No. of Recommendations: 19
A common analogy in value investing is the concept of "swinging at juicy pitches," of waiting for an excellent opportunity to come along. The opportunity, of course, is to buy a company for well below its fair value, "hitting a home run" once the market realizes that it had inadvertently thrown out a great company at fire sale prices and corrects the problem by adjusting the price upwards.

It's a great concept, and one I try to put in practice whenever practical. I would always like to buy that $1.00 of value for $0.50. The problem is that the juicy pitches are often few and far between. A true value investor would rather sit on cash than invest in a company that it not a value proposition.

I am not a true value investor. I have a wife. I have a day job. I have a house. I have family, friends, and extracurricular activities. I only have a limited amount of time I can spend on investing, and as such, I run the risk of striking out by missing the juicy pitches that might be tossed my way while I am not looking. I have profited quite well from those juicy pitches where I have been paying attention and swung. Because the obvious juicy pitches are obvious to everyone, however, the opportunity to swing at them is often limited to a short time window. The louder a stock screams "Buy me, stupid!", the more people will likely take it up on its offer, raising the price and reducing the quick profit potential for new investors.

If a juicy pitch happens to find me while I am actively looking, then I will swing at it and invest in the company. Where I differ with value investing, however, is with what to do when there are no obvious juicy pitches. Baseball pitchers have a wide range of pitches they can throw - fast balls, curve balls, sliders, breaking balls, etc. There are far more pitches thrown that are strikes than there are juicy pitches that are easy to hit. Value investors will let ordinary strikes pass them by on the quest for a juicy pitch. I don't. If it is a pitch anywhere in my strike zone, I will swing at it and buy a fraction of the company. I'm willing to buy $1.00 for $0.80, $0.90, or even $1.00. Additionally, rather than wait on the potential of a juicy pitch, I would rather be invested in a fairly priced company that will actively pay me for owning it and carries with it a decent likelihood of solid appreciation and potentially higher paydays to come.

There may be few true value plays in the market, but there are companies out there that are within a price range that would be considered approximately fair value. A few of those fairly priced companies are of the type that are growing their dividends regularly, supported by growth in the underlying businesses. So what if I can't pick the absolute bottom of a stock's chart? So what if I paid $0.98 or $1.00 or even (heaven forbid) $1.02 after commission for that dollar's worth of company? So what if I currently show small capital losses in the last two companies I've partially bought? I am getting paid a small, but potentially ever increasing paycheck for doing little more than sitting still and assuring that those companies are not fundamentally changing for the worse. And while I sit, presuming those companies' dividends and underlying businesses continue to grow over time, the value of those companies' stocks should also rise, which should provide a decent long run capital gain.

If there is a pitch in my strike zone, I'll swing at it. I'd rather risk the boring life of hitting mostly singles and doubles than regularly strike out while waiting for the perfect home run pitch. I'd rather invest in fairly priced dividend growth companies with decent long run prospects than wait in cash for the perfect value company that I will probably miss, because I couldn't react quickly enough. I'll swing at those strikes, and if a strike I'm swinging at happens to be a juicy pitch, then all the better.

Buying dividend growth companies at fair prices - that's my definition of swinging at strikes.

-Chuck
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I'd suggest you take a look at NFI & IMH. Both will do ok in a rising interest rate market & will compensate you for the risk you take.
Don
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No. of Recommendations: 5
Chuck....
you are going down the wrong logic path that many value investors go down. Good Mr Buffett said we're s'posed to find companies where the cash flow just goes up and up year to year...
he said
Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.

do you do that?

"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.

is that what you are doing?

Put together a portfolio of companies whose aggregate earnings (read dividends) march upward over the years, and so also will the portfolio's market value

is that what you are doing???

well then!!!
WELCOME HOME MR VALUE INVESTOR!!!

now quit straining at gnats, admit you're following a perfect value investing strategy, kiss your wife, and go to bed

e

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e,

Thanks for the diagnosis, doc...

When can I expect the bill?

And do you take my insurance? (Probably should have asked that one first!)

-Chuck
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Hi Don,

I'd suggest you take a look at NFI & IMH. Both will do ok in a rising interest rate market & will compensate you for the risk you take.

What about those two companies do you like that set them apart and above the rest of the m-REIT business? Do you own either or both of them? Mortgage REITs in general are not expected to do stellarly during a rising rate environment, as their costs of carry may increase faster than the rate adjustments to their clients. In addition, rising rates slow down the lucrative refi business and make existing, lower priced mortgages less valuable assets. I have no doubt that well managed Mortgage REITs will survive the uptrend in interest rates and some may even do quite well. I just don't think a rising rate environment is exactly the easiest business climate for m-REITs.

Help me understand what is so special about those two companies, and I may consider switching my existing M-REIT holdings to those.

-Chuck
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Both companies have hedged against rising rates. Look at 10Q from IMH - they should actually make more money because of the latest 25 basis point rise. They give the figures in the 10Q.
NFI, suggest you give www.nfi-info.net a good reading or check Yahoo's board only for HHill's posts.
Both are not your typical MREIT.
Don
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I'd rather not swing for the fences - you hit homers but you strike out a lot as well. I'd much rather get on base. I want consistency not streaks. I'd rather be a Rod Carew than a Mark McGwire. When it comes to investing, striking out too much is not good. Aside from the wallet impact, one isn't likely to stay with it for long in a bad streak. If I'm looking for consistency in my results, then it follows that I should look at companies that have shown consistency over the long run, ie, over a number of economic/interest rate cycles.

I get around the demands on my investment time by creating a universe of stocks I'd like to own (any of the decent screening tools will allow you to do this). Then I look at each with my software to determine if they have the consistency & growth characteristics that I want. I determine at what PE and yield, they would be cheap. Then I set up price alerts at a website I use to send me emails whenever the alert is hit. I update my analysis when quarterly earnings come out. For four weeks out of 52, there are demands on my time but I use tools to minimize the time and to keep me focused.

If nothing on my list is cheap, I'll sit in a short term bond fund collecting interest and preserving capital. I've been sitting since early 2003. Being a value investor (that's what a dividend growth investor is) requires lots of patience. It's tough at the beginning because we all tend to focus on gains. But the focus starts to shift as the income growth becomes evident. You become less focused on being McGwire (gains) and more on Carew (growing dividends with accompanying gains).

Mike
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HHill recent post in response to a question:

"Re: HHill, What happens in a couple of y
by: hhill51 07/08/04 08:34 am
Msg: 178514 of 178516

<< won't there always be enough steepness in the yield curve to allow NFI to continue to generate reasonably consistent earnings and dividents even in a gradually rising interest rate envirement?>>

Actually, the steepness of the yield curve is a minor factor in NFI's success. Their typical loan is fixed for two years, and then floats at 600 or more over 6-month LIBOR. Their financing floats 50 over 1-month LIBOR. Those two rates seldom, if ever, get inverted and stay inverted by any meaningful amount. The steepness of the yield curve enters the picture in the form of competing fixed-rate lending. If the fixed 30-year mortgage for subprime credits was 8% while L+600 was 10%, then more people would choose the fixed rate loans, which are more expensive to swap into floating rates.

NFI makes its spread on a (mispriced) credit curve. That credit curve charges a premium of 400 basis points for poor credit, even though this pool of borrowers only gives the lender around 100 basis points per annum of credit losses. That is the essence of where the profit will come from, no matter what shape we have in the Treasury yield curve."


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Getting back to the baseball analogy...

I tend to agree that a high average is better than "swinging for the fences" (and striking out a lot. I wonder...

Would dividends be like walks (achieved by a patient hitter)?

Would dividend increases be like a (faster) pinch runner? (And what about earnings increases?)

Would stock splits be like hits with runners in scoring position (RBIs)?

Would accumulating shares be like on-base percentage?

Would acquisitions/mergers be like getting a top player in a trade?

And what the heck (gasp) is the equivalent of a sacrifice???
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Hey BF

I agree with this approach completely. A few hours ago I bought a stock which fits this philosophy. Bank of America (bac).I am reasonably confident the current 4.2% dividend, earnings and stock price will increase over the years. Definitely a buy & hold for me.
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And what the heck (gasp) is the equivalent of a sacrifice???

Maybe something like a covered call.

Grasping at straws.

jobeare
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BAC is 2.15% or so. Where did you get 4.2?

nmckay
who's very interested at 4.2
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Actually, the yield on BAC is currently 4.31%...

http://finance.yahoo.com/q?d=t&s=BAC

The quarterly dividend was recently increased from 80 to 90 cents/share (pre-split), or $3.60 annually. Apparently, TMF has jumped the gun on halving it. (The split doesn't occur until August 27, at which time the quarterly dividend would become 45 cents/share, but the share price would also be cut in half, keeping the yield at 4.31%.)
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TMF isn't the only one. I also saw the same incorrect yield at cbs.marketwatch.com, cnnmoney.com, and several others. Apparently, some databases have already been updated to show the split dividend ($0.45/share). (Or all those sites are using the same database.) Odd.

Ken
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Hi spankyone,

A few hours ago I bought a stock which fits this philosophy. Bank of America (bac).
I beat you by a few hours, I think, but welcome aboard! See: http://boards.fool.com/Message.asp?mid=19776382

-Chuck
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Thanks for setting me straight.

nmckay
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Hey Babyfrog

I beat you by a few hours, I think, but welcome aboard! See

You might want to take a look at Regions Financial (RF). They recently merged with Union Planters. Increased quarterly dividend to .41, which at today's close of 30.20 = 5.4%. Value Line gives them a 2 for safety and has generally good things to say about them. I'm thinking seriously about it.
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addendum to above post.

Hold off on that juicy 5.4% dividend. Further research reveals RF paid an additional 8 cents dividend related to merger with Union Planters. If previous 33 cent dividend holds, yield will be 4.4% at current quote of 30.00 share. Sorry about that
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According to the Dividend History at Regions' website...
http://phx.corporate-ir.net/phoenix.zhtml?c=65036&p=irol-dividends

...it does appear that the (higher) 41-cent per share dividend is now the regular amount. They paid both 33-cents and an additional 8-cents on 4/1, but paid a full 41-cents on 7/1.
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I get around the demands on my investment time by creating a universe of stocks I'd like to own (any of the decent screening tools will allow you to do this). Then I look at each with my software to determine if they have the consistency & growth characteristics that I want. I determine at what PE and yield, they would be cheap. Then I set up price alerts at a website I use to send me emails whenever the alert is hit. I update my analysis when quarterly earnings come out. For four weeks out of 52, there are demands on my time but I use tools to minimize the time and to keep me focused.

How does one set up these price alerts?
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How does one set up these price alerts?

Go to Yahoo--Finance
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Hi Chuck

I am fairly new to investment, but I follow MF's picks and buy occasionally. You talk about dividend growth companies in your post. How do you decide whether the present value of those dividends constitutes growth, and how do you discount them? And what sort of time frame for holding do you use when making your decision? I can see that buying at 80 cents now for an estimated retreival of $1 after one year makes sense. How do you calculate the return? Are you using just dividend growth or are you including in your model capital growth (increase in share value)?

My questions are not frivolous. I have read a great deal about value investing on MF's boards, and it makes a lot of sense. But I have yet to see a formula other than those in the finance textbooks that anyone actually uses.

Off the subject a little, but still I think within the "strike zone", MF talks a lot about free cash flow. I have checked company information on MSN Money, and the cash flow statements for listed companies always include free cash flow at the bottom line. In some cases (GM, for example), it is negative. Do you use free cash flow when valuing stocks, and, if so, could you tell me what it really is?

Peter
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I get the analogy and am looking for the next good pitch. thx Chuck
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Hi Peter,

You talk about dividend growth companies in your post. How do you decide whether the present value of those dividends constitutes growth, and how do you discount them?
The dividend discount model is a stock valuation model that predicts the value of a company to be the net present value of expected future cash flows to shareholders, aka, future dividends. My initial stock screen includes an equation based on that model, to find companies where the current yield plus recent historical dividend growth rate exceeds twelve percent. Based on a derivation from the long run, steady-state dividend growth model, that equation screens to find companies where there is a decent chance of there being an expected return of at least 12% annually, though the screen alone is merely a starting point, not a be-all and end-all decision point.

For my screen, I use Reuters' "power screener" stock screening tool. There is a parameter called "{Div3YCGr%}" that measures the compound growth rate of dividends over the past three years. See http://boards.fool.com/Message.asp?mid=20695471 for more details and more information of the whys and hows behind that first-cut screen.

Once I have the screen results, I go to http://www.freeedgar.com to research the SEC filings for the companies that look most interesting. From there I see whether the historical growth rates look steady, whether there are indications as to if the dividend growth could be sustained into the future, and whether there are any nasty surprises waiting down the pike, like a potential channel stuffing issue.

If the books look clean enough, I look at the company's web site, look at news reports, and try to qualitatively (aka 'gut feel') judge if the company really looks decent and has a potential to continue to grow its dividends sustainably over time. If the quantitative analysis (the screen, the SEC filings investigations, and the projections) looks good, and the qualitiative analysis (the gut feel) looks good, then I'll be willing to buy a company.

How do you calculate the return?
If I buy a fraction of a company for $1000, plus a $7 commission, then I've spend $1007. If a year later, that stake in the company is worth $1100, plus I've recieved $20 in dividends from that company, then my total return is (($1100+$20)-($1007))/($1007) = 0.1122 = 11.22% in a year. That is, of course, before taxes. I hope each of my companies provides me a positive return, but often some exceed my expectations and some do not match my expectations. I look less at the return of each position than I do at the return of my entire portfolio, because I rely on diversification to protect me from single stock failures. See http://boards.fool.com/Message.asp?mid=21013628 for why that's so very important to me.

And what sort of time frame for holding do you use when making your decision?
In general, I look to dividend growth companies to be hopefully essentially 'forever' holdings. As long as a company can continue to grow its dividends sustainably, if the company is fairly valued, the growth in dividends should drive capital appreciation over time, thereby providing me with a decent long run total return. I hate excess portfolio friction (the costs of commissions and taxes associated with trading), so if I can avoid that while still making a decent return over time, I will do so.

In reality, once a quarter, I look at the companies in my portfolio and see if any of them need to be pruned because their future does not look bright enough to justify holding those companies any longer. Because I've learned to look for warning signs that appear in financial statements (like cash flow shrinking while earnings grow, or accounts receivable growing faster than revenues), through that quarterly review, I hope to be able to avoid troubles that creep into companies but get buried for a quarter or a year or so before being announced.

Are you using just dividend growth or are you including in your model capital growth (increase in share value)?
Over time, companies that grow their dividends sustainably should see their stock prices grow in line with the dividend hikes. Take a company that is currently paying $1.00 per year in annual dividends and is expected to grow those dividends 10% per year, "forever". For an investor with a 12% required rate of return, the long run dividend growth model predicts a value for the company of $1.00/(0.12 - 0.1) = $1/(0.02) = $50. One year later, the company's dividend is expected to be $1.10. If the company is still expected to grow its dividends at 10% per year and the investor still has a 12% required rate of return, then the long run dividend growth model predicts a value for the company of $1.1/0.02 = $55. As long as the dividends and the growth of those dividends are sustainable, the dividend discount model predicts that that dividend growth will drive share price appreciation.

Share price appreciation plus dividend payments equals total return... So while my model focuses on the payment and growth of dividends, it predicts that over time, the growth of those dividends will drive share price appreciation. This is the essence of dividend growth investing.

It is not a short run model, nor does it predict immediate positive returns. Often, the companies I buy stagnate and/or fall shortly after my purchase. Over time, if the companies' businesses meet and/or beat my sustainable dividend growth expectations, they tend to do quite well. See http://boards.fool.com/Message.asp?mid=20932438 and http://boards.fool.com/Message.asp?mid=20834492 for details. And if they don't meet those expectations, the combination of portfolio diversification and the quarterly review help me minimize my catastrophic losses.

Do you use free cash flow when valuing stocks, and, if so, could you tell me what it really is?
"Free Cash Flow" is the money left over after running the business, acquiring and divesting units, paying back or taking on debt, etc. It is a useful 'smell test' metric, because if a company's free cash flow is negative, dropping, or not rising about in line with its earnings, there is a very real chance that there is some (legal) accounting manipulation going on to juice the earnings in the short term. If the net free cash flow numbers do not look good, it doesn't necessarily turn me off of a company, but it does make me look deeper, to find the "free cash flow from operations" numbers and make a judgement based on those. Often, debt changes, acquisitions, infrastructure expansion, divestitures, or other financial moves will alter the overall "free cash flow" numbers, but the "free cash flow from operations" numbers helps determine the overall health of the ongoing operational business.

The list of accounting gimmics that companies can use to juice earnings in the short term is quite long. It is a lot tougher to juice free cash flow and free cash flow from operations.

My questions are not frivolous.
I am honored that you came here to ask your questions. They are certainly not frivolous. I hope that you continue your journey here and continue to learn.

I have read a great deal about value investing on MF's boards, and it makes a lot of sense. But I have yet to see a formula other than those in the finance textbooks that anyone actually uses.
Investing is part art, part science, part number crunching. The textbook equations are quite useful for starting grounds, and they can help you avoid the most obvious mistakes. In reality, you need to build a model that you like that you can stick with. Nobody, not even Warren Buffett, is right 100% of the time. And in the stock market, even if you're right in the long run, the market can certainly move against you in the short run. It is important to have a robust methodology, have conviction in it, and to be honest and objective in your analysis. Otherwise, you run the very real risk of "buying high and selling low" based on short term market moves that may be contrary to fundamentals.

Best of luck to you. Please check back with us and tell us how your investing style evolves over time.

-Chuck
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Hi Chuck

Thanks a lot. You gave a lot more attention to the answer than I was expecting, and a really useful set of principles. Many thanks

Peter
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