One of the biggest myths about investing in the stock market is that it’s just the same as gambling. Especially in my home country (Germany) this is still a widespread misbelief. According to the latest data, just about 10% of the Germans own stocks in some capacity, whether by directly investing in companies or through a mutual fund. This is an incredibly low portion. We even have a special word that reflects the aversion of owning shares: “börsenscheu”. Literally “market shy”. Many people I talked to still condemn stock market investments. It’s a pity, since owning a basket of high-quality shares is the single best strategy to build wealth over time.
Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas
To be clear: investing into stock market always carries a certain risk. No doubt about it. However you can minimize this risk. How? Simply by staying away from the losing game of trying to buy low and sell high. Rather choose a long-term investment horizon (more than 10 years) and focus on “boring” blue-chip companies. Personally, I picked one of the most boring investment styles available: dividend growth investing. This implies buying and holding businesses that reward their shareholder with an ever-raising payout. There is no excitement and it’s not going to make you rich fast. But when applied consistently, it will build you a good cash flow stream over time.
There are no “sure” things in life and they don’t exist in investing, either. However those people, who want to identify investments that are as close to sure things as possible, the defensive sector is a good point to start. Below is a snapshot that shows the sector allocation of my portfolio (compared to S&P 500).
As you can see, there are three sectors that are considered to have a defensive nature: consumer defensive, healthcare and utilities. Above all, companies from these segments have reliable cash flows. Think about it, even when the economy slows down and a recession begins, we most likely will continue to consume food, medicine and electricity. Sure, these investments may not go through the roof, but they will deliver a stable performance for the long haul. That is why I consider such holdings to be the core of my portfolio.
As the utility sector is still missing in my stock basket, I’ve been looking for a good candidate from this field. Luckily the search was rather short-lived. In the December watchlist I’ve introduced Dominion Energy (D) as a potential acquisition for January 2019. Dominion Energy has been quite popular among the DGI community lately. No surprise. D has proven to be a great investment – especially in volatile times. Beyond that, the juicy combination of high dividend yield and above average dividend growth is just hard to ignore. After examining the quality and valuation data, I have decided to pull the buy trigger here.
On January 11, I have purchased 23 shares of Dominion Energy (D) for a total investment of €1,408.28 ($1,612.48).
Dividend Yield: 5.25% | 5-yr. Dividend Growth Rate: 9.60% | Payout Ratio: 68% | Consecutive Dividend Increases: 15 years
D’s dividend resume looks solid across the board. A forward yield north of 5% combined with a 5-yr. dividend growth rate close to 10% is just outstanding. It’s hard to find a business that offers a comparable combination of these metrics. In December the board of directors has announced a dividend hike of 10%. The new quarterly dividend of $0.9175 (per share) will be payable in March 2019.
I assume that D will need to deliver good earnings and revenue results to be able to grow the dividend at such a high rate in the future. But first, let’s have a look on the past growth performance. D has increased its earnings per share from $3.05 in 2012 to $3.60 in 2017. This is a CAGR of 3.37%. In the same period the revenue was basically flat: $12.84 Bil. VS. $12.59 Bil.. Not much excitement here. But also nothing to worry about. Remember, an investment in the utility sector is defensive in its nature. We don’t expect rapid growth but rather stable earning and cash flows development. Truly it is about watching paint dry or grass grow here. Slow but steady.
Dominion Energy averaged an operating margin of 28.47% and a return on equity of 15.06% over the course of the past five years. These are quite strong results. Beyond the pure figures, I like to see a positive trend over time. D does not disappoint here as well. Both, the operating margin and the return on equity show a positive trend considering a five-year horizon.
Overall, Dominion Energy has strong quality characteristics. Morningstar, an independent investment research company, awards D a wide-economitc-moat rating. This is the best rating grade possible. An operation that has a wide-moat can fend off competition and earn high returns on capital for many years to come. Beyond that, Standard & Poor’s assigns D with a decent BBB+ credit rating. Summing up, we are looking at a great defensive investment opportunity that has some attractive quality aspects.
The next step is to examine whether the shares are attractively priced. There are many different methods to do it. Some are focusing on the historical value calculations, whereas other refer to future value calculation. However all of them have one aim in common: determining the fair value estimate. Looking at the historical value calculations, D’s share price appears to be undervalued.
FastGraphs’ forecasting tool shows a current P/E ratio of 17.1, compared to the normal 5-Yr. based P/E ratio of 20.5. We can derive the degree of undervaluation by relating both figures: 17.1/20.5 = 0.83 (Price/Fair Value ratio). D is 17% undervalued based on its own historical prices. Surprisingly Morningstar, that uses the DCF approach, comes to the exact same result. The investment research house awards D a four-star rating with a fair value of $84.
For my final valuation result I simply use an arithmetic average of four different valuation methods. So running the number I get a Price/Fair Value ratio of 0.88. This implies that Dominion Energy is 12% undervalued.
Dominion Energy qualifies as an attractive investment opportunity. Especially risk-averse investors might find a lot to like about this well-run utility business. Its reliable cash flows offer a good protection in case of an economical slow down. Beyond that, investors can enjoy an above average dividend yield that grows at a relatively high rate. While such a high growth rate is hard to maintain in the long run, I still expect D to raise its dividend but at a more moderate speed.
Let me know about your thoughts on D. What are your favorite long-term picks from the defensive sector?