Five Dividend Stocks I Wouldn't Buy

Sometimes good companies aren’t good buys, and this is not always a bad thing. Often it is a result of the market overreacting in a positive direction. The stocks simply become overvalued, but their underlying fundamentals remain excellent. Below are a couple of companies that fall into this group:

Illinois Tool Works Inc. (ITW) – Yield: 3.06% – 2 Stars – Analysis
Illinois ToolWorks Inc. is a diversified manufacturer that operates a portfolio of about 750 industrial and consumer businesses located throughout the world. As you can see from the information below, price is all that is keeping ITW from being a 4 Star stock:

• Recent Price: $40.00
• 3 Star Price: $38.99
• 4 Star Price: $36.20

3M Co (MMM) – Yield: 2.89% – 2 Stars – Analysis
3M Co. is a diversified technology company with a presence in various businesses, including industrial & transportation, healthcare, display & graphics, consumer & office, safety, security & protection services, and electro and communications. Like ITW above, price is all that is keeping MMM from being a 4 Star stock:

• Recent Price: $72.00
• 3 Star Price: $57.44
• 4 Star Price: $44.43

I was fortunate to purchase both of the stocks above when their prices were much lower, so I can’t complain that they are no longer 4 Star buys. However, for other companies, the road to fewer stars is not as appealing. Instead of a significant run up in their share price, the run up may have occurred in their debt or dividend payout percentage, or both. Here are some dividend companies and the challenges they are facing:

BP Plc (BP) – Yield: 4.67% – 1 Star
This supermajor integrated oil company (formerly BP Amoco p.l.c.) is based in London and is the world’s second largest publicly owned oil company and the fourth largest U.S. refiner. With Debt to Total Capital at an acceptable level and Free Cash Flow Payout at an undesirable level, a 3 Star rating is the best BP could earn at any price.

• Debt to Total Capital: 27%
• Free Cash Flow Payout: 69%
• Recent Price: $50.00
• 3 Star Price: $1.00

SUPERVALU Inc. (SVU) – Yield: 4.67% – 0 Stars
SUPERVALU INC. is one of the largest U.S. food wholesalers, and is also one of the biggest supermarket retailers in the U.S. With Debt to Total Capital at an undesirable level and Free Cash Flow Payout at an acceptable level (but with some years negative), a 3 Star rating is the best SVU could earn at any price.

• Debt to Total Capital: 73%
• Free Cash Flow Payout: 42%
• Recent Price: $15.00
• 2 Star Price: $14.75
• 3 Star Price: $1.00

The Hershey Company (HSY) – Yield: 2.89% – 0 Stars
The Hershey Company engages in the manufacture, marketing, distribution, and sale of various types of chocolate and confectionery, refreshment and snack products, and food and beverage enhancers in the United States and internationally. With both Debt to Total Capital and Free Cash Flow Payout at undesirable levels, a 2 Star rating is the best HSY could muster at any price.

• Debt to Total Capital: 83%
• Free Cash Flow Payout: 88%
• Recent Price: $40.00
• 2 Star Price: $1.00

Of the three, I believe BP stands the best chance of recovery. Though BP recently froze its dividend at $0.84/share (ADR), higher oil prices should lead to higher FCF and a dividend increase; it could easily add a fourth Star and once again enter the buy zone. I don’t have a lot of confidence in the other two.

Before buying a stock with hopes things will soon improve, it is a good idea to run some sensitivities to see where, or if, the stock can make a recovery. Modeling is cheap, selling an undesirable stock usually isn’t.

Full Disclosure: Long ITW, MMM, BP. See a list of all my income holdings here.

Comments

[Skinnyfrom ...:]

This opinion assumes one is looking only at the dividend. Some of these stocks have other features that will affect total return. For example, Hershey might welll be an acquisition candidate, and BP's value could rise with an increase in oil price that affects the value of its liquid (sorry) assets. 3M is an institutional favorite whose price might be a bit more stable than some others in a weak market. These an other factors should be considered in an analysis of total return. If you assume you will keep a stock effectively forever, then looking at the present value of its future stream of dividend payments is reasonable, considering (among other things) the factors you mention. Not too many people in the positiion nowadays of keeping stocks forever though.

Aug 05 09:28 AM

[User 466995:]

You apparently copied SuperValu's dividend yield into BP's dividend yield in your article -- they are both showing 4.67% above. BP is considerably better than that at about 6.5% today. If you had bought a bit before the recent run-up, you could have had 7.5% to 8.0%.
Also, BP has good upside potential as Skinny says above.

Aug 05 04:11 PM

[Bottom Up I...:]

SVU may be at risk of a dividend cut, its got a ton of debt, and faces a long road to recovery, but I think a < 7x forward earnings multiple more than reflects those concerns. As they selll underperforming assets and use free cash flow to pay down debt and rehab stores, any decent news is going to lead to multiple expansion. I think its worth $20 based on a 10x multiple of current earnings.

Disclosure - Long SVU

Aug 05 05:16 PM

[mdpath:]

It's always refreshing to read an analyst writing about stocks NOT to buy whether or not you agree with his conclusions.

Aug 06 09:11 AM

[cap3may:]

I agree with his decisions.

Just because Hersheys is a possible candidate for a buyout, doesn't mean the stock price will go up or the stockholders will get a bargain from the purchaser.

Take a look at what happened to National City when PNC bought them out. The stock holders got ripped off. Same goes with the bond holders of GM.

Aug 06 09:13 AM

[David Van K...:]

Dividend investing is a separate, distinct strategy from investing for capital appreciation. When someone embarks on a dividend-investing strategy, then keeping your eye on the ball (a consistently rising flow of dividends) is not only reasonable, it is mandatory. The strategy invariably leads to less interest in price variations, and price changes rarely become a reason to sell. That's because the owned shares are a dividend-generating machine no matter what their current price. Price, of course, is an important consideration when you BUY, not only because you want to purchase at an advantageous valuation, but also because a relatively low price usually goes hand-in-hand with a higher initial yield, from which you will benefit for as long as you own the stock.

Aug 06 09:17 AM

[Mark123:]

Your analysis on BP is completely incorrect..... I suggest a new set of batteries for your calculator and proof read your work prior to publishing... 3.36/50.56=6.64% ---I bought on 4/21/09 at 39 so my yield is 8.6% (as long as they keep paying)

Aug 06 10:32 AM

[Stan Sutfin:]

While it is true that BP has not increased its dividend since Aug. 2008 it does have a good record of increases prior thereto and a 6.7% yield today. With respect to a free cash flow payout of 69% I can't seem to find that info on any of several web sites. Would appreciate it if someone will point me in the right direction to find that info, Also, what percentage would be considered acceptable?

Aug 06 05:38 PM

[Stock Gambler:]

Stan - I use DividendInvestor.com for quick looks at dividend data. Shows payout of 49% for BP. I personally use anything under 70% or lower as acceptable.

Aug 07 02:45 PM

[Stan Sutfin:]

Thanks, looks like a good site.


On Aug 07 02:45 PM Stock Gambler wrote:

> Stan - I use DividendInvestor.com for quick looks at dividend
> data. Shows payout of 49% for BP. I personally use anything under
> 70% or lower as acceptable.

Aug 07 07:22 PM