How Confident Are You in This Stock's Value?

For two consecutive weeks, both the overall market and the real-money Inflation-Protected Income Growth portfolio have dropped a bit in value. As those drops were happening, one of the participants on the iPIG portfolio discussion board asked a really great question on the valuation estimate for one of the stocks in that portfolio.

In essence, the question boiled down to how confident I was in the $11 billion fair value estimate that I had originally pegged for J.M. Smucker's (SJM 1.18%) shares when they were added to the portfolio. That's a great question for an investor to ask about any given position, whether a market is moving up, down, or sideways.

How confident was I?
In short, I was confident enough in that valuation estimate to buy a position in J.M. Smucker's stock with real cash as part of the iPIG portfolio. I wasn't confident enough to bet the whole portfolio on it or give up the portfolio's other selection requirements of a solid balance sheet, well-covered and rising dividend, and reasonable diversification fit.

In addition, while that valuation estimate was sufficient to initiate the original buy on JM Smucker, its valuation needs to be reviewed as things change over time. That holds true for any stock.

For instance, defense contractor Raytheon (RTN) looked to be worth around $18.8 billion at the time it was selected for the iPIG portfolio, a level that was above the company's then-current price. The recent government budget sequestration and its limits on defense department spending was a key reason for that fairly low valuation estimate. As sequestration fears have subsided, Raytheon's stock has recovered, and the company recently commanded a $24.8 billion market capitalization.

While that level is above the iPIG portfolio's original valuation estimate, that original estimate was based on worries from the sequestration. Now that those fears are largely behind us, it's quite likely that Raytheon's shares are worth more than that original estimate -- which will be revised as the company comes up for its next review.

Valuations change -- that's why other factors count
Any valuation estimate is based on projecting the future. Either a company will deliver to those projection estimations or it won't. Additionally, over time, its future prospects will change based on evolving consumer tastes, competitive threats, and other market dynamics. That's why the iPIG portfolio depends on dividends and reasonable diversification on top of valuation to make its picks.

At the time it was selected, each company in the portfolio had a decent history of paying dividends to its owners -- and of raising those dividends over time as its business improved. This past week was a strong one from the dividend front as well, as three companies paid dividends to the iPIG portfolio, all at rates ahead of what they paid last year.

On Monday, industrial gas and chemicals company Air Products and Chemicals (APD 1.75%) handed the iPIG portfolio $0.71 per share, ahead of the $0.64 per share the company paid last year. On Thursday, pipeline giant Kinder Morgan (KMI 2.53%) shelled out $0.40 per share, ahead of last year's $0.35. Also on Thursday, toy maker Hasbro (HAS 0.22%) paid $0.40 per share, which was better than the $0.36 per share it paid in the same quarter last year.

Importantly, none of those companies had declared dividends at their new, higher rates at the time they became iPIG selections. But all of them had established decent track records of paying their owners increasing dividends and looked capable of continuing the trend. It was somewhat of a leap of faith to expect that trend to continue, but so far, it looks to be paying off in cold, hard cash.

All told, how is the iPIG portfolio doing?
Put the iPIG portfolio's dividends, valuation, and diversification principles together, and the overall portfolio is performing to expectations. As of this past Friday's close, the overall portfolio looked like this:

Data from the iPIG portfolio's brokerage account, as of Aug. 16, 2013.

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