Taking another look at Eaton Corporation

Eaton, ETN, has had a nice run in price since I bought it in July.  I identified ETN in a screen I ran on FAST Graphs shortly after subscribing to the service.   At the time, ETN looked to be priced about 35% under fair value.  I didn't do too much additional diligence, and purchased shares on July 5, 2012.

I purchased additional shares on July 6, July 12, and August 13, and received a dividend which was reinvested on October 19.  My weighted average cost for ETN now sits at $39.95.  ETN trading today at a price of $53.93.  This is a gain, including dividends reinvested, of 34.98%.

My initial premise was that the stock was under fair value by 35%, and now I've gained 35%.  Is it time to sell the position?  Let's take a look at the current valuation vs. earnings.

Here an historical look at earnings and price movement for the past 15 years:

Based on this graph, the price still needs to rise to about $61/share to reach "fair value" based on the average PE given over this 15 year period.

However, most stocks have suffered from "PE Compression" since the great recession of 2008, so I like to do a six year graph to get a more up to date picture.  Here is is for Eaton:

If you look at the blue PE line, you see the average PE for ETN has come down from the 15 year average of 14.9, to a six average of 13.9.  "Fair" value based on this ratio is $57.37.  Thus, today, ETN is trading below fair value, but only by $3.44 or 6%.  Moving to technical analysis (gasp), here is a YTD price chart:

From this you can see that July was a pretty good time to buy, and today may be a decent time to sell.  I'll expand the graph to three years:

This has me wondering about the PE ratios at each of these tops, so I'll go back to FAST Graphs, and check each below:

So, I went back over the black price line, and pulled the prices at each peak and valley, which FAST Graph gives you easily, but then divided by earning listed for that year.  Unfortunately, I can't figure out quarterly earnings for each of these points, and haven't found a source for these.  My PE numbers listed seem incorrect in absolute terms.  Correct directionally for this comparison, but incorrect nevertheless.  If the blue line represents PE=13.9, how can a point above the orange line have a PE of 13.8?  I'll have to ask Chuck.  Anyway, from this chart I conclude that ETN may be reaching fair value, and may be due for a dip after a nice run up from my buy point this summer.

Therefore, I'm placing a 4% trailing stop loss on the shares, which will guarantee me a sell price of at least $51.73 based on today's prices.  Let's hope it keeps climbing before execution.

Best Chump

Portfolio Snapshot December 17, 2012

Below are the latest holdings for my IRA.  Those following along will see that I've held on to ETN and added Kohl's and Omega Healthcare.  I have 28 holdings, and almost no cash.

The stocks are sorted by 5 year estimated total return based on the excellent FastGraph software.

I'll follow this up in a few days with a spreadsheet update showing gains/losses, and % of portfolio.

Best,

Chump

Should I Convert my Dividend Growth IRA to a Roth IRA?

Background

**Note to readers:  On Sunday, December 16, an astute Seeking Alpha reader pointed out an issue with my analysis.  After checking my spreadsheets, I determined that he was correct.  In my original analysis, I start removing $30k from the accounts to live on.  I index this number for 3% inflation throughout retirement.  As I take the money from income and RMDs, I correctly tax the withdrawals.  However, as the reader pointed out, I should be taking more pre-tax money from the conventional IRA so that the after tax amount gets me to parity with the amount I withdrawal from the Roth IRA.  So, to get $30,000 for expenses from the conventional IRA, I need to withdrawal approximately $45,600.  This reduces the value of the conventional IRA, and leaves less excess cash for reinvestment into a standard taxable account.

This change in the comparison effects case 1 most strongly;  The conventional IRA is still more valuable up to age 85, but the Roth IRA growth far outpaces the conventional IRA from that point onward.  Case 2 and Case 3 change slightly, but the outcomes and graphs remain very close to the originals.

I've replaced the conventional IRA spreadsheet with a revised version, and the Case 1 table and graph.

My conclusions and summary remain the same, but I thought it important that I show the proper data in case 1.

Sorry for the inconvenience!


While reading through some great articles on Seeking Alpha, the comments turned to conversion of an IRA to a Roth.  I was not aware that the laws had changed to allow creation of a Roth with converted IRA funds.

Unfortunately (or fortunately), our "married filing jointly" income exceeds the IRS limits for contribution to a Roth, so we don't currently have one.  Over the years, having worked at several large firms, I've been rolling my 401k plans into a conventional IRA, which is growing nicely.  After learning that a conversion was now possible, and reading some helpful comments on SA,  I decided to consult with my accountant.  Here is the gist of what I learned, though please keep in mind, I am far from expert regarding IRAs and tax rules.

In 2010, congress made it possible for those previously not eligible for a Roth IRA, to convert IRA proceeds to a Roth.  Due to income restrictions, I cannot openly contribute to a Roth, but I can convert a portion or all of my conventional IRA to a Roth.  The catch, of course, is taxes.  My IRA was funded entirely with pre-tax earnings from 401k contributions, thus, I need to pay federal and state income tax on any portion I choose to convert.

There are many attractive features of a Roth IRA, and I'd like to have one (whoa, I sound like one of my children).  They aren't taxed when you withdrawal money after age 59 1/2, and you aren't forced to take money out starting at age 70 1/2, the dreaded "required minimum distribution" or RMD in a conventional IRA. After you die, your Roth IRA can be passed along to your heirs without a tax hit.

Back to the question of should I convert my IRA?  The answer is far from simple.  There are many factors, and modeling them all (which I've attempted to do) is pretty cumbersome.  Age today, age when you plan to retire, income needs in retirement, tax bracket today, tax bracket with proceeds you are converting, tax rate when you retire, % of IRA funded with non deductible contributions; well, you get the picture.  I've found some calculators online and played with them, but I don't know the assumptions used and get differing numbers on different sites.  Thus, I decided to build a spreadsheet and model some scenarios myself.

Analysis

Changing numbers to protect my privacy, let's say I've managed to accumulate a conventional IRA worth around $200k at age 48.  I'm going to look at three different options for conversion:

1. Convert $15k per year until I retire at age 65
2. Convert $100k per year over two years
3. Convert $100k in one year, then stop

Taxes on the converted amounts will follow my current marginal tax rates of 33% federal, and an onerous 9.3% state (in my sunny state).  Care needs to be taken with the amount converted in any one year that the income doesn't put you into a new higher tax bracket, further damaging returns.  The schedule below shows today's federal tax brackets:

I'll be comparing these four options to my conventional IRA, which, at age 70.5, will require minimum distributions every year.  I'll assume a reduced marginal federal tax rate of 25% and the same state rate of 9.3% for these distributions, and will re-invest them into a standard taxable brokerage account.  For you lucky dogs living in low tax red states, I'll also look at a comparison with no state taxes.

I'll assume that both my current conventional IRA, and the taxable account I create with the RMDs after age 70, will have the same pre-tax performance; 6% growth in share price, 3% portfolio yield, and of course, dividends will grow every year by 6%.

First, a look at my projections for the conventional IRA:

Conventional IRA for Comparison

To keep it simple, I'm not adding any money to the IRA.  Further, dividends are reinvested until age 70, then used to fund a new taxable account with the "required minimum distributions."  At age 65, I start withdrawing cash for living expenses.  I assume I'll need $30,000 growing 3% per year to cover inflation.   However, I need after tax dollars, so I need to withdrawal more when you consider federal and state taxation.  The "Pre Tax Needed" and "Shortfall or Excess" columns do this calculation and shows how much is either needed via sales of shares, or in excess available for reinvestment.  I realize this is not enough to live on, but for this analysis, I'm assuming I will have additional sources of income for retirement expenses.

At age 70.5, I need to start pulling out the "required minimum distribution" or RMD.  The formula for required minimum distribution is based on the number of years the government thinks you will continue to live.  You take your assets in the IRA on December 31, then divide by the number of years you have left according to the handy table below:

Predicting how long I have left is bit depressing, as is watching the RMDs bite into my hard earned assets.  But don't fret, I'm not taking the RMD distributions and burning the cash in the fireplace; I'm reading Seeking Alpha, and investing the proceeds into...drum roll...what else, but a dividend growth portfolio of quality stocks.

From the RMD proceeds at age 70 1/2 and beyond, is born the new taxable dividend growth portfolio.  To further complicate matters, only income from IRA dividends can be reinvested into the IRA, while excess RMD cannot (don't tax rules make life fun?).  So, excess RMD leaves the fund and goes into the new taxable account, and excess income from IRA dividends, in excess of the RMD and what I withdrawal to live on, stay in the fund for reinvestment, and are not subject to taxation.  Using the same continued assumptions for growth, but now using after tax (federal + state) RMD and after tax dividends for reinvestment, I constructed a taxable dividend growth account similar to the IRA, it's shown below:

Taxable Account from RMD Excess

So while the original IRA is required to distribute an increasingly large chunk of cash, our DGI portfolio, even after taxes, helps soften the blow.  Please note, I increased the tax rate for this portfolio as I moved into new tax brackets based on income received from RMDs and dividends.

Now to the Roth conversion.  For this part of the analysis, I take the same IRA as in the first chart above to start, then pull uniform distributions out every year.  Per my assumptions, I'll take the $15,000 per year, pay taxes on these funds, and create a Roth IRA based on dividend growth stocks (of course).   For purposes of these analyses, I'm going to pay the taxes with money held elsewhere in a taxable account, to allow more money into the Roth and avoid any penalties while under the age of 59.5.  So to recap, I'm comparing my IRA + a taxable account that starts with $100,000 in it and grows by the excess RMD payments in retirement versus a conventional IRA with funds pulled out until retirement for conversion into a Roth IRA + a taxable account with $100,000 from which I will pay the necessary income taxes during the conversion years.  Wow, just explaining the planned analysis gets confusing!

Next is the IRA from which I'm converting funds:

Case 1 IRA less Converted Funds

Interestingly, even converting $15,000 each year until age 65, the portfolio manages to grow modestly.  After the conversions stop at age 65, the IRA grows more rapidly until RMDs kick in at age 70.5.  Conversions out of this account and into the Roth IRA are fully taxed, both Federal & State, then grow and re-invest tax free forever, with no taxes due when the proceeds are withdrawn.  The associated Roth IRA that I've created from the above conventional IRA looks like this:

Roth IRA Built with Converted Funds

At age 65, I start withdrawing $30,000 per year, growing 3% per year, to help with living expenses.  And because this is a Roth, I get the money tax free!  Further, because there is still IRA money left growing, I'll need to pay RMDs again at age 70.5.  Those monies will go back into the taxable account from which I paid the IRA conversion taxes.  The $100k taxable account from which taxes were paid, and into which RMD payments are going, is shown below:

$100k Taxable Account Tied to Roth

Analysis Results

The table and chart below summarize the results of the first analysis, case 1.  Total account value and annual income for the two account types are presented at different ages:

Case 1 Results

Here are the same data in a simple graph:

Case 1 Graph

Up until I hit age 85, the conventional IRA retains a greater overall value, and provides more income annually.  After age 90, the Roth catches up and passes the conventional IRA quickly.  From the analysis, you can see the huge negative effect of taxes.  The $15,000 per year conversion is taxed at a combined rate of 42.3%.  The tax bite is too much to overcome until age 90 in this scenario.  Running exactly the same analysis in a state with no income taxes, the situation for the Roth is improved slightly, with the Roth IRA overtaking the conventional IRA around age 85, or five years sooner.  Even with no state taxes, the analysis favors the conventional IRA until age 85, though the difference in the outcomes is reduced slightly.

In the second analysis, case 2, I convert money more quickly.  $100k per year over two years.  The tax hit will be high, but the money in the Roth IRA will have more time to grow.  Here is the case 2 data summary:

Case 2 Results

And the associated graph of the data:

Case 2 Graph

The conventional IRA is a clear winner.  The large tax bite paid over two years, $84,600, virtually killed that taxable account compared to an equivalent taxable account where no taxes are paid for conversion.  In the conventional IRA case, that $100k taxable account, even after paying income taxes every year, grows to a whopping $355k by age 65, and over $500k by age 70.  Using taxable account savings to pay the conversion taxes hurt the outcome significantly in this case.

For my third case, I'm converting $100k in the first year, then stopping the conversions, and letting both the original IRA and converted Roth grow.  Here is the summary table:

Case 3 Results

And the associated graph of the data:

Case 3 Graph

In case 3, where $100k is converted in a single year, the results between the two accounts are much  closer.  The IRA still provides more total value and income throughout the analysis, but by a small margin.  One cautionary note;  $100k converted in a single year (both case 2 and case 3) could put a large chunk of your income into a higher tax bracket, and thus further hurt returns for these cases.  I would likely convert exactly the amount necessary to get me to my next rung on the income tax table, and no more.

The other big factor in all of these cases is your State of residence.  If you live in a low, or no tax red state, the analysis gets more favorable for a conversion.  As in case 1, I repeated this analysis for 0% state taxes vs. the 9.3% in the graph above, and the results get even closer to even.   The graph for the 0% state tax is below:

Thoughts and Conclusions

• At my current age of 48, keeping my money in a tax deferred IRA seems a better choice than converting any or all to a Roth IRA.
• The best result came from case 3, converting only 1/2 of my IRA, and then heading into retirement with three accounts;  a conventional IRA, a Roth IRA, and a taxable dividend growth account.
• At age 65, the converted Roth IRA fund value and income will always be lower than the IRA due to the taxes paid upon converting.
• The Roth IRA really "shines" vs. the conventional IRA once you are retired and withdrawing funds.  Less money comes out, and more is available for reinvestment vs. the conventional IRA, due to taxes.
• High state income taxes hurt the argument for conversion.
• Minimizing tax loss when converting, and preserving capital with time for growth are the most relevant factors.
• Paying taxes out of the funds you are converting is a bad idea.  If you are younger than 59.5, a 10% penalty is due in addition to state and federal taxes.
• Our government seems to be the biggest beneficiary of a conversion.

Summary

The decision to convert funds from an existing conventional IRA to a Roth IRA are effected by myriad variables.  Age, tax rates, amount planned for conversion, income required in retirement, and how long you "plan" to live, all play a big role in the analysis.  From the "not so simple" analysis above, I'm leaning toward doing nothing.  Just sticking with my current IRA and taxable stock account.  That said, the thing I like about case three, or converting a portion of my IRA to a Roth IRA, is tax policy diversification.  It seems reasonable to assume we can't know what changes to tax policy we'll see in the next thirty years or more.  Having three types of retirement accounts versus two might be beneficial depending on how our laws change in the future.

Chump Portfolio Update - Friday, November 23

I ran a quick FAST Graph on my holdings to get a quick picture of valuation.  Here are the graphs:

I update the spreadsheet that goes with these holding later this weekend.  Happy Thanksgiving!

Health Care REITs - 11-14-2012

With the recent election results, it looks like Obamacare is here to stay, at least until the next presidential election.  Thus, I'll be making a few changes to my portfolio in the coming months.  A couple of recent articles on SA from Brad Thomas make the case for owning Health care REITs.

Link here:  http://seekingalpha.com/article/879881-sleep-well-at-night-with-these-durable-health-care-reits

and here:  http://seekingalpha.com/article/994421-healthcare-reits-should-perform-well-under-obama

So, using FAST Graphs, I took a quick look at the following:  HCP, HCN, OHI, VTR, HTA, SRZ and VTR.  Below are the summary graphs.

The pink line represents a "fair value" price based on income and cash flows.  Fair value for HCP is around $33/share.  Too expensive at a price in the mid 40's.

Fair value for HCN is $48.71, too expensive.

Fair value for VTR is around $41/share.  At $63+, too expensive.

Fair value for OHI is $29 based on income and cash flow, it appears to be undervalued at today's price below $22.  Note:  based on historical prices, Mr. Market has been paying 9 x FFO, or cash flow from operations.  This gives a price around $18.

HTA and SRZ are too new, and don't have any type of track record from which I can draw conclusions.

Thus, my favorite in the group is OHI.  Looking just a bit deeper, I see the following:

• Focus on nursing homes.  This seems a safe growing segment.
• The 7.9% yield is best of the bunch
• Forward eps growth estimated to be 6% (based on 2 analysts covering)
• Low growth, but good for this segment, and better than the competitors
• Beta of .91, good to have in a flat or declining stock market
• Health care real estate is nice recession proof hedge against a downturn in stocks

In summary - I'd like to add a REIT to the portfolio for diversification into real estate.  I sold NLY a month or so back when fed started QE infinite.  Health care, and long term care, seem like solid segments for investment as our boomer generation (me included) gets old and feeble. Obamacare should provide continued and increased funding for nursing homes in the long term.

I'm placing a limit order today for OHI below $22/share.  I'll start a position, say 33% of a "full" position, and look to add on further weakness in the coming months.

Halloween Update, 2012

Well, the markets are back up and running after Hurricane Sandy.  I thought I do a screen on my holdings using FASTGraph, and see if there are changes I should be considering.  The quick screen snapshot is shown here:

Overall, I'm pretty happy with the holdings I have.  Only three names have a PE over 15; MCD, WMT, KO - all in my core, and I'm underweight all three right now.  

The one holding I have not listed is TIPs.  I have about 8% of the portfolio in these inflation protected treasuries.  These seems a good hedge, and good place to put cash.  If the market corrects, I can sell some TIPs for cash to redeploy.  My current cash position is almost NIL.  

That's all for now.

Portfolio Update for October 19, 2012

Here is the portfolio update through this past Friday, October 19, 2012.  The Dow was down over 200 points on Friday, so everything took a hit to end the week.  Here is the spreadsheet which contains all of my positions:

I've highlighted stocks in green that I'd like to add a bit to if the market continues to dip next week.  I've made several adjustments these past few weeks including:  Sale of NLY, adding new names ADM and GD.  Have strategically sold some TIPs to generate a bit more cash, and this past Friday added to several names including:  DOV, EMR, MCD, ADM, GD, TEVA, CMI, CSCO, AAPL, and MSFT.  Also received dividends from MO and CVX.

Here are the YTD performance metrics:

That's all for now,

Chump

Holdings Update - October 15, 2012

I haven't done a proper update to the portfolio in a couple of weeks;  I'll definitely get the performance numbers updated this Friday.

I took a snapshot of the holdings via FASTGraph for 10-15-12, and the summary is here:

A couple of comments:

• Sold my position in NLY - started getting nervous about the long term prospects with QE infinity through at least 2015, and decided to move to cash and redeploy elsewhere.
• Since my last update, I've added small positions in GD and ADM - both potential core holdings with decent valuation, and great dividend track records.
• I've sorted the date by EYE ratio; earnings yield estimate.  I'd add shares to any name on the list "north" of MO.
• I added to some existing positions over the past two weeks including TEVA, CSCO, DOV, CMI, HAL and AAPL
• I remain underweight MDC, WMT, and KO - still seem a bit pricey to me at these levels.

Thats all for now.

Chump

Does Entry Point Matter to a DGI?

Background

My retirement portfolio has another fifteen years or so to grow and develop, and is the key factor determining when or if I'll ever be able to retire.  I've been reading Seeking Alpha now for over two years, and have become convinced that owning great dividend growth stocks will be key for my retirement goals.  

Over the years, my investments have evolved (or devolved) from stocks of companies where I've worked (F, XOM, HON, etc.) to DRIP stocks through an investment club, to trendy mutual funds, to low fee index funds, to a mix of index funds and ETFs.  Like many here at Seeking Alpha, I've found some great advice from the likes of Carnevale, Knapp, Fish, and too many others to name, and have now converted my legacy mutual funds, miscellaneous stocks, and ETFs to a portfolio of individual stocks.

I've adopted a hybrid dividend growth (DG) strategy to building my portfolio;  core holdings comprised of dividend champions to hold into retirement, and what I call non-core (for lack of imagination) holdings that still tend to be dividend payers, but may have a higher risk and growth profile.  As I approach retirement, I'll continue to add to the core portion of the portfolio, and reduce the size of the non-core holdings.  I have some great core holdings, many of the usual suspects, but in smaller allocations than I'd prefer, and there are many more on my watch list that I've yet to buy.  Put simply, many of the best DG stocks that I'd like to own long term, are trading above what I consider to be fair value.

Reasons for conducting this analysis

This got me thinking about entry point for stocks we plan to hold for a very long time - does the purchase price really matter? If I buy COST today (figure below, courtesy of FAST Graphs), a great company on my watch list,  above fair value, reinvest the dividends, will it really matter in 10 to 15 years?  Perhaps in the end, time will wash away or help conceal today's bad decision to pull the trigger at a price too high?  Or perhaps not.  Maybe I should be patient and continue to monitor the stock for next year or more, and wait for a better valuation.

I'm sure that it matters (by low, sell high and all), but perhaps time will mute the effects of entry point prices.  I tend to be impatient once I decide I'd like to own a stock, so I went into this hoping to see very little difference in return over a ten year or longer hold period - then I could just load up on all my favorite stocks now, regardless of valuation!

Analysis

In a "hat tip" to David Van Knapp, I decided to use real prices and dividends from an actual stock vs. artificial spreadsheet analysis (though I still found a way to use some cool spreadsheets).  With Chuck Carnevale's FASTGraphs tool, I started reviewing historical price trends for various stocks I own, with an eye out for a stock that clearly fluctuated above and below fair value, at least ten years ago.  I also wanted a dividend growth stock, and a stock valued by the market at roughly a PE = growth of 15.

I found a likely candidate in General Dynamics (GD).  Looking at a FASTGraph going back 18 years, GD's share price exhibited just the type of movement I was after:

GD's historical PE ratio paid by the market is 15.2, an almost perfect fit to the orange fair value line of 15 x earnings over the company's history.  Furthermore, during the area of focus in the circle, the price oscillated nicely above and below fair value over a five year period - great for my entry point analysis.

Zooming in on the area of focus, I've listed the prices and dates for five points of interest along the share price curve, each roughly one year apart:

Using the orange line as my fair value at each of the points, I then calculated a fair value for each of these points, and % of overvaluation or undervaluation that each exhibited.  The valuation % vs. fair value is shown in this figure:

For each case above, I created a dividend reinvestment spreadsheet using actual dividends, dates, and close prices on those dates.  I reinvested the dividends on the day they occurred, and continued the exercise until October 3, 2012, the date of GD's most recent dividend payment.  The spreadsheet for the "at fair value" case (case #3) is show here for reference (click to enlarge):

Running this analysis five times, once for each of the buy points discussed above, resulted in the following summary data which include total value of the investment, annual income, compound annual growth rate, and yield on original cost:

  

From these data, I make the following observations:

• Entry point (price) does matter.
• Buying below fair value really helped long term returns in this example.
• Buying below fair value = more shares purchased = more dividends, growth and income!
• In this example, buying above fair value didn't "wash out" over time - it depressed returns for the entire holding period.  If the stock were held for another 20 years, and the price appreciated 10 fold, then the differences in return would be very minor.  But for me, with a time horizon below 20 years, entry point really matters.
• As a comparison of Case 1 to Case 5 shows, waiting several years for an undervaluation situation to occur seems to trump the time effect of buying above fair value sooner.
• Dollar cost averaging into these positions was not considered (perhaps a future article).  It seems to me that DCA would work well as prices are dropping, but not so well while prices are rising.  I tend to avoid averaging into a position if I feel the stock is trading at a discount.  
• The S&P return from the case 1 entry point to October 3, 2012 resulted in a compound annual growth rate below 1%!  So the GD purchase, even at a high valuation, still beat the S&P over the same period by a wide margin.

Summary

I believe in buying stocks only when they are below fair value, and this analysis reinforced my conviction.  Undervaluation leads to better total returns, less risk, more dividend paying shares, and more income down the road.

With advances in information technology; the internet, myriad financial websites, FASTGraphs, David Fish's CCC list, etc., it has become very simple to quickly identify stocks that are priced below fair value.  The next time I have my heart set on a particular stock - a "must have" for my portfolio, I'm going to take a deep breath and wait until the stock trades at or below fair value - years if necessary, or deploy the money elsewhere.   With the excellent tools available to individual investors today, there is no (logical) reason to overpay for a stock.

Analysis of General Dynamics

After having sold SPLS and boosting my cash position, I've been screening stocks, looking for another great pick for the portfolio.   As I posted in my previous blog, I screened the small cap 600, the mid cap 400, and the large cap 100.  The results from those screens yielded some interesting companies, but besides AAPL and QCOM, many were financial, apparel, or airlines.  Since I own AAPL, and I am heavily weighted already in technology (MSFT, CSCO, INTC), I decided to pass on QCOM.

I then went back to the David Fish CCC lists.  I own several of the top Aristocrats and Champions, so I screened Contenders next.  Here is the result:

I own of few these already (TEVA, MSFT), several are similar to existing holdings NSC = CSX, CAT = CMI, and the others had some warts (BBY = value trap).  GD caught my attention with a low PE, a nice yield, and respectable EYE ratio.  Here are some FASTGraphs on GD:

Nicely undervalued vs. its historical PE (15 years).  Historical growth in EPS is 11.6%.   Here is a graph of price vs. normal PE for the past six years:

Still below fair value by around 9%.  Even though the stock took a big hit in 2008/2009, earnings continued to grow at 6.6%, giving us the undervaluation today.  Looking at yield, nice at 3.1%, with a good dividend track record:

GD has a nice track record of increasing dividends.  CAGR for the last 5 years of dividend growth is a very healthy 10.72%, and the payout ratio has remained around 25% or lower consistently.  An investment in GD 15 years ago handily outperformed the S&P by 6.3% annually.

Price to sales is at historic lows:

Looking at future earnings estimates, this year and next forecast by the company.  Out years a consensus of analysts following the stock:

This reinforces today's undervaluation, and while the 7% future growth is not all that exciting, I think this could change depending on the upcoming election.  GD has managed to sustain growth during 4 years of the Obama administration, and I suspect future growth estimates assume the current administration stays in power.  This could be viewed as a worse case future growth scenario.  Low debt, good payout ratio, nice yield and annual dividend increases all point to a well managed firm.  I ordinary would not like a stock that derives over 60% of its revenue from one customer (US Government), but because its the government, I don't view that nearly as risky as a major corporate customer.

While I'm skeptical of analyst opinions, I like to at least see what they are saying.  Here is a summary my Fidelity account (published without permission, hope this is legal :) :

GD is trading down today, I'm going to initiate a position, and build it over the coming few weeks.

Chump

Some New Screens I'm Running 10-3-12

I'd like to identify another stock to add to my non-core portion of the portfolio; a stock that may only be paying a small dividend, or gasp, no dividend (yet).  Growth (second gasp) is the theme for this next selection.

I sure like FAST Graphs.  I'm using it to screen various groups of stocks to find my next great company, undervalued, with incredible growth potential.  I'm using PE below 15, EPS historical growth of at least 15%, and forecasted EPS growth for the next 5 years of least 15%.  To put it simply:  Good growth history + good growth prospects + undervalued.  This narrows the field pretty quickly, and yields some interesting names for further investigation.  Maybe I should dubb this the "triple 15" screen?  Someone probably already has...

My first population screened was the Large Cap 100.  Applying the screen above yielded the following tickers:

 Only four names qualified, and I cheated a bit to get QCOM in the mix (I'm just interested in their stock, and wanted to evaluate them).

The next population I screened was the MidCap 400, here are those results:

This time the screen let through 12 companies.  I cheated again, this time with Foot Locker (PE of 15.5) because I was attracted to the dividend.

My last screen is on the Small Cap 600, here are the results:

This group produced 15 companies (actually 14, but I cheated again and added SKYW - look at that EYE ratio!) for further evaluation.

Now I'll spend a few days looking through these graphs and companies, then winnow the list still further.

That's all for now.

Portfolio Update Through 9-28-12

Here is a summary of the portfolio positions through the 28th, and some performance metrics follow:

As discussed in my previous blog, I decided to sell SPLS and increase my cash position.  Additional shares were added during the week to the following holdings:

• WAG
• EMR
• HAL
• CSX

I reduced the TIPs position slightly during the week to generate a bit a cash for the purchases above;  this prior to the sale of SPLS at week's end.  Now that SPLS is gone, the cash position in the portfolio is back up to 6.81%.  My TIP ETF balance is 9.82%, so combined with the cash position, I have around 15% available to invest in smaller % current holdings, or to add a particularly attractive new holding.

Some of the stocks on my attractive list include:  FDO, ADM, more WMT, MSFT, and TEVA.

Valuations on FDO and WMT are too high at this point.  Need to just wait on these.

Here are the summary performance stats for the portfolio through 9-28-12:

That's all for now.

Decision to Sell Staples

I put a limit order in today for my entire SPLS position.  If it triggers, I exit the position with a loss of just under 4%.  While this is painful, I think the story of the company is just too uncertain to hang on.

Here are my thoughts:

• My original decision was based on significant undervaluation and nice dividend yield, which the company has been consistently increasing.
• Shortly after I started the position, they had a disappointing earnings announcement, and lowered guidance for the full year.
• Tuesday, they announced they would be reducing brick and mortar square footage in the USA by 15%.  They have a small international presence in Europe and Australia, and both regions are unprofitable.
• Charges for the restructing over the next several years are expected to to exceed $150 million this year, and are not defined in future years.  I assume restructuring charges will continue until they hit their goal of 15% reduction in 2015.
• Earnings will be negatively impacted this year, 2013, and 2014.  Plus, the U.S. economy is struggling this year, so I expect earnings to be adjusted downwards significantly.

• The Fast Graph above shows the original premise - analysts projecting growth in eps of at least 6.8%.  Do you believe they will achieve earnings growth in 2012 and 2013?  I don't, so I expect the price and fair value to converge (lower price, lower expectations).  

Summary

• May be making a mistake here, but I'd like to have more cash in the portfolio to deploy on existing stocks at good valuations, or on new positions.