Watchlist – December 2018

There are many traps for an unwary investor that can lead you into deep water. One of my all time favourites is the erratic behaviour to buy cheap stocks just because they are cheap. Truth be told, I’m guilty of falling into that trap multiple times. Don’t get me wrong. Valuation is a key factor that requires an examination. But in the first place, quality has to be right. You want to invest in excellent companies that are trading at an attractive price. This is the most important part of the game.

It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price

Warren Buffett

I’ve set up a quality rating to gain a first understanding about the excellence of a business. Its function is to identify companies with substantial earnings power, great profitability, healthy balance sheet and strong cash flows. Subsequently the next step is to check whether the price is appropriate. This is when the valuation rating comes into play.

Screening criteria

That being said, I’ve run the numbers to come up with the TOP 5 ideas for the watchlist in December. These are the criteria, that I used for the screening:

  • Quality: Final score => 70 points (min. 4-star-stocks, good quality)
  • Valuation: Price/Fair Value Ratio =< 0,90 (min. 10% undervalued)

Final result – December 2018 watchlist

TOP 5 stocks for December 2018
Q/V Screening – December 2018 Watchlist

The quality rating is based upon 20 metrics divided into five categories. Each metric can score max. five points. In the end I sum up all points to come to the final quality score. Please take note that this is my individual rating approach. You might come to a different conclusion – and this is OK.  The valuation rating presents the final result in form of the Price/Fair Value ratio. It’s an arithmetic average of the four valuation methods that I use to value a company. The further the Price/FV ratio moves below 1, the more the stock is undervalued. For example a Price/FV ratio of 0.89 indicates that the stock is 11% undervalued. Currently there are 50 companies in the pool. Without further ado let’s have a look on the five stocks that have qualified for the watchlist in December.

(1) BlackRock

Dividend: 3.18% | 5-yr. Div. Growth Rate: 11.20% | Payout Ratio: 46%

BlackRock is the largest asset manager in the world, with $6.444 trillion in AUM at the end of September 2018. The company earns a four-star quality grade and appears to be 16% undervalued. I’ve initiated a position in BLK in mid November (you can read more about this purchase here: Recent Buys – BLK & GD). All in all my opinion about this high-quality business hasn’t changed since then. Therefore I believe the recent dip of BLKs share price below $400 offers a good opportunity to add to my position.


What I like: industry leader, trend towards passive managed products, low D/C (13%), excellent credit rating (AA-), wide moat (Morningstar)
What I don’t like: high-beta stock, dependency from economic cycles, increased competition among ETF providers

(2) Illinois Tool Works

Dividend: 3.09% | 5-yr. Div. Growth Rate: 13.30% | Payout Ratio: 60%

Illinois Tool Works (ITW) is a global diversified manufacturer with 85 business divisions and operations in more than 50 countries. ITW has qualified for the watchlist by earning a four-star grade in the quality rating. Furthermore the valuation approach indicates that its share price is about 11% undervalued. ITW is a member of the SF portfolio since July 2018. Thanks to the recent market volatility, we see an attractive price for this high-quality business. That is why I’m considering increasing my position.


What I like: expanding operating margins, 44 years of consecutive dividend increases, recent 28% dividend hike, 80/20 business approach, good diversification
What I don’t like: cyclical stock, sluggish industrial and automotive demand

(3) Bayer AG

Dividend: 4.34% | 5-yr. Div. Growth Rate: 8.06% | Payout Ratio: 70%

Bayer is a German healthcare and chemical conglomerate. The firm achieved a good four-star quality grade and seems to be significantly undervalued by 43%. The company’s shares had lost more than a third of their value this year on concerns about the legal and financial risks associated with its $63 billion takeover of Monsanto. Experts estimate €2 billion of legal costs in total linked to the remaining 9.000 lawsuits. However Bayers market capitalization slipped by more than €16 billion due to legal threats. In case that market participants have already priced in the worst case scenario, Bayer represents a good buy opportunity at current levels.

What I like: well-positioned drug division, leading brands (Aspirin, Aleve), recent focus on the core business (selling of the animal health division), restructuring and cost saving approach, wide moat (Morningstar)
What I don’t like: uncertainty of lawsuits linked to glyphosat, price pressure in the health industry

(4) Broadcom

Dividend: 4.64% | 5-yr. Div. Growth Rate: 51.10% | Payout Ratio: 40%

Broadcom Inc. is a global technology leader that designs, develops and supplies a broad range of semiconductor and infrastructure software solutions. AVGO earns four stars in the quality rating. Its share price appears to be significantly undervalued in the amount of 37%. I bought Broadcom in August when the market was pessimistic due to the CA acquisition. Since then I haven’t regret this purchase. In fact the only regret is that I didn’t buy more, since AVGO continues to fire on all cylinders. On December the 6th, Broadcom has presented rock solid Q4 figures: +12% increase in net revenue and +27% EPS growth. In addition the company has announced to increase its quarterly dividend for fiscal 2019 by 51%! Well, there is a lot to like and very little to dislike about that business.

What I like: well-positioned in the IoT segment, share repurchases, very high dividend growth, growing revenues and earnings, positive free cash flow trend
What I don’t like: cyclical industry, high exposure to Apple (Apple accounted for more than 20% of revenue in fiscal 2017)

(5) Bank of America

Dividend: 2.36% | 5-yr. Div. Growth Rate: 57.70% | Payout Ratio: 25%

With more than $2 trillion in assets, Bank of America is one of the largest financial institutions in the United States. As the previous candidates, BAC also earns a four-star quality grade. Moreover a Price/FV ratio of 0.66 states that the share price might be significantly undervalued. To be honest, Bank of America has been flying under my radar so far. In generall, the SF portfolio is quite underrepresented in the financial sector – without any position in banks. This is something I really would like to change. So BAC passing the quality and valuation criteria came just in time.

In Q3 2018 Warren Buffett’s Berkshire Hathaway bought more than $13 billion in bank shares – including an additional investment of $6 billion in Bank of America. Five out of Berkshire’s TOP 10 holdings are banks, with BAC being the largest. When the most successful investor of all times is heavily into banks, it might be not the worst idea considering investing either.

What I like: Buffett investment, good EPS growth, rising interest rates might be good for BAC (more interest income), focus on efficiency and risk reduction
What I don’t like: risk of legal and regulatory issues, dividend cut in the financial crises

Wrapping up

In volatile market environments it is especially crucial to be calm and stick to the plan. Personally, I practice to see market fluctuations as something natural. Share prices go up and fall. It’s their nature. There is nothing to panic about it. As long as the company’s quality is not affected, price fluctuations are nice gifts for long-term investors. The only problem we have to deal with, is to choose what gift we like the most.

Which companies made it to your buy list in December? Let me know about your potential candidates for this month.

 

8 Comments

  1. BrokeInvestor December 9, 2018 at 8:47 pm

    Hey Alex,
    Really nice list and I like the structure of your overview, especially the section where you list what you like and don’t like about each company 🙂
    ITW and BLK were the most recent additions to my portfolio 🙂 Broadcom was also in my radar and I featured it in one of my watchlists a few months ago. I would still love to add to this position.
    You also got me interested in Bayer. I noticed the news about their problems with “Roundup” weed killer (I actually remember my father using it when I was growing up in a village) and was going to follow up with how it ends up. But I don’t pay much attention to European stocks, except my home market (Baltic) somehow. I think I should change that 🙂
    Bank of America also was on my list when I was thinking of what to add from the Financials sector but BLK won that time and I think I have enough exposure to this sector now, since my portfolio is so small 🙂
    Once again, nice list and it will be interesting to see if you end up buying something from it!
    BI

    Reply
    1. Snugfortune December 10, 2018 at 3:09 pm

      Hi BI,
      thanks, I’m glad that you found the like/don’t like section useful.
      Also intresting that we have similar stocks on our radar. Concerning Bayer, I really like the company and the valuation. But the concerns surrounding glyphosate are really hard to evaluate. Bayer says they are optimistic to solve the lawsuits. However the share price might go nowhere until this issue is finally cleared.
      Actually, it’s a hard choice this time. I like all 5. Can’t say with certainty that I have a favourite this month=)

      Reply
  2. Dividend Daze December 10, 2018 at 3:35 pm

    Some solid choices on that list. I don’t own any myself but know a few others in the community that hold some of them. I love the quote as well. Very true, always go for quality and hold long term. Looking forward to seeing what you decide to buy next.

    Reply
    1. Snugfortune December 10, 2018 at 6:06 pm

      Agree, it’s all about quality and long-term investment horizon.
      Thanks for your visit!
      Cheers

      Reply
  3. DivHut December 10, 2018 at 11:14 pm

    I’m liking ITW a lot from the list. That name has been with me since I went the DGI route and I even bought some for baby DivHut. Also BLK has been making the rounds in the financial media as an undervalued solid play. There are many good choices to pick from these days. Thanks for sharing.

    Reply
    1. Snugfortune December 11, 2018 at 12:05 am

      DH, I can only congratulate you for holding ITW for such a long time. It looks like a “boring” company but ITW is a treasure in disguise. Two interesting facts. 1) On a 3yr, 5yr and 10yr horizon ITW has outperformed the S&P500 in terms of total return (f.e. 10yr, ITW: +280% VS. S&P500: +194%). 2) If you would have invested back in 1999 and didn’t sell, your yield on cost would be 10% today – without reinvested dividends! I begin to understand why you like it a lot =)
      Thanks for the visit.
      Cheers
      Alex

      Reply
  4. Divs4Jesus.com December 24, 2018 at 6:51 pm

    Hi Snug

    I have 3 of these on my radar for December AVGO, ITW, and BLK. I run my own screener/scoring system for approx. 50 stocks and AVGO came out on top – which you’ll see I purchase a couple days ago (bit early I guess looking at the way things have dipped). BLK came in above ITW but they were all in the “buy” range for me. For BAY it didn’t make the cut because high payout ratio and slower div growth. I’ll have to take a closer look at BAC.

    Lots of solid names in your portfolio!

    Cheers.

    Reply
    1. Snugfortune December 26, 2018 at 7:46 pm

      The best thing is that all these quality companies declined in price.
      And some of them are a steal imo.
      Thanks for stopping by.
      Cheers

      Reply

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