This time of year I like to pull old books off the shelf to remind myself of what I’ve forgotten, but maybe shouldn’t have.
Peter Lynch, the consummate stock picker whose Magellan Fund trounced the market for a couple of decades, wrote several books that are old now.
In one, Lynch proposed a nifty classification for stocks that’s not based on market cap or sector or style box or yield, but instead on how stocks behave and what investors might expect of them. He named his categories Stalwarts, Slow Growers, Fast Growers, Cyclicals, Turnarounds and Asset Plays.
Lynch didn’t use these classifications to categorize dividend stocks, but I thought I’d give it a try because I wondered whether it would shed any insight on dividend growth portfolios.
Stalwarts to Lynch were blue chips like Bristol Myers (NYSE:BMY), Coca Cola (NYSE:KO) and Johnson and Johnson (NYSE:JNJ). Steady earnings growers you might not brag about, but that would probably make money for you over time.
For investors seeking dividend growth, these might be the Dividend Achievers and Aristocrats at the core of many portfolios. Examples include JNJ, KO and Proctor and Gamble (NYSE:PG) in healthcare and household staples, but also a consumer cyclical like McDonald’s (NYSE:MCD) or steady retailer like Walmart (NYSE:WMT). Long-term holdings that compound yield-on-cost, year after year, steady as she goes.
Because these represent such high quality stocks, I would not be surprised to learn this category, along with the next one, is heavily weighted in many dividend growth portfolios.
Slow Growers are exactly what they sound like. Not much earnings growth, so not much capital appreciation or dividend growth. But these can be high yielding workhorses that plow for income an investor can spend right now or reinvest in new shares.
In Lynch’s day, prototypical Slow Growers were utilities. That’s probably still true, though skilled yield hunters seem to find solid but slow growing stocks in telecom and others industries as well.
And some Slow Growers can provide stellar returns. Dividend raiser DPL, Inc. (NYSE:DPL), a 4% yielding Midwest utility, outperformed the S&P 500 over the trailing 2-years and 5-years, and has maintained strong performance over more recent periods as well.
Fast Growers are also exactly what they sound like. Lynch loved these. And who wouldn’t, their earnings and stock prices are twin skyrockets.
The problem here for dividend investors is whether they are willing to trade off current yield for future growth. Take a stock like Factset Research Systems (NYSE:FDS), a midcap technology Dividend Achiever that typically yields 1% to 1.5%.
Chintzy, sure, but FDS earnings grew an average of 23% over the past 10 years, so even with two bears taking a bite, the stock doubled since the year 2000.
And true to Lynch’s typology, the search for fast growers needn’t be limited to tech stocks yielding 1%. How about 3% yielding Dividend Achiever Meridian Bioscience (NASDAQ:VIVO), a maker of diagnostic tests in the healthcare sector?
VIVO has racked up 10-year earnings growth averaging 27% annually. The stock? Up 400% from the market top in the year 2000.
Lynch would love these two. And I feel lucky to have discovered them in time to catch some large profits. Because Fast Growers are often lower yielding and less known than Slow Growers and Stalwarts, I would not be surprised to learn they are underrepresented in many dividend growth portfolios.
Granted, investors maximizing income for current spending might not have room in their portfolios for such stocks. But what about investors who are accumulating capital and won’t tap portfolio income for decades?
Cyclicals, by Lynch’s thinking, are easily misunderstood stocks that can lose lots of your money if you get your timing wrong.
Tell me about it, I own General Electric (NYSE:GE).
But investors looking for dividend growth can also find industrials here like Dividend Achiever United Technologies (NYSE:UTX), and others, that provide exposure to international infrastructure build out, and to business investment in general.
Experienced investors have learned it’s better to add to these positions when economic recovery is still uncertain and subtract when the economy is booming, because doing it the other way around is a formula for losses.
Broadly, of course, cyclicals would create growth potential during economic rebounds in portfolios include lots of Stalwarts; while industrial cyclicals diversify portfolios that otherwise might rely too much on consumer spending.
Turnarounds, in Lynch-language, are troubled stocks that bottom fishers dredge for. Companies healthy enough to pay dividends wouldn’t sink to the bottom of this murky pool, so the more relevant lesson might be that bottom fishing is slightly less treacherous with proven dividend growers, especially if they are being pulled under by a thrashing market or sector.
Several posters on this site have had success at this type of turnaround, which can result in outstanding yield-on-cost and substantial capital gains. But it is much easier to say it than do it, so kudos to those with the skills and stomach to do it well.
Asset Plays would also be different, I think, for dividend growers than what Lynch originally proposed. Specifically, dividend growth seekers can find commodity-related investments, such as REITs, and energy and mining stocks, to provide an inflation hedge. After all, gold bars and commodity futures contracts don’t pay growing cash dividends.
But REITs like Dividend Achiever Realty Income (NYSE:O) provide a 6.5% yield, while commodity producers like Australian miner BHP Billiton (NYSE:BHP), which has a “progressive dividend policy” of regular increases and a 2.2% yield, can also offer currency diversification, though not all dividend investors find that a compelling benefit.
So Peter Lynch’s One Up On Wall Street, first published in 1989, goes back on the shelf. But not before I got a different view of my stocks than my portfolio tracker gives me.
My main finding? Though I added to some current positions when the market pushed them into the “Turnarounds” category, I did not initiate any new positions in such stocks. That could have been profitable, based on stocks on my watch list. Ah, well, what might have been!
Finally, for brief profiles of some of the stocks mentioned here, and an in-depth laugh at GE, follow the Seeking Alpha links below.
There’s also a link to Lynch’s old book, though if you’d prefer to check out new books about real life adventures of a globe-trotting bond trader, or the economics of old-time pirate crews, follow the links to my Seeking Alpha book reviews.
References and Links
DPL, brief profile in “The Best and Worst of Recent Dividend Hikes,” December 14, 2009.
FDS, brief profile in “Three Midcap Tech Stocks with Rising Dividends,” August 24, 2009.
GE and brief discussion of UTX in “Earth to GE: Boost Your Dividend,” December 07, 2009.
O, brief profile in “The Super and Stupor in Recent Dividend News,” December 17, 2009.