Are you feeling a bit giddy right now? Perhaps even a tad euphoric? No one could blame you if you were, given how red hot the stock market has been over the past few months.
S&P 500 & My Phoenix Portfolio’s Top Winners Since March 23rd Low
Right now what some analysts have dubbed the “hopium” rally, driven in part by TINA (there is no alternative), FOMO (fear of missing out) and QE infinity, has led to some of the highest market valuations in US history.
On Forward P/E Basis, S&P 500 Is Approaching Severe Bubble Territory
|Year||EPS Consensus||YOY Growth||Forward P/E||Historical Overvaluation||Consensus CAGR Return Potential By End of Year|
(Source: Brian Gilmartin, Reuters/Refinitiv/IBES/Lipper Financial)
How historic is this hopium meltup?
If the S&P 500 rises just 9.6% more, then it would achieve a forward P/E of 27.3, and set a new record for the most overvalued market in US history.
But just because we’re either in a bubble or rapidly approaching one, doesn’t necessarily mean the market will necessarily correct soon.
- 9% of 12-month returns are explained by valuations/fundamentals
- 45% of 5-year returns are explained by valuations/fundamentals
- 90% of 10+ year returns are explained by valuations/fundamentals
This is why valuation alone cannot be used to time the market with precision or consistency. What higher valuations do tell us is that future long-term returns are likely to be far smaller.
If we exclude the Dot-Com bubble, then the 20-year average blended P/E for the S&P 500 has been 17.0, the market-determined fair value for stocks in the modern era.
If earnings grow as expected through 2022 and the market returns to the value hundreds of millions of investors, risking real money, have determined is long-term fair value, then the consensus return potential over the next 2.5 years is about 3% CAGR.
I define a bubble as when forward two to three-year consensus return potential is zero or negative.
So on a blended P/E basis, we’re not quite there yet, but we’re darn close.
In a market that seems to have lost its senses, and is driven by irrational exuberance and blind hope that nothing bad will happen over the next 2.5 years, why am I still buying stocks?
Even In The Biggest Bubbles Quality Blue-Chips Are Always On Sale
The Biggest Bubble In US History Still Provided Plenty Of Great Buying Opportunities
Foolish momentum traders (myself included at the time) dreamed of 100% annual returns every year.
As a nine-year-old investing my life savings into the tech bubble at the time, I recall asking my mother, with all earnestness “Where will I invest my trillions in a few years?”
Had I chased not mad dreams of fast fortunes but stuck to a disciplined strategy built on the time-tested principles of true wealth compounding, I would be a multi-millionaire by now. Realty Income in March 2000 was trading at 7X FFO, about 50% historically undervalued at the time. Berkshire was trading at similar discounts to its historical book value.
The world then seemed to abandon all sense of valuation and sound risk management, but history ultimately vindicated the Warren Buffetts of the world.
The Market Can’t Stay Irrational Forever
Normally few stocks go up in a bear market, but when prices become extremely detached from fundamentals, quality blue-chips can indeed rise during a historic market crash.
I’m not counting on anything I buy in the short term to go up in an inevitable market decline. Rather, I am counting on the time-tested principles of quality dividend-paying blue-chips, bought at reasonable to fair valuations, and then held for the long term, to help me achieve my goals of financial independence.
5 High-Yield Blue-Chip Bargains I’m Buying In This Red Hot Market
In the coming week, I’m planning on buying small amounts (about $500 in each) of
I buy one good deal or better blue-chip each day, as the “daily Phoenix portfolio buy” announced on the Dividend Kings’ chat board three times each day.
Each buy is small, with the goal of gradually building up my cash/bond allocation (28% right now) by about $1000 to $1500 per month, while waiting for an inevitable market downturn.
- When is that going to start? I don’t know and don’t need to know.
- How long will it last? I don’t know and my plan doesn’t require me to speculate.
- How bad will it be? I don’t know and don’t care, because I have a reasonable plan for ramping up buying to take advantage of great bargains at the time.
Why these five Phoenix watchlist blue-chips? Because even in this overheated market, they fulfill the goals of prudent long-term income investors.
Fundamental Stats On These 5 High-Yield Blue-Chips
- Average quality score: 9.2/11 Blue-chip quality vs. 9.6 average dividend aristocrat
- Average dividend safety score: 4.2/5 above-average vs. 4.6 average dividend aristocrat (about 5% dividend cut risk in this recession)
- Average payout ratio: 64% vs. 64% industry safety guideline
- Average debt/capital: 67% vs. 52% industry safety guideline vs 37% S&P 500
- Average yield: 5.4% vs. 1.9% S&P 500 and 2.3% aristocrats
- Average discount to fair value: 26% vs. 52% overvalued S&P 500
- Average dividend growth streak: 12.4 years vs. 25+ aristocrats, 20+ Graham Standard of Excellence
- Average 5-year dividend growth rate: 7.8% CAGR vs. 8.3% CAGR average aristocrat
- Average long-term analyst growth consensus: 6.1% CAGR vs. 7.1% CAGR average aristocrat, 5% to 7% CAGR S&P 500 historical norm (thriving companies)
- Average forward P/E: 12.1 vs. 24.9 S&P 500
- Average earnings yield: 8.3% vs. 4.0% S&P 500
- Average PEG ratio: 2.0 vs. 2.74 historical vs. 2.93 S&P 500
- Average return on capital: 254% (93% Industry Percentile, Extremely High Quality/Wide Moat according to Joel Greenblatt)
- Average 13-year median ROC: 167% (improving moat/quality)
- Average 5-year ROC trend: +6% CAGR (relatively stable moat/quality)
- Average S&P credit rating: A- vs. A- average aristocrat (2.5% 30-year bankruptcy risk)
- Average annual volatility: 23.3% vs. 22.5% average aristocrat (and 26% average Master List stock)
- Average market cap: $74 billion (large-cap)
- Average 5-year total return potential: 5.4% yield + 6.1% CAGR long-term growth + 6.2% CAGR valuation boost = 17.7% CAGR (13% to 23% CAGR with 25% to 30% margin of error)
- Probability weighted expected average 5-year total return: 7% to 19% CAGR vs. 1% to 4% S&P 500
These five blue-chips are some of the highest quality dividend payers in the world, as seen by their average credit rating of A-, stable outlook.
S&P and other rating agencies base ratings on formulas that calculate historical default risk based on initial ratings.
And since bond defaults often result in bankruptcies, these are highly correlated with long-term bankruptcy risk for companies.
(Source: The University of St. Petersburg)
The probability of these five companies going to zero is about 2.5% each. The probability of all five of them going bust within the next 30 years, is about 1 in 102.4 million. Granted that’s assuming a normal probability universe, which we don’t live in.
But the point is that these five high-yield blue-chips meet all three criteria of prudent long-term income investing.
- Preservation of capital: low risk of permanent loss of capital, very low risk of bankruptcy and prices going to zero
- return of my capital: 5.4% safe yield today growing about 6% CAGR over time according to the analyst consensus = approximately 32% of capital returned through dividends in five years
- return on my capital: very strong, probability-weighted mid-range expected total return: 13% CAGR vs. 2.5% for S&P 500
Think I’m being overly bullish about those probability-weighted estimates? Take a look at these companies’ consensus return potentials through 2022.
That’s estimated by taking the 2022 EPS consensus and assuming each company returns to its long-term, historical market-determined fair value multiple during periods of similar fundamentals and growth rates.
(Source: F.A.S.T. Graphs, FactSet Research) Now compare that to the S&P 500, and the horrible consensus return potential investors just buying the broader market, blind to dangerous valuations, might see in the short term.
S&P 500 2020 Consensus Total Return Potential
(Source: F.A.S.T. Graphs, FactSet Research)
S&P 500 2021 Consensus Return Potential
(Source: F.A.S.T. Graphs, FactSet Research)
S&P 500 2022 Consensus Return Potential
In case you think that “this time is different” and that the market’s earnings multiple will be permanently higher due to low-interest rates, and future debt-fueled stock buybacks, consider this.
Since 2009 we’ve had all the same conditions that are expected to continue in the future.
- Fed buying back a lot of bonds, injecting trillions worth of liquidity into financial markets.
- slower baseline economic growth of 2% to 2.5% resulting in low inflation expectations and interest rates remaining at historically low levels for the foreseeable future.
- Record corporate buybacks often funded with debt issued at record low-interest rates.
What was the market-determined fair value blended P/E during this time? 19? 20? 25?
Average Blended P/E Over Last 11 Years Was 17.0, Exactly The Same As The 20-Year Average
(Source: F.A.S.T. Graphs, FactSet Research)
Low-interest rates and copious buybacks didn’t inflate the market-determined fair value of stocks above its long-term modern era historical norm, and likely won’t do so in the future either.
Now compare the S&P 500 on the 3 goals of prudent long-term income investors.
- Preservation of capital: excellent, virtually zero chance of losing money…as long as you can wait long enough (corporate America can’t go bankrupt other than in an apocalypse)
- Return of your capital: very poor, paltry 1.9% yield likely to grow about 6.5% CAGR = approximately 11% of capital returned through dividends in five years
- Return on capital: Poor, short to medium-term potentially negative capital gains, and long-term low to mid-single digits vs. 7% to 9% CAGR historical S&P return
The goal of prudent long-term investing is generating sufficient returns and income to achieve your personal goals while taking the least amount of risk possible.
Am I claiming that AbbVie, Scotiabank, Bank of Montreal, Philip Morris, and MDU Resources are going to keep rocketing higher as they have in the past few months?
These 5 Stocks, S&P and Dividend Aristocrats Since March 23rd
Of course not, that was potentially a bear market low. The short-term gains you see after bear market lows are, in the words of Ben Carlson, “epic face-ripping rallies.”
However, I’ve not focused on the short term.
My long-term goal is achieving financial independence with quality companies, run by competent and trustworthy management, that are paying me generous, safe, and steadily growing income in all economic and market conditions.
Dividend Sensei’s Real Money Phoenix Portfolio Bucket
(Source: Morningstar) -28% cash/bond allocation not shown
Like my fellow Dividend King, Nick Ward, I divide my retirement portfolio into buckets. This is my Phoenix bucket, made up entirely of Dividend Kings Phoenix Portfolio daily buys that we make each day.
In a world of unprecedented pandemic, economic and earnings uncertainty, with risks to the market rising on a daily basis, I sleep very well at night knowing my hard-earned savings are entrusted to the skilled management at these financially strong companies.
Is a market downturn coming at some point? You better believe it.
Will I lose sleep when it arrives? No, because my long-term financial goals don’t rely on luck, but uses sound and time-tested risk-management and long-term investing principles to create my own luck.
In 24 years of investing experience, I’ve learned what doesn’t work, trying to get rich quickly.
In 6.5 years as an analyst, I’ve learned what does work, which is making, in the words of Charlie Munger, “consistently not stupid” decisions.
Let the market blow its hopium/TINA/FOMO/QE Infinity Bubble. Perhaps we’ll even set a new record in terms of historical overvaluation.
At the end of the day, those whose savings are safety ensconced in a bunker SWAN portfolio have nothing to fear from the future, nor do we need to have crystal balls to meet our long-term goals.
—————————————————————————————-Dividend Kings helps you determine the best safe dividend stocks to buy via our Valuation Tool, Research Terminal & Phoenix Watchlist. Membership also includes
- Access to our five model portfolios
- Daily Phoenix Portfolio Buys
- 30 exclusive articles per month
- Our weekly podcast
- 20% discount to F.A.S.T. Graphs
- real-time chatroom support
- exclusive weekly updates to all my retirement portfolio trades
- Our “Learn How To Invest Better” Library
Click here for a two-week free trial so we can help you achieve better long-term total returns and your financial dreams.
Disclosure: I am/we are long ABBV, BNS, BMO, PM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Dividend Kings owns ABBV, BNS, BMO, PM, and MDU in our portfolios.