Monday, December 29, 2014

Dividend Angels – a possible searching ground for investment opportunities

In my strategy, I have been looking for quality companies, which have managed to increase dividends every year for at least one decade. The thinking behind this requirement is that a company which raises dividends for at least ten years in a row has shown commitment to shareholders. This also reduces the risk that a company achieves a dividend growth record simply by being lucky, and not because it has the underlying fundamentals to withstand the brutal forces of economic downcycles.  I get interested when the underlying earnings per share for those companies increase in lockstep with those growing distributions. To me this is an indication that there is a good chance that this trend could continue in the future. There are no guarantees, which is why I also focus on the fundamental analysis of each company, in order to determine if earnings and dividends can go up. I get particularly interested however, when the companies that grow earnings and dividends, and have a consistent track record of dividend increases, are selling at attractive valuations.

There are approximately 350 companies which have managed to increase dividends for at least ten years in a row. US companies have historically been really good about maintaining a stable and increasing dividend payments to shareholders. This is evidenced by the consistent increase in dividends per share of companies in the S&P 500 index as well over the past 50 – 60 years. As I keep researching companies however, I have found that there are even more companies, which tend to increase dividends gradually over time, just not every single year.

General Mills, Inc. (GIS) manufactures and markets branded consumer foods in the United States and internationally. General Mills has increased dividends for 11 years in a row, and never cut them in the past 115 years. General Mills raised its dividends for 29 years in a row through 1995. However, after it spun-off Darden Restaurants (NYSE:DRI) to shareholders, the dividend was frozen. General Mills raised dividends again between 1996 and 1999, but then kept them unchanged until 2004. Currently, General Mills is a dividend achiever, as it has managed to boost dividends for 11 years in a row. The ten year dividend growth rate is 9.90%/year. The stock is close to fully valued at 19.10 times forward earnings and yields 3%. Check my analysis of General Mills.

Baxter International Inc. (BAX) develops, manufactures, and markets products for people with hemophilia, immune disorders, infectious diseases, kidney diseases, trauma, and other chronic and acute medical conditions. Baxter has paid dividends since 1934 and has managed to increase them for 8 years in a row. Up to 1998, the company was a dividend aristocrat that had increased dividends for 42 years in a row. However, after a few spin-offs, the dividend was frozen until 2006. Baxter is in the process of splitting into two parts, which should occur sometime in 2015. One will be focusing on developing and marketing biopharmaceuticals, while the other will be focusing on medical devices. Currently, the stock is selling at 15.30 times forward earnings and yields 2.80%. Check my analysis of Baxter.

Kellogg Company (K), together with its subsidiaries, manufactures and markets ready-to-eat cereal and convenience food products primarily in the United States and the United Kingdom. The company has paid dividends since 1925 and has increased them for ten years in a row. Between 1960 and 2001, the company had raised annual dividends every year. However it kept dividends unchanged between 2002 and 2004, this ending the long streak of consecutive dividend increases. Currently, the stock is selling at 17.10 times forward earnings and yields 2.90%. Check my analysis of Kellogg.

Paychex, Inc. (PAYX) provides payroll, human resource, insurance, and benefits outsourcing solutions for small to medium-sized businesses in the United States and Germany. Between 1990 and 2009, the company managed to increase annual dividends every single year. Paychex started growing dividends again in 2011. I often preferred ADP to Paychex, because the former always had more sustainable payouts, better valuations and consistent dividend growth every year. In addition, back when I analyzed Paychex in 2009 the dividend payout looked unsustainable. Lucky for shareholders, the dividend was not cut, but simply frozen for two years. Currently, the stock sells for 25.40 times expected earnings and yields 3.20%.

The Hershey Company (HSY), together with its subsidiaries, manufactures, markets, distributes, and sells chocolate and sugar confectionery products, pantry items, and gum and mint refreshment products. The annual dividend payment has increased by 9.60% per year over the past decade. Hershey ended a 35-year streak of consecutive dividend increases in 2009, by keeping distributions unchanged. However, it resumed dividend growth in the following year. Currently, the stock is overvalued at 23.60 times estimated 2015 earnings, and yields 2%. Check my analysis of Hershey at Seeking Alpha.

Eaton Corporation plc (ETN) operates as a power management company worldwide. Eaton has paid a rising dividend for over 3 decades, although it hasn't raised it every year. For example, in the past two decades the company kept annual dividends unchanged in 1999, 2000, 2002 and 2009. The company's business model is somewhat more cyclical than the type of dividend growth companies I have traditionally focused on. Due to the cyclical nature of the segments, it is understandable that dividends fail to get increased during recessions. The annual dividend payment has increased by 13.80% per year over the past decade Currently, the stock is selling at 15 times forward earnings and yields 2.80%. Check my analysis of Eaton at Seeking Alpha.

The Walt Disney Company (DIS), together with its subsidiaries, operates as an entertainment company worldwide. The company is not a typical dividend growth stock, although it has paid dividends since 1957, and has never cut them. Disney is the type of company that raises dividends for a few years, then keeps them unchanged, after which it raises them again. Disney is also one of the 60 companies, which could be purchased commission-free using Loyal3, with as little as $10. The annual dividend payment has increased by 13.50% per year over the past decade. Currently, the stock is close to fully valued at 20.20 times FY 2015 earnings and a yield of 1.20%. This is the type of quality company that looks expensive most of the time, yet quietly builds wealth for long-term shareholders. Check my analysis of Disney on Seeking Alpha.

The Boeing Company (BA), together with its subsidiaries, designs, develops, manufactures, sells, services, and supports commercial jetliners, military aircraft, satellites, missile defense, human space flight, and launch systems and services worldwide. Based on the company's dividend history, it looks like it has maintained dividends and increased them every so often for over 43 years in a row. The quarterly payment has increased from $0.00329/share to $0.91/share during this time period. The company has an order backlog of 490 billion dollars. The stock is selling for 15.30 times forward earnings and yields 2.80%.

I have been considering recently whether it would make sense to hold such companies in my portfolio. I am also wondering whether I can still consider a company a dividend growth one, if it raises dividends occasionally, but never cuts them. Long-time readers are familiar that I tend to buy those companies with a ten year streak of consecutive dividend increases, but I do not sell after a dividend is left unchanged. This is because in my analysis of dividend paying companies, I have noticed that when a dividend growth stock freezes dividend amounts after raising them for so many years, they frequently start raising them again. In addition, I get to thinking about long-term results, rather than requiring too much each year in terms of dividend growth rates. If you think about it, what is the difference for the long-term investor between those two companies:

Company A that sells for $100/share today, has a P/E of 16 and has an annual dividend of $3. In 10 years, the company increases dividends to $6/share, doubles earnings per share, and investors now value the shares at $200. Incidentally they sell for a P/E of 16. The company increased dividends each year by 7%.

Company B also sells for $100/share today, has a P/E of 16 and has an annual dividend of $3. In ten years, it also manages to double earnings and dividends, and investors also bid up the price to $200/share. However, the dividend was not increased in two out of the past ten years, but never cut.

In general, I would have preferred stock A, because of the annual dividend increases. However, if company B is available at a lower P/E, or I believed that it offered better growth potential over the next ten years, it might be a better investment for me as a dividend growth investor.

Lately, many investors are having trouble finding decent investment opportunities. I am still finding good quality companies selling at decent valuations, but the problem is that I have high positions in many of those already. Since I keep thinking about valuation as well, I tend to favor companies that sell at lower P/E ratios, without concentrating too much in particular industries like oil however. In my search for companies with low valuations, I have stumbled upon a few overlooked ideas, which are outside my screen. Now, if you are a beginning investor, it is a very good idea to develop an objective set of criteria and to follow it well. However, if you have been doing what I have been doing for 7 – 8 years, chances are that you have mostly been putting your money in a similar group of securities. This creates a risk from a diversification perspective. However, the past 2 years have been difficult, since many of my usual suspects are selling at the very top of the valuation range that I am willing to put money to. This leaves me with a low margin of safety, in case my investment thesis is wrong.

As a result, I have branched out into other companies, which has resulted in a steep increase in the number of positions in my portfolio. In my dividend growth plan, I keep talking about companies that pay a certain yield today, and have a certain expected growth in dividends in generic terms. This is because I do not care whether I hold 30, 60 or 90 dividend paying stocks as long as I manage to put my capital to work that satisfies my valuation and quality criterion. For example, if I owned 50 dividend paying stocks, and none of them are buys today, they might still be good holds. Since I have cash to invest every month from contributions and dividends, I need to get to work and find a good use for it. If the best ideas I can find at the time I have the cash are not perfect fits, that is fine, as long as they are bought at a good valuation, have quality characteristics, and have decent growth prospects. I will make mistakes, like I did with American Realty Capital Properties (ARCP), but I also know that I don't need all of my stock selections to be winners in order to come out ahead in the long-term and achieve my goals. Once again, dividend investing is not a black or white process, and is part art part science.

Full Disclosure: Long ETN, GIS, K, BAX

Relevant Articles:

The ten year dividend growth requirement
Investors Should Look for Organic Dividend Growth
How to read my stock analysis reports
Should Dividend Investors Ever Break Their Rules?
Dividend Champions - The Best List for Dividend Investors

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