Monday, March 14, 2016

What should I do about slowing dividend growth?

In the past week, two of my holdings raised their quarterly dividends. Unfortunately, those dividend increases were pretty pathetic. I evaluated each of them, to determine what to do in this situation.

Colgate-Palmolive Company (CL), together with its subsidiaries, manufactures and sells consumer products worldwide. It operates through two segments: Oral, Personal and Home Care; and Pet Nutrition. The company announced a 2.60% increase in its quarterly dividend to 39 cents/share. This marked the 53rd consecutive annual dividend increase for this dividend king. The company has managed to increase annual dividends at a rate of 10.50%/year over the past decade.

I looked at previous dividend increases since 1977 for Colgate-Palmolive, in order to put the latest dividend increase in perspective. I noticed that in 1980, the company had a 3.70% dividend raise, after keeping distributions unchanged for over an year and a half. Throughout most of the 1980s, Colgate-Palmolive maintained a rate of slow dividend growth, particularly as it increased quarterly dividends every two years. Due to the fact that the dividend increase always occurred on the last quarter of the first year after the raise, the company still managed to boost annual dividends paid to shareholders, despite the fact that the quarterly dividend was actually hiked every two years. The slow dividend growth in the 1980s was driven by slow earnings growth at the time.


Date
Quarterly Dividends
Dividend Increase
4/21/2015
 $  0.38000
5.56%
4/17/2014
 $  0.36000
5.88%
4/19/2013
 $  0.34000
9.68%
4/20/2012
 $  0.31000
6.90%
4/21/2011
 $  0.29000
9.43%
4/22/2010
 $  0.26500
20.45%
4/22/2009
 $  0.22000
10.00%
4/22/2008
 $  0.20000
11.11%
4/20/2007
 $  0.18000
12.50%
4/20/2006
 $  0.16000
10.34%
4/22/2005
 $  0.14500
20.83%
4/23/2003
 $  0.12000
33.33%
7/24/2001
 $  0.09000
13.92%
7/22/1999
 $  0.07900
14.91%
4/23/1997
 $  0.06875
17.02%
7/21/1995
 $  0.05875
14.63%
7/19/1994
 $  0.05125
13.89%
7/20/1993
 $  0.04500
16.13%
7/21/1992
 $  0.03875
16.96%
4/19/1991
 $  0.03313
17.77%
10/19/1989
 $  0.02813
21.62%
10/20/1987
 $  0.02313
8.85%
10/21/1985
 $  0.02125
6.25%
4/19/1983
 $  0.02000
6.67%
10/20/1981
 $  0.01875
7.14%
10/21/1980
 $  0.01750
3.67%
1/19/1979
 $  0.01688
8.00%
7/19/1977
 $  0.01563
13.67%

Colgate is expected to earn $2.75/share in 2016 and $3.01/share in 2017. The company has been unable to exceed the earnings of $2.65/share from 2012. After three – four years of no earnings growth, and an increase in the dividend payout ratio, it is understandable that dividends per share cannot grow by much. The stock is overvalued at 24.90 times expected earnings,  yields 2.30% and has a dividend payout ratio of 56.70%.

General Mills, Inc (GIS). manufactures and markets branded consumer foods in the United States and internationally. The company raised its quarterly dividend by 4.50% to 46 cents/share. The stock yields 3%. This marked the 13th consecutive annual dividend increase for this dividend achiever. The company has managed to increase annual dividends at a rate of 10.50%/year over the past decade.

I looked at previous dividend increases since 1984 for General Mills, in order to put the latest dividend increase in perspective. I noticed that in 1999, the company raised quarterly dividends by a token 3.80%. After that, General Mills didn’t increase dividends for five years, until 2004. There had been small dividend hikes along the way over the past decade as well, but those were during a period where the company hiked dividends twice per year.

Date
 Quarterly Dividends
Dividend Increase
4/8/2015
 $     0.44000
7.32%
4/8/2014
 $     0.41000
7.89%
7/8/2013
 $     0.38000
15.15%
7/6/2012
 $     0.33000
8.20%
7/7/2011
 $     0.30500
8.93%
7/8/2010
 $     0.28000
14.29%
1/7/2010
 $     0.24500
4.26%
7/8/2009
 $     0.23500
9.30%
7/8/2008
 $     0.21500
7.50%
4/8/2008
 $     0.20000
2.56%
7/6/2007
 $     0.19500
5.41%
1/8/2007
 $     0.18500
5.71%
7/6/2006
 $     0.17500
2.94%
1/6/2006
 $     0.17000
3.03%
10/5/2005
 $     0.16500
6.45%
7/8/2004
 $     0.15500
12.73%
1/6/1999
 $     0.13750
3.77%
4/8/1997
 $     0.13250
6.00%
4/8/1996
 $     0.12500
6.38%
7/2/1993
 $     0.11750
11.90%
7/6/1992
 $     0.10500
13.51%
7/3/1991
 $     0.09250
15.63%
7/3/1990
 $     0.08000
16.36%
7/3/1989
 $     0.06875
17.02%
7/1/1988
 $     0.05875
17.50%
7/6/1987
 $     0.05000
25.00%
10/6/1986
 $     0.04000
10.34%
4/4/1986
 $     0.03625
3.57%
7/3/1984
 $     0.03500
9.79%

General Mills is expected to earn $2.86/share in 2016 and $3.06/share in 2017. The factor that makes this company a hold at most is the inability to grow earnings per share by much since 2011. In 2011, General Mills earned $2.70/share. This provides an explanation as to why dividend growth is slowing down. As I have mentioned before, without growth in earnings per share, future dividend growth is limited. This is because a company can only increase the dividend payout ratio so much, before hitting a natural ceiling. The stock is overvalued at 21.30 times expected earnings,  yields 3% and has a dividend payout ratio of 64.30%.

The most interesting part is that each one of these companies is selling at or close to 52 weeks highs. I am tempted to sell some of those shares, since using the most recent data points I do not see much improvement on a go forward basis. Both companies sell at more than 20 times expected earnings. I would not put new capital to them if I were just starting over as a dividend growth investor.

One of the lessons I have learned is to stay invested in the companies I own, no matter what (dividend cuts being the only major exception). I have found that too much activity is counter-productive to my investment performance. After studying historical dividend growth rates for a lot of dividend growth stocks, I have learned that one should not get scared and sell at the first time of trouble or a slowdown. This is because it is impossible to predict whether any slowdown is temporary or the beginning of the end.

This means that if I were to sell my stakes in those two companies, I will be worse off because I would have to pay high taxes on gains I have generated. I would also lose out on future dividend income. In addition, the companies I purchase with the proceeds might perform worse than the original two companies. It is also quite possible that these businesses are experiencing short-term turbulence, which could very likely be overcome in a few years. These are dominant global businesses, which have stable earnings and revenues that are somewhat recession resistant. If emerging market economies rebound, and the dollar stops appreciating as much, earnings per share would finally have a tailwind, rather than a significant headwind.

On the other hand, I have learned that I should not be putting more money to work in a company where dividend growth slows down dramatically. Dividend policies reflect the expectations for business performance in the next 12 – 24 months. If management expects business to be slow, they will set a dividend policy that reflects this lackluster outlook. In other words, a small dividend hike reflects management expectations for low earnings growth in the near future.

Full Disclosure: Long CL and GIS

Relevant Articles:

The most important metric for dividend investing
Dividend Kings for 2016
Give your investments time to compound
Five Dividend Growth Investing Lessons I Have Learned
How to value dividend stocks

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