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Summary

  • The stock market as measured by the S&P 500 continues to hover near an all-time high.
  • It is getting harder to find reasonably valued dividend growth stocks to invest in today.
  • There are still high-quality attractive blue-chip dividend growth stocks available for current investment.
  • 25 Dividend Champion research candidates at or near fair value currently.

Introduction

The stock market as measured by the S&P 500 continues to hover near an all-time high. However, all this prosperity is causing a significant amount of angst and worry for many investors. To these investors it just seems logical that a major correction must be just around the corner. My advice to the worried investor is that they must be cognizant of the difference between high price and high valuation.

These are not synonymous concepts. Relative to a company's fundamental value, its stock price can be at an all-time high and simultaneously undervalued. Conversely, the company's stock price can be at an all-time low while being significantly overvalued. True valuation is relative to the company's earnings power past, present and future.

Nevertheless, from the perspective of the overall market, it is getting harder to find reasonably valued dividend growth stocks to invest in today. This is especially crucial for retired investors who are seeking high-quality and safe dividend growth stocks to provide a growing income stream. On the other hand, even though the market may be fully valued in the aggregate, there are still high-quality attractive blue-chip dividend growth stocks available for current investment.

With this article, I will present 25 Dividend Champion research candidates that I believe are at or near fair value currently. As always, I recommend that investors conduct their own comprehensive research and due diligence on each. Moreover, these 25 research candidates are comprised of companies with different characteristics of earnings growth and yield. Consequently, not each candidate may meet the specific investment objectives of every dividend growth investor.

However, I believe that there is something for everyone within this high-quality group of dividend payers. Some of these candidates are more appropriate for high current yield, others may be more appropriate for a higher total return with the potential for a growing yield, and everything in between. Consequently, I will present these 25 candidates in 4 groupings relative to current yield, expected future earnings growth potential and cap size.

The S&P 500 Current Valuation Perspectives

One of the most common metrics that people point to when attempting to assess the fair value of the stock market is Professor Shiller's Cyclically Adjusted Price-Earnings ratio, more commonly known as CAPE. This statistical expression is simply the current price of the S&P 500 divided by the average of 10 years' worth of earnings adjusted for inflation.

Professor Shiller's CAPE is often associated with and allegedly supported by the writings and recommendations of Ben Graham and David Dodd in their classic books "Security Analysis" and/or the more famous "The Intelligent Investor". In truth and fact, Graham and Dodd in Chapter 12 of "The Intelligent Investor" titled "Things to Consider about Per-Share Earnings" did recommend that investors "don't take a single year's earnings seriously."

This is sound financial advice that I personally endorse, but at the same time I don't believe it indisputably supports the use of CAPE. Later in the same chapter under the section "Use of Average Earnings," they had this to say:

"In former times analysts and investors paid considerable attention to the average earnings over a fairly long period in the past-- usually from 7 to 10 years. This mean figure was useful for ironing out the frequent ups and downs of the business cycle, and it was thought to give a better idea of the company's earnings power than the results of the latest year alone."

Once again, I agree and consider this sound advice.

However, in this same section, they added an important qualifying statement as follows: "If such figures are used in conjunction with ratings for growth and stability of earnings during the same period, they could give a really informing picture of the company's past performance." I also agree with this advice and observation, and I can see how this has led many people to conclude that CAPE is founded on and supported by Graham and Dodd.

However, this would only be true if you stopped reading Chapter 12 up to this point because Graham and Dodd added an additional qualifier in their next section titled "Calculation of the past Growth Rate," where they stated what I feel is a critical qualifier as follows: "It is of prime importance that the growth factor in the company's record be taken adequately into account. Where the growth has been large the recent earnings will be well above the 7 or 10 year average, and analysts may deem these long-term figures irrelevant."

Personally, I contend that this last statement by Graham and Dodd highlights a primary weakness of solely relying on Professor Shiller's CAPE to assess the relative valuation of the stock market (S&P 500). When earnings growth is high (and I will add my own perspective consistent), then the average of the past 7 or 10 years becomes less relevant.

However, in fairness to Professor Shiller's CAPE valuation metric, Graham and Dodd then went on to say the following:

"This need not be the case. The earnings can be given in terms both of the average and the latest figure. We suggest that the growth rate itself be calculated by comparing the average of the last 3 years with corresponding figures 10 years earlier."

The primary thesis that I am attempting to illustrate with the above can be summarized as follows. I believe that Graham and Dodd believed in deep, and as comprehensive as possible, fundamental analysis regarding investing in common stocks. Consequently, I don't believe they would support the use of a simple statistical metric in order to assess the fair valuation of an individual stock or the overall stock market (S&P 500), for that matter.

More simply stated, although the argument could be made that Graham and Dodd believed that the long-term average or "mean figure" was a useful component for consideration in the overall scheme of things, I don't believe they would have agreed to utilizing the mean exclusively or in isolation. Instead, they might have supported it in conjunction with deeper analysis to include considerations of the future potential earnings power of the entity being analyzed.

It should also be taken into consideration that Graham and Dodd did not have access to the powerful computers that are at our disposal today. Consequently, they were relegated to relying more on numbers on a page that they gathered from financial statements. Therefore, and based on the notion that a picture is worth 1000 words (or numbers on a page), I offer the following analysis of the S&P 500 historical earnings results via the F.A.S.T. Graphs™ research tool that reflects my interpretation of what Graham and Dodd were trying to teach us.

My first graph depicts the earnings only of the S&P 500 since 2006. This essentially covers the 7- to 10-year timeframe that Graham and Dodd recommended. Over this timeframe, the average earnings growth rate of the S&P 500 computes to 4.8%. However, by studying the graphic closely, a more detailed understanding of the S&P 500's earnings results over this timeframe is revealed. For example, by examining the change per year (Chg/Yr) column at the bottom of the graph, I quickly ascertain that with the exception of the Great Recession years, the S&P 500 earnings growth was generally above its average (see green highlight).

In the same context, I can see that once again, notwithstanding the Great Recession, earnings of the S&P 500 have trended upward. Consequently, I would argue that simply calculating a 10-year average or mean earnings number for the S&P 500 does not reflect the indices' true historical earnings power or achievements.

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Therefore, consistent with the Graham and Dodd recommendation: "We suggest that the growth rate itself be calculated by comparing the average of the last 3 years with corresponding figures 10 years earlier," my next graphic examines the historical earnings results of the S&P 500 since 2011.

Here I discover that the average earnings growth rate of the S&P 500 over the timeframe 2011-2013 is 8.67% per annum. Although this calculation is more representative of the S&P 500's 7- to 10-year earnings prowess, notwithstanding the Great Recession years, the simple fact that we had a recession represents an important input in my analysis. Consequently, I now have a perspective of the S&P 500's earnings generating capability post recession.

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My final graph on the S&P 500 produces a complete earnings and price correlated F.A.S.T. Graphs™ with dividends and a calculation of the normal P/E ratio over this timeframe. I specifically chose this period of time because it occurs just after the recession of 2001, but includes the Great Recession of 2008-2009. Therefore, I can now analyze and evaluate the earnings and price relationship of the S&P 500 in far greater detail than simply relying on a statistical average or single number.

What this expanded analysis reveals is both interesting and informative. For starters, I discover a very strong correlation and relationship between the S&P 500's reported earnings and its stock price over time. But more importantly, I now possess a detailed perspective of the S&P 500's price action relative to earnings levels over this extended timeframe. I can clearly see periods of overvaluation, undervaluation and fair valuation, as well as how the future stock price action of the S&P 500 responds to each.

And I want to emphatically add that these earnings and price relationships are based on actual numbers and not a theoretical statistic. Moreover, based on this historical analysis, I believe it is logical to conclude that the S&P 500 is currently fully valued based on its historical normal P/E ratio (the dark blue line) since 2002, and moderately overvalued based on its theoretical intrinsic value P/E ratio of 15 (the orange line). But most importantly, I can further conclude that the current valuation of the S&P 500, although fully valued, is far from bubble territory, at least based on recent historical precedent.

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This brings me to a few remarks regarding a pet peeve I have with many arduous advocates of Professor Shiller's CAPE as a market forecasting tool. I have read several articles and blogs where the authors have suggested that authors, pundits or analysts utilizing forward earnings in the appraisal of a stock or the stock market were charlatans. I personally consider this attitude both misguided and ludicrous.

As an investor, it seems perfectly clear to me that my future returns will be tied solely to, as well as functionally related with, the future earnings power of the entity I choose to invest in. After all, it is the future earnings of the company I choose to invest in that will be the source of, and driver of, future capital appreciation and dividend income.

Therefore, it is imperative that I take every step I can, and utilize every resource at my disposal to assess the future earnings prospects of the investments I am considering. I can learn from the past, and I can establish a clear perspective of the earnings power of a given business from the past, but I can only invest in the future. Consequently, it seems only logical to me that the future is what I should be most concerned with.

In this regard I am not naïve enough to believe that I, or any other analyst for that matter, can forecast the future earnings power of a company with perfect precision. However, I do believe that I and other analysts can do it within a reasonable enough range of probabilities to implement a successful investment strategy. Investing is not a game of perfect, nor does it need to be. And perhaps more importantly, I believe that it is easier to forecast the future earnings prospects of a successful and established business with a good track record than it is to attempt to forecast what their stock price might do in the short run.

With the above in mind, I now offer the following Estimated Earnings and Return Calculator based on the consensus estimates of analysts reporting to S&P Capital IQ. There are 22 analysts (see green highlights at the bottom of the graph) forecasting the earnings of the S&P 500 for 2014 of $117.29, representing a 9% year-over-year growth rate (see orange highlights). For 2015 there are 20 analysts forecasting earnings of $127.64, representing another 9% year-over-year growth rate (see orange highlights). This is as far out as I typically am willing to evaluate or accept analyst earnings forecasts for any entity I am analyzing (orange vertical line on the graph).

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At this point I feel it's relevant to provide additional color regarding analyst estimates. There are many that are quick to completely discount future earnings estimates. However, as I previously alluded to, I feel that mindset is both misguided and unwarranted. Although I agree that analyst estimates are rarely perfectly precise, I disagree that they have no value. Moreover, I would also argue that they are generally accurate enough to be of value, even when they are not perfect.

To illustrate my point, I offer the following excerpts of an analysis of the S&P 500's 2nd quarter 2014 earnings estimate results presented by Christine Short, Director S&P Global Markets Intelligence:

"Consensus Earnings Report
From S&P Capital IQ
Global Markets Intelligence
August 19, 2014
Christine Short, Director S&P Global Markets Intelligence

For Q2, S&P 500 earnings growth is expected to come in at 10.2% y-o-y, with EPS of $29.68.

472 companies have reported earnings results for the second quarter. 312 of those companies have beat analysts' estimates, 100 have missed, and 60 have met."

For additional insight, I offer the following graphic courtesy of the same report presented by Christine Short of S&P Capital IQ. My point being that a more comprehensive and in-depth approach to analyzing the earnings of the S&P 500 seems far superior to relying on a simple metric or statistic such as CAPE.

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For the reader's additional insight on the validity or accuracy of analyst estimates of the S&P 500, I offer the following detail. Since calendar year 2002, which covers the timeframe of the complete F.A.S.T. Graphs™ of the S&P 500 presented above, the accuracy of the analyst estimates on the S&P 500 is quite revealing. For 9 of those 12 years, the S&P 500's actual earnings exceeded the consensus estimates, but usually by a reasonable margin of error.

During the 3 years where the S&P 500's earnings came in below analyst estimates, 2 of those years, 2007 and 2009, were reasonably close. However, I feel that it's only fair to point out that analysts estimated 2008 (Great Recession) earnings of $61.17, but the S&P 500's actual earnings came in at only $49.51, which was a significant miss. Although I'm not precisely sure what we can conclude from this, other than possibly that estimating earnings during a severe recession might be fraught with error.

Nevertheless, I feel comfortable stating that, for the most part, consensus estimates tend to be more accurate than many are willing to give them credit for. Once again, they are rarely perfect, but as the analysis above suggests, they tend to err more on the conservative side than they do on the aggressive side. At least if recent history is any guide.

25 Dividend Champions At or Near Fair Value

Aside from analyzing or discussing the current state of the market as represented by the S&P 500, I would like to now move on to an analysis of individual stocks, which I consider to be a more relevant activity. As I stated many times in the past, I believe in the reality that it is a market of stocks and not a stock market.

Although I would acknowledge that possessing a view of the relative valuation of the overall market might be of some usefulness, I further contend that analyzing the relative valuation of the specific individual companies that I am examining is more relevant and intelligent. Since I do not believe in investing in the whole market via an index fund as many others do, I focus instead on looking for individual investment opportunities within the market.

Consequently, my approach is to screen the universe of stocks with the objective of identifying attractively valued potential investment candidates that I can have confidence in, and that meet my personal investment objectives. Not every company in a large universe like the S&P 500 can meet those criteria; therefore, I choose to not concern myself with things that I would not invest in. If I invested in an S&P 500 index fund, I would surely be holding certain companies that I would otherwise not willingly invest in.

For those investors looking for a reliable and growing dividend income stream, the Dividend Champions list of companies provided by fellow Seeking Alpha author David Fish represents a fertile field of potential candidates. However, just because a company has raised their dividend for a minimum of 25 consecutive years, as all the Dividend Champions have, it does not simultaneously indicate that they are all good investments at the current time. Even the best companies in the world can become overvalued at any point in time.

Consequently, and consistent with what I presented about the valuation of the overall stock market as represented by the S&P 500, of the 107 Dividend Champions, I only found 25 that I considered reasonably valued or close to it. Therefore, I offer the following as attractive research candidates that could either be purchased or placed on the dividend growth investor's watch list. To be clear, that doesn't make the other 82 Dividend Champions bad investments today, nor does it suggest that if you own them they should be sold. Instead, it simply means that many Dividend Champions may not be optimum buy candidates today.

Additionally, I have categorized these 25 Dividend Champions according to cap size and forecast future earnings growth rates. Moreover, I believe the following list contains something that could meet the varied investment objectives of dividend growth investors with different goals and needs. Within the following list, there are companies that offer high current yield, some that offer an attractive total return potential with a growing dividend income and some that offer both good current income and capital appreciation potential.

11 Large-Cap Dividend Champions for Above-Average Current Yields and Above Average Capital Appreciation Potential

This first list of 11 Dividend Champion research candidates contains many blue-chip large-cap selections. Therefore, it is offered for those investors seeking safety along with an attractive dividend yield and capital appreciation. Some of them are undervalued, some of them are fairly valued (or very close to it), and some of the bluest of blue chips are trading at typical quality premiums.

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5 Large-Cap Dividend Champions for Current Yield and above Average Total Return

This next list comprised of 5 large-cap Dividend Champions is offered for those investors more interested in a high total return coupled with a reasonable current yield. As I suggested with the first list, some of these research candidates appear attractive today, and a few might be best placed on a watch list pending a moderate correction in their prices.

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7 Mid-Cap Dividend Champions for Growth and Income

It can be argued that medium capitalization companies might be more risky investments than their large-cap counterparts. In contrast, it can also be argued that mid-cap companies might have an easier time growing their businesses due to their smaller size.

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2 Small-Cap Dividend Champions for Above-Average Current Yield

In addition to the notion that small-cap stocks are typically more risky, the 2 small-cap Dividend Champions on this list are both financials. Nevertheless, the attractiveness of both of these research candidates rests with their above-average current yields.

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Summary and Conclusions

I believe there is no question that it is harder to find attractive dividend paying stocks to invest in today than it has been in recent years. However, that is not to say that there are no attractive dividend paying stocks available. With this article, I presented 25 Dividend Champions that I believe are worthy of conducting further research on. Some of them can be bought immediately, while others although fully valued today, I would further argue are not simultaneously overvalued. This is especially true with the highest quality blue chips on the list.

Moreover, this list is not offered as an all-inclusive list because there are also other high-quality dividend growth stocks that are also fairly valued today. On the other hand, for the dividend growth investor, especially those in retirement or close to it, I believe the Dividend Champion companies represent the elite of dividend growth stocks. Consequently, selections from this list can provide a solid foundation upon which to build a dividend portfolio.

In future installments of this series, I will offer a more comprehensive analysis of specific examples taken from each of the 4 categories presented above. Therefore, this article should be viewed as a preview of potential research candidates prior to a more comprehensive review.

Disclosure: Long AFL,CVX,ED,JNJ,MCD,PG,SWK,T,WMT,TGT at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Source: 25 Dividend Champion Investment Opportunities: Something For Every Retired Investor, Part 1