This Stock Gets an “A” for Dividend Safety and Looks Fairly Valued

You’ve seen their brown trucks. Investing in their stock might bring you some green dollars every quarter.

United Parcel Service (UPS) gets an A from Safety Net Pro for dividend safety. That means that under their cash-flow-based method of analyzing dividend safety, UPS’s dividend is considered to be extremely safe.

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But is UPS stock valued decently at the moment? Let’s see by applying my usual 4-step process.

Step 1: FASTGraphs Default. The first step is to compare the stock’s current price to FASTGraphs’ default estimate of its fair value.

That default estimate is based on a price-to-earnings (P/E) ratio of 15, shown by the orange line on the following graph.

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The black line is UPS’s actul price. From the graph, we can see that UPS is trading 18% above its fair value under this method of appraisal.

Step 2: FASTGraphs Normalized. The second valuation step is to compare UPS’s price to its long-term average P/E ratio. This adjustment accounts for the fact that many stocks typically trade at valuations above or below a P/E ratio of 15, which was used in the first step.

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Here, we see that UPS’s average P/E over the past 15 years has been 22.1. Since UPS is trading at a current P/E of 17.7, this method suggests that the stock is currently undervalued by 20%.

By the way, I calculate that percentage simply by dividing the current P/E ratio by the “normal” P/E ratio: 17.7 / 22.1 = 0.80 = 80%, or 20% undervalued.

Step 3: Morningstar Star Rating. Morningstar uses a comprehensive net present value (NPV) technique for valuation.

Many investors consider this approach to be a superior method for valuing stocks when compared to using P/E ratios as we just did with FASTGraphs.

In its NPV approach, Morningstar makes a projection of all the company’s future profits.

The sum of all those profits is discounted back to the present to reflect the time value of money. The resulting net present value of all future earnings is considered to be the fair price for the stock today.

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On Morningstar’s 5-star grading scale, 3 stars means that Morningstar believes that UPS is fairly valued. They have a fair price of $101 on the shares, which is just a little higher than the current price of about $97.

Step 4: Current Yield vs. Historical Yield. 

Finally, we compare the stock’s current yield to its historical yield. It is better to be near the top of that range than the bottom. We can use a FASTGraphs display to see the historical yield.

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Just eyeballing this graph, which goes back to 1999, we can see that UPS’s current yield of 3.2% is historically high, which suggests that the stock is undervalued.

On the other hand, if we shorten the graph to the last 10 years, we get a different impression.

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Here, we see that UPS’s current yield is about average over the past 10 years. That suggests that the stock is fairly valued.

Let’s be conservative and use the second graph rather than the first.

Valuation Summary:

Using the 4 approaches just described, our valuation summary for VTR  looks like this:

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My conclusion is that United Parcel Service is fairly valued at the present time. Its current price of about $97 is practically identical to its fair value price of $98.

If after due diligence you like the company and it is a good fit for your portfolio, now is a decent time to buy it.

If you are looking for a bargain, though, you might want to wait and see if you can get a better price. I think that “bargains” start at 10% below fair value, which would be $88. At that price, the yield would also be better at about 3.5%.

You could enter a limit order for $88 and see if it hits on a dip. Many investors lay in wait for better prices by doing this. It relieves you from checking every day.

If the stock’s price dips to the limit that you set, the order converts to a market order and will normally be executed while you are out on the golf course or otherwise occupied.

— Dave Van Knapp

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