I’m not an economic expert. It’s impossible for me to filter all the macro factors and how they impact each of my stock holdings. Thankfully, there’s a way to still get good returns on my stock investments.
One powerful tool is the financial information that’s available at our fingertips for anyone with access to the internet. You can dig out a company’s annual report and look at the trends of the key metrics. FAST Graphs provides a more useful graphical representation of this information.
I’ll use Magna International (TSX:MG)(NYSE:MGA) stock as an example. The price to adjusted earnings per share ratio or P/E (the orange line) indicates the auto parts company is cyclical.
The normal P/E (the blue line) shows that the stock price (black line) better fits with the normal P/E. Therefore, if you buy at above the blue line, you’re probably paying more than you should for the stock. If you have access to the graph, you should compare different periods (say, 5, 10, and 15 years) of the valuation.
Valuation: Is the stock a good buy now?
The stock is expensive: If you buy Magna stock when it’s above the blue line, you’ll earn long-term total returns that are lower than how the business will perform.
The stock is reasonably priced: If you buy the stock when it touches the blue line (which is now), you’ll earn long-term total returns that align with how the business is going to perform.
The stock is cheap: If you buy it when it’s under the blue line, you’ll earn long-term total returns that are greater than how the business will perform.
Everyone will make tonnes of money if it were that easy to determine if a stock was cheap or not. You see the last peak of the stock in the graph? I remember a pundit recommending the Magna as a top stock pick when it was about CAD$103 per share. Although it wasn’t the CAD$126 peak, it was still far from the normal P/E line. And history shows that the stock price always reverts to the mean, the long-term normal P/E.
Magna has increased its dividend for 12 consecutive years based in US$. Its 10-year yield history suggests that the dividend-growth stock could be a good buy getting close to (or above) a yield of 3%.
MGA Dividend Yield data by YCharts
What makes Magna stock more complicated is its cyclicality. At times, its earnings drop from recessions or other macro factors. When it does, its P/E will contract and the stock will fall substantially.
In contrast, utility stocks that have highly stable earnings have much lower volatility stock prices.
Because of its sensitivity to business cycles, Magna maintains a low payout ratio compared to safe (high earnings predictability) utility stocks like Fortis (TSX:FTS)(NYSE:FTS). Magna’s payout ratio is estimated to be 28-35% this year. In comparison, Fortis’s payout ratio will be approximately 76-84% this year.
Magna has lots of margin of safety to protect its dividend in the event that its earnings drop a lot like it did between 2019 and 2020.
Magna International stock is not a bad buy now, which is why we picked up some shares earlier this month. The stock correction has reverted the stock to its long-term normal P/E. It pays a decent yield of close to 2.9%. And its dividend is sustainable with a logically low payout ratio.
The analyst consensus 12-month price target is about US$107, which indicates the stock is undervalued by more than 40%. Though, I would use this price target for over the next 2-3 years instead.
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Disclosure: As of writing, we own TSX:MG.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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