Caution: US Equities At All Time Highs
Although the S&P 500 closed slightly lower Wednesday, the index is still near its all time high as investors continue to enjoy an 8-year bull market. However, many equity analysts remain cautious as stocks appear to be trading at inflated multiples. Goldman Sachs' even went on record saying that they believe the US bull market is in its last few innings.
But what is an enterprising investor to do with that information? It’s too costly to sit on the sideline, especially while the Trump trade rally is showing no sign of slowing. So where should investors look? One safe bet is to look at members of the S&P 500 Dividend Aristocrats ETF (BATS:NOBL). This ETF consists of a select group of 52 S&P 500 stocks with 25+ years of consecutive dividend increases. Investors can count on these dividends to potentially help offset losses from any type of market pullback... when it happens.
However, there's little upside in being too defensive in this bull market. So we used finbox.io’s dividend discount models to see if there are any Dividend Aristocrats that still appear to be fundamentally undervalued.
2 Dividend Aristocrats Trading at a Discount
As quick reminder, a dividend discount model estimates the value of a company's stock price based on the theory that its true value is equal to the sum of the present value all of its future dividend payments to shareholders.
After applying this technique to the 52 Dividend Aristocrats, there were two companies that stood out: Hormel Foods (NYSE:HRL) and AbbVie (NYSE:ABBV).
As illustrated in the chart below, Hormel Foods' historical net income growth has averaged around 15% over the last several years. The company has also paid out roughly 25% to 35% of net income in the form of dividends. Applying similar assumptions in the 5-year dividend discount model (shown on the right hand side) concludes a fair value of $42.30 per share. This implies that the company's shares are currently 13% undervalued.
<img src='http://res.cloudinary.com/finbox/image/upload/v1487799653/HRL_DDM_jr8mc2.jpg' alt= ‘HRL Dividend Discount Model’>
View Hormel Foods DDM model.
AbbVie has distributed a significant amount of its earnings in the form of dividends (~60%) since the company spun off from Abbott (NYSE:ABT) in 2013. The company appears to be trading at a 10% discount to fair value when applying similar assumptions in the 5-year dividend discount model as shown below.
<img src='http://res.cloudinary.com/finbox/image/upload/v1487808631/ABBV_DDM_iiqcxy.jpg' alt= ‘ABBV Dividend Discount Model’>
View AbbVie DDM model.
It’s worth noting that dividend discount models are known to provide conservative estimates of fair value as some cash leakage not taken into account. However, as economist John Maynard Keynes once noted:
-- "It is better to be roughly right than precisely wrong." --
Hence, the conservative nature of the model should help investors get comfortable with the upside potential for each company. These two Dividend Aristocrats could prove to produce outsized total returns in a bull market as well as a safe haven in a down market.
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photo credit: Joe Sirianni
