The 'Magnificent Seven' Dividend Growth Stocks Overlooked by the Stock Market

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 |  Includes: ABT, CL, JNJ, KMB, PEP, PG, SYY
by: Chuck Carnevale

This article is about a group of dividend growth stocks that I have admired over most of the 40-plus years I've been in the investment business. But even though I have always admired these great companies, which I now dub the “Magnificent Seven,” I have rarely owned them because the markets have normally overpriced them. However, as you will soon see, the great recession of 2008 changed all that. These magnificent blue-chip stalwarts, each a recognized giant in its industry, have finally become reasonably priced based on earnings and cash flows.

Positioning Statement
However, before we elaborate on the valuation opportunity that we believe this group of blue-chip stocks offer, a few comments on investing principles are in order. An efficient way to accomplish this is to share a few comments made by Charles Brandes at the Eighth Annual Value Investors Conference held this year in Omaha, Nebraska:
"Opportunities for stock picking:
  1. Fundamentals will prevail in the long term.
  2. Price matters.
  3. Wealth creation comes from business."
We feel these are extremely wise words that establish a solid foundation and blueprint that investors can follow when building their stock portfolios. The “Magnificent Seven” dividend growth stocks that we are going to cover, can be easily evaluated on the basis of Charles Brandes’ sage advice above. Each of these companies have solid fundamentals, their recent stock prices are as attractive as they have been in decades, and each of them are firmly established businesses with long histories of operating excellence.
The “Magnificent Seven” Summarized
The following table generated by the F.A.S.T. Graphs™ research tool provides a quick summary of these great companies listed in order of highest dividend yield to the lowest. The first column shows the current PE ratio, the next column lists the historical normal 15 year PE ratio. A quick review of these two columns illustrates how each of these “Magnificent Seven” dividend growth stocks are currently undervalued on a historical basis. The next column lists the current dividend yield based on the May 5, 2011, closing price. Most interestingly, the blended yield from an equal investment in each of these seven companies averages approximately 3.23%. This is slightly above the 3.2% yield currently available on a 10 year treasury bond.
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The “Magnificent Seven” through the Lens of our graphs
Since a picture is worth 1000 words, the following pictorial review of each of our seven blue-chip dividend growth stocks vividly depicts the opportunity we believe that each provides. Therefore, prudent investors seeking quality dividend paying growth stocks can decide for themselves whether or not any, or all, of these great businesses are worthy of further consideration. For each example we will start with a 20 year logarithmic graph that plots earnings growth (orange line), the historical normal PE ratio (blue line) and the monthly closing stock prices (black line) all correlated with each other. Next we will provide a graph at normal scale that includes dividends (light blue shaded area) paid out of earnings (green shaded area). Finally, we will provide the associated performance calculations to include the important dividend cash flow table.
Kimberly-Clark (NYSE:KMB)
From the 20 year logarithmic graph on Kimberly-Clark (KMB) we discover that its stock price has rarely been below the orange earnings justified valuation line as it is today. The 4.2% dividend yield is the highest of the group, but as should be expected, its historical earnings growth rate has been the lowest.
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One of the most important points that we want to highlight on each of these companies, is how well they were able to navigate through the recession of 2008. Even though Kimberly-Clark (KMB) did experience a minor drop in earnings in calendar year 2008, this was still the second most profitable year in the company's history.

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When looking at the performance graph below, notice that we highlighted a time when the company's current yield approximated today's yield. There are two important considerations to be gleaned from this exercise: The first is to notice how the historically high current yield is available due to today's low historical valuation. And second to illustrate the concept we call growth yield, but others refer to as yield on cost (YOC).
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SYSCO Corp. (NYSE:SYY)
We recently authored a comprehensive article on Sysco (SYY) - link. It is due to report earnings on Monday, May 9, and it will be interesting to hear what the company has to say. However, as the logarithmic graph below depicts this company's recent valuation is among the lowest it has been in decades. Therefore, the current 3.6% dividend yield is higher than you would normally expect when investing in Sysco.
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Once again, one of the most important points that we want to highlight on each of these companies is how well they were able to navigate through the recession of 2008. Although Sysco did experience some minor flattening of earnings through the recessionary years, it nevertheless remained strongly profitable.
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When looking at the performance graph below, notice that we highlighted a time when the company's current yield approximated today's yield. There are two important considerations to be gleaned from this exercise: The first is to notice how the historically high current yield is available due to today's low historical valuation. And second to illustrate the concept we call growth yield but others refer to as yield on cost (YOC).
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Abbott Labs (NYSE:ABT)
The logarithmic graph on Abbott Labs (ABT) depicts a quintessential example of a consistent record of earnings growth. Today's historically low valuation offers an abnormally high 3.3% dividend yield at its current price.
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In the case of Abbott Labs (ABT), this extremely well-run blue-chip did not experience a recession on an operating basis. Therefore, one could conclude that the recent historical low valuation represents an attractive entry point. On February 18, 2011, the Board of Directors of Abbott Labs increased the dividend by 9%. This was the 39th consecutive year the company has increased the dividend and the 349th consecutive quarterly dividend paid since 1924.
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When looking at the performance graph below, notice that we highlighted a time when the company's current yield approximated today's yield. There are two important considerations to be gleaned from this exercise: The first is to notice how the historically high current yield is available due to today's low historical valuation. And second to illustrate the concept we call growth yield but others refer to as yield on cost (YOC).
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Johnson & Johnson (NYSE:JNJ)
The logarithmic graph on Johnson & Johnson (JNJ) does illustrate a slowdown in earnings growth in recent years. However, the graph also clearly shows that the company remains a very profitable business. The current 3.3% dividend yield is abnormally high for this quality company.
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Although Johnson & Johnson (JNJ) continued to grow its business during the recession, its growth rate was slower than normal. The prospective investor needs to decide if today's low valuation justifies building a long-term position in this blue-chip. On April 28, 2011, the Board of Directors of Johnson & Johnson declared a 5.6% increase in the quarterly dividend. This was the 49th consecutive year that the company raised the dividend.
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When looking at the performance graph below, notice that we highlighted a time when the company's current yield approximated today's yield. There are two important considerations to be gleaned from this exercise: The first is to notice how the historically high current yield is available due to today's low historical valuation. And second to illustrate the concept we call growth yield but others refer to as yield on cost (YOC).
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Procter & Gamble (NYSE:PG)
The logarithmic graph on Procter & Gamble (PG) illustrates another example of a strong business that remained profitable during and through the recessionary times. We also notice that even though valuation remains at historically low levels, valuation is beginning to rise. Consequently, although the current yield of 2.9% is at a premium to what you could normally purchase the stock at, it is not as high a premium as some of the other examples covered in this article.
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Once again, Procter & Gamble (PG) represents another example of a company that remained strongly profitable through the recent recessionary period. On April 11, 2011, the Board of Directors of the Procter & Gamble Company declared a 9% increase in the dividend. Procter & Gamble has been paying a dividend for 121 consecutive years, and has increased the dividend every year for the past 55 consecutive years at an annual compound average rate of 9.5%.
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When looking at the performance graph below, notice that we highlighted a time when the company's current yield approximated today's yield. There are two important considerations to be gleaned from this exercise: The first is to notice how the historically high current yield is available due to today's low historical valuation. And second to illustrate the concept we call growth yield but others refer to as yield on cost (YOC).
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PepsiCo (NYSE:PEP)
The logarithmic graph on PepsiCo (PEP) offers a vivid depiction of how the market has historically priced this quality company far in excess of its earnings justified value. Consequently, today's dividend yield of 2.8% is higher than investors have historically been able to buy the stock at.
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PepsiCo (PEP) clearly went through the recession in fine order with very little stress on operating results. Nevertheless, the price initially dropped due to a minor flattening of earnings during the great recession of calendar year 2008. From the graph below it seems obvious that very little has changed with PepsiCo other than its valuation. On May 4, 2011, the Board of Directors of PepsiCo declared a 7% increase in the company's annual dividend. This represents the company's 39th consecutive annual dividend increase.
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When looking at the performance graph below, notice that we highlighted a time when the company's current yield approximated today's yield. There are two important considerations to be gleaned from this exercise: The first is to notice how the historically high current yield is available due to today's low historical valuation. And second to illustrate the concept we call growth yield but others refer to as yield on cost (YOC).
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Colgate-Palmolive Co. (NYSE:CL)
The logarithmic graph on Colgate-Palmolive Co. (CL) provides a final example of a blue-chip dividend growth stock that is currently being price at a historically low valuation. However, its current 2.5% dividend yield shows that it is not as undervalued as some of the other examples. Colgate-Palmolive currently commands the highest price earnings ratio of the “Magnificent Seven.”
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Colgate-Palmolive (CL) is clearly a company with a consistent long-term record of earnings growth. As a result, the market has historically placed a premium on its shares. Although it's true that earnings have flattened a little of late, the company still remains extremely profitable. On February 24, 2011, the Board of Directors of Colgate-Palmolive Company increased the dividend by 9% citing the company's positive outlook. The company has paid uninterrupted dividends since 1895.
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When looking at the performance graph below, notice that we highlighted a time when the company's current yield approximated today's yield. There are two important considerations to be gleaned from this exercise: The first is to notice how the historically high current yield is available due to today's low historical valuation. And second to illustrate the concept we call growth yield but others refer to as yield on cost (YOC).
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Conclusions
Although we have long admired each of the “Magnificent Seven” companies on this list, we have usually been frustrated by the high valuation that the market has typically priced their shares at. Consequently, since we believe you make your money on the buy side, we were not willing to invest, as we were frustrated by the high prices. However, in recent times, since the recession of 2008, we have been frustrated on the other side. For the most part, these high-quality companies have not kept pace in recent years with the stock market as measured by the S&P 500 (NYSEARCA:SPY). The following table summarizes this point:
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We believe that the recent underperformance of these “Magnificent Seven” blue-chip dividend growth stocks may represent a window of opportunity that has not been seen for decades. The stock market does not always make sense in the manner in which it prices stocks over the short run. However, we believe that, as Charles Brandes so aptly put it, fundamentals will prevail in the long term. As it relates to this group of names, we believe that the fundamentals are strong, the prices historically low, and that these businesses will generate wealth going forward. But it's up to each investor to conduct his or her own comprehensive research in order to decide for him or herself.

Disclosure: I am long KMB, SYY, ABT, JNJ, PG, PEP.
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.