History has revealed that the best performing stocks during the previous decades have been those that shelled out ever-increasing cash to shareholders in the form of dividends. In a recent study, S&P 500 stocks that initiated dividends or grew them over time registered roughly a 9.6% annualized return since 1972 (through 2010), while stocks that did not pay out dividends or cut them performed poorly over the same time period.
Such analysis is difficult to ignore, and we believe investors may be well-rewarded in future periods by finding the best dividend-growth stocks out there. Let’s take a look at the recent performance of 15 high dividend payers and disclose their ‘valuation ratings’ and most recent Valuentum Dividend Cushion scores. Valuentum updates each firm’s cash-flow derived valuation rating and Dividend Cushion scores at least on a quarterly basis (or after material events). The Valuentum Dividend Cushion is a pure financially-derived cash-flow coverage ratio that considers a dividend payers future free cash flow, expected future cash dividend payments, and balance sheet (net cash/debt) information. Valuentum includes a number of the firms below in its Dividend Growth portfolio.
Stocks Discussed: MMM, MO, T, BAX, HAS, KALU, KMB, KMP, KLAC, MSFT, PM, PG, RTN, RSG, VZ
3M (MMM) – Overvalued – Dividend Cushion: 1.9 – Dividend Yield: 2.5%
There’s little doubt across the team at Valuentum that shares of 3M are overpriced. 3M is a perfect example of the saying that a good company doesn’t always make a good stock. We think the odds are long that 3M will outperform the market in the years ahead, as dividend growth investors have bid the firm to levels far beyond what we would consider to be an acceptable fair value range. The company’s first-quarter results weren’t poor, and its outlook calling for organic local-currency sales growth of 3%-6% wasn’t bad, but investors are just too enamored by the company’s recent 35% dividend increase. Further advancement at this pace is just unlikely, in our view, and we think investors will have a better time to enter 3M’s shares in the next few years.
Altria (MO) – Fairly Valued – Dividend Cushion: 1.2 – Dividend Yield: 5%
Altria is one of our favorite dividend growth ideas. The company continues to raise the dividend at a nice clip and holds a prized 27% ownership stake in SABMiller, which continues to perform well. SABMiller currently sports a ~R800 billion market capitalization (or about $80 billion USD at current exchange rates), which means Altria is effectively sitting on $21.6 billion in potential cash (about 30% of its market capitalization) at current price levels. We think this hidden asset within Altria’s portfolio is the primary difference between our fair value of Altria and its market price. The firm grew first-quarter adjusted diluted earnings per share by nearly 6% and reaffirmed its 2014 full-year diluted earnings per share range. Altria expects to maintain a dividend payout ratio target of about 80% of earnings, so whenever earnings advance, its dividend payout will as well. If it needs excess cash to fund a one-time dividend or boost annual dividend expansion, it can tap its valuable stake in SABMiller. Altria has financial flexibility that most firms would love to have, and we love holding it in the Dividend Growth portfolio.
AT&T (T) – Fairly Valued – Dividend Cushion: 0.5 – Dividend Yield: 5.1%
We don’t like the debt loads of telecom firms. All things considered, firms that generate significant cash flow, have little incremental capital requirements, and boast little to no debt on their balance sheets are the ones with strong dividend-growth potential. This particular profile is as about as far away as possible for AT&T. The company had its best revenue growth in more than two years and its best first-quarter postpaid net adds in five years during the first quarter, but we can’t overlook the impediments to AT&T’s future dividend expansion. Capital expenditures absorbed nearly two thirds of cash from operations in the period, and while the company expects to haul in $11 billion in free cash flow for 2014, it is staring down a mountain of long-term debt ($71.6 billion at quarter end). Its cash balance doesn’t even cover debt maturing within one year, which itself is not included in the long-term debt count. AT&T may have been a great dividend growth idea 10 or 15 years ago, but it is not today. The company’s Dividend Cushion score is below 1.
Baxter (BAX) – Fairly Valued – Dividend Cushion: 1.8 – Dividend Yield: 2.7%
Baxter is one of the many dividend growth ideas in the healthcare space. Its strong image and brand is augmented by an extensive global footprint and channel strength. The company continues to enhance its position in hemophilia and advance its pipeline to late-stage development — all good things. There are close to 20 phase III pipeline programs compared to just a couple in 2005. On an adjusted basis, first-quarter earnings per share advanced 9%, while worldwide sales jumped 5%, excluding the contribution of Gambro revenues. We like the company’s product pipeline, its Dividend Cushion score, and annual dividend yield. We’re strongly considering adding it to the Dividend Growth portfolio.
Hasbro (HAS) – Fairly Valued – Dividend Cushion: 1.9 – Dividend Yield: 3.1%
Hasbro has fared much better than its peer Mattel (MAT), and we made a great call in choosing Hasbro over its peer in the Dividend Growth portfolio. Hasbro owns well-known brands such as Transformers, Nerf, Playskool, My Little Pony, G.I. Joe, Magic: The Gathering, and Monopoly. The company has been paying dividends since 1977 and has an excellent track record of consistency. In a difficult revenue environment for physical toys, Hasbro still grew revenue 2% in its first quarter thanks to strength in its international segment and its licensing business. The company is solidly profitable, has strong cash-flow generating capacity, and a healthy balance sheet. It remains a position in the Dividend Growth portfolio, and we’re fine with that.
Kaiser Aluminum (KALU) – Fairly Valued – Dividend Cushion: 2.2 – Dividend Yield: 1.9%
We generally don’t like commodity producers (they have no control over price), but we’re quite impressed with Kaiser Aluminum’s Dividend Cushion score. Aerospace and high-strength products (Aero/HS) represent roughly 40% of Kaiser’s business, and the aerospace industry perhaps has never been stronger. Still, pricing pressure was something that Kaiser mentioned in its first-quarter release regarding its outlook for 2014, and the company’s adjusted consolidated EBITDA dropped in the first quarter both in absolute terms and as a percentage of valued added revenue. We think dividend growth investors can find better ideas than Kaiser Aluminum at this juncture.
Kimberly-Clark (KMB) – Fairly Valued – Dividend Cushion: 1.3 – Dividend Yield: 3%
Kimberly-Clark is best known for its personal care and consumer tissue brands, which include Huggies, Pull-Ups, Little Swimmers, Depend, Kleenex, Scott, and Cottonelle. Its portfolio remains strong. Organic sales advanced 4% during its first quarter thanks to an impressive 12% increase in K-C International, and the company reaffirmed its earnings per share target in the range of $6-$6.20 per share. Kimberly-Clark has raised its dividend in each of the past 40+ years, and its Dividend Cushion score indicates future dividend increases are in store for investors. Shares aren’t necessarily cheap, and we think investors could get a better price in the next few years. It’s not a portfolio holding.
Kinder Morgan (KMP) – Fairly Valued – Dividend Cushion: 1.5 – Dividend Yield: 7.1%
Kinder Morgan Energy Partners has been a controversial idea. The view that MLPs are inherently risky enterprises is not based on their operations, but instead is grounded on the riskiness of their business structure, which is always reliant on new capital. Bulls will say that this is just how MLPs operate (and they’re special entities to be evaluated differently), and some will even refuse to accept this view. But the reality is that the inherent riskiness and capital-market dependence of an MLP is a fact: the entity is dependent on new, incremental money for growth spending. This has always been the case, and the SEC and accounting boards have signed off on it. We don’t like the MLP structure any more than the next person, but we accept the abnormal risks related to it in the form of a significantly larger distribution payout than otherwise could be had under a general operating structure (as in a corporation). Kinder Morgan Energy Partners had a strong first quarter and raised its cash distribution 6%, to $5.52 per unit annualized, and it has largely shrugged off the market’s concerns, punctuated by a Barron’s article, about how it accounts for maintenance capital spending. The midstream pipeline giant expects to pay at least $5.58 per unit in 2014, so unitholders should expect another increase in the distribution this year. Still, the unique fundamental risks of an MLP’s business model cannot be ignored.
KLA-Tencor (KLAC) – Fairly Valued – Dividend Cushion: 3.2 – Dividend Yield: 2.7%
KLA-Tencor is among the largest semiconductor equipment companies in the world. The firm supplies process control and yield management solutions to a variety of industries: LED, data storage and photovoltaic. The company’s calendar first quarter (fiscal third quarter) results left much to be desired. KLA-Tencor’s commentary in the release regarding semiconductor device makers facing enormous challenges in transitioning from planar to 3D transistor structures and the notion that the semiconductor capital equipment industry is currently experiencing a pause in demand doesn’t get us very excited. Its guidance for fiscal fourth-quarter revenue and earnings came in lower than consensus expectations, and we won’t be rushing to add shares to the Dividend Growth portfolio.
Microsoft (MSFT) – Fairly Valued – Dividend Cushion: 3.4 – Dividend Yield: 2.8%
Microsoft is one of the largest weightings in the Dividend Growth portfolio, and very few other firms pack the punch of its elevated Valuentum Dividend Cushion score. Its name should be synonymous with dividend growth and safety. The company’s calendar first quarter (fiscal third quarter) results were solid, and we don’t have any qualms with its conservative fourth-quarter outlook. We think the real story with Microsoft, however, is its undervaluation coupled with a fortress balance sheet that will propel years and years of future dividend growth. Microsoft will be one of the best dividend growth gems over the next two decades, in our view, and we continue to like shares quite a bit.
Philip Morris (PM) – Fairly Valued – Dividend Cushion: 1.2 – Dividend Yield: 4.5%
To us, the best dividend growth idea in the tobacco space is Altria. Bulls of Philip Morris say the company has fantastic international growth potential, but so does Altria via SABMiller. Philip Morris’ first-quarter performance also didn’t spell expansion potential. Adjusted diluted earnings per share, excluding currency impacts, advanced less than 5%, while cigarette shipment volume tumbled more than 4%. The company is still expecting a 6%-8% increase in adjusted diluted earnings per share during 2014, and it may just hit that mark via pricing growth, but it is far from a fast grower. Altria’s stake in SABMiller gives it comparatively more flexibility to grow its dividend payout, and Altria already has a higher yield than Philip Morris. We’re sticking with Altria in the Dividend Growth portfolio.
Procter & Gamble (PG) – Fairly Valued – Dividend Cushion: 1.4 – Dividend Yield: 3.1%
Procter & Gamble’s brands include Tide, Ariel, Gillette, Venus, Bounty, Charmin, Pantene, Olay, Pampers, Crest, Oral-B, Duracell, and Vicks. The firm boasts 120+ consecutive years of dividend payments and 55+ consecutive years of dividend increases. Its payout is rock-solid. There’s very little that one quarter could ever do to make or break Procter & Gamble, but we were generally pleased with its calendar first quarter (fiscal third quarter) performance. It’s no surprise that the company is operating in a highly-competitive, slow-growth environment, but it still put up 3% organic growth and 17% core earnings-per-share expansion during the period. Innovation, pricing expansion, and productivity will be the keys to the company’s future dividend expansion, and we think Procter & Gamble’s proven track record speaks to continued success. We like the firm as a position in the Dividend Growth portfolio.
Raytheon (RTN) – Fairly Valued – Dividend Cushion: 2.8 – Dividend Yield: 2.4%
Raytheon caught investors by surprise with its disappointing first-quarter results following a bullish piece in Barron’s over the weekend. The defense contractor’s adjusted earnings per share fell to $1.43 in the period from $1.56 per share in the first quarter of last year, as net sales dropped to $5.5 billion from $5.9 billion. Operating cash flow improved in the period, but the company credited this more to the timing of collections than any fundamental improvement. Sales dropped in all four of its business segments, and operating income in all but one. Boeing (BA) is our favorite defense contractor, but this is more due to its exposure to the burgeoning aerospace industry than anything else. We won’t be adding shares of Raytheon to the Dividend Growth portfolio.
Republic Services (RSG) – Fairly Valued – Dividend Cushion: 0.9 – Dividend Yield: 3%
Solid waste operators generate strong and predictable cash flow. Within the collection line of a waste hauler’s business, residential services provided to municipalities and individual households are on a service-based model (not-volume based) and can largely be viewed as insulated from economic pressures. Such a constant revenue stream helps to mitigate cyclical pressures in a trash taker’s commercial collection and industrial roll-off lines, which also fall into the overall waste-collection category. Cell-by-cell landfill build-out provides additional flexibility with respect to capital outlays, as haulers can scale back expenditures during troubled economic times. It’s probably no surprise why trash takers boast lofty payouts. Republic Services’ first-quarter results were decent, but its Dividend Cushion has waned in recent years. It has been one of the few firms we have removed from the Dividend Growth portfolio, and while we like its stable collection operations and landfill position, we don’t intend to add it back to the Dividend Growth portfolio anytime soon. It is a holding in the Best Ideas portfolio.
Verizon (VZ) – Fairly Valued – Dividend Cushion: 2.1 – Dividend Yield: 4.4%
Verizon has complicated matters way too much as of late. Even though the firm is one of the market’s great cash generators, we have material concerns about the size of Verizon’s debt load following its decision to bring Verizon Wireless into the fold. Simply put, investors cannot ignore the balance sheet, which is critical in assessing financial risk and the concept of value creation. We do not think Verizon’s elevated debt load bodes well for dividend growth investors in the near term, nor do we think it is a prudent move to add on so much debt so late in the economic cycle. The company’s first quarter results showed lower postpaid adds and a higher churn rate relative to expectations, and we’re just not excited about its soon-to-be-mountain of debt on the balance sheet in an ultra-competitive environment. We’re not considering the firm for addition to the Dividend Growth portfolio.
Wrapping Things Up
The Valuentum Dividend Cushion continues to be the primary metric we use in deciding which companies to add to the Dividend Growth portfolio, and we’ve yet to have a dividend cut in the portfolio to date. But as you can see, not every firm that has an elevated Valuentum Dividend Cushion score is worthy of inclusion to the Dividend Growth portfolio. Only the best of the best dividend growth giants are included.