After six months of careful consideration and procrastination, I finally took the plunge last week and purchased a small parcel of Woolworths Limited (ASX: WOW) shares for my portfolio.
And now that I have, I'm feeling pretty confident about my investment – although it now only makes up around 2.5% of my total portfolio. You might think that's not really much of a risk, but it's still money that could be invested elsewhere – so every dollar counts!
There were a number of reasons why I decided to finally make the buying decision and these are outlined below:
Valuation
This was probably the biggest influence on my decision. I realise that Woolworths will be facing some challenging conditions over the short term, but I think the market has taken a far too negative view on the stock.
Over the past 18 months, more than $16.5 billion has been wiped off Woolworths market capitalisation. Is the company in such bad shape that 35% of its value should just disappear? I don't think so, and that is why I'm comfortable with my decision (right now).
Woolworths hasn't provided FY16 guidance, but based on Morningstar's forecast, the shares are currently trading around 14x FY16 analyst estimates. In my opinion, most of the pessimism surrounding the stock has already been priced in, and the current discounted valuation offers a pretty good risk-reward opportunity.
Dividend
Investors should always be careful when it comes to dividends and never buy a stock based on the expected dividend alone. With that said, the 5.5% dividend yield on offer right now is pretty hard to resist.
Woolworths has increased its dividend every year over the last 10 years at a compound annual growth rate of 12.6% and this was even the case in FY15. Although I'm not confident of another dividend increase in FY16, I do think Woolworths will at least maintain or at worst marginally decrease its dividend in the year ahead. This should provide some support for the share price, but this is never the sole basis for any of my investment decisions.
Competitive Advantages
Amongst all the pessimism surrounding the stock, it can be hard to forget that Woolworths is still this country's leading retailer and biggest supermarket operator. There is no doubt the company is facing increased competition from the likes of Coles, Aldi and Costco, but the fact remains that Woolworths has the leading logistics network, biggest buying power and the largest store network.
It might be hard to forget, but Woolworths is still the most profitable supermarket and the clear leader in liquor sales in Australia. Still, I'm not completely ignoring the challenges the company is facing with its Masters venture and falling sales in BIG W. There is no doubt the company will need time to rectify these problems, but I think the company will be able to use its competitive advantages to become a great turnaround story in the years ahead.
Long-term investing
There is no doubt I would love to see the share price gain 20% over the next two weeks, but that is not what my investment in Woolworths is all about. I actually don't expect the share price to make a meaningful recovery in the short-term, but I am confident that over the long-term, Woolworths shares will be significantly higher than they are today.
Importantly, I am happy to buy at these prices, knowing that it would take something disastrous for the share price to fall another 20% from here. While not impossible, it is highly unlikely, and this puts the odds back in my favour over the long term.
