Dividend champions are companies that have increased their dividend every year for at least 25 consecutive years. Walgreens & Co. (WAG) is the dividend champion, which we have identified as the company offering the greatest potential for the highest total annual return. Walgreens has generated a consistent above-average earnings growth rate over the past 15 years, averaging 13.7% per annum. However, from 1998 calendar year 2008, Walgreens' stock price was significantly overvalued by the market. Consequently, in view of today's historically low valuation, coupled with exceptional expectations for future growth, Walgreens sits at the top of the list of dividend champions based on the highest potential long-term performance.
With interest rates hovering near all-time lows, investors looking for income are faced with limited choices. The traditional high yields from bonds and other fixed income vehicles are no longer available to meet the goals of retirees needing income to live off. Moreover, it is almost a certainty that today's low yields are not adequate to fight inflation. Consequently, there is a growing investor interest in dividend paying common stocks, especially those that have a long record of increasing their dividend every year.
Growth and dividend income stocks are defined as those that provide the opportunity for long-term capital appreciation and a growing dividend income stream over time. Both capital appreciation and dividend growth will generally be consistent with the company's average earnings growth, assuming there is strict adherence to sound valuation.
Walgreens: Large-cap growth at an attractive price
Company description from website: "Walgreens (walgreens.com) is the nation's largest drugstore chain with fiscal 2011 sales of $72 billion. The company operates 7,830 drugstores in all 50 states, the District of Columbia and Puerto Rico. Each day, Walgreens provides nearly 6 million customers the most convenient, multichannel access to consumer goods and services and trusted, cost-effective pharmacy, health and wellness services and advice in communities across America. Walgreens scope of pharmacy services includes retail, specialty, infusion, medical facility and mail service, along with respiratory services. These services improve health outcomes and lower costs for payers including employers, managed care organizations, health systems, pharmacy benefit managers and the public sector. Take Care Health Systems is a Walgreens subsidiary that is the largest and most comprehensive manager of worksite health and wellness centers and in-store convenient care clinics, with more than 700 locations throughout the country."
Earnings determine market price: The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.
Walgreens: Historical earnings, price, dividends and normal P/E since 1998
Click to enlarge
Walgreens: Performance table
The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two components of total return, capital appreciation and dividend income. Dividends are included in the total return calculation and are assumed paid, but not reinvested.
When presented separately like this, the additional rate of return that a dividend-paying stock produces for shareholders becomes undeniably evident. In addition to the 5.7% capital appreciation, long-term shareholders of Walgreens would have received an additional $25,786.86 in dividends that increased their total return from 5.7% to 6.5% per annum.
The following graph plots the historically normal P/E ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price to earnings ratio on this quality company is as it has been since 1998.
A further indication of valuation can be seen by examining a company's current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for Walgreens is 0.41, historically.
Looking to the future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:
1. The rate of change (growth rate) of the company's earnings.
2. The price or valuation you pay to buy those earnings.
Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. Walgreens Co. is clearly an industry-leading superior business, and based on consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, Walgreens represents an opportunity for growth at a reasonable price. The important factor is that Walgreens, with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized future returns.
The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.
The consensus of 20 leading analysts reporting to Capital IQ forecast Walgreens Co.'s long-term earnings growth at 12%. Walgreens has long-term debt at 14% of capital. The company is currently trading at a P/E of 12, which is the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Walgreens Co.'s True Worth™ valuation would be $79.54 at the end of 2017, which would be a 18.2% annual rate of return from the current price.
Earnings yield estimates
Discounted future cash flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for stake holders over time. Therefore, since earnings determine market price in the long run, we expect the future earnings of a company to justify the price we pay.
Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low-risk Treasury bonds. Comparing an investment in Walgreens Co. to an equal investment in 10-year Treasury bonds, illustrates that Walgreens' expected earnings would be 7.7 times that of the 10-Year T-Bond Interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.
Summary and conclusions
This report presented essential "fundamentals at a glance" illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although a quick glance can tell you a lot about the company, it is imperative as a reader that you conduct your own due diligence in order to validate whether the consensus estimates seem reasonable.
When looking at the historical earnings and price correlated graphs on Walgreens, we see that there really is no such thing as a normal P/E ratio (the blue line on the graph). Massive overvaluation has caused Walgreens' P/E ratio since the late 1990s to consistently fall. Then, the recession of 2008 brought a sharp drop in both the stock price and P/E ratio contraction for this quality company. However, the most important point this article endeavors to make is that Walgreens' business continued to generate close to an impeccably consistent operating performance through it all.
Consequently, now that Walgreens is largely undervalued, there is significant opportunity for above-average returns at below-average risk.
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.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.