- Creating a large-cap dividend growers' 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 14.27%.
- Description and a buy recommendation for the fourth company in the portfolio; Deere & Company (DE).
In order to create a large-cap 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, I looked for companies that have high shareholder yield. According to the well known investor and asset manager James P. O'Shaughnessy, shareholder yield unites a stock's dividend yield with its buyback yield to show what percentage of total cash the company is paying out to shareholders. The buyback yield is the percentage of one year reduction of the company's shares outstanding.
The screen's method that I use to build this portfolio requires all stocks to comply with all following demands:
- The stock is included in Russell 1000 index.
- Dividend yield is greater than 2.0%.
- The payout ratio is less than 60%.
- The annual rate of dividend growth over the past five years is greater than 4%.
- The PEG ratio is less than 1.50
- The shareholder yield is greater than 4%.
- The ten 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 30, 2014, I discovered the following ten stocks:
The table below presents the dividend yield, the payout ratio, the compound average annual dividend growth over the past five years, and the PEG ratio for the ten companies.
In this article, I will focus on the fourth stock in the portfolio; Deere & Company (NYSE:DE), since I follow this company.
Deere & Company is the world's largest maker of farm tractors and combines, and a leading producer of construction equipment. The company was founded in 1837 and is headquartered in Moline, Illinois.
The table below presents the valuation metrics of DE; the data were taken from Yahoo Finance and finviz.com.
Deere's valuation metrics are good; the trailing P/E is very low at 9.9.93, and the Enterprise Value/EBITDA ratio is fairly low at 10.27. The PEG ratio is low at 1.33, and the price-to-sales ratio is very low at 0.89 also compared to its historical values.
DE PS Ratio (TTM) data by YCharts
Latest Quarter Results
On May 14, Deere reported its second-quarter fiscal 2014 financial results, which beat EPS expectations by $0.17 (6.90%) and missed Street's estimates on revenues.
The company reported that net income was $980.7 million, or $2.65 per share, for the second quarter ended April 30, compared with $1.084 billion, or $2.76 per share, for the same period last year. For the first six months of 2014, net income was $1.662 billion, or $4.46 per share, compared with $1.734 billion, or $4.41 per share, last year. Worldwide net sales and revenues decreased 9 percent, to $9.948 billion, for the second quarter and were down 4 percent, to $17.602 billion, for six months. Net sales of the equipment operations were $9.246 billion for the quarter and $16.195 billion for six months, compared with $10.265 billion and $17.058 billion for the same periods last year.
In the report, Samuel R. Allen, chairman and chief executive officer said:
John Deere is on its way to another year of solid financial and operating performance. Our second-quarter earnings showed further proof of the adept execution of our operating plans. We kept costs and assets well under control while successfully managing major new-product transitions associated with more stringent emissions standards. In addition, our construction and forestry and financial services operations delivered improved results, reflecting the power of our broad-based business lineup.
Dividend and Share Repurchase
Deere's forward annual dividend yield is fairly high at 2.64% and the payout ratio is only 22%. The annual rate of dividend growth over the past three years was very high at 18.7%, over the past five years was at 12.8%, and over the past ten years was also very high at 16.0%. 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 DE's performance has been impressive in this respect.
Since DE is generating strong cash flow and the payout ratio is very low, I believe that the company is well-positioned to achieve steady dividend growth going forward.
Deere has an aggressive share buy-back program; it initiated a new $8 billion program in 1Q14. In the first fiscal 2014 two quarters the company repurchased $1.1 Billion of its shares, and in 2013, Deere repurchased $1.5 billion of its shares.
Source: Deere & Company June/July Presentation
A comparison of key fundamental data between Deere and its main competitors is shown in the table below.
Deere has the lowest P/E ratio and the lowest price-to-sales ratio among the stocks in the group, however, its debt to equity is the highest.
The charts below give some technical analysis information.
The DE stock price is 0.12% below its 20-day simple moving average, 0.84% below its 50-day simple moving average and 4.55% above its 200-day simple moving average. That indicates a short-term, and a mid-term downtrend, and a long-term uptrend.
Chart: TradeStation Group, Inc.
The weekly MACD histogram, a particularly valuable indicator by technicians, is negative at -0.22 and descending, which is a bearish signal (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 52.77 which do not indicate oversold or overbought conditions.
Many analysts are covering the company but their opinion is extremely divided. Among the 24 analysts, only one analyst rates it as a strong buy, 3 rate it as a buy, 12 analysts rate it as a hold, 6 rate it as an underperform, and two analyst rate it as a sell.
TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering DE stock there are only five analysts who have the four or five star rating, two of them recommend the stock, and the other three analysts have a sell rating on the stock.
Deere's stock has significantly underperformed the market in the last years. Since the beginning of the year, DE's stock has declined 0.9%, while the S&P 500 index has increased 6.1%, and the Nasdaq Composite Index has risen 5.5%. Moreover, since the start of 2013, DE's stock has gained only 4.8%, while the S&P 500 index has increased 37.4%, and the Nasdaq Composite Index has risen 46.0%.
According to the company, Deere's worldwide sales of agriculture and turf equipment (84% of FY13 revenue) are forecast to decrease by about 7 percent for fiscal-year 2014, including a negative currency-translation effect of about 1 percent. The company explains that although the agricultural economy remains in a relatively healthy condition, farm income is forecast to be lower than last year. The decline is putting pressure on demand for farm equipment, especially for larger models. At the same time, strength in the U.S. livestock sector is providing support to sales of mid- and smaller-size tractors.
The chart below demonstrates the reason for the decline in the prices of the main agriculture products; the world's stocks-to-use ratio is relatively high now, especially for cotton.
Source: Deere & Company June/July Presentation
Although Deere is expecting lower revenue for the current year, in my opinion, the stock is cheap now considering its valuation. Since the prices of agriculture products are cyclical, investors can expect a return to growth in the demand for agricultural equipment in the near future.
Furthermore, Deere is continuing its efforts to expand its presence in the fast-growing markets of China and India. As these heavy populated big countries enjoy a better standard of living, and populations and incomes across these countries continue to rise, there will be an increase in demand for crops and for agricultural equipment.
Deere has compelling valuation metrics and good earnings growth prospects. Deere is generating strong cash flows, and it returns value to its shareholders by aggressive stock buyback program and by increasing dividend payments; the annual rate of dividend growth over the past ten years was very high at 16.0%. In my opinion, after the retreat in its stock price, it is now an excellent opportunity for long-term investment in DE's stock at a cheap price.
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 benchmarks (S&P 500, Russell 1000), 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
Five years back-test
Fifteen years back-test
The large-cap dividend growers' portfolio has given much better returns during the last year, the last five years and the last fifteen years than the S&P 500 and the Russell 1000 benchmarks. The Sharpe ratio, which measures the ratio of reward to risk, was also much better in all the three tests.
One-year return of the portfolio was high at 27.38%, while the return of the S&P 500 index during the same period was at 21.62%, and the return of the Russell 1000 index was at 22.15%. The difference between the large-cap dividend growers' portfolio to the benchmarks was even more noticeable in the 15 years back-test. The 15-year average compound annual return of the portfolio was extremely high at 14.27%, while the average annual return of the S&P 500 index during the same period was only 3.05%, and that of the Russell 1000 index was at 3.47%. The maximum drawdown of the screen was at 57.27% while that of the S&P 500 was at 57%, and that of the Russell 1000 was at 56.87%.
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.