Dividends Tell the Story
Standard & Poor’s Dividend Aristocrats
The Best Aristocrat Right Now
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Look at Dividends First and Foremost
Sales can provide more than a hint of how a company is doing, but sales alone do not prove that a company is profitable now or will become profitable in the future.
Earnings can also be a good barometer of the condition of a company, but companies can include or exclude so many “extraordinary” items of income, expense and balance sheet items that investors need to dig into most companies’ financial statements to determine whether earnings are really and truly growing.
In my view, dividends are the most reliable indication of a company’s growth and stability. Dividends are the payments of a company’s hard-earned profits. A company’s ability to continually pay 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 exclude companies paying really low dividends; these companies pay dividends yielding more than 1% per year. This figure is called the dividend yield and is calculated by dividing the annual dividend per share by the current stock price.
When evaluating dividends and yields, beware of a common pitfall: dividend coverage. 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). The dividend coverage ratio indicates if earnings can support the dividend.
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 if a company’s growth has slowed, a portion of earnings should be reinvested back into the organization.
Rising dividends indicate that the management and board of directors of a company are reasonably sure the company is performing well and will continue to perform well in the foreseeable future.
Standard & Poor’s Dividend Aristocrats
Ten years ago, S&P (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 it included all companies that have increased their dividends each of the past 25 years and have a market cap of at least $3 billion. Currently the Index contains 54 companies in a wide variety of industries.
The performance of the Index has been very impressive. It has outperformed the ordinary S&P 500 during the past 1-, 3-, 5-, 10-, 15- and 20-year periods (the last two periods are back-tested). Comparisons include stock price appreciation and dividends for both indexes.
The performance of the S&P 500 Dividend Aristocrats Index is even more impressive when the low risk of the companies is taken into consideration. Currently, the Dividend Aristocrats Index includes 54 companies, with 14 companies (27% of the Index) in the conservative Consumer Staples sector and only two companies (4% of the Index) in Information Technology. The S&P 500 Dividend Aristocrats Index has consistently outperformed the S&P 500 Index both when the market is rising and when it is falling!
Some of our seasoned investors might remember the “Nifty Fifty” during the 1960s and 1970s. Well, the S&P 500 Dividend Aristocrats might be the new and improved Nifty Fifty. If you would like the complete list of 54 companies that are currently included in the Dividend Aristocrats Index, just reply to this email. My listing includes the current price, annual dividend, dividend yield and forecast dividend growth rate. It’s free, of course!
On September 22, 2011, I wrote a Cabot Wealth Advisory entitled “The Importance of Dividends.” The column listed 10 blue-chip stocks, including Abbott Labs, Chevron, IBM, Microsoft and Walgreen, and all paid above average dividends. How did these “stodgy” old stocks perform?
My top 10 blue-chip stocks returned 68.1%, not including dividends, in the past 45 months. Every one of the 10 companies increased their dividends during that time and every one of the companies increased in value. That’s a 100% win percentage! How good is 68.1% appreciation? It’s better than the Dow Jones Industrial Average, better than the S&P 500 Index, and, yes, I beat Warren Buffett’s Berkshire Hathaway performance during the same time period. I couldn’t possibly create a better example of why you should include high-quality dividend-paying companies in your portfolio.
The Best Aristocrat Right Now
I scanned the list of 54 Dividend Aristocrat stocks to find the best undervalued company with better-than-average dividend growth prospects for the future. My pick is W.W. Grainger (GWW), a blue chip company that currently sells at an attractive price.
W.W. Grainger (GWW 242) distributes repair and maintenance supplies and services used by businesses and institutions in the U.S. and Canada. Grainger dispenses material handling equipment, safety and security supplies, lighting and electrical products, power and hand tools, pumps and plumbing supplies, cleaning and maintenance supplies, and forestry and agriculture equipment.
Grainger also operates business support centers that provide coordination and guidance services in accounting and finance, investor relations, business development, risk management, human resources, health and safety, and security.
Grainger generates 88% of its $10 billion in sales from the U.S. and Canada with smaller operations in Europe, Asia and Latin America. The company serves more than two million customers worldwide through a network of integrated branches, distribution centers, websites and export services.
Sales advanced 7% and EPS (earnings per share) climbed 8% during the 12 months ended 3/31/15. Sales will likely increase 8% and EPS will rise 10% to $13.75 for the 12-month period ending 3/31/16. Recent acquisitions are contributing better-than-expected sales and earnings results, and additional purchases are expected during the next 12 months. Grainger maintains a very strong balance sheet and ample cash to fund acquisitions and expand operations. Growth will be limited by foreign currency exchange rates during the remainder of 2015 and weak business conditions in Canada.
Because Grainger is a blue-chip company, its shares warrant a higher P/E (price to earnings ratio) than the current 19.4. Grainger has increased its dividend for 43 consecutive years. The dividend, which yields 1.9%, was raised again in April. Shareholders have profited from the 15% average annual increases during the past decade, which will very likely continue well into the future. Buy GWW at the current price.
Lastly, I invite you to follow me on Twitter. I send out at least one interesting tweet every day!
Until next time, be kind and friendly to everyone you meet.
Sincerely,
J. Royden Ward
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