Dividend growth investing [DGI] seeks to create an income revenue stream from dividend income that increases year on year. Blue chip companies that are able to sustain their annual dividend payments and grow them over time are highly sought after by dividend growth investors, who over the long term seek capital growth in the stock price, in addition to sustained increases to dividend payouts. In a DGI portfolio these dividends may be reinvested in the stock, or set aside as cash to direct into other dividend growth stocks, with the aim being to generate a sustainable revenue stream from ongoing dividend payments.
Blue chip companies with strong records of increasing dividends annually are highly sought after by dividend growth investors. This article will compare the historical performance of two leading industrial companies; Caterpillar (CAT) and Cummins (CMI). It will examine historical performance with respect to dividends and share price, and will seek to identify if either stock is suitable for inclusion in a DGI portfolio.
Blue Chip Industry Leaders
In August 2011 I wrote a short comparative article on the merits of Caterpillar versus Cummins as potential long term stocks to hold within an investment portfolio. Both companies are industry leaders and on face value look like suitable companies to include in a diversified investment portfolio. As I have stated previously:
Both companies are iconic entities within their respective fields, and consumers of the products are staunchly CAT or Cummins biased. This ensures a loyal customer base respectively, which drives company sales on a continuing basis. They have dedicated industries heavily reliant on their products, including mining companies, earthmoving companies, and the trucking transport industry. Cummins has a solid reputation built on delivering consistently over time, and CAT is well known for its after sales and through life support, offering reliable maintenance and spare parts support anywhere in the world 24/7.
However, over the course of the last 12 months I have started to research and focus on the merits of DGI as a suitable portfolio construct to save for retirement, largely due to reading David Van Knapp's articles (among others) on Seeking Alpha. To this end I considered it pertinent to revisit one of my earliest articles on Seeking Alpha, to establish if Caterpillar (which I favor) and Cummins are considered suitable for inclusion in a DGI portfolio.
Caterpillar vs Cummins Comparison
The scope of Caterpillar and Cummins operations is detailed below from their respective websites:
For more than 85 years, Caterpillar Inc. has been making sustainable progress possible and driving positive change on every continent. With 2011 sales and revenues of $60.138 billion, Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The company also is a leading services provider through Caterpillar Financial Services, Caterpillar Remanufacturing Services and Progress Rail Services.
A global power leader, Cummins is a corporation of complementary business units that design, manufacture, distribute and service engines and related technologies, including fuel systems, controls, air handling, filtration, emission solutions and electrical power generation systems. Cummins employs approximately 44,000 people worldwide and serves customers in approximately 190 countries and territories through a network of more than 600 company-owned and independent distributor locations and approximately 6,500 dealer locations. Cummins earned $1.85 billion on sales of $18.0 billion in 2011.
A current performance snapshot for each company is detailed below:
Caterpillar. At the time of compiling data for this article CAT was $87.06 per share, $29.89 (26%) below its 52 week high of $116.95. The company trades at a P/E of 9.00, EPS of $9.77, and has a current market capitalization of $56 billion.
Cummins. At the time of compiling data for this article CMI was $99.71 per share, $29.80 (23%) below its 52 week high of $129.51. The company trades at a P/E of 9.80, EPS of $10.06, and has a current market capitalization of $19 billion.
Under current market conditions both stocks on face value represent a discounted entry point for long term investors. However a DGI portfolio will seek to examine a number of factors in addition to share price, P/E and EPS figures. In addition to dividend yield, the effect of stock-splits on portfolio stock holdings total value and revenue income streams need to be considered. Year-on-year dividend yield, dividend growth and total dividends paid matter, in calculating and assessing the ability of companies to sustain returns to shareholders.
Dividend Performance Comparison Table. To expand on the current performance snapshot above, I have collated raw data from 1996 to 2012 from both Caterpillar and Cummins investor pages on their websites, and then conducted a number of basic calculations to allow for the effects of stock splits on shares held, capital value, dividend yield, dividend growth and dividend revenue.
The calculations are based on holding one share in each company as at the first recorded dividend paid date on their website, and what that one share holding is worth as at 2 November 2012. An end of year snapshot is taken on/about 1 December annually. The collated results are detailed below:
Dividend Yield. The annual dividend yield based on these calculations are listed below; current yields are 2.25% for CAT and 1.81% for CMI. It is worth noting that for the last six years CAT has outperformed CMI for dividend yield, and CMI outperformed CAT for the nine years prior. Neither company has sustained dividend growth based on yield alone.
Dividend Growth. While dividend yield seems to indicate CAT is stronger in current markets based on annual yield, when we look at dividend growth on a year-on-year basis, both companies have erratic performance. Both companies have significant fluctuations in dividend growth although CMI's fluctuations appear more severe than CAT. Of concern for dividend growth investors though is CMI has one instance in 2001 where dividend growth was negative (2001) and two years where dividends paid experienced no growth on the year prior (2004 & 2005). These three instances for CMI are shaded red in the table below.
Total Dividends Paid. Allowing for the effects of two 2-for-1 stock splits per company, the cumulative effect of total dividends paid per holding is illustrated below. Noting the differing outcomes of the previous two tables, the striking difference here is that the holding for Caterpillar has sustained a year-on-year increase for total dividends paid for 17 years straight.
While Cummins has accelerated it's total dividends paid in the last five years, when compared against Caterpillar it has one year where the total dividends paid halved (dividends only paid twice in 2001), followed closely by two consecutive years where the dividends paid experienced no annual growth (2004 & 2005). These three instances for CMI are shaded red in the table below. The company also conducted two 2-for-1 stock splits in 2007 (although the second stock split was payable in January 2008).
Cyclical Demand Versus Inelastic Demand
What may be affecting the consistency of dividend yield and dividend growth is the cyclical nature of the markets that Caterpillar and Cummins support with their products. Both companies are prone to movements in share price and revenue driven by cyclical markets; commodities markets are a good example, whereby demand increases during a mining boom (as has been the case in recent years) and wanes during a downturn (as mining markets have experienced in recent months).
The consistency of their returns is more affected than a company whose products are subject to inelastic product demand, such as a listed entity producing and supplying baby formula and diapers; irrespective of what markets are doing the demand for these items remains. That is not to say that companies subject to cyclical markets are not suitable for inclusion in a DGI portfolio, but rather it is another factor that needs to be taken into consideration for stocks like Caterpillar and Cummins.
Summary and Recommendation of Actionable Item
Having reviewed each of the companies performance with respect to dividends, we can see that yield, growth and total dividends paid offer a different perspective on whether either company is suitable for inclusion in a DGI portfolio. While both companies seem to fail for sustained upwards movement in dividend yield and dividend growth, the final table demonstrates underlying potential for Caterpillar to be considered by dividend growth investors, noting it's sustained growth of total dividend return.
Of course, dividend growth and dividends paid represent only one aspect of selecting and retaining stocks in a DGI portfolio; capital growth of the underlying stock and future potential of the company are equally as important. The summary table of consolidated data above illustrates the year-on-year performance of each stock, showing the progression of stock value, shares held and total dividends paid, allowing for one share of each stock being held at the commencement of the 17 year comparison.
The summary table illustrates that on a total return basis for dividends Caterpillar outperforms Cummins for the first 14 years, however Cummins has made significant gains in the last three years. Whether or not these can be sustained remains to be seen given present market conditions. Both companies dividend yield is currently below a level that would be desirable for DGI portfolios, however Caterpillar's consistent track record for total dividends paid over 17 years make it a potential future candidate for inclusion in a DGI portfolio. This would obviously be subject to investors conducting their own due diligence regarding market conditions and potential issues likely to affect future revenue and performance for each company.
Disclosure: I am long CAT.