Relative to historical norms the overall stock market as measured by the S&P 500 is overvalued with the current blended P/E ratio of 19.2. Historically, the S&P 500 would be considered fairly-valued when its P/E ratio was between 15 to 16. Therefore, some could argue that the market is not terribly overvalued, but instead fully valued or simply highly valued at this time. Regardless, it is a historical fact that today’s stock market valuation is not low.
As it relates to best-of-breed dividend growth stocks, the valuations are even more extended than the overall stock market. Chronically low interest rates have increased the demand, and therefore, the valuations of high-quality dividend growth stocks. With this said, I am fully aware that there are those who would consider this introduction as merely stating the obvious. However, I have a very specific, and in my view, important reason for providing the above summary.
As I have stated numerous times in the past, I believe in a market of stocks in contrast to a stock market. However, I also find myself in the minority. Most people that I come across seem to be concerned about what the market might or might not do in the near future. As a result, they tend to lump all stocks into the same basket. Personally, I evaluate each stock I own or that I am interested in individually based on their own fundamental merits.
Consequently, I am constantly searching for attractive value regardless of general market levels. Therefore, with this article I will be covering 12 dividend growth stocks that I consider undervalued despite the general high level of the overall stock market currently. After all, this is what value investors do.
Principles of Value Investing: How and When It Works
The idea that value investing and long-term investing go hand-in-hand is critically important to understand. Value investors are not market timers. Instead, value investors are interested in long-term results generated at the lowest risk possible and with as much certainty as possible. In this regard, value investors clearly understand that forecasting short-term movements in a stock’s price is an exercise in futility, and therefore, an exercise in uncertainty.
Additionally, value investors also understand that fundamentals are what generates true value in a business. Long-term investors position themselves as stakeholders in fine businesses, and as such, concern themselves more with how the business they own is performing than they do how a fickle stock market might be treating it in the short run. Value investors also understand that short-term price volatility is the side effect of liquidity. In the short run, buy and/or sell decisions are often based on emotional responses and not deep analysis.
This is the real meaning of Ben Graham’s famous metaphor: “The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine–tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine–assessing the substance of a company.” To my way of thinking, Ben Graham’s message is quite clear. In the long run it’s the underlying performance of the business that matters most, and not the investing public’s too often fickle opinions in the short run.