Recent Buy - Rollover IRA (6)

Back in March I decided to largely forgo the options trading strategy that I had been employing in my Rollover IRA.  It's not that it wasn't profitable, rather it was a decision based more on efficiency and effort.  When I was actively trading options, primarily around dividend growth stocks, I was constantly having to look for new ideas and manage existing positions and frankly it just took a lot of time.


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.

Well, I just couldn't help myself and made another small purchase for my Rollover IRA.  The company might have some negative associations with it, but they produce and manufacture critical elements that just about every country in the world needs: defense.  

I purchased 3 shares of Lockheed Martin (LMT) in my Rollover IRA at $389.00 per share.  After commissions the total cost basis came to $1,171.95 or $390.65 per share.  

Lockheed Martin is a Dividend Contender with 16 consecutive years of dividend growth.  Based on the current quarterly payout of $2.20 per share these shares will provide $26.40 in dividends over the next year and carry a YOC of 2.25%.  
  



Due to this purchase my Rollover IRA's forward 12-month dividends increased to $2,228.74.

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.  Lockheed doesn't have the best dividend history, as there was a cut back in 2000; however, every year starting in 2002 dividend growth has been there.
 

*A full screen version can be found here.

Of the 16 1-year periods during Lockheed's dividend growth streak, annual dividend growth has ranged from 9.9% to 56.9%.  The average annual dividend growth has come in at 20.6% with a median of 16.5%.

Of the 12 rolling 5-year periods annualized dividend growth has been equally impressive.  It's ranged from 11.4% to 27.3% with an average of 19.7% and a median of 20.5%.

The 1-, 3-, 5- and 10-year rolling dividend growth rates since 2003 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.

Lockheed's 5 year moving average dividend yield is 2.78%.  With a current annual dividend of $8.80 per share, dividend yield theory suggests that a fair price for Lockheed would be around $316.  My purchase price of $390.65 suggests ~19% downside to the average yield.  

The fair value range based on dividend yield theory is between $287 and $352.  At a current price in the $390 area that suggests that shares are still overvalued between 10%-26%.  

Based on Lockheed's history a dividend increase announcement should be coming before the end of the month.  Assuming a 10% increase to a quarterly payout of $2.42 per share that annualizes to $9.68 then the fair value range would necessarily rise.  At that dividend payout the fair value range based on dividend yield theory would increase to $316-$387.  

That's in the ballpark of my stock analysis on Lockheed Martin where I pegged a fair price in the $360-$430 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.

Using enterprise value multiples based on TTM data Lockheed is a bit of a mixed bag.  The EV/EBIT multiple is 15.4x, while the EV/EBITDA multiple is 13.6x.  The EV/FCF is quite high at 27.0x.

Looking at more traditional valuation multiples, Lockheed looks much better.  The TTM P/E sits at 19.0x.  Based on analyst estimates for 2019 and 2020 of $21.21 and $25.36, respectively, the corresponding P/E ratios at 18.4x and 15.4x.

Over the next 5 years analysts expect Lockheed to show earnings growth of 14.5%.  Assuming that comes to pass the estimated annual returns based on my purchase price are 17.0% before accounting for valuation changes.

Conclusion

The last 3 purchases for my Rollover IRA fell more into the high quality, good growth, but a premium valuation.  I didn't have much issue with that as the purchases were small and the plan is to ultimately build up the position over time.

However, I believe this purchase falls is at a much better valuation.  A TTM P/E of just 19.0x, current year P/E of 18.4x and next year P/E of 15.4x is pretty dang attractive assuming that Lockheed can manage the 14.5% annual growth that's expected.  The starting yield is a bit smaller than I'd like, but it's a decent level and the soon to be announced dividend increase will help to remedy that some.

While I believe the valuation is pretty attractive, it still relies on a lot of growth to come to fruition.  That's why I decided to make just a small purchase at this time with the plan being to add on any significant pullbacks.  Ultimately I'd like to invest between $5-$10k in Lockheed Martin and see where things go.

I've started compiling the dividend history, growth rates and dividend yield theory for many dividend growth companies.  The Lockheed Martin'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 Lockheed Martin?  Are there any industries or sectors that you just can't bring yourself to invest in?