MP Market Review – August 16, 2024

This month’s edition of the ‘Timely Ten’ brings both familiar names and a notable newcomer to our lineup of the top ten most undervalued companies from ‘The List,’ as determined by dividend yield theory.

While many of the ‘Timely Ten’ remain unchanged from last month, there’s a significant switch: Canadian National Railway has replaced TC Energy Corp., which surged 18% recently and dropped out of the top ten. For those who conducted their due diligence and invested, it’s been a rewarding journey. We strategically added TC Energy Corp. to our model portfolio following our three-dot rule, exercising patience as the market eventually caught up to our insights. The wait was worth it.

Among the group, Canadian National Railway and TD Bank stand out as the highest-quality companies deserving of further analysis. Both are currently navigating short-term challenges, yet their strong historical fundamentals suggest they are poised for long-term success. We have used two dots on each, so we are being a bit more selective as we consider our final allocation.

The rest of the ‘Timely Ten’ have been regulars on the list, indicating that their challenges might take longer to resolve. This reinforces our commitment to continuously monitoring all companies on ‘The List,’ as we aim to avoid tying up capital for extended periods in favor of seizing better opportunities in quality companies that have temporarily fallen out of favour.

Here’s a recap on how we select our ‘Timely Ten’:

Step three in our process involves monitoring our quality dividend growers regularly, which can become quite challenging depending on the number of companies we track. Fortunately, we rely on ‘The List’ instead of the vast array of stocks in the index, which streamlines our task. Nevertheless, we continually seek methods to enhance our efficiency. Through dividend yield theory, we’ve discovered an approach that has proven remarkably effective in aiding us with our efforts over the years.

Dividend yield theory is a simple and intuitive approach to valuing dividend growth stocks. It suggests that the dividend yield of quality dividend growth stocks tends to revert to the mean over time, assuming that the underlying business model remains stable. In practical terms, if a stock pays a dividend yield above its ten-year average annual yield, its price will likely increase to return the yield to its historical average. Knowing that price and yield go in opposite directions, this theory helps us find stocks poised for a positive price correction.

We have pre-screened our candidates using the criteria we initially laid out in building ‘The List’. This helps us considerably narrow the universe of investable stocks.

1. Dividend growth streak: 10 years or more.
2. Market cap: Minimum one billion dollars.
3. Diversification: Limit of five companies per sector, preferably two per industry.
4. Cyclicality: Exclude REITs and pure-play energy companies due to high cyclicality.

Next, we rank ‘The List’ by how significantly each stock is priced below its fair value (Low Price), as calculated using dividend yield theory. To determine fair value, divide the current dividend by what you consider to be the stock’s historically high yield.

All companies above the thin black line have a current price below fair value (sensibly priced). The stocks above the thick black line make up our ‘Timely Ten’.