A Safe Income Stock
What’s a yield-hungry, risk-averse investor to do today? Well, as Janet Yellen herself noted, on a risk-reward basis, the equity market is a better place to be today than fixed income. Stocks don’t have the same principal guarantees as fixed income, but buying shares of high-quality, long-lived companies with predictable income streams going forward is the next best thing.
In Cabot Dividend Investor, my premium advisory, we call them “Safe Income” investments and have a tier of our portfolio dedicated to these long-term holdings. Here’s our criteria for selecting these stocks:
The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year. For example, the first holding in my Safe Income tier (alphabetically) is Aflac (AFL), an insurer that does much of its business in Japan. Aflac has faced sales challenges over the past year, and the yen’s decline against the dollar has made year-over-year earnings comparisons tricky. But the insurer earns consistent, passive income from premiums and investments, and passes that cash along to investors in the form of quarterly dividends.
Currently, Aflac yields 2.5%. The stock is also resilient, trading in a tight sideways range during the market’s last six weeks of turmoil. Long-term, I expect Aflac to reward investors with steady returns and regular dividend increases.J.Royden Ward, Editor of Cabot Benjamin Graham Value Letter
From Cabot Wealth Advisory 1/15/13 Sign up for free Cabot Wealth Advisory e-newsletter
For this Cabot Wealth Advisory, I combined Warren Buffett's and Benjamin Graham's criteria for choosing stocks. I looked for stocks with:
1) Free cash flow more than $20 million--cash needs include dividends, operating expenses, capital improvements, and research.
2) Net profit margin more than 15%--a good indicator of growth sustainability.
3) Return on equity more than 15%--a barometer of future appreciation.
4) Discounted cash flow value higher than current price--Standard & Poor's is a good source to find discounted cash flow estimates.
5) Market capitalization more than $1 billion--small companies not allowed.
6) Standard & Poor's rating of B+ or better--indicates financial stability and steady growth of earnings and dividends.
7) Positive earnings growth during the past five years with no deficits--very important.
8) Dividends currently paid--always important and helps your return, too.
Aflac (AFL) is the world's largest supplemental cancer insurance provider, deriving 75% of its business from Japan. Most of Aflac's policies are individually underwritten and marketed at worksites through independent agents, with premiums paid by the employee.
Aflac Japan's insurance products are designed to help pay for costs that are not reimbursed under Japan's national health insurance system, and include supplemental health and life insurance. Aflac Japan provides insurance to one out of every four Japanese households.
Aflac has expanded its product line and added new marketing venues in recent years. Non-cancer insurance policies now account for 70% of new sales. Aflac's rapid growth in Japan is propelled by its success in selling through banks and post offices where sales reps are located.
Aflac's focus on new products, such as hybrid whole life insurance products, and its successful promotions in Japan are performing well. Sales increased 15% and earnings per share (EPS) rose 40% during the 12 months ended 12/31/12. Insurance policy sales in Japan are growing more rapidly than expected.
Growth should continue at a rapid pace in 2013, too. Japan's new prime minister has announced several worthwhile programs to bring Japan's economy out of the doldrums, which will help Aflac's sales. In addition, sales in the U.S. sales have improved noticeably.
AFL shares sell at 9.1 times 2012 EPS of 5.85, which is well below Aflac's 10-year average P/E of 10.6. Lower risk in Aflac's bond holdings and further successes in Japan will produce strong growth in future years. AFL shares are low risk and sell at a deep discount to Standard & Poor's discounted cash flow value of 79.80. The 2.6% dividend yield adds significant value. I expect AFL to increase to my Minimum Sell Price target of 79.75 within one to two years.
I will continue to follow Aflac and other blue-chip, high-quality companies in my Cabot Benjamin Graham Value Letter.
Editor's Note: You can find additional stocks selling at bargain prices in the Cabot Benjamin Graham Value Letter. In every issue, you'll find my legendary Maximum Buy and Minimum Sell Prices for over 250 stocks. Click here to get started today!
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