Strong dividend stocks with outstanding future growth prospects is the holy grail of the long-term investor. I like to make initial screens of high dividend companies - in this case above 4% annual yield - along with filters for Price to Earnings per Share Growth, Payout Ratio, Return on Equity and Long-Term Debt/Equity Ratio.
Price to Earnings Per Share Growth
This measure illustrates the growth of earnings per share over time. The 1-Year Expected PEG Rate is an annualized growth estimate, based on growth projections made by analysts, the company or other credible sources. You do have to be a little careful looking at who is doing the projections. There needs to be some strong basis for why the company should be able to grow earnings into the future. Essentially if the EPS Growth Rate is higher than the PE Ratio, you are at a good purchase point.
The Payout Ratio evaluates the company's ability to continue paying its dividend, by comparing the dividend paid out per share with its earnings per share. The general rule is that for most companies a payout ratio below 60% is conservative, between 60%-80% is more aggressive and should be watched, while above 80% and especially nearing 100% is alarming. Any payout ratio at or above 100% is unsustainable long term. There are exceptions to this. One example is mortgage REITs. Due to the tax laws they operate under they are required to pay out a minimum of 80%, 90% and above and frequently mREITs will touch above 100%. In any case companies that pay more than 100% are paying investment capital back to shareholders - a massive red flag to future growth.
Return on Equity
ROE is considered a measure of management effectiveness. It measures how much profit a company generates based on the amount of money investors have in equity in the company. The higher the number the better the company is growing profits.
This value computes the proportion of a company's debt compared with its shareholder equity. This identifies the amount of leverage the company uses, the amount of leverage in borrowed funds utilized by a specific company. It is best to compare the numbers to industry averages since different economics require different amounts of capital investment. In all cases, higher numbers are riskier than those with lower leverage ratios since companies with higher ratios are paying more potential profits out in interest payments. This can be a huge drag on earnings going forward.
By themselves each of these filters is merely information and they should not be followed blindly. The information needs to be analyzed against the current company, market and economic situation to see how everything fits together in order to make the best investment decisions.
Taking all the above information into consideration, I use the companies that pop out from my dividend screen as a starting point for some closer analysis. For this article I want to look at a random group of some higher dividend shares: Avon Products, Inc (AVP), Bristol-Myers Squibb Company (BMY), BP plc (BP), and Exelon Corporation (EXC). I will then look at them in a little more detail for PEG, ROE and the Debt/Equity ratio.
Avon Products Inc.
Avon Products, Inc. manufactures and markets beauty and related products worldwide. The company markets its products through direct selling and independent representatives. Avon Products, Inc. was founded in 1886 and its headquarters is in New York, New York.
Avon was recently quoted at $15.69 per share. Its price earnings ratio is at 27.46 off of earnings per share at $0.57. It has a 52-week trading range of $14.50-$23.58.
AVP data by YCharts
The price has been in a long downslide since late 2009 and has been testing new lows. I don't mind the historical slide, but I would at least like to see some sign it has stabilized or started to at least ease up. Worse, the payout ratio has exploded to 349%. That is incredibly alarming. It has an annual dividend of $0.92 producing a yield of 5.80%. Its five-year average dividend yield is at 3.20%. But with that payout ratio the dividend is completely unsustainable. Unless there is some massive reason to believe the situation will drastically change I expect the dividend will be cut.
UPDATE: During the process of writing this article Avon announced a 73% cut in its dividend from $0.23 to $0.06 while share price has fallen to $15.11.
The company has a PEG of 1.76% compared with a PE of 56.4. Its total debt-to-equity ratio for the most recent quarter is at 2.53 compared with an industry average of 0.62.
AVP PEG Ratio data by YCharts
While the original dividend looked good, everything else looks out of whack. The PEG is miniscule versus the PE ratio. In particular the ROE has steadily fallen from around 93% in early 2009 to a more recent 7.19%. There is nothing here to recommend as a dividend investment, although a person who likes to short must love Avon, recently and into the foreseeable future.
Bristol-Myers Squibb Company
Bristol-Myers Squibb is a pharmaceutical company. Its principal products include PLAVIX for protection against fatal or non-fatal heart attack or stroke, as well as a host of other medicines used in the treatment of hypertension, diabetic nephropathy, stroke prevention, schizophrenia, bipolar mania disorder, depressive disorder and for the treatment of HIV.
The company was recently quoted at $33.05 per share. Its price-earnings ratio is at 16.22 off of earnings per share at $2.80. It has a 52-week trading range of $30.10-$36.34. The company has an annual dividend of $1.36 producing a yield of 4.10%. Its five-year average dividend yield is at 4.60%.
BMY data by YCharts
The share price has been heroically advancing since 2009. However that payout ratio stands at 121.3%, jumping from the 65% range just earlier this year. The company has a PEG rate of 10.33%. Its total debt-to-equity ratio for the most recent quarter is at 0.53 compared with an industry average of 0.46.
BMY PEG Ratio data by YCharts
The company is coming off a sharp earnings cliff after the expiration of its exclusive patent rights to its cardiovascular drug Plavix. Earnings were down 18% in 2Q 2012. Seeking Alpha contributor Trefis wrote an excellent article on the subject, including the following thoughts:
In the third quarter, we anticipate the decline in revenue and net income will continue due to the ongoing fall in sales of Plavix and Avapro. This decline will be partially offset by sales growth of other key drugs in the company's portfolio, namely Yervoy, Onglyza, Baraclude, Sprycel, Orencia, and Nulojix, among others. Earnings will also benefit from the Amylin acquisition, completed in the third quarter. This acquisition provided Bristol-Myers the anti-diabetic drugs Byetta and Bydureon, whose sales will add to the company's top line growth in the third quarter.
I think Bristol Myers looks good for the future, but I would want to see earnings stabilize before I actually jump in. I would put this stock on on my watch list and reconsider at the next quarterly results.
BP p.l.c. is big energy production on an international scale. It also owns and manages crude oil and natural gas pipelines; processing facilities and export terminals. The company continues to recover from the massive Gulf of Mexico oil spill.
BP was recently quoted at $41.77 per share. Its price-earnings ratio is at 7.76 off of earnings per share at $5.38. It has a 52-week trading range of $36.25-$48.34. It has an annual dividend of $1.92 producing a yield of 4.60%.
BP data by YCharts
Price is down after the Gulf Coast oil spill but has settled into a solid trading range. The five-year average dividend yield is at 5.60% and it maintains a conservative 30% payout ratio. There was no growth in earnings per share due to the disaster. Its total debt-to-equity ratio for the most recent quarter is at 0.42 compared with an industry average of 0.33. Both are numbers are conservative.
BP PEG Ratio data by YCharts
Return on equity for BP historically is in the 15%-25% range, with the exception of the wildly fluctuating numbers surrounding the Gulf of Mexico spill.
As far as yield, financial strength and earnings the company looks outstanding, with the exception of the worries revolving around the legacy of the Gulf of Mexico. In its 3Q Earnings release management stated:
BP expects to make a final payment of $860 million into the $20 billion Gulf of Mexico Trust Fund in the fourth quarter of 2012. At the end of the third quarter, the cash balances in the Trust Fund and the Qualified Settlement Funds amounted to $10.9 billion, with $19.1 billion contributed and $8.2 billion paid out.
Management goes on to say:
The US Department of Justice (DoJ) has been conducting an investigation into the Gulf of Mexico oil spill regarding civil and criminal laws. BP is in ongoing discussions with the DoJ and other federal agencies regarding a possible settlement of these claims and whilst it is ready to settle on reasonable terms, a number of unresolved issues remain and there is significant uncertainty as to whether an agreement will ultimately be reached. BP has repeatedly said that it is willing to settle on reasonable terms but otherwise continues to prepare vigorously for the start of trial MDL 2179, now scheduled for late February 2013.
I expect most if not all of the company's legal and civil penalty issues over the Gulf Coast will be finalized in 2013, and in any case I expect all likely negative results are already reflected in the share price. I expect the dividend will be safe, and the company will go about growing earnings again. I consider BP a buy now, although more conservative investors may want to wait until later in 2013 to make sure there are no legal complications.
Exelon Corporation is a utility services holding company in the United States. It is involved in the generation of electricity from nuclear, fossil, hydro, and renewable energy sources in northern Illinois, southeastern Pennsylvania, and central Maryland.
Exelon was recently quoted at $35.87 per share. Its price-earnings ratio is at 15.26 off of earnings per share at $2.80. It has a 52-week trading range of $34.54-$45.4 and has an annual dividend of $2.10 producing a yield of 5.80%.
EXC data by YCharts
Shares are down about 25% for the year, while the payout ratio has jumped from a normally conservative level below 40% to above 80%. Its five-year average dividend yield is at 4.00%. There was no growth with the company's earnings per share.
Why? Well according to an article by Jim Polson in Bloomberg.com, electricity spot prices have crashed:
Benchmark wholesale electricity prices in PJM Interconnection LLC, the nation's largest power market, have fallen 35 percent since that time to average $41.60 a megawatt- hour in October.
EXC PEG Ratio data by YCharts
Meanwhile costs at its nuclear power plants have sharply increased. Rising costs and decreasing earnings is always bad news. The good news is its total debt-to-equity ratio for the most recent quarter is at 0.87 compared with an industry average of 1.18. Still, the share price continues to fall due to worries that the board will need to cut the dividend.
Four dividend stocks all with strong dividend yields but further analysis shows how different they all are. In my book, BP is a buy now while the others need to be avoided. Bristol Myers may become a long-term buy next year.