Dumpster Diving The 2016 Dividend Champions

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Includes: ADM, HCP, MMM, T, TROW, VFC
by: Eric Landis

Summary

With the market in full sell-off mode, now is a great time to be looking for bargains.

Some stocks that have been discarded by the market can be attractive additions to your portfolio.

This report will look at the Dividend Champions List and select four companies that are worth a look at currently depressed prices.

The S&P has now fallen nearly 12% from 52-week highs and is in full-on correction mode, making it a great time to be looking in the bargain bin for possible investment opportunities.

^SPX Chart

^SPX data by YCharts

During the sell-off, many individual stocks have seen much greater declines than the 11.8% seen by the broader market, as 30 of the 107 companies on the Dividend Champions list have seen declines of at least 25%. Of course, just because a company has fallen in price doesn't mean that it is trading at a value. As importantly, not all value stocks are those that have seen price declines, as a company can be trading near 52-week highs and still be trading at a discount to fair value. As Warren Buffett famously said, "Price is what you pay, value is what you get."

For the price losers, the difficulty lies in trying to determine if a decline in share price is due to a broken business model or if it is simply a temporary blip on the earnings radar that can be fixed. For the price winners, the difficulty lies in trying to determine what fair valuation should be paid for growth, as overpaying for growth can be just as bad as underestimating a decline.

With this article, I will put the Dividend Champions List under the magnifying glass, and see if I can find any companies that look attractive at current prices, whether they are high or low. This will be done primarily by using F.A.S.T. Graphs, which helps to determine if the company is trading above or below historical valuation levels. Additionally I will be looking at the financial strength of the company, repeatability of earnings, and analyst expectations for future growth.

The first example is Archer Daniels Midland (NYSE:ADM), which is an agricultural processor and food products provider with a 40-year track record of dividend increases. This company operates in the cyclical agriculture industry, which is currently seeing difficult times with low crop prices. Additionally, as the largest ethanol producer in the country, the severe drop in energy prices has caused its ethanol earnings to take a substantial hit on lower crush margins. This has resulted in lower earnings in 2015 and uncertain expectations for 2016.

You can see the volatility in earnings over the years on this 15-year chart from F.A.S.T. Graphs.

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With a blended P/E of 11.7, the stock is trading well below the normal valuation level of a 17 P/E seen during the period. Additionally, the 3.55% dividend yield is the highest seen in the last 15 years. This yield is also set to become higher as they company is in line to raise the dividend rate with the next declaration. I don't expect the raise to be as high as in recent years, but a 5% boost is a reasonable expectation that would lead to a 3.7% forward yield, which is attractive for long-term investors.

ADM Dividend Yield (<a href=

ADM Dividend Yield (TTM) data by YCharts

I am not confident that we have seen the bottom in ADM, but I do think this is a good time to begin scaling into a position. The company has seen a temporary drop in earnings in a cyclical industry, which has been resulted in a corresponding drop in share price. Now is the time to be buying cyclicals, as depressed prices allow investors to lock in unusually high yields for the long term.

The second example is AT&T, Inc. (NYSE:T), which is a telecommunications and satellite television provider with a 32-year streak of dividend increases. Unlike Archer Daniels, AT&T is a slow and steady grower of earnings and dividends that produces a reliable 3%-5% growth rate over the years. I consider AT&T similar to a utility company as it provides a needed service that is less affected by the general economy.

AT&T is currently trading at a 12.6 P/E, which is on the low end of the range seen since coming out of the recession. This is surprising to me, as earnings growth is actually expected to accelerate at a 5%-6% rate going forward as the company integrates the DirecTV purchase that was finalized last year.

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There are concerns regarding the elevated debt levels for the company as it has increased spending on the DirecTV acquisition, spectrum purchases, and expansion into Mexico. Management has stated their intent to pay down the debt levels in coming years, which could lead to a bit lower dividend growth rate in the near term. However, with a nearly 5.7% yield and cheap valuation, this looks to be a nice entry point for long-term income investors.

The next company, HCP, Inc. (NYSE:HCP), is a real estate investment trust "REIT" with a 30-year streak of dividend increases. The company invests primarily in real estate serving the healthcare industry in the United States. HCP has one of the longest dividend growth streaks in the REIT sector and its BBB+ credit rating is also among the best of its peers.

At an 11.5 P/FFO, shares are currently trading at levels not seen since the Great Recession, and its payout ratio is also at a reasonable 72% of FFO. A dividend increase is on the horizon with the next declaration, and I expect it to be similar to the 3%-4% growth rate seen in recent years.

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With a 6.2% current yield and potential 6.5% forward yield on a dividend hike, this looks like a nice entry point for investors. The healthcare industry is fairly immune to recession, which provides a bit more certainty for future earnings compared with some of the others on the list.

My final example, T. Rowe Price Group, Inc. (NASDAQ:TROW), is an asset management company with a 29-year streak of dividend increases. The company operates with a conservative balance sheet that carries no debt, which has helped it to weather the storm during market declines.

The company is trading nearly 24% below 52-week highs on concerns of slowing growth as the market has stalled. As an asset management company, T. Rowe does well in a rising market as it earns more profits on rising account levels. Unlike the previous examples, T. Rowe seems the most susceptible to further decline should the market continue its fall.

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At a 14.3 P/E, shares appear to be trading at an attractive valuation, however, this is dependent on earnings remaining at or rising from current levels. With a possibly lower overall market on the horizon, current analyst estimates may not hold, which could lead to further decline in the share price. However, with a dividend increase expected with the next declaration, the current 3.2% yield will be heading higher. A 10% boost would lead to a 3.5% yield, which would be a nice entry point for investors.

Close, But Not Quite

Two other companies that I am watching, but not quite ready to call cheap despite the fact they are trading near 52-week lows, are V.F. Corp. (NYSE:VFC) and 3M Company (NYSE:MMM). I think both are excellent companies with promising futures, but neither are quite at the point where I am willing to buy yet.

3M is trading for about 18.3 times earnings, which is reasonable, but still above levels normally seen for the company. There is also uncertainty for earnings, as 2015 estimates have been lowered from $7.77 to $7.55 and 2016 estimates have dropped from $8.55 to $8.23 over the last 90 days.

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The yield is becoming attractive at nearly 3%, and this is set to grow with the upcoming dividend announcement. However, I don't see much safety in current prices and will be patient in waiting for an entry point. I would likely pull the trigger at around $132, which would be a 16 multiple on current 2016 earnings estimates.

Like 3M, V.F. Corp. has seen a significant pullback, as it is currently nearly 30% below 52-week levels. However, despite this pullback, it remains above historical valuation levels. It too has seen earnings estimates fall, as 2016 numbers have been cut from $3.70 to $3.52 over the last 90 days.

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I would get interested in VFC at the $50 level, which would provide a nearly 3% yield and a 15.8 P/E on 2015 earnings.

Conclusion

The market pullback is beginning to provide some nice opportunities for long-term investors. Several companies are now trading at a discount to historical valuation levels and some, like Archer Daniels, are also providing historically high dividend yields. Some of the blue chips, like 3M Company and V.F. Corp are becoming more attractive, yet don't quite meet my valuation targets at this time.

Uncertainty remains high with the volatile market, but I hope these ideas can help investors discover some investment ideas worthy of further due diligence.

Disclosure: I am/we are long T.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am a Civil Engineer by trade and am not a professional investment adviser or financial analyst. This article is not an endorsement for the stocks mentioned. Please perform your own due diligence before you decide to trade any securities or other products.