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Two Reasonably Appealing Stock Ideas

May 20, 2013 | About:
I recently wrote about the difficulties that us value/dividend investors face in allocating capital to equities right now. The S&P 500 is up 17% YTD and we're only a little more than five months into the year. Are many companies worth 17% more now than they were five months ago? Were many stocks 17% cheaper than they should have been five months ago? As always, it's not really my focus to answer questions like these as at that point you're trying to value an entire market which is impossible. I simply try to ascertain the intrinsic value of a company on a per-share basis and then see if I can purchase shares for as far under that number as possible. My overarching goal is to retire by 40 years old, and as such my mission is to build my passive income via dividends to the point where they exceed my expenses. I always try to remind myself that even in a broad market that is possibly overextended, it's difficult to build a rising passive income stream if I'm not actively contributing to it.

Although I don't see many companies out there trading with any significant degree of discount to their intrinsic value currently, I do see a few companies that are trading at fair values or slightly better based on fundamental quantitative analysis as well as qualitative feelings about future prospects. I'm going to discuss two potential ideas below, along with a few ancillary ideas that are similarly valued in corresponding sectors.

Exxon Mobil Corporation (XOM)

Exxon is the largest company in the world by market capitalization. It's a massive energy company, and operates in an industry where scale and size matters. The world's energy thirst isn't going anywhere, and is likely only to increase as many of the most populous countries in the world, including China and India, grow their economies and many of their citizens burgeon into middle class consumers. Exxon is well placed to take advantage of these trends. One of the great things about XOM among energy companies is that it's an integrated supermajor, meaning that they are diversified between upstream and downstream operations with exploration & production of oil and gas, as well as refining and transportation operations. This means that no one particular aspect of energy will have an overwhelming effect on the business. They can continue to profit from refining when oil prices are lower, and in contrast can benefit on the E&P side when oil prices are up.

Exxon currently trades for a P/E of 9.36 and shares offer an entry yield of 2.75%. This entry yield, while not spectacular, is solid in this market. The yield is backed by 31 years of dividend growth, with a 10-year dividend growth rate of 9%. The balance sheet is almost flawless, cash flows are very strong and earnings have been crowing at a very attractive clip of 13.31% compounded annually over the last 10 years from 2003-2012.While XOM is a suitable investment at current prices, Chevron Corporation (CVX) would also make a great alternative here. Currently, XOM trades near the low end of its 5-year low P/E ratio. Overall, I find XOM to be reasonably appealing at current prices at just under $92 per share. The payout ratio stands at 25.6%, so there's plenty of room for continued dividend growth.

Some current analyst opinions on the valuation of XOM:

*Morningstar rates XOM as a 4/5 star valuation with a Fair Value estimate of $97.00.

*S&P rates XOM as a 5/5 star Strong Buy with a Fair Value calculation of 93.50.

The Bank of Nova Scotia (BNS)

I wrote about why I was bullish on certain Canadian companies a couple months ago, and why I particularly liked a few of the big Canadian banks. Just after the article went live I purchased equity stakes in two of the larger Canadian banks: BNS and Toronoto-Dominion Bank (TD). I still really like these banks and am almost evenly split between the two. I find them almost equally appealing in different ways, but I simply picked BNS here because of their international exposure. Taking that a step further, I also like Royal Bank of Canada (RY) in this space. Most of the big Canadian banks are very high quality banks that held up very well in the recent financial crisis. Although the share prices of these banks cratered in late 2008 along with the rest of the market, operations continued to hum along fairly normally and dividends weren't cut. Since I initiated positions with TD and BNS the share prices have been fairly static, underperforming the U.S. market by a large margin. This allows for an opportunity to purchase shares at the same levels they were trading at months ago. A further note: I really like Wells Fargo & Company (WFC), and although shares have participated in the S&P 500 rally this is a high quality bank trading at a reasonable valuation based on future growth prospects.

BNS shares are trading hands with a P/E of 11.15. The entry yield is very solid at 4.14%, so shares in this bank offer one of the better opportunities for current income in a stretched market. The dividend growth is solid, just as the growth in earnings are. Although they kept the dividend payout static during the economic crisis, they've raised the dividend twice over the last year for a total of 9.1% growth in the dividend year-over-year. EPS growth has averaged a compound annual growth rate 12.72% over the last 10 years. BNS has an attractive balance sheet and most of its operations are in a very stable Canadian economy. There are some near-term headwinds with a very expensive Canadian housing market, but long-term the big Canadian banks look pretty solid as they function largely as an oligopoly. The payout ratio is at a very healthy 46%, so further dividend growth is highly likely. Overall, BNS appears to be reasonably priced here at just over $57 per share.

Some current analyst opinions on the valuation of BNS:

*Morningstar rates BNS as a 3/5 star valuation with a Fair Valuation estimate of $61.00.

*S&P rates BNS as a 4/5 star Buy with a Fair Value calculation of $63.90.

In summary, while I think the broad market is a bit pricey based on a number of different metrics (Shiller P/E being the most prominent), I remain vigilant on valuing individual companies based on company-specific merits and fundamentals. I view the two companies discussed in this article, along with the four other ancillary ideas mentioned, to be reasonably appealing stocks based on their current price and that relationship to their intrinsic values on a per-share basis. While I'm not crazy about the current market and I'm currently building my cash position, I do have an interest in acquiring equity stakes in the companies mentioned in this article at today's prices. They are all high quality businesses trading for valuations that aren't completely out of line.

Full Disclosure: Long CVX, BNS, TD, WFC

How about you? Find any of the companies mentioned reasonably valued?

About the author:

Dividend Mantra
Trying to retire by 40 by investing in dividend growth stocks and living frugally, valuing time over money.

Visit Dividend Mantra's Website


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