In Search of Value and Income Growth in Today’s Volatile Stock Market

With the volatility we’ve seen over the last couple of months leaving the stock market teetering on the cusp of an official bear market, I went in search of some value opportunities.

But what if the market still has a long way to drop?  

With a slumping stock market that could continue well into the new year I am not satisfied with growth alone, I want to offset the potential for further losses with some income.

My search for undervalued companies that have growing and reliable income streams (in the form of dividends) led me to dust off my watch list. I analyzed four companies to uncover potential buys that met the following criteria:

·       Undervalued

·       Resources to sustain their debt obligations should the economy head into a recession

·       Good dividend yield with commitment to raise dividends into the future

The four companies I analyzed represent some potential stability in uncertain times:

·       Union Pacific

·       CN Rail

·       Sherwin Williams

·       Proctor & Gamble

Using my checklist for selecting winning stocks here is my quantitative analysis:

(Stock price and P/E ratio as of Dec 27, 2018)

The winner for me is Union Pacific, a 150+ year old railway company.

Here is how I decided Union Pacific best met my selection criteria and why I feel it is the winner of the lot:

Proctor & Gamble (PG): What could represent more safety than one of the largest consumer packaged goods company in the world? A high-quality name that falls short of my valuation criterion. In all the years I’ve been following this stock I can never seems to find a good entry point.

Sherwin Williams (SHW): A large paint company that has long been on my watchlist, Sherwin Williams has a solid management team that has delivered for shareholders – an annualized 18% return over a 15-year period. That’s amazing. While it’s the first time in a long while I’ve seen a more reasonable valuation for Sherwin Williams, it’s not really undervalued and carries a low dividend yield (0.9%). However, management seems committed to returning earnings to shareholders as it’s averaged an 11% dividend growth rate per year over the last five years. I’ll continue to watch Sherwin Williams and will snap it up quickly if I smell a bargain.

CN Rail (CNR): This railroad finished a close second for me, and you can certainly make a strong case for picking CN Rail. It’s PEG (Price/Earnings to Growth), which is an indicator of the company’s current valuation that factors in earning growth, shows the market is likely not fully valuing the company’s growth potential. It also appears to be quite financially stable with a decent debt to equity ratio. I already own CN Rail so I opted for some railroad diversity, which brings me to my winner.

The Winner - Union Pacific (UNP): Perhaps the most undervalued of the group, Union Pacific checks all the valuation boxes – it has a P/E ratio just under 15, a very high earnings yield (11%), and low PEG ratio (0.46). Union Pacific also has an attractive dividend yield of 2.3% and has averaged an 11% dividend growth rate per year over the last five years. The company’s leadership team have proven to be good capital allocators, as indicated by their high Return on Equity (59%). Their recent capital investments have delivered good returns dropping the company’s operating ratio significantly over the last few years. These capital investments have brought up debt loads (1.07 debt to equity ratio) but its interest coverage ratio leaves me satisfied they can weather economic storms.  

In these uncertain times I make smaller purchases of a company I like (than I normally would) to dollar cost average down should the market continue to decline.

Good luck, and don’t forget the wise words of esteemed investor Warren Buffet:

              “Be fearful when others are greedy and greedy when others are fearful."

 

Note: The articles posted on this site are my opinions and should note be considered as professional financial advice. Please consult a financial professional before using any information offered on The Informed Investor blog.