My approach to value-based investing is something that represents the result of a lot of experience, both good and bad over more than two decades of time. One of the big questions that I had to answer for myself fairly early in the process was simple: out of the thousands of stocks that are available to choose from, how do I start narrowing my analysis into stocks that are the most likely to fit the requirements I have? That is where my reliance on dividends came into play. Early on, I knew that I wanted to use fundamental strength as one of the foundational cornerstones of my system.
Dividends are one of two ways that a company’s management can “return value” back to shareholders. The other method is through stock buybacks. Buyback programs are pretty popular among analysts, because they reduce the total number of shares outstanding of a given stock, which theoretically should translate to a higher stock price as earnings continue to grow. The assumption, however is that earnings will continue to grow – something that this year has proven can be harder at times to do than at others. Even if earnings continue to grow, share appreciation from buybacks is something that isn’t usually seen right away. It takes time and usually blends into the overall context of broad activity.
I like dividends, because they provide shareholders with a passive income source that is often very competitive with the yields that can be found in other instruments like Treasury bonds. With Treasury yields likely to remain near historical lows for the foreseeable future, that also means that dividend yields are even more attractive than normal. From a qualitative standpoint, they also reflect management’s confidence in their ability to keep the business running profitably, since dividends usually represent a long-term management commitment. Dividends have to approved by a company’s board of directors, and the fact that they represent a cost on a company’s balance sheet is a big reason the large majority of publicly traded stocks do NOT pay dividends at all.
That simply fact is why dividends became a big theme of my system; I estimate that only a little over half of the companies on the three major U.S. exchanges pay any kind of dividend at all, while only about a third pay a consistent quarterly dividend. That makes dividends a useful way to immediately shorten the universe of stocks I pay attention to companies that implicitly should have stronger fundamental profiles than most others.
Standard Motor Products Inc. (SMP) is an interesting case study about the value of dividends in the current market environment. This is a company in the Auto Components sub-industry. Auto companies, by and large have been affected over the past year by COVID pressures that have dramatically reduced miles driven by Americans, and that means less demand for replacements of all types of components – tires, engine parts, sensors, and so on. That pressure is a reason that a number of companies in the industry that did pay a dividend have temporarily suspended their payouts, or eliminated them altogether. SMP was among that group early in the year, but in their latest earnings statement reinstated their quarterly dividend payout.. It’s too late to jump on board the first of those reinstated payouts – the ex-dividend date was November 13 – but the move puts this small-cap company ahead of a lot of bigger brethren in reasserting their confidence in their management approach and their future prospects and made me sit up and take notice.
Shortly after that earnings announcement, the stock started to pick up a lot of bullish momentum, driving from a range around $45 to a mid-December peak above $55. The stock sold off sharply from that point before bottoming at the beginning of this month at around $40. It is a bit higher from that point and appears to be settling into a new consolidation range at around $42. This is a company will a solid balance sheet that includes minimal debt, good liquidity and an improving operating profile. I think the stock’s drop in the last month represents an opportunity that shouldn’t be ignored.
Fundamental and Value Profile
Standard Motor Products, Inc. is an independent manufacturer and distributor of replacement parts for motor vehicles in the automotive aftermarket industry with a complementary focus on heavy duty, industrial equipment and the original equipment service market. The Company’s segments include Engine Management Segment and Temperature Control Segment. The Engine Management Segment manufactures and remanufactures ignition and emission parts, ignition wires, battery cables, fuel system parts and sensors for vehicle systems. The Temperature Control Segment manufactures and remanufactures air conditioning compressors, air conditioning and heating parts, engine cooling system parts, power window accessories and windshield washer system parts. The Company sells its products primarily to warehouse distributors, large retail chains, original equipment manufacturers and original equipment service part operations in the United States, Canada, Latin America and Europe. SMP has a current market cap of about $963 million.
Earnings and Sales Growth: Over the last twelve months, earnings have grown about 56%, while revenues increased a little over 11.5%. In the last quarter, earnings improved by almost 206%, while revenues grew a little over 38.5%. The company’s margin profile is solid, and is showing signs of strengthening; over the last twelve months, Net Income was 5.5% of Revenues, and increased to 8.33% in the last quarter.
Free Cash Flow: SMP’s free cash flow is healthy, at about $95.4 million over the last year. It has also increased from about $77.92 million in the last quarter, and $53.34 million at the beginning of the year. Those numbers might not sound impressive by themselves, especially compared to the totals you’ll from much larger companies in the market; but remember that this is a small-cap stock with a total market cap of just about $1 billion. That provides a better context to view these numbers in; when you think about Free Cash Flow on that basis, it translates to a useful Free Cash Flow Yield of 10%.
Debt/Equity: The company’s Debt/Equity ratio is 0, implying there is very little long-term debt. In fact, SMP’s balance sheet only shows about $100,000 in total long-term debt versus $16.76 million in cash and liquid assets in the last quarter (up from $13.27 million in the last quarter). The company’s healthy operating profile, along with a solid cash position means that the company has good liquidity and should have no problems servicing the debt they have.
Dividend: SMP’s annual divided is $1.00 per share and translates to a yield of about 2.36% at the stock’s current price. The dividend also appears safe, running at less than a third of SMP’s earnings per share.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $60 per share. That means the stock is very undervalued, offering about 41% upside to that fair value target price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above shows the last year of price activity for SMP. The red diagonal line traces the stock’s upward trend from its low point in May at around $34 to its December peak above $55. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The selloff at before the end of 2020 was sharp and only took a little over a week to hit its low point at around $40. After rebounding to about $43 about a week ago, the stock dropped again but appears to have found support at around $42 from the 61.8% retracement line. A push above resistance at $43 should see short-term upside to about $45, and possible to $47 where the 38.2% retracement line sits. If bearish momentum picks up again, a drop below $40 could see the stock fall to between $38 and $36 before finding new support.
Near-term Keys: SMP’s fundamentals are very solid, and in fact have improved throughout the year – which is remarkable considering broad conditions that have plagued its industry throughout the year. The December drop is severe, but at this point really just represents an even better long-term opportunity that what was available in November. If you prefer to focus on short-term opportunities, you could use a push above $43 as a signal to buy the stock or work with call options, using $45 to $47 as practical exit targets, depending on the strength of bullish momentum. A drop below $40 would be a strong signal to consider shorting the stock or buying put options, with $38 to $36 offering practical exit targets on a bearish trade.