease in P₀

Price to Book

Finding the relationship of fundamental company characteristics to a company's price to book ratio simply involves dividing both sides of the above equation by B₀.

Using the above formula then, an investor can determine:

• increase ROE₀ increases P₀/B₀
• increase in D₀/E₀ increases P₀/B₀
• Increase in g increases P₀/B₀
• Increase in r decreases P₀B₀.

In the end, using the dividend discount model provides more information than taking the future cash flows from a stock investment and discounting them back to the present via a present value calculation. Delving underneath the formula can provide insight into a company's future prospects if an investor can determine the fundamental company factors that may or may not improve in the future.

Pamela Peterson Drake, Ph.D., CFA of James Madison University has a nice site containing investment information on topics such as portfolio theory and fundamental analysis, just to name a few. Once on the site, click on the "modules" tab.

Source:

Investing in stocks (pdf)
By: Pamela Peterson Drake, Ph.D., CFA
http://peregrin.jmu.edu/~drakepp/investments/modules/module8.pdf

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Value In A Bear Market

It became official this past week with the S&P 500 Index entering a bear market by declining more than 20% from its high in October of 2007. The only way to have escaped damage to an investment portfolio in this market would have been to sell out of equities completely in October. Realistically, no investor has successfully timed in AND out of market cycles from peak to trough. Certainly there will be the occasional investor that brags about the time they went to all cash. What they don't say is that they went to cash months or years before the market top or they remained in cash through the entire next bull market.

Now that the markets are in bear market territory several questions come to mind.

1. How long will the bear market last?
2. Should one invest in stocks now?

Answering the second question first. One key aspect to investing is to buy low and sell high. With many stocks down significantly from their market highs, investment opportunities do exist in high quality firms where the potential purchase price is far below a company's fair market value or below its intrinsic value. For example, most banks will survive the current financial disruption. Everyone still needs to eat and wash their cloths. This is a reason stocks like Wal-Mart (WMT) continue to do well. Is there value in staples companies like Procter & Gamble (PG)? InBev (INB.BR) certainly believes there is value in Anheuser Busch (BUD).

So, should one invest in stocks now? If an investor's goals and objectives, along with portfolio allocation analysis, suggest equities should be a part of an overall portfolio, then value can be uncovered in some stocks. To potentially minimize additional market contraction, using an investment discipline focused on strong dividend growth companies and/or strong cash flow companies, can uncover attractive investment opportunities. An added benefit to owning high quality companies is their stock prices tend to hold up better in down markets.

Back to the first question of how long will the bear market last. No one can accurately predict the actual end date of this current bear market. However one can learn something by looking at the history of past bear markets.

The recent issue of The Outlook ($) newsletter by Standard & Poor's looks at the magnitude and duration of the last nine bear markets since 1956. A common question asked today is what generally occurs after the market declines 20%. S&P notes:

• [the bear markets] have varied in magnitude from the decline of 20% for the market in 1990 to the 48.2% from 1973 to 1974 and the 49.1% from 2000 to 2002.

• History shows that the S&P 500 didn’t cross the 20% threshold until two-thirds of the way through the overall decline.

• From 1956 to 2001, these nine bear markets lasted an average 14 months, yet it wasn’t until the 9th month after the market top that the S&P 500 finally fell into bear market territory. This time was the same as the average: We topped out on October 9, 2007, and crossed into bear market mode almost exactly nine months later.

The below table outlines the market performance at various time periods following the 20% correction.

(click on table for larger image)

Out of the nine bear market since 1956, there were only two periods where the market was down further after 12 months, the 1956-1957 bear market and the 1973-1974 bear market.

Who knows if the worst is over, but history would suggest a large part of the decline is already priced into equity prices. Could they go lower--certainly. However, using a disciplined investment approach could uncover some rewarding investment opportunities.

Source:

Breaking the 20% Threshold
The Outlook
Standard & Poor's
By: Sam Stovall
http://www.outlook.standardandpoors.com/NASApp/NetAdvantage/mkt/OutlookMarketInsight.do?subtype=OWMO&pc=NET&tracking=NET&context=Company&docId=13391373

(I hold a long position in Wal-Mart and Procter & Gamble)

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Market In A Downtrend But Ready For A Bounce?

As noted in the chart below, the S& 500 Index remains in a downtrend since mid-October 2007.

(click on chart for larger image)

However, given the intermediate oversold level of the S&P 500 Index, it is possible we could see a bounce higher in the market in the near term. The percentage of S&P stocks trading above their 50 day moving average is 10 percentage points below the level hit in March of this year when the market bounced off of a low. On the other hand, the percentage of stocks trading above their 150 day moving average is quite a bit higher than the level reached in March 2007 (see below charts.)

(click on charts for larger image)

The market's tone for Friday will likely be set by General Electric's (GE) earnings report at 8:30.

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Another Decline In Investor Bullish Sentiment

Wednesday, the American Association of Individual Investors reported results of their weekly investor sentiment survey. Recall the sentiment survey is a contrarian indicator (one of many) and the less bullish individual investors, the more likely the market may be nearing a bottom. The results show individual investors continue to be less bullish on the market.

For the week, the level of bullishness declined to 22.17% versus last week's reading of 23.93%. The 8-period moving average of the bullishness level continued to declined and is reported at 32.8%versus last week's average of 35.7%.

(click on graph for larger image)

Data Source: American Association of Individual Investors

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