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The Timely Ten: Blue Chip Buys with Value and Yield

03/14/2019 5:00 am EST


Kelley Wright

Managing Editor, Investment Quality Trends

Our The Timely Ten list represents our top ten current recommendations from among our universe of undervalued blue chip stocks, explains dividend expert Kelley Wright, editor of the industry-leading advisory service, Investment Quality Trends.

Short of utilizing the personal investment management services of our sister company, IQ Trends Private Client Asset Management, this is as close to real time advice you can get. Traditionally we have suggested the following criterions for subscribers to consider in their investment considerations:

• An S&P Dividends and Earnings Quality Ranking of A- or better

• A “Growth” designation for outstanding longterm annual dividend growth of 10% over the last twelve years
• A price/earnings ratio (P/E) of 15 or less

• A payout ratio (percentage of earnings paid out as a dividend) of 50% or less (75% for Utilities)

• A debt level of 50% or less (75% for Utilities)

Historically, investors that have relied solely on these criterions in their stock selection process have been handsomely rewarded over time.

The only critique is that some stocks remain in the Undervalued area for a significant amount of time before they begin to demonstrate price appreciation. For the investor with a long-term investment time-horizon this is not an issue, as they are getting paid to wait from consistent dividend payments and dividend increases.

For the investor with a shorter-term investment time-horizon, the discipline and patience required to let the full value of a company be expressed in its stock price may prove too difficult, and result in them abandoning this time-proven strategy, which is unfortunate.

There are multifaceted explanations/reasons for why a stock may remain in the Undervalued area for an extended period.

In our experience, although a company may offer excellent current value in terms of its dividend yield, its internal economic measures may not be sufficiently attractive for current buying interest, thus the high dividend yield and the extended period in the Undervalued category.

To augment the traditional criterions above, and to identify those Undervalued stocks that also have excellent internal economic measures, in March, 2016, we introduced metrics to The Timely Ten we use at Private Client to construct portfolios for managed accounts.

These metrics are: Return on Invested Capital (ROIC), Free Cash Flow Yield (FCFY) and Price to Value Ratio (PVR). Return on invested capital (ROIC) measures how much profit a company generates for every dollar invested in the company.

Our belief is it is the truest measure of a company’s cash on cash returns. As such, we are interested in companies that produce a lot of cash from their investments in the company because this is where profits, and therefore dividends, come from. We like an ROIC of at least 10%.

Free cash flow (FCF) is the amount of cash that remains after everything has been paid, all new investments have been made, and is available for distributing to all the equity shareholders. In the old days, we used to call this “profits.”

As with many fundamental measures, investors tend to believe that “more is good, but less is not.” With free cash flow this isn’t always the case, however. A large amount of free cash flow may indicate the company can’t find sufficient opportunities for new investment(s), which can limit future growth prospects.

Negative free cash flow, on the other hand, could indicate that the company has an abundance of investment opportunities but not enough internal cash flow to pursue all of them. A flat or zero level of free cash flow could be a sign that the company is generating just enough cash to fund its growth opportunities.

With the way that earnings are calculated and reported, however, P/E’s are a questionable measure of value. Our belief is the free cash flow yield (FCFY), which is the free cash flow divided by the adjusted enterprise value of the company, gives much greater insight to a company’s value than does the P/E ratio.

We look for an FCFY of at least 5%. Price to Value Ratio (PVR) is a measure of how the market is valuing the future growth prospects of a company. In our experience the Street tends to extrapolate the present into the future, forever, which is just plain silly.

Here are our current Timely Ten:

AbbVie (ABBV) — yielding 5.39%
Philip Morris International (PM) — yielding 5.23%
Eaton Vance (EV) — yielding 3.31%
JP Morgan Chase (JPM) — yielding 3.04%
International Business Machines (IBM) — yielding 4.51%
Lockheed Martin (LMT) — yielding 2.86%
Omnicom Group (OMC) — yielding 3.45%
Home Depot (HD) — yielding 2.96%
Raymond James (RJF) 1.62%
PepsiCo (PEP) — yielding 3.22%

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