In this article, let's take a look at one important holding of Joel Greenblatt (Trades, Portfolio)�s Gotham Asset Management, Garmin Ltd. (GRMN), the $8.72 billion market cap company, which has recently announced a 6.3% dividend hike.
Joel Greenblatt (Trades, Portfolio) disclosed holding 1.51 million shares, up by 35% on the quarter, with the value of the stake amounting to $71.84 million. However, the stock returned a negative 10% in the quarter. Further, Jim Simons and Louis Moore Bacon started new positions in the quarter, with 375,242 and 20,120 shares, respectively.
Company Strengthens
The company provides navigation, communications and information devices for the aviation, marine, general recreation, automotive, wireless and OEM markets. It has headquarters in the U.S. and manufacturing facilities in Taiwan.
According to company reports, dividends have been paid since 2003.Garmin has announced a 6.3% increase in its quarterly dividend to $0.51 from $0.48 per share, which will generate an annualized dividend of $2.04 per share. The trailing dividend yield is close to a 1-year high so I think it is good news for dividend investors.
The firm has a strong balance sheet simply because it has no long-term debt. It generates good cash flows, which helps the company mainly in three ways: in dividend hikes, share repurchases and also strategic acquisitions.
Yahoo! ( YHOO ) Finance estimated a one-year target share price of $51.18. The actual closing price is at $45.57, so the projected one-year return of 12.3%. In addition, for holding the stock one year you'll be paid a dividend of $0.51 per share each quarter, totaling $2.04 at the end of the year. If we divide this number by current price per share, we obtain the dividend yield, which is the other component of the return on an investment for a stock, and in this case is 4.4%. So the total expected return for investing in Garmin is 16.7%, which we believe is an attractive stock return.
So now, let�s use all the informationto try to find the intrinsic value of the stock.
Calculation of Intrinsic Value
In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.
Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).With the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.
To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.
This formula condenses to: V0=(D0 (1+g))/(r-g)=D1/(r-g)
where:
V0 = fundamental value
D0 = last year dividends per share of Exxon's common stock
r = required rate of return on the common stock
g = dividend growth rate
Let�s estimate the inputs for modeling:
Required Rate of Return (r)
The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stockj = risk-free rate + beta of j x equity risk premium
Assumptions:
Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.75% [1] . This is a very low rate because of today�s context. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of4.9%. So, I think it is more appropriate to use this rate.
The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm�s debt-to-equity ratio is unchanged and it doesn�t issue new equity.
Because for most companies, the GGM is unrealistic, let�s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.
Dividend growth rate (g) implied by Gordon growth model (long-run rate)
G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).
Intrinsic Value
Year
Value
Cash Flow
Presentvalue
0
Div 0
2.04
1
Div 1
2.14
1.886
2
Div 2
2.26
1.760
3
Div 3
2.41
1.657
4
Div 4
2.59
1.574
5
Div 5
2.81
1.508
5
Terminal Value
64.51
34.641
Intrinsicvalue
43.03
Current share price
46.85
Final Comment
We found that intrinsic value is below the trading price by 8%, so we can conclude that the stock is fairly valued. So, if you trust in the model and assumptions, I would recommend holding this stock in your portfolios. This conclusion is based on the use of a margin of safety, which means that an investor should buy a stock when it is worth more than its price on the market plus a margin (more or less 20% is used).
We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment.
Other investors reported long positions in the stock, including Murray Stahl (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio).
Disclosure: Omar Venerio holds no position in any stocks mentioned.
[1] This value was obtained from the U.S. Department of the Treasury
[2] This value was obtained from Yahoo Finance.
[3] These values were obtained from Bloomberg�s CRP function.
[4] These values were obtained from Yahoo Finance.
