Due to reader requests, I’ve decided to break up my weekly “Best Dividend Stocks To Buy This Week” series into two parts.

One will be the weekly watch list article (with the best ideas for new money at any given time). The other will be a portfolio update.

To also make those more digestible, I’m breaking out the intro for the weekly series into a revised introduction and reference article on the 3 rules for using margin safely and profitably (which will no longer be included in those future articles).

To minimize reader confusion, I will be providing portfolio updates on a rotating tri-weekly schedule. This means an update every three weeks on:

My retirement portfolio (where I keep 100% of my life savings)
The Best Dividend Aristocrats And Kings To Buy In November
My “What I’m Buying Next” series, which explains what companies are on my immediate buy watch list, from which I make all weekly retirement portfolio buys.
The Market Continues To Steadily Climb A Wall Of Worry
Remember the May trade conflict pullback? When rising trade uncertainty and recession fears caused the S&P 500 to fall 6% in a month?

This Is What Market Fear Looks Like

Trade sensitive tech stocks got gutted. But, as I and so many long-term analysts point out, volatility is the best friend of anyone who can keep their head when others are losing theirs.

We’ve averaged a 5% to 9.9% pullback every six months since 1945 and also during the longest bull market in history.

What “Greedy When Others Are Fearful” Can Do

The S&P 500 is now up 6 straight weeks and 14.5% since it’s the May trade war pullback. Trade sensitive tech names like Apple (NASDAQ:AAPL) are up a stunning 53% and some are now grossly overvalued.

Why are stocks climbing their Wall of Worry as they have always done?

White House Economic Advisor Larry Kudlow is saying we’re in the final stages of a phase one trade deal (expected in December).
Fed Chairman Powell testified before congress that the risk of recession is very low, but tame inflation will let the Fed hold back on rate hikes for the foreseeable future.
Earnings season was better than expected (companies historically beat earnings 72% of the time by about 3% to 4%) – this quarter 75% of companies beat expectations by an average of 3.9%.
However, investors shouldn’t get too euphoric.

Valuations Are Stretched, And Pullback Risk Is Elevated

We may avoid a recession, but the New York Fed is estimating that US economic growth in Q4 is down to 0.4%.

The Atlanta Fed’s real-time economic model is even more pessimistic, estimating just 0.3% growth in Q4.

The nowcasts of fourth-quarter real personal consumption expenditures growth and fourth-quarter real gross private domestic investment growth decreased from 2.1 percent and -2.3 percent, respectively, to 1.7 percent and -4.4 percent, respectively.”

The good news is that the overall blue chip economist consensus is still for 1.5% GDP growth in 2020, despite a dip to 1.3% in Q1.

That’s the slowest growth rate in any year since 2009, but still not a recession.

However, slowing global and US growth has caused earnings growth expectations to fall steadily all year.

This year’s consensus growth EPS growth rate on the S&P 500 is now 0.0% according to FactSet’s John Butters.

What does that mean for stocks? That valuations are getting rather lofty.

The 25-year average forward PE on the S&P 500, which I consider a reasonable proxy for fair value, is 16.2. We’re now at 18.0, about 10% historically overvalued.

Investor sentiment, as measured by the seven technical indicators of CNN’s fear and greed index, is now extremely elevated and verging on euphoria.

Does that mean a December style crash is coming soon? Not at all. Notice how, in 2017, the greed index was even higher and fluctuated wildly. From November 2016 to January 2018, the stock market rose 14 consecutive months, and the peak decline was 2.5%.

Valuations and broader market sentiment can only tell us when pullback/correction risk is elevated, not when the next downturn will begin, or how bad it will be.

Historically speaking, a 5% to 9.9% pullback is likely to start by the end of April, and current valuations and corporate earnings fundamentals support the notion that within about five months a normal and healthy pullback will commence.

The average pullback lasts one month and sees stocks fall 7% from their peak. That’s exactly what happened in May.

But guess what? As my fellow Dividend King Chuck Carnevale likes to say “it’s a market of stocks, not a stock market.” On Nov. 12, no less than 77 S&P 500 companies, 15.4% of index constituents, were trading in a bear market.

Something good is always on sale which is why my retirement portfolio is buying quality dividend growth names every single week, no matter what the broader market is doing.

The Dividend Kings’ Approach To Valuing And Recommending Stocks
See this article for an in-depth explanation of how and why the Dividend Kings value companies and estimate realistic 5-year CAGR total return potentials.

In summary, here is what our valuation model is built on:

5-year average yield
13-year median yield
25-year average yield
10-year average P/E ratio
10-year average P/Owner Earnings (Buffett’s version of FCF)
10-year average price/operating cash flow (FFO for REITs)
10-year average price/free cash flow
10-year average price/EBITDA
10-year average price/EBIT
10-year average Enterprise Value/EBITDA (factors in debt)
These metrics represent pretty much every company fundamental on which intrinsic value is based. Not every company can be usefully analyzed by each one (for example, EPS is meaningless for REITs, MLPs, yieldCos, and most LPs). But the idea is that each industry appropriate metric will give you an objective idea of what people have been willing to pay for a company.

I line up the expected and realistic growth rates of companies with time horizons of similar growth, thus minimizing the risk of “this time being different” and overestimating the intrinsic value of a company.

I maintain 9 total valuation lists, covering:

48 level 11/11 quality Super SWANs (the best dividend stocks in America which collectively have tripled the market’s annual returns over the past 25 years)
All the Dividend Kings
All the Dividend Aristocrats
All safe (level 8+ quality) midstream MLPs and C-corps
All DK model portfolio holdings
Our Top Weekly Buy List
Our Master Valuation/Total Return Potential List (279 companies and counting)
It’s from these lists that I present four potentially excellent long-term dividend growth opportunities that smart investors can buy, despite the currently elevated market multiples and short-term pullback risk.

4 Great Dividend Stocks Smart Investors Can Buy At Record Market Highs
Each of these companies is owned in one or more of the Dividend Kings’ model portfolios (High-Yield Blue Chip, Deep Value Blue Chip, Fortress and our $1 Million retirement portfolio).

(Sources: F.A.S.T. Graphs, FactSet Research, Reuters’, YCharts, Dividend Kings Master Valuation List, management guidance, analyst consensus, Gordon Dividend Growth Model)

General Dynamics: A Reasonably Priced Fast-Growing Dividend Aristocrat

General Dynamics is a Dividend Kings’ Fortress portfolio (100% 11/11 quality Super SWANs) holding.

Today, it’s not a deep value stock, merely trading at a reasonable price, especially considering its expected growth rate.

2018 actual: 13% growth
2019 FactSet consensus estimate: 6%
2020 consensus growth: 9%
2021 consensus growth: 10%
2022 consensus growth: 11%
GD is about 5% undervalued for 2020’s expected results, and this dividend aristocrat (28-year payout growth streak) has a strong overall growth profile courtesy of recent contract wins with the DoD, and ramp-up of its redesigned Gulfstream G500 and G600 private jets.

FactSet long-term growth consensus: 8.9% CAGR
Reuters’ 5-Year CAGR growth consensus: 8.3% CAGR
YCharts long-term growth consensus: 8.9% CAGR
Historical Growth Rate: 9.9% CAGR over 20 years (6% to 14% CAGR rolling growth rates)
Realistic Growth Range: 6% to 10% CAGR
Historical Fair Value: 14 to 17 PE
If General Dynamics grows at the low end of its growth range and trades at the low end of fair value, then it should still deliver at least 5% CAGR total returns.

Sounds pretty awful right? Not when you consider that most asset managers expect the S&P 500 to deliver 3% to 7% CAGR total returns…possibly over the next 15 years (Dividend Kings estimates 6% to 6.5% annual market returns).

And that’s just the conservative long-term return estimate. Here is the Dividend Kings’ base case forecast for General Dynamics.

Our base case forecast is using GD’s mid-range 15.5 PE and FactSet’s long-term 8.9% consensus growth rate. That shows GD is very capable of 11% CAGR total returns.

The upper end of realistic return potential is generated by 10% growth and a return to the upper end of fair value PE (17).

Today’s investor can realistically expect GD to potentially double their investment over the next half-decade, in a best-case-scenario.

Fortress targets long-term double-digit returns but only with companies that meet our portfolio goals.

GD offers a slightly higher yield (by 0.4%), faster long-term growth (S&P 500 earnings and dividends grow at 6% to 6.5% over time) and is likely to not just crush the market’s returns in the next five years, but also beat the S&P 500’s 9.1% CAGR historical total return.

In an overvalued market, a fast-growing Super SWAN quality dividend aristocrat that’s trading at a reasonable price makes for a potentially attractive investment.

MPLX: The Safest 11+% Yield You Can Buy Today

Wall Street Has Literally Never Been More Bearish On MLPS

MPLX is owned in three Dividend Kings portfolios and represents about 4.7% of my retirement portfolio. I have room under my risk cap (6%) and industry cap (16%) to keep buying a bit more, locking in the best valuations in MPLX history.

MLPs, even 11/11 quality Super SWANs like Enterprise Products Partners (EPD), have been gored over the past two months. The industry has fallen for eight consecutive weeks and 15 of the last 17.

That has literally never happened before, not during the Financial Crisis, and not during the darkest days of the 2014 to 2016 oil crash when oil plunged 77% to $26.

Is oil crashing? No, it’s $57, with most large producers having break-even costs of $40 or less.

Is oil production shrinking? No, the US Energy Information Administration’s latest forecast estimates that US crude production will increase 1 million bpd next year, and oil prices will average $55, basically where it is now.

What about natural gas? The EIA estimates gas production will grow next year to another record high with gas prices averaging about $2.50, the breakeven level for most big gas producers.

Meanwhile, the International Energy Agency just reported that global oil demand in October more than doubled from September to 1.1 million bpd YOY. By 2030 the IEA estimates that declining production from legacy wells will drive crude to $90.

What about MPLX itself? Is the distribution at risk of a cut?

Cash flow is still soaring, thanks to the ANDX acquisition. Cash flow, according to FactSet consensus is for 42% growth in 2019 and 25% in 2020.

Distribution coverage is rising steadily, from 1.36 in Q2 to 1.42 in Q3 and YTD coverage was 1.54 (65% DCF payout ratio). For context, 1.2 coverage or 80% payout ratio is safe for self-funding MLPs like MPLX.

Leverage is at a very safe 4.0, within management’s target range of 4.0 or less. 5.0 or less is safe according to credit rating agencies who rate MPLX BBB or the Moody’s equivalent.

Maybe MPLX itself has run out of growth runway? $2 billion in capex spending this year and $2 billion next year is enough to drive 3% organic growth. Buybacks at super accretive rates (16.5% DCF yield) can get MPLX to slightly faster growth.

In fact, here’s MPLX’s growth profile.

FactSet long-term growth consensus: 4.0% CAGR
Reuters’ 5-Year CAGR growth consensus: 5.1% CAGR
YCharts long-term growth consensus: 4.0% CAGR
Historical Growth Rate: 12.6% CAGR over 7 years
Realistic Growth Range: 3% to 5%
Historical Fair Value: 7 to 9 times EBITDA
MPLX is such an anti-bubble stock that even if the current insane valuation never improved and it didn’t grow at all…ever, you’d still make 11.6% annual total returns from the well covered and still growing distribution (27 quarterly hikes in a row).

In reality, MPLX is likely to grow at a modest pace, purely from organic growth and future buybacks. If it grows 1% slower than any analyst consensus estimate ($2 billion in annual capex would achieve this), then MPLX could easily double your investment over the next five years.

That’s even if the valuation only returns to the low end of its historical range, which was created in the worst MLP bear market in history.

For the record, the Ben Graham fair value formula estimates MPLX’s fair value at 8.8 times EBITDA, which is the upper end of its own fair value range.

If MPLX grows at the upper end of its growth range and merely trades near the upper end of historical fair value, it could nearly triple your money over the next five years.

Prudential: A Great Deep Value Financial Set To Soar If We Avoid Recession

Prudential is a Dividend Kings’ Deep Value Portfolio holding. We bought it at about $92 and still consider it a great long-term opportunistic buy today.

Like many insurance companies, PRU has been hurt by this year’s crashing interest rates and rising recession scare (fears that rates would fall even lower or even go negative).

However, according to the bond market and the Cleveland Fed/Haver Analytics model 12-month recession risk is down to 27% from 48% at the start of September.

Core inflation is firming up and the job market remains strong, driving slow but steady gains in wages. Fed Chairman Powell recently testified before Congress that, while the Fed won’t be hiking rates anytime soon, they are done cutting, given the low risk of recession. Specifically, Powell told Congress that he doesn’t “feel that the probability of recession is at all elevated.”

That is a solid backdrop for deeply undervalued Prudential to do well in the coming years when the 18 analysts that cover the company expect earnings growth to accelerate.

2018 actual growth: 10%
2019 FactSet consensus growth: 2%
2020 consensus growth: 5%
2021 consensus growth: 10%
More importantly, despite a persistently low rate environment (by historical standards), Prudential’s long-term growth profile appears solid.

FactSet long-term growth consensus: 9.0% CAGR
Reuters’ 5-Year CAGR growth consensus: 6.9% CAGR
YCharts long-term growth consensus: 7.7% CAGR
Historical Growth Rate: 12.5% CAGR (rolling growth rates 14% to 16% CAGR)
Realistic Growth Range: 5% to 10% CAGR
Historical Fair Value: 9 to 11 PE

Even if Prudential only grows at the low end of its growth potential and returns to the low end of fair value, it’s still likely to deliver double-digit long-term returns. That’s the power of a safe 4% yield and a forward PE of 7.4, which bakes in about -2% CAGR long-term growth forever, according to the Ben Graham fair value formula.

Dividend Kings’ Deep Value portfolio targets 15+% long-term total returns by investing in above-average quality companies when they are deeply out of favor.

PRU growing at the upper end of its realistic growth range and merely returning to the higher end of its normal 9 to 11 PE range could potentially deliver 22% CAGR total returns and nearly triple your investment over five years.

CVS Health: This Defensives Wall Street Darling Has Plenty Of Room To Run

CVS is one of Dividend Kings’ Deep Value and High-Yield Blue Chip Portfolio’s biggest winners. Our cost basis is $55 and in my retirement portfolio, my cost basis is $53.

Behold The Power Of Quality Deep Value Investing

The CVS bears have finally been silenced, with CVS now becoming a Wall Street darling once more. This comes as no surprise to any students of Graham, Dodd, or the overall Buffett school of value investing.

But guess what? CVS is STILL a great buy today, given how well the Aetna integration is going.

Management is guiding for 10% to 12% long-term growth, starting in 2022 and beyond.

Here’s what the 26 analysts who cover CVS think is likely in the coming years.

2018 actual growth: 20%
2019 consensus growth (based on management guidance): -1%
2020 consensus growth: 2%
2021 consensus growth: 6%
2022 consensus growth: 10%
Analysts believe that management’s growth plan will succeed, even if they don’t believe double-digit growth can be sustained over time.

FactSet long-term growth consensus: 4.9% CAGR
Reuters’ 5-Year CAGR growth consensus: 2.9% CAGR (factors in slower growth in 2019 and 2020)
YCharts long-term growth consensus: 4.1% CAGR
Management Guidance: 10% to 12% CAGR (after 2022)
Historical Growth Rate: 10.9% CAGR over the last 20 years, rolling growth rates 11% to 20%
Realistic Growth Range: 3% to 12%
Historical Fair Value: 14 to 16 PE
Even a company that grows at 3% is worth 14.5 times earnings according to the Graham Fair Value formula built into F.A.S.T Graphs.

For the conservative end of our forecast, we model the company’s own low end of fair value, a PE of 14. Which could still deliver nearly 12% CAGR long-term returns that the S&P 500 has very little chance of achieving, barring a meltup that would invariably lead to bubble valuations and likely a severe correction or bear market.

CVS’s double-digit return potential is purely a function of realistic growth and a PE that’s still in the single digits, even after a 44% rally (its PE bottomed at 7.3 and it was 52% undervalued in April).

What happens if management achieves its double-digit long-term growth guidance? Then, CVS likely and JUSTIFIABLY could return to a 16 PE, which is the upper end of normal for this stock.

More than tripling your investment over five years, even after a 44% rally, is the realistic best-case scenario for CVS. Not because it returns to a bubble valuation as it had when it began its recent bear market (23.1 PE) but merely by management delivering the upper end of growth guidance and the stock returning to the upper end of fair value.

What if none of these stocks appeal to you? That’s where the rest of this article comes in.

So, let’s take a look at a reasonable and methodical way to screening quality dividend stocks for valuation, so you can always make prudent investment decisions that fit your needs.

Morningstar Is A Good (But Not Perfect) Place To Start Looking For Good Ideas
Morningstar is typically (though not always) a good starting location for blue-chip income investing ideas. That’s because they are 100% focused on long-term fundamentals, rather than 12-month price targets like most sell-side analysts (the ones that issue “Buy, Sell, Hold” recommendations). Most of their fair value estimates are reasonable (though not always – more on this in a moment). So, here are all my blue-chip watch list stocks that Morningstar estimates are at least 20% undervalued.

Even with the market near all-time highs, you can see that, at least, according to Morningstar, there are plenty of quality names available at bargain prices. Dividend Kings disagrees with some of these valuations (Imperial Brands (OTCQX:IMBBY) is just 34% undervalued for example), but for the most part, these are quality companies trading at attractive valuations.

But you can’t just look at any one analyst’s fair value estimate and know if it’s a good buy. That’s because every company has its own risk profile, and differing business models mean that a 20% discount to fair value of a highly cyclical company (like commodity producers) isn’t the same for one with very stable and recession-resistant cash flow (like a consumer staples company).

This is where looking at Morningstar’s star ratings is a good next step. These ratings, which correspond to a reasonable buy, good Buy, and Very Strong Buy recommendations, factor in a company’s risk profile, industry trends, management quality, and Morningstar’s definition of “Moatiness” (which I sometimes disagree with but are for the most part on the money when it comes to corporations).

Morningstar’s moat definition is based on their belief that a company can maintain returns on invested capital above its weighted cost of capital (using their assumptions plugged into the CAPM model) for 20 years or longer (wide moat) and 10 years or more (narrow moat). I look for competitive advantages that allow returns on invested capital above the industry norm and above the cash cost of capital (which matters more to the ability to grow dividends over time).

Here are my watch list companies that Morningstar considers 4- or 5-star Buys and Strong Buys.

You’ll note that there are a lot more 4- and 5-star stocks than ones trading 20% or below Morningstar’s estimated fair value. That’s because Morningstar is adjusting for quality, safety, and overall cash flow stability (via their uncertainty ratings).

This is why Chevron (CVX), a 10/11 quality SWAN dividend aristocrat gets a four-star rating from Morningstar despite the analyst estimating it’s just 11% undervalued. Dividend Kings agrees that Chevron is a good buy, but estimate it’s just 7% undervalued right now.

Quality Score (Out of 11) Example Good Buy Discount To Fair Value Strong Buy Discount Very Strong Buy Discount

7 (average quality) AT&T, IBM 20% 30% 40%
8 above-average quality Walgreens, CVS 15% 25% 35%

9 blue chip quality Altria, AbbVie 10% 20% 30%

10 SWAN (sleep well at night) quality Pepsi, Dominion Energy 5% 15% 25%

11 (Super SWAN) – as close to a perfect dividend stock as exists on Wall Street 3M, JNJ, CAT, MSFT, LOW 0% 10% 20%
To me, a Super SWAN dividend king like 3M (NYSE:MMM) is more attractive 20% undervalued than a lower quality company like IBM (NYSE:IBM) that’s 35% undervalued. But at the right price, even an average quality company that has a safe dividend that’s likely to grow at all is a potentially attractive investment, at least for some people’s needs.

However, while a 4- or 5-star Morningstar stock is usually a good long-term investment, it’s important to remember that some of its recommendations can be far off the mark. Dividend Kings uses a 100% pure F.A.S.T. Graphs-powered historical valuation method that only looks at historical and objective data and sometimes disagrees with Morningstar.

Typically, these disagreements are minor. Sometimes, they are not. For example:

Company Morningstar Fair Value Dividend Kings 2019 Historical Fair Value
3M (MMM) $176 $188
Microsoft (MSFT) $155 $100
Apple (AAPL) $220 $167
Nike (NKE) $102 $66
Home Depot (HD) $170 $199
Simon Property Group (SPG) $189 $206
UnitedHealth Group (UNH) $310 $214 in 2019 about $240 in 2020
Merck (MRK) $104 $76
American Water Works $93 $80
(Sources: Morningstar, Dividend Kings valuation/total return potential lists)

Morningstar usually has similar estimates as us for most sectors, but for popular momentum stocks (like many tech names), they often appear to try to justify rich valuations. For example, here are the PE multiples they use to determine fair value for Super SWANs Nike, Microsoft and UnitedHealth.

Nike: 36 PE = Morningstar fair value (historical PE range 22 to 26)
Microsoft: 29 PE = Morningstar fair value (historical PE range 16 to 20)
UnitedHealth: 21 PE = Morningstar fair value (historical PE range 14 to 18)
Home Depot’s fair value estimate of $170 from Morningstar is based on

We are maintaining our fair value estimate of $170 per share after incorporating second-quarter results. This implies a 2019 price/earnings ratio of 16 times and an enterprise value/EBITDA multiple of 12 times. – Morningstar

We don’t disagree that Home Depot is overvalued (by about 19%), but we take issue with the multiples Morningstar is assigning to EBITDA and EV/EBITDA (the acquirer’s multiple used by private equity).

Home Depot is expected to grow 8% to 10% over time, and during the last 13 years, when it’s grown at a similar rate the market-determined that 19 times earnings was fair value for this company. 18 to 21 PE is the company’s fair value range outside of bubbles and bear markets.

16 times PE is not an outlandish multiple, but it ignores the fact that real investors risking real money have determined that Home Depot’s competitive advantages and industry-leading management quality (as seen by its margins and returns on invested capital) are worth a premium.

How can you tell whether Morningstar’s fair value estimates are reasonable or just plain crazy? By looking at objective metrics, like P/E ratios.

Price-To-Earnings Vs. Historical Norm

While no single valuation method is perfect (which is why DK uses 10 of them), a good rule of thumb (from Chuck Carnevale, the SA king of value investing and founder of F.A.S.T. Graphs) is to try not to pay more than 15 times forward earnings for a company. That’s the same rule of thumb that Ben Graham, the father of value investing, considered a reasonable multiple to pay for a quality company.

This is because P/E ratios are the most commonly used valuation metric on Wall Street, and 15.0 P/E being a reasonable price for quality companies is based on Mr. Carnevale’s 50 years of experience in asset management valuing companies. He bases that on an earnings yield of 6.7% (inverse of a 15 P/E) being roughly equal to the 200-year return of the stock market.

Chuck also considers 15 times cash flow to be prudent for most companies, as do all the founding Dividend Kings.

Here are dozens of blue-chip companies with very low forward P/Es and their five-year average P/Es. Note that some industries are naturally prone to lower multiples (such as financials) due to more cyclical earnings. Which is why you want to compare their current P/Es to their historical norms. (Morningstar offers 5-year average P/Es, but 10 years is better for factoring in industry/sector downturns.)

Don’t forget that P/E ratios for MLPs, REITs, and yieldCos are not a good indication of value since high depreciation results in lower EPS. Price/cash flow is a better approach with such pass-through stocks.

Historical P/E and a 15.0 rule of thumb are not perfect. 5-year average P/Es can give a false reading if something extreme happened, like a bubble or industry crash, causing the energy P/E ratio averages to become absurd.

This brings me to another important metric to check: price-to-cash flow, which replaces the P/E ratio for REITs, yieldCos, MLPs/midstreams, and many LPs.

Price-to-Cash Flow Vs. Historical Norm

While earnings are usually what Wall Street obsesses over, it’s actually cash flow that companies run on and use to pay a dividend, repurchase shares, and pay down debt. Thus, the price-to-cash flow ratio can be considered a similar metric to the P/E ratio but a more accurate representation of a company’s value. Chuck Carnevale also considers a 15.0 or smaller price-to-cash flow ratio to be a good rule of thumb for buying quality companies at a fair price. Buying a quality company at a modest-to-great cash flow multiple is a very high-probability long-term strategy.

Again, comparing a company’s price-to-cash flow against its historical norm can tell you whether it’s actually undervalued. Dividend Kings uses 10-year average cash flows, and Morningstar only offers 5-year averages. For cyclical companies, sometimes, that can cause skewed results (which is why we use longer time periods and as many of our 10 valuation metrics as are industry-appropriate).

Here are the companies on my watch list with the lowest price-to-cash flows.

Again, historical price-to-cash flow estimates are not perfect. TerraForm Power (TERP), a level 8/11 quality yieldCo, was run into the ground and nearly bankrupted by its former sponsor SunEdison (which did go bankrupt). Brookfield Asset Management rescued it and turned it into a great high-yield dividend growth stock, which justifies a much higher valuation.

Similarly, fundamentals can deteriorate, such as with discount broker TD Ameritrade (AMTD). Here’s Morningstar’s Michael Wong explaining why the end of commissions could significantly impact AMTD’s future growth.

We are tempering our near- to medium-term outlook for TD Ameritrade’s earnings, given the 2019 cut in commission pricing that lowers recent revenue by 15%-16%, the change in the U.S. interest-rate environment, and potential for a correction in the stock market.” – Morningstar

While thesis breaking events are rare for quality companies (AMTD is a 9/11 quality blue chip) they do sometimes happen. Now in the case of Ameritrade or Super SWAN Charles Schwab (SCHW), the safe dividend growth thesis isn’t broken just weakened.

Dividend Kings estimates AMTD is worth $46 (not Morningstar’s $52) and here’s why.

FactSet long-term growth consensus: 0.9% CAGR
Reuters’ 5-year growth: -6.4% CAGR
YCharts long-term growth consensus: 6.5% CAGR
F.A.S.T. Graphs long-term growth extrapolation: 2.8% CAGR
Historical growth rate: 18.5% CAGR over the last 20 years, rolling growth rates 10% to 59% CAGR
Historical fair value: 18 to 20 PE
Historical analysis doesn’t work well if a company can’t realistically grow at its historical rate.

As you can see there is now a lot of uncertainty surrounding AMTD’s long-term growth rate. It’s likely to keep growing but much slower than its historical double-digit rate. That’s the growth rate that justified a premium 19 or so PE over time.

The Ben Graham fair value formula estimates that a company growing at 2.8% over time is worth 14.1 times earnings. As you can see if AMTD can achieve that long-term growth it could still be a great investment while offering a generous if slowly growing dividend.

BUT if you just blindly assume that it’s going to return to its historical 19 PE, then you might expect 20% CAGR total returns and be rather disappointed.

Dividend Kings harnesses the Graham Fair Value formula built into F.A.S.T Graphs to help us value companies that have impaired future growth relative to their pasts. Those formulas and rules of thumb help us make reasonable and prudent decisions including how to value a company for which historical multiples need to be thrown out the window.

But what if the reverse happens? What if a company significantly improves its business model and accelerates growth? Well, then you also have to take that into account.

PE/Growth Ratio (Growth At A Reasonable Price) And Putting It All Together
According to Chuck Carnevale and Ben Graham, Buffett’s mentor and the father of value investing, a 15 P/E is prudent for most companies, even slow-growing ones. But if a company is able to grow especially fast (over 15% over time), it deserves a higher multiple. That’s because the compounding power of time means a company that grows at a faster rate can generate many times greater wealth and income for you.

How Much Your Money Will Grow Based On Company Growth Rate And Time Period

Long-Term Growth Rate 10 Years 20 Years 30 Years 40 Years 50 Years
5% 1.6 2.7 4.3 7.0 11.5
10% 2.6
17.5 45.3 117.4
15% 4.0 16.4 66.2 267.9 1,084
20% 6.2 38.3 237.4 1,470 9,100
25% 9.3 86.7 807.8 7,523 70,065
30% 13.8 190.0 2,620 36,119 497,929
35% 20.1 404.3 8,129 163,437 3,286,158
40% 28.9 836.7 24,201 70,038 20,248,916
45% 41.1 1,688 69,349 2,849,181 117,057,734
50% 57.7 3,326 191,751 11,057,332 637,621,500

Note that this table is simply meant to illustrate a point. It’s not actually possible for any company to grow 50% annually for 50 years, which would mean earnings and cash flow growing nearly 1 billion-fold (it would have to literally take over the world).

Most investors, depending on their needs (and ideal asset allocation), can likely achieve 5-10% returns over time. Warren Buffett is one of the greatest investors in history, with about 21% CAGR returns over 54 years.

Since 2000, the S&P 500’s earnings growth has been about 6.5% CAGR, which is why a company that can realistically grow much faster may be worth a higher-than-normal P/E (or price-to-cash flow). This is where the PE/Growth or PEG ratio comes in.

While this method is limited by what growth assumptions you use, it’s a quick and dirty way to screen for potentially attractive dividend growth investments when used in conjunction with other methods. The S&P 500’s PEG ratio is currently 2.7 to 3.0 (depending on the growth estimates you use). A PEG of 1.0 or less is generally excellent.

Here are my watch list stocks with PEGs of close to one, as estimated by Morningstar’s forward growth forecast (some of those growth estimates are likely to be proven wrong).

PEG is a good way to strive for “growth at a reasonable price”, or GARP. However, the obvious flaw is that it’s based on forward projections that can be wrong All valuation metrics have their limitations, which is why you shouldn’t rely on just one.

For example, FedEx (FDX) is a great company, trading at a nice discount, which is why Dividend Kings Deep Value portfolio bought it. But it’s PEG is not 0.4, which implies about 30% long-term growth (6% to 14% is realistic, depending on if we get a recession).

Here are the PEG Ratios of some of these companies, using FactSet data and consensus growth estimates

FedEx: 11.2 forward PE/13% long-term growth = 0.86
PXD: 17.1 forward PE/ 21% long-term growth = 0.81
CBS: 6.9 forward PE/6.7% long-term growth = 1.03
DAL: 9.2 forward PE/9.9% long-term growth = 0.93
CAT: 11.6 forward PE/12% long-term growth = 0.97

A PEG of close to one is still excellent, especially compared to the 3 PEG of the broader market. But the point is that screening a company via all of these approaches can minimize the chances of overpaying for a quality name (make sure to check that earnings and cash flow are growing, so you don’t buy a value trap by mistake).

For example, MPLX passes all these value screens.

Dividend Kings Historical Discount To Fair Value: 52% (Very Strong Buy)

Morningstar’s estimated discount to fair value: 41% (5 stars)

2019 P/EBITDA: 4.1 (vs. 7 to 9 historical)

Price of operating cash flow: 5.3 vs 7 to 9 historical norm

PEG: 1.03 (based on P/EBITDA and FactSet 4% long-term consensus growth)

First, you need to know what companies are worth owning (Dividend King’s motto is “quality first, valuation second and proper risk management always). That’s where a good watchlist is useful. Next, you need to know what a company’s worth today. That involves looking at several fundamental valuation metrics such as dividends, earnings, and cash flow.

When you find a company that is both above-average quality and trading at a below-average valuation, then you have truly found a powerful tool to achieving your long-term financial goals.

Quality Stocks At 52-Week Lows Are Great Screening Candidates

Note that, like any valuation screening tool, 52-week lows are not sufficient but a place to begin your research.

I maintain a master list that takes every company I track for Dividend Kings and applies an 11-point quality score based on dividend safety, the business model, and management quality.

7: average quality, seek 20% discount to fair value and limit to 2.5% of invested capital or less
8: above-average quality company, seek 15% discount to fair value or better, limit to 5-10% of invested capital
9: blue-chip company, limit to 5-10% of invested capital and seek 10% discount to fair value
10: SWAN stock, buy with confidence at 5% or greater discount to fair value or better, limit to 5-10% of invested capital
11: Super SWAN (as close to an ideal dividend stock as you can find on Wall Street), fair value or better, limit to 5-10% of your invested capital
A score of 7 is average quality, which means a 2% or smaller probability of a dividend cut during a recession, based on how much S&P 500 dividends have been cut in past economic downturns (2% was the highest average cut during the 1990 recession, all other recessions were less).

I’ve programmed that watch list to track prices and use the 52-week low as a means of knowing when a blue-chip or SWAN stock is within 5% of its 52-week low and, potentially, a Buffett-style “fat pitch” investment. This means a quality company is:

Trading near its 52-week (or often multi-year) low
Undervalued per other valuation methods
Offers a high probability of achieving significant multiple expansion within 5-10 years, and thus delivering double-digit long-term total returns over this time period
Another method you can use is to target blue chips trading in protracted bear markets, such as sharp discounts to their 5-year highs. Buying a company at multi-year lows is another way to reduce the risk of overpaying and boost long-term total return potential.

In the above table, I’ve set it up to show all the methods we’ve discussed today. You can thus see that most of the above companies are potentially fantastic long-term buys, based on many important valuation metrics, including Morningstar’s qualitative ratings (of management quality, moat, and margin of safety).

This is what I mean by “fat pitch” investing – buying them when they are at their least popular (“Be greedy when others are fearful”). It doesn’t mean buying some speculative, small company with an untested business model in hopes it becomes the next Amazon (NASDAQ:AMZN).

The goal is to buy quality blue chips whose fundamentals are firmly intact, and whose valuations are so ridiculously low that modest long-term growth can deliver 15-25% CAGR total returns as the market realizes its mistake.

Mind you, it can take a long time for coiled springs like these deep value blue chips to pop (sometimes 5-10 years), but as long as their business models remain intact and they keep growing cash flow and dividends, they eventually will, which is why seven of the nine best investors in history have been value investors.

Bottom Line: Focus On Consistent Smart Investment Decisions And NOT What The Market Is Doing From Week To Week
I will admit that six straight weeks of gains on the S&P 500 is fun and exciting. Who doesn’t like to see their portfolio rise steadily higher with very low volatility? And who doesn’t love a good streak, if only because such things are so rare?

BUT we can’t forget that the very reason stocks are the best performing asset class in history (and why we own them in the first place) is because of the Wall of Worry they have to climb to achieve such rewarding long-term returns.

The risks facing our economy and corporate earnings growth continue, with a phase one trade deal far from guaranteed.

Recession is a low probability event right now, but slower economic growth and anemic earnings growth means that pullback/correction risk is now elevated.

But that doesn’t mean you can’t still make reasonable and prudent investment choices each week.

The Dividend Kings Master List of 279 companies shows

135 companies trading at fair value or better
17 dividend aristocrats at fair value or better
5 dividend kings at fair value or better
15 11/11 quality Super SWANs at fair value or better
Factor in next year’s likely 6% to 8% earnings growth on our companies, and the potential reasonable or attractive buy candidates over 150 and cover every goal, risk tolerance, and time horizon.

General Dynamics, MPLX, Prudential, and CVS are four great examples of how smart investors can avoid the dangerous of overvaluation, and harness the proven income and profit compounding power of above-average quality companies purchased at attractive prices.

But even if you don’t like those four ideas, the point is that you must always remember that quality and growth potential alone is insufficient due diligence. Valuation always matters, so make sure to use a reasonable and methodical approach to screening potential investment candidates to maximize your long-term total returns.

Long-term financial goals are not achieved by brilliance, but merely, in the words of Charlie Munger, consistently “not stupid” decisions with your hard-earned money.

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Author: Seeking Alpha Staff

Source: Seeking Alpha: The Best Dividend Stocks Smart Investors Can Buy Right Now

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