Wednesday, September 30, 2009

Utility dividends for current income

Electric, Gas and Water utilities have always been traditionally regarded as income stocks by investors. Their high current yields, and the relative stability of their distributions made them a preferred choice for investors who are seeking current income from their assets.

Utilities typically pay out a large portion of their earnings as dividends, which explains their slow dividend growth and high dividend yields. Most utilities operate as natural monopolies, which guarantees almost no competition in their specific geographic areas. It would be very costly to run two separate electrical grids, and such investment could take many decades to pay off. Thus utilities tend to generate stable earnings and revenues in any economic conditions, as people keep using water, gas and electricity in their daily lives no matter what.

A main risk factor for many utilities is government legislation in regards to greenhouse gases, which could increase their costs over time. Such legislation could force utilities to purchase CO2 pollution allowances, which could cut into earnings. The heavy government regulation could be the driving force behind future growth however. A recent phenomenon has been the smart grid initiative.

The smart grid initiative integrates information and communication technology into electricity generation, delivery, and consumption, making systems cleaner, safer, and more reliable and efficient. While it would be costly to modernize electric grids, there is some stimulus available from the department of energy. The department of energy plans to distribute $3.9 billion in Recovery Act funds for smart grid projects through two funding opportunities. The first provides $3.3 billion for deploying and implementing smart grid technologies across the country. The second provides $615 million for smart grid pilot projects. (Source: Yahoo Finance)

Because of the stability of their cash flows, utilities could afford increasing their dividends for long periods of time. Most utilities that I have stumbled upon have had a history of dividend increases, followed by a steep dividend cut, which is then followed by another string of dividend increases. More often than not however, dividend cuts in the Utilities Sector are followed by dividend increases for several years until the dividend payment reaches or exceeds the previous levels. Because of this cyclical nature of utility dividends I view the sector as more suitable for current income generation that for solid dividend growth. Thus for a younger investor who has more than 2 decades until they plan on living off their dividend income in retirement, I would not recommend a high exposure to utilities.

While current yields on utilities tend to be higher than the yields on S&P 500, dividend growth is much slower, which could erode the purchasing power of your utility dividend income over time. I view utilities stocks similarly to fixed income, as they are very sensitive to interest rates and have stable distributions.

Utility stocks typically lag during strong bull markets as investors chase higher growth prospects. In flat or bear markets however utility stocks do not decline as much and they are further helped by their generous dividend yields.

While it is true that some utilities don’t have a strong history of raising distributions, there are several utilities, which have raised their distributions for more than 25 consecutive years, and thus are part of the dividend champion’s list:

It is important to look at the dividend payout ratios, the EPS trends and the EBIT to interest expense ratio in order to gauge the sustainability of the dividend payment over time. The EBIT to interest expense or coverage ratio is an important indicator which shows whether utilities could afford servicing their debt obligations. While some investors focus only on the debt to asset ratios, I view the ability to service interest payments as an important factor that shows how sustainable the company’s ability to operate as a going concern actually is.

Because of the slow dividend growth, I would not consider initiating a position in utilities stocks yielding less than 4% to 5%.

Full Disclosure: Long ED

This post was included in the :The Carnival of Personal Finance #226 – The AFM Turn’s 5 Edition

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Monday, September 28, 2009

McDonald’s Delivers Strong Dividend Growth

Several companies raised distributions last week. The most notable raiser was fast food chain McDonald’s (MCD), which surprised investors with a 10% dividend increase. This marked the 33rd consecutive annual dividend increase for this Oak Brook, Illinois based dividend aristocrat.

McDonald's Chief Executive Officer Jim Skinner said, "So far in 2009 we've returned nearly $4.0 billion to shareholders through dividends and share repurchases, bringing total cash returned since the beginning of 2007 to about $15.5 billion. With today's dividend increase, we expect to end the year near the high end of our three-year, $15 billion to $17 billion total cash return target."
Skinner continued, "This achievement reflects the success of our better, not just bigger strategy, which has helped drive sales, profits and, ultimately, cash from operations. Going forward, our philosophy on our use of capital remains unchanged. Our first priority is to reinvest to grow our business and enhance shareholder value. After these investment opportunities, we expect to return all of our free cash flow over the long term through dividends and share repurchases -- while maintaining a strong financial foundation. Today's dividend increase underscores our confidence in the long-term strength of our business and ongoing commitment to returning cash to shareholders."

The golden arches have definitely weathered the economic storm relatively unscattered, with monthly sales consistently marking comparable gains. I recently added to my position in McDonald’s (MCD), as I believe that the company posseses strong dividend growth characteristics. The company has more than doubled its dividends since 2006.

Several other companies announced increase in distributions:

Lockheed Martin Corporation (LMT), Lockheed Martin Corporation engages in the research, design, development, manufacture, integration, and sustainment of advanced technology systems, products, and services in the United States and internationally., increased its quarterly dividend by 10.50% to 63 cents per share. Lockheed Martin Corporationi has increased its quarterly dividend in each of the past six years. The stock currently yields 2.90%.

Sanderson Farms, Inc. (SAFM), which Sanderson Farms, Inc., an integrated poultry processing company, engages in the production, processing, marketing, and distribution of fresh, frozen, processed, and prepared chicken products in the United States., increased its quarterly dividend by 7% to 15 cents per share. Sanderson Farms, Inc. doesn’t follow a path of regular annual dividend increases that I prefer in a dividend stock.

ConAgra Foods, Inc. (CAG), which operates as a food company in North America and internationally, increased its quarterly dividend by 5% to 20 cents per share. This is the third dividend increase for ConAgra Foods, Inc. since the company cut its distributions in 2006. The stock currently yields 3.50%.

Chimera Investment Corporation (CIM), which invests in residential mortgage backed securities (RMBS), residential mortgage loans, real estate-related securities, asset backed securities (ABS), increased its quarterly dividend by 50% to 12 cents per share. Chimera Investment Corporation is a relativelyshort dividend history, which started in 2007. The dividend payment seems to be fluctuating a lot, which is not something to have when you try to live off your income streams. The stock currently yields 11.80%.

Hatteras Financial Corp. (HTS), which invests in adjustable-rate and hybrid adjustable-rate single-family residential mortgage pass-through securities guaranteed by a U.S. Government agency or issued by a U.S. Government-sponsored entity, increased its quarterly dividend by 4.5% to $1.15 per share. Despite the fact that Hatteras Financial Corp. has only been around since 2008, its dividends have been pretty stable. The stock currently yields 13.90%.

Triangle Capital Corporation (TCAP), which is a private equity and venture capital firm specializing in buyouts, change of control transactions, acquisitions, growth financing, and recapitalizations in lower middle market companies, announced that its board has approved a 2.5% increase in dividends to 41cents/share. Triangle Capital Corporation has increased quarterly dividends since ever since it went public in 2007. The stock currently yields 14.10%.

I would be careful with the last three stocks mentioned, as they distribute most of their earnings out to shareholders, and thus have to depend on stock sales in order to keep growing the business. More stock sales dilute existing shareholders’ interests and could spell trouble if the capital markets freeze for one reason or another. Successful dividend investing is more than just chasing the highest dividend stocks – it’s more about finding a stock that has adequately covered dividends, whose business model could support future dividend increases.

Full Disclosure: Long MCD

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Friday, September 25, 2009

Toronto-Dominion Bank (TD) Dividend Stock Analysis

Toronto-Dominion Bank, through its subsidiaries, engages in the provision of retail and commercial banking, wealth management, and wholesale banking products and services in North America and internationally. It operates through four segments: Canadian Personal and Commercial Banking, Wealth Management, U.S. Personal and Commercial Banking, and Wholesale Banking. This international dividend achiever and Canadian Dividend Aristocrat has raised dividends for 15 years in a row.

Over the past decade this dividend growth stock has delivered an average total return of 13.20% annually.

The company has managed to deliver a 5.60% average annual increase in its EPS between 1999 and 2008. Analysts expect Toronto-Dominion Bank to earn $4.98 share next year, followed by a 4% increase to $5.17/share in the year after that.

The Return on Equity has recovered from its 2003 lows of 26% and is at a very impressive level at 42%. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Annual dividends have increased by an average of 20.50% annually since 1999, which is higher than the growth in EPS. Most of the dividend growth came from the expansion in the dividend payout ratio, which more than tripled from 15% in 1999 to 48% in 2008.
A 20 % growth in dividends translates into the dividend payment doubling every three and a half years. If we look at historical data, going as far back as 1973, Toronto-Dominion Bank has actually managed to double its dividend payment every six years on average. The company last raised its dividends in 2008.

The dividend payout ratio has more than tripled from 15% in 1999 to 48% in 2008. In 2002 the company lost money, which is why it is at zero for the year. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently the Toronto-Dominion Bank is attractively valued at 17 times earnings, yields 3.50% and has an adequately covered distribution. The main issue with this dividend investment is that it has failed to increase its distributions for five quarters in a row. The company has until the last quarter of 2010 to raise its dividend, or otherwise it would lose its dividend achiever status. In the meantime it is a solid hold for me. That is unless you are looking for some exposure to the financial sector for your dividend portfolio. As such TD could be a nice small starter position to consider.

Full Disclosure: Long TD

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Wednesday, September 23, 2009

Dividends Stocks versus Fixed Income

Many retirees who are seeking current income from their assets invest in fixed income securities, most of which provide a stable stream of income. Fixed income investments do have some disadvantages relative to stocks that pay dividends, and thus retirees which fail to account for these, could end up with no income at the worst time possible .

First, while typical fixed income securities provide a dependable income stream, its purchasing power is typically eroded by inflation. Even at 3% per annum, the purchasing power of one dollar decreases by 50% in 24 years. Double that inflation rate to 6% annually and now the purchasing power of one dollar is down by 50% in 12 years and by 75% in 24 years. Stocks that pay rising dividends provide the best inflation proof source of income. Dividend based distributions can grow, interest based distributions usually don't. Unless interest income is reinvested, the interest income cannot grow over time to compensate for the eroding value of inflation.

Second, right now qualified dividend income is taxes at 15% for the highest tax bracket in the US, which is almost half the top tax for interest income in the States. In Canada dividend income also received a preferential treatment relative to fixed income.

Third, bonds typically don’t increase their interest payments if the business is doing well. Stocks, which represent partial ownership of companies, tend to share higher profits with shareholders either through dividend increases or through stock buybacks. Thus stocks tend to provide higher total returns over time as they could provide higher capital gains and higher dividend incomes.

Stocks have disadvantages as well however.

First, if a company goes under and declared bankruptcy, fixed income holders are the only ones that get at least some return of their investment. Stockholders on the other hand typically receive nothing when the company emerges from bankruptcy.

Second if a company faces financial difficulties it could easily afford to cut or eliminate its dividends, but it would have to go through huge hurdles before it could get bondholders to agree to reduce or eliminate their interest payments.

Fixed income securities guarantee a return of your investment some time in the future, whereas stocks don’t provide that.

That being said I do believe that the best strategy for long-term investors is to have an allocation to both stocks and bonds. Fixed income tends to provide dependable income even in the worst bear markets. In addition to that fixed income investments provide diversification in bear markets and are the only asset to provide returns to investors during deflationary periods.

Stocks are great vehicles to own during average and high inflationary periods, and they could provide investors with rising inflation adjusted streams of dividend income over time. There are companies which have long records of raising their distributions. The possibility of receiving rising dividends from stocks, make equities a preferred method of investment for many investors. Some early holders of stocks like Johnson & Johnson (JNJ), Exxon Mobil (XOM), and Altria (MO) are now enjoying double or even triple digit yields on cost on their original investments, even without reinvesting their dividends. Similar investments even in the safest highest yielding fixed income securities would still be generating the same incomes, provided that they have not matured.

Currently I like several dividend stocks, which have the best prospects to grow their distributions over time.

Johnson & Johnson (JNJ) has increased dividends for 47 consecutive years. Johnson & Johnson engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Check my analysis of the stock.

Mcdonald’s (MCD) has increased dividends for 32 consecutive years. McDonald’s Corporation, together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. Check my analysis of Mcdonald’s.

Chevron (CVX) has increased dividends for 22 consecutive years. Chevron Corporation operates as an integrated energy company worldwide. Check my analysis of Chevron.

Abott Labs (ABT) has increased dividends for 37 consecutive years. Abbott Laboratories manufactures and sells health care products worldwide Check my analysis of the company.

Clorox (CLX) has increased dividends for 32 consecutive years. The Clorox Company manufactures and markets a range of consumer products Check my analysis of the stock.

Full Disclosure: Long ABT, CLX, CVX, JNJ, MCD, MO

This post was featured on the Carnival of Personal Finance #225- Planning Winter Edition

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Sunday, September 20, 2009

Eight Dividend Increases in the news

The market continued going higher, despite all concerns about valuations, unemployment and the recession. Most analysts are divided on whether the 6 month advance is over or not. Dividend investors on the other hand however are not so concerned about the overall state of the market, as long as dividends are being paid indeed. The main problem with a rising market however is that it leaves fewer attractively valued stocks to enter or reinvest dividends. If you find the right dividend growth stocks however, which tend to raise distributions every year or so, one does not need to rely on dividend reinvestment for growth in their passive income.

Several such prominent dividend players announced that their boards of directors have approved distribution raises for stockholders.

Realty Income Corporation (O), which engages in the acquisition and ownership of commercial retail real estate properties in the United States, increased its monthly dividend to $0.1426875 per share from $0.142375 per share. Realty Income Corporation is a dividend achiever, which has increased its quarterly dividend in each of the past fifteen years. The stock currently yields 6.20%.

Tom A. Lewis, Chief Executive Officer of Realty Income commented, "We are pleased that, despite challenging economic conditions, our operations allow us to once again increase the amount of the dividend we pay to our shareholders. With the payment of the October dividend we will have made 471 consecutive monthly dividend payments."

Philip Morris International (PM), which manufactures and sells cigarettes and other tobacco products in markets outside of the United States of America, increased its quarterly dividend by 7.4% to 58 cents per share. Philip Morris International was spun out of Altria Group (MO) in 2008. Since then the company has raised distributions twice. The stock currently yields 4.90%.

Texas Instruments Incorporated (TXN), which engages in the design and sale of semiconductors to electronics designers and manufacturers worldwide, increased its quarterly dividend by 9% to 12 cents per share. The stock currently yields 1.80%.

W. P. Carey & Co. LLC (WPC), which provides long-term net lease financing for companies, increased its quarterly distributions by 8% to 50 cents per share. This marks the 34th consecutive distribution increase for this dividend achiever. The stock currently yields 7.00%.

The Kroger Co. (KR), which operates as a food retailer in the United States, increased its quarterly dividend by 5.6% to 9.5 cents per share. Kroger began raising dividends in 2006. The stock currently yields 1.70%.

Corporate Office Properties Trust (OFC), which is a real estate investment trust (REIT) that engages in the acquisition, development, ownership, management, and leasing of suburban office properties., increased its quarterly dividend by 5.4% to 39.25 cents per share. Corporate Office Properties Trust is a dividend achiever, which has increased its quarterly dividend in each of the past thirteen years, which it has more than doubled since 2004. The stock currently yields 4.10%.

Agree Realty Corporation (ADC), which is a real estate investment trust (REIT), that engages in the ownership, development, acquisition, and management of retail properties, which are primarily leased to national and regional retail companies in the United States, increased its quarterly dividend by 2% to 51 cents per share. Agree Realty Corporation does not have a consistent history of dividend increases, although it hasn’t cut distributions either since 1994. The stock currently yields 9.30%.

Full Disclosure: Long PM, MO and O

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Friday, September 18, 2009

Paychex (PAYX) Dividend Stock Analysis

Paychex, Inc., together with its subsidiaries, provides payroll, human resource, and benefits outsourcing solutions for small- to medium-sized businesses in the United States and Germany. This dividend achiever has raised dividends for 19 years in a row.

Over the past decade this dividend growth stock has delivered an average total return of 3.70% annually.

The company has managed to deliver a 12.60% average annual increase in its EPS between 1999 and 2008. Analysts expect Paychex to earn $1.33 share next year, followed by an 8% increase to $1.44/share in the year after that.

The Return on Equity has recovered from its 2002-2006 lows and is at a very impressive level at 42%. This is especially positive given the fact that the company remains virtually debt free. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Annual dividends have increased by an average of 23.50% annually since 1999, which is higher than the growth in EPS.
A 24 % growth in dividends translates into the dividend payment doubling every three years. If we look at historical data, going as far back as 1990, Paychex has actually managed to double its dividend payment every two and a half years on average.

The dividend payout ratio has more than doubled from 35% in 1999 to 81%. The company’s dividend payment looks unsustainable, given the slow expected growth in earnings over the next few years. This could not only hinder any near term dividend growth, but also could place the dividend in danger of a cut. The solid dividend growth over the past few years did not come from EPS growth but mainly from expansion if the dividend payout ratio. In addition to that the company failed to increase dividends in July, which marked the fifth consecutive quarter of unchanged distributions.
A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Paychex is valued at 18.70 times earnings, yields 4.40% and has a dangerously high dividend payout ratio. I view its closest competitor ADP as more attractively valued of the two. ADP is larger, has a more diversified business base, its dividend still has room to grow and is adequately covered by earnings.

Full Disclosure: Long ADP

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Wednesday, September 16, 2009

Are High Dividend Stocks worth it?

As an investor in the accumulation stage, I tend to focus on companies with yields of at least 3% and expectations of future dividend growth. Most of these companies have a history of consistent annual dividend increases which exceeds ten years. I do receive constant criticism from readers however, that I profile very few stocks yielding 5%-6% or more; and then I do feature them I always express my negative opinion on the securities. I am not willing to accept an extremely high dividend payout ratio, which would have been acceptable for a utility or a Master Limited Partnership.

I do realize that most investors want to generate enough income as possible from their nest eggs, which have been accumulated over the spans of several decades’ worth of hard work and sacrifice. The problem with this approach is that investors end up focusing on the end result, without giving much thought about the sustainability and growth of the dividend payment. In other words, although it would take for a 3% yielder 7 years to double your original dividend payment and yield on cost, when the dividend growth is 10%, I believe that investors are better off in a sustainable lower yielder, than in an unsustainable high yielder. The company yielding 6% today that cuts its distributions a few months down the road could end up generating far less income than what you expected.

Some investors also disagree with me that stocks which are yielding 3% – 4% would barely produce enough income to keep up with inflation. The problem with this assumption is that in its goal of chasing the highest yielding stocks, you could end up losing from inflation. For example if you held all of your money in a group of stocks, yielding 8%-10%, and spending all the dividend income produced by your positions, you would lose purchasing power over time. Even worse – if the dividend payment is unsustainable, your yield on cost could even become lower than the current yield on S&P 500, if the company decides to cut distributions. Consider for example Bank of America (BAC), which at the beginning of 2008 would have yielded a cool 6.20%. Fast forward one year later, and the company is currently yielding 0.20%. The worst part is that the yield on your original investment in BAC is now 0.10%.

Compare this to Kimberly-Clark (KMB), which yielded about 3% at the beginning of 2008 but which has raised distributions twice, for a total dividend growth of 13.21%. Your yield on cost is almost 3.5% now, and that is without taking into effect any dividend reinvestment.

A common issue among high yielders is that they have a high dividend payout ratio. This means that the company is paying most of its earnings out as dividends, and doesn’t leave much for reinvestment in the business. If you add in stagnant earnings per share growth, and you basically have a disaster in the making. If that company all of a sudden decides that it needs cash for anything like merger or acquisition or if its earnings drop due to an economic contraction, chances are very high that the dividend payment, which was unsustainable in the first place, would be the first on the management’s chopping block.
Consider Pfizer (PFE) for example. The company spotted a very high payout ratio both in 2007 and 2008. Investors who purchased the stock hoping that this cash rich drug giant would pay a 6%-7% were terribly disappointed when on January 26th Pfizer cut its dividend. The move helped the company save billions, which were much necessary for its acquisition of Wyeth (WYE).

I do realize however that dividend growth is not guaranteed as well. But then I have a requirement of an initial minimum yield of 3% as a margin of safety in case this happens. Chances of a dividend cut are much larger for a company with a current yield of 6%, than for a company yielding 3%. The market is efficient in this section, so you have to understand what risk the high yielders represent, before leaping into the unknown.

Just for the sake of comparison, I identified the components of the dividend aristocrat’s index, which currently yield more than 4%. Of the eleven companies presented, only Kimberly-Clark (KMB) and Cincinnati Financial (CINF) had what somewhat sustainable dividend payouts.



Full Disclosure: Long CINF and KMB

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Monday, September 14, 2009

Kraft Foods freezes dividends

Kraft Foods Inc., together with its subsidiaries, manufactures and markets packaged food products and grocery products worldwide. The company has consistently raised dividends since it went public in 2001. It was a part of tobacco conglomerate Altria Group (MO), until Kraft was spun off in May 2007.

As a company whose management shared the values of Altria group (MO) to consistently reward shareholders with dividend increases and share buybacks, Kraft (KFT) has attracted the interests of many dividend investors. While it has raised distributions for only seven consecutive years, many investors didn’t see this as a problem, but believed that the company would soon join the ranks of the elite dividend achievers.

Just last week the company announced that it has would leave its current dividend payment of $0.29/share unchanged for the fifth consecutive quarter. In addition to that there were no share repurchases in first quarter 2009, and the company's authorization to repurchase shares expired on March 30, 2009.

The major news about Kraft has been its attempted takeover of Cadbury (CBY). The board of directors of Cadbury has rejected the offer so far, citing the fact that it undervalues the company. Other issues related to this takeover would include competing bidding from rivals Nestle or Hershey (HSY). This could make the acquisition of Cadbury (CBY) pricier than initially expected, and Kraft might have to pay top dollar if it really wanted to own the British based confectionery company.

Prominent dividend companies which are typically engaged in mergers and takeovers of a large proportion and which end up overpaying might need a lot of cash fast. Thus freezing or cutting the dividend payment should not be an uncommon factor in such situations.

The deal would definitely be accretive to Kraft and its owners in the long run. If the merger with Cadbury were completed, Kraft Foods would expect to revise its long-term growth targets to 5+% for revenue and 9-11% for earnings per share, from its previously announced 4+% and 7-9% respectively. If it overpays however, those estimates not only might have to be revised downwards, but it would be Kraft’s shareholders that would ultimately pay the price in terms of dividend cuts or freezes.

I was planning on initiating a position in Kraft before the announcement on September 8, but I would wait for the acquisition to unfold before I take any action. The company has four more quarters where it can afford to keep the distributions unchanged. Should it increase them within that time frame and also should it manage to earn approximately $1.95-$2.00/share in 2009, I would consider initiating a small position there. Without any dividend growth, even the best yielding stock would eventually erode your purchasing power due to inflation.

Full Disclosure: None

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Friday, September 11, 2009

Automatic Data Processing (ADP) Dividend Stock Analysis

Automatic Data Processing, Inc. provides technology-based outsourcing solutions to employers, vehicle retailers, and manufacturers. It operates in three segments: Employer Services, Professional Employer Organization Services, and Dealer Services. This dividend aristocrat has raised dividends for 34 consecutive years. Back in November 2008 Automatic Data Processing announced a 13% dividend increase.

Over the past decade this dividend growth stock has delivered an average total return of 0.50% annually. In 2007 ADP spun off its Brokerage Services business, distributing one share of Broadridge Financial (BR) common stock for every four shares of ADP common stock held by shareholders. The total returns calculation for ADP over the past decade includes this transaction.

The company has managed to deliver an 8.00% average annual increase in its EPS between 1999 and 2008. Analysts expect Automatic Data Processing to earn $2.38 share in FY 2009, followed by a small decline to $2.36/share in FY 2010. ADP’s earnings have been constrained by decrease in overall employment levels, closings at small and midsize businesses it services and a general decrease in interest income from funds held for clients. Never the less the company could achieve strong revenue growth of 5%-6% annually, as its markets such as HR management services and Business Process Outsourcing are expected to grow annually in the 5%-6% range over the next five years. The company is a leader in the processing space, and could achieve growth through acquisitions and expansion abroad. There is a high barrier to entry in order to compete in ADP’s business segments. I like the recurring revenue and long term deals structure that ADP’s business enjoys. This leads to stability in cash flow generation, which provides for a good foundation for solid dividend growth over time.

The Return on Equity has remained in a tight range between 17% and 23%. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Annual dividends have increased by an average of 15.50% annually since 1999, which is higher than the growth in EPS. The company has also managed to decrease the number of dillluted shares outstanding from 636 million in 1999 to 527 million in 2008 through share repurchases.
A 15 % growth in dividends translates into the dividend payment doubling every five years. If we look at historical data, going as far back as 1979, Automatic Data Processing has really managed to double its dividend payment every five years.

The dividend payout ratio has doubled to 50%. As the company matures, it has returned most of its earnings back to stockholders in the form of increased distributions and share buybacks. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Automatic Data Processing is attractively valued at 16.00 times earnings, yields 3.40% and has an adequately covered dividend payment. In comparison to its closest competitor Paychex (PAYX), which trades at a P/E of 19 and yields 4.4% with a dividend payout ratio of 80%, I view ADP as more attractively valued. I would be looking forward to adding to my position in Automatic Data Processing (ADP) on dips.

Full Disclosure: Long ADP

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Thursday, September 10, 2009

Why now might be a good time to buy Manulife (MFC)

This post is presented by Intelligent Speculator, a blog that discusses the markets, makes some picks, mainly in the ETF asset classes as well as technology stocks.

Making stock picks is never easy, but we are now ready to make another one. Manulife has been in the news for the past few weeks, mainly for negative reasons. On August 6th, it took markets by surprise by announcing a 50% cut to its quarterly dividend, from .26$ to .13$, starting with this year’s September 21st dividend. It is a surprise in the sense that few had expected such a drastic measure. Most investors are aware that Manulife, like many other insurance companies, has been hit very hard by the recent financial crisis. This move will save the company $800 million, in order to recover its historical stability from what has now become a vulnerable financial situation. Naturally, investors did not appreciate the move and the stock price dropped very quickly. This might be an opportunity to get a solid stock at a decent price, for many investors. While in the past we have warned about investing in financials, we believe they are now back on the right track.

Manulife's CEO said: "While we recognize the importance of a cash dividend to many of our common shareholders, we believe that retaining more of our earnings is the most effective means of building capital while still providing an attractive yield for our shareholders who will benefit as we deploy our capital for growth." Most companies would deliver a similar message when dropping their dividend but I do believe that the more positive news is that Manulife did not wait too long to make this move. The company's stock is down 42% over 2 years because of bad hedging decisions that have been very costly.

Big buys, like Jarislowsky Fraser (who holds 49.5 million shares), have already confirmed they would be buying more shares as they deem the drop as exaggerated. "I don't like dividend cuts, but it was the prudent thing". One question, of course, is if you'd prefer investing in an insurance company like Manulife that has already dropped its dividend yield or perhaps take a chance on the banks. They continue to do their best to keep up their dividend yields yet it is still unclear if they will be able to do so.

Personally, I'd go ahead and buy Manulife, the stock seems poised to recover, eventually. Even now, its dividend yield of about 2,4% is not bad considering the current market. For the next 12 months, the estimated earnings per share are 1.244 (according to Bloomberg) so even its current valuation should warrant a purchase of the stock.

What do you think? Agree with the purchase of MFC with a medium to long term time objective?

Full Disclosure: None

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Wednesday, September 9, 2009

Not all dividend stocks are overvalued

While the market has enjoyed impressive gains ever since it hit a multi year low in March 2009, investors are beginning to get nervous about valuation. If valuation is too high, chances are that investors are overpaying for stocks purchased, which could lead to lower performance over time.
Luckily however, the rally off of March lows has been lead by speculative names from the financial sector. Most of the high quality names that dividend investors follow, such as Johnson & Johnson (JNJ) or Pepsi Cola (PEP), have mainly followed the market higher in its ascend. If we were truly in a new bull market however, then we should expect that most investors would switch to quality blue chip companies. Another positive part is that stock prices are still lower, in comparison to their levels in September 2008.

While entry price does matter, defensive dividend investors should also look at the dividend coverage and the company’s ability to grow the distributions over time. Only after these two prerequisites are met, should investors begin evaluating companies with at least a decade long histories of dividend increases on the basis of valuation.

A minimum requirement for yield should also provide an adequate margin of safety in dividend income to investors in the event that the timing of the purchase was not correct in the short term. Even if the stock price stays below the entry price of dividend investors for a prolonged period of time, they would still be in a position to get paid to hold the stock. Enterprising dividend investors might even be able to re-invest distributions at lower prices.
In addition to that, if the company manages to keep raising distributions even during economic downturns, then it should also be able to increase dividends during economic rebounds. Thus, one could reasonably expect that share prices would increase during a bull market.

I have listed several dividend stocks, which are not overstretched. They are mostly dividend achievers and aristocrats. These are some of the positions I have added to most recently.

Abbott Laboratories (ABT) manufactures and sells health care products worldwide. The company has raised dividends for 37 years in a row. Abbott currently trades at 13.30 times earnings and yields 3.50%, with an adequately covered dividend. (analysis)

Automatic Data Processing, Inc. (ADP) provides technology-based outsourcing solutions to employers, and vehicle retailers and manufacturers. It operates in three segments: Employer Services, Professional Employer Organization Services, and Dealer Services. The company has raised dividends for 34years in a row . Automatic Data Processing, Inc. currently trades at 14.70 times earnings and yields 3.40%, with a sufficiently covered dividend. (analysis)

The Clorox Company (CLX) engages in the production, marketing, and sales of consumer products in the United States and internationally. The company operates through four segments: Cleaning, Lifestyle, Household, and International. The company has raised dividends for 32 consecutive years. Clorox spots a P/E ratio of 15.50 and yields 3.40%. (analysis)

Emerson Electric Co.(EMR), a diversified global technology company, engages in designing and supplying product technology and delivering engineering services to various industrial and commercial, and consumer markets worldwide. Emerson Electric has raised dividends for a record 52 consecutive years. The company trades at 15.3 times earnings, has an adequately covered dividend and yields 3.50%. (analysis)

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Johnson & Johnson has raised dividends for a very impressive 47 consecutive years. The company trades at 13.3 times earnings, has an adequately covered dividend and yields 3.20%. (analysis)

McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. McDonald’s Corporation has raised dividends for 32 years in a row. The company currently trades at 14.90 times earnings , has a very well covered dividend payments and yields 3.60%. (analysis)

Just because a company has raised distributions for a long period of time however, this doesn’t mean that the current yield is going to be excessive. It is the fat yield on cost that long-term dividend investors are after. Also remember that companies cannot control its yield, which is a function of the stock price. Companies could however maintain a proactive dividend policy, where they strive to continuously raise distributions year in and year out.

Some dividend investors also completely ignore capital gains in the equation. While it is true that dividends typically account for 40% of the average annual stock market total returns, it is important to note that the remaining 60% have come from capital gains. The companies listed above not only have adequately covered dividend payments and decent current yields, but they also have strong capital appreciation characteristics.

Full Disclosure: Long ABT, ADP, CLX, EMR, JNJ, MCD and PEP

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- Six things I learned from the financial crisis
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- Dividend Reinvestment is important
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Tuesday, September 8, 2009

Verizon Hikes Dividends

With the expectations for the long Labor Day weekend, few companies announced any dividend hikes. The major dividend increase came from Verizon Communications Inc. (VZ) which offers Wireline and Domestic Wireless communication service in the US. The company’s board of directors announced a 3.3% increase in its quarterly dividends to 47.5 cents/share. This is the third consecutive year that Verizon's Board of Directors has approved a quarterly dividend increase in September.

Verizon chairman and CEO said: "This increase reflects the strength of our cash flow and balance sheet. It demonstrates the Board's commitment to return cash to our shareholders while continuing to invest in the long-term growth of our business."

The company currently yields a very respectable 6.10%. Before you decide that Verizon (VZ) is a great company to own however, please consider the following information.

First, the company has been unable to increase earnings per share over the past decade. EPS has declined from $2.66 in 1999 to $2.26 in 2008. Smart dividend growth investors understand that without growth in earnings, the company’s ability to generate dividend growth is very slim.

Second, the company does not have a long history of consecutive dividend increases. The company started raising its distributions in 2005, after 6 years of unchanged dividend payments. The positive factor however is that the company has not cut its dividends over the past 25 years. It has either raised them or kept them unchanged.

Third, the dividend payout ratio is not covered well enough to support further dividend increases. Currently this indicator is at 77%. This, coupled with the fact that EPS growth has been stagnant over the past decade not only means that future dividend growth would be close to zero, but that the dividend payment could end up in jeopardy of a dividend cut. The positive factor here is that in 2008 cash flow was $7.57 per share. The capital expenditures required to maintain the business run at about $6/share. This leaves all remaining cash flow for dividends.

The company’s growth could come from focusing on its wireless operations, realizing synergies from acquisitions of Alltel and cost efficiencies. I view as a positive the fact that Verizon (VZ) is selling almost 5 million fixed lines and 1 million broadband customer accounts to Frontier for $8.6 billion. Wireline is in a decline, and thus focusing most of the attention to wireless operations is a smart move for the long run.

At this point of time I am not a big fan of telecom companies such as Verizon (VZ) and AT&T (T), which both spot above average dividend yields. Their dividend payouts are above 74%, which seems unsustainable to me. Earnings growth also appears to have stalled, which is not a good sign for long term dividend growth.

On the other hand I like the fact that both companies have been gaining share of the wireless markets either through acquisitions or organic growth. The telecom market is highly competitive; the costs to maintain and operate a network run in the tens of billions of dollars for companies the size of AT&T (T) and Verizon (VZ).

At this point of time I would maintain a hold on both AT&T (T) and Verizon (VZ). While the current yield is very tempting, without a boost to dividends in the future, inflation would erode their purchasing power over time.

Full Disclosure: None

Relevant Articles:

- AT&T (T) Dividend Stock Analysis
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Friday, September 4, 2009

Sherwin-Williams (SHW) Dividend Stock Analysis

The Sherwin-Williams Company engages in the development, manufacture, distribution, and sale of paints, coatings, and related products. It operates in three segments: Paint Stores Group, Consumer Group, and Global Finishes Group. The company, which has raised dividends for 31 consecutive years, is a member of the S&P Dividend Aristocrats index. Back in February 2009 Sherwin-Williams announced a 1.40% dividend increase.

Over the past decade this dividend growth stock has delivered an average total return of 5.70% annually. Sherwin-Williams’ stock price is currently trading almost 20% lower from its all-time highs set in 2007.

The company has managed to deliver a 9.30% average annual increase in its EPS between 1999 and 2008. Sherwin-Williams is expected to earn $3.60 share in FY 2009, followed by $4.10/share in FY 2010. Despite the housing crisis, and expectations of 10% declines in sales for Sherwin-Williams, homeowners would still need to use paint in order to freshen the look of their houses. Home renovation and remodeling projects could be a driver for growth even in a slow economy. Residences are typically the largest investment for homeowners, who tend to spend regularly on maintenance and improvement projects in order to increase their values.
I believe that the company has a strong cash flow generation ability, which should serve it well in the longer term. Strategic acquisitions could add to growth, as could new store openings abroad.

The Return on Equity has generally trended upwards, and has stayed above 20% over the past 7 years. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Annual dividends have increased by an average of 12.60% annually since 1999, which is higher than the growth in EPS. The company has also managed to decrease the number of dillluted shares outstanding from 168 million in 1999 to 117 million in 2008 through share repurchases. In 2008, the Sherwin-Williams purchased 7.25 million shares of its common stock in the open market, and continued its policy of paying out approximately 30% of the previous year’s diluted net income per share in the form of a cash dividend.
A 12 % growth in dividends translates into the dividend payment doubling every six years. If we look at historical data, going as far back as 1989, Sherwin-Williams has actually managed to double its dividend payment every seven years on average.


The dividend payout ratio has largely remained under 40% over the past decade, with the exception of 2000. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Sherwin-Williams is trading at 16.70 times earnings, yields 2.40% and has an adequately covered dividend payment. I would be looking forward to adding to my position in Sherwin-Williams (SHW) on dips below $48.

Full Disclosure: Long SHW

Wednesday, September 2, 2009

Six things I learned from the financial crisis

I started blogging about dividend growth stocks in January 2008; right around the time the market started its slide. Fast forward 18 months and we have seen it all: from companies which were once deemed too big to fail and which were later acquired for pennies on the dollar to the blowups of several prominent pyramid schemes and hedge funds. Back in early 2008 most investors were not fully aware of the dangers that the real estate implosion would have on the overall economy. Some aggressive investors lost much more than S&P 500 in 2008 due to their heavy concentration in certain sectors built at the highs of the market, use of excessive leverage and chasing “broken companies” which offered suspiciously high yields, which proved unsustainable.
In order for investors to become better at allocating capital, it is important to learn from ones mistakes. I have identified several mistakes, which could have saved investors billions had they known about them in the first place:

1) Diversify your portfolio. We often hear that diversification is dead and the fact that in a crisis almost all assets go down in sync. While this is somewhat true, a simple diversification strategy where an investor held some allocation to government fixed income, would have resulted in smaller losses. There are several bond ETF’s which hold US Treasuries. Examples include iShares Barclays 20+ Year Treas Bond (TLT) and iShares Barclays 7-10 Year Treasury (IEF). It is also important to understand that simply adding different asset classes in a portfolio may not provide any diversification benefits. For example adding fixed income from High-Yield Bonds would not have provided any diversification benefits, as most junk bonds represent companies with low credit ratings, which have a higher chance of defaulting during a crisis. Several Junk Bond ETF’s such as iShares iBoxx $ High Yield Corporate Bd (HYG) were introduced right before the financial crisis.
In addition to that, investors who concentrated their portfolios in just a handful of companies (10 – 15) would have under performed their benchmarks even if they had just one AIG (AIG) or Bank of America (BAC) in it. Both companies were considered the best of the best, before the crisis affected them and they had to seek government funds, while reducing or eliminating distributions to shareholders.

2) Build positions over time. While dollar cost averaging provides inferior returns in strong markets relative to a lump sum investment, the chance of a black swan effect ala 2008 makes it preferable for investors to build their positions slowly. This would be another control that would prevent your portfolio from collapsing, in case your stock analysis didn’t work out as planned.

3) Don’t chase high yield stocks blindly. Back in 2008, many financial stocks had very attractive dividend yields in the low double digits. Some of those like Citigroup (C), Bank of America (BAC) and Fifth Third Bank (FITB) had long histories of consistent dividend increases each year. The problem was that these stocks could not sustain paying their distributions, since they were earning much less than what they were paying out. At the end of the day these companies had nowhere else to go but cut their distributions, which was a strong sell indicator for many dividend growth investors. Most of the dividend cuts in the financial sector were followed by massive implosions in shareholders value from companies such as Citigroup (C), Lehman Brothers, Fannie Mae (FNM) and Freddie Mac (FRE).

4) Don’t use excessive leverage. Using leverage means borrowing money to invest in something for the purpose of magnifying your profit potential. When you are right, leverage works in your favor. For example if you purchased a stock on margin, and it increased 10%, your leveraged return would be almost 20%. When you are wrong though, leverage could result in disastrous results and bankruptcy. Using the same example, a leveraged bet on the wrong side of the table where the underlying fell by 10% results in a 20% loss.
The whose housing mess was created by allowing people who cannot afford expensive houses speculating on housing prices enjoying double digit increases for eternity, while being heavily leveraged. Once housing prices started dropping like a rock, panicked sellers helped exacerbate the problem by adding more fuel to the already severe drop in values. This caused interest payments on mortgage backed securities to not be paid, which triggered collapses in financial companies such as Ambac (ABK) and Fannie Mae (FNM) which then sent shockwaves throughout the world.

5) Don’t overpay for stocks. Investors often overpay for stocks because of the recency phenomenon, where they discount double-digit growth indefinitely. This leads to purchasing stocks with unacceptably low dividend yields, high P/E ratios and rosy predictions for strong dividend growth for eternity. Such conditions are simply unsustainable. The so called “Tech Four Horsemen” that CNBC’s “Fast Money” touted in the last quarter of 2007, Apple (AAPL), Research in Motion (RIMM), Google (GOOG) and Garmin (GRMN) all spotted unusually high valuations until growth expectations declined substantially. Investors suffered huge losses in the process.

6) Understand what you are investing into. It is important to understand what one is getting into by reading a prospectus for example. Many mortgage-backed securities were marketed to individuals and institutions as no risk investments. Investors who took the trouble to check the 500-page prospectus of such investments would have avoided severe losses. It is important to keep simple and within your circle of competence. Another example includes some dividend ETFs which were supposed to offer stable income, but which ended up heavily concentrated in financials and REITs. Retirees who depended on those ETFs rather than individual stock selection for income, were caught by surprise. Even the S&P Dividend Aristocrats Index ETF (SDY) and Dow Jones Select Dividend Index (DVY) at some point in time included dividend stocks which shouldn’t have been there. Even now the Dividend Aristocrats Index includes stocks like General Electric (GE), Pfizer (PFE) and Gannett (GCI) which should be avoided by dividend investors.

While this list is not meant to be a comprehensive all-inclusive one, it is a great starting point for both novice and experienced investors. I believe that investing has never been a perfect science, but one could achieve perfection by learning from their mistakes and not repeating them over and over.

Full Disclosure: None

This article was included in the Carnival of Personal Finance: Live From Monticello

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