Today I was reading Dividend Mantra's post titled "What are you buying?" , well unfortunately I'm not buying anything right now although there's still some values available it's definitely not like it was the last quarter of 2011. The Stoic commented "There are several companies that I would like to add to my portfolio to better diversify, but just can't justify today's prices compared to just four months ago. This is my biggest challenge these days: if entry price matters or if DCA would be the best approach." This is very much the position that I would be in was I actively investing right now versus investing in my debt payoff.

I think the best course of action now would be to do both, DCA and get the entry price you want. As long as your monthly investment amount is high enough I think it would be prudent to blend the two by taking half of your amount and DCA into whatever position is the best value at the time or underweight in your portfolio. I would then build up cash with the other half. My reasoning behind this is that even though the markets have made a historic run and the consensus is that we're due for a pullback, or at the very least a cooling off period of flat trading, that you just never know what the markets and investor sentiment in general is going to do.

Due to the general lack of across the board value I think this could work out. If the markets continue to shoot higher then you're still adding to your positions and getting lower entry prices while building up some cash for the day when a pullback does come.

Personally I hope the "Sell in May and go away" rears its head again this year.

Pursuing Early Financial Independence through Dividend Growth Investing and other Passive Income.

## Wednesday, March 28, 2012

## Monday, March 26, 2012

### Selling Puts for Added Income

Today I'll be looking at Medtronic. Medtronic's current price is $38.70 and is a Dividend Aristocrat with 34 consectutive years of raising their dividend. The lowest of their 1, 3, 5 and 10 year dividend growth rates is 8.7% with the highest at 17.8%. The most recent payout ratio is 30.50% with a current yield of 2.50%.

If you're looking for more downside protection and therefore less of a chance of being put the shares then I like the #37 put since you get 4.59% of downside til the option could possibly be exercised and a total of 5.99% of downside before you would lose money on the move. That while still providing an adequate return for the approximate 2 month holding period.

The $39 put would be intriguing to me if I had the money to make the move. The put would currently be in the money meaning it could be exercised right away; however, you still have 2.79% of downside protection before you would lose money on the move. As long as the shares don't trade less than $37.62 if worked out for you. I think based on the return possibilities for a fairly steady stock that it would probably be the option I would look to make a move on since you would get a better dividend yield over buying outright.

I would normally try and get further downside protection but this is a shorter term option than some of the previous ones that I've looked at.

Strike Price | Option Price | Cost Basis if exercised | Total Return if Expires | CAGR if Expires | YOC if exercised |
---|---|---|---|---|---|

$37.00 | $0.62 | $36.38 | 1.08% | 7.69% | 2.66% |

$38.00 | $0.93 | $37.07 | 1.66% | 12.04% | 2.61% |

$39.00 | $1.38 | $37.62 | 2.49% | 18.44% | 2.57% |

If you're looking for more downside protection and therefore less of a chance of being put the shares then I like the #37 put since you get 4.59% of downside til the option could possibly be exercised and a total of 5.99% of downside before you would lose money on the move. That while still providing an adequate return for the approximate 2 month holding period.

The $39 put would be intriguing to me if I had the money to make the move. The put would currently be in the money meaning it could be exercised right away; however, you still have 2.79% of downside protection before you would lose money on the move. As long as the shares don't trade less than $37.62 if worked out for you. I think based on the return possibilities for a fairly steady stock that it would probably be the option I would look to make a move on since you would get a better dividend yield over buying outright.

I would normally try and get further downside protection but this is a shorter term option than some of the previous ones that I've looked at.

## Sunday, March 25, 2012

### AT&T Stock Analysis

I ran AT&T through my screening process to see where it currently stands. AT&T is closed on Friday 3/23/12 at $31.52.

DCF Valuation:

Analysts expect AT&T to grow 7.78% per year for the next 5 years and I've assumed that after that they will grow at 2.00%. Running those numbers through the DCF analysis with a 10% discount rate gives a value of $37.21. DCF valuation shows that AT&T is currently undervalued by 15.29%.

Graham Number:

Walmart's TTM EPS is $0.67 with a BVPS of $17.81. Using the Graham Number calculation you get a value of $16.39. Using these numbers AT&T is overvalued by approximately 92%; however, the TTM EPS value is artificially low due to the failed buyout of T-Mobile. If you recalculate based off the forecast $2.35 EPS you get $30.69 meaning that AT&T is currently overvalued by approximately 2.71%.

Average High Dividend Yield:

AT&T's average high dividend yield for the prior 10 years is 6.13% and for the previous 5 years it's 6.36%. Based on the 10 year yield, AT&T's low price should be $28.71. The price based on the 5 year yield is $27.67. This means that AT&T is overvalued by 9.80% and 13.93% respectively.

Average Low PE Ratio:

AT&T's average Low PE Ratio for the past 10 years is 14.90. This number is closer to 12 if you take out the current trailing PE ratio of 47 that AT&T has. Using the 10 year average however you get a value of $35.03 based on analyst estimates of $2.35 EPS. This means that AT&T is currently undervalued by approximatley 10%. The 5 year calculations give a price target of $40.95 with a PE ratio of 17.42. These are even more skewed because of the current 47 PE ratio, taking that out you get a PE target of 11.40 with a price target of $26.79.

Dividend Discount Model:

For the DDM I assumed that AT&T will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 2.33%. After that I assumed AT&T can continue to raise dividends by 2.0% and used a discount rate of 7.5%. Based on this AT&T is worth $30.71 meaning it's overvalued by 2.63%.

PE Ratios:

AT&T's trailing PE is 47.04 and it's forward PE is 12.41. The trailing PE is so high due to the payout of the failed T-Mobile acquisition. The CAPE for the previous 10 years is 16.26 and taking out the trailing PE from that calculation gives an CAPE of 15.15.

Fundamentals:

AT&T's gross margin is for FY 2011 was 45.28% and FY 2010 was 49.04%. I don't like the direction that the gross margin is heading but it is still very high which is nice to see. They're profit for for FY 2011 was 3.11% and FY 2010 was 15.98%. Once again the T-Mobile issue is rearing it's head. The Cash-to-Debt ratio is 0.05. I'm not too worried about the Cash-to-Debt ratio since AT&T is essentially a utility that demands lots of capital investments usually meaning more debt.

Share Buyback:

AT&T's shares outstanding have increased every year since 2008. Most recently it increased another 1.97%.

Dividend Analysis:

Obviously with a company like AT&T you're interested in current yield and not the dividend growth rate. AT&T's current yield is 5.58%. The 1 year growth rate is 2.33%, 3 year 2.38%, 5 year 4.39% and 10 year 5.69%. None of these are barnburning growth rates but if AT&T can get the growth rate closer to 5% it would be very intriguing.

The payout ratio has been fairly steady above the 70% mark. I would prefer that the payout ratio be lower to allow for larger increases but in AT&T's case I think it's prudent to allow a higher payout ratio. Once again, with AT&T your looking for either stability or high current yield not necessarily dividend growth.

Return on Equity and Return on Capital Invested:

AT&T's ROE and ROCI have been all over the place. Between 2001 and 2006 both values were trending down and since then they began expanding again. The following graph shows AT&T's ROE and ROCI since 2001.

Average Price and EPS:

EPS have been all over the place the past 2 years with a huge increase from 2009 to 2010 and then a huge drop off from 2010 to 2011.

Forecast:

The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 10 years. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. Currently AT&T is trading only $5.25 higher than this value.

Conclusion:

The average of all the valuation models gives a value of $32.47 which means that AT&T is currently trading at a 2.92% discount to the fair value.

Overall I think that AT&T is slightly overvalued at the current price. I would look to get at least a 6% entry yield which corresponds to a purchase price of $29.33. At that entry price you would begin your accumulation at a 16.5% discount to the average valuation. So in other words AT&T is not a stock I would be purchasing now and I would wait for the price to drop.

Selling puts would be one way to begin purchasing at a good margin of safety; however, the current put premiums would not meet my criteria unless you go out until at least July. And even then you would be looking at a only a 5.15% CAGR if the shares were not put to you.

DCF Valuation:

Analysts expect AT&T to grow 7.78% per year for the next 5 years and I've assumed that after that they will grow at 2.00%. Running those numbers through the DCF analysis with a 10% discount rate gives a value of $37.21. DCF valuation shows that AT&T is currently undervalued by 15.29%.

Graham Number:

Walmart's TTM EPS is $0.67 with a BVPS of $17.81. Using the Graham Number calculation you get a value of $16.39. Using these numbers AT&T is overvalued by approximately 92%; however, the TTM EPS value is artificially low due to the failed buyout of T-Mobile. If you recalculate based off the forecast $2.35 EPS you get $30.69 meaning that AT&T is currently overvalued by approximately 2.71%.

Average High Dividend Yield:

AT&T's average high dividend yield for the prior 10 years is 6.13% and for the previous 5 years it's 6.36%. Based on the 10 year yield, AT&T's low price should be $28.71. The price based on the 5 year yield is $27.67. This means that AT&T is overvalued by 9.80% and 13.93% respectively.

Average Low PE Ratio:

AT&T's average Low PE Ratio for the past 10 years is 14.90. This number is closer to 12 if you take out the current trailing PE ratio of 47 that AT&T has. Using the 10 year average however you get a value of $35.03 based on analyst estimates of $2.35 EPS. This means that AT&T is currently undervalued by approximatley 10%. The 5 year calculations give a price target of $40.95 with a PE ratio of 17.42. These are even more skewed because of the current 47 PE ratio, taking that out you get a PE target of 11.40 with a price target of $26.79.

Dividend Discount Model:

For the DDM I assumed that AT&T will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 2.33%. After that I assumed AT&T can continue to raise dividends by 2.0% and used a discount rate of 7.5%. Based on this AT&T is worth $30.71 meaning it's overvalued by 2.63%.

PE Ratios:

AT&T's trailing PE is 47.04 and it's forward PE is 12.41. The trailing PE is so high due to the payout of the failed T-Mobile acquisition. The CAPE for the previous 10 years is 16.26 and taking out the trailing PE from that calculation gives an CAPE of 15.15.

Fundamentals:

AT&T's gross margin is for FY 2011 was 45.28% and FY 2010 was 49.04%. I don't like the direction that the gross margin is heading but it is still very high which is nice to see. They're profit for for FY 2011 was 3.11% and FY 2010 was 15.98%. Once again the T-Mobile issue is rearing it's head. The Cash-to-Debt ratio is 0.05. I'm not too worried about the Cash-to-Debt ratio since AT&T is essentially a utility that demands lots of capital investments usually meaning more debt.

Share Buyback:

AT&T's shares outstanding have increased every year since 2008. Most recently it increased another 1.97%.

Dividend Analysis:

Obviously with a company like AT&T you're interested in current yield and not the dividend growth rate. AT&T's current yield is 5.58%. The 1 year growth rate is 2.33%, 3 year 2.38%, 5 year 4.39% and 10 year 5.69%. None of these are barnburning growth rates but if AT&T can get the growth rate closer to 5% it would be very intriguing.

The payout ratio has been fairly steady above the 70% mark. I would prefer that the payout ratio be lower to allow for larger increases but in AT&T's case I think it's prudent to allow a higher payout ratio. Once again, with AT&T your looking for either stability or high current yield not necessarily dividend growth.

Return on Equity and Return on Capital Invested:

AT&T's ROE and ROCI have been all over the place. Between 2001 and 2006 both values were trending down and since then they began expanding again. The following graph shows AT&T's ROE and ROCI since 2001.

Average Price and EPS:

EPS have been all over the place the past 2 years with a huge increase from 2009 to 2010 and then a huge drop off from 2010 to 2011.

Forecast:

The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 10 years. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. Currently AT&T is trading only $5.25 higher than this value.

Conclusion:

The average of all the valuation models gives a value of $32.47 which means that AT&T is currently trading at a 2.92% discount to the fair value.

Overall I think that AT&T is slightly overvalued at the current price. I would look to get at least a 6% entry yield which corresponds to a purchase price of $29.33. At that entry price you would begin your accumulation at a 16.5% discount to the average valuation. So in other words AT&T is not a stock I would be purchasing now and I would wait for the price to drop.

Selling puts would be one way to begin purchasing at a good margin of safety; however, the current put premiums would not meet my criteria unless you go out until at least July. And even then you would be looking at a only a 5.15% CAGR if the shares were not put to you.

## Saturday, March 24, 2012

### All Positive Portfolio

Not sure if this is necessarily a good thing or a bad thing but as of yesterday's close every position in my brokerage account is in positive territory since I initiated a position. While this is good to see it's not the best since I would prefer for stock prices to stay depressed longer while I build positions up and allow my dividends to purchase more shares. I'm sure sometime later this year we'll see something that pushes some positions back in to negative territory.

## Friday, March 23, 2012

### Little Green George Washingtons

I believe that in the long term dividend growth stocks will provide solid returns while being less volatile than the market in general. It's not flashy and it's not a get rich quick scheme. However, when 40% of the long term total return on stocks is from dividends and around 100% of the total return from stocks over the last 10 years is due to dividends, meaning negative price appreciation, they offer the best way to set up the core part of your portfolio.

I had been thinking of writing a post on the reasons why I chose dividend growth stocks to be the core investment philosophy that I follow but Tim McAleenan said it in one of the most clear and concise articles possible. His article "The Beginning Days of Dividend Growth" sums up why I believe dividend growth stocks are solid for someone just starting out or someone that's already in retirement.

I had been thinking of writing a post on the reasons why I chose dividend growth stocks to be the core investment philosophy that I follow but Tim McAleenan said it in one of the most clear and concise articles possible. His article "The Beginning Days of Dividend Growth" sums up why I believe dividend growth stocks are solid for someone just starting out or someone that's already in retirement.

## Thursday, March 22, 2012

### Net Worth

Your net worth is the total of all your assets (cash, investments, house, etc.) minus the total of all your liabilities/debts (credit card debt, student loans, car loan, mortgage, etc...). If you've been following along you've noticed that I update my net worth monthly for everyone to see. It's a good way to keep track of your progress along the path of paying off debts to saving to investing to financial independence.

Dividend Mantra had a good post today about yournet worth. I'd never really thought of my net worth compared to my starting point as a new born baby. It can be pretty eye opening as it was for him to realize you've been around for 20+ years and would have nothing to show for it if you completely liquidated everything.

Dividend Mantra had a good post today about yournet worth. I'd never really thought of my net worth compared to my starting point as a new born baby. It can be pretty eye opening as it was for him to realize you've been around for 20+ years and would have nothing to show for it if you completely liquidated everything.

## Wednesday, March 21, 2012

### Dividend Increases

I know these are a little old news but they happened over last week while I was distracted with getting to spend time with Lynsy. It was a nice break to get to take a week off from checking through financial information on different companies.

Wells Fargo announced that it will pay an additional $0.10 per share on top of the $0.12 that it's already paid for the first quarter of 2012 and will keep the rate at $0.22 per share per quarter. This is right in line with where I was expecting the dividend to be increased to when I originally purchased the stock. This brings the new annual rate to $0.88 from $0.48, a increase of 83%.

JP Morgan Chase announced earlier this month that it will increase it's quarterly dividend to $0.30 from $0.25 per share. This brings the annual dividend up to $1.20 per share. That's a 20% increase in the dividend.

*Held in Roth IRA

My Brokerage portfolio's YOC increased from 2.38% to 2.41% and my ROTH IRA portfolio's YOC increased from 2.86% to 3.44%.

Wells Fargo announced that it will pay an additional $0.10 per share on top of the $0.12 that it's already paid for the first quarter of 2012 and will keep the rate at $0.22 per share per quarter. This is right in line with where I was expecting the dividend to be increased to when I originally purchased the stock. This brings the new annual rate to $0.88 from $0.48, a increase of 83%.

JP Morgan Chase announced earlier this month that it will increase it's quarterly dividend to $0.30 from $0.25 per share. This brings the annual dividend up to $1.20 per share. That's a 20% increase in the dividend.

Symbol | Previous Quarterly Dividend | Current Quarterly Dividend | Current Annual Dividend | Old YOC | New YOC |
---|---|---|---|---|---|

WFC | $0.12 | $0.22 | $0.88 | 2.01% | 3.68% |

WFC* | $0.12 | $0.22 | $0.88 | 1.89% | 3.47% |

JPM* | $0.25 | $0.30 | $1.20 | 3.24% | 3.89% |

*Held in Roth IRA

My Brokerage portfolio's YOC increased from 2.38% to 2.41% and my ROTH IRA portfolio's YOC increased from 2.86% to 3.44%.

## Tuesday, March 20, 2012

### Selling Puts for Added Income

It's about time for another look at possible put option moves to get a better entry price or for added income. All calculations are based off of prices from March 20, 2012.

Today I'll be looking at Bank of America. I still have high regard for high capital gains returns. I know it's not necessarily a solid dividend stock right now but at current prices you could be getting a great yield on cost due to the increase in the dividends to go along with solid capital gains. The current price for Bank of America is $9.82 giving a 0.40% current dividend yield.

I currently own shares of BAC and wish I had picked up more at cheaper prices. I think within a 2-3 year time frame you could still be looking at a double or triple from today's prices. If you're looking to not have the shares put to you then go with the lowest strike price for the put. Personally I would go for something that's around a 50/50 chance of getting exercised as long as you still get a good discount versus purchasing the shares outright at current prices. I like the May $10 strike put since you still have 6.42% downside protection before you would begin to lose money and if the stock continues to go up as I think it will you'd be looking at a 5.42% return in a little less than 2 months.

*Assumed 25% tax bracket and the commission costs of $8.70 that I would pay.

Today I'll be looking at Bank of America. I still have high regard for high capital gains returns. I know it's not necessarily a solid dividend stock right now but at current prices you could be getting a great yield on cost due to the increase in the dividends to go along with solid capital gains. The current price for Bank of America is $9.82 giving a 0.40% current dividend yield.

Strike Price | Option Price | Cost Basis if exercised | Total Return if Expires | CAGR if Expires | YOC if exercised |
---|---|---|---|---|---|

$9.00 | $0.22 | $8.78 | 1.11% | 13.89% | 0.45% |

$10.00 | $0.64 | $9.36 | 4.15% | 61.44% | 0.42% |

Strike Price | Option Price | Cost Basis if exercised | Total Return if Expires | CAGR if Expires | YOC if exercised |
---|---|---|---|---|---|

$9.00 | $0.36 | $8.64 | 2.28% | 14.95% | 0.46% |

$10.00 | $0.81 | $9.19 | 5.42% | 38.68% | 0.43% |

I currently own shares of BAC and wish I had picked up more at cheaper prices. I think within a 2-3 year time frame you could still be looking at a double or triple from today's prices. If you're looking to not have the shares put to you then go with the lowest strike price for the put. Personally I would go for something that's around a 50/50 chance of getting exercised as long as you still get a good discount versus purchasing the shares outright at current prices. I like the May $10 strike put since you still have 6.42% downside protection before you would begin to lose money and if the stock continues to go up as I think it will you'd be looking at a 5.42% return in a little less than 2 months.

*Assumed 25% tax bracket and the commission costs of $8.70 that I would pay.

## Monday, March 19, 2012

### Absence

Sorry for my absence this past week. I was off from work which thankfully coincided with Lynsy's spring break from school. I was so glad to get to spend a whole week with her and not have to worry about getting called out for work or for her to have to be at school. Definitely one of the best weeks I've had in a long time.

## Thursday, March 8, 2012

### Nominal vs Real Return

Nominal returns are the total annual return that you received on the investment. Real return accounts for the effects of inflation.

Real Return = Nominal Return - Inflation Rate

For the purposes of this example I've assumed that $1 is invested at the beginning of 2012 and no additional investments are made for the rest of the study period. Since Warren Buffet knows a lot more about investing than I do, we'll use his 7% total return assumption. From 1914 to 2010 the average inflation rate was 3.38% so we'll go on and use that. There's a big difference in the dollar value at the end of 33 years.

The nominal return ends up turning $1 in to $9.33 of 2044 dollars. However the actual purchasing power that you have increased after accounting for inflation is only $3.23. The real return is only 35% of the nominal return. For that you can thank inflation This exercise goes to show that inflation is definitely something to take into account when planning your retirement saving.

Little changes in assumptions can make a huge difference in the final values. I've run the calculations for several different scenarios and the results are in the following table.

You can use the previous table to multiply your total investment balance by the real dollars column for whatever scenario you wish to get an approximation of your portfolio if you don't contribute anything else and let it be for 33 years. For example I currently have just under $80,000 across all my investment accounts. I'll take the 7% return with 3.38% inflation, the real dollar column shows $3.23. So $80,000 x $3.23 = $258,400. That's not bad but if you have followed this blog I'm looking for much better than that.

The scenario that I expect to play out is something in the area of the 7% nominal return with the 3% inflation rate. That would mean that every dollar that was invested at the beginning of 2012 would turn in to $3.65 of purchasing power. While inflation is a big concern in the long run, I believe that some effects of inflation can be accounted for through smarter purchases and getting your expenses to align with your true life goals. Of course so many variables go in to any projections that these are a rough guide. It's good to play around with the numbers to see what different scenarios would produce. We're all searching for the right balance between saving enough plus a little bit more for comfort so that we can enjoy our life as it goes. I hope that we can all find that balance.

Real Return = Nominal Return - Inflation Rate

For the purposes of this example I've assumed that $1 is invested at the beginning of 2012 and no additional investments are made for the rest of the study period. Since Warren Buffet knows a lot more about investing than I do, we'll use his 7% total return assumption. From 1914 to 2010 the average inflation rate was 3.38% so we'll go on and use that. There's a big difference in the dollar value at the end of 33 years.

The nominal return ends up turning $1 in to $9.33 of 2044 dollars. However the actual purchasing power that you have increased after accounting for inflation is only $3.23. The real return is only 35% of the nominal return. For that you can thank inflation This exercise goes to show that inflation is definitely something to take into account when planning your retirement saving.

Little changes in assumptions can make a huge difference in the final values. I've run the calculations for several different scenarios and the results are in the following table.

Nominal Return | Inflation Rate | Real Return | Nominal Dollars | Real Dollars |
---|---|---|---|---|

4.00% | 3.38% | 0.62% | $3.65 | $1.23 |

4.00% | 3.00% | 1.00% | $3.65 | $1.39 |

4.00% | 2.50% | 1.50% | $3.65 | $1.63 |

7.00% | 3.38% | 3.62% | $9.33 | $3.23 |

7.00% | 3.00% | 4.00% | $9.33 | $3.65 |

7.00% | 2.50% | 4.50% | $9.33 | $4.27 |

10.00% | 3.38% | 6.62% | $23.23 | $8.29 |

10.00% | 3.00% | 7.00% | $23.23 | $9.33 |

10.00% | 2.50% | 7.50% | $23.23 | $10.88 |

You can use the previous table to multiply your total investment balance by the real dollars column for whatever scenario you wish to get an approximation of your portfolio if you don't contribute anything else and let it be for 33 years. For example I currently have just under $80,000 across all my investment accounts. I'll take the 7% return with 3.38% inflation, the real dollar column shows $3.23. So $80,000 x $3.23 = $258,400. That's not bad but if you have followed this blog I'm looking for much better than that.

The scenario that I expect to play out is something in the area of the 7% nominal return with the 3% inflation rate. That would mean that every dollar that was invested at the beginning of 2012 would turn in to $3.65 of purchasing power. While inflation is a big concern in the long run, I believe that some effects of inflation can be accounted for through smarter purchases and getting your expenses to align with your true life goals. Of course so many variables go in to any projections that these are a rough guide. It's good to play around with the numbers to see what different scenarios would produce. We're all searching for the right balance between saving enough plus a little bit more for comfort so that we can enjoy our life as it goes. I hope that we can all find that balance.

## Wednesday, March 7, 2012

### Walmart Stock Analysis

I ran Walmart through my screening process and was pretty intrigued by the results. Walmart is currently trading at $59.76.

DCF Valuation:

Analysts expect Walmart to grow 9.10% per year for the next 5 years and I've assumed that after that they will grow at 1.5%. Running those numbers through the DCF analysis with a 10% discount rate gives a value of $72.46. DCF valuation shows that Walmart is currently undervalued by 17.5%.

Graham Number:

Walmart's TTM EPS is $4.52 with a BVPS of $20.82. Using the Graham Number calculation you get a value of $46.02. The Graham Number says that Walmart is currently overvalued by 29.9%.

Average High Dividend Yield:

Walmart's average high dividend yield for the prior 10 years is 1.85% and for the previous 5 years it's 2.39%. I think that the 10 year average is artificially low due to the high valuation that Walmart was trading for in the early 2000's. Based on the 10 year yield Walmart should trade at $84.31. The price based on the 5 year yield is $65.37. This means that Walmart is undervalued by 29.1% and 8.6% respectively.

Average Low PE Ratio:

Much like the high dividend yield being skewed the Low PE ratio is also skewed due to the excessive valuations in the early 2000's. In 2001 you saw Walmart trade between a 30 and 48 PE ratio. Even in 2005 Walmart was trading between a 21 and 25 PE ratio. It's average low 10 year PE ratio is 16.27 and the 5 year PE is 12.41. Baed on the PE's Walmart should trade at $79.09 and $60.32 meaning that Walmart is undervalued by 24.4% and 0.9% respectively.

Dividend Discount Model:

For the DDM I assumed that Walmart will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 15%. After that I assumed Walmart can continue to raise dividends by 2.5% and used a discount rate of 7.5%. Based on this Walmart is worth $49.22 meaning it's overvalued by 21.4%.

PE Ratios:

Walmart's trailing PE is 13.22 and it's forward PE is 12.30. The CAPE for the previous 10 years is 21.54. I feel the CAPE is a little overstated once again thanks to the high valuations afforded Walmart's shares in the early 2000's.

Fundamentals:

I usually look for a higher gross and net margin but Walmart is in the low margin retail business. For these I'll compare them to the industry to see how they stack up against their competitors. Their gross margin is 3.8% higher than the industry and the net profit margin is 8.1% higher than the industry. Since Walmart doesn't pass my minimum margin amounts due to their business it's nice to see that they are well above their competition in a low margin business. I would like for the cash to debt ratio to be better than the current 0.15.

Share Buyback:

Over the past year Walmart was able to decrease the shares outstanding by 2.60%.

Dividend Analysis:

The current yield is a little low for my entry price but a 2.44% yield is close to my entry yield of 2.50%. Especially since Walmart's dividend growth rates are great. The 1 year is 20.66%, 3 year 15.40%, 5 year 16.86% and the 10 year is 20.14%. I usually like to see the 10 year at least 10% but all four are at least 15%. And what's even better is that the payout ratio is only 32.3%. This means there's still plenty of room to increase the dividend for a long time.

Return on Equity and Return on Capital Invested:

I don't normally look for a specific number but prefer to see fairly stable or increasing values for ROE and ROCI. The following graph shows Walmart's ROE and ROCI since 2001.

Average Price and EPS:

Due to the high valuation that Walmart had in the early 2000's the share price has been relatively flat to allow for the EPS to catch up to justify the valuation.

Forecast:

The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 10 years. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. Currently Walmart is trading only $0.44 higher than this value.

The average of all the valuation models gives a value of $66.22 which means that Walmart is currently trading at a 9.7% discount to the fair value.

Overall I think that Walmart is on the border of hitting my entry criteria. I would probably start accumulating at any price below $59 and buy on the way down. A $59 entry price would start your position at an approximate 11% discount to the average fair value. The other option is to sell puts to guarantee a entry price that you seek. With Walmart being a large and stable company I'm not sure you could get adequate premium yield from the puts to make it worth tying your money up.

DCF Valuation:

Analysts expect Walmart to grow 9.10% per year for the next 5 years and I've assumed that after that they will grow at 1.5%. Running those numbers through the DCF analysis with a 10% discount rate gives a value of $72.46. DCF valuation shows that Walmart is currently undervalued by 17.5%.

Graham Number:

Walmart's TTM EPS is $4.52 with a BVPS of $20.82. Using the Graham Number calculation you get a value of $46.02. The Graham Number says that Walmart is currently overvalued by 29.9%.

Average High Dividend Yield:

Walmart's average high dividend yield for the prior 10 years is 1.85% and for the previous 5 years it's 2.39%. I think that the 10 year average is artificially low due to the high valuation that Walmart was trading for in the early 2000's. Based on the 10 year yield Walmart should trade at $84.31. The price based on the 5 year yield is $65.37. This means that Walmart is undervalued by 29.1% and 8.6% respectively.

Average Low PE Ratio:

Much like the high dividend yield being skewed the Low PE ratio is also skewed due to the excessive valuations in the early 2000's. In 2001 you saw Walmart trade between a 30 and 48 PE ratio. Even in 2005 Walmart was trading between a 21 and 25 PE ratio. It's average low 10 year PE ratio is 16.27 and the 5 year PE is 12.41. Baed on the PE's Walmart should trade at $79.09 and $60.32 meaning that Walmart is undervalued by 24.4% and 0.9% respectively.

Dividend Discount Model:

For the DDM I assumed that Walmart will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 15%. After that I assumed Walmart can continue to raise dividends by 2.5% and used a discount rate of 7.5%. Based on this Walmart is worth $49.22 meaning it's overvalued by 21.4%.

PE Ratios:

Walmart's trailing PE is 13.22 and it's forward PE is 12.30. The CAPE for the previous 10 years is 21.54. I feel the CAPE is a little overstated once again thanks to the high valuations afforded Walmart's shares in the early 2000's.

Fundamentals:

I usually look for a higher gross and net margin but Walmart is in the low margin retail business. For these I'll compare them to the industry to see how they stack up against their competitors. Their gross margin is 3.8% higher than the industry and the net profit margin is 8.1% higher than the industry. Since Walmart doesn't pass my minimum margin amounts due to their business it's nice to see that they are well above their competition in a low margin business. I would like for the cash to debt ratio to be better than the current 0.15.

Share Buyback:

Over the past year Walmart was able to decrease the shares outstanding by 2.60%.

Dividend Analysis:

The current yield is a little low for my entry price but a 2.44% yield is close to my entry yield of 2.50%. Especially since Walmart's dividend growth rates are great. The 1 year is 20.66%, 3 year 15.40%, 5 year 16.86% and the 10 year is 20.14%. I usually like to see the 10 year at least 10% but all four are at least 15%. And what's even better is that the payout ratio is only 32.3%. This means there's still plenty of room to increase the dividend for a long time.

Return on Equity and Return on Capital Invested:

I don't normally look for a specific number but prefer to see fairly stable or increasing values for ROE and ROCI. The following graph shows Walmart's ROE and ROCI since 2001.

Average Price and EPS:

Due to the high valuation that Walmart had in the early 2000's the share price has been relatively flat to allow for the EPS to catch up to justify the valuation.

Forecast:

The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 10 years. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. Currently Walmart is trading only $0.44 higher than this value.

The average of all the valuation models gives a value of $66.22 which means that Walmart is currently trading at a 9.7% discount to the fair value.

Overall I think that Walmart is on the border of hitting my entry criteria. I would probably start accumulating at any price below $59 and buy on the way down. A $59 entry price would start your position at an approximate 11% discount to the average fair value. The other option is to sell puts to guarantee a entry price that you seek. With Walmart being a large and stable company I'm not sure you could get adequate premium yield from the puts to make it worth tying your money up.

## Tuesday, March 6, 2012

### Recent Transaction

Yesterday I bought back the $42 Hal 07202012 Call option that I sold in early February. When I originally sold the option I was hoping that it would just expire since I didn't want to have to deal with the extra taxes due to the shares being bought through the ESPP. I sold the call for $1.60 with a $8.03 total commission so that netted me $151.97 or a 3.62% yield for the term of the option. I was able to buy back the option to close out the position for $0.76 yesterday with a total commission of $7.97 which cost me a total of $83.97. The 2 trades combined netted me a total of $68.00 or 1.62% option yield over 32 days. That equates to a 20.12% CAGR. Since I was able to get almost half of the option yield in only 20% of the time I thought it was a pretty solid move to lock in the gain and not have the risk of the shares being called away triggering a higher taxable event for my ESPP shares. Unfortunately the stock market decided that today it wanted to finally freak out about the global economic situation and I could've bought the call to close out the position for $0.62 which would have given me a much better gain. Oh well, pigs get slaughtered right? If the shares were not part of the ESPP then I would have let the option go to the end most likely although I feel that this was a good move regardless.

### Net Worth Update - February 2012

February was another great month for my net worth. I had my third $10k+ positive move. Almost half of that was due to my employer's profit sharing hitting my 401k account. Another big chunk was from debt payment. It's good to see that number going down more and more each month. It's one step closer to not having to commit any money towards that and to put it to better use through savings.

I was double checking my formulas in my spreadsheet and noticed that I was counting my 401k and Rollover IRA as liquid assets. Which I guess technically they would be but at huge penalties. That change will be reflected in this month's update.

Current Assets: $125,183.45

Curent Liquid Assets: $50,471.88

Current Debts: -$35,120.70

Net Worth: $90,062.75

My savings rate for February was 73.09% from my take home pay. As usual this doesn't include my 401k contributions. I might start keeping track of savings off of net pay just to see where I stand on that front.

YTD my net worth has increased 30.97% for a total of $21,299.30. It'll be fun to see when exactly I can get my net worth to break the $100k mark. I think April or May will bring that about.

I was double checking my formulas in my spreadsheet and noticed that I was counting my 401k and Rollover IRA as liquid assets. Which I guess technically they would be but at huge penalties. That change will be reflected in this month's update.

Current Assets: $125,183.45

Curent Liquid Assets: $50,471.88

Current Debts: -$35,120.70

Net Worth: $90,062.75

My savings rate for February was 73.09% from my take home pay. As usual this doesn't include my 401k contributions. I might start keeping track of savings off of net pay just to see where I stand on that front.

YTD my net worth has increased 30.97% for a total of $21,299.30. It'll be fun to see when exactly I can get my net worth to break the $100k mark. I think April or May will bring that about.

## Monday, March 5, 2012

### Option Buyback?

Back in the beginning of February I sold a call option for HAL with a strike price of $42 for $1.60. The option expires on July 20th. Based on the sale if the option expired I would have earned $151.97 over about 5 months. This would have been a total return of 3.62% which translates to a 7.98% CAGR.

Lately Halliburton's share price has been struggling. A little over a week ago it was at it's YTD high and has gone down in almost a straight line since. I recently checked the price of the option and saw that it's currently around $0.80 per contract. I'm thinking of buying back the option to close it out. If I can buy it back at $0.80 I would have earned 1.58% in a little over a month which translates to a 18.61% CAGR.

I'm still weighing my options because I wouldn't necessarily mind the shares being called away to get the full $152 and get to sell my shares well above my purchase price. However I'm due to the tax implications of selling the shares early since they were bought through my ESPP I would like to the keep the shares long enough to at least get them taxed at the long term capital gains rate. Halliburton has been a pretty volatile stock since on 2/15/12 it was at $35.23, closed at $38.51 on 2/24/12, and is currently trading at $34.97. That's a 9.3% move up followed by a -9.19% all within the last 19 days.

Lately Halliburton's share price has been struggling. A little over a week ago it was at it's YTD high and has gone down in almost a straight line since. I recently checked the price of the option and saw that it's currently around $0.80 per contract. I'm thinking of buying back the option to close it out. If I can buy it back at $0.80 I would have earned 1.58% in a little over a month which translates to a 18.61% CAGR.

I'm still weighing my options because I wouldn't necessarily mind the shares being called away to get the full $152 and get to sell my shares well above my purchase price. However I'm due to the tax implications of selling the shares early since they were bought through my ESPP I would like to the keep the shares long enough to at least get them taxed at the long term capital gains rate. Halliburton has been a pretty volatile stock since on 2/15/12 it was at $35.23, closed at $38.51 on 2/24/12, and is currently trading at $34.97. That's a 9.3% move up followed by a -9.19% all within the last 19 days.

### Nucor Stock Analysis

Nucor (NUE) operates mini-mills in the steel process. I recently ran their numbers through my spreadsheet and I'm fairly intrigued by the possibilities. Especially since I think the global economy is improving and the demand for steel should increase in the coming years leading to higher profits for Nucor.

DCF Valuation:

Analysts foresee NUE growing earnings by 9.55% per year for the next five years and I've assumed they will continue to grow earnings at 2.50% per year after that. Using a discount rate of 10% and taking the future earnings back to present value NUE is fairly valued with the DCF giving a price of $43.54 and NUE's current stock price is $43.57. These calculations are based on the TTM EPS of $2.45. If you start the calculations based off the analysts expectation of $3.12 for this year the DCF becomes $55.44 meaning it's currently undervalued.

Graham Number:

The Graham Number for NUE is $36.03 based off TTM EPS meaning it's overvalued by about 21%. If you use the analysts 2012 EPS estimate you get a Graham Number of $40.66.

Average High Dividend Yield:

The AHDY for NUE over the previous 10 years is 2.78%. It's current yield is 3.35%. In order for it to reach it's AHDY the stock price must increase to $52.58 meaning a 17% upside.

Average Low PE Price:

NUE's ALPE for the previous 10 years is 16.19. By applying that to the analysts $3.12 estimate for 2012 EPS, you get a low price of $50.51. This is about a 14% upside.

Dividend Discount Model:

For the DDM, I've assumed a discount rate of 7.5% and a long-term dividend growth rate of 2.50%. For the next five years I've assumed the lesser of the 1, 3, 5 & 10 year dividend growth rates which is 0.69%. Discounting the future dividends back to today you get a price of $25.07. I think NUE's prospects are better than that and they will be able to increase the dividend more than the 0.69%, so re-running the numbers with a 6% growth rate for the next 5 years you get a price target of $31.63.

PE valuations:

NUE's Trailing PE is 17.78 and their forward PE is 10.68. Their CAPE for the previous 10 years is 16.20. This means on a trailing basis they are slightly overvalued versus CAPE but is undervalued on a foward looking basis.

Fundamentals:

I don't like their gross and profit margins as low as they are but that is more of a factor of the current economy. Both have improved over the last year with the gross margin improving 82% and the profit margin improving 359%. I like seeing that the margins are moving in the right direction and should continue to get better as global steel demand increases. I would like to see a better cash to debt ratio but NUE's is a industry the requires more debt than some. Revenue has increased 26% over the past year.

Dividend Analysis:

I like the current yield being over 3%. The 1 and 5 year growth rates are a little concerning but the 5 and 10 year growth rates make me fairly certain that the recent low growth rates are due to the crazy mess that we have been through in recent years. They're payout ratio is a little high for my liking but I see it going down despite increases in the dividends as a function of earnings rising faster.

The following charts shed a bit of light on the numbers.

As you can tell from the first chart, earnings have been growing much faster than the stock price over the past 2 years. The second chart shows the forecasted prices based off the historical PE's and earning estimates. I included a price line based off a compressed PE that is only 0.75 of the average PE for the last 10 years to give an added margin of safety. If you can get a purchase price close to the forecast based off the projections ($37.89) then you should be able to see a good return on capital and enjoy a nice YOC (3.85%).

Unless the stock market pulls back I'm not sure if you'll ever see that stock price any time soon. The best way to get a lower entry price is probably through cash-secured puts where you can at least earn a solid return while waiting for the price to come back. You can check my previous post on NUE puts to see my thoughts on those possibilities.

Overall I think NUE is fairly valued at this point in time.

*I've added the following on 3/5/12

Since I mentioned that I feel the better way to buy into NUE is to sell puts I figured I should at least give an option. I like the $39 Jul 20 2012 Put for $1.86. This would give you a creation price of $37.14 which would give a good margin of safety (~21%) to the average valuation that I calculated of $46.98. Your YOC would be 3.92% which is a great yield for a solid company like NUE. And if the option just expires you would get a total return of 3.41% over approximately 5 months or a CAGR of 9.42%. Either outcome would be welcomed by me. Unfortunately I can't make this move since I don't have the $3,900 sitting around.

DCF Valuation:

Analysts foresee NUE growing earnings by 9.55% per year for the next five years and I've assumed they will continue to grow earnings at 2.50% per year after that. Using a discount rate of 10% and taking the future earnings back to present value NUE is fairly valued with the DCF giving a price of $43.54 and NUE's current stock price is $43.57. These calculations are based on the TTM EPS of $2.45. If you start the calculations based off the analysts expectation of $3.12 for this year the DCF becomes $55.44 meaning it's currently undervalued.

Graham Number:

The Graham Number for NUE is $36.03 based off TTM EPS meaning it's overvalued by about 21%. If you use the analysts 2012 EPS estimate you get a Graham Number of $40.66.

Average High Dividend Yield:

The AHDY for NUE over the previous 10 years is 2.78%. It's current yield is 3.35%. In order for it to reach it's AHDY the stock price must increase to $52.58 meaning a 17% upside.

Average Low PE Price:

NUE's ALPE for the previous 10 years is 16.19. By applying that to the analysts $3.12 estimate for 2012 EPS, you get a low price of $50.51. This is about a 14% upside.

Dividend Discount Model:

For the DDM, I've assumed a discount rate of 7.5% and a long-term dividend growth rate of 2.50%. For the next five years I've assumed the lesser of the 1, 3, 5 & 10 year dividend growth rates which is 0.69%. Discounting the future dividends back to today you get a price of $25.07. I think NUE's prospects are better than that and they will be able to increase the dividend more than the 0.69%, so re-running the numbers with a 6% growth rate for the next 5 years you get a price target of $31.63.

PE valuations:

NUE's Trailing PE is 17.78 and their forward PE is 10.68. Their CAPE for the previous 10 years is 16.20. This means on a trailing basis they are slightly overvalued versus CAPE but is undervalued on a foward looking basis.

Fundamentals:

I don't like their gross and profit margins as low as they are but that is more of a factor of the current economy. Both have improved over the last year with the gross margin improving 82% and the profit margin improving 359%. I like seeing that the margins are moving in the right direction and should continue to get better as global steel demand increases. I would like to see a better cash to debt ratio but NUE's is a industry the requires more debt than some. Revenue has increased 26% over the past year.

Dividend Analysis:

I like the current yield being over 3%. The 1 and 5 year growth rates are a little concerning but the 5 and 10 year growth rates make me fairly certain that the recent low growth rates are due to the crazy mess that we have been through in recent years. They're payout ratio is a little high for my liking but I see it going down despite increases in the dividends as a function of earnings rising faster.

The following charts shed a bit of light on the numbers.

As you can tell from the first chart, earnings have been growing much faster than the stock price over the past 2 years. The second chart shows the forecasted prices based off the historical PE's and earning estimates. I included a price line based off a compressed PE that is only 0.75 of the average PE for the last 10 years to give an added margin of safety. If you can get a purchase price close to the forecast based off the projections ($37.89) then you should be able to see a good return on capital and enjoy a nice YOC (3.85%).

Unless the stock market pulls back I'm not sure if you'll ever see that stock price any time soon. The best way to get a lower entry price is probably through cash-secured puts where you can at least earn a solid return while waiting for the price to come back. You can check my previous post on NUE puts to see my thoughts on those possibilities.

Overall I think NUE is fairly valued at this point in time.

*I've added the following on 3/5/12

Since I mentioned that I feel the better way to buy into NUE is to sell puts I figured I should at least give an option. I like the $39 Jul 20 2012 Put for $1.86. This would give you a creation price of $37.14 which would give a good margin of safety (~21%) to the average valuation that I calculated of $46.98. Your YOC would be 3.92% which is a great yield for a solid company like NUE. And if the option just expires you would get a total return of 3.41% over approximately 5 months or a CAGR of 9.42%. Either outcome would be welcomed by me. Unfortunately I can't make this move since I don't have the $3,900 sitting around.

## Saturday, March 3, 2012

### Dividend Update - February 2012 *Revised

*Well, I didn't check my brokerage account until today and just noticed that some of the dividends that are usually paid out in March were pushed foward to leap day on February 29th. So I've revised my February dividend update.

February ended up being a pretty good month for dividends, much better than was expected since I had 3 positions payout on 2/29 when I was expecting a March payout. Unfortunately since I'm really gungho about paying off debt I haven't been able to add to my brokerage account to increase my dividend income. That on top of work being slow meaning lower take home pay has had a double effect on keeping me from investing more.

I've received a total of $37.27 in dividends this year so far. March will end up paying out around $50 so it should be another good month for dividends.

My Roth IRA has paid out a total of $8.00 in dividends so far in 2012.

It's not much over the 2 accounts but it's still an extra $45.27 that I've invested that I wouldn't have otherwise.

February ended up being a pretty good month for dividends, much better than was expected since I had 3 positions payout on 2/29 when I was expecting a March payout. Unfortunately since I'm really gungho about paying off debt I haven't been able to add to my brokerage account to increase my dividend income. That on top of work being slow meaning lower take home pay has had a double effect on keeping me from investing more.

Company | Dividend Amount | Shares Purchased |
---|---|---|

AT&T(T) | $8.80 | 0.300 |

Proctor & Gamble (PG) | $5.25 | 0.082 |

Alcoa (AA) | $0.90 | 0.087 |

Wells Fargo (WFC) | $1.57 | 0.051 |

ConocoPhillips (COP) | $10.66 | 0.139 |

Intel (INTC) | $9.45 | 0.351 |

February 2012 Total | $36.63 |

I've received a total of $37.27 in dividends this year so far. March will end up paying out around $50 so it should be another good month for dividends.

Company | Dividend Amount | Shares Purchased |
---|---|---|

Wells Fargo (WFC) | $3.00 | 0.098 |

February 2012 Total | $3.00 |

My Roth IRA has paid out a total of $8.00 in dividends so far in 2012.

It's not much over the 2 accounts but it's still an extra $45.27 that I've invested that I wouldn't have otherwise.

## Friday, March 2, 2012

### Income Update - February 2012

February was right in line with most of my other months as far as expenses go. I'll start seeing the decrease in our cable bill since we dropped cable down to the most basic and have increased our internet speed and signed up with Netflix. This will save me around $40 a month so at least I'll have that to help bring my expenses down. I'm getting frustrated that I haven't made much progress on decreasing my expenses more. My total food budget unfortunately went right back up to my average for last year. I know part of the reason is because we went out to eat more than usual this month. The other main reason it went back up is because I was home more this month than usual. And whenever I'm home I try and pick up lots of groceries to help Lynsy out. Overall it was still a pretty good month. I brought home $6,464.06 in February and was able to save or use as debt payment 73.09% of my income.

## Thursday, March 1, 2012

### JNJ Stock Analysis

I've started to try and consolidate my stock analysis spreadsheets to make it easier for myself to cruch numbers. I like JNJ and would love to get in but right now it seems that it's a little overvalued and there's just too many question marks about the company right now with all the recalls and accompanying bad PR plus a change at CEO.

DCF Valuation:

Using a discount rate of 10% the stock is currently overvalued by about 17%. Assuming that EPS will grow 5.70% per year for the next 5 years and terminally at 3%. If you use the discount rate based off the so-called "risk free" rate of the 10 yr treasury then the numbers are skewed since the current rate is around 2%. Since I feel that you should still take this into account since that would be the most conservative that you could get, I ran the numbers based off a 8% discount rate. Using a 8% discount rate then JNJ becomes undervalued by about 11%.

Dividend Discount Model:

For my DDM analysis I assume a discount rate that is 75% of the rate that I use for the DCF. So using a 10% DCF rate gives a 7.5% DDM rate. Assuming that JNJ can grow dividends at 6.64% for the next 5 years and 3% terminally, JNJ is currently overvalued by about 15%, giving a target price of $56.36. Running the numbers based off the 8% DCF rate you arrive at JNJ being undervalued by about 11% with a target price of $73.26. These calculations are highly dependent on the inputs.

Graham Number:

We'll add Mr. Benjamin Graham's number which is the square root of 22.5 * TTM EPS * BVPS. The Graham Number gives a fair price of $40.56 meaning that JNJ is currently overvalued by about 60%.

Avg. High Dividend Yield:

The average high dividend yield for the past 10 years is 3.11%, while JNJ has a current dividend yield of 3.50%. This means that shares are currently undervalued by about 17%. Theoretically the average high yield for the previous 10 years should be the approximate high yield that you will get during any given year. I think these numbers are skewed to give a higher target price based on the abnormally low yields earlier in the 2000's thanks to the overexuberance of the stock market at the time.

Avg: Low P/E:

The average low PE over the past 10 years is 15.29 and the current TTM PE is 18.62 with a Foward PE of 11.97. Much like the average high dividend yield, I feel that these numbers are skewed thanks to the overvaluation of the market in general in the early 2000's. JNJ was trading at an average low PE of 25.67 between 2001 and 2005. This has a big effect on the 10 year average low PE. The last 5 year PE is 13.52 compared to the 15.29 for the 10 year average.

Fundamentals:

JNJ's Gross Margin contracted slightly from 69.49% to 68.69%. I'm not worried about that. Their Profit Margin has contracted from 21.65% down to 14.87%. This is most likely due to one time issues due to the recalls. I don't like to see the Cash to Debt ratio moving down although they do still have enough cash to cover their long-term debt obligations. The dividend payout ratio is 65% however that is another issue related to the reduced EPS that should be a one time issue.

If you take the average share price given from the 5 models you get a $61.76 meaning that JNJ is overvalued by about 5% at $65 per share. Based on these calculations and the questions about how they will deal with the recall issues and a new CEO I don't feel that JNJ offers good value at this time. While some models say that it's undervalued by as much as 10% I don't think there is enough margin of safety built in right now.

DCF Valuation:

Using a discount rate of 10% the stock is currently overvalued by about 17%. Assuming that EPS will grow 5.70% per year for the next 5 years and terminally at 3%. If you use the discount rate based off the so-called "risk free" rate of the 10 yr treasury then the numbers are skewed since the current rate is around 2%. Since I feel that you should still take this into account since that would be the most conservative that you could get, I ran the numbers based off a 8% discount rate. Using a 8% discount rate then JNJ becomes undervalued by about 11%.

Dividend Discount Model:

For my DDM analysis I assume a discount rate that is 75% of the rate that I use for the DCF. So using a 10% DCF rate gives a 7.5% DDM rate. Assuming that JNJ can grow dividends at 6.64% for the next 5 years and 3% terminally, JNJ is currently overvalued by about 15%, giving a target price of $56.36. Running the numbers based off the 8% DCF rate you arrive at JNJ being undervalued by about 11% with a target price of $73.26. These calculations are highly dependent on the inputs.

Graham Number:

We'll add Mr. Benjamin Graham's number which is the square root of 22.5 * TTM EPS * BVPS. The Graham Number gives a fair price of $40.56 meaning that JNJ is currently overvalued by about 60%.

Avg. High Dividend Yield:

The average high dividend yield for the past 10 years is 3.11%, while JNJ has a current dividend yield of 3.50%. This means that shares are currently undervalued by about 17%. Theoretically the average high yield for the previous 10 years should be the approximate high yield that you will get during any given year. I think these numbers are skewed to give a higher target price based on the abnormally low yields earlier in the 2000's thanks to the overexuberance of the stock market at the time.

Avg: Low P/E:

The average low PE over the past 10 years is 15.29 and the current TTM PE is 18.62 with a Foward PE of 11.97. Much like the average high dividend yield, I feel that these numbers are skewed thanks to the overvaluation of the market in general in the early 2000's. JNJ was trading at an average low PE of 25.67 between 2001 and 2005. This has a big effect on the 10 year average low PE. The last 5 year PE is 13.52 compared to the 15.29 for the 10 year average.

Fundamentals:

JNJ's Gross Margin contracted slightly from 69.49% to 68.69%. I'm not worried about that. Their Profit Margin has contracted from 21.65% down to 14.87%. This is most likely due to one time issues due to the recalls. I don't like to see the Cash to Debt ratio moving down although they do still have enough cash to cover their long-term debt obligations. The dividend payout ratio is 65% however that is another issue related to the reduced EPS that should be a one time issue.

If you take the average share price given from the 5 models you get a $61.76 meaning that JNJ is overvalued by about 5% at $65 per share. Based on these calculations and the questions about how they will deal with the recall issues and a new CEO I don't feel that JNJ offers good value at this time. While some models say that it's undervalued by as much as 10% I don't think there is enough margin of safety built in right now.

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