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Basics of the research

This article presents a research on the Chevron Corp. (CVX) stock. It is the fourth one from a series which examines some risk and reward characteristics of several well known dividend paying stocks - Johnson & Johnson (JNJ), Coca Cola Co. (KO), Procter & Gamble Co. (PG), Chevron Corp. and PepsiCo Inc. (PEP). Subsequent articles are built on the previous ones, so readers could expect to find more information and stocks comparisons as the number of articles grows.

The first three articles covered Johnson & Johnson, Coca Cola and Procter & Gamble.

The main purpose of the analysis is to provide information about the historical risk, and especially the tail risk, which is present in a stock's distribution of total returns. Tail risk is the risk of getting returns which stand as far as several standard deviations from the mean. In order to make an informed decision, an investor should compare the tail risk of several similar investment opportunities. Tail risk could have a significant effect on a stock's return, mostly because of its potential magnitude. By definition, such tail returns are a rare event. The potential problem appears if the tail risk materializes in a period in which investors expect a withdrawal from the portfolio to happen. This could disturb financial strategies, and depending on the leverage used, it could have serious consequences on financial stability of the entities involved. The tail risk is represented by two characteristics of the distribution of returns - skewness and kurtosis.

Regarding the long-run risk of loss, a positive skewness is sometimes the preferred one. The reasoning behind this view is that the positive skewness incorporates a higher historical probability that a large unexpected return would be on the positive side, i.e. larger than the mean. On the other hand, a negative skewness presents a higher probability of an unexpectedly large negative return during some period. Hence, it shows an increased risk concerning the available capital at the end. For a better understanding the reader could use the classic explanation where the negative skewness is compared to picking up nickels in front of a bulldozer. The large unexpected negative return comes with the bulldozer's move.

The kurtosis as a measure of risk indicates whether the return distribution could experience fat tails. Those are major risk descriptors which show whether there is a larger than the normal probability of having returns far from the mean, both positive and negative. For instance, a kurtosis value of zero shows there is no such higher-than-normal probability. We should not that by 'normal' we mean the probability present in a normal distribution of returns and not the returns of some particular benchmark index.

For more information, readers could check the Johnson & Johnson article in which the skewness and kurtosis were explained in more details.

The total return of a stock is a sum of its price change and the cash flow which investors get on a regular basis, basically in the form of dividends. Because dividends and share repurchases are a major part of the examined stocks' total return, a special attention will be paid to risk on cash distributions.

The current research of Chevron Corp. covers returns data from the last 43 years. As with the other examined companies, this long period includes several different economic environments and cycles, both good and bad ones. Hence, the calculated long-run coefficients could be expected to be relatively free from sampling biases and closer to the true descriptors of the stock's population of returns.

Nevertheless, the readers should keep in mind that historical performance does not guarantee future results.

Readers should also account for the mean reversion tendency the returns generally exhibit in time. As mentioned in the first article, the performance in the more recent periods, i.e. the last 12 months or last 5 years, could be more important and useful for the moment but it would tend to get closer to the mean characteristics of the longer time frame periods, given that no significant change in the economic environment or the company itself has happened.

The Companies Selected

The companies selected for the analysis have a long dividend distributing history. Moreover, they have increased the dividend size in almost each of the last 40 years. The one exception from this rule is Chevron - the company has suspended dividends distribution in the period 1976 - 1984, most probably because of the "oil glut" and its effect on the global economy.

The average yearly dividend increase for Chevron for the last 40 years amounts to 10.7%. For comparison purposes, those values for JNJ, KO and PG are 14.91%, 10.75% and 10%, respectively.

During the last 5 years the companies also distributed wealth to their shareholders through share repurchases. Generally this increases the demand for stocks and has a positive effect on their price. If at the end of the fiscal year the company has a different amount of basic shares outstanding than at the beginning, this change could also affect the size of the dividend paid and the payout ratio.

Chevron Stock's Characteristics and Analysis

Chevron Corp. is an U.S. based company which operates in petroleum, chemicals, mining, power generation, and energy sectors worldwide. It was founded in 1879 and is headquartered in San Ramon, California.

Chevron Corp.

(click to enlarge)

Comparison with Johnson & Johnson, Coca Cola, Procter & Gamble and S&P500

The CAGR based ranking between the examined companies goes like this:

We see that with the exception of the last year's performance, the CVX stock provided the best compound annual growth rate in the group.

The pattern of January 2013 price performance which was similar for most of the other examined stocks, is seen even clearly here. In the CVX case the January and December 2012 increases made for the biggest rise in average monthly return for the last 12 months compared to the other three companies.

Taken on their own however, the 6% and 3% increases in the last two months do not represent something much extraordinary in the price history of the CVX stock. As such, the risk of the stock price marking lower returns in February is lower than it is for PG, where the 12% January increase was a clear outlier. Despite the last two months price increase, we see that CVX lags the last 12 months performance of the other three stocks and S&P500.

Comparing the graphs of adjusted monthly prices, we see that apart from the differences in KO's price behavior which were commented in more details in the Coca Cola analysis, all the companies seem to be in a long term uptrend. The last major decline of CVX was during the June 2008 - February 2009 period, where CVX declined by about 37%. For the same period, the S&P500 lost about 43% of its value. During the previous major crisis, in 2001-2002, the stock's price was slightly affected because of the different underlying causes of the crisis.

Chevron undertook 4 stock splits in the examined period - in December 1973, March 1981, June 1994 and September 2004. With the exception of the first split, all the other prices at which the stock experienced a split were around the $100 price level.

Regarding the risk adjusted price return for the whole examined period, the CVX stock stands at the bottom compared to the other three companies. Its Sharpe ratio is 0.18 against 0.20 for PG and 0.19 for both KO and JNJ. That low result reflects primarily the higher standard deviation the CVX returns experienced in history. Standard deviation however measures deviations on both sides of the mean average value while other risk characteristics shown below, namely skewness, present the CVX as not so much riskier stock.

CVX's risk-adjusted return is better than the S&P500's one (a Sharpe ratio of 0.15) for the same period.

Analysis of Risk on Dividends and Cash Distributions

Because the total return consists of a price and a dividend return we should also examine the risks on the dividend portion of the total return. With the exception of the "oil glut" period in the 1980s, Chevron has constantly increased the size of its dividend, similar to the other three examined companies. The average annual growth rate for the last 40 years is 10.7%.

The projected dividend for 2013 (see the table above) seems realistic, without putting much pressure on the company's financial results. It implies a dividend growth rate of about 10.3%. This is below the average dividend growth rate for Chevron and below the growth rates from the last two years. Regarding risk however, it is preferable to leave more room on the upside than on the downside. Using the average payout ratio for the last 5 years we arrive at company's net income of $24.2B for year 2012 which is below the Chevron's reported one of $26.18B. This leads us to the conclusion that the payout ratio would most probably be below the average one which further mitigates the risks on dividends.

The payout ratio of CVX is the lowest one in the examined group of companies. The cash distribution ratio, which includes dividends and share repurchases, is also the lowest in the group. These present the CVX stock as the one with lowest level of risk concerning the cash distribution to shareholders compared to the other three examined companies.

Another risk characteristics

CVX returns distribution histogram

Examining the whole period of 43 years we see a returns distribution with a positive skewness and a significant excess kurtosis. The positive skewness (0.41) speaks of a higher-than-normal historical risk of an unexpected positive monthly return which would stand far from the mean value. Of the examined stocks and S&P500, CVX has the highest positive skewness. All the others exhibit a negative (KO, PG, SPX) or close to zero skewness.

The kurtosis (2.07) is the second highest in the group. Only PG exhibits a higher kurtosis for the whole examined period. Such a kurtosis shows a distribution with fatter tails, both compared to the normal one and to the distributions of the other three companies. The fatter tails present an increased probability of having extremely large returns on both sides of the mean, generally. The combination with a positive skewness suggests more of those surprising returns could be higher than the mean. Even if the highest achieved to date monthly return (about 36% in November 1980) is excluded from the data, the skewness remains the highest positive one (0.2) in the group.

The closer time frames change the situation regarding the skewness. It becomes negative. A kurtosis of -1.27 for the last 12 months suggests fatter tails of the return distribution. This combination of fatter tails and negative skewness of -0.46 suggests increased risk of extreme returns far from the mean, with the prevailing number of them being below the mean.

Regarding the correlation and beta, it seems like recently the CVX stock moves more in line with the general market.

Because of the mean reversion tendency which the characteristics of the returns generally follow, we could expect that the more recent descriptors would converge to the longer term ones. If the long-run coefficients are indeed closer to the true population descriptors, we should expect the recent risk characteristics of CVX to gradually revert to the longer-run values. In the case of CVX this would benefit the stock's recent risk characteristics because the longer term descriptors show less risk on the downside.

Source: Risk And Reward Analysis Of 5 Dividend Stocks - Part IV: Chevron Corp. In Focus