Thursday, November 15, 2018

Franklin Resources (BEN) Dividend Stock Analysis

Franklin Resources Inc. (BEN) is a publicly owned asset management holding company. The firm provides its services to individuals, institutions, pension plans, trusts, and partnerships. This dividend champion has paid dividends since 1981 and managed to increase them for 37 years in a row.

The most recent dividend increase was in December 2017, when the Board of Directors approved a 15% increase in the quarterly dividend to 23 cents/share.

Over the past decade this dividend growth stock has delivered an annualized total return of 6.10% to its shareholders. Future returns will be dependent on growth in earnings and dividend yields obtained by shareholders.

The company has managed to deliver a 3.70% average increase in earnings per share over the past decade. Franklin Resources is expected to earn $2.87 per share in 2019 and $2.96 per share in 2020. In comparison, the company earned $3.19/share in 2018 ( the amount includes a one-time adjusting item of $1.80/share related to the new tax law that was signed at the end of 2017).

Between 2008 and 2018, the number of shares outstanding has decreased from 715 million to 538 million. The consistent decrease in shares outstanding adds an extra growth kick to earnings per share over time.

Overall I am bullish on asset managers, who have the odds stacked in their favor for future success. Essentially, the goal of the game is to get as much in assets under management, and then try to have low costs relative to competitors. As a large portion of customers stay with a manager, this generates fees for years to come.

Since asset prices tend to rise over time, asset managers who earn a fixed fee based on amount of money they manage are destined to earn more as well. This would not be a smooth ride up, but nevertheless the rising tide is destined to lift all boats up. Even if stock markets end going up by 6 - 7% in price annually for the next 2 - 3 decades, those asset managers are going to earn 6-7% more per year merely because they manage those assets. As long as the amount redeemed equal amount of new money invested, the asset manager will earn more money for shareholders simply for being there.

It is a pretty sweet model after all, where if you come up with a mutual fund idea and raise hundreds of millions from investors, you get to earn an annuity like income stream, as long as asset levels are at least maintained. There is no risk for the manager, and the risk is borne by investors in the funds.

Of course, if those asset managers also find ways to market their products and receive more in inflows from investors, their earnings per share could grow much faster than overall profits from other US sectors.

The main problem behind mutual fund companies and asset managers is the rise in passive investing approaches, which have been popularized by Vanguard. It is tough to compete against an organization which runs its passively managed funds at cost, thus minimizing expenses for shareholders in those funds. However, I do believe that not all assets will end up in index funds, although the competition will much tougher than before. Even the passively managed index funds are not a panacea for the ordinary mom and pop investor, who needs some guidance for managing their retirement money. From my personal experience , ordinary investors tend to focus on their jobs and lives, and are not very focused on investing decisions. This is why it is quite possible that traditional asset managers who manage to reach to those individuals, and sell relevant investment products that generate recurring revenues to them, will benefit.

It is very easy to buy and sell an investment these days, which makes "asset stickiness" a potential problem. In the case of Franklin Resources, assets under management have been in a decline for several years. This has pressured revenues and profits down. Other assets managers such as T.Rowe Price and Eaton Vance have managed to grow assets under management in recent years. Earnings per share have been aided by share buybacks. I do not like the fact that this asset manager is losing assets under management during a bull market. How bad would things get when we get a bear market? Of course, the tide could always turn. New products can increase revenues, plus strategic acquisitions could also boost assets under management, and then profits. The risk with acquisitions is that a very high price is paid out of desperation to get some growth, which could turn out to be a poor decision in the long run. Given the high level of assets under management, I wonder if Franklin Resources can become an acquisition target itself. It is obvious that the mutual fund business is not in the same position as the one enjoyed in the past 30 - 40 years. However, these businesses still generate fat profit margins and a lot of excess cashflows, which can enrich shareholders for a long time.

I am actually more bullish on investment advisers such as Ameriprise Financial (AMP) than mutual fund companies such as Franklin Resources . However, many individuals who buy an investment such as a mutual fund, tend to hold on to that investment for years. In addition, fewer individuals have company pensions, which means that they would have to manage their own money, or otherwise risk not retiring. This is why professionally managed money will still be around, and earn fees for decades to come.

The annual dividend payment has increased by 13.90% per year over the past decade, which is higher than the growth in EPS. I expect dividends to grow in the low single digits over the next decade. While Frankln Resources has a low dividend payout, and a low dividend yield, it has managed to distribute special dividend payments to shareholders on several occasions over the past decade as well.

A 14% growth in distributions translates into the dividend payment doubling every five years on average. If we check the dividend history, going as far back as 1992, we could see that Franklin Resources has managed to double dividends almost every five years on average.

In the past decade, the dividend payout ratio has increased from 11.30% in 2008 to 28.80% in 2018. The company has done a combination of special dividends, share buybacks and dividend increases. If the underlying business keeps contracting however, there will be a limit to future dividend growth.  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, Franklin Resources is selling for times 10.80 times forward earnings and yields 3%. The stock seems cheap, and has a very good safe dividend for now. What worries me as a long-term investor is the fact that assets under management have been declining over the past four years, amidst a strong bull market. This has brought revenues and net income down. While I appreciate the special dividends and share buybacks at low valuations, I am hesitant to invest in a business whose fundamentals are declining. If management turns the business around, investors today will be handsomely rewarded by the dividends, special dividends and share buybacks, while the valuation multiple will likely expand too. A prolonged bear market could be crippling to a company whose customers are withdrawing their investments and the value of those investments goes down due to stock price declines.

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Monday, November 12, 2018

Six Companies Growing Dividends for Shareholders

I review the list of dividend increases every week, in an effort to monitor existing holdings as well as identify companies for further research. In my weekly reviews on the blog, I usually focus on companies that have raised distributions for at least a decade, unless I already own shares of said companies.

Over the past week, there were six companies that raised dividends to shareholders. I reviewed each one briefly below:

AbbVie Inc. (ABBV) discovers, develops, manufactures, and sells pharmaceutical products worldwide. The company was created in 2013, when Abbott Laboratories split into two companies – Abbvie and Abbott. Last week Abbvie raised its dividends for a second time this year, from 96 cents/share to $1.07/share. Abbvie has continued raising dividends to shareholders for the five years since becoming a separate publicly traded company. The current payment is much higher than the quarterly distribution of 40 cents/share that was paid in 2013. The stock sells 11.20 times forward earnings and yields 4.80%.

When I reviewed the stock in September, I liked the valuation but didn’t like the growth prospects for Abbvie. Unfortunately, the company generates too high of a percentage of sales and profits from one blockbuster drug. That drug is going to lose patent protection, and will start seeing a lot more competition over the next 5 years. Others may argue that this uncertainty is already priced in, even more so after the recent declines after I passed on the stock in September. Either way, I will continue holding on to my existing Abbvie shares.

Vectren Corporation (VVC) provides energy delivery services to residential, commercial, and industrial and other contract customers. The company raised its quarterly dividend by 6.70% to 48 cents/share. The dividend increase marked the 59th consecutive year that Vectren (VVC) has increased the annual dividends to shareholders. Over the past decade, Vectren has managed to boost its annual dividends at a rate of 3%/year. This dividend king has managed to grow earnings from $1.87/share in 2007 to $2.60/share in 2017. The company is expected to earn $2.88/share in 2018.

The long streak of dividend increases for this dividend king is the result of the company’s continued successful execution of key strategic initiatives. Vectren has recognized the value of our long history of dividend growth and the role it has played in delivering above average shareholder returns. Unfortunately, the company is going to be acquired soon, which means that its long history of dividend increases will cease. While many fear mongers discuss dividend cuts, my experience is that many dividend investors end up having to sell their shares, because the businesses they own get acquired. Vectren is another company that is part of this statistic. That being said, the stock is overvalued at 24.90 times forward earnings and yields 2.70%.

AmerisourceBergen Corporation (ABC) sources and distributes pharmaceutical products in the United States and internationally. The company raised its quarterly dividend by 5.30% to 40 cents/share. This marked the 14th consecutive annual dividend increase for this dividend achiever. Over the past decade, the company has managed to grow distributions at a rate of 29.30%/year. Between 2007 and 2018, the company has grown earnings per share from $1.25 to an adjusted $6.49/share. The company is expecting to earn $6.65 to $6.95/share in 2019, which means that it is selling at 13.40 times forward earnings at the low range of estimates and that it yields 1.80%. In general, low yielding securities should be growing distributions at a high rate. While the stock seems cheap, I need to research further why there is a deceleration of dividend growth.

Automatic Data Processing, Inc. (ADP) provides business process outsourcing services worldwide. It operates through two segments, Employer Services and Professional Employer Organization Services. The company raised its quarterly dividend by 14.50% to 79 cents/share, which is the second dividend increase in an year. The new $0.79 quarterly dividend represents a 25.40% increase in the quarterly dividend compared to a year ago, and is a strong signal of the board's confidence in ADP's future and its commitment to shareholder friendly actions. Over the past decade, the company has managed to grow distributions at a rate of 11%/year.  This dividend champion has managed to grow earnings from $2.34/share in 2008 to $3.66/share in 2018. The company expects diluted earnings per share to hit $4.25/share in 2019. The stock is overvalued at 34.60 times forward earnings and yields 2.10%. Given the high valuation, I would have to take a pass on for now. I would be interested to add to ADP on dips below $85/share.

Emerson Electric Co. (EMR), a technology and engineering company, provides various solutions to industrial, commercial, and residential markets worldwide. The company raised its quarterly dividend by 1% to 49 cents/share. This marked the 62nd consecutive annual dividend increase for this dividend king. The ten year dividend growth is 5.90%/year. The company grew earnings from $2.66/share in 2007 to $3.46/share in 2018. Emerson Electric provided a 2019 guidance of $3.55 - $3.70/share. The stock is fully valued at 19.30 times forward earnings and yields 2.90%.

Spectra Energy Partners, LP (SEP) operates as an investment arm of Spectra Energy Corp. Spectra Energy Partners, LP, through its subsidiaries, engages in the transportation of natural gas through interstate pipeline systems, and the storage of natural gas in underground facilities in the United States. The partnership raised its quarterly distribution to 77.625 cents/unit. This was a 6.90% increase over the distribution paid during the same time last year. Spectra Energy Partners has raised distributions for 11 years in a row. Since the end of 2007, the MLP has managed to grow distributions every single quarter, which is not a small achievement. Right now this MLP yields 8.70%.

Relevant Articles:

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Thursday, November 8, 2018

How to avoid dividend cuts

As a dividend growth investor, my goal is generate enough dividend income to pay for my expenses in retirement. I focus on dividend income, since it is more stable and more reliable portion of total returns, which makes it easier to predict that stock prices. I have shared with you my process for screening, identifying and analyzing companies. While the risk of dividend cuts is out there, there are ways to minimize the number of dividend cuts and also to reduce their impact on the overall dividend income. Although I have had dividend cuts in my history as an investor, these have not derailed me from hitting my goals. After watching the investment environment for the past two decades, I have seen a few things. The best thing about dividend cuts are the lessons learned from the experience.

In order to reduce the chance of dividend cuts, the investor needs to focus on several key metrics:

1) Dividend Payout Ratio

The dividend payout ratio is calculated by dividing the annual dividend income over earnings per share. In other words, this is the portion of earnings which are distributed to shareholders in the form of dividends. A lower number is usually better, because it allows for a better margin of safety on the dividend stream from earnings. The margin of safety is helpful when earnings decrease in the short run, due to a soft economy for example. Companies that have ample room for maneuvering can continue paying and even increasing those dividends when earnings are temporarily down and the payout ratio temporarily spikes up.

In my analysis, I look for a payout ratio that is less than 60%. I also look at the trends in the dividend payout ratio, in order to see if it is growing or decreasing. I do not want to see companies that grow the dividend by expanding the payout ratio. I want companies to grow the dividend, while keeping the payout ratio around a range and keeping a lid on the payout ratio.

However, certain companies in certain industries can afford to pay higher portions of their earnings to shareholders. Many utilities for example tend to distribute over 60% - 70% and even 80% of their earnings to shareholders in the form of dividends. These companies are regulated monopolists, which tend to generate stable earnings and revenues over time. Due to this stability of the business model, they can afford to have high payout ratios. The dividend analyst can usually evaluate the sustainability of the dividend by reviewing the trends in the payout ratio. A public utility that has paid between 70% and 80% of earnings as dividends over the past decade has a sustainable dividend. An industrial company that grows its dividend and sees its payout ratio rise from 35% to 80% however does not strike me as an investment with a sustainable distribution. In another example, a company like Altria (MO) with a stated target of 80% and a history of a high payout ratio and rising earnings per share is another exemption that I consider.

2) Earnings Per Share

In general, we want earnings per share which are stable and growing. While some fluctuations in earnings per share do occur as a result of the economic cycle, we want to see a steady climb upwards over time. Without growth in earnings per share, a company cannot afford to raise distributions to shareholders as there is a natural limit to future increases. This will be evident when the dividend payout ratio starts increasing, while earnings are stagnant.

Rising earnings provide the fuel behind future dividend increases. In general, a healthy company will grow earnings over time, distribute a portion to shareholders in the form of dividends, and reinvest the rest to maintain or grow the business. A business with stable earnings can provide more reliable dividend payments than a business with more volatile earnings streams however. For example, most automotive companies in the world are cyclical companies. This means that their earnings ebb and flow with the ebb and flow of the economy. As a result, earnings go from highs to lows rather violently. When times are great, earnings are at their peak just as the economy is at its peak. The dividend payout ratio looks high, but this is usually a mirage, because earnings are about to take a dive just at the economy is taking a dive. This rapid fluctuation in earnings is the reason why there are no auto companies which are members of the dividend achievers index.

3) Business model

The stability of the business cannot be emphasized enough. Companies with strong earnings and revenue streams, which are less sensitive to the economic cycles can afford to pay dividends come rain or shine. When reviewing the longest streaks of dividend increases, I have found quite a few utilities and consumer staples companies. When the demand for the products or services is relatively inelastic, you can afford to maintain and grow dividends, since you have better visibility about the near term business prospects. That doesn’t mean to focus only on a few industries however, since things can change over time. This is why we need to be diversified, but also not to diversify for the sake of diversification either.

4) Debt and acquisitions

I rarely discuss debt in my analysis. In my experience, I have found that debt in the normal course of business is not a major issue when it comes to dividend safety. Debt can become an issue when it is coupled with a major acquisition. When you take on debt, you are essentially spending money today that you do not have, and as a result the future you has to pay for a period of time. Leverage is a two-way street that enhances your performance on the upside or the downside. If you acquire a business with all debt, and the business performs well, it can pay for itself from those profits. This leaves you with the debt paid off, and the business being your own letting you get future dividends in perpetuity. If you the business fails however, you have to still pay that debt and interest on it, which will hurt performance. If you are too leveraged, it may mean increased risk of bankruptcy if you have less wiggle room if business turns soft.

When you acquire a company, there are a lot of good things that can occur – namely synergies, increase in scale of operations, adding new products and expanding the business reach. However, a lot of things can happen that can derail acquisitions including having different cultures, integrating different systems and actually realizing those efficiencies of scale.

In my experience, there have been several companies that cut dividends after large acquisitions that were paid for with debt. Those include Pfizer (PFE) and Cedar Fair (FUN). If we talk purely about debt, we have Kinder Morgan (KMI) which had to cut dividends in 2015 after its credit rating took a hit after an acquisition.

In general, I do not look at debt too much. Again, as stated above debt can be an issue when combined with a major acquisition. This usually leads to a halt to future dividend increases, and sometimes even to dividend cuts. Many investors look at debt to equity or debt to assets. I prefer looking at interest coverage from earnings.

So if a company earns $100 million in profits, and spends $20 million on interest expense, I would argue that debt shouldn't be an issue.

I think that this is the only article I have written on debt.

5) Things Change

Unfortunately, sometimes things happen. When you buy a security with bright prospects, great valuation and attractive payout ratio today, you may not be aware that changes may be coming years or decades down the road. Technologies disrupts businesses, but also consumer tastes change as well. The economic cycle can be ravaging for businesses, and poor management may also be to blame. This is why we need to diversify as investors, in order to mitigate the effect of disasters on our retirement projections.

For example, investors who bought GE for the dividend growth were negatively impacted by the dividend cut in 2009. This was the first dividend cut since 1938. If you bought GE in 1995, you may not have expected that 4 years later this company would cut dividends because of its financial division. Nor would you have expected that the company would cut dividends in 2017 and eliminate them in 2018. The writing was on the wall when the dividend payout ratio increased beyond 60%, which indicated that the dividend would be cut. However, that was many years after our hypothetical investor bought GE in the 1990s. Now GE has cut dividends in 2017 and again just a few weeks ago.

In another example, when I bought Coca-Cola (KO) stock in 2008 and 2009, I saw the company as a solid dividend payer that will grow earnings per share and dividends per share for years down the road. Unfortunately, the company has been unable to grow earnings per share since 2012. Coca-Cola has continued raising its dividend however. As a result, its dividend payout ratio is very high, which means that the dividend is less safe. If Coca-Cola manages to grow earnings from here, it will likely be able to grow the dividend and would reduce the dividend payout ratio. The lower payout ratio will result in a higher margin of safety of the distribution, making it more resilient to external shocks.
In order to prevent damage from changes, I have several controls in place. I try to be diversified and own at least 40 – 60 companies representative from as many sectors and industries as possible.

Another investment where things have not turned out as expected is IBM (IBM). The company expected to hit $20/share in earnings per share by 2015, and was buying back stock for years. Once it failed to reach its goals, IBM has continued raising dividends and buying back stock, but earnings per share have been going nowhere. After the recent acquisition of Red Hat, the company has announced a halt to its buybacks. This is ironic, because shares are selling at a multi-year low. While the dividend may be safe for now, the magic cocktail of new acquisitions, flat earnings per share, increased debt levels and high payout ratios and multi-decade high in the dividend yield make the distribution less safe. Needless to say, I haven't added to IBM in quite some time, and allocate my dividends elsewhere.

However, I also focus on my entry criteria when adding new funds to work or allocating dividends for reinvestment. In addition, I sell after a dividend cut, and reinvest the proceeds elsewhere to minimize the blow to dividend income.


Today we discussed five factors I leverage to reduce the risk of dividend cuts. While the risk of dividend cut will always be out there, I believe that it can be managed by the strategic dividend growth investor. The nice factor to consider is that in a diversified portfolio consisting of 50 securities, one dividend cut by 50% is easy to overcome if the rest of components grow distributions to offset the cut. In addition, by selling after a dividend cut and reinvesting the proceeds in a company that keeps growing distributions can have a positive income and psychological benefit for the investor, because it would allow them to reasses the situation with a cool head.

Having an investment plan that focuses on dividend safety, valuation, and sound portfolio management could ultimately be beneficial in including all factors listed above, and help the investor reach their goals and objectives.

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Monday, November 5, 2018

Three Dividend Stocks Rewarding Shareholders With a Raise

As part of my monitoring process I review the list of dividend increases every week. Every month, I also review and update the list of dividend champions.

This process helps me follow the developments in companies I own. It also helps me identify companies for further research. I use the following logic to narrow the list down and evaluate companies:

I try to focus my attention on companies that have raised dividends for at least a decade. This helps me to focus on companies that have managed to grow dividends through an average economic cycle of boom and bust.

I also review the recent dividend increase, relative to the dividend growth over the past decade. This is a helpful indicator to determine whether dividend growth is decelerating or accelerating. I do not want companies that reward shareholders with token increases, when their payout ratios are high and earnings growth is non-existent.

Speaking of earnings growth, I want a company that is growing earnings per share, and has achieved a positive EPS growth over the past decade. Rising earnings per share are the fuel behind future dividend increases. When you look at trends in EPS however, you may need to dig deep behind some large year-over-year fluctuations in order to account for one-time events. I also look at forward earnings per share, in an effort to quickly scan a large list of dividend stocks, since forward estimates tend to take out one-time items. However, earnings estimates are usually a little over-optimistic, which is why they have to be taken into consideration along with prior year earnings, as well as earnings per share over the past decade. Others also like to look at revenues too. Isn’t investing analysis fun?

I also focus on dividend safety. A dividend payout ratio above 60% is usually a warning sign. Another warning sign includes a rising payout ratio – in general we want a stable trend in the payout ratio over the past decade. All rules have exceptions to them however – companies in the utilities and tobacco industries for example have high payout ratios. The safest dividend is one with a payout ratio below 60%, where earnings per share are growing, and the dividend grows at the pace of earnings growth.

Last but not least, we also want to evaluate the company for valuation. I take into consideration the information for each company I gathered above, and rank those companies against my entry criteria. Most notably, I look for companies selling below 20 times forward earnings.

Now that you know how I evaluate companies, I am including three dividend champions that raised dividends to shareholders over the past week. The companies include:

Black Hills Corporation (BKH) operates as a vertically-integrated utility company in the United States. It operates in three segments - Electric Utilities, Gas Utilities, Power Generation, and Mining. The company raised its quarterly dividend by 6.30% to 50.50 cents/share. This was the 48th consecutive annual dividend increase for this dividend champion. The recent raise was larger than the 2.80%/year average annual raise over the past decade. Between 2008 and 2017, the company raised its earnings from $2.75/share to $3.21/share. The company is expected to earn $3.42/share in 2018. The stock seems fairly valued at 17.40 times forward earnings and yields 3.40%. Given the slow rate of earnings and dividend growth however, I view it as a hold at best today.

Mercury General Corporation (MCY) engages in writing personal automobile insurance in the United States. The company raised its quarterly dividend by 0.40% to 62.75 cents/share. This marked the 32nd consecutive annual dividend increase for this dividend champion. It was slower than the ten year average of 1.80%/year. Between 2007 and 2017, the company’s earnings fell from $4.34/share to $2.62/share. The company is expected to earn $2.44/share in 2018. Mercury General seems overvalued at 24.60 times forward earnings. The stock yields 5%, but the dividend doesn’t seem well covered based on forward earnings. I would give the company a pass at this time.

Cintas Corporation (CTAS) provides corporate identity uniforms and related business services primarily in North America, Latin America, Europe, and Asia. It operates through Uniform Rental and Facility Services and First Aid and Safety Services segments. The company raised its annual dividend by 26.50% to $2.05. This is the 35th consecutive year that the annual dividend has increased, which is every year since Cintas went public in 1983. The dividend raise was larger than the ten year average of 15.30%/year. Between 2008 and 2017, the company raised its earnings from $2.15/share to $7.56/share. The company is expected to earn $7.24/share in 2018. I like the company, but unfortunately it is overvalued at 24.80 times forward earnings. The stock yields 1.10%. I would be interested in Cintas on dips below $145/share.

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