Recent Buy: July 13th, 2015
It has been a busy and challenging month for me at my new job, but it’s going well. I was so used to my old gig where I could finish my work in just a few hours and have time to read about the market, write articles and comment on other inspirational blogs all while leaving the office early. That easy gig is behind me now, but who wants to take the easy way out when it limits your full potential? Advancing my pay and building a successful career in television production will take years of my time and commitment just like the dividend growth strategy I’m using for my investments. I’ve come a long way from serving tables just a few years ago, and now I’m proving to myself that I can change my life for the better. I’ve been investing fresh capital into my portfolio every single month since I started this blog over a year ago and, even with my higher than average income, I still have to keep it up for many more long years to reach true financial independence. I say bring it on because I love conquering challenges.
The stock market seems set to climb again after witnessing several days of gains. It’s pure noise as usual for a long term investor like myself. I’m averaging into several businesses over time and hope I never have to sell a position. I’m always on the lookout for those best of class growing companies that raise their dividends each year. One day I’ll use these dividend payouts for all of my daily expenses and claim financial independence once and for all.
I recently initiated a position in Eaton Corporation (ETN) which I recently listed as one of the five attractively valued businesses I want to own. ETN has been on my radar for a long a while and on July 13th, I purchased 22 shares for $66.02 each with a $6.95 commission for a total transaction of $1,459.39. The 3.32% yield on my purchase adds $48.40 to my 12-month forward dividend income for a new overall total of $2,189.08 or an average of $182.42 a month. My objective for this purchase was for safe higher than average current yield, steady capital growth, and a purchase at a fair or undervalued stock price.
Eaton Corporation was founded in 1911 and since then its customers have looked to it for innovative ways to manage electrical, hydraulic and mechanical power more efficiently, safely and sustainably. ETN currently employs over 102,000 people and sells products in more than 175 countries. The company has paid a growing dividend for over 30 years, but sometimes it’ll go a few years without a raise and that’s to be expected in the volatile industrial sector. Eaton operates in five business segments which are Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace, and Vehicles. In 2014, net sales were $22.6 billion which is almost twice the 2010 net sales of $13.7 billion. This growth comes on the heels of some very successful recent acquisitions, and I believe this company’s best days are still ahead.
This is a massive company with presence in many end markets such as Agriculture & Forestry, Aviation, Community Infrastructure, Construction, Data Centers, Energy, Government & Military and Healthcare. This is one of those behind the scenes businesses where you don’t even notice you’re using or seeing their products, but they’re all around you. Eaton Corporation pairs well with my holding of United Technologies (UTX), and I’d love to own even more of their competitors such as Parker-Hannifin (PH) and Johnson Controls (JCI).
A $10,000 investment in ETN 20 years ago would have easily outperformed the S&P 500 and be worth $89,798.85 today. That’s a total return of 798.42% and an average total annualized return of 11.62%.
Revenue has grown from $9.7 billion at the end of 2004 to $22.6 billion at the end of 2014 for a compounded average growth rate (CAGR) of 8.83%. Earnings per share grew from 2.06 to 3.76 for a CAGR of 6.20%. These are solid numbers for a higher yielding and boring industrial stock.
Eaton has a detailed plan for those investors who fear upcoming business challenges due to interest rate hikes and other global events. The annual shareholder letter is a great read and the company highlights several areas where it’s maximizing opportunities in this “new normal” global market.
The business headlines over the last several months have highlighted slowed momentum for many organizations and raised investor concerns—stagnant global growth, tough economic challenges in many emerging nations, unusual volatility in currency and commodity prices, regional political instability and increased regulatory reform. At Eaton, we believe these conditions are unlikely to change. Accordingly, we’ve worked hard to craft a strategy to succeed in these new conditions and to ensure that our execution maximizes our opportunities. ~ 2014 shareholder letter.
The business has been using its cash flow very responsibly over the last few years and shows a debt/capital ratio of just 33%. I’m a big fan of their five acquisitions since 2012 including the largest in Eaton’s history of Cooper Industries. The Cooper integration is ahead of schedule and already providing greater benefits than Eaton anticipated. Intelligent acquisitions are key to the long term survival of a business this size, and Eaton has a fantastic track record.
The long term dividend history is impressive. Even with dividends at a standstill from 1998-2002 and then again in 2009, the 19 year dividend growth rate average through 2014 is an impressive 9.4% and sports a CAGR of 9.1%. This doesn’t even include the recent 12.24% increase realized in March of this year. I’m expecting this growth to stay steady, and the rich but sporadic dividend history gives me comfort should I see any future dividend freezes.
RISKS INCLUDE BUT ARE NOT LIMITED TO:
- Slower economic growth
- Currency headwinds
- Increasing competition
- Supply chain disruptions
Upon initial inspection of ETN’s fast graph, it appears to be slightly undervalued compared to its earnings with a blended P/E ratio of 14.1. It’s also slightly undervalued compared to its 20 year normal P/E ratio of 14.9. (For those unfamiliar with Fast Graphs, when the black current price line moves into the dark green earnings area it indicates the business is undervalued. Here is a basic demo on how to read fast graphs):
Aside from fully understanding a business, I try to invest with some sort of total return expectation which helps me understand whether or not the current stock price is trading at a fair value. Using Chuck Carnevale’s precise return strategy, I’ve gained confidence in my steady capital appreciation investment objective by estimating the following scenarios:
- Analyst Estimates: This calculation uses S&P Capital IQ data to help us predict a reasonable return:
With growth capitalized at a reasonable P/E ratio of 15, I will have witnessed an impressive 12.55% total annualized rate of return through 2017. That’s a gain of $16.66 in price per share and a $5.83 gain in potential prorated dividend income. ETN tends to hit or beat analyst expectations about 75% of the time.
- Historical Compounded Annual Growth Rate (No Analysts): Here, I use the lowest annual earnings growth rate from the last decade which is a 7 year annual return to date of 4.7%:
This shows me a total annualized return of 10.90% through 2017. I’m expecting growth to be higher than that, so I’m in good shape here. For fun, I plugged in the highest percentage growth from the last ten years, which was a 5 year CAGR of 29.2% and I’d end up with an astonishing 84.94% annualized return through 2017. That number was a major outlier though and I don’t expect to land anywhere near it. I’d be very happy to end up anywhere above the 10.90% of the graph I displayed.
- Most Pessimistic Case: This calculation is based on the lowest normal P/E multiple of the last decade which was 14.4 over the last 9 years:
- Most optimistic Case: This calculation is based on its highest premium normal P/E ratio over the last decade which was a 5 year P/E ratio of 16.2:
This is the best calculated return yet at an annualized rate of 15.89% through 2017. That’s a solid return for a stock yielding 3.3%. My investment would double about every six and a half years at that rate which is music to my ears.
Eaton Corporation has all the makings of a fantastic long term investment and meets all of my objectives. I believe it currently trades for a very attractive price, and I’m super happy to be a shareholder. I would love to average down on any future weakness and am looking to jump in again if it falls to around the $62 level. I’m excited to see what Eaton acquires next and can’t wait to watch the new CEO bring Eaton into the next decade.
What stocks are on your radar in July? What are your thoughts on ETN?