With the release of Toy Story 3, Mattel (MAT) is currently receiving a lot of investor attention. The stock currently commands a P/E ratio of 13.6, and offers an above-average dividend yield of 3.4%. Mattel only has 22% debt on the balance sheet and generates strong, albeit inconsistent, cash flows. At first glance this all sounds rather attractive for the conservative investors seeking dividend income, however, the story is not as sanguine when reviewing Mattel's history.
It's a simple and undeniable fact that dividends are a function of earnings. For short periods of time a company can maintain their dividend during a temporary earnings interruption. Over the longer term earnings must manifest in order for the dividend to be safe. The operating history of Mattel, as it relates to its earnings and dividend record, offers a convincing example of the validity of the relationship between dividends and earnings.
Figure 1 below plots Mattel's earnings since 1991 and provides a graphic depiction of Mattel's dividend record over this time period. The orange line with white triangles represents the True Worth™ or intrinsic value of Mattel based on our modified formula of Ben Graham's formula for valuing a stock. What should be clear from this graph is that although Mattel does experience spurts of very attractive growth, at least on a historical basis, the also experience periods of cyclicality or erratic earnings growth.
Figure 1 20yr EPS Growth
click to enlarge
Figure 2 below plots monthly closing stock prices (black line) since 1991. The fact that stock prices closely correlate or follow earnings growth in the long run is clearly evident with this graph. Even though short-term volatility can cause stock price to become disconnected from its earnings justified value, in Mattel's case, it inevitably and often swiftly reverts to the mean. We believe that the important principle here is that earnings are far more important than stock price volatility in the long run.
Figure 2 20yr EPS Growth Correlated to Price
Figure 3 below calculates the performance associated with Figure 2. Two things become clearly evident when reviewing Mattel's historical performance as it relates to its historical earnings growth. First of all, Mattel’s 7.5% annualized rate of return correlates very closely to the 6.7% earnings growth they achieved over this time. Valuation is always an important factor regarding return generation, however, in Mattel's case, over this time frame, beginning and ending valuations were very similar. Therefore, the rate of return achieved and the earnings growth rate achieved are very similar results.
The importance of earnings to dividends is also vividly depicted in this performance chart. In calendar year 2001 and 2002 Mattel was forced to cut their dividend from $0.36 a share in calendar 2000, to only $0.05 a share in 2001 and 2002 (red shaded area, Figure 3). To be fair, Mattel did reinstate their dividend in 2003 to $0.40 a share, their highest ever, and from this point, through calendar 2007 an upward trajectory of dividends based on earnings recommenced.
However, as earnings once again faltered during the great recession of 2008 Mattel was forced to maintain the same dividend of $0.75 a share for calendar years 2008 and 2009. Time will tell what happens to their dividend in 2010. The number for 2010 in Figure 3 is marked with an “E” for estimate, and is a calculation based on forecast earnings growth, which may or may not transpire.
Figure 3 20yr Dividend and Price Performance
The current consensus estimates by analysts for Mattel's growth over the next five years ranges between 8% and 10%. Perhaps the launch of Toy Story 3 and the many sell-through opportunities it brings, coupled with several initiatives instituted by Chairman & CEO Robert A. Eckert, will enable these forecasts to come true.
Ordinarily, we only write about companies that we currently have a position in. In Mattel's case, we are writing about a company that we once owned and sold due to deteriorating fundamentals along with controversy regarding their then current CEO. We often revisit a position that has been previously sold, because we invest significant intellectual capital through research when we own it. Consequently, since we have a foundation of knowledge in place, we already possess a head-start on the research process. And there is never any justifiable shortcut to comprehensive and thorough research.
Our EDMP, Inc. F.A.S.T. Graphs™ provide the benefit of an instantaneous summary of essential fundamentals at a glance. Thanks to this elegant tool we can immediately ascertain how well a company has been managed and how successful its business has been as an operating business. As fundamental investors we maintain that operating results, i.e. earnings and cash flows are what matters most to the long-term prudent buy-and-hold investor. Our EDMP, Inc. F.A.S.T. Graphs™ provide extensive evidence that in the long run earnings matter more than price volatility.
At first glance Mattel looks like a fairly valued stock selection with an attractive current dividend yield. In fact and truth, this may actually be the case. However, its historical cyclicality should at the very least be a serious consideration for investors seeking dividend income. As always, we recommend that a comprehensive research effort be made before the money is invested. Mattel is certainly a quality company with great brands and a solid balance sheet. The real question the dividend investor needs answered is whether or not the dividend can be counted upon to be there in the future.
Disclosure: No postition in MAT at time of writing.