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Dividend growth investing, growth at reasonable price, long-term horizon
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This is part 3 of four-part series about why I chose the 28 stocks listed here [I added Novartis AG (NYSE:NVS) and ConocoPhilips (NYSE:COP), and later Textainer (NYSE:TGH)]. The information contained in the brief summaries were originally published in the article tagged above.

A Brief Summary Of My Strategy

This portfolio will be maintained for about 45 years, into my retirement, and maybe even further into it. I plan to invest an initial amount of $30,000 into some dividend stocks, and add $400 monthly over 45 years, and grow the money by 8.3% yearly. (I think this should be achievable as a 10-year backtest showed a return of 10.7% yearly. I know past performance is not a representation of future performance, but I think 8.3% is a fair estimate).

Portfolio Management

To manage my portfolio, I plan to check the news for the stocks in my portfolio every weekend, and read articles on great sites like Seeking Alpha, Yahoo Finance, MSN Money and The Motley Fool. Besides this, when stocks are more overvalued (most stocks are still fairly priced at the moment), I plan to get loaded up on cash (I will add $400 monthly) and just collect my dividends while waiting. I will then wait for stocks to be more undervalued (e.g., recession, correction) before buying more stock, and will only sell when the dividend stocks decrease their dividend or announce news that are unfavorable to investors.

Here are some of my selling guidelines:

  1. Decrease/Elimination Of Dividend
  2. Uncertainty With Future Dividend Payments
  3. Losing Market Share Rapidly/Not Competitive Enough/Fundamental Problems

The Mission Of The Portfolio

The mission of this portfolio is to provide myself with steady capital appreciation and a growing stream of dividends to be reinvested into the respective companies. Besides this, I also aim for a portfolio that will yield around 4%, and this dividend, along with the returns in the stock price itself, be able to beat both inflation and the major indexes over the years. Later in life during retirement, I also aim to live solely off these dividends and have a good retirement (along with my family).

Here are some general qualities of the stocks in my portfolio:

  1. All of these stocks have at least 5 years of consecutive dividend increases [except Kraft (NASDAQ:KRFT), a spinoff from the former Kraft Foods].
  2. All stocks listed have outperformed the S&P 500 during the latest 2008 recession except Aflac (NYSE:AFL). (the reason is in the article I tagged above).
  3. All have payout ratios of below 90%. The exceptions, AT&T (NYSE:T), Omega Healthcare (NYSE:OHI) and Kinder Morgan Pt (NYSE:KMP) are capital intensive businesses and have safe payout ratios when the formula is tweaked from Dividends Paid/EPS to Dividends Paid/FFO.

Here are some general statistics about my portfolio:

  1. Outperformed the S&P 500 by 6.88% annually over the past 10 years (My portfolio 10.70% vs S&P 500 3.82%, including dividends).

    Note: Subject to survivorship bias

  2. Yield of 4.2%
  3. P/E of 15
  4. Beta of 0.67
  5. 5-Year dividend growth of 12.2%

Here are the 7 stocks I will be covering in this article:

Company Consecutive Dividend Increases (Years) Dividend Yield (%) 5-Year Dividend Increase (%)
Lockheed Martin (NYSE:LMT) 10 4.9 21.1
Lorillard (NYSE:LO)+ 5 5.3 27.5
McDonald's (NYSE:MCD) 36 3.4 20.4
Altria (NYSE:MO) 44 5.4 15.0
Novartis 11 3.8 21.3
Omega Healthcare (OHI) 10 7.1 10.1
PepsiCo. (NYSE:PEP) 40 3.0 12.2

Stocks which are trading at or below fair value have an plus (+) next to them.

1. Lockheed Martin

Lockheed Martin is a security and aerospace company and engages in the design, development, manufacture, integration, and sustainment of advanced technology systems and products in the areas of defense, space, intelligence, homeland security, information technology, and cyber security in the United States and internationally. The company operates in four segments: Aeronautics, Electronic Systems, Information Systems & Global Solutions, and Space Systems. A big portion of its revenues (82%, from 2011 10-K) come from business from the U.S. government, which looks worrying, as the U.S. could cut spending on defence to hit deficit targets. But, it is the largest defense contractor in the USA as well as in the world, building vehicles like helicopters, ships, planes, spacecraft and a variety other items used for military and other needs. It has also been offered many contracts by many governments, and the list of over 50 governments include Korea, China, Singapore, Sweden, Denmark, USA, as well as many other big names.

The company has a $30.42B market cap and a dividend yield of 4.89% as of 15.01.2013's closing price of $94.02. The company has increased its dividends yearly for the past 10 years without fail, which is a good achievement, giving it a Dividend Contender status. Lockheed also has a 45.65% payout ratio. Paying out less than half its 2011 earnings, the dividend looks well-covered and poised for further long-term growth.

I also like the company's fundamental numbers. Firstly, it has a ROE of 140.7%. This ROE number is within the top 1% of the entire universe of stocks, and has also increased astronomically over the past 10 years, increasing over twentyfold from just 5% in 2003 to its current number of 140.7%, as seen here. Secondly, its EPS numbers have been increasing rapidly over the past 10 years, from $1.18 in 2002 to $7.85 in 2011, representing a 20.9% increase annually over 10 years, which is remarkable performance. Although this is the case, this fabulous performance could partially be attributed to the company's buying back of shares over the past 10 years (another reason why I like the company). Shares outstanding have been decreased considerably over the past 10 years, totalling 3.4% annually.

Lockheed Martin looks fairly priced at 10.7X trailing 12-month earnings. It only looks fairly priced as it is expected to decrease earnings next year, with its forward P/E higher than its trailing P/E. It is also trading at an sky-high 12.5X book value, which is something I do not really like. Although this is the case, one must note that book value undervalues certain important intangibles like brand name.

Here is a chart showing Lockheed Martin's past dividend payments:


(Click to enlarge)

2. Lorillard

Founded in 1760, Lorillard manufactures and sells cigarettes in the United States. It markets approximately 43 product offerings in various brand names, including Newport, Kent, True, Maverick, and Old Gold. Although cigarette companies have been facing many headwinds around the world to reduce smoking, Lorillard still looks attractive to me in a few ways. Firstly, it has invested in new alternatives to traditional cigarettes, like electronic-cigarettes, which is a rapidly growing industry that could provide Lorillard with growth going forward. Secondly, it has a growing market share. Its market share has grown from just 12% in 2009 to 14% in 2012, which is an impressive increase in just three years. Thirdly, a lot of Lorillard's products are what are called "value cigarettes". These are cigarettes that are sold at cheaper-than-market prices, which have attracted many smokers, and have fueled growth in return.

The company has a $15.21B market cap and pays an attractive dividend of 5.28% as of 15.01.2013's closing price of $39.13 (Shares have just split 3-for-1 on 15.01.2013). The company has increased its dividends every year since its 2008 IPO, and with 5 years of consecutive dividend increases, it has attained Dividend Challenger status. Lorillard has a 71.10% payout ratio, which is still acceptable to me. Therefore, the dividend looks safe at the moment.

I also like the company's fundamentals. Firstly, it has seen rapid EPS growth over the past 4 years. Its split-adjusted EPS in 2008 was $1.72, and its EPS in 2011 was $2.66, which represents a 11.4% growth annually over the past 4 years. Secondly, the company's days inventory number has dropped steadily since its IPO in 2008. Days inventory was 38.3 days in 2008, and that number is now 24.5 days. Days Inventory is a measure of a company's performance that gives one an idea of how long it takes a company to turn its inventory into sales. This is another positive point about the company as this is a sign that sales are improving.

Lorillard looks attractively priced at 14.1X trailing 12-month earnings and 12.9X forward earnings. This valuation, as compared to its peers, is the lowest of all.

Here is a chart of Lorillard's past dividend payments:


(Click to enlarge)

3. McDonald's

McDonald's is the biggest fast-food restaurant chain in the world and operates 34,000 restaurants in over 120 countries around the globe. I like McDonald's established brand around the world, and the fact that its food has become a need for many people, saving time and being delicious. Additionally, because of this, McDonald's has a significant amount of pricing power as people do not mind paying a slight premium for a brand they recognize and love.

The company has a $91.87B market cap and pays a dividend of 3.37% as of the stock's closing price of $91.51 on 15.01.2013. This dividend aristocrat has increased dividends since its IPO in the mid-1970s, which equates to a 36-year dividend increasing streak, earning itself Dividend Champion status. The company has a 52.17% payout ratio, which shows that the dividend is well-covered and also looks poised to grow further into the future.

The company's fundamental numbers also look extremely attractive. Firstly, its ROE number has been increasing astronomically over the past 10 years, from a mere 8.70% in 2002 to 40% today, which is excellent progress for just 10 years. Secondly, McDonald's is also buying back shares, with shares outstanding declining 2.4% annually over the last 10 years, from 1.27B in 2002 to just 1.00B today. Thirdly, McDonald's is a fast-growing company (even though it is a large company), with its EPS growing 21.3% annually over the past 10 years, and growing from just $0.77 in 2002 to $5.27 in 2011, as shown here. Although it is not expected to grow at such a rate going forward, it is expected to grow at a good 8.81% annually over the next 5 years.

McDonald's is slightly overvalued at the moment, trading at 17.2X trailing 12-month earnings. Although this is the case, one can still consider buying it at today's prices as it has a strong brand and still considerably fast growth. A more conservative value investor can consider waiting until McDonald's hit the low-$80s to mid-$80s range.

McDonald's dividend chart is not accurate (did not account for stock splits), so here is McDonald's 30 year dividend history (McDonald's 2012 dividend payment is $2.87):

2011 2010 2009 2008 2007 2006 2005 2004 2003 2002
$2.53 $2.26 $2.05 $1.625 $1.5 $1 $0.67 $0.55 $0.4 $0.235
2001 2000 1999 1998 1997 1996 1995 1994 1993 1992
$0.225 $0.215 $0.196 $0.176 $0.1605 $0.1465 $0.132 $0.11675 $0.10525 $0.09875
1991 1990 1989 1988 1987 1986 1985 1984 1983 1982
$0.09025 $0.083 $0.07537 $0.07 $0.06057 $0.04917 $0.04889 $0.04213 $0.03593 $0.02914

I previously written this article outlining McDonald's fundamental strength.

4. Altria

The Virginia-based Altria Group manufactures and sells cigarettes, smokeless products, and wine. I especially like Altria's diversified portfolio of cigarette brands in its portfolio. The portfolio contains popular brands like Marlboro, Virginia Slims and Columbia Crest. In recent years, it has diversified its portfolio of just traditional cigarette brands into other smokeless cigarette brands (Copenhagen, Skoal) and even into wine brands.

The company has a $66.38B market cap and pays a 5.37% dividend yield as of 15.01.2013's closing price of $32.78. This dividend aristocrat has increased its dividends for 44 consecutive years, attaining Dividend Champion status. I like this company's dividend even more as management already has a dividend payout target of 80%, as shown here on the company's website. Therefore, the company's 87% payout ratio can be excused.

Its fundamentals also look acceptable. Firstly, it has a high ROE number of 94.2%, which is within the top 1% of the entire universe of stocks. This proves that management is using shareholders' investments well and not wasting the money by investing them into unprofitable ventures. Secondly, the company is also buying back shares at a modest pace, with shares outstanding decreasing from 2.11B in 2007 to 2.03B today, which represents a 0.8% decrease in shares outstanding annually. Shareholders do not own the entire company, therefore, share buybacks will enable shareholders to own a larger share of the company without increasing the number of shares they hold.

Altria looks slightly overpriced at is current valuation of 17X trailing 12-month earnings. With its high (and increasing) dividend, I have no problems buying at today's prices, although more conservative investors would consider waiting until the stock price hits the $30 mark.

Altria's dividend chart is also inaccurate (as splits were not accounted for), therefore, here is Altria's dividend history since 1989 as shown here, (Altria's 2012 dividend payment is $1.76):

2011 2010 2009 2008 2007 2006 2005 2004 2003 2002
$1.55 $1.42 $1.3 $1.16 $0.86 $0.77 $0.71 $0.65 $0.61 $0.56
2001 2000 1999 1998 1997 1996 1995 1994 1993 1992
$0.51 $0.46 $0.42 $0.39 $0.37 $0.34 $0.28 $0.23 $0.20 $0.18
1991 1990 1989
$0.15 $0.12 $0.10

5. Novartis

Novartis AG engages in the research & development, manufacture, and marketing of healthcare products worldwide. The company provides products ranging from drugs, eye care products, vaccines, blood testing and molecular diagnostics products, readily available consumer medicines and animal health products. I like Novartis' business as what it mainly manufactures and sells- drugs, will always be needed by humans, as falling sick is inevitable. Although this is the case, here is a caveat: it might have some impairment charges and other such charges on its new drugs which are in trial.

The company has a $176.50B market cap and pays a 3.81% dividend as of 15.01.2013's closing price of $65.22 The company has increased its dividends yearly for the past 11 years without fail, achieving Dividend Contender status. Novartis has a dividend payout ratio of 62.17%, which shows that the dividend is well-covered and safe.

Besides a good dividend, Novartis also has favorable fundamentals. Firstly, its EPS number has increased at steadily over the past 10 years. EPS has increased from $1.38 in 2002 to $3.78 in 2011, which represents an annual increase in EPS of 10.6% over 10 years. Secondly, its shares outstanding number has dropped slightly from 2.47B in 2002 to 2.41B in 2011. This equates to a slight 0.3% decrease in shares outstanding over the past 10 years, as shown here.

Although this is the case, it is trading at a fairly-valued 18.4X trailing 12-month earnings. It is fairly valued to me as the company took $1.5B in charges in Q4 2011 and a further $200M in charges in Q1 2011. The news statements can be found in the links I provided above. After accounting for these two extra charges, the trailing P/E ratio decreases to the 15 range, which is in-line with the company's nominal P/E ratio in the range of 14-15.

Here is a chart of Novartis' past dividend payments:


(Click to enlarge)

6. Omega Healthcare

Omega Healthcare Investors (a REIT- has to pay at least 90% of its income to investors), invests in healthcare facilities- mainly long-term healthcare facilities. It provides lease (or mortgage financing) to operators of skilled nursing facilities (SNF), assisted living facilities (ALF), independent living facilities and rehabilitation/acute care facilities. The company's portfolio of real estate investments consists of 400 healthcare facilities- 370 SNFs, 10 ALFs, 5 specialty facilities, fixed rate mortgages on 13 SNFs, and 2 SNFs. As stated above, it mainly leases (90% of portfolio) property to operators of skilled nursing facilities, which mainly houses old folks. As the number of those aged above 85 in USA is projected to increase rapidly going forward, Omega looks well-positioned from benefiting from these demographic trends.

The company has a $2.78B market cap (still a mid-cap with lots of potential for growth) and pays a neat dividend of 7.09% as of the 15.01.2013's closing price of $24.82. The company has increased its dividend payments for 10 years straight, giving it Dividend Contender status. The company's Dividend payout ratio (according to FFO) is 90.72%, which seems a little high, but with EPS estimated to grow over the next few years (as seen below), the dividend seems no problem going forward.

I also like the stock for a couple of other reasons. The company has been exceptionally strong on days when the market was down, being one of the best performers in my portfolio for many bearish days. Omega has also outperformed the market considerably in 2012- by over 15 percentage points. Fundamentally, the company also looks strong. Firstly, the company's FFO number has been increasing steadily over the past 10 years, increasing from $0.78 in 2002 to $1.83 in 2011 (additionally, estimates for 2012 at $1.94 and estimates for 2013 at $2.06), which equates to a 8.9% growth rate over the past 10 years. Secondly, the company's ROE numbers, although not outstanding, has been on the rise. From a negative ROE of (-3.10%) in 2002, it has progressed slowly but steadily to its current ROE number of 11.0%, which is also commendable.

The company is trading within fair value at the moment, trading at 12.7X FFO at the moment. The company's nominal valuation over the past 5 years is 12X FFO. Investors may want to consider waiting until the stock declines to the $22-$23 range before taking a position.

The following chart shows Omega Healthcare's past dividend payments:


(Click to enlarge)

7. PepsiCo

PepsiCo manufactures and sells snacks, carbonated and non-carbonated beverages, dairy products, and other foods worldwide. It operates in four divisions: PepsiCo Americas Foods (PAF); PepsiCo Americas Beverages (PAB); PepsiCo Europe; and PepsiCo Asia, Middle East, and Africa (AMEA). Some famous snack brands are Lays, Doritos, Quaker, PastaRoni, and some famous beverage brands are Mountain Dew, 7-Up, Miranda, and not forgetting Pepsi, its main and most famous brand. I like the company not only because of its diversified portfolio of famous brands, but also because of the fact that people will not stop spending a little bit of money buying snacks and famous drinks like Pepsi or Coca-Cola (NYSE:KO) because of a recession.

The company has a $110.75B market cap and pays a 3.00% dividend as of 15.01.2013's closing price of $71.60. The company has increased its dividends yearly for the past 40 years without fail-- a great achievement, therefore attaining Dividend Champion status. PepsiCo has a 55.46% dividend payout ratio, which shows that the dividend is well-covered and is safe.

I also like the company in some other ways. Firstly, the company's EPS numbers has increased steadily over the past 10 years, growing from $1.67 in 2002 to $4.03 in 2011, representing a 9.3% growth annually in EPS over the past 10 years. Secondly, the company has also been buying back shares at a respectable rate over the past 10 years, decreasing their shares outstanding by 1% annually since 2002. This is favorable to shareholders as shareholders do not own the entire company, they only own part of it, and buybacks enable them to own a larger portion of the company without buying more shares. Thirdly, the company has a high ROE of 26.1%, which is also a good sign. This means that management is actually making good use of shareholders' investments and not wasting them away.

The company is trading at a slightly overvalued 19X trailing 12-month earnings, as compared to its 5-year average of 17.7X. Therefore, I would consider waiting until share prices decline to the range of $66-$67 per share before taking a position- which looks achievable over the short term.

The following chart shows PepsiCo's past dividend payments:


(Click to enlarge)

Conclusion

In conclusion, I like to choose companies with steady earnings growth, steady dividend growth, and have a business that sells a product/offers a service that people need, to make up my portfolio. These companies, however boring their businesses are, will reward shareholders over time. Additionally, if you are considering to buy any of the stocks listed here, please also do your own due diligence before buying as I have only covered a few of the companies' qualities briefly.

Source: Investing In Dividend Stocks: Why I Chose The Stocks In My Portfolio - Part 3