A Growing Safety Consciousness
Safety of dividend income has become a stronger priority for me due to the longevity of this bull market and the volatility caused by the recent precipitous drop in oil prices.
Diversification is an important factor in portfolio safety. In what may be viewed as a counter-intuitive move, I have reduced the number of holdings in my retirement income portfolio from 46 to 24. As a way to mitigate the potential risk of having more concentration in each holding, I am designing the portfolio around the companies about which I have the most conviction.
For several years, I have "ranked" the portfolio companies by their tenure on David Fish's list of Dividend Champions, Contenders and Challengers. I list them this way on my spreadsheet as a way of reminding myself to be slow to part with those companies near the top of the list and to be more vigilant about evaluating the companies near the bottom of the list.
A few months ago, I asked myself whether the portfolio design should change as I move through the early, mid to late years of retirement. My tentative plan was described in a Seeking Alpha article about an alternative design for a portfolio. The short version is that as I become older, my goal is to hold an increasing percentage of Dividend Champions.
Rank According to Conviction
The current oil-induced market slide has progressed from correction to bear market to near-panic among some oil-related companies. On December 10th, Steven Grasso said on CNBC's Fast Money, "Oil can go much lower. It can go to $45. If it goes to $45..." Melissa Lee interjected, "What happens to the market?" Grasso replied, "Well, at this point, it's going to collapse..."
It has been five and a half years since I've heard warnings of a broad market "collapse" from an analyst or trader.
After my recent article about Helmerich & Payne, a comment by Seeking Alpha member HVAC52 prompted me to share in that comment thread my recent "rankings" of my holdings, primarily with dividend safety in mind. As I went through the exercise of ranking the companies in the portfolio, I tried to think, "If I had to sell every holding but one, which one would I keep?" And, "If I had to sell just one tomorrow, which one would it be?"
I invite you to do this exercise with your holdings. You may be surprised at how you rank them, and you may learn something new about your companies and your attitude toward them. This is how I ranked my 24 holdings:
- Johnson & Johnson (NYSE:JNJ)
- W.P. Carey (NYSE:WPC)
- Procter & Gamble (NYSE:PG)
- Genuine Parts (NYSE:GPC)
- Kinder Morgan (NYSE:KMI)
- 3M (NYSE:MMM)
- Emerson Electric (NYSE:EMR)
- PepsiCo (NYSE:PEP)
- Starwood Properties (NYSE:STWD)
- National Retail Properties (NYSE:NNN)
- HCP, Inc. (NYSE:HCP)
- Realty Income (NYSE:O)
- AT&T (NYSE:T)
- Chevron (NYSE:CVX)
- Wisconsin Energy (NYSE:WEC)
- Helmerich & Payne (NYSE:HP)
- WGL Holdings (NYSE:WGL)
- Northwest Natural Gas (NYSE:NWN)
- Hannon Armstrong (NYSE:HASI)
- McDonald's (NYSE:MCD)
- Hercules Technology (NASDAQ:HTGC)
- Tupperware (NYSE:TUP)
- Triangle Capital (NYSE:TCAP)
- Linn Co. (LNCO)
Two Other Ways to Rank Your Holdings
The above list is reproduced in the left side of the table below, alongside two other ways to rank your holdings.
In the center columns, I offer a way that I have already mentioned - how I list the holdings in my retirement account on my worksheet. The year given is the year in which the company began its streak of (at least) annual consecutive dividend increases.
The right side of the table below was prompted by Seeking Alpha contributor Bob Wells. In the comment thread following my Helmerich & Payne article, he raised a good point about the process of ranking one's holdings. He asked how much weight I put in the credit ranking of each stock. Bob pointed out that Lowell Miller and Chowder require BBB+ or higher rating.
Bob always asks excellent questions. His question inspired me to add a new column to my spreadsheet. I checked the long-term debt ratings given to the various companies by Standard & Poor's. I did not find an S&P rating for STWD, but I found ratings for this company by Moody's. The right column below reveals my findings. As with most investment data, these ratings are "moving targets" and may not be the latest available data. Where available, I used the rating for a company's long-term debt.
Genuine Parts and Helmerich & Payne are not rated, although they have stellar balance sheets with little debt. Thus, I have listed them below the companies given an BBB- rating by S&P.
You can find the credit ratings for various Hannon Armstrong investments, ranging from AAA to not-rated. Their higher-rated projects are government-related.
(Credit ratings were updated on December 29, 2014.)
Dover Corporation (NYSE:DOV) Added to Watchlist
On Friday, December 12, I discovered that Dover, an old friend and former holding from years back, closed at $67.82, just six cents above its 52-week low (also reached on Friday) of $67.76. The current price is 26% off the 52-week high price of $91.84.
About one-fourth of Dover's business is related to the oil industry. So, this excellent diversified industrial company has been caught in our current oil-induced downdraft. Is this an unusual buying opportunity for a company that tends to trade at a premium valuation? Or, is this one of the many "falling knives" to be avoided in today's market?
I decided to dig a little deeper.
Dover's website describes the Downers Grove, Illinois company as a diversified global manufacturer with 28,000 employees and annual revenues of $8 billion. Dover delivers innovative equipment and components, specialty systems and support services through four major operating segments: Energy, Engineered Systems, Fluids and Refrigeration & Food Equipment. Dover combines global scale with operational agility. The company cites its almost 60 years of an entrepreneurial approach, where employees take an ownership mindset and collaborate with customers to redefine what's possible.
The Energy segment is the part of the company's operations that has caused analysts to turn cautious on Dover. Seeking Alpha contributor The Value Investor wrote an article about Dover in October 2014, when DOV traded at about $80 per share, which TVI viewed as a fair valuation "given the growth, the past performance" and "the modest leverage on the balance sheet." TVI followed this with a December 8 article about analysts' new caution. In that article, TVI wrote that Dover "might re-test the October lows at around $70 per share," where he/she would be "willing to pick up a few shares on the back of the appealing multiples, the strong historical dividend track record, and long term track record of the business."
Dover states that its energy segment serves the drilling and production markets by developing "high-performance artificial lift, pumps, high-accuracy sensor and monitoring solutions that advance the efficiency and safety of extracting oil and gas."
Brands in the Dover Energy segment are Cook Compression, Dover Artificial Lift, Quartzdine, TWG, US Synthetic and Waukesha Bearings. The company's website has a short animated video that describes how Dover Energy products help customers succeed in the drilling and production sector.
Dover says the Engineered Systems segment is involved with printing, identification, vehicle service, aerospace components and waste-handling equipment. The company "collaborates closely with customers to innovate for greater speed and accuracy in production to increase their profitability." It leverages its "geographic scope and diverse expertise across specialized industries to develop more effective solutions" for customers.
Brands in Dover's Engineered Systems segment include Datamax-O'Neil, DE-STA-CO, Environmental Solutions Group, Markem-Imaje, Microwave Products Group, MS Printing Solutions, OK International, Performance Motorsports Inc., Sargent Aerospace & Defense, Texas Hydraulics, Vehicle Service Group and Warn Offroad.
Dover seeks to "drive excellence in the global pump and fluid handling markets, collaborating with customers to develop innovative, efficient solutions." Products include specialized tubing equipment for fueling and vehicle wash, as well as transference and dispensing of critical materials to meet ever-changing market demands. Dover says it is "constantly growing into new geographies and end-markets such as energy, chemical, food and pharmaceutical to expand performance for customers."
Refrigeration & Food Equipment
By now, you may have the picture that Dover sees its forte as "driving excellence" and collaborating with customers to design and build the products they need to enhance their profitability. Dover states that it works "relentlessly to increase efficiency and decrease cost to elevate customers' performance in refrigeration, electrical equipment, heating and cooling and food and beverage packaging." Dover strives to "innovate strategically to meet ever-changing market demands, and help customers improve sustainability, surpass expectations for end-consumer needs and drive growth in emerging economies."
If you click on some of the above links, you will get a tour of Dover's worldwide diversified industrial manufacturing operations.
Dover's roots are in the Automobile Rotary Lift Company, founded in 1925. Known as Rotary Lift, the company was instrumental in popularizing the hydraulic lift elevator. In 1955, Dover Corporation was founded with Rotary Lift as its first division. Rotary Lift continues to manufacture automobile lifts as part of Dover's Vehicle Service Group (above). Many US citizens know the Dover name through the company's production of passenger elevators. However, the Dover Elevator Division was sold in 2000 to the German industrial conglomerate ThyssenKrupp. Ironically, Dover now makes almost everything except passenger elevators!
After spending considerable time trying to track down my portfolio companies' debt ratings, I'm pleased to say that Dover has a dedicated web page for its debt ratings. The company's long-term debt is rated A by S&P, A2 by Moody's and A by Fitch. I rate it "A" for transparency.
Dover is #2 on David Fish's list of Dividend Champions at 59 consecutive years of dividend increases. Dover is just behind #1 American States Water, and just ahead of #3 Northwest Natural Gas. Genuine Parts is #4 and Procter & Gamble is #5.
David Fish puts Dover's 5-year dividend growth rate at 10.0%. Combined with a current yield of 2.36%, the Chowder Rule number is 12. I think I just heard someone say, "Bingo!"
On December 13, I completed a Stock Selection Guide for DOV. This tool was developed by the National Association of Investment Clubs in the 1950s. The SSG looks at ten years of history to determine a potential price range during the next five years. Data is from Morningstar via NAIC's Better Investing website. (I first completed an SSG on Dover in the early 1980s, when DOV was purchased by my investment club.)
The closing price on December 12 2014 was $67.82. The 52-week price range is $67.76 to $91.84. The average high Price/Earnings ratio for the past five years is 14.2. The average low PE ratio has been 9.0. The average PE ratio for the past five years is 11.6. The current PE ratio is 13.8.
Here are the price ranges, the earnings per share, dividends and the high yield achieved in each of the past calendar years (DOV's fiscal year ends December 31). Since we are near the end of 2014, I'm including the 2014 year-to-date data:
|Year||Low Price||High Price||EPS||Dividend||High Yield|
* On December 8 2014, Dover released updated guidance for 2014, projecting earnings per share of $4.55 to $4.62.
The current dividend is $.40 per quarter, for an annual rate of $1.60. The quarterly dividend was raised from $.375 to $.40 with the dividend paid on September 15 2014.
At a 12/12/14 closing price of $67.82, the yield was 2.36%. This is the high yield so far in 2014, which is below DOV's high yield for each of the past five years. This suggests that the price could continue to drop. I used a 2.7% yield as a support level for the stock price when I calculated a projected low price for the stock. At the current dividend of $1.60, a 2.7% yield would result in a price of $59.26. If the price of oil continues to decline, a 3.2% yield may be a more prudent estimate for a possible low price, which would be $50.00.
I projected a possible high price during the next five years of $108.30. This assumes a high PE of 14.2 (the 5-year average high PE) and an estimated high earnings of $7.63 per share (which was based on an estimated 5-year average annual EPS growth of 6.5%).
These projections created a possible "buy" zone from $59.26 to $71.50, and a possible "sell" zone from $96.10 to $108.30.
The 12/12/14 closing price of $67.82 (which is in the "buy" range) reflects a potential compound annual return of 12.1%, including dividends over the next five years, if the possible high price of $108.30 is achieved.
Another factor to consider before making an investment in Dover is that the current PE ratio of 13.8 is above the 5-year average PE ratio of 11.6. The current trailing 12-month EPS is $4.91, and Dover now estimates its 2014 EPS will be $4.55 to $4.62. A PE ratio of 11.6 on earnings of $4.55 would result in a stock price of $52.78.
This is not a recommendation to buy or sell Dover (or any other security). I present this as an idea for a stock to study. Please do your own study and due diligence. I have no position in DOV, but I have added it to my watchlist. One factor that I must weigh in my deliberation is that I recently purchased shares of Helmerich & Payne, which is in the oil drilling business. This may not be a good time to be overly exposed to that industry. On the other hand, this may be an opportune time to be investing in that industry.
Disclosure: The author is long NWN, GPC, PG, EMR, MMM, JNJ, PEP, HP, MCD, WGL, T, HCP, CVX, NNN, O, WPC, WEC, TCAP, STWD, TUP, LNCO, KMI, HTGC, HASI.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The credit ratings were updated on December 29, 2014.