Buy the Dip on Canadian National Railway

Summary:

#1 Canadian National Railway is back on track for future growth.

#2 The stock jumped by 10.67% over the past 12 months, but lost 5% in the past 30 day. , It’s time to buy the dip.

#3 Meanwhile, the dividend has jumped by 120% over the past 5 years.

 

Canadian National Railway (CNI) has been on a great stock ride over the past 12 months. As the TSX decreased by 2%, CNI stock is up 10.67% as at August 19th. This creates another interesting entry point for this strong dividend grower.

Revenue

Revenue Graph from Ycharts

As you can see, the railroad industry cycles up and down. The latest down cycle happened during the oil bust, but CNI’s great diversification helped it weather the storm

 

Source: CNI Q2 presentation`

Now that the Canadian economy seems to be more resilient than expected, Canadian National Railway has started to see signs of recovery faster than expected.

How CNI fares vs. My 7 Principles of Investing

We all have our methods for analyzing a company. Over my years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rules: I try to avoid most companies with a dividend yield over 5%. I will make very few investments like this (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment, or because the company has nothing else but a constant cash flow to offer its investors. However, high yields hardly come with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

CNI hasn’t been one of the most generous companies in term of yield. It has maintained a very cautious approach by steadily increasing the dividend but also keeping enough money for its capital intensive business model. After all, taking care of thousands of kilometers of railroads has a price! Overall, CNI’s yield isn’t incredible at 1.57%, but it surely doesn’t raise a red flag.

CNI meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Source: Ycharts

While CNI’s dividend yield isn’t impressive, its dividend growth history is. CNI shows a dividend growth streak of 22 consecutive years. If it were an American company, it would even be part of the Dividend Achievers. On top of that, CNI’s annualized growth rate for the past 5 years is 17.08%. The company has more than doubled its payouts during this period going from $0.188/share to $0.415/share (Canadian dollar).

CNI meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what has happened with a company. As investors, we are more concerned about the future than the past. This is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

After this impressive dividend growth period, you would expect the company to show a relatively high payout ratio. Well, think otherwise. Both CNI’s payout and cash payout ratios are under 40%. The company has already been known for its stellar operating ratio in its industry and this reflects on earnings and cash flow.

CNI meets my 3rd investing principle.

Principle #4: The Business Model Ensures Future Growth

Looking at past metrics tells you a story about a company. Unfortunately, this doesn’t mean history will repeat itself in the future. A good way to make sure it does is to understand how the company makes money. CNI owns and operates one of the largest and most efficient railroads systems in North America. Railroad transportation is one of the best ways to move commodities and other goods across such a large continent. Since it is virtually impossible for a new company to build railways these days, CNI will continue to generate cash flow year after year.

 

CNI shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect timing to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have set some savings aside. There is a valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

Looking at the past 10 years, you can see the PE ratio is getting closer to a 10 year high. This usually doesn’t look good.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I rather see companies like big money making machine and assess their value as such.

Here are the details of my calculations:

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.65
Enter Expected Dividend Growth Rate Years 1-10: 10.00%
Enter Expected Terminal Dividend Growth Rate: 7.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $276.46 $136.89 $90.42
10% Premium $253.42 $125.48 $82.89
Intrinsic Value $230.39 $114.07 $75.35
10% Discount $207.35 $102.66 $67.82
20% Discount $184.31 $91.26 $60.28

Source: how to use the Dividend Discount Model

Note: this section has been done using CAD metrics.

Looking at the dividend discount model, I can see CNI is still offering potential.

CNI meets my 5th investing principle with a potential upside of 14%

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest struggles an investor faces is  knowing when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is  time to pull the trigger. My investment decisions are motivated by the fact that the company either does or does not conform my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company  are not valid anymore, I sell and never look back.

Investment thesis

Canadian National Railway is the most productive railroad company with the best operating ratio in the industry (55.1%). At a 1.64% yield, we can’t talk about a “strong” dividend payer. However, after digging further, I realized how strong the company’s fundamentals are. CNR has a very strong economic moat since railways are virtually impossible to replicate. Therefore, you can count on increasing cash flow coming in each year. Plus, there isn’t any better way to transport most commodities than by train.

Potential Risks

There isn’t much risk when you invest in a steady cash earning company where virtually no new competitors could enter. This is a privileged market where CNI is dominant.

CNI shows a solid investment thesis and meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Canadian National Railway will offer great entry points from time to time as it evolves within in a cyclical industry. However, CNI will not show incredible stock price growth overtime. This is a steady earning company that will show more dividend growth than anything else.

CNI is a core holding.

Final Thoughts on CNI – Buy, Hold or Sell?

In short, CNI is definitely a BUY. The company shows a 14% upside and a strong dividend growth potential. Plus, in the event of a market crash, you can count on CNI and its 22 years of dividend growth history to continue raising your “waiting payment”.

Disclaimer: I do hold CNI in my DividendStocksRock portfolios.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Apple: A Growth or Dividend Growth Stock?

Summary:

#1 AAPL stock price rose by 65.37% over the past 5 year lagging the S&P 500 by about 9%.

#2 However, the company has also increased its dividend by 65.36% for a 10.58% CAGR.

#3 Combined together, AAPL stock outperformed the market.

When I first purchased shares of Apple (AAPL), it was way after their original stock surge. I added AAPL to my portfolio once they raised their dividend for the first time, right before the stock split. At that time, there were lots of concerns around the company’s ability to “survive” in the smartphone industry and continue to generate growth. After a thorough analysis, I made the bet that AAPL would become another Microsoft (MSFT); a company generating strong cash flow and increasing its dividend generously. Almost 5 years after my first trade, let’s look at Apple and its dividend growth potential.

What Makes Apple a Good Business?

Apple is an icon of the techno which survived the techno bust in 1999. Their products are made with great attention and aim at perfection. While its products are not perfect (yet), it has built a perfect product ecosystem. Your MacBook, iPad, iPhone, and your Apple Watch all blend together. You can share your pictures, favorite songs, and applications with any device. Apple has succeeded to have fans instead of customers.

Revenue

Revenue Graph from Ycharts

The company is still highly dependent of how their iPhones sales are going. For example, during their latest quarter (Q3 2017), the company shows 55% of its sales coming from the iconic smartphone:

Author’s chart, AAPL Q3 2017 numbers

While this seems like a red flag to many investors, I see something else: a year ago, iPhones were 65% of its revenue (source MarketWatch). Considering the iPhone 7 was launched in September 2016 (after the MarketWatch article has been written), we see the company is reaching serious momentum in their Services division. Over the past 12 months, this sector has increased its revenue by 22%.

How AAPL fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income-seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple: when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly comes with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

As far as my first principle goes, we can’t tell AAPL has a high dividend yield! This is probably what an income seeking investor will tell you if you asked about their opinion on this stock. Unfortunately, a 1.50%-2% yield doesn’t attract the dividend-growth crowd. After all, don’t forget that MSFT started just like that:

Source: Ycharts.

AAPL meets my 1st investing principles.

Principle#2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Source: Ycharts

What really matters to me is the dividend growth. While AAPL dividend growth history is relatively new, it shows the kind of trend I’m looking for. With a 10.58% CAGR dividend growth rate over the past 5 years, AAPL is up to a great start to become a Dividend Achiever in no time.

AAPL meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

While management’s committed to provide shareholders with ever-growing dividends, the company has lots of room to meet its promise. You can expect a double-digit dividend growth for the next decade.

AAPL meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

I don’t think Apple is a one trick pony at all. It used to rely on its MacBook sales for a while, then it invented the iPod and surfed on this wave for a while. The current “new trick pony” is the iPhone, but Apple is already working on various other products. In the meantime management can enjoy what is the most important thing for any company… cash flow!

Source: Ycharts

Apple is an innovative company that has the resources and the will to continue in this path.

AAPL still shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect timing to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

After being given a very low multiple for about 2 years, AAPL seems to be back to its average valuation. Mind you, I think there is still room for a higher multiple considering the current market valuation.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend-growth investor, I’d rather see companies like big money-making machines and assess their value as such.

Here are the details of my calculations:

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $2.52
Enter Expected Dividend Growth Rate Years 1-10: 10.00%
Enter Expected Terminal Dividend Growth Rate: 8.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $389.63 $193.54 $128.23
10% Premium $357.16 $177.41 $117.54
Intrinsic Value $324.69 $161.28 $106.86
10% Discount $292.22 $145.15 $96.17
20% Discount $259.75 $129.02 $85.48

Please read the Dividend Discount Model limitations to fully understand my calculations.

According to the DDM, AAPL currently trades at its fair market value. However, if I had to initiate a position in AAPL, I would gladly do it at fair market value. This is the type of company that will show a great combination of dividend growth and capital growth in the future.

AAPL meet my 5th investing principle but with limited upside potential.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact of whether the company confirms my investment thesis or not. Once the reasons (my investment thesis) of why I purchase shares of a company are not valid anymore, I sell and never look back.

Investment thesis

The company is already evolving to find other sources of revenue to stop being “the iPhone company”. Apple TV, iWatch, Apple Music, and Apple Pay are their most recent innovations. The company continues to offer a great product ecosystem and add more products that can connect to each other. This perfect ecosystem continues to attract more customers away from Androids to connect with Apple products.

Potential Risks

When you look at any “techno stock”, there is always a great risk. What is a premium product (the iPhone) today could become the next joke amongst geeks in the span of 12 months. It happened to BlackBerry (BBRY) and it could happen to Apple at any time.

AAPL shows a solid investment thesis and meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

As previously mentioned in this analysis, AAPL shows a combination of both capital and dividend appreciation. While we are looking at a very solid company, AAPL still evolves in the technology sector. For this reason, AAPL stock could definitely go up or down rapidly upon shocking news. For this reason, I think AAPL would be a better fit in a growth portfolio than in a core one.

AAPL is a growth holding.

Final Thoughts on AAPL – Buy, Hold or Sell?

I’ve been a happy AAPL shareholder for many years now and I would not hesitate to enter into a new position if I was building another portfolio. AAPL is definitely a buy until it goes to a ridiculous value such as $200…

Disclaimer: I do hold AAPL in my DividendStocksRock portfolios.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Where do you find value in this market?

While I’m an eternal optimist, I must admit the current market value is making me a little bit uncomfortable. When you look at the S&P 500 average PE history, we rarely hit above our current PE average. Worst; each time it happened, valuation crashed not too long after.

Data: multpl.com

Should I stop investing? Should I wait? These are questions we all ask ourselves right now. But, in the end, I know something; the market always wins. Betting against the market is a bad idea. Waiting for the market to crash before investing would make me leave a lot of dollars on the table in the meantime (because we don’t know when the market will ever crash!). I have another question for you instead: where do you find value in this market? If you can answer this question, you will not have to worry about investing at an all-time high.

Where to start

Instead of trying to figure out when the market is about to crash, I rather work on finding value. The market is not on sale as it was a few years ago. The easy money is gone but it doesn’t mean you can’t find any interesting companies.

I always start my search with a focus on dividend growing stocks. I’m looking for companies that focus on increasing rewards for investors. Therefore, if I ever run into the bad luck of investing new money right before a market crash, I make sure that I will get well paid to wait until my portfolio recovers. A good start for my research is the dividend achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

I like the Achievers as they count newer dividend growers in their list. Focusing on the Dividend Kings or the Aristocrats limits investors to “old” dividend growers that might now find many growth vectors within their mature business model.

I also pull out an equity search to find strong growers over the past 5 years. A long dividend growth history is nice, but companies that have been able to raise their distribution recently are better. There are currently great opportunities with younger dividend growers such as Disney (DIS), Apple (AAPL) and Starbucks (SBUX).

Beware of the fundamentals

I like to compare the high of bull market to a big wave. When the wave rises, it brings everything on top. If you are in the ocean, you can’t do anything else but follow this huge power. Fishes, shells and even garbage are taken from the bottom and raised to the top. When the economy is doing well, it often happens that even the worst companies show good numbers.

When we look at macroeconomics data, we see unemployment rate is low, inflation is low, rates are low and consumer confidence is… high! This could become a toxic cocktail as consumers have access to cheap money and they tend to buy more stuff since they have a good job and they are confident in the future.

Therefore, when you pull out 5 year history data for many companies, chances are you will find raising revenues and earnings. Debt payments won’t slow down companies as debts are cheap right now. For this reason, I tend to be more demanding and add stronger criterions. For example, I will not accept payout and cash payout ratio over 100%. Ideally, I will even consider only companies showing ratios under 80%. I want to make sure dividend payouts will continue to raise even if the market crash.

My Favorite places to find value right now

As I mentioned earlier, I found that DIS, AAPL and SBUX are currently trading at an interesting price. I’m also adding Lowe’s (LOW ) to this short list. While they are very different companies and are not in the same sector at all, they all share many similarities:

#1 Their dividend yield is low (under 2%) and ignored by many income seeking investors

DIS is paying 1.45% yield, AAPL 1.61%, SBUX at 1.80% and LOW recently passed the 2% mark at 2.09% since the stock lost 9% of its value over the past 3 months. In a low interest environment, income seeking investors are looking for investments to return low yield bonds. Investing in low yield stocks doesn’t really meet their criterion. This is why I feel these companies are being ignored in this bullish market.

#2 Double-digit dividend growths over the past 5 years

While their dividend yield is not impressive, their growth pace is. DIS shows a 15.77% annualized growth rate, AAPL 10.72%, SBUX at 24.08% and LOW at 26.68%. Besides AAPL, they all doubled their payments within the past 5 years.

#3 Their payout ratio is low (under 45%)

After showing such strong dividend growth, I would expect payout ratio to be relatively high. I was pleased to find out that the highest rate was SBUX at 44.40% followed by LOW at 41.62%, AAPL at 27.14% and finally DIS at 25.79%. No matter what happens in the upcoming years, I know those 4 companies will continue raising their dividend as they have lots of room to do so.

#4 Business model generating strong and increasing cash flow

These four companies don’t only show good earnings, but they also show their ability to grow their cash flow from operation year after year. More cash in the bank account also means more cash to be distributed as dividend payment!

#5 They all show strong growth vectors for the future

Disney has created an important growth vector through their movie division. The acquisitions of Marvel and Lucas Film (Star Wars) have created an unlimited box of blockbuster ideas. Their ability to multiply their revenue coming from those movies is quite impressive too. For each movie, there will be multiple gears, toys and apparel sold.

Apple has created a very sticky product ecosystem making Apple customers more fans than clients. While AAPL relies mostly on their iPhone sales to generate their cash flow, their service business (Apple Pay, Apple music, etc.) is growing rapidly.

Starbucks has lots of room to increase its store numbers. But management doesn’t stop there. Through their membership application, the company is able to know what its clients want and modify their offer accordingly. This is how SBUX has improved its menu, store sizes and business hours.

Finally, Lowe’s completed a major acquisition in Canada with Rona last year. I expect it will learn from this experience, generate synergy and eventually go for more acquisitions in the future. LOW has a solid business model in the U.S. and can export it to other countries.

After going through a deep analysis of each company’s business model, I also used a double-stage dividend discount model to value each stock. The idea is to give a value to the future dividend payments. Therefore, no matter what the market is doing, I keep my focus on increasing dividend payments and their value. Those four companies have proven to be traded at a discount value.

What about you? Have you found any undervalued companies right now?

 

Disclaimer: I own DIS, AAPL, SBUX, LOW in my DividendStocksRock portfolios.