What to do when a stock filter coughs up a stock that has you reaching for the bargepole?
The last time I ran the “Dividends don't lie” stock filter, in early April, I turned my nose up a bit at Galliford Try plc (LON:GFRD), the housebuilding, regeneration and construction group that took a fall when its joint-venture partner, Carillion, bit the dust.
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The group had enjoyed eight successive years of dividend growth before it was bounced into a rights issue by the hit it took from Carillion's involuntary withdrawal from their joint venture.
The history of the company suggests that now it has sorted out the balance sheet it will return to providing its shareholders a growing dividend income but my personal preference was to let the dust settle a bit.
This time around, the stock filter has come up with another company that has suffered a few slings and arrows – while paying its erstwhile boss an outrageous fortune!
Yes, we are talking about WPP group PLC (LON:WPP), the acquisitive advertising and marketing group.
Even before it had parted company with its founder and controversial boss, Martin Sorrell, the stock was proving about as popular as drawing Germany in the office World Cup sweepstake.
Since Sorrell stepped down – perhaps fearing a not so gentle push, given an internal investigation into allegations of personal misconduct – a number of analysts have come forward to suggest that it will get worse before it gets better.
Others are suggesting that the Sorrell empire will be hastily dismantled in an attempt to make the group a bit less cumbersome.
All of which makes it a bit tricky to get a handle on whether WPP is a genuine contender for the “Dividends don’t lie” virtual portfolio.
READ Do dividends still not lie? (A word to the Weiss)
The idea behind this virtual portfolio is that reliable and regular dividend-paying companies may see their shares fall out of fashion but sooner or later the market will come to recognise the value of those dividends.
How do the metrics measure up against Geraldine Weiss's investment philosophy
So, the first question we ask when looking for an undervalued dividend stock is: does it pay a dividend?
In the case of WPP, the answer is: yes, it does.
Last year it paid out 60p, which means that with its share price in the doghouse at 1,200p or thereabouts, it is yielding 5%.
The second question we ask is: is it yielding more than its average dividend yield over the last 10 years, and once again the answer is yes. Usually, the shares yield around 3.2% so they are currently yielding 50% more than they usually do, which means it is a safe assumption that the yield is towards the top end of the historical 10 year range – which was another criterion applied by investment guru Geraldine Weiss, the woman behind the “Dividends don’t lie” theory.
Weiss also liked a stock to have a record of growing dividends over a period of 10 years, and WPP boasts eight years of rising dividends (possibly more – our records only go back eight years).
The company targets paying out 50% of its retained earnings as dividends, and the consensus forecast for the current year’s earnings is 117.51p, which would imply a dividend of 58.75p – a slight cut but close enough for rock & roll.
Lastly, it is trading on a projected earnings per share multiple of less than 20? After plunging from 1,620p a year to 1,200p now, the stock is trading on around half that.
All of which makes it hard to argue with giving WPP careful consideration, even if some brokers think the stock is in a (possibly terminal) tailspin.
A lot of brokers are sitting on the fence with WPP
According to data aggregator Factset, four of the 31 brokers following the stock rate it as a ‘strong sell’ and one as a mere ‘sell’. Fifteen are sitting on the fence; two rate it a ‘buy’ and nine as a ‘strong buy’.
So, the stock is not as big a contrarian play as you might think, although the positive broker recommendations might just be down to some analysts taking their time to adjust their forecasts.
What does seem unarguable is that the agency is going through a sticky time, with the likes of Google and Facebook posing a threat to its very existence.
On top of that, it has lost the guiding hand of its founder and his incredible contacts book; worse still, he has set up in competition with WPP and will no doubt be looking to steal clients away.
Nevertheless, at its current price, investors who like a dabble may take the view that all of that is priced in.