Advantages of Dividends
Standard & Poor’s Dividend Aristocrats
Two Dividend Aristocrats for 2013
Look at Dividends First and Foremost
The best indication that a company is prospering is its history of dividend payments. Certainly, sales provide more than a hint of how a company is doing, but sales alone do not prove that a company is profitable now nor that it will become profitable in the future.
Earnings can also be a good barometer of the condition of any company, but companies can include or exclude many “extraordinary” income, expense and balance sheet items. Investors really need to dig into companies’ financial statements to determine whether earnings are actually growing.
In my view, dividends are the most reliable indication of a company’s growth and stability. Dividends are payments to shareholders of a company’s hard-earned profits. A company’s continuous payment of dividends provides concrete evidence that the company is performing well.
Advantages of Dividends
Accounting malfeasance is harder, or impossible, if a large transfer of cash is going to shareholders on a regular basis. I don’t mean companies paying really low dividends; I am referring to companies paying dividends of more than 1% per year. This figure is called the dividend yield and is calculated by dividing the annual dividend by the current stock price.
When evaluating dividends and yields, beware of a common pitfall: dividend coverage. The dividend coverage ratio indicates whether earnings can support the dividend. You can evaluate dividend coverage by dividing the annual dividends per share (latest quarter times four) by the last four quarters of earnings per share (DPS divided by EPS).
As a general rule of thumb, most successful dividend investors avoid companies with a dividend payout ratio above 50% or 60%. Anything above that mark means the company may not be investing enough capital back into the organization. Even though a company’s growth has slowed, it’s still critical to reinvest a portion of earnings back into the organization.
Rising dividends indicate that the management and board of directors of a company are reasonably sure the company is performing very well now and will continue to perform well during the foreseeable future.
Standard & Poor’s Dividend Aristocrats
Seven years ago, Standard & Poor’s created an index to show how the performance of companies with outstanding records of dividend payments fared compared to all companies. They called it The S&P 500 Dividend Aristocrats Index and included all companies that have increased their dividends every year during the past 25 years and have a market cap of $3 billion. Currently the Index contains 54 companies in a wide variety of industries.
The performance of the Index has been impressive. It has outperformed the ordinary Standard & Poor’s 500 Index through December 31, 2012, during the past 1-, 3-, 5-, 10-, 15- and 20-year periods (the last three periods are back-tested). Comparisons include stock price appreciation plus dividends for both Indexes.
The performance of the S&P 500 Dividend Aristocrats Index is even more impressive when the inherent low risk of the companies is taken into consideration. Currently, the Index includes 54 companies, with 13 companies (24.0% of Index) in the conservative Consumer Staples sector and only one company (1.8% of Index) in the riskier Information Technology sector. The S&P 500 Dividend Aristocrats Index has consistently outperformed the S&P 500 Index when the market is both rising and falling!
The Best Aristocrats
I scanned the list of 54 Aristocrat stocks to find undervalued companies with better-than-average dividend growth prospects for the future. Dover Corp. (DOV) and Family Dollar Stores (FDO) are blue chip companies that currently sell at attractive prices.
Dover Corp. (DOV) is a diversified industrial manufacturer, but unlike many companies in the industrial sector, Dover has minimal dealings with the U.S. and other governments that are initiating drastic spending cuts. The company’s output includes: compressors, flow meters and bearings for industrial and aerospace customers; pumps and valves for clients in the petroleum industry; and microwave filters and automated equipment for the assembly of circuit boards for electronic industry manufacturers.
Dover recently acquired Anthony International which makes specialty glass doors for refrigerators and freezers. Anthony will add noticeable sales and earnings in 2013 and beyond. The acquisition, plus the divestiture of underperforming assets, will enable sales and earnings growth to accelerate in 2013. Sales will likely increase 9% and EPS (earnings per share) will climb 15% to 5.48 in 2013.
At 12.4 times my 2013 EPS forecast and with a dividend yield of 2.1%, DOV shares are very attractive and should outperform the S&P 500 Dividend Aristocrats Index during the next 12 months. Dover Corp. has increased its dividend every year for the past 25 years and will very likely increase the dividend by a substantial amount at mid-year. The dividend coverage ratio for DOV is a very conservative 29%–well below the maximum target of 50%. Buy DOV now.
Family Dollar Stores (FDO) operates a chain of more than 7,000 retail discount stores in 44 states. FDO seeks low- to middle-income consumers and sells a selection of competitively priced merchandise. Items include consumables, home products, apparel and accessories, seasonal goods and electronics. Prices generally range from under $1.00 to $10.00.
Family Dollar is aggressively opening new stores and renovating old stores. Sales increased a better-than-expected 13% during quarter ended 11/30/12, and same-store sales advanced an impressive 6.6%. However, EPS inched ahead just 1% as higher marketing costs and abundant price mark-downs caused the weak earnings results.
Sales will likely rise 11% and EPS will climb 15% to 4.25 during the next 12-month period ending 2/28/14. New store openings could produce even better results. At 13.7 times my forecast, FDO shares are undervalued. Family Dollar has increased its dividend every year for the past 25 years and just last week raised the dividend by a whopping 24%. The dividend yield is now 1.8%. The dividend coverage ratio for FDO is only 28%, which again, is well below my maximum level of 50%. Buy FDO now.
Until next time, be kind and friendly to everyone you meet.
Editor of Cabot Benjamin Graham Value Letter
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