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Two Reasonably Valued Blue Chips: WMT, IBM
Posted by: Dividend Mantra (IP Logged)
Date: August 25, 2013 02:47PM

When I talk about "blue chip" stocks, I'm typically referring to shares in very high quality companies that have excellent, long-standing reputations for profitability during all economic cycles. A more narrow definition could be described as stocks that are tracked by the Dow Jones Industrial Average (DJIA). The two companies I'm going to profile below fit both definitions, and are trading for reasonable valuations despite the fact that they are really high quality companies with global scale and wide economic moats behind their businesses. I mainly invest in blue chips because I plan on living off the dividend income my portfolio spits out for decades, so I don't want to have to worry about whether or not some of the companies I'm investing in will be bankrupt tomorrow. While there have been some blue chips over the last century that have gone bust (like Eastman Kodak Company), they are relatively few and far between and generally the decline is rather slow and painful rather than an overnight bankruptcy.

While both of these businesses are reasonably valued at today's prices, keep in mind that one should still remain cautious about the broader market's modest overvaluation, and due to this overvaluation prices could come down in the short-term on these two stocks and many other stocks in the market. However, I'm a long-term investor so I try to pay less attention to macroeconomic events and more attention to the individual quantitative fundamentals inherent with each company along with qualitative aspects that give me confidence in the ability for a company to continue operating profitably well into the future.

Wal-Mart Stores, Inc. (WMT)

Wal-Mart needs no introduction. Or at least I hope it doesn't. This is a $240 billion global retailer juggernaut, with over 10,000 stores under it's banner. With a P/E of just 14.33, I believe an investor has an opportunity to buy into one of the world's best, and biggest businesses. The entry yield is just 2.56% at today's prices, but that relatively lackluster yield is backed by 39 years of dividend growth and a 10-year dividend growth rate of 18.1%. Furthermore, the dividend payout ratio is under 37%, so there is plenty of room for further dividend growth. The balance sheet is attractive and stable, with a debt/equity ratio of 0.6.

Earnings per share have a compound annual growth rate of 10.58% over the last nine years, and I think WMT has plenty of growth ahead. Remember how they operate more than 10,000 stores worldwide? Well, only 393 of these are located in China. The most populous country on the planet. And try only 20 in India. That's the other country with over 1 billion people. So, while they have saturated the domestic market to a degree, international growth is really in its infancy. So, the growth they've experienced, while phenomenal, is relatively handicapped by the fact that they haven't yet taken full advantage of the company's potential. While e-commerce is a threat, as are small retailers like the dollar stores, I feel that Wal-Mart is well positioned to counter e-commerce with the favorable deals they've been able to strike with suppliers which has led them to be a low-cost leader, and they also own a chunk e-commerce via their web sales. As far as small dollar stores go, WMT has been focusing on smaller stores to enter key markets they weren't able to before. The sheer scale of this company makes me a believer, even though the history of retail is littered with companies that lost their former glory. I am currently invested in this company and interested in increasing my ownership stake if the price stays near today's price of under $74 per share.

*Morningstar currently rates WMT as a 3/5 star valuation with a Fair Value estimate of $74.00.
*S&P Capital IQ currently rates WMT as a 4/5 star Buy with a Fair Value calculation of $81.30.

International Business Machines Corp. (IBM)

While I'm admittedly not a big fan of the technology sector, I think IBM deserves merit and consideration here. It currently trades with a P/E of 13.18, and at a price not too far above where Warren Buffett bought a stake worth over $11 billion. He bought a large portion of his stake back in late 2011, but has been intermittently adding to it since. His purchase price has been estimated to be around $173 based on the trading range of the stock during the second and third quarters of 2011, and you have IBM shares currently trading for about $185 right now. Not too often do you get an opportunity to buy a stake in a company near what Warren Buffett paid. The entry yield stands at a fairly low 2.05%, but the 10-year DGR is 18.8% and IBM has raised it's dividend for 18 consecutive years. With a payout ratio of just 27%, I believe dividend growth will remain strong for the foreseeable future. The balance sheet is slightly leveraged, however, with a debt/equity ratio at 1.5. EPS has a CAGR of 14.23% over the last nine years, which is extremely strong and no doubt helped by the large share buyback program IBM has long had in place.

IBM is a solutions company. They take problems that businesses have and create IT-based solutions for those problems. And that's where IBM is a bit unique, and I think why Warren Buffett, traditionally extremely tech-shy himself, decided to take such a big bite out of this company. IBM has been able to create a moat around it's business simply based around the fact that they are the best in the world at solving big problems for big businesses and once they implement their solutions, be it hardware and/or software, it's hard to switch to competitors. And so, IBM has been able to dig a substantial moat based around high switching costs which were created because of unique business intelligence properties. IBM is also one of the best companies out there at putting long-term operational plans in place, most recently with the 2015 road map which dictates $20 EPS in 2015. Certainly there are risks here because technology evolves much quicker than other industries, but IBM has been a leader for decades even while the tech landscape has changed dramatically. They were able to switch from a low-margin hardware business to a higher-margin software and solutions company many years ago, so they are able to adapt. Overall, I feel IBM is one of the best picks in the tech sector and I'm currently interested in initiating a position over the next month or two if the price can stay relatively stable.

*Morningstar currently rates IBM as a 4/5 star valuation with a Fair Value estimate of $208.00.
*S&P Capital IQ currently rates IBM as a 4/5 star Buy with a Fair Value calculation of $229.20.

How about you? Interested in either of these high quality companies with high dividend growth?

Full Disclosure: Long WMT

Thanks for reading.


Stocks Discussed: WMT, IBM,
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