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Many dividend growth investors, myself included, are in search of investments that have the potential to return a high yield on cost (YoC) at some point in the future. This is often achieved through a combination of moderate to high initial yield, dividend growth, and possibly reinvestment of dividends in the early years.

In this article, I share the results of a screen for Industrials aimed at identifying companies that have the potential to reach 20% YoC within 10 years. That is to say, we are looking to identify companies in which we might invest $1000 today in the hopes that they will generate an income stream of $200 / year by year 10. As part of working towards this goal, I assume that an investor will reinvest dividends.

The screen is broken into two components: 1) an identification of companies with the potential to reach 20% YoC as projected by their current dividend yield, 5-year average dividend yield, and historical dividend growth rates; and 2) an additional filter by Piotroski F-score as a first line of defense against possible "yield traps". I explain each component of the screen below and then give the companies that passed.

Initial World of Companies

To begin, I limit the universe of companies under consideration to those found on David Fish's U.S. Dividend Champions Spreadsheet, which I refer to as the CCC spreadsheet from here on out. To make this list, a company must have raised its dividend every year for the last five years.

Screening for High Yield on Cost

In order to project a future yield on cost, you need to know how far into the future you are projecting, what the starting yield is, what number you will use for yield at the time that dividend reinvestment occur, and what number you will use for the dividend growth rate.

Based on those four things and using the ideas developed in "Deriving and Using a 'Rule of 72' for Dividend Growth Reinvestors", you can forecast the income produced in the future (should the future be so kind as to meet or exceed your projections).

For the purposes of this screen, I make use of current and historical data as follows:

  1. I use the current dividend yield as the starting point.
  2. To determine a yield at the time of dividend reinvestment, I first look at the current yield and the 5-year average dividend yield, as reported by Morningstar. I take the lesser of those two numbers and then decrease the resulting number by 10%. I will use this number in our model as the amount by which the number of shares owned increases each year.
  3. To determine a dividend growth rate, I first take the 1-year, 3-year, and 5-year compound average dividend growth rates as listed in the CCC spreadsheet. Then I take the smallest of those numbers and decrease it by 25%. I use this number in our model for the future dividend growth rate. Should the company not have a 5-year dividend growth rate due to being a new addition to the CCC universe, I use the 1-year and 3-year growth rates.

After completing the above, I identify all stocks in the CCC universe for which the model predicts at least 20% YoC by year 10. At this point in the process, I have identified a number of future high yielding candidates.

Piotroski F-score

Next, I looked for a metric to try to identify businesses that are showing improvement in ways other than those illustrated by historical dividend growth. I considered using debt/equity or payout ratio measures at this point, but I decided to focus instead on the Piotroski F-Score as I believe it to be a more direct measure of whether this year's business is "better" than last year's. Ideally an improving business plus a strong dividend growth history will set the stage for satisfactory future results.

In 2002, Piotroski published "Value Investing: The Use of Historical Financial Statements to Separate Winners from Losers," in which he defined the F-score. The F-score is often used in conjunction with value screens as a starting point for separating potential value traps from true value plays. It's computation is broken into nine components as follows:

  • Profitability
  1. Net Income - Score 1 if net income is positive in current year.
  2. Operating Cash Flow - Score 1 if cash flow from operations is positive in current year.
  3. Return on Assets - Score 1 if RoA is higher in the current year than in the previous year.
  4. Quality of Earnings - Score 1 if cash flow from operations exceeds net income before extraordinary items.
  • Leverage, Liquidity, and Source of Funds
  1. Decrease in leverage - Score 1 if there is a lower ratio of long term debt to average total assets in the current year than in the previous year.
  2. Increase in liquidity - Score 1 if there is a higher current ratio in the current year than in the previous year.
  3. Absence of share dilution - Score 1 if the firm did not issue new shares/equity in the preceding year.
  • Operating Efficiency
  1. Gross margin - Score 1 if there is a higher gross margin in the current year than in the previous year.
  2. Asset Turnover - Score 1 if there is a higher asset turnover ratio this year than in the previous year.

A company's F-score will be a number from 0 to 9. If you are interested in reading more about the F-score and its use and performance in screens, you may find "Reviewing Piotroski's F-Score: Method, Results, And 10 Stock Ideas" to be interesting. I get my F-scores from the stock quotes at Gurufocus.

For the purposes of this screen, I excluded all companies with an F-score of 5 or lower.

Results

Four industrials sector stocks passed both measures. They are Sturm, Ruger & Company Inc. (RGR), Cummins Inc. (CMI), G&K Services (GK), and Union Pacific (UNP). Below is the historical data for each company and the numbers used in the YoC projections.

Sturm, Ruger & Company Inc.

Sturm, Ruger & Company designs, manufactures, and sells firearms within the United States. The historical dividend metrics are:

Current Yield5-Year Ave. Yield5-Year DGR3-Year DGR1-Year DGR
3.18%2.9%N/A61.9201.2

The Piotroski F-score is 6.

The future Yield on Cost model took as inputs:

  • Current Yield of 3.18%
  • Dividend Reinvestment Yield of 2.61%
  • Dividend Growth Rate of 46.43%

Should these projections be borne out in the future, RGR investors will achieve 20% YoC in a bit under 4 years. To achieve a 20% YoC in 10 years, the dividend growth rate would need to be at least 15.5% over the 10 years given the current yield and assumption about yield upon reinvestment.

Cummins Inc.

Cummins designs, manufactures, distributes and services engines and related technologies. The historical dividend metrics are:

Current Yield5-Year Ave. Yield5-Year DGR3-Year DGR1-Year DGR
1.73%1.5%33.23735.8

The Piotroski F-score is 6.

The future Yield on Cost model took as inputs:

  • Current Yield of 1.73%
  • Dividend Reinvestment Yield of 1.35%
  • Dividend Growth Rate of 24.9%

Should these projections be borne out in the future, CMI investors will achieve 20% YoC in a bit over 9 years. To achieve a 20% YoC in 10 years, the dividend growth rate would need to be at least 23% over the 10 years given the current yield and assumption about yield upon reinvestment.

G&K Services Inc.

G&K Services is in the business services industry and offers branded uniform and facility services to companies. The historical dividend metrics are:

Current Yield5-Year Ave. Yield5-Year DGR3-Year DGR1-Year DGR
1.72%1.4%31.835.158.9

The Piotroski F-score is 7.

The future Yield on Cost model took as inputs:

  • Current Yield of 1.72%
  • Dividend Reinvestment Yield of 1.26%
  • Dividend Growth Rate of 23.85%

Should these projections be borne out in the future, GK investors will achieve 20% YoC in a bit under 10 years. To achieve a 20% YoC in 10 years, the dividend growth rate would need to be at least 23.2% over the 10 years given the current yield and assumption about yield upon reinvestment.

Union Pacific

Union Pacific is a railroad company located in the western two-thirds of the United States. The historical dividend metrics are:

Current Yield5-Year Ave. Yield5-Year DGR3-Year DGR1-Year DGR
1.94%1.8%29.832.129

The Piotroski F-score is 7.

The future Yield on Cost model took as inputs:

  • Current Yield of 1.94%
  • Dividend Reinvestment Yield of 1.62%
  • Dividend Growth Rate of 21.75%

Should these projections be borne out in the future, UNP investors will achieve 20% YoC in 10 years.

Conclusion

I was a bit surprised to find 3 low yield, high dividend growth picks make the list. I will be exploring some of these names for my own portfolio, but I am extra cautious about relying upon extraordinary growth over a sustained period of time to achieve my goals.

Data presented here is in its raw form. Stocks and data presented are for informational purposes, and this is not a recommendation to invest or to not invest. Potential investors are advised to conduct a thorough due diligence process.

Source: 4 Industrials With Potential To Reach 20% Yield On Cost In 10 Years