Three Dividend Growth Stocks Defying Skeptics Expectations

Everyone likes the story of the underdog . This is the person who has everything going against them in life, yet they still prevailed. Every person can identify themselves as the underdog, because most everyone has been an underdog at some stage of his or her life.

The following three companies have managed to defy skeptics expectations, and prove them wrong, time and again. The companies are Digital Realty Trust (DLR), Dr Pepper Snapple (DPS) and PepsiCo (PEP).

Digital Realty Trust (DLR) recently increased its quarterly dividend by 6.40% to 83 cents/share. This REIT has raised distributions since going public in 2004. Back in May 2013, a short-seller hedge fund announced that Digital Realty would melt to $20/share. Hence they initiated a short position in the REIT, which has made a lot of investors very nervous. The hedge fund guy had several points about why the stock is going down, which I refuted point by point back in May. The other factor that scared investors in REIT in general was the threat of rising interest rates, which is supposed to obliterate the sector. In reality, even if treasury bonds yield 5%, investors would still be better off in high yielding REITs that can grow distributions over time. This is because those REITs will protect the purchasing power of income and principal against inflation. I have since added to my position in Digital Realty, and in one of those accounts I am automatically reinvesting distributions into more share ( this is something I rarely do). While I have no clue whether the stock price is going up or down from here, I am fairly confident that the dividend is going up over time.

It is likely that slowing dividend growth is probably worrying some investors. However, I have no problem holding a company with a safe 6% yield, which is growing above the rate of inflation. Check my analysis of Digital Realty Trust.

PepsiCo (PEP) was another company raising distributions in the past week. Despite decreased soda consumption in North America, the company has growth in snacks and in international sales. The company announced a 15 percent increase in its annualized dividend to $2.62 per share from $2.27 per share, to take effect with the June 2014 payment. The increase will be the 42nd consecutive annual increase in dividends per share for this dividend champion. It also anticipates increasing share repurchases in 2014 to approximately $5 billion. Check my analysis of PepsiCo.

The company expects to grow earnings per share by 7% in 2014, which is a healthy number. If a company sells at the same price to earnings multiple, and expands earnings per share by 7%/year and pays a 3% annual dividends, this can provide the investor with an annual total return of 10%. The only downside I can see with PepsiCo is if the P/E multiple contracts to say 15 times earnings, which would be an opportunity for investors like me in the accumulation phase of the game to buy more stock for the same amount of funds. As I have explained before, price fluctuations should mean nothing to long-term investors, except for as a tool to find bargains that were underpriced by the manic-depressive Mr Market.  The upside for PepsiCo is earnings per share growth of at least 7%/year for the next 15 - 20 years. This could translate into earnings per share of almost $9 in 2024 and $18 in 2034. In reality, I could see that earnings per share growth can easily exceed that amount, given the exposure to growing emerging market economies, and a diversified products base.

The other upside for PepsiCo is if the snacks and beverages divisions are split-up, as some activist investors have recommended. This could unlock a lot of value for shareholders, as managements will be more focused on the core underlying segments, rather than two somewhat different businesses. In my experience, spin-offs are usually very beneficial to shareholders.

The other company I follow and own a small position in includes Dr Pepper Snapple (DPS). The compaby raised quarterly dividends by 7.90% to 41 cents/share. Dr Pepper Snapple was spun-off from Cadbury Schweppes in 2008, and has raised dividends since 2009. The company derives most of its profits from Carbonated Soft Drinks in the US, Canada and Mexico. This is not the rosiest of places to be heavily concentrated on, as volumes in North America have been decreasing for several years. However, the company has been able to cut costs, increase prices, repurchase stock and increase earnings per share even in this difficult environment. This is a quality company, which will be around 20 years from now, and will still be pumping out cold hard cash for shareholders. I could see how the company can easily grow earnings per share by 7%/year for the next 20 years, and pay a 3% yield, for an annual total returns of 10%. The company sells at 16 times earnings, which is cheaper than rivals Coca-Cola and PepsiCo. The one kicker is that every 20 years or so, Dr. Pepper could earn a couple billion dollars from its licensing agreements with PepsiCo and Coca-Cola, which are used for share buybacks and debt reductions. Plus, there is always the possibility that Dr. Pepper gets acquired by one of its larger rivals, which could result in better payoffs for shareholders.

However, I am actually more bullish on PepsiCo and Coca-Cola (KO), because they derive a large portion of revenues from outside the US. That being said, I still find Dr Pepper to be an impressive company. However, adding a third “soda” company to my portfolio is not really adding that much to it. Hence, I am keeping the amount invested below 1%. Check my analysis of Dr. Pepper.

Full Disclosure: Long DPS, DLR, KO and PEP

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Brown-Forman (BF.A)(BF.B) Dividend Stock Analysis

Brown-Forman Corporation (BF.A) (BF.B) engages in the manufacturing, bottling, importing, exporting, marketing, and selling alcoholic beverages. It provides whiskey, ready-to-drink products, vodka, tequilas, champagnes, wines, liqueur, and other distilled spirits. This Dividend Champion has paid dividends since 1960 and has increased them for 30 years in a row.

The company’s latest dividend increase was announced in November 2013 when the Board of Directors approved a 13.70% increase in the quarterly annual dividend to 29 cents /share. The company’s peer group includes Diageo (DEO), Beam (BEAM), and Constellation Brands (STZ).

Over the past decade this dividend growth stock has delivered an annualized total return of 14.80% to its shareholders.

The company has managed to deliver an 11% average increase in annual EPS over the past decade. Brown-Forman is expected to earn $2.96 per share in 2014 and $3.26 per share in 2014. In comparison, the company earned $2.75/share in 2012.

In addition, between 2004 and 2013, the number of shares decreased from 229 million to 215 million.

The company has several strong brands such as Jack Daniels Tennessee Whiskey, which accounts for a large portion of its revenues. Other brands include Finlandia and Southern Comfort. There is strong customer loyalty for company’s products, particularly for its Jack Daniels line of whiskeys, which results in strong pricing power. If you want Jack Daniels, and the store doesn’t sell it, you will likely go to another store. This is an example of a wide-moat. Another example include the high returns on equity and capital that the company has been able to generate over the past decade.

Besides growth in Jack Daniels whiskey, which has recorded 21 years of consecutive volume increases, the company grows sales through brand extensions, such as Gentleman’s Jack.

Another venue for growth includes international expansion. Currently 59% of sales come from international versus 15% that were generates 20 years ago. About 30% of sales were generated in Europe, 14% Australia, and 15% in other countries such as Mexico and Japan. As a result, I believe there is plenty of room for growth in emerging countries such as China, Brazil, and Russia, to name a few obvious opportunities.

The company owns its distribution in many markets such as Australia, Brazil, Canada, China, Mexico, Turkey etc. In other markets such as Russia ,Japan, South Africa, it operates under fixed term contract with distributers. In the UK,which accounted for 9% of sales in 2013, Brown-Forman has a cost sharing agreement with Bacardi. The company is focused on investing in its distribution network, which allows it to focus on its brands and improve margins. In 2014, it will start operating its own distribution network in France.

Other room for growth could include strategic acquisitions. Previous acquisitions include Finlandia Vodka, Southern Comfort, Casa Herradura and Chambord Liqueur Brand. Interesting enough, Jack Daniel's Tennessee Whiskey was acquired in 1956 for $20 million.

Management has been very shareholders friendly, as it has deployed capital intelligently, in order to maintain high returns on capital invested. In addition, they distributed special dividends in 2010 and 2012, when preferential tax treatments on qualified dividends were set to expire. They rank each of the company's brands according to its return on investment. The adherence to  intelligent capital allocation means that they pour dollars only into their most promising brands.

There are a couple risks that I see with Brown-Forman. The first risk is that the Brown family exerts a lot of control over the company through the dual-class shareowner structure. For example, the A shares have voting rights, while the B shares have no voting rights, although they do share same proportionate amounts of dividends. The Brown Family has over 66% of the voting power, through its ownership of A shares either directly or through family controller entities. Hence the company is classified as a “controlled company”.

The other risk is that there is too much reliance on Whiskey sales, which could be bad for revenue growth if consumer tastes change. Jack Daniels category accounts for over half of product volumes.

The annual dividend payment has increased by 10.20% per year over the past decade, which is slightly lower than the growth in EPS. The growth in distribution payments over the next decade will likely be equal to or slightly higher than the growth in earnings per share.

A 10% growth in distributions translates into the dividend payment doubling every seven years on average. Since 1988, Brown-Forman has been able to double dividends every eight years on average.

Not included in the chart are special dividends of $4/share in 2012 and $0.67/share in 2010.

The dividend payout ratio has largely remained in a range between 32% and 39% over the past decade. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

The company has a really high return on equity, which is common for most high quality dividend payers that do not require a lot of equity to operate the business. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Currently, the stock is overvalued, as it trades at a P/E of 27.20 and yields only 1.60%. I am analyzing the company because I believe it is a quality dividend growth company, which will be a very good addition to my portfolio on dips below $60. I will still keep holding onto my existing shares, which I believe have a value of approximately 30 times earnings to a private owner. As earnings will increase over time, that value should increase as well. To put it in Warren Buffett terms, this is an excellent business, but unfortunately the price is too rich to justify an investment at present terms.

There has recently been M&A activity in the industry, as Beam Inc (BEAM) is in the process of being acquired by Japanese company Suntory at 30 – 32 times earnings. It is possible that Brown-Forman shares could have been bid up because they could be a potential acquisition target by a larger competitor. However the dual-class shareholder structure, and the fact that voting power is concentrated in the Brown family, makes a successful acquisition of Brown-Forman by someone like Diageo (DEO) highly unlikely. This could be a plus however, as acquisitions of quality dividend companies rob shareholders of the acquisition target from the dividend growth potential they could have enjoyed, had the company not been bought out. If earnings per share double every decade, and dividend payout ratios are maintained, long-term investors will do just fine.

I currently find Diageo (DEO) to be a much better value, at 18.70 times earnings and yield of 2.40%. Therefore, I recently purchased Diageo shares.

Full Disclosure: Long BF.B, DEO

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Optimal Cash Allocation for Dividend Investors

Many income investors I have gotten to interact with, seem to be struggling on the topic of what their optimal cash allocation should be. I am going to try and discuss this from my own experience of someone in the accumulation stage of the game.

High allocations to cash can be helpful in situations where markets are dropping. Purchasing attractively priced shares after a 10% - 20% drop in prices is much easier when you have a certain allocation of cash. However, if you have high allocations to cash, and prices keep rising, you have a high opportunity cost of this resource. The past five years have been brutal for those who have been waiting in cash, waiting for a huge correction, which never came. At the same time, the purchasing power of this cash is constantly decreasing, which is normal for cash.

In the current low interest rate environment, having a lot in cash would probably not generate much in income. In addition, investors would be losing out on potential for dividend compounding if they are not fully invested.  If one finds Coca-Cola (KO) overvalued at 19 times earnings, or already has a full position in McDonald’s (MCD), they might decide to focus on a Philip Morris International (PM), Altria (MO) or Kinder Morgan (KMI) instead. One can always find attractively valued dividend stocks out there, as long as they keep looking.

In reality, investing cash as soon as it becomes available in companies which are cheap at the moment could be the most optimal strategy for investors. I find that hoarding too much cash in an effort to wait out until prices correct by a certain predetermined amount such as 10% - 20%, is similar to market timing. Based on numerous studies that have been conducted on investor behavior and performance, it is very safe to assume that for over 90% of investors out there, market timing is a losing proposition.

In general, it does not really make that big of a difference twenty years after the investment, if one purchased at the high for the year or the low, as long as they made the transaction. For example, in 1988, shares of Coca-Cola (KO) traded between a low of $2.20/share and a high of $2.80/share. Investors who didn't want to buy at 2.80/share because the price was “too high”, missed out on the rising stream of dividends that is still going on. While the results from investing at $2.20 and $2.80 are going to be different, the most important thing is to have purchased an asset like Coca-Cola and hold on for as long as it made sense. And Coca-Cola was certainly a good value in 1988, selling for somewhere between 12.20 and 15.80 times earnings and yields between 2.60% - 3.40%. One investor that took advantage of this hidden value was the Oracle of Omaha himself, whose holding company is earning an yield on cost of over 30% on their investment in the world's largest soft-drink maker.

Also in 1988 Bank of America (BAC) traded between $4.50/share and $7/share. Investors who purchased the stock at either the high or the low were much better off than those who held on to their cash and waited for a correction. Of course, if investors didn’t sell after the first dividend cut in 2008 however, they would not have had much to show for their investment. But selling your dividend stocks is not the topic of this article.

In my dividend portfolio, my cash allocation is somewhere between positive 1- 2% and a negative 1- 2%. I usually let dividends accumulate and then reinvest them in the best values at the moment. In addition, I typically try to add cash to my portfolio monthly. I accumulate the cash and then try to make purchases with the proceeds.

I get lists of attractively priced stocks by running my monthly screen on the lists of dividend champions and dividend achievers. As a result of my cash contributions every month, plus the addition of cash dividends from my accounts, I manage to purchase shares in anywhere between one and three companies. Sometimes however, a company that I have analyzed and liked, would get into value territory. My cash infusion might be a few weeks away, yet knowing that this opportunity might be short lived I might take action. One such example occurred in 2010, when Yum! Brands (YUM) announced a dividend increase that effectively put the stock at the 2.50% entry yield I require. I immediately jumped in, and bought a small position on margin. A few days later, my cash deposit and the dividends I received in the meantime increased my cash position above zero.

If stock prices were to fall precipitously from here, many companies which have been previously overpriced, would become cheaper. As a result, investors would be able to scoop up great businesses at depressed prices. Those who are still in the accumulation stage and deploy their cash every month will be able to take advantage of the opportunity and buy quality shares at a discount. More experienced investors might also decide to use margin and make investments, a few days or weeks prior to any planned cash deposits into their brokerage accounts. Investors who held some cash however, would likely be able to deploy a large portion of it in attractively valued stocks, provided that they do not freeze under fire, and provided that they do not wait for even lower prices that may or may not materialize. These are the investors who should carefully consider however the opportunity cost of holding that cash for extended periods of time waiting for a market decline, versus deploying that cash immediately.

Full Disclosure: Long MCD, KO, PM, MO, KMI, YUM,

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Five Quality Dividend Payers I Bought on the Dip

In the past couple of weeks, I added to my positions in four companies, and initiated a position in two more. It is exciting to see stock prices starting a descend to more attractive values. I am starting to get excited about the possibility of further downside for share prices in 2014, if I am lucky of course. As an investor in the accumulation phase, I get to buy more dividend paying shares when my retirement income is on sale.

I view every stock that I purchase as essentially buying time. Every dividend check represents money I earned that I didn't have to exchange my labor for. This is the beauty of having your money work for you, invested in compounding machines that design and sell products and services around the world, make profits, reinvest in the business and send you a growing pile of excess cash to your brokerage account.

The five companies I purchased are listed below. I also purchased McCormick & Co (MKC) last week, but won’t discuss it here, because I already analyzed it in detail on Friday.

I added to my position in Target (TGT), as part of my intent to dollar cost average my way into the company throughout 2014. Target has suffered from breaches into the credit and debit card accounts of millions of customers in the US. In addition, Target seems to have mismanaged its expansion in Canada. As a result, the stock price has been on a slow slide since the middle of 2013. I find the stock to be a very good value at 15.10 times earnings and a yield of 3.10%. The company has also managed to increase dividends for a cool 46 years in a row. Check my analysis of Target.

Another company I added to was Wal-Mart Stores (WMT). Wal-Mart Stores, Inc. operates retail stores in various formats worldwide. The company has increased dividends for 39 years in a row. Over the past decade, Wal-Mart has managed to increase dividends by 18%/year. This dividend champion trades at 14.20 times earnings and a yield of 2.50%. Check my analysis of Wal-Mart.

For a second month in a row, I also added some McDonald’s (MCD) as well. McDonald’s Corporation franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. This dividend champion has rewarded shareholders with a dividend raise for 38 years in a row. Dividend growth has been slowing down however, from 22.80%/year over the past decade all the way to 13.90%/year over the past five years. Currently, the stock is attractively priced at 17.30 times earnings and yields 3.40%. Check my analysis of McDonald’s.

I purchased shares of Diageo (DEO) for both my taxable and Roth IRA account. Diageo plc produces, distills, brews, bottles, packages, and distributes spirits, beer, wine, and ready to drink beverages. I had previously owned a token position in Diageo, which I sold in early 2013 to simplify my portfolio. This international dividend achiever trades at 18.30 times earnings and a yield of 2.40%. Diageo has managed to increase dividends for 16 years in a row. When competitors such as Beam (BEAM) were acquired at 30 times forward earnings, companies like Diageo look much cheaper. Of course, Diageo is 4 – 5 times larger than the likes of Beam of Brown-Forman (BF.B), so they are less likely to be an acquisition target. Check my analysis of Diageo.

I also added to my shares of General Mills (GIS) in the Roth IRA account. General Mills, Inc. produces and markets branded consumer foods in the United States and internationally. The company has paid dividends for 115 years and never reduced them. In 1995 it lost its status of a dividend champion of 29 years, after freezing distributions following spin-off of Darden Restaurants (DRI). In addition, General Mills has increased dividends for the past 10 years in a row. Over the past decade, General Mills has managed to increase dividends by 9.90%/year. Currently, this dividend achiever is trading at 17.90 times earnings and yields 3.20%. Check my analysis of General Mills.

I almost added to my position in Philip Morris International (PM), but I stopped myself, since it is the second or third largest position in my portfolio by weight. While I really like the company, its fundamentals and the possibilities for growth in earnings and dividends, I do want to be diversified and not overly reliant on a single security for my dividend income in retirement. However, if it drops to $75 and below, I might add some more to the position there. It is very rare that you can find a company with growing earnings, dividends , cheap valuations and a fat current yield, which is sustainable.

What securities did you buy over the past couple of weeks?

Full Disclosure: Long TGT, WMT, DEO, GIS, PM, MCD, BF.B, MKC

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Five Dividend Paying Companies with Consistent Share Buybacks

In a previous article I discussed the positive and negative sides of stock buybacks. In general, I am interested in dividends paid to me in cash, rather than the potential for a capital gain that share buybacks might deliver. The issue with buybacks is that managements quite often have terrible timing with execution of programs. For example, when times are good and companies are flush with cash, managements start repurchasing stock at high prices. However, when times are bad, managements conserve cash and not only fail to take advantage of repurchasing stock at depressed values, but might even issue more stock to bolster liquidity. General Electric (GE) is a prime example of this phenomenon, as it spent billions repurchasing stock at prices between $35- $39/share prior to the financial crisis, only to sell half a billion shares at $22 when things got tough. This is not an example of intelligent capital allocation.

However, if management can consistently buy out other shareholders at attractive prices, and buybacks don’t mask the eroding effects of share compensation, I can view them somewhat favorably. I am particularly favorable towards companies which consistently perform share buybacks, and do not overpay for those shares. I went through the list of the top 20 buybacks for the past three years, and identified several companies which have managed to repurchase a significant amount of stock each year for the past five years.

	2013	2012	2011	2010
(XOM)	$20,875	$21,131	$12,050	$18,951
(IBM)	$12,800	$10,455	$12,593	$11,601
(WMT)	$7,600	$6,298	$14,776	$7,276
(PM)	$6,524	$5,297	$4,801	$5,448
(MSFT)	$4,429	$3,116	$9,133	$8,958

Exxon Mobil Corporation (XOM) engages in the exploration and production of crude oil and natural gas, and manufacture of petroleum products. The company has raised dividends for 31 years in a row. Over the past decade, this dividend champion has managed to increase dividends by 9.60%/year. Currently, Exxon Mobil trades at 12.20 times earnings and yields 2.70%. Check my analysis of Exxon Mobil.

International Business Machines Corporation (IBM) provides information technology products and services worldwide. The company has raised dividends for 18 years in a row. Over the past decade, this dividend achiever has managed to increase dividends by 19.40%/year. Currently, IBM trades at 11.70 times earnings and yields 2.20%. Check my analysis of IBM.

Wal-Mart Stores, Inc.(WMT) operates retail stores in various formats worldwide. The company has raised dividends for 39 years in a row. Over the past decade, this dividend champion has managed to increase dividends by 18%/year. Currently, Wal-Mart trades at 14 times earnings and yields 2.60%. Check my analysis of Wal-Mart.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised dividends for 5 years in a row. Quarterly dividends increased from 46 cents/share in 2008 to 94 cents/share by the end of 2013. Currently, Philip Morris International  trades at 14.80 times earnings and yields 4.80%. Check my analysis of Philip Morris International.

Microsoft Corporation (MSFT) develops, licenses, and supports software, services, and hardware devices worldwide. The company has raised dividends for 11 years in a row. Over the past decade, this dividend achiever has managed to increase dividends by 15%/year. Currently, Microsoft trades at 13.40 times earnings and yields 3%. Check my analysis of Microsoft.

These companies also return profits to shareholders through regular dividend increases as well. In general, I view those managements as some of the most shareholder friendly ones in the US. This is because they are able to grow underlying profits through careful capital allocation, and only accepting projects that have a high likelihood of hitting internal rates of return. These cash machines then shower shareholders with more cash in the form of dividends, and buy out weak hands in the share buyback process as well.

When companies reduce number of shares outstanding, this also reduces the total amount of cash they need to pay to shareholders. Therefore, if total amounts spent on buybacks and dividends stay constant each year, this would lead to an almost automatic dividend increase for the limited partners in those consistent share repurchasers. If companies also manage to boost net income over time, stock buybacks can essentially turbocharge earnings per share growth.

Now, there are probably more companies with consistent buybacks out there as well. However, I only focused on the largest ones for 2011, 2012 and 2013, and made sure that these were not one time events. I would still prefer a bird in the hand through a cash dividend payment however, although I am not opposed to managements who consistently buy out other shareholders, thus making my shares more valuable in the process. The important thing is for these managements to avoid overpaying for these shares, which is a very rare thing in corporate America.

Full Disclosure: Long XOM, IBM, PM, WMT

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