Recent Buy - Rollover IRA (4)
Contrast that with the core dividend growth investing approach which is some combination of buy, hold, collect, reinvest and monitor once a quarter, semi-annually or annually. That's much less of a time commitment and frees up a lot of mental energy.
As such I've backed off on my options trading and have converted a good portion of the portfolio as more of a "classic" dividend growth portfolio. I also began reporting my dividends for the portfolio since it's adopted the same approach, for the most part, of my FI Portfolio. That doesn't mean I won't trade options, but the pace and intensity is backed way down.
I kicked off September with 2 purchases in the health care sector. Neither one of these purchases was large, by any means, or even all that cheap. So why buy shares? Well I was reading the comment stream on an article on Seeking Alpha and it really kind of stuck with me.
"I have seen too many portfolios where people's best performers were small in size and they didn't take advantage of the company's out-performance. Ask them why and they say the company was always overvalued. No it wasn't! It was simply selling at a premium, a premium that was justified due to the company's performance." - ChowderThat's something that I've come to realize in my nearly 8 years of dividend growth investing. The smaller your purchases the less importance that needs to be paid to valuation and the more importance that needs to be placed on quality.
That doesn't mean that valuation shouldn't play a role in your purchase decision and we should still be after "reasonable" valuations; however, I think "hitching your wagon" to great companies is more important over the long term.
I covered the first purchase, Becton, Dickinson & Company (BDX) last week and will cover the other purchase today. On September 3rd I began a stake in Stryker Corporation (SYK) within my Rollover IRA. The position in new to my Rollover IRA although I've owned shares in this great business for several years now in one of my other portfolios.
I bought 5 shares of Stryker for $217.50 per share. After commission the total cost basis for the position comes to $1,092.45 or $218.49 per share.
Stryker is a Dividend Champion with 26 consecutive years of dividend growth. Based on the current quarterly payout of $0.52 per share the shares will provide $10.40 in dividends over the next year and carry a YOC of 0.95%.
Due to this purchase my Rollover IRA's forward 12-month dividends increased to $2,189.24 .
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. Stryker has consistently rewarded shareholders with pay raises.
**Stryker paid annual dividends through 2009 and began quarterly dividends in 2010
Stryker's dividend growth streak dates back to 1994 and now sits at 26 years.
Of the 25 1-year periods during Stryker's dividend growth streak, annual dividend growth has ranged from 8.3% to 117.4%. The average annual dividend growth rate works out to 26.6% with a median of 18.1%.
Of the 16 rolling 10-year periods of Stryker's streak annualized dividend growth is extremely impressive. Annualized dividend growth over a 10-year period has ranged from 17.9% to 37.4% with an average of 28.8% and a median of 30.7%. That's incredible growth for an extended period of time.
The 1-, 3-, 5- and 10-year rolling dividend growth rates since 1994 can be found in the chart below.
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.
Stryker's 5 year moving average dividend yield is 1.27%. Based on the current annual dividend of $2.08 the share price would need to decline to ~$164 to give that starting dividend yield. Since these shares were purchased at a 0.95% dividend yield that suggests roughly 25% downside potential.
The fair value range based on dividend yield theory is between $148-$183. Although Stryker is due for a dividend increase in December. Assuming a $0.05 increase, 9.6% raise, up to $0.57 per share per quarter the fair value range would rise to $163-$200.
That's in the ballpark of my stock analysis on Stryker where I pegged a fair price in the $169-$205 range.
I've started using enterprise value when looking at multiples for companies rather than just the market cap. The concept is the same, but enterprise value accounts for the debt that a company carries and backs out the cash on the balance sheet. In other words, using enterprise value multiples will reward strong balance sheets and cash rich companies with lower multiples than companies that carry high debt loads.
Stryker doesn't look all that cheap here using enterprise value multiples, but I knew that going into the position and this is just a starter lot of shares to get exposure to a high quality company with every intention to make larger purchases on any sell offs.
Using TTM data, the EV/EBIT multiple is 26.9x or a 3.7% EBIT yield. The EV/EBITDA multiple is 21.8x or a 4.6% EBITDA yield. Likewise, the EV/FCF multiple is 45.8x or just a 2.2% FCF yield.
Looking at more traditional valuation multiples Stryker looks better, but is still not a screaming buy by any means. Over the TTM, Stryker has earnings of $9.34 per share and estimates for FY 2019 are for $8.21 with FY 2020's estimates at $9.01. That puts the P/E multiples at 23.4x, 26.6x and 24.2x, respectively.
The dividend is well covered by earnings and free cash flow. Using FY 2019 and FY 2020's estimates and the current annual dividend rate of $2.08 per share the payout ratios stand at 25.3% and 23.1%, respectively. Over the TTM Stryker's free cash flow payout ratio is 38.8%.
Over the next 5 years analysts expect Stryker to show earnings growth of 10.4%. Assuming that comes to pass the estimated annual returns based on my purchase price are 11.3% before accounting for valuation changes.
Much like my purchase of Becton, Dickinson, this purchase wasn't my best value purchase by any means. That being said I think it's a reasonable place to purchase shares in an excellent company as long as you're focused on the truly long term investment prospects.
My ultimate goal is to build up my investment in Stryker with a rough target of $7.5k to $10k of capital invested. This purchase gets me between 11-15% of the way there.
With the ultimate goal in mind I was fine paying up for what I deem to be a very high quality business. I'll be looking to add another chunk of shares in the $190-$200 range, ~10% below my purchase price, and add more with each additional 5% drop.
I fully realize that an opportunity such as that could take a while to present itself. But I wanted to have a stake in Stryker even if it's started on the high end of fair value.
I've started compiling the dividend history, growth rates and dividend yield theory for many dividend growth companies. The Stryker'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 Stryker? How do you balance the decision to purchase high quality companies at elevated valuations?