A Dividend Contender is defined as a company that has increased its dividend for a minimum of 10 - 24 straight years. A.O. Smith Corp. (NYSE:AOS) is a Dividend Contender that has raised its dividend every year for 18 consecutive years. The complete Dividend Contenders list is compiled courtesy of David Fish. (Open as an excel spreadsheet and look at the tabs on the bottom to find the Dividend Contender list).
About A.O. Smith Corp:
A. O. Smith Corporation is a leading global manufacturer and marketer of residential and commercial water heaters and boilers. A. O. Smith offers our customers an additional competitive advantage in that the company designs, builds, distributes and field supports the world's broadest and deepest line of residential and commercial water heaters, as well as commercial boilers. This single-source concept simplifies ordering, installation and service and is backed by more than 70 years of research and innovation.
A.O. Smith Corp: A Dividend Contender with 18 Consecutive Years of Dividend Increases
Since dividends are paid out of earnings, a clear perspective of a company's historical earnings growth record is a vital component of a dividend investor's prudent due diligence process. The following graph plots A.O. Smith Corp.'s earnings per share since 1998. A quick glance to the right of the graph shows that A.O. Smith Corp. has increased earnings at a compounded rate of 7.8% (see purple circle on graph) per annum.
Even though A.O. Smith Corp. has averaged 7.8% earnings growth, you can see that there have been several brief periods where earnings fell and then recovered. Therefore, the cyclical nature of this company's operating results is an important piece of information for the dividend growth investor contemplating building a position in this dividend contender.
Click on any graphic below to enlarge:
Dividend Contenders 10-24 Straight Years of Dividend Increases
With interest rates hovering near all-time lows, investors seeking income are faced with very limited choices. The traditional high yield available from bonds and other fixed income vehicles are no longer available to meet the goals of retirees needing income to live off of. Moreover, it is almost a certainty that today's low yields are not adequate enough 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 dividends every year.
Earnings Determine Market Price and Dividend Income: The following earnings and price correlated F.A.S.T. Graphs clearly illustrates the importance of earnings to both price movement and dividend income. 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.
Here is a link to a live and fully functioning graph on A.O. Smith. We suggest running graphs over numerous time frames as part of a more comprehensive fundamental analysis. This will provide the reader the opportunity to review a more thorough fundamental analysis of the company.
Since dividends are paid out of earnings, and therefore represent additional return on top of what the market capitalizes earnings at, they are depicted by the light blue shaded area and stacked on top of the earnings line. Therefore, a quick visual of these two important components is simultaneously revealed: The additional return that dividend paying stocks provide, plus the percentage of earnings paid to shareholders as dividends (payout ratio).
Performance Table: Capital Appreciation and Dividend Income A.O. Smith Corp.
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 a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 6.3% capital appreciation (Closing Annualized ROR), long-term shareholders of A.O. Smith Corp. would have received an additional $31,689.61 in dividends that increased their total return from 6.3% to 7.2% per annum.
(Note: Since this is a Dividend Contender it has raised its dividend every year for at least 10-24 years, therefore, negative dividend growth rates shown, if any, will be attributed to special additional dividends paid in excess of the company's regularly reported dividend rate)
The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as normal 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 A.O. Smith Corp. is 1.20, which is historically high.
Looking to the Future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns, and the dividend and its growth rate are a function of two critical determinants:
The rate of change (growth rate) of the company's earnings
The price or valuation you pay to buy those earnings
Therefore, forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
It then logically follows that measuring performance without simultaneously measuring valuation is a job half done. At its current price, which is attractively aligned with its True Worth valuation, A.O. Smith Corp. represents a potential opportunity to invest in a Dividend Contender at a reasonable price. The important factor is that A.O. Smith Corp. 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 an increasing dividend income stream and potentially attractive 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 eight leading analysts reporting to Capital IQ forecast A.O. Smith Corp. long-term earnings growth at 22.5%. A.O. Smith Corp. has medium long-term debt at 29% of capital. A.O. Smith Corp. is currently trading at a P/E of 19.3, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 27. If the earnings materialize as forecast, A.O. Smith Corp.'s True Worth valuation would be $165.94 at the end of 2017, which would be a 26.1% annual rate of return from the current price, including assumed dividends.
Earnings Yield Estimates
Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because Earnings Determine Market Price and dividend income 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 prospective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in A.O. Smith Corp. to an equal investment in 10-year Treasury bonds illustrates that A.O. Smith Corp.'s expected earnings would be 8.9 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 & Conclusions
This report presents essential "fundamentals at a glance" on Dividend Contender A.O. Smith Corp., 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 with just a quick glance you can know a lot about the company, it's imperative that the reader conduct his or her own due diligence in order to validate whether the consensus estimates seem reasonable or not.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.