# Using The H Model To Value Dividend Aristocrats

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Includes: ABT, PBI, SYY, T, WBA
by: Richard Bulkeley

The H Model or Gordon growth model is another way of valuing a company. It says that the value of a company is the net present value of all of its future dividends. The model is best suited to companies with a stable track record of increasing their dividends and who pay out a relatively consistent and high proportion of earnings as dividends. These are precisely the kind of companies a dividend investor should be interested in. I also like the H Model because of its implicit assumption that companies will eventually slow down to approximately the growth rate of the general economy.

For those of you who like math, the formula is below. Those of you who don't like math may want to have a look at it anyway; it's not as complicated as it first looks, I promise.

Value = (Div * (1+LG)) / (R-LG) + (Div * H * (EG - LG)) / (R-LG)

Div is the company's current annual dividend per share

LG is the long term average growth rate of the economy

H is half of the number of years you believe it will take the company to revert to the long term average growth rate

EG is the exceptional growth rate (the current medium term dividend growth rate)

R is your required return on the stock

This article looks at 22 of the larger market cap Dividend Aristocrats through a simple H Model to try and screen for those that might form part of a dividend portfolio. Values will be sourced as follows:

Div will be the dividends paid in 2012.

LG will be 2.5% (since 1947 the average has been 3.47% so I am being somewhat pessimistic).

H will vary from company to company because some companies are more able to sustain a competitive advantage than others. A generally accepted range is 10-20 years of exceptional growth (so an H of 5-10). For this initial survey I will use the company's P/E ratio to give the years of exceptional growth because it tends to fall between 10 and 20 for established stocks and is a shortcut for how the market views the company's future prospects. It's a bit of a hack, but it will do for an initial survey.

EG will be the average dividend increase for the last five years.

R will be 10% because that's what I require for established stocks - it's not just based on being a round number, there is some thought about sustainable real rates of return in there too.

So, let's look at the table:

 Dividends per share H EG Price Value Difference Yield 3M Co (NYSE:MMM) 2.54 8.3 4.23% 105.09 39.58 -62% 2.4% Abbott Laboratories (NYSE:ABT) 2.01 4.7 9.63% 35.01 36.27 4% 5.7% AT&T (NYSE:T) 1.8 14.6 5.32% 36.6 34.51 -6% 4.9% Automatic Data Processing (NASDAQ:ADP) 1.74 11.2 11.70% 64.18 47.68 -26% 2.7% Bemis Co Inc (NYSE:BMS) 1.04 11.7 3.55% 38.87 15.92 -59% 2.7% Clorox Co (NYSE:CLX) 2.56 9.84 11.90% 83.94 66.54 -21% 3.0% Coca-Cola Co (NYSE:KO) 1.12 9.8 8.46% 38.59 24.02 -38% 2.9% Colgate-Palmolive (NYSE:CL) 2.72 11.2 11.80% 114.9 74.81 -35% 2.4% Consolidated Edison Inc (NYSE:ED) 2.46 7.6 0.85% 58.77 29.49 -50% 4.2% Emerson Electric Co (NYSE:EMR) 1.64 10.1 8.24% 56.2 35.05 -38% 2.9% Exxon Mobil Corp (NYSE:XOM) 2.28 4.6 9.84% 89.26 41.43 -54% 2.6% Johnson & Johnson (NYSE:JNJ) 2.44 10.2 8.19% 78.55 52.19 -34% 3.1% Kimberly-Clark (NYSE:KMB) 3.24 10.6 7.03% 93.4 64.96 -30% 3.5% McDonald’s Corp (NYSE:MCD) 3.08 9.3 14.02% 99.38 85.96 -14% 3.1% Medtronic (NYSE:MDT) 1.04 6.8 17.24% 45.87 28.08 -39% 2.3% PepsiCo Inc (NYSE:PEP) 2.15 9.8 9.39% 76.95 48.76 -37% 2.8% Pitney Bowes Inc (NYSE:PBI) 1.5 3.4 2.61% 14.88 20.57 38% 10.1% Procter & Gamble (NYSE:PG) 2.25 8.7 10.23% 76.8 50.96 -34% 2.9% Sysco (NYSE:SYY) 1.12 9.3 7.36% 33.76 22.04 -35% 3.3% Target Corp (NYSE:TGT) 1.44 7.5 20.72% 67.43 45.78 -32% 2.1% Walgreen Co (WAG) 1.1 9.7 23.75% 42.78 45.21 6% 2.6% Wal-Mart Stores (NYSE:WMT) 1.88 7.3 13.98% 73.65 46.79 -36% 2.6%

So, this initial H Model survey of 22 Dividend Aristocrats returned just 5 that are currently undervalued. I don't view this as cause for concern for the following reasons:

1. Many Dividend Aristocrats currently offer a pretty lousy yield. For example, Target has a five year average dividend growth of 20.7% but its yield is only 2.0%. Low yield means the excess return available from the stocks is not very high.
2. I would always rather a model err on the size of caution. Most of the market is not particularly worth buying and I almost never short a stock so if the model filters out the average stocks by showing them as being over-valued then I am fine with that.
3. Better writers than me have argued that there is a dividend bubble / rush to yield happening. I agree with them. If this is correct then we would expect to see Dividend Aristocrats being over-valued by the market.

Stocks of interest are:

Abbott Laboratories - Unfortunately, ABT is not likely to pay \$2 in dividends this year as it split off ABBV (the research laboratories) at the start of the year. This is a problem with using historical numbers rather than forecasts, but you can't fake history. ABT's first quarterly dividend was \$0.14, which suggests a full year dividend of \$0.56 which puts it solidly back in the overvalued territory.

AT&T - AT&T is a nice low Beta stock (boring is good). Unfortunately, they are paying out a dividend that is higher than their earnings. This is not a good sign for the sustainability of that dividend. That's enough of a red flag to keep me out.

Pitney Bowes Inc - A 10% yield is pretty impressive. The problem is that PBI is in a pretty terrible industry - physical post. There are a lot of good signs that PBI might be able to turn things around and they are sitting on a pile of cash that makes for a pretty good dividend cushion while they try. It's definitely worth looking at more closely.

Walgreen Co - Walgreen have a very impressive dividend growth rate over the last five years and a long history of both dividend and earnings growth. I also like the macro factors - 75% of the US population live within 5 miles of a Walgreens, and the aging population suggests that demand for prescriptions and other health care items will be increasing. I'm not sold on the 2.3% yield but if they can keep growing it at even the 17% rate of this century then it will continue to be an attractive stock for a long time.

So there we have it. The H Model has given us five Dividend Aristocrats that may be worth a closer look, and a ten minute (or less) examination of each of them has singled out two that are worth doing due diligence on.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PBI, WAG over the next 72 hours. 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.