Don’t Capitulate…Instead, Appreciate Dividends!

Guest post by Nick Ward

I usually try to avoid single stock discussion in these Durable Dividends articles because I want this series to be focused on higher level, strategic, and educational content when it comes to the dividend growth investing strategy.  

However, this week, I will be zooming in on a couple of specific stocks because of their recent share price movement and lessons that investors can learn from it.  

The stocks I’m talking about are Bristol-Myers Squibb (BMY) and British American Tobacco (BTI).  

I own both of these stocks in my personal portfolio.  And, these are both stocks that are regularly discussed amongst subscribers at a couple of Wide Moat Research’s premium services: The Dividend Kings and The Intelligent Dividend Investor.  Therefore, I suspect that many investors will be interested in the recent rallies that both of these blue chip dividend growth stocks have experienced throughout 2022 thus far and the wisdom that can be derived from their recent storylines.  

It seems like every week when I put these Durable Dividends articles together, I’m touching upon the subject of fear and greed and how falling prey to these two emotions tends to result in poor performance for the average investor.   

I’m sorry if I sound like a broken record to you in that regard; however, the fact of the matter is, if I can hammer home just one idea with this series, it is to avoid emotion, stay rational, and above all else in the markets, maintain a strict and disciplined focus on stocks’ underlying fundamentals.  

I am a value investor, so I believe that fundamentals should (and given enough time, will) dictate share price performance.  

I’ll be the first to admit that the market is not totally efficient and therefore, many assets are mispriced, especially in the short-term.  

As I’ve said many times before, this is due to the fact that sentiment drives prices in the present.  Only with enough time to reflect on its reactive follies does the market correct itself and revert towards the mean.  

And it can be hard to maintain a focus on fundamentals when a stock’s price performance continually goes in a different direction than you believe the underlying data says that it should.  

The market’s inefficient is a constant test of the value investors’ discipline and patience.  

I get it…believe me.  

But, an efficient market can also present attractive opportunities…

With that in mind, I wanted to highlight recent share price moves from both BMY and BTI.  

These are a couple of unloved stocks, which were recently beaten down by what I considered to be irrational fear, creating buying opportunities.  

Throughout their sell-offs, I continually highlighted my fair value estimates for both stocks to subscribers.  I even recently posted a video to my public YouTube channel which performed a deep dive on Bristol-Myers because I saw a lot of fear developing around the stock on The Dividend Kings chat board and I wanted to shine a light on why I continued to believe that BMY offered one of the most compelling bullish theses in the entire market.  

Simply put, I hated the idea of people capitulating to the fear surrounding these stocks and throwing in the towel prematurely.  

I’m all for exiting a position if and when the fundamental thesis breaks.  Doing so can be painful (no one likes locking in losses); however, the fact is, no one is perfect, sometimes we get things wrong, and without the benefit of a working crystal ball, every investor is going to place a losing bet or two.  Pulling out of a losing bet can limit further losses.  But, it’s my belief that we should let the fundamentals influence these types of sales…not fear.  

You see, from late August when Bristol-Myers made its current 52-week high of $69.75 to its recent lows in the $53 area in early December, BMY shares fell more than 23%.  However, there didn’t appear to be a fundamental catalyst for this sell-off.  

BMY management did not provide a negative update for future guidance during this period.  BMY beat Wall Street’s estimates on both the top and bottom lines during its Q3 report in late October.  During that report, Bristol-Myers’ leadership maintained its forecast for $45-$50 billion in free cash flow during the 2021-2023 period.  And several times since during investor presentations, BMY’s executives have maintained this guidance.  

While it’s true that BMY has several significant patent cliffs coming up over the next 5 years or so, this should not have been news to anyone.  Furthermore, the company continues to highlight the strength of its pipeline and even recently made another acquisition (with its $13 billion purchase of MyoKardia) which should bolster its future growth potential. 

In short, the sell-off to the lower $50’s didn’t make sense.  

This is common practice for BMY shares, which have seen their earnings-per-share increase by more than 4x since 2014 (rising from $1.85 in 2014 to a projected $7.51 in 2021)…however, during this same period of time, we’ve witnessed BMY’s share price has languished (BMY closed the year in 2014 trading for $59.03, meaning that at the trough of its recent sell-off, shares had posted negative returns during this 7-year period).  

This disconnect between bottom-line performance and share price performance represents an irrational mistake by the markets (in my humble opinion).  And, as I pointed out in the video above, this is why I believed that BMY had upside potential of roughly 50%).  

Well, since early December, we’ve seen BMY experience a strong rally, rising from ~$53/share to its current share price in the $65 area (representing gains of greater than 21%).  The S&P 500 is down 2.16% year-to-date thus far and during 2022, BMY shares are up 4.14%.  

To me, the fundamentals pointed towards this relative alpha and I wouldn’t be surprised to see BMY continue to outperform the major indexes moving forward as its earnings multiple continues to revert back towards its historical mean. 

Even after its 20%+ rally, BMY is trading for just 8.2x forward earnings, which is well below the S&P 500’s ~21x forward multiple and BMY’s own 5 and 10-year average P/E premiums of 14.x and 18.9x, respectively.  

The same story has recently played out for British American Tobacco.  

This is another unloved stock, largely due to the perceived secular headwinds facing traditional tobacco names.  However, as I’ve pointed out many times in the past, BTI is working hard to transition its sales away from combustible tobacco and into new-age nicotine related products.  

Like BMY, BTI shares have suffered over the last 5 years or so.  During this period of time, BTI’s share price  is down more than 25%.  However, even in the face of anti-tobacco perception, BTI continues to grow its bottom-line (in U.S. dollar terms and even more so on a constant currency basis), which, one again, leads me to believe that there is a major disconnect going on between the market’s sentiment and the stock’s actual fundamentals.  

Like BMY, it appears that the market has changed its tune when it comes to BTI, from bearish to bullish, over the last month or so.  

BTI also hit a recent low in early December and since then, its shares have risen from their 52-week lows of $33.62 to new 52-week highs of $42.50.  

This was a pretty violent 26% swing (in a little more than a month’s time) for a mature, relatively boring stock like BTI.  

And, what’s even more interesting about this move is that the company’s management team has not posted earnings or changed guidance in any significant way.  

Looking at consensus analyst estimates, BTI’s outlook for 2022 has actually worsened a bit during the last 3 months, with Wall Street EPS estimates falling from $4.86 for 2022 down to $4.74.  

In short, nothing major has changed for BTI since early December (technically, if anything, the fundamental outlook has gotten slightly worse)…meaning that the stock’s massive rally  that we’ve seen over the last month or so has been entirely based upon sentiment. 

This is a perfect example of how irrational, fickle, and whimsical the market can be in the short-term.  

Frankly, an efficient market shouldn’t see swings like this.  

But, they happen all of the time…for no good reason…which is exactly why I say that investors should not focus their attention on short-term share price movements, but instead, the fundamentals.  

You see, while this 26% rally from BTI was large, it was entirely justifiable, based upon the company’s earnings data.  

Looking at BTI’s 2022 consensus EPS estimate of $4.74, even after its rally, BTI is trading for just 8.95x.  This is well below the broader market’s forward multiple, as well as BTI’s own 5 and 10-year premiums of 10.97x and 13.79x.  

Looking at the data, I continue to believe that BTI could rise another 20% and still be fairly valued.  I continue to believe that BMY offers a ~40% margin of safety.  

This is why I was not tempted in the least to sell my shares in early December (on the contrary, I recently added to my BMY position).

My focus on the fundamentals here enabled me to avoid fear, avoid capitulating and selling into weakness, and ultimately, put me in a situation where I was able to participate in the recent rally.  

And the beauty of it all is that while I know that patience doesn’t come naturally to many individuals, the dividend growth strategy can help with that.  

You see, my focus on fundamentals provided me with confidence that the dividends paid by both BMY and BTI were safe, and likely to continue to grow.  Therefore, I knew that I would be paid handsomely while I waited for the market to come to its senses with regard to the valuation premiums being applied to these stocks.  

It’s great when a focus on passive income reinforces good behavior and you’re ultimately rewarded for it with strong rallies!  

About the Guest Author
Nick Ward Nicholas Ward is a research analyst who currently writes for Seeking Alpha, The Dividend Kings, iREIT, and Forbes Real Estate Investor. Before that, he was Founder and Editor-in-Chief of The Dividend Growth Club, as well as the Income Minded Millennial. Nicholas has also contributed to Sure Dividend, Investing Daily, and The Street, where he covered stocks in Jim Cramer's Action Alerts PLUS Portfolio.

Nicholas holds a bachelor of arts from The University of Virginia, where he studied English and studio art. Prior to transitioning into the financial industry, he managed a vineyard in the foothills of the Blue Ridge Mountains.