Challenge-Do Not Overlook These Future Dividend Challenger Stars-Part 3

by: Chuck Carnevale


More people than ever are retiring today, and there is no end in sight as the baby boomer generation has reached retirement age. This one demographic fact alone has generated a host of doomsayers with dismal prophecies about what this will do to our economy, and perhaps more importantly, how and why they believe that the baby boomer generation is facing financial hardship and even ruin. However, as a baby boomer myself, I disagree with these Armageddon forecasts.

Harry S. Dent Jr., is one of the more famous doomsayers currently, and like many others, he bases his dire predictions on the consumption behaviors of the burgeoning baby boomer generation. According to Dent and others, the spending patterns of baby boomers will mirror those of past generations. In essence, they are forecasting that baby boomers will spend less as they get older, and because they are such a major demographic force, this will negatively impact our economy. However, there are many that disagree, including yours truly.

On April 10, 2012 in an article titled "Boomers Move Into Their Golden Years" Trends Magazine offered the following:

"Yet, as we cited earlier, a new model of life-cycle spending patterns developed in 2008 by McKinsey & Company shows that for the average "early Boomer," spending peaks at age 62 (not 47).1 After having roughly doubled their per capita spending between the ages of 30 and 55, this model indicates that Boomers reduce it on average by about 20 percent over the course of retirement. Why this dramatic shift and what will it mean?"

Trends Magazine then went on later in the same article offering reasons to support their view as follows:

"The Trends editors have consistently argued that the lives of Baby Boomers and the rest of the U.S. population in the first two decades of the 21st century will be unprecedented in human history because of nine crucial factors:

  • People are leading longer, healthier lives, due to quantum leaps in health care.
  • Jobs now depend less on manual labor, and more on experience, making them better suited for older workers.
  • The small size of Gen X encourages companies to retain the Boomers' knowledge, skills, and experience to remain competitive.
  • America's well-developed entrepreneurial culture and infrastructure encourages and enables business startups, as never before.
  • A whole generation is entering its later years with a self-image that has always been based on work and youth.
  • America is serving increasingly as the de facto "corporate headquarters" of the global economy and increasingly leveraging resources around the world to create value.
  • A global glut of capital is driving down returns on investments, and making it easier for individuals and businesses to borrow or raise equity.
  • The most affluent generation in history will reach its peak in spending later than previous generations because, historically, affluent people keep spending later in life.
  • Boomers are continuing to make family commitments later in life than their parents. Many Boomers married later and had children later than their parents and grandparents did. This, coupled with the propensity of generations X and Y to live at home well into their 30s, will motivate Baby Boomers to spend more money later in life, if they have it."

Perhaps that last phrase "if they have it," may be the most important part of their whole thesis. People entering retirement now are finding it more difficult than it has been in many decades to generate sufficient income on their assets to live off of. With interest rates at historic lows, a fair yield on their investable dollars is hard to find. Yet, people in retirement need yield.

Retirees Need Income Generating Solutions

In the past I have supported fixed income vehicles as appropriate options for retirees needing current income. However, as interest rates have steadily fallen since the 1980s, I have, temporarily at least, altered my views about fixed income. With interest rates at historic low levels, the risk-reward characteristics of fixed income instruments have been turned upside down. Long known for their safety and high-yield, bonds and other fixed income instruments are no longer the safe, high-yielding investments they once were. Consequently, when interest rates eventually rise to more historically normal levels, the prices on bonds issued today would dramatically fall.

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Therefore, for now at least, I favor blue-chip dividend paying stocks over bonds. For starters, bonds no longer offer their traditional yield advantage. But even more importantly, bonds offer fixed income streams. This is especially a disadvantage during inflationary environments. In contrast, properly selected dividend paying stocks offer the opportunity for an increasing dividend yield each year. Consequently, for the above reasons and others, I currently favor blue-chip dividend paying equities over fixed income.

However, in order to get as close as I can to the safety characteristics that fixed income has traditionally offered, I favor dividend paying stocks with a legacy of increasing their dividends each year. Naturally, my favorite choices are found within the Dividend Aristocrats or Dividend Champions. These are companies that have increased their dividend every year for 25 or more consecutive years. Even in today's strong stock market environment, I have found many Dividend Champions at sound or reasonable valuations that therefore appear worthy of deeper research which I wrote about here.

Moreover, beyond the elite lists of Dividend Champions and Aristocrats, I also found many interesting fairly valued research candidates in the Dividend Contenders group as well, which I wrote about here. In this part 3, my final article in this series, I searched for and found Dividend Challengers in value. This group of dividend paying stocks is comprised of companies that have increased their dividends for 5 to 9 consecutive years.

Clearly, Dividend Challengers do not have the long records of dividend increases that Champions and Contenders possess, but that in itself does not mean that there are not safe and attractive opportunities for the dividend growth investor within this group. In fact, in many ways, and for many reasons, some of the most attractive dividend paying stocks capable of meeting the challenges faced by retirees seeking an adequate income today can be found in the Dividend Challengers group. Therefore, I offer the following Dividend Challengers that appear attractive even considering the run-up in the general stock market over the past several years.

Dividend Challengers In Value

As I did in part 1 and in part 2 of this series featuring fairly valued dividend paying stocks, I present my list by sector. Since diversification is such an important component for reducing risk, I suggest that the following lists of fairly valued Dividend Challengers offer ample opportunity from which to diversify a dividend growth portfolio. Additionally, I further broke the Dividend Challengers down into categories by type.

My first category covers traditional C Corp.'s over various sectors. Next, I will provide a list of companies within the financial sector exclusively, because I felt this specific sector carries more risk than the others. Of course, I'm referring to the aftermath of the Great Recession which I believe was in great part due to issues caused from the financial sector. Finally, I will review Dividend Challengers that are organized as master limited partnerships (MLPs). Again, I separated MLPs due to their unique capital structures and configurations. I will provide a brief commentary on my views of financials and MLPs separate from my traditional candidates.

Traditional Dividend Challengers by Sector

As you review the following lists of apparently fairly valued Dividend Challengers, I believe you will find candidates that could fit every individual dividend growth investor's unique needs, goals and objectives. For those retirees in the distribution phase, there are many that will provide above-market current and growing dividend yields. For those looking to accumulate a larger asset base, there are Dividend Challenger candidates offering above-average growth of both capital and dividend income.

Moreover, the following lists are offered as potential candidates worthy of, but prior to, the requisite more comprehensive due diligence and research process. Additionally, some may be fully valued, but I feel none of the constituents on the list are overvalued. Of course, this last statement assumes that these companies will continue to perform in the future in a similar fashion as they have in the past. This is why further due diligence is so important.

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High Total Return Candidates

Even though Dividend Challengers do not possess the long histories of dividend increases as their counterparts in fellow Seeking Alpha Author David Fish's rapidly becoming famous CCC lists of dividend Champions, Contenders and Challengers found here, they do have recent streaks indicating their commitments to paying and growing their dividends.

In some cases, the companies on the Challengers list have not been public long enough to create streaks of dividend increases for more than a decade. In other cases, specific companies have established a commitment to sharing profits with their shareholders via dividends. In other words, even though each company on the following lists are Dividend Challengers, this in itself does not mean that they are all the same. This supports another reason why further due diligence and research is imperative.

With the above said, I believe there's a compelling reason to consider investing in certain Dividend Challengers in order to supplement or augment dividend growth portfolios. Upon researching these lists for this article, I have concluded that there are many exceptional companies to be found on the Dividend Challengers list. With my first 2 specific examples, Accenture (NYSE:ACN) and CSX Corp (NYSE:CSX), I provide candidates for both an above-average and growing current dividend yield, and the opportunity to provide above-average capital appreciation, and therefore, above-average future total return.

Accenture PLC

My first example, Accenture, is a fast-growing company in the IT consulting and services industry with a history of consistent above-average earnings growth. This high-growth dividend paying company instituted their first dividend in August 2006. However, up until November of fiscal 2009, Accenture paid their dividend annually. Since that time they have been paying a semiannual dividend in mid-May and mid-November of each year. For a more detailed look at this fast-growing dividend stock, I offer the following article authored by my Associates at F.A.S.T. Graphs™.

There are a couple of important factors that I would like to focus the reader's attention on based on the following historical Earnings and Price Correlated F.A.S.T. Graphs™ below. First of all, notice how monthly prices have followed and closely correlated with the orange earnings justified valuation line. Moreover, notice how monthly prices (the black line) react whenever price falls below, or rises above the orange earnings line.

In order to clarify my point, I offer the following quote by Peter Lynch in his best-selling book 'One Up On Wall Street:'

"You can see the importance of earnings on any chart that has an earnings line running alongside the stock price. On chart after chart the two lines will move in tandem, or if the stock price strays away from the earnings line, sooner or later it will come back to the earnings."

The following Earnings and Price Correlated graph on Accenture clearly illustrates and validates Peter's thesis. The reader might note how Accenture's stock price rose above fair value early this year, but how it is subsequently, and I believe inevitably moved back into alignment with earnings justified valuation (see red circle).

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When reviewing Accenture's historical performance associated with the above graph, two things stand out. First of all, notice that Accenture generated returns on behalf of its shareholders that were more than three times greater than the average company as represented by the S&P 500. Secondly, as it relates specifically to dividend growth investors, notice that Accenture's dividend growth rate, since it has been paying one, has averaged over 30% per annum.

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Since Accenture is in the consulting and service industry, its business requires only moderate capital expenditures (capxps) in order to generate its above-average growth. In spite of these low requirements, common equity per share (ceqps) or book value has increased at a compound annual growth rate exceeding 15%.

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Moreover, since this article is about dividend growth stocks, I thought it would be illuminating to review two important cash flow metrics. After all, dividends must come from cash flows. Accenture clearly generates solid cash flow per share (cashps), and even after paying dividends, has substantial free cash flow per share (fcflps) left over. Note: FUN Graphs calculates free cash flow after dividends have been paid.

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CSX Corporation

CSX Corporation, together with its subsidiaries, provides rail-based transportation services. For a more detailed look at this fast-growing Dividend Challenger I direct the readers to a recent article published by my fellow associates at F.A.S.T. Graphs™.

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As will be the case in all of the examples that I feature in this article, notice that CSX has generated above-average shareholder returns, to include above-average cumulative dividends on its shareholders' behalf. This example, and the others I will feature in this article, supports my contention that it is a market of stocks and not a stock market. In other words, regardless of how you may feel about the market in general, there are always attractive investment opportunities to be found regardless of the markets' level. I believe that CSX represents a case in point.

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The following Estimated Earnings and Return Calculator illustrates that 28 analysts reporting to Capital IQ expect CSX to continue growing earnings at approximately 11% per annum. On that basis, I believe that CSX can continue to generate above-average long-term returns and dividend growth going forward.

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High Current Income

In addition to above-average total return opportunities, the Dividend Challengers list also contains opportunities for above-average and growing current yield. Therefore, I offer Digital Realty Trust Inc (NYSE:DLR), a REIT, for the readers' consideration and due diligence. Recently, this has been a much-maligned REIT due to the significant drop in its share price in 2013. However, I believe this represents an important, and I contend often misguided, phenomenon regarding how investors think about stocks.

Unfortunately, at least in my opinion, too many investors today judge a stock based solely on its price action. Even more unfortunately, their judgments are made with little regard or consideration given to the underlying fundamentals of the business behind the stock. In other words, if the price of a stock has recently fallen, it is a bad stock. Conversely, if the price of a stock has recently risen, it is a good stock.

However, my experience has taught me that such investor behavior can be extremely deleterious to long-term performance. Far too often after a stock's price has risen dramatically, it has simultaneously become overvalued and therefore a poor long-term investment from that point. In contrast, after a stock's price has recently fallen it may become an extremely attractive undervalued long-term opportunity. Of course, this is predicated on the fact that fundamentals remain intact. In other words, earnings and dividends continue to be solid and grow.

I believe that Digital Realty Trust Inc. represents an example of a REIT with solid fundamentals that has gone on sale. As evidence of my belief, I offer the following Earnings and Price Correlated graph. Since this is a REIT, the graph reveals calculated Funds From Operations (FFO) rather than earnings. The reader should note that price has certainly fallen in fiscal 2013, but both Funds From Operations (the orange line) and dividends (both the pink line and blue shaded area on the graph) have remained solid and even grown.

More importantly, the reader might note that this is not the first time that Digital Realty's price has fallen below its FFO justified valuation. Moreover, note how price has returned to fair valuation in all cases, and in rather short order, after an unjustified drop in price. Personally, I believe this represents an example of opportunity loudly knocking at the door. However, my view is a long-term view.

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Additionally, I think it's interesting to see that Digital Realty has generated substantially above-average returns for its shareholders over its history as a public company, in spite of its current low valuation. Again, since this article is about investing in dividend stocks, take special notice of the total dividends paid versus the S&P 500 over Digital Realty's publicly-traded history.

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However, since the F.A.S.T. Graphs™ research tool is a dynamic one, I thought it would be interesting to review the company over the past three calendar years, which includes the one we are currently in. Here we once again see a strong correlation between price and FFO (Funds From Operations). Moreover, we see that price has recently deviated from justified valuation (the orange line).

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When reviewing the performance associated with the above 3-year historical graph, it should be no surprise that Digital Realty has significantly underperformed the S&P 500 over this timeframe. However, if dividend income is your objective, you may be surprised to realize that even though price performance has been abysmal recently, Digital Realty has generated dividend income that is almost 3 times more than what the S&P 500 produced. In other words, in spite of short-term price weakness, the dividend continues to reward shareholders.

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In summary, I believe that Digital Realty's current valuation does not reflect its intrinsic value. Clearly, price has fallen far beyond what fundamentals would indicate it should. Digital Realty currently offers a dividend yield of 6.7%. In my experience and opinion, high yield is a magnet that will soon attract a higher and more appropriate valuation. Of course, I cannot say precisely when that might occur, but I'm being lavishly compensated by the dividend while I wait.

For a more detailed look into Digital Realty I direct the reader to a recent article authored by fellow Seeking Alpha author Brad Thomas. Although I cannot defend a high expertise in REITs, however, I believe that Brad has the credentials that support his expertise in this sector.

For additional insights into what might be occurring with Digital Realty's price and valuation I direct the reader to another fellow Seeking Alpha author Markus Aarnia and his recent article discussing how insiders are looking at Digital Realty's current valuation.

Philip Morris International (NYSE:PM)

I can't say that the tobacco industry is one of my favorites. However, it's hard to deny the investment results and consistent operating history of Philip Morris International. After being spun off from its parent in March 2008, Philip Morris International has produced consistent above-average earnings growth and a very high and growing dividend yield. However, in addition to the industry it operates in, its current high debt to capital is a caveat.

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Since its debut as a public company, Philip Morris International has produced above-average total returns and significantly above-average dividend income on behalf of its shareholders. Moreover, as evidenced by the above graphic, Philip Morris International appears reasonably valued currently.

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Consistency Matters: Oracle Corp. (NASDAQ:ORCL)

One of the factors that I covet when looking for attractive common stock investments is consistency of performance. More plainly stated, I favor companies with records of consistently above-average long-term growth. I believe that Oracle Corp. represents a case in point. The following 10-year Earnings and Price Correlated graph illustrates how consistently Oracle has grown earnings at an above-average rate. It's also important to notice how strong its earnings performance was prior to, during and after the Great Recession of 2008.

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Moreover, in the spirit of looking for consistency I like to take advantage of the dynamic nature of the F.A.S.T. Graphs™ research tool. By running various time frames, I can quickly and easily determine if a company's earnings growth is accelerating, decelerating or staying the same. By running the following 7-year Earnings and Price Correlated graph on Oracle, which covers our recent Great Recession, I discover that earnings growth is actually higher than Oracle achieved on the longer 10-year graph, averaging over 18% per annum versus just under 18% per annum on the 10-year graph.

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However, since we live in a "what have you done for me lately" world, I again shorten my timeframe to only the last four calendar years. Interestingly, I discover that Oracle has once again generated acceleration in earnings growth over the shorter time period. Yet, in spite of this earnings growth consistency, Oracle's stock price is currently below its historical norms. Therefore, it seems only fitting that fellow Seeking Alpha author Ray Merola was inspired to write this article found here.

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To be perfectly candid, the financial sector is not one that I have great confidence in since the debacle that led to the Great Recession of 2008. Nevertheless, and to be fair, it is not logical to paint all financials with the same negative brush. Consequently, I offer the following lists of Dividend Challengers in the financial sector for your review. Perhaps the low valuations on this sector are justified, or maybe there is great opportunity resting among some of these names. I will let the reader judge the merits, or lack thereof, on each and any of the following selections to their own determinations.

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In today's yield-hungry world, it would seem foolish to ignore the high yields available on many high quality master limited partnerships. However, MLPs possess various tax considerations that might preclude them as suitable investments in qualified retirement accounts. On the other hand, most of these tax issues are manageable for those with the willingness and/or wherewithal to deal with K-1's and other tax issues.

Therefore, I offer the following list of what appear to be attractively valued MLPs that simultaneously possess high current yields. Once again, investing in MLPs may not be for everyone. On the other hand, there are valid and strong reasons why dividend investors might want to examine this equity asset class.

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Enbridge Energy Partners: (NYSE:EEP)

My featured MLP is Enbridge Energy Partners LP. Once again I refer you to a comprehensive article authored by fellow Seeking Alpha author Ray Merola for additional insights into this MLP.

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The primary advantage of considering MLPs is their high current yield. Although capital appreciation slightly lagged the S&P 500 since 2007, total dividends paid were multiples greater than the S&P 500's dividends paid. Clearly, in today's yield-starved environment, MLPs are worth considering in spite of the tax issues they present.

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Summary and Conclusions

This concludes my series of articles comprised of companies on fellow Seeking Alpha author David Fish's CCC lists. By researching these lists of high quality blue-chip dividend paying stocks with legacies of increasing their dividend each year, I have concluded that there remain many excellent opportunities for dividend growth investors seeking an increasing dividend income stream. Moreover, in spite of the recent run-up in stocks in the general sense, I do not believe that the valuations have become extended or even remotely close to bubble territory.

In truth, finding fair value in today's environment was more difficult than it was just a few years ago. On the other hand, valuation is there for those with the foresight and willingness to look. It is undeniable that the stock market has had a strong run since coming out of the Great Recession. It is also understandable that this has caused many investors to fear that a correction may be imminent. However, even if that were to happen, I do not believe it negates the value of investing in high-quality blue-chip dividend paying stocks when valuations are sound or reasonable.

Like every correction that I have ever experienced in my 40+ years as an investor, I believe that any future correction will be temporary. But most importantly, a correction in stock price for solid companies with continuing fundamental strength will only hurt those that panicked and sell. Personally, I don't believe it's ever wise to sell a valuable asset for less than its true worth. This especially applies to dividend paying stocks that continue to raise their dividends, and in many cases, their earnings even though their prices may be temporarily weak. As Warren Buffett once so aptly put it "fear is the foe of the faddist, but the friend of the fundamentalist." Investing in solid businesses when valuations are sound is a time-tested proven strategy, regardless of what the short-term market may or may not do.

Finally, I believe that prudently investing in wonderful businesses at sound valuation will provide many opportunities to be thankful for in the coming years. Therefore, we all can have investment success to be thankful for, over many Thanksgivings to come. Happy Thanksgiving!

Disclosure: Long ORCL, CAN, DLR, NOV, TGH, UNP, EEP, EPB, DRI and RAI at the time of writing.

Disclosure: I am long ORCL, ACN, DLR, NOV, TGH, UNP, EEP, EPB, DRI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.