Kelley Wright's Timely Ten: Investment Quality Trends

02/13/2020 5:00 am EST

Focus: DIVIDEND

Kelley Wright

Managing Editor, Investment Quality Trends

The Timely Ten represents our top ten recommendations from the Undervalued category each month, asserts Kelley Wright, blue chip dividend expert and editor of Investment Quality Trends.

We offer this portfolio for investors who are looking to build a portfolio from scratch, are partially invested and looking to add new positions, or are fully invested and merely in need of some affirmation and hand holding.

Traditionally, when selecting stocks, we look for an S&P Dividends and Earnings Quality Ranking of A- or better; long-term annual dividend growth of 10% over the last twelve years; and a price/earnings ratio (P/E) of 15 or less.

To augment these traditional criterions, we also consider metrics such as 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.

Free cash flow yield (FCFY) is a ratio that compares the free cash flow to the value of the business. Most investors are familiar with the P/E Ratio, which is the price of the stock divided by the earnings of the company. With the way that earnings are calculated and reported, however, P/E’s are a questionable measure of value.

Our belief is the FCFY, which is the FCF 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. Understanding this tendency gives us the opportunity find value where the Street does not, however.

To keep this short and simple, a PVR of 1.0 indicates the Street is valuing the future growth to remain on par with the company’s historical average. Each tenth (0.1) is a ten percent change in that assessment.

For example, a PVR of 0.9 indicates the Street is valuing the future growth prospects of the company at a 10% discount from the company’s historical average — forever.

A PVR of 1.1 indicates the Street is valuing the future growth prospects of the company at a 10% increase from the historical average — forever. We look for a PVR between 0 and 1.6, with the lower the number the better.

Here are our current Timely Ten stock recommendations:

Comerica (CMA) — yielding 3.90%
Wells Fargo (WFC) — yielding 3.91%
Eaton Vance (EV) — yielding 3.15%
M&T Bank (MTB) — yielding 2.64%
Omnicom Group (OMC) — yielding 3.26%
Walgreens Boots Alliance (WBA) — yielding 3.39%s
Simon Property Group (SPG) — yielding 5.78%
UNUM Corp. (UNM) — yielding 3.93%
General Mills (GIS) — yielding 3.69%
Cracker Barrel OCS (CBRL) — yielding 3.28%

Regarding the overall market, monetary policy is still accommodative on a historical basis. With a divided government, impeachment, and the general election, however, I don’t see Congress getting anything of substance accomplished until after the election, which isn’t necessarily a bad thing.

All bull markets eventually end, but I don’t think this one is finished yet. This is to say that I don’t see a bear market, or a recession, on the horizon. I think a correction or two is unavoidable, perhaps even one with a little bite, but all in all I see fairly clear sailing.

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