A check was placed in the mail today and should arrive at the brokerage firm for posting by Thursday. At that time, the new purchase is going to be ROST.
Going into 2014 we established some company goals we wanted to achieve with the funds going into the Roth Ira. The portfolio is already established with a series of core positions and we wanted to expand on the core positions.
It was our goal to add a technology and financial company, as well as a railroad and a couple of speculative positions where the yields would be below our normal acceptance criteria, but hopefully we wanted to offset that with high dividend growth and capital gain appreciation.
We wanted to purchase these companies with a discount to fair value. We wanted a 10% discount, 15% would be even better. We decided that we would confirm the double digit discount with at least two firms.
If we were unable to find a high quality company selling at a discount, we would simply add to one of the core positions at fair value.
The first thing I look for in a company is its financial strength rating. If a company doesn't pass this criteria, I go no further with my due diligence, regardless of how sexy the story sounds.
I look for companies that rate a 1 or 2 for safety by Value Line, or a BBB+ credit rating by Morningstar, or a B+ quality rating by S&P Capital IQ.
S&P gives ROST a credit rating of A- and an A+ rating for quality. ROST qualifies for purchase once the valuations and company fundamentals line up.
When I look to purchase a company, I'm looking for a dividend and dividend growth. Normally I look for an initial yield that is 50% above the yield for the S&P 500. I use SPY to determine the yield for that Index.
The current yield for SPY is 1.85% and when you multiply that by 50% I get a yield of 2.78%. That would be my minimum yield under current market conditions unless I was looking to speculate. I am considering ROST a speculation play due to it's low yield which means I must count more on capital appreciation over dividend income in the near term.
Since I am looking to speculate, I expect higher earnings rates than I would with my blue chip core positions. My minimum earnings growth expectations for growth and spec companies is 10%.
My minimum requirement for estimated earnings on a growth or spec company is 10% as well.
During my research, of the 50 plus companies I have on my watch list, ROST was the only company that qualified with a 10% discount to fair value by both Morningstar and S&P Capital IQ, and had 10% estimated earnings growth rate.
In looking at price discounts a few companies came close. It came down to four companies. ROST, MA, TGT and BAX.
Here are the price discounts as of May 9.
ROST ... S&P says ROST is undervalued by 13.6%. M* says ROST is undervalued by 15.7%.
MA ... S&P says MA is undervalued by 10.3%. M* says MA is undervalued by 9.3%. ... This was close enough to a double-double to consider for purchase.
TGT ... S&P says TGT is undervalued by 7.7%. M* says TGT is undervalued by 12.7%. ... TGT was close, but not close enough for consideration at this time in this portfolio.
BAX ... S&P says BAX is undervalued by 8.8%. M* says BAX is undervalued by 10.6%. Again, this one was close enough to consider but I decided to pass as BAX is expected to spinoff a part of their business and I want to wait until the dust settles on that one.
So it came down to ROST and MA for this portfolio.
In looking at estimated earnings growth, ROST is expected to grow earnings at a rate of 12.2%. MA is expected to grow earnings at a rate of 17.7%. Both companies passed the double digit earnings growth criteria.
One aspect that is important to me when investing other people's money, is that I want to get their position off to a fast start. If I can select companies that are expected to beat the market over the next six to twelve months, it provides them with the confidence to hold during market corrections. I try to provide them with a little peace of mind if I can.
With this in mind, I look for undervalued companies that look to have upside price momentum. I look for companies that most analysts can agree on that the company in question is expected to outperform in the near term.
In order to determine who qualifies under this criteria, I turn to Fidelity and a rating service they call Starmine. This system rates the accuracy of the firms participating in the system. Fidelity assigns each covered company with an Equity Summary Score.
The Equity Summary Score is an accuracy-weighted sentiment derived from the ratings of independent research providers on Fidelity.com. It uses the past relative accuracy of the providers in determining the emphasis placed on any individual opinion.
These scores range from 0 which is Very Bearish to 10 which is Very Bullish. Anything above a 7.0 is a Buy.
ROST carries an ESS rating of 8.4 Buy. ... MA carries an ESS rating of 8.1 Buy. ... Both companies are expected to outperform the market over the next six to twelve months.
In looking at earnings, I want a company to have increased earnings in at least 7 of the last 10 years. ROST has raised earnings in 9 of the last 10, which also includes the years of the Great Recession.
MA hasn't been trading for 10 years but they have increased earnings in 7 of the 7 years they have been trading.
In looking at revenues, ROST has an impressive record of revenue growth. Over the last 10 years they have a 15.11 CAGR of revenue.
MA has a 7 year record of 9.77% CAGR for revenue growth.
It's at this point that ROST is edging ahead and the rest of this analysis applies to ROST.
I don't know how to accurately read a balance sheet or income statement so I have to outsource that task. I use Jefferson Research to help me with this.
Here are their findings:
Earnings Quality ... Strongest
Cash Flow Quality ... Strongest
Operating Efficiency ... Strong
Balance Sheet ... Strong
Valuation ... Least Risk
I was impressed with the fundamentals here.
Return on Equity has been rising each year for the last 5 years.
2008 ... 27.8%
2009 ... 31.1%
2010 ... 41.1%
2011 ... 44.6%
2012 ... 46.5%
2013 ... 48.3%
ROST had a couple of years where cash flows were declining, but they are rising again. Over the last 10 years the cash flow per share has a 24.36% CAGR. This is what helps support the dividend growth.
McLean Capital Research says that ROST is not only growing ROE, but it is also growing what they call economic profit. They say ROST is creating shareholder value.
According to McLean, cash flows from operations are 1.2 times that of operating income. Cash Flows from Operations have grown another 4.3% year over year. This company is generating significant amounts of free cash flow and is clearly self-funding, which brings us to the yield and dividend growth.
The current yield is just 1.2% which means I need significant dividend growth to offset the low current yield.
ROST has grown the dividend for 20 consecutive years according to the CCC list put out by David Fish. What I find impressive is not only the high CAGR of the dividend, but the consistency of that high growth over all time frames.
1 year ... 21.4%
3 year ... 28.6%
5 year ... 29.0%
10 year ... 27.9%
In summation, I was looking for a growth company whose estimated earnings were predicted at 10% or more, with a high quality company that was selling at a 10% or more discount to fair value. The company had to pay a dividend and had to have exceptional dividend growth, and a record of paying a high dividend growth rate over many years.
Additionally, not only was valuation important, but the timing of the purchase was of importance as well.
From November of 2013 to the current date, the price for ROST has been declining. While price has been declining, On Balance Volume has been rising. This is known in the technical world as a bullish divergence. Volume usually confirms price direction. It's not this time.
This is an indication that Institutional Investors are accumulating shares of ROST on small price pull backs.
When you look at the following chart, note how price has fallen since November, but the indicator below the volume chart has been rising.
This is very good news from a timing standpoint. In my opinion, value and timing are on the same page together.
On Thursday of this week, when the funds hit the account, I will be purchasing ROST.