Monday, September 30, 2019

Six Dividend Growth Stocks Rewarding Shareholders With a Raise

There were five companies with at least a decade of dividend increases under their belt which hiked distributions last week. There was one company with a nine year record included, because I am monitoring it more closely these days. I reviewed the latest increase against the ten year average in each of the three instances. I also reviewed the trends in earnings, and then looked at the valuation, in order to come up with a conclusion on whether these companies are worth researching further or not. I own shares in one of these companies, but I would not be adding today to it. I did identify one company that may be worth a second look if I can find it at the right entry price.

The companies raising dividends last week include:

Lockheed Martin Corporation (LMT), a security and aerospace company, engages in the research, design, development, manufacture, integration, and sustainment of technology systems, products, and services worldwide. It operates through four segments: Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space.

The Lockheed Martin Corporation board of directors raised its quarterly dividend by 9.10% to $2.40 per share. This marked the 17th year of annual dividend increases for this dividend achiever. Over the past decade, it has managed to grow distributions at an annualized rate of 16.20%.

Lockheed Martin managed to boost earnings from $7.86/share in 2008 to $17.59/share in 2018. The company is expected to earn $21.21/share in 2019

The stock sells at 18.30 times forward earnings and offers a dividend yield of 2.50%.

Honeywell International Inc. (HON) operates as a diversified technology and manufacturing company worldwide. The company’s Board of Directors approved a 9.80% increase in the company's regular quarterly cash dividend from 82 cents per share to 90 cents per share. This marked the ninth consecutive annual dividend increase for this future dividend achiever. During the past decade, this company has managed to boost dividends at an annualized rate of 10.80%.

Honeywell managed to grow earnings from $3.75/share in 2008 to $8.98/share in 2018.
The company is expected to earn $8.10/share in 2019

The stock is slightly overvalued at 20.70 times forward earnings. Honeywell yields 2.10%. It may be worth a closer look below $162/share.

Artesian Resources Corporation (ARTNA) provides water, wastewater, and other services on the Delmarva Peninsula.

ARTNA Artesian Resources Corporation’s Board of Directors approved a 1.5% increase in the company’s dividend to 24.96 cents/share. Artesian Resources has paid quarterly dividends to its shareholders for 108 consecutive quarters and for the 23rd consecutive year has increased dividends. Over the past decade, this dividend achiever has managed to grow distributions at an annualized rate of 3%.

Artesian Resources has managed to increase earnings from 86 cents/share in 2008 to $1.54/share in 2018.

The stock is overvalued at 24 times earnings and offers a low dividend yield of 2.70%. The yield is low given the slow growth in distributions per share.

BancFirst Corporation (BANF) operates as the bank holding company for BancFirst that provides a range of commercial banking services to retail customers, and small to medium-sized businesses. It operates through Metropolitan Banks, Community Banks, and Other Financial Services segments. The company raised its quarterly dividend by 6.70% to 32 cents/share. This marked the 27th consecutive annual dividend increase for this dividend champion. The company has managed to boost its distributions at an annualized rate of 8.50%/year over the past decade.

Between 2008 and 2018, the company managed to increase earnings from $1.43/share to $3.76/share.
BancFirst Corporation is expected to earn $3.99/share in 2019

The stock is fairly valued at 14 times forward earnings and offers a dividend yield of 2.30%.

OGE Energy Corp. (OGE) operates as an energy and energy services provider that provides physical delivery and related services for electricity and natural gas primarily in the south central United States. It operates in two segments, Electric Utility and Natural Gas Midstream Operations.
The Company’s Board of Directors approved a 6.20% increase in its quarterly dividend to 38.75 cents per share. This marked the thirteenth consecutive annual dividend increase for this dividend achiever. Over the past decade, the company has managed to boost distributions at an annualized rate of 7%/year.

OGE Energy managed to grow earnings from a low of $1.25/share in 2008 to $2.12/share in 2018.
The company is expected to generate $2.12/share in 2019.

The stock is slightly overvalued at 21.40 times forward earnings. OGE Energy yields 3.40%.

Hingham Institution for Savings (HIFS) provides various financial products and services to individuals and small businesses in the United States.

The company’s Board of Directors raised its quarterly dividend by 2.60% to 40 cents/share. This was an increase of 11.10% over the dividend paid during the same time last year. Hingham Institution for Savings also distributes special dividends in the fourth quarter. The last special dividend was for 50 cents/share. Since the company has been raising dividends starting in 1995, it should be included in the dividend champions list from December 2019.

Hingham Institution for Savings grew its earnings to $ 13.90/share in 2018, from $2.96/share in 2009.
The stock yields 0.80% today, excluding the impact of special dividends. The stock is selling at 13.70 times forward earnings.

Relevant Articles:

2019 Dividend Champions List
My Portfolio Monitoring Process In a Nutshell
Nine Companies That Love To Raise Their Dividends
Dividend Achievers versus Dividend Contenders & Champions

Thursday, September 26, 2019

U.S. Bancorp (USB) Dividend Stock Analysis

U.S. Bancorp (USB) is a financial services holding company, which provides various financial services in the United States. It operates in five segments: Corporate and Commercial Banking, Consumer and Business Banking, Wealth Management and Investment Services, Payment Services, and Treasury and Corporate Support.

U.B. Bancorp has increased dividends for 9 years in a row. It just recently raised its quarterly dividend last week by 13% to 42 cents/share – just half a cent below the highest dividend from before the financial crisis. The company lost its status of a dividend aristocrat during the financial crisis, after accepting TARP money and cutting dividends from 42.50 cents/share to 5 cents/share. It resumed growing the dividend from a low base in 2011, and as the regulation restrictions have come off a little bit, it has room for an above average dividend growth.

Earnings per share have increased from $1.62/share in 2008 to $4.14/share in 2018. U.S. Bancorp is expected to generate $4.29/share in 2019. For reference, peak earnings per share prior to the financial crisis hit $2.61/share in 2006. Earnings per share decline to 97 cents/share in 2009, before rebounding. This just goes to show that the bank has generated higher earnings and is more valuable than before the crisis. Further, it kept profitability every quarter during the crisis, which is a testament to its diversified revenue base, and conservative underwriting standards.

During the next recession, we will likely see a decline in earnings per share, likely triggered by a larger provision for credit losses. The strong underwriting culture will balance any losses and keep them from getting too excessive during the next crisis.

Closing unprofitable and underperforming branches will increase efficiency and cut costs, which could translate into higher profits. An increase in online banking could require a smaller retail footprint, which could reduce operating costs. On the other hand, in order to be successful in digital, companies like U.S Bancorp need to invest in its technology. Furthermore, a reduction in the number of branches could be bad for building and maintaining long-term relationships with customers. The increase in online banking could also be a negative, given the rise in FinTech’s, and the fact that technology is increasingly making it easier for consumers to compare options. While inertia is a powerful force, I wonder whether consumers will be willing to stay put with a checking or savings account that doesn’t yield anything, when other alternative can provide better returns with a click of a button. I also wonder if consumers will stick to products that charge them a recurring monthly fee, instead of switching to the many low to no cost alternatives out there.

Growth in the economy will stimulate demand for new loans . While the net interest margins will fluctuate, I expect that a bank like USB with solid underwriting can manage to grow profits over time, through more loans and by utilizing its low cost depositors base.

U.S. Bank’s assortment of fee-income generating segments is more diverse than those of other banks. Examples includes payments, trust services, investments services and mortgage banking. This makes US Bank somewhat less dependent on net interest income for revenues.

U.S. Bank profits from its position in payments services, which provides a stream of income that more recurring type in nature. This includes credit and debit cards, merchant processing and corporate payment products. These are highly scalable as a business.

Trust services and wealth management services are another more stable business model with a recurring revenue stream characteristic, which can insulate somewhat the income statement from the ups and downs of the credit cycle.

The dividend payout ratio was at 105% in 2008, just prior to the dividend cuts in 2009. The payout ratio dropped to 21% and then even further to 12% as profits started rebounding. Since 2012/2013, the dividend payout ratio has remained around 30%. While U.B. Bancorp also prioritizes share buybacks, I believe that the payout ratio can increase a notch over the next decade. A lower payout ratio is a good cushion against steep drops in earnings that we will experience during the next recession. This minimizes the chance of another dividend cut, though it doesn’t eliminate it. Even if the payout ratio stays around 30%, pure earnings growth could deliver growth in distributions to patient stockholders.

During the financial crisis, the number of shares outstanding increased. However, since 2010, U.S. Bancorp has steadily repurchased shares. As a result, the number of outstanding shares has decreased by 16%. There will be more funds for share buybacks going forward, which would boost earnings per share. The added boost to earnings per share could also provide a continued boost to dividends per share (given a flat payout ratio).

U.S. Bancorp (USB) is attractively valued at 13 times forward earnings and offers a current yield of 3%, which is well covered by its strong and diversified earnings base.

Relevant Articles:

USB Dividend Analysis
US Bancorp (USB) cuts its dividend by 88%
Don’t chase High Yielding Stocks Blindly
Dividend Investing During the Financial Crisis
Six things I learned from the financial crisis

Monday, September 23, 2019

Record Dividend Payments in the US For A Decade

It has been over a decade since the Great Recession ended. The end of the recession was marked with a profit rebound, and a continued rise in dividends.

The quarterly dividend on S&P 500 index of the largest corporations in the US hit a record $14.24, which is a record in the second quarter of 2019 (the last date for which data is available). The earnings per share on the largest US corporations is also hitting records. US stock prices are not surprisingly close to all-time-highs. According to the Dividend Growth Model, which I have been discussing since 2008, when you get rising earnings, which lead to rising dividends, you are likely to get higher share prices as well ( assuming you didn't overpay at the time of the investment).

A return of dividends shouldn’t be viewed as anything but a good thing. Profits bounced back almost immediately after the recession. Now patient shareholders are getting what they deserve: a four-times-a-year reminder that they, not management, own the company.

Paying dividends is a tax-advantaged way to reward shareholders. It's a signal of managements confidence in your ability to produce earnings above that dividend, because companies don't pay dividends above a threshold where they have confidence that they can maintain those dividend payouts. Nobody wants to cut a dividend.

It also has a subtle but very important effect in reining in mindless empire building. There's an arrogance to the notion that a company's best internal reinvestment opportunity is better than its shareholders' best reinvestment opportunity in the entire world of investing. And that's what tacitly being said by hanging on to all of the earnings. Funding empire building is a disservice to investors, because often it winds up being used to fund dumb projects.

Companies can also return excess profits in the form of share buybacks. I think of share buybacks as a special stealth dividend. But they're not reliable. Companies announce share buybacks and often pursue them and often don't. Companies announce share buybacks linked to management stock-option redemption, so if they award stock to the management team, they instantly sell it. That's the usual practice. Companies then institute a buyback of a like number of shares. This not a buyback -  that's facilitation of management compensation, and it should be viewed as such.

If buybacks could be as reliable as dividends, I would like them, but there's far more talk about buybacks than a reality of buybacks. Buybacks have been an off-again, on-again part of the landscape. So I don't trust buybacks. I like them, but I don't trust them.

During the past week, there were several companies which decided to reward shareholders, by increasing their dividends. That's a good sign. I reviewed the ones with the longest streaks of dividend increases for your pleasure below:

Texas Instruments Incorporated (TXN) designs, manufactures, and sells semiconductors to electronics designers and manufacturers worldwide. It operates in two segments, Analog and Embedded Processing.

Texas Instruments Incorporated raised its quarterly cash dividend by 17%, from $0.77 per share to $0.90. The announcement marks 16th consecutive year of dividend increases for this dividend achiever. The company has reduced its outstanding shares by 46% through its consistent share repurchases since the end of 2004.

Between 2008 and 2018, the company managed to grow earnings from $1.45 to $5.59/share. The company is expected to earn $5.32/share in 2019.

The stock looks overvalued at 23.80 times forward earnings. Texas Instruments yields 2.80%. It may be worth a second look on dips below $106/share.

Realty Income (O) The Monthly Dividend Company, is an S&P 500 company dedicated to providing stockholders with dependable monthly income. The company is structured as a REIT, and its monthly dividends are supported by the cash flow from over 5,900 real estate properties owned under long-term lease agreements with commercial tenants.

Realty Income hiked its monthly dividend to 22.70 cents/share. The new monthly dividend is 2.90% higher than the monthly dividend paid during the same time last year. Realty Income will become a dividend champion at the end of 2019, after raising dividends for 25 years in a row.

Over the past decade, Realty Income has managed to boost distributions at an annualized rate of 4.50%.

Between 2008 and 2018, Realty Income has managed to grow FFO from $1.84/share to $3.12/share. Realty Income expects FFO/share in the range of $3.26 - $3.31 for 2020.

The stock is overvalued at 23.30 times forward FFO. Realty Income yields 3.60% today. Investors have bid up the Monthly Dividend Company, because it has dependable rent streams, which increase over time. In addition, Realty Income is also growing its FFO/share over time. I would like to see this quality REIT sell at a more reasonable valuation, before adding to my position there. Check my analysis of Realty Income for more information about the company.

Ingredion Incorporated (INGR) produces and sells starches and sweeteners for various industries. The company operates through four segments: North America, South America, Asia Pacific and Europe, and Middle East and Africa.

Ingredion raised its quarterly dividend slightly by 0.80% to 63 cents/share. Ingredion has managed to reward shareholders with a raise for 9 years in a row. The dividend increase is a far cry from the 16.90% annualized dividend growth over the past decade.

Between 2008 and 2018, Ingredion's earnings grew from $3.52/share to $6.15/share. The company is expected to generate $6.65/share in 2019. Earnings per share are decreasing since hitting a high of $7.06/share in 2017. If we take this into account along with the soft increase in dividends last week, I think that management is not expecting a lot of good things happening in the near term. For that reason, I view Ingredion as a hold, despite the low P/E of 12.30 and the well covered dividend yield of 3.10%.

Microsoft Corporation (MSFT) develops, licenses, and supports software, services, devices, and solutions worldwide.

Microsoft  raised tis quarterly dividend by 10.90% to 51 cents/share. That’s the 15th consecutive annual dividend increase for this dividend achiever. Over the past decade, the company has managed to boost dividends at an annualized 14.10%.

Between 2009 and 2019, Microsoft's earnings have leaped from $1.62/share to $5.06/share. Microsoft is expected to generate $5.24/share in 2019.

The stock is overvalued today at 26.60 times forward earnings and offers a dividend yield of 1.45%. I would find Microsoft to be a better value worth looking at on dips below $105/share.

W. P. Carey (WPC) ranks among the largest net lease REITs with an enterprise value of approximately $20 billion and a diversified portfolio of operationally-critical commercial real estate that includes 1,198 net lease properties covering approximately 137 million square feet.

W.P. Carey raised its quarterly dividend to $1.036/share. The new dividend is 1.10% higher than the distribution paid during the same period last year. The rate of dividend increases has been steadily decelerating in recent quarters. For reference, the ten year annualized dividend growth is 7.70%. W.P. Carey is a dividend achiever with a 21 year track record of annual dividend increases.

W.P. Carey has managed to boost AFFO from $3.09/share in 2008 to $5.39/share in 2018.

W.P. Carey expects AFFO/share to be in the range of $4.95 - $5.05/share in 2019.

I find the REIT to be fully valued today at 18.20 times forward AFFO. The REIT offers a very slow distribution growth, but yields a respectable and relatively safe 4.60%. It is cheaper than the likes of Realty Income and National Retail Properties but offers slower dividend growth too. If Interest rates were to rise however, all REITs will see lower prices, higher yields and higher costs of capital. Check my analysis of W.P. Carey for more information about the REIT.

International Bancshares Corporation (IBOC) hiked its semi-annual dividend by 10% to 55 cents/share. This marked the tenth consecutive annual dividend increase for this newly minted dividend achiever.

The company has a ten year annualized dividend growth of 1.30%, due to cutting dividends in 2009.

The company grew earnings from $1.90/share in 2008 to $3.24/share in 2018.

Right now, the stock is attractively valued at 12.20 times earnings. International Bancshare Corporation yields 2.75%.

McDonald's Corporation (MCD) operates and franchises McDonald's restaurants in the United States and internationally.

McDonald’s raised its quarterly dividend by 8% to $1.25/share. McDonald's is a dividend aristocrat which has raised its dividend for 43 consecutive years. The ten year annualized dividend growth is at 9.90%.

Between 2008 and 2018, McDonald's managed to boost earnings from $3.77/share to $7.54/share. The company is expected to generate $8.02/share in 2019.

Right now I find McDonald's to be overvalued at 26.10 times forward earnings. The stock yields 2.40%. McDonald's may be worth a second look on dips below $160/share.

Relevant Articles:

What drives future investment returns?
Rising Earnings – The Source of Future Dividend Growth
How to read my weekly dividend increase reports
Dividend income is more stable than capital gains

Thursday, September 19, 2019

M&T Bank Corporation (MTB) Dividend Stock Analysis

M&T Bank Corporation (MTB) operates as the holding company for Manufacturers and Traders Trust Company; and Wilmington Trust, National Association that provide banking services. The last time I looked at the company was in 2008, when it had a 27 year track record of annual dividend increases.

Today, the company has increased dividends for 3 years in a row. M&T Bank kept dividends unchanged during the financial crisis, and only recently started raising them again. The bank took some TARP money, and is one of the few, if not the only TARP recipient that didn't cut dividends during the financial crisis. This is impressive, and is a testament to the strong management, which also did a very good job of keeping to a conservative loan approvals process. Most of the other major financial institutions ended up cutting or eliminating dividends. For example, everyone seems to like J.P. Morgan (JPM) today. However, J.P. Morgan cut its dividends during the financial crisis to maintain liquidity.

The last dividend increase was in August 2018, when the company raised is quarterly dividend by 25% to $1/share. Unfortunately, the board of directors has missed the opportunity to raise dividends in August 2019. In their defense, they raised dividends twice in 2018. If they raise dividends anytime by the end of 2020, the company will establish a five year track record of annual dividend increases.

Between 2008 and 2018, the bank has managed to boost earnings from $5/share to $12.74/share. The company is expected to generate $13.82/share in 2019.

M&T Bank has delivered strong performance because of its excellent underwriting, efficient operations, and acquisitions.

The company had a large exposure to real estate loans during the financial crisis, but stayed afloat and was one of the few financial institutions that did not cut dividends between 2007 and 2009. Rather, it maintained dividends unchanged, and recently started increasing them.

That’s because the company has sound underwriting standards, and focuses on risk adjusted yields, rather than chasing business and yield.

In the short-term, the decrease in interest rates and the interest rate inversion will be a headwind to profits. That would be offset by long-term growth in deposits and loans. The business is highly cyclical, and exposed to the ups and downs of the economy. During the next recession, the amount of loans will decrease, and the amount of charge-offs will increase. A company like M&T Bank with sound underwriting will experience a lower drop in profitability than peers. I like the deposit base, which tends to grow over time, and provides a float like instrument for the bank to use, as the average depositor is not earning much from their accounts. The decrease in interest rates will increase refinancing of loans, which could shrink interest margins in the short-run.

There has been a change at the top, as the long-time CEO who instilled the culture of smart underwriting died in 2017. However, many analysts believe that the people that remain at the bank have been trained under the right culture, and will continue doing the right thing.

Approximately one-third of business is in fee-based products, which scale well.

An increased penetration of online banking will result in a lesser need for branches, which could reduce costs, and increase profits down the road.

The number of shares outstanding has increased between 2008 and 2018. Since 2016, the bank has managed to use share buybacks to reduce the number of shares outstanding. The general growth in shares was due to major acquisitions done in 2011 and 2015. M&T Bank could likely continue its long-term earnings growth through strategic acquisitions done at the right price.

The dividend payout ratio has been declining over the past decade, as earnings per share have been increasing, while the dividend was mostly flat during that time period. I believe that there is ample opportunity for M&T Bank to boost dividends above the rate of earnings growth over the next decade. The bank’s dividend is safer than other financial institutions, because they haven’t raised it as much.

Overall, I find M&T Bank to be attractively valued at 11.60 times forward earnings. The bank has a yield of 2.50% today, which is well covered. There is ample room to grow future dividends down the road over the next decade.

Relevant Articles:

TARP is bad for dividend investors
Replacing dividend stocks sold
The return of Financial Dividends
Dividends Offer an Instant Rebate on Your Purchase Price
How to properly weight dividend portfolio holdings

Monday, September 16, 2019

Three Dividend Growth Stocks Rewarding Investors With a Raise

There were three companies with at least a decade of dividend increases under their belt which hiked distributions last week. I reviewed the latest increase against the ten year average in each of the three instances. I also reviewed the trends in earnings, and then looked at the valuation, in order to come up with a conclusion on whether these companies are worth researching further or not. I own shares in one of these companies, but I would not be adding today to it. I did identify one company that may be worth a second look if I can find it at the right entry price.

Per my dividend growth investing strategy, I am looking for companies that grow earnings and dividends, which are also available at attractive valuations. When I acquire shares in a company, I monitor the situation, in order to determine if my original thesis is still working. I also use my weekly dividend increase monitoring process to uncover companies for further research.

The companies raising dividends last week include:

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes, other nicotine-containing products, and smoke-free products and related electronic devices and accessories.

The company raised its quarterly dividend by 2.60% to $1.17. Philip Morris International has managed to boost distributions annually since being spun off from Altria in 2008.

The company has managed to boost dividends at an annualized 16%/year over the past decade. However, dividend growth has definitely slowed down substantially, to just 4.80%/year annualized over the past five years.

Dividend growth has slowed down due to the lack of earnings growth since hitting $5.26/share in 2013. The company has been able to boost dividends by increasing its dividend payout ratio, which has a natural limit to dividend growth.

Between 2008 and 2018, earnings per share rose from $3.24 to $5.08. The company is expected to generate $5.22/share in 2019.

The stock is attractively valued at 14 times forward earnings and offers a dividend yield of 6.40%. The payout ratio is at 89.70%, which is high for a tobacco company, but potentially dangerous given the flat earnings. There is an increased risk that the dividend may be sacrificed if PMI and Altria are allowed to merge.

For a value investor, it may make sense to buy the stock today, and hope that the P/E multiple expands so that you can sell the stock. You will be paid a nice 6.40% in the process, for as long as the dividend is at least maintained. As a long-term dividend growth investor, I see increased risks of a dividend cut, and I do not want to be limited to just earning the dividend from a security. I buy shares in growing businesses to hold on to, and not to buy low and sell high. The flat earnings per share create pressure on management to do something, such as pursue acquisitions and do different things to jump-start earnings growth. This activity may come at the expense of the dividend. If they successfully manage to kick-start earnings growth, then the payout ratio could gradually decline to a more manageable level, while still growing the dividend. Either way, I will continue holding on to PMI and Altria for the time being, but will refrain from adding more to my positions.

New Jersey Resources Corporation (NJR) is an energy services holding company, provides regulated gas distribution, and retail and wholesale energy services. The company operates through four segments: Natural Gas Distribution, Clean Energy Ventures, Energy Services, and Midstream segments.

The board of directors of New Jersey Resources approved a 6.80 percent increase in the quarterly dividend rate to 31.25 cents per share. This marked the 24th consecutive annual dividend increase for this dividend achiever.

Between 2008 and 2018, the company has managed to grow earnings from $1.30/share to $2.64/share. The company is expected to earn $1.96/share in 2019.

The stock looks overvalued at 23.10 times forward earnings and yields 2.80%. While the dividend is secure, I am a little put off by the volatility in earnings per share. This security requires much closer research to identify the reasons behind the sharp ups and downs in earnings than your typical dividend growth stock.

Fortis Inc. (FTS) operates as an electric and gas utility company in Canada, the United States, and the Caribbean.

The Board declared a common share dividend of $0.4775 per share, marking its 46th consecutive year of increased dividends. This is one of the few international dividend companies with such a long history of annual dividend increases. The new payment represents a 6.10% increase over the prior dividend of 45 cents/share. Fortis also provided guidance of a 6% annualized dividend increase through 2024.
Over the past decade, Fortis has managed to grow dividends at an annualized rate of 5.70%. I love the consistency around the annualized dividend growth. I decided to check the grows in earnings during the past decade.

The company managed to earn $1.51/share in 2008, and grow the bottom line all the way up to $2.59/share in 2018. This comes out to an annualized earnings growth of 5.50%/year, which is just a tad slower than the annualized historical dividend growth during the same time period. The company is expected to generate $2.57/share in 2019, implying lack of growth this year. The forward payout ratio is at 74%.

Right now the stock seems a little overvalued at 21.60 times forward earnings, offers a dividend yield of 3.40%, and a payout ratio of a little over 74%. Fortis may be worth a second look if it is available for less than 20 times earnings. Just as a side note, I wanted to mention that all figures are in Canadian Dollars for Fortis.

Relevant Articles:

Rising Earnings – The Source of Future Dividend Growth

Thursday, September 12, 2019

The Blueprint for Successful Dividend Investing

This is a guest post by Nick McCullum from Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to systematically identify and rank high-quality dividend growth stocks suitable for long-term investment.

Dividend growth investing is one of the most straightforward and powerful ways to build long-
term wealth. It can also seem highly complicated to those without experience in this investment strategy.

Fortunately, one of the best things about dividend growth investing is its ease of implementation. This makes it well-suited for a wide variety of investors.

Additionally, dividend growth investing stands the test of time. This investment strategy has been studied/written about since at least 1934, when Security Analysis (arguably the most famous book on investing) was published:

“The prime purpose of a business corporation is to pay dividends regularly and, presumably, to increase the rate as time goes on.”
– Benjamin Graham in Security Analysis

Clearly, something is special about dividend growth investing.

With that in mind, this article will describe four easy-to-understand principles that form the blueprint for successful dividend growth investing.

Invest in Consistent Dividend Growers

There is plenty of academic evidence to show that stocks with consistently rising dividend payments tend to outperform the broader stock market.

Identifying stocks with strong dividend growth prospects, however, can be difficult.

History is on our side here – dividend history matters. Stocks with long streaks of dividend increases are highly likely to continue increasing their dividends for years to come.

Take the Dividend Aristocrats, for instance. To be a Dividend Aristocrat, a stock must:

·         Be in the S&P 500
·         Have 25+ consecutive years of dividend increases
·         Meet certain minimum size & liquidity requirements

The Dividend Aristocrats are a great source of evidence to support to benefits of dividend growth stocks because they have widely outperformed the S&P 500 over long periods of time.

More specifically, the last decade has seen the Dividend Aristocrats return 10.6% (including reinvested dividends) per year compared to the S&P 500’s total return of 7.7% per year.

The Dividend Aristocrats, along with other databases of stocks with long dividend histories like the Dividend Achievers and the Dividend Kings, are excellent places to look for stocks with solid prospects of consistent dividend increases moving forward. 

Be Mindful of the Payout Ratio

One of the most common mistakes that dividend growth investors make is ‘chasing yield’ – the act of blindly investing in high yield dividend growth stocks without adequate research into the underlying business fundamentals.

Investors are initially attracted to these high yield stocks by the prospect of generating exceptionally high dividend income, but their expectations are quickly crushed after a too-high dividend yield is reduced by a dividend cut.

High yield dividend stocks are not necessarily bad investments. In fact, high yield is preferable, all else being equal.

The trouble is that in reality, all else is not equal. In most cases, a higher dividend yield is accompanied by a higher payout ratio – and high payout ratios may indicate that a company’s dividend is unsustainable.

The payout ratio expresses (as a percentage) how much of a company’s earnings are paid out as dividend payments. The payout ratio is important because it allows us to assess the risk of a future dividend cut.

Historically, stocks that cut their dividend payments have been the worst performers out of all subsets of dividend growth stocks.

Source: Hartford Funds

Chasing high yield dividend stocks can lead to investing in stocks with unsustainable payout ratios, resulting in dividend cuts.

Accordingly, keeping an eye on the payout ratios of your investees is a key component of a successful dividend growth investing strategy.

Avoid Overvalued Dividend Stocks

How to do well as a dividend growth investor can be summarized with the following sentence:

Invest in great businesses with strong competitive advantages and shareholder friendly managements trading at fair or better prices.

That last part – investing in businesses trading at fair or better prices – is the topic of this section.

Even the very best businesses can make terrible investments if their stocks are trading at terribly high valuations.

“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.” - Warren Buffett

Fortunatly, there are a number of useful valuation metrics that investors can use to identify attractively-priced stocks. The most important are:

·         The price-to-earnings ratio (PE ratio)
·         The price-to-book ratio (PB ratio)
·         The price-to-cash-flow ratio

Of these three useful valuation metrics, the most widely-used is the price-to-earnings ratio.

The price-to-earnings ratio measures how much an investor is paying for each dollar of underlying corporate earnings. Another interpretation of the price-to-earnings ratio is the amount of years it would take for an investor to be paid back if the company paid out all of its net income as dividends.

Corporate valuation is part art, part science. When assessing a company’s valuation, it is important to make two significant comparisons:

·         Compare the company’s valuation to its historical average
·         Compare the company’s valuation to its peer group

If a company’s price-to-earnings ratio is below that of its peer group and its long-term historical average, the company will, on average, make an attractive investment.

One word of caution should be said for investors looking to analyze companies using the price-to-earnings ratio.

It is important to use the earnings metric which most accurately describes the profitability of the underlying business. Accordingly, we recommend using a company’s adjusted earnings-per-share when computing its price-to-earnings ratio.

Adjusted earnings-per-share is a metric that backs out one-time accounting charges that may artificially impact a company’s earnings. Examples include restructuring charges, merger- and acquisition-related charges, or foreign exchange fluctuations.

Changing from traditional earnings (or GAAP earnings) to adjusted earnings-per-share can have a significant impact on a company’s EPS. Consider Altria (MO), for example:

·         2016 GAAP earnings-per-share: $7.28
·         2016 adjusted earnings-per-share: $3.03

Altria’s GAAP earnings-per-share is more than twice as high as its adjusted earnings-per-share, driven by a significant, one-time cash windfall when SAB Miller (which Altria had a 27% stake in) was acquired by Anheuser-Busch Inbev.

Clearly, these ‘earnings’ will not be repeated in future years, and should be excluded from the company’s net income when estimating its future earnings potential.

Note: A couple of years ago, Dividend Growth Investor wrote an insightful article on Altria’s ‘apparent’ undervaluation due to its artificially high GAAP earnings-per-share. I suggest you read it here.

Invest For The Long Term

“The single greatest edge an investor can have is a long-term orientation.”
– Seth Klarman, billionaire portfolio manager at the Baupost Group

Long-term investing has a number of intuitive benefits that dramatically improve one’s likelihood of building wealth through successful dividend growth investing.

The first advantage to long-term investing is that it is more tax efficient. Stocks held for more than one year are subject to the long-term capital gains tax rate, which is lower than the short-term capital gains tax rate.

In addition, investors don’t need to pay taxes on their capital gains until they sell.

Long-term investing allows us to continually invest those deferred capital gains taxes (which technically belong to the government) for our benefit. This strategy is sometimes called the ‘Buffett Loan’ because of its extensive use by superinvestor Warren Buffett.

To get a sense of how powerful this ‘Buffett Loan’ can be, consider two hypothetical Berkshire Hathaway (BRK.A) (BRK.B) investors:

·         One holds for the long-term (taxes are deferred)
·         One sells and repurchases each year (taxes are paid annually)

The comparison of each investor’s total returns is shown below, assuming a 20% long-term capital gains tax rate.

Source: Yahoo! Finance

The difference is astounding, and provides enough evidence by itself to support long-term investing.

Incredibly, there are also two other main benefits to long-term investing.

Long-term investing reduces frictional investing costs such as brokerage commissions.

While there exist plenty of low-cost stock brokers in today’s investor-friendly world, every dollar spent on brokerage commissions is one dollars that can’t compound for your benefit.

Thirdly, long-term investing is easier.

When you’re investing on a time frame of years or decades, the day-to-day fluctuations in stock prices suddenly become much less gut-wrenching. You also spend less time on portfolio management, because long-term investing naturally leads to smaller trading volume in the portfolio of an individual investor.

Long-term investing is certainly beneficial for investors, but it can be difficult to execute in practice.

Having well-defined buy and sell rules helps to manage your portfolio for the long-term. We recommend selling stocks only when they become grossly overvalued (with a normalized price-to-earnings ratio exceeding 40x) or when they cut their dividend.

Final Thoughts

At Sure Dividend, we strongly believe that dividend growth investing is one of the most effective and repeatable strategies for building long-term wealth. This is a belief that we share with the Dividend Growth Investor website.

Dividend growth investing can seem very complicated to those just starting out. However, the blueprint for successful dividend growth investing is actually quite simple:

·         Invest in consistent dividend growers
·         Be mindful of the payout ratio
·         Avoid overvalued stocks
·         Invest for the long term

Applying these principles to your own investment strategy should yield dividends (pun intended) for years to come. 

Relevant Articles:

Monday, September 9, 2019

My Portfolio Monitoring Process In a Nutshell

As part of my monitoring process, I review the list of dividend increases every week. I have also found it helpful to incorporate this monitoring process with the process I use to evaluate companies quickly. I use my secret screening process, which I have been discussing in detail over the past decade.

In my screening process, I generally look for the following:

1) A minimum streak of ten consecutive annual dividend increases
2) A P/E ratio below 20.
3) A dividend payout ratio below 60% ( with an exception for certain types of securities such as REITs)
4) Annual dividend growth exceeding inflation over the past decade
5) Growth in earnings per share over the past decade, to substantiate future dividend growth

I try to put all of this information together in my evaluation of the companies I am researching. The screening process is just the first part of the evaluation of course – a more detailed analysis is needed of each security, in order to get a feel for the business. To make matters even more complicated, the parameters can be changed depending on underlying conditions.

For example, if interest rates were to get to 10%,it may be better to focus on companies with a lower P/E ratio. However, if interest rates were to stay at 2% or 3% for the foreseeable future, a P/E ratio of 30 would not be inappropriate. I came up with a P/E of 20 a decade ago, when I could easily find Treasury Bonds yielding 4% to 5%. I have not increased the P/E ratio requirement yet, because I also want to have some margin of safety, in case yields get back up to 4% over the next decade. I am stating that, in order to warn investors not to look at P/E ratios in a vacuum, while ignoring the present condition of interest rates and growth expectations of US businesses.

In addition, the screen helps me see enough of the data, which helps me to compare between two different companies. For example, if two companies sell at a P/E of 20, the one that grow earnings and dividends at 7%/year is cheaper than the one that grows earnings and dividends at 2%/year.
I also find it great to know what to look for. But it is equally great to know what to avoid.

Going back to the monitoring of dividend increases, I identified three companies which raised dividends last week, and have at least a ten year history of annual dividend increases.

I put all three companies through my screening process, and did a quick review to determine if these companies are worth pursuing further. The companies include:

Verizon Communications Inc. (VZ) offers communications, information, and entertainment products and services to consumers, businesses, and governmental agencies worldwide.

The company raised its quarterly dividend by 2.10% to 61.50 cents/share. This is the 13th consecutive year Verizon’s Board has approved a quarterly dividend increase. Over the past decade, this dividend achiever has managed to grow distributions at an annualized rate of 3.10%.
Between 2009 and 2018, Verizon managed to grow its earnings from $1.72/share to $3.76/share. Verizon is expected to generate $4.80/share in 2019.

The stock is attractively valued at 12.30 times forward earnings and offers a dividend yield of 4.10%. I alerted subscribers to my premium newsletter that I am buying Verizon when it was in the mid $50s. I would be more interested in Verizon in the low 50s and below.

Vector Group Ltd., (VGR) manufactures and sells cigarettes in the United States. It operates in two segments, Tobacco and Real Estate.

The company raised its quarterly dividend by 5% to 40 cents/share. This marked the 21st consecutive year of annual dividend increases for this dividend achiever. Over the past decade, the company has managed to boost dividends at an annualized rate of 5%.

Between 2009 and 2018, Vector Groups earnings per share grew from 22 cents/share to 48 cents/share. The company is expected to generate 37 cents/share in 2019.

I believe that the stock is overvalued at 34 times forward earnings. I do not think that the dividend is safe, given the high payout ratio. The stock yields 12.70%, which is unsustainable in my opinion.

Brady Corporation (BRC) manufactures and supplies identification solutions and workplace safety products to identify and protect premises, products, and people in the United States and internationally.

The company raised its quarterly dividend by 2.40% to 21.75 cents/share. This marked the 34th annual dividend increase for this dividend champion. During the past decade, Brady has managed to grow distributions at an annualized rate of 3%.

Over the past decade, the company managed to grow earnings from $1.32/share in 2009 to $1.73/share in 2018. The company is expected to earn $2.38/share.

The stock is a little overvalued at 21.40 times forward earnings. It yields a safe 1.70%, which is a low yield for a slow growing dividend stock. Based on 2018 earnings per share, the stock looks even more overvalued at 29.50 times earnings. Given the high P/E ratio and the low earnings and dividend growth, I view the stock as a hold.

Relevant Articles:

Ten Dividend Growth Stocks For Retirement Income
Should I invest in AT&T and Verizon for high dividend income?
Why do I use a P/E below 20 for valuation purposes?
How to value dividend stocks

Tuesday, September 3, 2019

How to invest a lump sum

Imagine that you are able to receive a lump sum today, due to an event such as a sale of a business, cashing out of a pension, inheritance or winning the lottery. After you rejoice a little, you start asking yourself what to do with the money. I keep asking myself the same question quite frequently, and think my way through this “problem”.

If I received a lump-sum payment today, I would approach it differently, depending on the level of experience I have, the time I am willing to commit to investing per week, and the level and effort of continuing investing education I am willing to commit myself to. For sake of comparison, lets imagine that I am about to receive $1 million tomorrow.

The easiest option is to build a portfolio consisting entirely of mutual funds, covering indices such as S&P 500, US Total Market Index or a World Total Market Index. This would be in a situation where I didn’t know much about investing, didn’t have the time nor inclination to spend too much time on it, or decided it would have been too big of a hassle for me to pick stocks individually. I would basically put the money in a ladder of Certificates of Deposit first, and have an equal amount of those CD’s expire every month for 24 – 36 months. That way, I am mentally removing the pressure of having to invest all money at once, and I am also removing the opportunity to invest most of the money in my cousin’s business idea of a social network for cats (Catbook anyone?). As an equal amount of money is available each month, I will have it invested in the mix of stock funds. The purpose of dollar cost averaging is to avoid putting all the money at once, in order to avoid the risk of putting the money at the highest prices. By investing an equal amount each month, I am increasing chances that I will get decent prices for stocks I buy, and avoid overpaying. I will also miss out if prices keep going straight up for those 24 – 36 months, but that would be a risk worth taking, since it would also mean I would not put all money right before a major correction. The conventional way of this portfolio is to sell a portion each year to cover expenses. This could work in most situations, unless of course the stock market is down right when you start withdrawing or if the stock market is flat for the majority of time.

The other option I would take if I were willing to put the time and effort into it would be to invest the money in dividend paying stocks directly. I would still start with a CD ladder however, and put equal amounts into attractively valued dividend paying stocks every month for 24- 36 months. I would start by screening the list of dividend champions and dividend achievers every month, identify companies for further research, and put an equal amount of funds into the ten most promising ideas every single month. I would rinse and repeat every single month for 24 – 36 months. Over time, I should be able to gain some sort of understanding behind a large portion of those dividend champions, through regular reading and research about these companies. As the knowledge of each company is accumulated, it would be much easier to act. This process could take a lot of time at first, since it would require spending time researching whether the companies that met a basic entry screen are worth my money. After that however, additional follow-ups on each company should not take that much time each year on average. My goal would be to have a portfolio consisting of at least 40 different dividend paying stocks, representative of as many sectors as possible. That doesn’t mean owning utilities just so you own utilities. It means buying into companies selling at attractive valuation, but also making sure that I do not concentrate too much in a particular sector such as financials for example.

I would also build a portfolio around the three different types of dividend growth companies I have previously identified. The biggest mistake to avoid is focusing only on current dividend yield, without doing much additional work about its sustainability, potential for growth, understanding of the business etc.

Living off dividend income is pretty easy, once a portfolio is set up. When I receive dividend checks directly deposited in my brokerage account, this is cold hard cash I can do whatever I want with. I do not have to stress over whether we are about to enter a bear market, and I would run out of money simply because prices are depressed. I would receive cash dividends, which will get increased above the rate of inflation over time. I would likely accumulate all dividends for a three month period, then spend it equally over the next three monhts. If there is anything left over, I would reinvest it into more dividend paying stocks.

I have chosen of course to focus on selecting individual dividend paying stocks. It is cheaper in the long run to build a portfolio of dividend paying stocks, and rarely sell them. I only sell when dividend is cut or eliminated or when stocks are acquired for cash. I also try to outguess valuations from time to time, but my results have proven that I should not do that. In majority of situations, I am better off just sitting out there, doing nothing. This is the most difficult thing to do in investing.

My portfolio is generating dividends every month, quarter and year. The holdings I own tend to increase those dividends over time, maintaining purchasing power of income, and making my shares more valuable. While stock prices fluctuate from year to year, dividend income is always positive, it is more stable, and thus it is better tool to use when designing a portfolio to live off of. Plus, even the cheapest mutual funds that cost say 0.10% per year are more expensive on a portfolio worth $1 million, since they result in $1000 in annual costs. With brokers such as Interactive Brokers, I would have to make 1000 investments at $1/trade in order to reach the same costs per year. In addition, I would be able to hold on to most stocks and only buy shares in companies which I find properly valued, and possessing the characteristics I am focusing on. I could also avoid selling shares and incurring taxable expenses merely because an index committee decides to remove companies from their lists.

I like the fact that the companies I own provide me with fresh cash in a regular, predictable patterns. This is similar to what my experience is when working – receiving a paycheck at an equal intervals of time. With dividend stocks, I do the work upfront in selection at proper valuation, and then receive the cash for years if not decades to come.

In summary, it makes sense to spread out the investment of a lump sum received in order to reduce investment risks, and reduce the impact of mistakes. The investor who manages a considerable amount of funds should have the goal of preserving wealth first, so that it can last for decades. This will be achieved by spreading purchases over time, diversifying the portfolio in at least 40 individual securities from a variety of sectors, continuing their quest for investment knowledge and requiring quality and attractive prices in the types of investments they purchase.

Relevant Articles:

Why Sustainable Dividends Matter
Dividend Portfolios – concentrate or diversify?
Reinvest Dividends Selectively
Dollar Cost Averaging Versus Lump Sum Investing
Diversified Dividend Portfolios – Don’t forget about quality

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