5 Dividend Stocks With The Best CEOs To Consider For Your Portfolio

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 |  Includes: BHP, MCD, NFLX, SIEGY, YUM
by: Investment Underground

By Joe Escalada

CEOs are the private-sector equivalent of politicians. Many of them give magnificent speeches, have sex appeal, and tell you what you want to hear. They tend to be tidy, tall, white males. Like politicians, they exploit our human weakness to cling to authority.

As rational investors, we have to correct for our cognitive biases, including our human need to gravitate to authority figures. To account for this bias, we should question authority, especially any authority that wears a suit, tie, and wants something from us. We should require a preponderance of evidence before paying a premium above reasonable valuations for the leadership of a charming CEO.

Consider the relative valuations of BHP Billiton Ltd. (NYSE:BHP), Netflix, Inc. (NASDAQ:NFLX), Siemens AG (SI), Yum! Brands, Inc. (NYSE:YUM), and McDonald's Corp. (NYSE:MCD). Each company is led by a highly-praised CEO, though not all of these stocks are cheap:

Ticker

P/E (ttm)

P/E (forward)

P/S (ttm)

P/B

Dividend Yield

BHP

7.93

7.58

2.54

3.24

3.30%

SI

12.83

8.37

0.73

1.87

3.00%

NFLX

32.82

19.51

2.54

20.22

0.00%

MCD

17.68

15.27

3.47

5.93

2.80%

YUM

20.75

16.09

2.03

13.13

2.20%

Click to enlarge

These valuations can be combined with future growth and future price multiple estimates to forecast total returns for each stock. Total returns were calculated for a three- or five-year holding after selling the stock at a price to earnings multiple of 13. (The investor would be able to sell the stock for a profit only if buyers were willing to pay for the stock at reasonable multiples. If investor sentiment had soured, the investor would either have to hold the stock or take a loss. Dividend yield is assumed to be reinvested into shares of the company. Earnings growth over the holding period will be taken as the lesser of earnings growth over the last five years and earnings growth projected by analysts for the next five years. This earnings growth rate was then used to calculate terminal price-to-earnings ratios, that is, the price paid today divided by earnings at the end of the holding period.)

3 Years Growth

5 Years Growth

Ticker

g (past)

g (future)

Terminal P/E

Annualized Return

Terminal P/E

Annualized Return

BHP

103.33%

17.40%

4.90

43%

3.56

34%

SI

18.21%

35.50%

7.77

22%

5.56

22%

NFLX

45.10%

29.32%

15.18

-5%

9.07

7%

MCD

15.73%

10.01%

13.28

2%

10.97

6%

YUM

13.37%

12.56%

14.55

-2%

11.48

5%

Click to enlarge

Both relative valuation and the above total return scenarios demonstrate that BHP and SI are reasonably valued, being priced to compensate investors appropriately for the risk of holding stocks. Thus, investors essentially get the leadership of esteemed CEOs of these firms for free. BHP’s CEO is Marius Kloppers, a MIT Ph. D. and an INSEAD MBA. He has held the CEO position since 2007. Siemens’ CEO, Peter Löscher, earned his master’s degree from the Vienna University of Economics and Business Administration and like Kloppers, has held the CEO position for four years. At current valuations investors in SI and BHP can benefit from the leadership of world-class CEOs without paying a premium.

In contrast, McDonald’s and Yum! Brands have higher valuations and CEOs who do not have fancy educational pedigrees. MCD’s CEO is Jim Skinner. He never graduated from college, and has been with McDonald’s for 39 years. Skinner is the 2009 Chief Executive Magazine CEO of the year. Similarly, YUM’s David Novak is also a company man. He has been working in YUM subsidiaries since the 1980s and has been YUM! Brands CEO for 10 years. He holds a BA from the University of Missouri.

Should you pay a premium to purchase these stocks at current prices to gain the leadership of people who have worked in the company for decades, but don’t have advanced degrees? I wouldn’t pay a premium for management. For investors who insist on seeking management skill, they ought to require more than just attendance from their executives. A long tenure by itself doesn’t mean much. Moreover, the lack of advanced degrees means that there should be a higher burden of evidence for assigning extra value to management.

Is my skepticism justified? Consider Netflix’s CEO Reed Hastings, whose controversial price hikes and plans to split the company preceded the stock’s recent 40% price drop. Neither decision by Hastings warranted the scorn received in the press. Certainly, Netflix price increases were reasonable considering the service the company provides. A couple can still buy a month’s entertainment from Netflix for less than the price of going to the movies twice. Furthermore, though the concept of splitting the Netflix DVD and streaming operations into separate companies isn’t consistent with the common value proposition to customers, investors should applaud the willingness Hastings has shown to sell pieces of the company when he feels it would benefit shareholders. In contrast, many CEOs do not act in the interest of their shareholders and try to hoard power and subsidiaries for as long as possible. Empire building helps justify CEO salaries, even if it ultimately comes at the expense of shareholder value. Media and share price responses to management decisions by Hastings really don’t make sense. In this case, leadership was punished by investors, not valued by them.

That being said, I wouldn’t buy Netflix at today’s valuations. The share price is still too high.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.