The Second Step In Income Investing. In one of my previous posts, I listed several stocks that had passed my screen for income producing investments. At that time, I warned that this list was not a recommended list since it takes one more step to determine whether the investment is a suitable candidate. I have selected one of these investments to illustrate the evaluation process I use. The company I selected to demonstrate the process is Fidelity National Financial (FNF). The information given here comes from Yahoo Finance, which provides sufficient statistics to begin the evaluation process.
Step One. Overall View Of The Company Business. FNF is basically an insurance company. (Not to be confused with the company that provides mutual funds and asset management for investors.) By far their dominant insurance product is title insurance, which they market directly to the real estate industry and also through other title agencies who conduct the search, closing, and escrow function and receive the lion's share of the title insurance fees. The company has a good reputation in the real estate industry. In one of my past lives I owned a title insurance agency and did business with this company. The experience was positive. It does help to have some experience with a company your investing in but it is not required.
Step 2. Basic Financial Information. This information will give you an idea of the the relative size of the company and the average volume of shares traded on a daily basis. FNF has an overall market cap of 3.11 billion and an average of 2+ million shares per day are traded. This means that the company falls into the medium category in terms of size and a sufficient number of shares trade per day that it is unlikely that you would have any difficulty in liquidating your shares should you need access to your funds right away. This is an obvious advantage over a long-term CD or annuity which would cost you a substantial early surrender charge. Commissions for the sale of 1000 shares at a discount brokerage house could be as low as $7.00, virtually negligible compared to CD's or annuities.
Step 3. Some Important Statistics. These are things you should know about just about any company you buy. 1. Price/Earnings Ratio. (P/E). This company sells for 10.3 times earnings. A relatively low ratio. I believe this indicates that the company is not over-valued relative to its ability to produce revenue. 2. Price to sales ratio. The annual sales of this company are almost twice the market value with a price to sales ratio of .55. 3. Price to Book Value. The company sells for less than its net worth with a ratio of .9. All these ratios indicate that the company MAY be a bargain. These low ratios also indicate that the market opinion of the growth prospects for the company is low. This is pretty much to be expected since the company growth prospect is pretty much tied to the real estate industry which is disarray right now.
Step 4. Financial strength. In view of the dim prospects for the real estate industry, it is important to have some idea of the ability of the company to continue operating in an unfavorable environment. 1. Cash. The company has cash assets of almost $338 million as opposed to long and short term debt of $802 million. This combined with annual sales of 5.9 billion appears ample to fund dividend payout and operating expenses. 2. Debt to Equity Ratio. The total debt of the company divided by the shareholder equity is 23.2%. This is an indication of good overall financial health. 3. Current Ratio. This ratio is the ratio of short-term debt divided by short-term assets such as cash and other assets that can be liquidated easily to produce cash. This value is .39, Again relatively low for the industry. From these statistics you can determine that the company has the ability to sustain operations in a relatively hostile environment. If you believe that the current environment will stay the same or improve over the next 5 years, this is a relatively favorable situation.
Step 5. Dividend Sustainability. Since your objective is a stable income stream, this is the most important step in determining if the investment is right for you. The most important factor here is the payout ratio which is the dividends paid divided by the reported earnings. FNF has a ratio of 49%, a figure below 50% is relatively healthy and a figure above 100% indicates you might look for a dividend cut sooner rather than later. You might also look at the dividend growth history. Many investors believe this is more important than the current dividend yield; however, if you need income to pay the bills today, this isn't the case. FNF has a negative dividend growth rate. They cut it from $1.20 per share in 2007 to $.60 per share in 2008. This is a negative factor; however, the fact that they have already began to increase it again to the current level of $.72 is an indication that management believes they should have little trouble in maintaining it at that level. My opinion is that these factors are overall positive for the sustainability of the dividend.
Overall Opinion. This is a suitable investment for my portfolio. I believe they can maintain the current dividend. I also believe there is a potential for future price appreciation and dividend increases. All this will depend on a rebound in the real estate industry. I believe that will happen gradually even if the economy doesn't rebound a great deal. The fact that there are few properties being built means that the supply will eventually tighten resulting in an improvement in the supply demand ratio.
Caution. Remember, I said that this is a suitable investment for my portfolio, not yours. Just about any investment is suitable for some portfolios. Whether or not is suitable for yours depends on a number factors such as age, other assets you own, and your current cash flow situation.
Last Post of 2010. I have been writing this blog since 2006. More than 4 years. If you are one of my new readers, I might recommend you look at some of the older ones. You may find some ideas that benefit your financial situation. Would be glad to hear from you if you do. I plan to continue this blog through next year if my health holds out. Here is to a successful year for all of us.
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