Large-Cap, Lower Risk Dividend Portfolio That Can Outperform By A Big Margin

Jun.14.14 | About: National Oilwell (NOV)

Summary

Creating a large-cap lower risk dividend stocks portfolio that can outperform the market by a big margin.

15-years back-testing of the portfolio’s method has given a high average compound annual return of 12.12%.

Description and a buy recommendation for the first company in the portfolio; National Oilwell Varco.

In order to create a large-cap lower risk dividend stock portfolio that can outperform the market by a significant margin, I have used the following screen. It is based on an attempt to search for very profitable companies that pay rich dividends and that have raised their payouts at a high rate for the last five years. Furthermore, in order to decrease the maximum expected drawdown to a lower level than that of the benchmark I had to be satisfied with a bit lower return, but still much better than the benchmark.

The screen's method that I use to build this portfolio requires all stocks to comply with all following demands:

  1. The stock is included in Russell 1000 index.
  2. Dividend yield is greater than 2.0%.
  3. The payout ratio is less than 50%.
  4. The annual rate of dividend growth over the past five years is greater than 5%.
  5. Total debt to equity is less than 0.40.
  6. Average annual earnings growth estimates for the next five years is greater than 5%.
  7. The twenty stocks with the lowest payout ratio among all the stocks that complied with the first six demands.

I used the Portfolio123's powerful screener to perform the search and to run back-tests. Nonetheless, the screening method should only serve as a basis for further research. All the data for this article were taken from Yahoo Finance, Portfolio123 and finviz.com.

After running this screen on June 14, 2014, I discovered the following twenty stocks:

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The table below presents the dividend yield, the payout ratio, the average annual earnings growth estimates for the next five years, and the debt to equity ratio for the twenty companies.

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In this article, I will focus on the first stock in the portfolio; National Oilwell Varco, Inc. (NYSE:NOV).

The Company

National Oilwell Varco, Inc. provides equipment and components for oil and gas drilling and production; oilfield services; and supply chain integration services to the upstream oil and gas industry worldwide. The company was founded in 1862 and is headquartered in Houston, Texas.

Valuation Metrics

The table below presents the valuation metrics of NOV; the data were taken from Yahoo Finance and finviz.com.

Varco's valuation metrics are very good; the trailing P/E is low at 13.75 and the enterprise value-to-EBITDA ratio is very low at 7.65. According to Yahoo Finance, NOV's next financial year forward P/E is very low at 11.37 and the average annual earnings growth estimates for the next five years is high at 11.18%. These give a low PEG ratio of 1.02. The PEG Ratio - price/earnings to growth ratio is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.

Latest Quarter Results

On April 28, National Oilwell Varco reported its first-quarter 2014 financial results, which beat EPS expectations by $0.02 (1.40%) and missed on revenues. The Company reported that for its first quarter ended March 31, 2014, it earned net income of $589 million, or $1.37 per fully diluted share, compared to fourth quarter ended December 31, 2013 net income of $658 million, or $1.53 per fully diluted share. Excluding pre-tax transaction charges of $19 million, earnings were $602 million, or $1.40 per fully diluted share. Revenues for the first quarter of 2014 were $5.78 billion, a decrease of six percent from the fourth quarter of 2013 and an increase of nine percent from the first quarter of 2013. Operating profit for the quarter, excluding the transaction charges, was $880 million, or 15.2 percent of sales. Sequentially, first quarter operating profit decreased 10 percent, while year-over-year first quarter operating profit increased eight percent. Backlog for capital equipment orders for the Company's Rig Technology segment at March 31, 2014 was an all-time record of $16.35 billion, up one percent from the fourth quarter of 2013, and up 27 percent from the first quarter of 2013. New orders during the quarter were $2.33 billion, reflecting continued healthy demand for oilfield equipment.

Dividend

Varco has been paying dividends since 2009, the forward annual dividend yield is at 2.37% and the payout ratio is only 18.4%. The annual rate of dividend growth over the past three years was very high at 30.4%.

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Source: Charles Schwab

On May 15, the company announced that its Board of Directors has approved an increase in the regular quarterly cash dividend to $0.46 per share of common stock from $0.26 per share of common stock, payable on June 27, 2014 to each stockholder of record on June 13, 2014. The Company has a history of annual increases in its quarterly cash dividend since it started paying cash dividends.

I consider that besides dividend yield, the consistency and the rate of raising dividend payments are the most crucial factors for dividend-seeking investors, and NOV's performance has been impressive in this respect.

Competitors

A comparison of key fundamental data between Varco and its main competitors is shown in the table below.

National Oilwell Varco has the lowest Enterprise Value/EBITDA ratio and the lowest debt to equity ratio among the stocks in the group. Moreover, it also has the highest dividend yield at 2.37%.

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The NOV stock price is 3.78% above its 20-day simple moving average, 6.35% above its 50-day simple moving average and 9.82% above its 200-day simple moving average. That indicates a short-term, mid-term, and a long-term uptrend.

Analyst Opinion

Many Analysts are covering the stock, but their opinion is divided. Among the 31 analysts, nine rate it as a strong buy, ten rate it as a buy, eleven rate it as a hold, and one analyst rates it as an underperform.

TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering NOV stock there are only nine analysts who have the four or five star rating, seven of them recommends the stock. On June 12, Societe Generale's, 4-Star analyst Edward Muztafago upgraded National-Oilwell Varco from Hold to Buy with a price target of $93.00.

Major Developments

On May 30, the company announced that it has completed the spinoff to its stockholders of its distribution business as an independent public company, NOW Inc. (NYSE:DNOW). Company's Chairman and CEO Clay C. Williams said:

This action demonstrates National Oilwell Varco's commitment to provide long-term value to our stockholders. With its strong management team in place, NOW is well-positioned to be a successful independent company.

According to the company, domestic land drilling and well service firms are increasing activity, which is leading to increased demand for drilling and stimulation equipment to develop unconventional shales. Furthermore, the $2.33 billion in new capital orders and record backlog demonstrate that demand for oilfield equipment remained high in the first quarter.

National Oilwell Varco will continue to benefit from the rising prices of oil and natural gas. Oil and natural gas prices have been rising from the start of the year. WTI crude price has risen 17.9% from its low of $90.69 per barrel on January 09, 2014, to $106.91 per barrel on June 14, while Henry Hub natural gas price has risen 14.3% since the beginning of the year to $4.739 per Million Btu.

WTI crude July 2014 leading contract

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Henry Hub natural gas July 2014 leading contract

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Charts: TradeStation Group, Inc.

Conclusion

National Oilwell Varco will continue to benefit from the rising prices of oil and natural gas. Varco has compelling valuation metrics and strong earnings growth prospects; its Enterprise Value/EBITDA ratio is very low at 7.65. Varco is generating strong free cash flows; its price-to-free-cash-flow ratio is very low at 14.45. The company has a history of annual increases in its quarterly cash dividend since it started paying cash dividends. All these factors bring me to the conclusion that NOV stock is a smart long-term investment. Furthermore, the rich growing dividend represents a gratifying income.

Back-testing

In order to find out how such a screening formula would have performed during the last year, last 5 years and last 15 years, I ran the back-tests, which are available by the Portfolio123's screener.

The back-test takes into account running the screen every four weeks and replacing the stocks that no longer comply with the screening requirement with other stocks that comply with the requirement. The theoretical return is calculated in comparison to the benchmark (S&P 500), considering 0.25% slippage for each trade and 1.5% annual carry cost (broker cost). The back-tests results are shown in the charts and the tables below.

One year back-test

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Five years back-test

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Fifteen years back-test

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Summary

The large-cap low risk portfolio has given much better returns during the last year, the last five years and the last fifteen years than the S&P 500 benchmark. The Sharpe ratio, which measures the ratio of reward to risk, was also much better in all the three tests. Furthermore, the maximum drawdown, which normally is much bigger in a small portfolio than in the benchmarks, was much smaller in the 15-year tests.

One-year return of the screen was high at 23.31%, while the return of the S&P 500 index during the same period was at 17.92%. The difference between the large-cap low risk portfolio to the benchmark was even more noticeable in the 15 years back-test. The 15-year average compound annual return of the screen was extremely high at 12.12%, while the average annual return of the S&P 500 index during the same period was only 2.96%. The maximum drawdown of the screen was at 47.96%, much lower than that of the S&P 500 was at 57%.

Although this screening system has given superior results, I recommend readers use this list of stocks as a basis for further research.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.