Introduction
This series of articles is designed to identify attractive, blue-chip, higher-yielding dividend growth stocks that are currently available at sound valuation. Consequently, the primary determinant for a company to be included in this series is sound and attractive current valuation.
In other words, the research candidates presented in this series should not be thought of as the absolute best dividend growth stocks on the planet. Instead, they should be thought of as soundly valued dividend growth stock opportunities available at reasonable valuations in today’s moderately overheated market.
As I indicated in my first 2 articles in this series found here, andhere, finding high-quality stocks, especially dividend growth stocks, in a fully-valued market environment like we have today is difficult, to say the least. Adding fuel to the fire is the current low interest rate environment. This makes matters more complex in several ways. Not only are investors looking for better yields, but they are also looking for better total returns.
Consequently, there are many investors who believe that the quest for return and yield has elevated the demand for equities, thus driving valuations too high. Many believe this is especially relevant with blue-chip dividend growth stocks such as those found on fellow Seeking Alpha author David Fish’s CCC lists of companies with consecutive dividend increase streaks. However, the truth is that many blue-chip dividend growth stocks are in fact overvalued, but not all of them. It is a market of stocks, not a stock market.
Ignore the Market – Invest In the Business
I believe that one of the biggest mistakes that many investors make is to worry too much about the market while ignoring excellent investment opportunities that may be available. In the long run, I believe that the stock market has very little to do with investing in great businesses. In the short run, measured by days, weeks, months or quarters, there will often be a direct correlation between the price action of all or most stocks, and the stock market in general. However, in the longer run, the performance of the business that you invest in is significantly more important.
Consequently, I believe that worrying about whether the market may rise or fall in the short run is a distraction that investors simply cannot afford. I believe this is especially true for retired investors and focused dividend growth investors that are looking for their portfolios to generate the income they need to support them and their families.
For the vast majority of blue-chip dividend growth stocks, the dividend income they generate is significantly more stable and more predictable than the fickle price volatility of an auction stock market. In other words, since I am absolutely certain that neither I, or anyone else, can predict what the stock market or the price of a given stock will do in the short run, I see no sense in allowing it to influence my investing decisions. Instead, I prefer to focus on things that I can predict within reasonable probabilities of error.
In “Common Stocks and Uncommon Profits”, which I consider to be one of the classic investment books ever written, Philip A. Fisher in chapter 5 “When To Buy” put it this way:
Unless it is one of those rare years when speculative buying is running riot in the stock market and major economic storm signals are virtually screaming their warnings, I believe this class of investor should ignore any guesses on the coming trend of general business or the stock market. Instead, he should invest the appropriate funds as soon as the suitable buying opportunity arises.
I bring this up because in both of my previous articles in this series, comments were made where people were suggesting that they were going to wait for a better entry point. Additionally, comments were made suggesting that the market would soon drop; therefore, they were waiting for that to occur before they invested.
Frankly, that line of thinking disturbs me for a couple of reasons. First of all, it is literally a fact that money lost can possibly be made back. In contrast, when time is gone, it is gone forever. Therefore, any dividend that is missed is gone forever. Dividends are paid in specific time frames (typically quarterly or monthly), and the only investors that get them are the ones that owned the stock at the time they are paid.
Second, investors that are waiting for a correction in a stock or the stock market have literally a 50-50 chance of being correct. The stock or the market might go up, or it might go down, and we will only know through hindsight. However, once a dividend is paid to me, I am 100% certain that I received it, and I am about 99% certain that I will receive future payments, assuming of course that I’ve invested in the right company.
To summarize this section, I offer an additional quote from Phil Fisher’s book that followed my previous quote above:
In contrast to guessing which way general business or the stock market may go, he should be able to judge with only a small probability of error what the company into which he wants to buy is going to do in relation to business in general. Therefore, he starts off with two advantages. He is making his bet upon something which he knows to be the case, rather than upon something about which he is largely guessing.
Introduction to Digital Realty Trust Inc. (DLR)
Digital Realty Trust is a REIT that owns, acquires, develops and manages data centers which are technology-related real estate. The following short business description is presented, courtesy of their fourth quarter 2014 earnings conference call presentation:
Digital Realty Trust, Inc. supports the data center and colocation strategies of more than 600 firms across its secure, network-rich portfolio of data centers located throughout North America, Europe, Asia and Australia. Digital Realty’s clients include domestic and international companies of all sizes, ranging from financial services, cloud and information technology services, to manufacturing, energy, gaming, life sciences and consumer products.
For additional clarity on Digital Realty’s business, I offer the following slides from the company’s overview presentation March 2015:
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To access the full company overview presentation, follow this link.
Digital Realty Trust Inc.: A Right REIT at a Right Time
In spite of the fact that the overall stock market is moderately overvalued, and even considering that many high-quality REITs are likewise fully valued to moderately overvalued, I believe that Digital Realty Trust Inc. is an exception to the rule. This REIT offers a current dividend yield of 5.2%, is attractively valued at a blended P/FFO (price to funds from operations) of 13.2 and is conservatively expected to increase near-term future FFO (funds from operations) at 4.8%.
Consequently, the combination of a high and growing current yield, sound current valuation and moderate future growth present a reasonable opportunity for investors to earn high double-digit returns over the next couple of years. In order for the reader to obtain a precise calculation of the future total returns I expect this quality REIT to deliver, I offer the following live fully functioning, FFO, dividends and price correlated F.A.S.T. Graphs™ on Digital Realty Trust Inc.
To calculate the opportunity I expect, I suggest that the reader follow these simple steps. First, after Digital Realty Trust Inc. initially went public in October of 2004, its first year of FFO growth was abnormally high at 180%, which aberrantly skews its long-term historical growth rate. Therefore, I suggest that the reader shorten the time frame by clicking on any of the orange rectangles at the top of the graph that are shorter than the “ALL” or “12Y” time periods. Any time frame shorter than the 12Y will present a more accurate representation of the company’s true historical FFO growth.
Once an appropriate historical time frame is produced, simply point your mouse to the last price on the graph (the black line) and click it until a red circle and a pop-up appears. Next, point your mouse to the last ((F)) on the orange line on the graph (note: be sure that there is an orange square appearing in the top left of the pop up) and click again until a red line and pop-up window appears.
The pop-up window will produce return calculations that would apply if the expected growth were to manifest and the price moved to that fair value reference line. This will illustrate the high double-digit total return opportunity that I expect by fiscal year-end 12/31/2016.
I feel this is an important exercise, because I personally never invest without having a precise rate of return objective over the next year or two clearly in my mind, based on reasonable assumptions of growth and valuation. These return calculations support my contention and belief that Digital Realty Trust presently represents a right REIT at a right time.
(Note: I have prepared a very short video on how to utilize and navigate the F.A.S.T. Graphs™ historical earnings and price correlated research tool. I highly suggest that the reader take the time to learn how to utilize and benefit from this tool.)
For additional insight into why I believe that Digital Realty Trust is a sound investment at its current valuation, I suggest a careful review of the FFO and price relationship in relation to the orange FFO justified fair valuation reference line over any time frame shorter than the twelve-year (12Y). Clearly, the best time to invest in this REIT has been when the price was below the orange line, as it now is.
For the maximum margin of safety, the absolute best time to invest in this REIT was in October of 2013, when the price was touching the light green dividend line (some will see this as a white line). However, that opportunity only presented itself once in the REIT’s history as a public company. Therefore, as investors, we must take what the market gives us, as long as valuation is sound, as I believe it is with Digital Realty Trust at current levels.
A Short Lesson In Investor Psychology
Before I move on to presenting additional reasons why I like Digital Realty Trust at today’s levels, I would like to take a sidebar and talk a little bit about investor psychology as it relates to valuation. It is perhaps a fact of human nature that investors tend to like a stock when its price is going up, and to dislike a stock when its price is going down.
Anecdotal evidence of this quirk in investor psychology can be found by examining an article and the comments that followed by fellow Seeking Alpha author Brad Thomas on Digital Realty Trust on December 27, 2013. This article was published at approximately a time when Digital Realty Trust’s stock price was at a historic low price and valuation (incidentally, representing a significant margin of safety as referenced above) and can be found here. You can point to the price line corresponding with that date on the live graph above, and see vivid evidence of what I’m speaking about.
Here are two comments (with the names of the commenters purposely left out) from the article that speaks loudly to my thesis about investors disliking a stock when the price is down. The first comment illustrates a strong desire to flee from the position, coupled with the hope that a recovery might provide a better exit point. Nothing in the comment suggests even the consideration that a bargain had manifested.
I own this dog, but I’m waiting for a better opportunity to dump it. Totally don’t trust management anymore, so I am more skeptical than usual of the company’s performance forecasts.
This second comment illustrates how much emotional stress a falling stock price can create. This investor apparently lightened up the position, but did not sell out entirely. But what I found most interesting with this second comment was a suspicion that the stock had truly become a great bargain, with perhaps an honest assessment that emotion was precluding prudent action.
I must say that the price action is making me very uncomfortable since I do own a considerable amount of the stock but not nearly so much as a few months ago. The reason I bought was in the supposition that 5 years from now storage requirements will be much greater than today and hence DLR should benefit. However, there is a limit to the percentage of ones assets to risk in a particular endeavor and I do not know whether I am mentally capable of risking any more, even though it sure does looks like a heck of a buy at these levels.
I believe that the true lesson that should be gained is that investors should learn to trust fundamentals more than price action. Keep in mind that there was no material deterioration in Digital Realty Trust’s FFO or dividend performance. The only thing that was weak was the stock price. However, there were fears and rumors raging that large company clients might prefer building and running their own data centers. There were even a few examples where that occurred, but the impact on the company’s operating results proved less onerous than were feared.
Digital Realty Trust: Looking To the Future
In late 2013, Digital Realty Trust’s management announced that they intended to take a more conservative approach to their business going forward. These initiatives included a reshuffling of management with the objective of making the best use of their talent and resources to align the company’s operations with a more conservative long-term investment strategy.
Additionally, management committed to being more prudent with acquisitions, noting that they had turned down several large deals with what they considered less desirable tenants. They have also transitioned to a more prudent build-to-order model. These actions have led many analysts to conclude that the company will moderate its pace of new property investments and is working to maximize the efficiency of its existing portfolio.
Although this includes targeting higher leasing rates and better returns on investment as well as the divestiture of what management considers noncore assets, it is also expected to slow future FFO growth. On the other hand, future FFO growth is simultaneously expected to be more predictable and sustainable as a result.
An article on March 5, 2015, by Bill Stroller, staff writer for the website “Benzinga” reported on 5 takeaways from comments by Digital Realty’s CEO Bill Stein at a recent Citi conference as follows:
5 Key Takeaways – Citi Conference
1. Growth Drivers – SMACC: There are five vertical markets that Digital Realty sees as most important to future revenue growth:
- Social: Facebook continues its growth as a top 10 DLR customer; LinkedIn is growing rapidly and is expected to be a top 20 customer.
- Mobile: The growth of wireless data, including the Internet of Things (IOT).
- Analytics: “Big Data” is another new vertical growth market. Specifically, Stein felt that retailers will be the biggest contributors in this vertical segment.
Retailers are compiling a vast array of data on each consumer, in an effort to better predict consumer buying behavior in order to target mobile ads wherever the customer is shopping. - Content/Media: A relatively new vertical market for Digital. Stein gave Netflix streaming and Xfinity on-demand services as examples.
- Cloud: Last, but clearly one of the largest contributors. Stein gave IBM‘s recent growth as an example of how the Digital’s customer mix is rapidly changing. Two years ago, IBM was not a top 10 customer. Fast forward to today, and IBM represents approximately 6 percent of revenues.
Mr. Stein also reported what he believed to be the following advantages to his firm:
2. Digital Realty Advantages: In addition to growing through marketing to the SMACC vertical markets, there were two areas that Stein felt were competitive advantages versus its peers:
- Digital Realty has a BBB investment grade rating from all three ratings agencies. This translates to a lower cost of capital for DLR compared to its peer group.
- The ability for DLR to service its customer base on a global basis.
3. Edge Data Centers: The Digital management team discussed how the need for new, smaller “Edge” data centers was an emerging trend that could result in a material increase in demand for raised floor space.
- These “Edge” data centers could act as a filter to screen out data that does not need to be analyzed or stored in the cloud.
- This type of data center was not contemplated in the original deployment models of the largest “Hyper-Scale/Web Scale” operators.
4. Development Trends: Larger data center campuses such as Digital’s Ashburn, Virginia are efficient and create an ecosystem that facilitates the ability for enterprise customers and cloud customers to exchange data.
On the other hand, Digital’s PBB product will lose traction compared to the fully improved Turnkey data centers customers prefer today.
Additionally, Digital will begin to offer customers who do not require full “2N” redundancy new product offerings such as N+1, or N, at a lower price point. Less equipment will drive ROIC.
5. Growth By Region: During the next three to five years, Stein anticipates these growth trends:
- Asia/Pacific will grow from its current low base of 4 percent of revenue to 10 percent or more. Digital is currently “assembling the pieces” for a data center park in Singapore. Additionally, DLR may look to bring in a JV partner for a land parcel it owns in Japan, in part due to the low returns in Japan compared to other markets.
- Europe: Stein expects future organic growth to decline compared to the North American market, due to continued economic weakness relative to the U.S.
Notably, organic growth for Digital includes new land up developments. Inorganic growth would be by portfolio acquisitions, which would be “opportunistic,” according to Stein.
F.A.S.T. Graphs™ Forecasting Calculators: Digital Realty Trust Inc.
The following five live and fully functioning F.A.S.T. Graphs “Forecasting Calculators” will allow the reader to produce precise future return calculations to include expected capital appreciation and dividends based on those estimates for future FFO growth. I think this is extremely important, because I personally never enter into an investment without having a precise potential return number in mind. These calculators easily and efficiently facilitate that process.
The first 2 calculators “Estimates” and the “Normal PE” are based on the consensus of 18 analysts forecasting FFO growth estimates of 4.8% for the next 2 forward fiscal years. Incidentally, these forward estimates are consistent with the guidance provided by the company as follows:
Company guidance: courtesy S&P Capital IQ:
Situation: Digital Realty Trust Inc. provided earnings guidance for the full year of 2015. For full year 2015, the company expects core FFO to range from $5 to $5.10 per share.
Additionally, the “3-5Y TL” (3-5 Year Trend Line) calculator reports a longer-term trend line growth of 5% by 9 analysts. I consider all of these estimates as reasonable expectations for Digital Realty Trust Inc.
To calculate precise future rate of returns for any forward years, simply point to the ((F)) on the orange fair valuation reference line and a pop-up with return calculations to include prorated dividends will appear. These calculations illustrate the intermediate-term, and/or the longer-term return opportunity that I believe this high-yielding fairly valued REIT offers at today’s valuation.
(Note: I have prepared a very short video on how to utilize and navigate the 5 forecasting calculators. I highly suggest that the reader take the time to learn how to utilize and benefit from these tools.)
Analyst Scorecards on Digital Realty Trust: 1 Year and 2 Years Forward
There are many skeptics that do not put much faith or credence on consensus analyst estimates. Therefore, as an additional piece of analytical evidence and support, I offer the following record of analyst forecasts on this high-quality REIT. The following scorecard illustrates that analysts have been very accurate with their estimates within a reasonable margin of error of 20% with their 2-year forward forecasts.
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This next analyst scorecard summarizes the record of consensus analyst estimates on Digital Realty Trust for both 1-year and 2-year forward forecasts. Since Digital Realty Trust has been a publicly traded REIT, the analysts have compiled an almost perfect record of forecasting future FFO. Of course, this does not necessarily mean that the above forecasts will follow suit, but the past record represents a great confidence builder, at least in my opinion.
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Summary and Conclusions
Although in the general sense, the stock market may in fact currently be fully valued to moderately overvalued. However, it does not necessarily follow that every stock in the market is likewise overvalued. The primary objective of this series of articles is to identify specific examples of high-quality, high-yielding dividend growth stocks that are prudently available for investment today. I believe that Digital Realty Trust represents an excellent example.
This high-quality blue-chip REIT has been a consistent performer as an operating business since it first went public. It has produced consistent and steady FFO growth, and as a result, raised its dividend every year in its existence as a public company. It offers a very attractive current yield of 5.2%, a very reasonable current valuation and the opportunity for moderate future growth. The combination of high current yield coupled with reasonable future growth indicates the opportunity for high double-digit future intermediate returns. Consequently, I see no reason to take the risk of waiting for a bad market to purchase this high-quality REIT. The dividend provides an excellent downside buffer, and if the price were to fall in the short run, I believe that would present an exceptional opportunity to add more Digital Realty Trust to your portfolios.
Disclosure: Long DLR at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.