Recent Buy (13)

Purchases for my FI Portfolio have been few and far between the last few years.  That's not for lack of opportunities or desire rather it had to do with our lives being on a roller coaster.  However, there's a light at the end of the tunnel as our main goal for this year is to get rid of all non-mortgage debt and then refocus our energy towards building up the portfolio.  

We aren't contributing fresh capital to our investments just yet as we're focused on getting rid of our non-mortgage debt.  However, that doesn't mean that we're not able to make new purchases thanks to the dividends that keep rolling in from our other positions and some sales that we've made.  Although I'm hopeful to start making at least one regular purchase each month starting in September!

One of my goals for my FI Portfolio for 2019 is to build up the positions rather than build out the number of positions.  Essentially I want to increase my exposure to the companies that I own instead of many smaller positions that make it hard to be motivated to monitor the company.  With the dividend growth strategy I still think it's fine since the bulk of the work is done upfront; however, I still think that in general the less the better.

The downturn in the markets to start August has started to unlock some value.  I've already made 3 purchases this month, Pfizer (PFE), Altria (MO), and 3M (MMM) and on August 15th I made a 4th.  I purchased an additional 22 shares of Cisco Systems (CSCO) for $46.25 per share.  The total cost basis, including commissions, for this lot came to $1,022.45 or $46.48 per share.

Cisco is a Dividend Challenger with 8 consecutive years of dividend growth.  Based on the current quarterly dividend rate of $0.35 per share the YOC for this position is 3.01% and I can expect to receive $30.80 in annual dividends barring any future increases.

I now own 42.246 shares of Cisco after first initiating a position in February.  The average per share cost basis for my position is $47.97 and the entire position carries a YOC of 2.92%.  My Cisco shares can be expected to produce $59.14 in annual dividends. 

The catalyst for the purchase was Cisco's share price dropping over 12% from August 13th's close to intra-day trading August 15th after earnings were released.  I happened to bottom tick that purchase exactly, which rarely happens and isn't something I aim for, but it's fun to see that every once in a while.



Due to this purchase my FI Portfolio's forward 12-month dividends increased to $7,307.05.

Dividends

As a dividend growth investor any potential investment must Jerry Maguire me, i.e. "SHOW ME THE MONEEEEEEYYYY!!!!".  I judge that based on a company's history of both paying and growing dividends to shareholders.  Cisco is still in the early stages of its dividend history after just initiating a dividend back in 2011.  That being said the streak has been pushed up to 8 years which is a good start.
 

*A full screen version can be found here.

While Cisco's dividend growth streak isn't the lengthiest out there, they've more than made up for it with rapid growth.  I don't expect 20% annual dividend growth to be the norm moving forward; however, I do think 5-10% can be achieved.

The 1-, 3- and 5-year rolling dividend growth rates since 2012 can be found in the chart below.  

*A full screen version can be found here.

Valuation

One valuation method that I like to use is dividend yield theory.  The idea behind dividend yield theory is that large, stable companies will see their dividend yields revert to their mean over time.  So when the yield is higher than "average", shares are undervalued and when it's lower than "average", shares are overvalued.

*A full screen version of this chart can be found here.

As you can see in the above graph, my YOC of 3.01% isn't the highest that shares of Cisco have offered over the last 5 years but I do think it's in the realm of fair value.  

The current 5-year moving average dividend yield sits at 3.15%.  In order for Cisco to offer that dividend yield the share price would have to decrease to $44 or roughly 4% lower from my purchase price.  

Based on a quick and dirty Gordon Growth Model calculation Cisco needs to grow the dividend at 6.78% per year in order to generate 10% annual returns which I believe is achievable for Cisco over the long term.

When looking at valuation multiples shares of Cisco look a lot more attractive.  Based on my purchase price of $46.48 the TTM P/E ratio is at 16.2x.  Using analyst estimates for the current year, FY 2020, the P/E ratio is at 13.9x while the next year, FY 2021, is just 13.0x.

I've also started looking at multiples using enterprise value.  The reason I like using enterprise value is that it encapsulates purchasing the entire business, both the equity and the debt net of cash.  I think this better encapsulates the true cost to own the business.  Using EV/EBIT, Joel Greenblatt's Magic Formula valuation metric, Cisco is trading at a 13.7x EV/EBIT multiple or a 7.3% EBIT yield.  Looking at EV/EBITDA it's 12.1x or 8.3% EBITDA yield.

My preferred EV multiple is the EV/FCF.  Cisco looks attractive on a free cash flow basis as well with just a 13.2x EV/FCF ratio or a 7.6% FCF yield.  In other words, before accounting for a premium to buy the entire business and assuming that free cash flow would remain consistent then you would generate a 7.6% annual cash return.

Conclusion

In April when I updated my valuation on Cisco I pegged the upper $40's as an attractive entry point on Cisco with a fair value in the low $60's.  Of course at the time the expected earnings growth was substantially higher, but as the trade war has continued and recession fears have grown, earnings growth expectations have come down as well.

My attractive entry point on Cisco has come down with the growth expectations and now sits right around the $46 area with a fair value between $55-$60.  That implies somewhere around 18-30% upside potential.

We've made some good headway on the debt reduction and one of the car loans will be paid off either before the end of August or sometime in September.  Once that car loan is gone the current plan is to transfer enough savings each month to make one purchase, ~$1k, with the remaining cash flow going to debt reduction and building up our cash reserves.  So needless to say I'm pretty excited about what the remainder of 2019 can bring.

I've started compiling the dividend history, growth rates and dividend yield theory for many dividend growth companies.  Cisco's can be found here and the remaining companies that I've already gathered the data on can be found here.  As new companies are added the list will be updated.

What do you think of my purchase of Cisco?  Did you add any shares on the earnings related drop?