New Dividend Challengers Should Carry Warning Labels: "Caution! Not Recession Tested!"

Includes: HSY, SDRL
by: Mike Nadel


David Fish's CCC list is a valuable resource, but should only be the start of research.

Most CCC newcomers with 5 years of dividend growth have not proven themselves through a recession.

Seadrill and Hershey show just how different two new "Challengers" can be.

Before buying any company, I spend plenty of time looking at the famed "CCC" list. All Dividend Growth Investing practitioners should do likewise, with this caveat: Most CCC newcomers have experienced only the heady times of this current bull market -- leaving investors to wonder what will become of these companies' dividends during the next financial meltdown.

Dutifully compiled by David Fish, the CCC list includes companies that have been increasing dividends for at least 25 consecutive years (Champions), a decade or more (Contenders) and 5-plus years (Challengers).

In my research, a company's mere presence on the list always has been a huge positive. It has meant the firm kept raising its dividends right through the Great Recession of 2007-09.

Unfortunately, every Challenger no longer can make that claim.

Before I go any further, let me say that this in no way is meant to diminish the importance of David Fish's CCC list. His work is chock full of valuable information and provides a great service to thousands of investors.

This is just a reminder that there are no guarantees in investing, even for CCC companies. As David told me during a recent comment exchange:

"That's an excellent point and part of the broader statement that not all CCC companies are equal ... so the CCC is just a starting point for more in-depth research. Even the newest Challengers are vastly different. While some had cut their dividends during the Great Recession, others are new dividend payers (and raisers), so they don't have that 'blemish,' and others only briefly 'froze' their payments."

Challenger Challenge: SDRL vs. HSY

As examples, let's take two recently minted Challengers: Seadrill Limited (NYSE:SDRL) and The Hershey Company (NYSE:HSY).

Seadrill, an offshore deepwater drilling company, yields 10.7%. It has paid dividends only since 2007, and it cut its dividend 26% from 2008 to 2009. Priced at $36.25 on May 22, 2008, Seadrill lost 82% of its value in less than 10 months, closing at $6.65 on March 9, 2009. Additionally, it is in a volatile industry and its balance sheet is loaded with debt.

Hershey, which has been pleasing chocoholics for more than a century, has relatively low debt and a billion-dollar cash stockpile. It yields 2.3%. While it didn't raise its dividend from 2008 to 2009, it didn't cut it, either; indeed, it has increased payouts in 38 of the last 39 years, including through three recessions. Hershey's price fell from $56.75 on April 5, 2007, to $30.75 on March 10, 2009, a peak-to-trough loss of 46%.

Although there's nothing fun about seeing the value of one's investment fall 46%, that actually compares quite favorably to the 57% drawdown of the S&P 500 (NYSEARCA:SPY), not to mention Seadrill's deep decline.

I own neither SDRL or HSY. Hershey is a blue-chipper that has been around forever and probably will be around forevermore, but it has always seemed a little too pricey while not yielding quite enough for my DGI portfolio. Despite a recent pullback, it still sports a price/earnings ratio of nearly 25 -- much higher than the industry average and even its own lofty five-year norm.

As for Seadrill, it is attractively valued with a sub-10 P/E, but its Value Line safety rating is only a 3. (HSY is rated 2; I require a score of 1 or 2 for most purchase candidates.) Though it has been on my watch list for years, I have deemed SDRL just speculative enough to have never pulled the trigger.

If told I absolutely had to buy one of the two as a long-term holding, I would choose Hershey. It has proven it can survive a recession, and its balance sheet indicates it could survive the next one, too. Even today, SDRL is barely back to its pre-recession peak while Hershey is trading 62% over its 2007 high. Besides, I'm all about owning companies that will provide a reliable, growing income stream in retirement, and only one of the two has such a track record.

Conclusion: Caveat Emptor!

Thankfully, nobody is insisting I make that choice. This isn't about HSY and SDRL, anyway. I'm not saying whether an investor should buy, sell or hold either company. Seadrill and Hershey simply served to demonstrate the vast differences between two new Dividend Challengers.

As David Van Knapp, my choice as "The Godfather of DGI," recently said during an exchange on the subject:

"Every 5-year look-back should come with a warning label. ... It is said that investors often suffer from 'recency bias.' This is a good time to guard against that. All 5-year metrics - prices, dividends, sales, earnings, P/E ratios, everything - need to be considered with a grain of salt considering the unusual backdrop."

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.