By Mark Bern, CPA CFA
These are two behemoths of two different industries that pay at or near four percent in dividends. If an investor is looking for a dominant company with the potential for rising dividends and appreciation these are two stocks the investor should consider. Do they fit the mold of rising dividend stocks? The questions we must ask are:
1. Can the companies continue to raise dividends?
2. Will the companies find the path to growth in revenue and earnings in the future?
3. Do the companies offer above average return for the level of risk?
These are difficult questions, but we need to try to answer them to the best of our abilities. Let’s start with a look into the past and compare what the numbers say over the last five years for each company. Pfizer (PFE) has had sales growth of two percent per year on average over that period and earnings have dropped by an average of ten percent per year. Cash flow at Pfizer fell an average of six percent per year while dividends have increased by an average of 6.5 percent per year over those last five years. There is nothing very impressive here.
General Electric (GE) hasn’t done any better. Sales have risen by an average of two percent per year while earnings have dropped by an average of four percent per year. Cash flow at GE fell 0.5 percent per year while dividends actually fell also by 1.5 percent on average. You may be wondering at this point why I even bother to write about these two companies. Well, let’s take a closer look at what is going on at each in the most recent year or so and see if we can spot anything worthy of note.
First, it appears that sales will once again be falling at both companies for the full year in 2011. Pfizer actually had a pretty good year in 2010, but things were skimpy in the previous years. The good news for GE is that the rate of decline has improved markedly and we can now expect to see actual increases again beginning in 2012. At PFE, sales may actually achieve close to parity with 2010 which is a good sign also. But PFE is about to lose its patent protection on Lipitor, the company’s number one selling product. Competition by generic offerings will create stiff competition for PFE in 2012. Future revenue increases at PFE will depend heavily upon acquisitions as its pipeline is not likely to produce blockbusters in ample quantity or quality to offset the losses in sales from Lipitor. But there are acquisition possibilities that the company could scoop up which would keep sales from dropping and perhaps even create some decent top line growth in a couple of years. I cannot imagine that PFE will decline this course of action. So I am hopeful since the company has plenty of cash and financing flexibility with its excellent balance sheet to make immediate moves in this area.
Cash flow at both companies is rising, although it is rising much faster at PFE, approximately ten percent in 2011 and almost 26 percent in 2010. GE’s cash flow is rising at about three percent per year; not huge but consistency could pay off here.
Earnings per share (EPS) have risen in each of the last two years for GE at rates of about 17 percent and 11.7 percent for 2011 and 2010, respectively. PFE had a tough time in 2010 seeing a huge rise in sales but experiencing a corresponding decrease in EPS of 16.3 percent. But 2011 is shaping up much better with EPS likely to increase by 11.7 percent. It is worth noting here that the third quarter results for PFE were outstanding with revenue rising seven percent and EPS up over 300 percent from the same period in the previous year. It is also important to mention here that less than half of that growth came from Lipitor, so there may actually be hope coming sooner than I expect; we’ll just have to watch and see.
After taking a terrible beating in 2009 and 2010, dividends at GE are on the rise again. But the cuts have many investors questioning whether they can trust GE to get back to the course of annual increases without major disruptions. PFE has gone through much the same thing, but to a lesser degree and has increased its dividend for 2011 by 11 percent over 2010 levels. The payout ratio at PFE is still a bit high at 70 percent, while GE has trimmed its payout ratio down to a more manageable 44 percent this year.
Profit margins at GE have risen by just over 15 percent in each of the past two years, while PFE has manage an increase in 2011 of about 11 percent but saw its margin drop in 2010 by 29 percent.
Overall debt is not a comparable item since GE has such high leverage levels with its GE Capital units. But both companies are in relatively good shape here. And it is important to note that GE Capital is once again the primary driver of earnings at GE. It amazes me that two companies with such diverse operations can have any statistic that is so similar, but here we are. Return on Equity at both companies is running at about 10.5 percent.
So, what I glean from the numbers thus far is that perhaps the worst may be behind these two companies. But just how bright is the future? Well, this is a very subjective area of analysis, but if we take what has been happening in the past four quarters for each company and assume that the improvements can be sustained, then layer on top of that the expectation that both companies will use some of that prodigious cash flow generated to buy back shares and increase dividends, and finally if we assume that managements of both companies will continue to reduce costs and also use some of the cash flow to make strategic acquisitions with greater growth potential we can clearly (that’s probably not the right word to use here) see some potential. The final element is our assumption about global growth and regulations. I can’t predict either with any real clarity, but my best guess is that, if not in the next year or two, by at least 2014 we should see global economic growth return to better levels and that the healthcare regulations will no longer be an issue affecting costs to the same extent as today. Those are my assumptions, so if you disagree your outcomes will also be different.
I expect revenue per share growth at each company to “average” about three percent per year over the next five years. I also expect EPS growth to average 12 percent for GE and ten percent for PFE over that period. Finally, I expect dividends at GE to increase at an average rate of seven percent per year over the next five years, while dividends at PFE increase at about three percent on average. In closing, I believe that either company, if held for the long term (at least three years) should provide good income as well as appreciation that should keep investors well ahead of inflation.