Health Care Stocks For A Dividend Growth Portfolio - Part 2

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Includes: A, ABBV, ABC, ABT, AMGN, AZN, BAX, BAYRY, BCR, BDX, BMY, CAH, DGX, GILD, GSK, JNJ, LLY, MCK, MDT, MRK, NVO, NVS, PFE, PRGO, RHHBY, SNY, STJ, SYK, TEVA, TMO, ZBH, ZTS
by: Factoids
Summary

A well-diversified portfolio would have close to a 10% weighting in this sector.

This sector offers the change for major price appreciation along with dividend growth.

This article uses current valuation metrics to identify attractive options in this sector.

It has been six months since I published "Retirement Portfolio for Dummies - The Health Care Components". It is time for an update. In part one of this article, I provided the year to date data along with the EPS history and P/E ratios. I showed total returns since 2010. I parsed the data in ways that assisted in understanding the current valuations. I provided historical data that justified the assessment that now is an average time to buy into this sector.

In this part of the update, I will set my five-year forward dividend CAGR (Compound Annual Growth Rate) projections. My risk assessments will come in the form of setting RRRs (Required Rates of Return) that are strongly based on the current debt credit ratings, and lightly based on debt to market capitalization ratios along with historical earnings projection accuracy. I will then provide a ten stock buy list on this 32 components universe based on the "yield + CAGR - RRR" formula.

Those who have read my prior articles have mostly acclimated to my metric-driven assessment process. First-time readers will have more numbers thrown at them than they can juggle. I find this sector attractive because of its potential to capture lots of dividend growth. And that is a good place to start this presentation:

Dividend Growth History based on Q2 Dividends

The dividends are displayed rounded to a tenth of a the penny, while some have dividends encoded in the data at a hundredth of a penny. For the last two columns, "Av Growth Last 2Yrs" is for the average dividend growth over the last two years and "Av Growth Last 6 Yrs" is average growth over six years. The average is derived by calculating the dividend growth for each year, and dividing by the number of years. This is not a compounded growth rate.


Dividends/Share/Quarter Percentage Dividend Growth Av Growth
Company and ticker 2009 2010 2011 2012 2013 2014 2015 09-10 10-11 11-12 12-13 13-14 14-15 Last 6Yrs

Agilent Technologies (NYSE:A) 0.0 0.0 0.0 7.1 8.6 9.4 10.0 na na na 20.00 10.02 5.93 na
AbbVie Inc. (NYSE:ABBV) 0.0 0.0 0.0 0.0 40.0 42.0 51.0 na na na na 5.00 21.43 na
AmerisourceBergen Corporation (NYSE:ABC) 5.0 8.0 11.5 13.0 21.0 23.5 29.0 60.00 43.75 13.04 61.54 11.90 23.40 35.61
Abbott Laboratories (NYSE:ABT) 19.2 21.1 23.0 24.4 14.0 22.0 24.0 9.90 9.00 6.09 -42.62 57.14 9.09 8.10
Amgen Inc. (NASDAQ:AMGN) 0.0 0.0 0.0 36.0 47.0 61.0 79.0 na na na 30.56 29.79 29.51 na
AstraZeneca PLC (NYSE:AZN) 57.5 63.7 70.0 70.0 70.0 70.0 70.0 10.78 9.89 0.00 0.00 0.00 0.00 3.45
Baxter International Inc. (NYSE:BAX) 26.0 29.0 31.0 33.5 49.0 52.0 52.0 11.54 6.90 8.06 46.27 6.12 0.00 13.15
Bayer AG (OTCPK:BAYRY) 34.3 33.5 40.3 39.0 45.1 72.1 63.8 -2.59 20.36 -3.13 15.67 59.90 -11.55 13.11
CR Bard Inc. (NYSE:BCR) 16.0 17.0 18.0 19.0 20.0 21.0 22.0 6.25 5.88 5.56 5.26 5.00 4.76 5.45
Becton, Dickinson and Company (NYSE:BDX) 33.0 37.0 41.0 45.0 49.5 54.5 60.0 12.12 10.81 9.76 10.00 10.10 10.09 10.48
Bristol-Myers Squibb Company (NYSE:BMY) 31.0 32.0 33.0 34.0 35.0 36.0 37.0 3.23 3.13 3.03 2.94 2.86 2.78 2.99
Cardinal Health, Inc. (NYSE:CAH) 17.5 19.5 21.5 23.8 30.2 34.3 38.7 11.43 10.26 10.70 26.89 13.58 12.83 14.28
Quest Diagnostics (NYSE:DGX) 10.0 10.0 10.0 17.0 30.0 33.0 38.0 0.00 0.00 70.00 76.47 10.00 15.15 28.60
Gilead Sciences Inc. (NASDAQ:GILD) 0.0 0.0 0.0 0.0 0.0 43.0 43.0 na na na na na 0.00 na
GlaxoSmithKline PLC (NYSE:GSK) 40.9 46.0 52.6 54.9 55.0 64.0 69.5 12.47 14.35 4.37 0.18 16.36 8.59 9.39
Johnson & Johnson (NYSE:JNJ) 49.0 54.0 57.0 61.0 66.0 70.0 75.0 10.20 5.56 7.02 8.20 6.06 7.14 7.36
Eli Lilly and Company (NYSE:LLY) 49.0 49.0 49.0 49.0 49.0 49.0 50.0 0.00 0.00 0.00 0.00 0.00 2.04 0.34
McKesson Corporation (NYSE:MCK) 12.5 18.0 18.0 20.0 22.0 24.0 24.0 44.00 0.00 11.11 10.00 9.09 0.00 12.37
Medtronic Inc. (NYSE:MDT) 20.5 22.5 24.3 26.0 28.0 30.5 30.5 9.76 8.00 7.00 7.69 8.93 0.00 6.90
Merck & Co. Inc. (NYSE:MRK) 38.0 38.0 38.0 42.0 43.0 44.0 45.0 0.00 0.00 10.53 2.38 2.33 2.27 2.92
Novo Nordisk A/S (NYSE:NVO) 5.2 7.0 9.1 12.5 15.9 20.8 19.0 35.19 29.30 37.29 27.56 30.34 -8.43 25.21
Novartis AG (NYSE:NVS) 43.0 50.0 58.8 61.5 63.2 68.0 70.4 16.28 17.64 4.56 2.85 7.51 3.56 8.73
Pfizer Inc. (NYSE:PFE) 32.0 18.0 20.0 22.0 24.0 26.0 28.0 -43.75 11.11 10.00 9.09 8.33 7.69 0.41
Perrigo Company PLC (NYSE:PRGO) 5.5 6.3 7.0 8.0 9.0 10.5 12.5 14.55 11.11 14.29 12.50 16.67 19.05 14.69
Roche Holding AG (OTCQX:RHHBY) 13.3 17.4 21.5 23.2 25.3 27.5 27.1 31.32 23.26 8.26 8.71 8.66 -1.28 13.16
Sanofi (NASDAQ:SNY) 35.5 40.7 45.6 43.9 46.6 47.8 40.2 14.63 12.00 -3.62 6.04 2.58 -15.81 2.63
St. Jude Medical Inc. (NYSE:STJ) 0.0 0.0 21.0 23.0 25.0 27.0 29.0 na na 9.52 8.70 8.00 7.41 na
Stryker Corporation (NYSE:SYK) 10.0 15.0 18.0 21.3 26.5 30.5 34.5 50.00 20.00 18.33 24.41 15.09 13.11 23.49
Teva Pharmaceutical Industries (NYSE:TEVA) 14.5 18.8 23.2 26.1 32.0 34.7 34.0 29.66 23.40 12.50 22.61 8.44 -2.02 15.76
Thermo Fisher Scientific, Inc (NYSE:TMO) 0.0 0.0 0.0 13.0 15.0 15.0 15.0 na na na 15.38 0.00 0.00 na
Zimmer Holdings, Inc. (ZMH) 0.0 0.0 0.0 18.0 20.0 22.0 22.0 na na na 11.11 10.00 0.00 na
Zoetis Inc. (NYSE:ZTS) 0.0 0.0 0.0 0.0 6.5 7.2 8.3 na na na na 11.54 13.79 na

Average 14.46 12.32 10.97 14.35 12.62 5.82

In the spreadsheet to follow, I use two metrics of my own creation. Those are two price-implied CAGR numbers. To calculate the first one, I take the RRR and subtract the yield. What justifies that formula? When a stock is correctly valued and the CAGR is not discounted, then the Yield + CAGR = RRR. Doing the kind of formula manipulation we learned in algebra, we can arrive at a formula for CAGR by subtracting "Yield" from both sides of that equation. Doing that, we get to "CAGR = RRR - Yield." I would want the RRRs to be higher for the riskier stocks for such a formula to produce meaningful output.

When it comes to P/E ratios, a low price/DCF ratio would logically belong to a stock with a lower CAGR or higher risk, and a high price/DCF ratio would logically belong to a stock with a higher CAGR or lower risk. My formula is "Ratio - adjustment = CAGR." I would want the adjustment to be lower for the riskier stocks because risk would already be a factor in producing lower P/Es for such a formula to produce meaningful output. A RRR of 8.5 (which is for AA credit rated companies) produces an adjustment of 14.5. A RRR of 9.5 (which is for A rated companies) produces an adjustment of 10.5. A RRR of 10.5 (which is for lower rated companies) produces an adjustment of 6.5. Due to P/E ratios currently being high (something that logically happens when dividend growth is also high), the output of "Ratio - adjustment" is multiplied by 0.83 to arrive at the price-implied CAGR.

Why do I provide two different price implied CAGRs?

Using the "CAGR = RRR - Yield" formula, the CAGR can not be greater than the RRR. There are not that many stocks with 5-year CAGRs above the 10% to 12% range I use for RRRs, but there are some. So "RRR - Yield" understates the CAGR for companies with high CAGRs. Due to EPS failing to grow in equally stair-stepped increments, there are several times when the "P/E ratio"-based formula fails to produce meaningful output. I am using the EPS projection for 2015 to set the CAGR projection. But what about situations where the market is setting its valuation of a stock based on 2017 or 2018 projections that are substantially higher than the 2015 projection? In those instances, the 2015 P/E ratio is sending the wrong signal -- or understated signal -- on which to make a price implied CAGR assessment.

The CAGR setting done below is only done for stocks where I have 2010 EPS data.

Five-year metric trends

The
average calculation for growth is for ten years" for 2006 through 2016.

The first average is the sum of changes for each individual year over ten-year period, with that result divided by 10.

The second average is the difference between the current and beginning number, divided by the beginning number, with that result divided by 10.

On the right is My CAGR, last three-year dividend growth, last five-year EPS Growth and one brokerage CAGR projection.

David Fish's CCC List CAGR was dropped and replaced with next four-year EPS growth using the Nasdaq 2018 projection.

At the far right are two Price-Implied CAGRs along with three Yahoo CAGRs.


Co. 10 11 12 13 14 15 16 Average Average CAGR PI-CAGRs & Yahoo

A eps 2.00 2.95 3.12 2.88 3.04 1.70 1.95 My 4.00% RRR-yield 9.06%
growth 150.00 47.50 5.76 -7.69 5.56 -44.08 14.71 23.64% -4.14% Last 3 11.98% P/E Ratio 12.15%
div 0.00 0.00 0.29 0.34 0.38 0.40 Nasdaq -4.77% Yahoo Q2-15 0.85%
growth 20.00 10.02 5.93 Last5 -5.15% Yahoo Q1-15 11.50%
div/eps 0% 0% 9% 12% 12% 24% 5.70% Brkr 0.00% Yahoo Q4-14 11.50%

The EPS trend is extremely volatile of A, and that scares me. There is a huge gap in the two price-implied CAGRs, and that scares me. The consensus projections from Yahoo are volatile, and that scares me. I want to be conservative in setting a growth projection when I cannot see any trends.

ABC eps 2.19 2.51 2.76 3.14 3.97 4.92 5.55 My 11.50% RRR-yield 8.78%
growth 31.14 14.61 9.96 13.77 26.43 23.93 12.80 22.94% 39.12% Last 3 32.28% P/E Ratio 10.92%
div 0.32 0.40 0.52 0.84 0.94 1.16 Nasdaq 21.60% Yahoo Q2-15 17.18%
growth 60.00 25.00 30.00 61.54 11.90 23.40 49.36% 363.02% Last5 17.38% Yahoo Q1-15 10.90%
div/eps 15% 16% 19% 27% 24% 24% 15.75% Brkr 0.00% Yahoo Q4-14 13.28%

I do not set dividend CAGRs higher than 12% because the history I have seen in other sectors informs me that such a cap is wise. The 11.5% CAGR for ABC is in line with the 2014 increase, but it is well below the long-term trend in growth and the growth projections from Yahoo. It is also below the trend in EPS growth. I am being conservative with this projection. A 24% payout of the 2018 EPS projection of $7.40 results in a dividend of $1.78. That would be 53.4% dividend growth over the next three years, or a 17.8% average growth rate.

AMGN eps 5.21 5.33 6.51 7.60 8.70 9.58 10.56 My 8.40% RRR-yield 7.57%
growth 6.11 2.30 22.14 16.74 14.47 10.11 10.23 12.90% 20.09% Last 3 29.95% P/E Ratio 5.92%
div 0.00 0.00 1.44 1.88 2.44 3.16 Nasdaq 12.90% Yahoo Q2-15 11.29%
growth 30.56 29.79 29.51 Last5 14.74% Yahoo Q1-15 11.10%
div/eps 0% 0% 22% 25% 28% 33% 10.79% Brkr 8.00% Yahoo Q4-14 11.14%

AMGN started paying dividends in 2012. Like many dividend starters, the dividend growth has been great. I expect forward growth to be in line with EPS growth because the dividend/EPS ratio is already up to 33%. My 8.4% projection is more in line with the price-implied CAGRs. AMGN has historically provided guidance, and that earnings guidance has been highly accurate. A 30% payout of the 2018 EPS projection of $13.19/share results in a dividend of $3.96. That would be 25% dividend growth over the next three years, or an 8.25% average growth rate.

AZN eps 5.60 7.33 6.41 5.06 4.28 4.21 4.08 My 2.00% RRR-yield 4.47%
growth 7.90 30.89 -12.55 -21.06 -15.42 -1.64 -3.09 5.53% 0.60% Last 3 0.00% P/E Ratio 2.25%
div 2.55 2.80 2.80 2.80 2.80 2.80 Nasdaq 2.98% Yahoo Q2-15 3.10%
growth 10.78 9.89 0.00 0.00 0.00 0.00 8.35% 19.79% Last5 -10.75% Yahoo Q1-15 0.10%
div/eps 46% 38% 44% 55% 65% 67% 50.25% Brkr 0.00% Yahoo Q4-14 0.10%

AZN has a falling EPS. There is some charity in giving AZN a 2% growth projection.

BAX eps 3.98 4.31 4.53 4.67 4.90 3.97 4.10 My 4.50% RRR-yield 6.41%
growth 4.74 8.29 5.10 3.09 4.93 -18.98 3.27 13.01% 9.25% Last 3 16.44% P/E Ratio 5.82%
div 1.16 1.24 1.34 1.80 1.96 2.08 Nasdaq 0.77% Yahoo Q2-15 3.98%
growth 11.54 6.90 8.06 34.33 8.89 6.12 14.07% 23.79% Last5 -0.52% Yahoo Q1-15 4.78%
div/eps 29% 29% 30% 39% 40% 52% 32.52% Brkr 9.00% Yahoo Q4-14 6.18%

BAX has low double-digit trends in growth in EPS and dividends over the last ten years. But EPS growth over the last 5 years has averaged only 3.54%. And the dividend/EPS ratio is creeping up. Those are strong omens that dividend growth is going to slow. The analysts project a return to growth. BAX is one of the components of this sector that has offered forward earnings guidance for several years. Using the midpoint of that guidance as the analyst projection, BAX has very good earnings projection accuracy. It is due to that historical accuracy that I want to set my CAGR projection in strong alignment with the analysts. At the same time, the EPS trends cause me to want to have my projection set on the conservative side.

BCR eps 5.60 6.40 6.57 5.78 8.40 9.02 9.95 My 9.50% RRR-yield 9.99%
growth 10.02 14.29 2.66 -12.02 45.33 7.38 10.31 12.17% 16.60% Last 3 5.01% P/E Ratio 11.31%
div 0.68 0.72 0.76 0.80 0.84 0.88 Nasdaq 11.10% Yahoo Q2-15 10.79%
growth 6.25 5.88 5.56 5.26 5.00 4.76 6.25% 7.50% Last5 10.73% Yahoo Q1-15 11.32%
div/eps 12% 11% 12% 14% 10% 10% 12.35% Brkr 0.00% Yahoo Q4-14 13.31%

BCR has good EPS growth and anemic dividend growth. Long term, that is better for BCR than the opposite condition. But I want EPS growth to result in proportional dividend growth. I was conservative in setting my CAGR projection compared to other sources. Still, my projection is way above the dividend growth trend.

BDX eps 4.90 5.33 5.37 5.81 6.25 7.08 8.46 My 8.50% RRR-yield 8.31%
growth -1.01 8.78 0.75 8.19 7.57 13.28 19.49 10.57% 18.68% Last 3 10.06% P/E Ratio 7.69%
div 1.48 1.64 1.80 1.98 2.18 2.40 Nasdaq 16.04% Yahoo Q2-15 10.03%
growth 12.12 10.81 9.76 10.00 10.10 10.09 12.84% 20.28% Last5 9.86% Yahoo Q1-15 5.82%
div/eps 30% 31% 34% 34% 35% 34% 30.43% Brkr 8.00% Yahoo Q4-14 7.27%

BDX has had better dividend growth and EPS growth, and the dividend/EPS ratio is slowly creeping up. BDX is one of the components of this sector that has offered forward earnings guidance for several years. Using the midpoint of that guidance as the analyst projection, BAX has below-average earnings projection accuracy. It is due to the lack of historical accuracy that I want to set my CAGR projection below that of the analysts and more in alignment with the five-year EPS trend.

BMY eps 2.16 2.28 1.99 1.82 1.85 1.76 2.31 My 11.00% RRR-yield 7.33%
growth 28.57 5.56 -12.72 -8.54 1.65 -4.86 31.25 3.45% 13.33% Last 3 2.86% P/E Ratio 25.48%
div 1.28 1.32 1.36 1.40 1.44 1.48 Nasdaq 22.57% Yahoo Q2-15 16.66%
growth 3.23 3.13 3.03 2.94 2.86 2.78 2.87% 2.86% Last5 1.35% Yahoo Q1-15 16.15%
div/eps 59% 58% 68% 77% 78% 84% 78.67% Brkr 3.00% Yahoo Q4-14 12.01%

Some stocks sell at valuations based on their drug pipelines, and short-term growth in EPS fails to capture a growth picture, which is expected to come in 2018 and beyond. BMY is a good example. Even if the consensus analyst projection of 16% is right, BMY already has a price-implied CAGR of 25%. BMY could easily turn out to be a great investment. But one needs to have a heck of a lot of confidence in their ability to correctly size that upcoming growth from their drug pipeline. A 55% payout of the 2018 EPS projection of $3.52 results in a $1.94 dividend for 2018. $1.94 divided by the current $1.48 is 31% growth -- or 10% over the three-year period.

CAH eps 2.22 2.67 3.21 3.73 3.84 4.37 4.89 My 9.50% RRR-yield 7.75%
growth -36.21 20.27 20.22 16.20 2.95 13.80 11.90 4.77% 5.43% Last 3 17.09% P/E Ratio 8.06%
div 0.70 0.78 0.86 1.10 1.21 1.37 Nasdaq 14.97% Yahoo Q2-15 10.73%
growth 25.00 11.43 10.26 27.91 10.18 13.20 29.80% 91.00% Last5 13.01% Yahoo Q1-15 11.31%
div/eps 32% 29% 27% 29% 32% 31% 22.62% Brkr 0.00% Yahoo Q4-14 11.20%

CAH is one of the big three distribution sub-sector stocks where I expect my growth projection system is expected to work. I strongly tend to set conservative CAGRs. And my 9.5% CAGR is conservative compared to those of the analysts, last five year EPS growth number and growth based on the 2018 EPS projection. But even with a very conservative CAGR projection, the yield + CAGR numbers beat the sector average. A 30% payout of the 2018 EPS projection of $6.14 results in a dividend of $1.84. That would be 34% dividend growth over the next three years, or an 11% average growth rate.

DGX eps 3.98 2.85 3.92 4.00 4.10 4.76 5.12 My 8.50% RRR-yield 9.04%
growth 5.57 -28.39 37.54 2.04 2.50 16.10 7.56 7.52% 6.31% Last 3 28.82% P/E Ratio 9.38%
div 0.40 0.40 0.68 1.20 1.20 1.32 Nasdaq 8.54% Yahoo Q2-15 10.72%
growth 0.00 0.00 70.00 76.47 0.00 10.00 18.76% 30.00% Last5 13.15% Yahoo Q1-15 9.41%
div/eps 10% 14% 17% 30% 29% 28% 17.69% Brkr 0.00% Yahoo Q4-14 10.04%

DGX lacks any consistency in its distribution growth history. It is either feast or famine. Last five-year EPS growth is only 4.11%. I wanted to be conservative in setting my projection.

GILD eps 1.69 1.81 1.71 2.01 8.09 10.86 11.02 My 11.00% RRR-yield 9.46%
growth 16.55 7.10 -5.52 17.54 302.49 34.24 1.47 111.19% 1092.00% Last 3 NaN% P/E Ratio 4.31%
div 0.00 0.00 0.00 0.00 0.00 1.72 Nasdaq % Yahoo Q2-15 13.30%
growth Last5 70.04% Yahoo Q1-15 13.22%
div/eps 0% 0% 0% 0% 0% 16% 1.58% Brkr 0.00% Yahoo Q4-14 14.48%

GILD has just started paying dividends. EPS growth is huge since sales of Harvoni began. Harvoni is 48% of sales, making GILD something of a one-trick pony. I am leaning heavily on the analyst consensus numbers to make my projection.

GSK eps 0.99 3.25 3.53 3.73 2.96 2.96 2.38 My 2.00% RRR-yield 3.36%
growth -71.95 228.28 8.62 5.67 -20.64 0.00 -19.59 15.59% -3.64% Last 3 -4.85% P/E Ratio 4.31%
div 2.30 2.46 3.28 2.76 3.00 2.78 Nasdaq 2.62% Yahoo Q2-15 7.70%
growth 15.96 7.14 33.50 -16.08 8.85 -7.33 5.87% 6.89% Last5 -5.19% Yahoo Q1-15 1.00%
div/eps 232% 76% 93% 74% 101% 94% 92.67% Brkr 2.00% Yahoo Q4-14 3.00%

GSK lacks EPS growth. There is a fair amount of charity in giving GSK a 3% projection. But GSK is priced for higher growth than that. The numbers strongly say to stay away from GSK.

JNJ eps 4.76 5.00 5.10 5.52 5.97 6.14 6.41 My 5.20% RRR-yield 5.54%
growth 2.81 5.04 2.00 8.24 8.15 2.85 4.40 5.48% 6.23% Last 3 7.09% P/E Ratio 1.63%
div 1.96 2.16 2.28 2.44 2.64 2.80 Nasdaq 4.86% Yahoo Q2-15 5.13%
growth 6.52 10.20 5.56 7.02 8.20 6.06 9.45% 13.16% Last5 5.13% Yahoo Q1-15 5.96%
div/eps 41% 43% 45% 44% 44% 46% 40.74% Brkr 7.00% Yahoo Q4-14 6.50%

JNJ is a good conservative choice. JNJ has historically provided guidance, and that earnings guidance has been highly accurate. JNJ is the lone AAA-rated component in this sector. Its debt to market cap is tiny. EPS growth happens with sufficient regularity. The JNJ equity can almost be though of as a bond substitute, or even a US treasury substitute. My CAGR projection of 5.2% is in line with third party projections in the of 5s. JNJ's dividend/EPS ratio is creeping up, and the last five-year EPS growth trend is only 5.42%. JNJ's yield + CAGR is now below sector average. But it is the yield + CAGR - RRR metric that makes JNJ look better. Put in different words, JNJ is too safe to sell at an average yield + CAGR. But it is already at that valuation.

LLY eps 4.74 4.41 3.39 4.15 2.78 3.16 3.51 My 4.20% RRR-yield 5.81%
growth 7.24 -6.96 -23.13 22.42 -33.01 13.67 11.08 2.24% 0.57% Last 3 0.68% P/E Ratio 8.11%
div 1.96 1.96 1.96 1.96 1.96 2.00 Nasdaq 15.29% Yahoo Q2-15 4.63%
growth 0.00 0.00 0.00 0.00 0.00 2.04 2.84% 2.89% Last5 -1.80% Yahoo Q1-15 4.58%
div/eps 41% 44% 58% 47% 71% 63% 50.70% Brkr 0.10% Yahoo Q4-14 -0.76%

LLY lacks EPS growth in the here and now. But the 2016 through 2018 EPS projections say that growth is coming. So does the price implied CAGR derived from the P/E ratio. The div/EPS ratio is terrible, so dividend growth should lag EPS growth. My projection is in line with the Yahoo projection, but well behind the growth in the Nasdaq provided projections. Here is why: A 50% payout of 2018's projected $4.48 EPS results in a dividend of $2.24. 12% growth over the next three years is 4% per year.

MCK eps 4.62 4.86 6.38 6.33 8.35 12.60 14.56 My 12.00% RRR-yield 10.10%
growth 13.51 5.19 31.28 -0.78 31.91 50.90 15.56 15.83% 46.65% Last 3 6.67% P/E Ratio 11.34%
div 0.72 0.72 0.80 0.80 0.96 0.96 Nasdaq 32.72% Yahoo Q2-15 16.70%
growth 11.11 0.00 20.00 0.00 Last5 25.77% Yahoo Q1-15 17.17%
div/eps 16% 15% 13% 13% 11% 8% 10.04% Brkr 9.00% Yahoo Q4-14 17.13%

MCK is one of the big three distribution sub-sector stocks where I expect my system is expected to work. I strongly tend to set conservative CAGRs. And my 12% CAGR is conservative compared to those of the analysts. It is very conservative compared to the last five-year EPS growth number. The dividend/EPS ratio is falling, and that is good. On the other hand, dividend growth is inconsistent and the yield is tiny. The yield is too tiny to be a good driver of income growth for a retired investor. But keep an eye on it. MCK has the potential to double its dividend in any given year. Thus, MCK could end up on my buy list one day.

MDT eps 3.22 3.37 3.46 3.75 3.82 4.39 4.45 My 6.00% RRR-yield 6.93%
growth 10.27 4.66 2.67 8.38 1.87 14.92 1.37 8.31% 8.02% Last 3 7.87% P/E Ratio 3.35%
div 0.82 0.90 0.97 1.04 1.12 1.22 Nasdaq 10.41% Yahoo Q2-15 7.22%
growth 9.04 9.76 8.00 7.00 7.69 8.93 12.90% 23.33% Last5 5.84% Yahoo Q1-15 8.16%
div/eps 25% 27% 28% 28% 29% 28% 24.44% Brkr 8.00% Yahoo Q4-14 6.73%

MDT has had annual dividend growth over the last ten years of 12.90%, but dividend growth over the last three years is only 5.84%. Couple that with last five-year EPS growth of only 5.84%, and one has justification for setting a moderate dividend CAGR projection. My 6% projection is slightly more conservative than that from third party sources.

MRK eps 3.42 3.77 3.82 3.49 3.49 3.44 3.81 My 4.80% RRR-yield 5.47%
growth 5.23 10.23 1.33 -8.64 0.00 -1.43 10.76 6.82% 8.14% Last 3 2.33% P/E Ratio 2.94%
div 1.52 1.52 1.68 1.72 1.76 1.80 Nasdaq 7.95% Yahoo Q2-15 4.39%
growth 0.00 0.00 10.53 2.38 2.33 2.27 1.75% 1.58% Last5 0.40% Yahoo Q1-15 4.55%
div/eps 44% 40% 44% 49% 50% 52% 47.63% Brkr 4.00% Yahoo Q4-14 0.47%

MRK lacks EPS growth, but there is some optimism in the 2016 and 2018 projections. A 50% payout of the 2018 EPS projection of $4.60 results in a $2.30 dividend projection. The current dividend is $1.80. 27% growth divided by the three years to get to 2018, and one gets a 9% CAGR. Such a projection is out of alignment with all the other numbers. That makes MRK worthy of investigation. My CAGR projection still remains low.

NVO eps 0.92 1.02 1.42 1.67 1.67 1.62 1.88 My 10.00% RRR-yield 9.18%
growth 29.58 10.87 39.22 17.61 0.00 -2.99 16.05 20.84% 43.71% Last 3 16.49% P/E Ratio 26.12%
div 0.28 0.36 0.50 0.64 0.83 0.76 Nasdaq 15.42% Yahoo Q2-15 15.50%
growth 35.19 29.30 37.29 27.56 30.34 -8.43 32.76% 88.81% Last5 13.98% Yahoo Q1-15 14.50%
div/eps 31% 36% 35% 38% 50% 47% 32.90% Brkr 0.00% Yahoo Q4-14 12.60%

NVO has had great EPS growth and even better dividend growth. The dividend/EPS ratio is rising, so forward dividend growth should be much more in alignment with EPS growth. That is usually bad news. But last five-year EPS growth has been 13.98%. A 50% payout of the 2018 EPS projection of $2.70 results in a dividend of $1.35. That would be 77.6% dividend growth over the next three years, or a 25.8% average growth rate. My projection is much more conservative.

NVS eps 4.26 3.78 3.89 5.01 5.23 5.17 5.49 My 7.50% RRR-yield 5.79%
growth 15.45 -11.27 2.91 28.79 4.39 -1.15 6.19 7.81% 8.48% Last 3 4.64% P/E Ratio 5.48%
div 2.00 2.35 2.46 2.53 2.72 2.82 Nasdaq 9.32% Yahoo Q2-15 7.80%
growth 16.28 17.64 4.56 2.85 7.51 3.56 12.65% 20.49% Last5 8.23% Yahoo Q1-15 8.20%
div/eps 47% 62% 63% 50% 52% 54% 48.58% Brkr 5.00% Yahoo Q4-14 8.80%

My 7.5% CAGR projection for NVS is roughly in alignment with most third party projections and the current trend. A 50% payout of the 2018 EPS projection of $7.18 results in a dividend of $3.55. That would be 27% dividend growth over the next three years, or a 9% average growth rate.

PFE eps 2.22 2.31 2.19 2.22 2.26 2.04 2.35 My 2.25% RRR-yield 5.23%
growth 9.90 4.05 -5.19 1.37 1.80 -9.73 15.20 2.75% 2.63% Last 3 8.37% P/E Ratio 2.52%
div 0.72 0.80 0.88 0.96 1.04 1.12 Nasdaq 4.76% Yahoo Q2-15 3.16%
growth -43.75 11.11 10.00 9.09 8.33 7.69 6.00% 3.68% Last5 0.69% Yahoo Q1-15 2.17%
div/eps 32% 35% 40% 43% 46% 55% 51.51% Brkr 6.00% Yahoo Q4-14 1.35%

PFE lacks EPS growth. The good news: it is already priced for that outcome.

PRGO eps 2.93 4.01 4.99 5.61 6.39 7.64 8.88 My 12.00% RRR-yield 9.75%
growth 75.45 36.86 24.44 12.42 13.90 19.56 16.23 33.96% 94.47% Last 3 16.07% P/E Ratio 14.83%
div 0.25 0.28 0.32 0.36 0.42 0.50 Nasdaq 18.74% Yahoo Q2-15 12.68%
growth 14.55 11.11 14.29 12.50 16.67 19.05 12.14% 16.25% Last5 17.31% Yahoo Q1-15 13.41%
div/eps 9% 7% 6% 6% 7% 7% 10.87% Brkr 0.00% Yahoo Q4-14 14.65%

My 12% CAGR projection for PRGO is roughly in alignment with most third party projections.

RHHBY eps 1.37 1.40 1.62 1.56 1.56 1.90 2.11 My 7.00% RRR-yield 6.06%
growth -4.20 2.19 15.71 -3.70 0.00 21.79 11.05 Last 3 8.37% P/E Ratio 6.20%
div 0.70 0.86 0.86 0.93 1.10 1.08 Nasdaq Yahoo Q2-15 6.70%
growth 31.32 23.26 0.00 8.26 18.13 -1.28 19.20% 42.79% Last5 8.97% Yahoo Q1-15 5.80%
div/eps 51% 61% 53% 60% 70% 57% Brkr 0.00% Yahoo Q4-14 7.30%

I can not find historical EPS numbers for RHHBY or 2018 EPS projections. The dividend growth record is impressive. My 7.5% CAGR projection is roughly in alignment with most third party projections.

SNY eps 3.53 3.48 3.19 3.40 3.45 3.11 3.21 My 2.00% RRR-yield 5.33%
growth -3.29 -1.42 -8.33 6.58 1.47 -9.86 3.22 6.47% 2.07% Last 3 -2.40% P/E Ratio 2.08%
div 1.63 1.82 1.76 1.86 1.91 1.61 Nasdaq 2.61% Yahoo Q2-15 5.85%
growth 14.63 12.00 -3.62 6.04 2.58 -15.81 8.12% 22.37% Last5 -1.38% Yahoo Q1-15 5.85%
div/eps 46% 52% 55% 55% 55% 52% 48.31% Brkr 0.00% Yahoo Q4-14 5.85%

SNY lacks EPS growth. It is probable that the dividend is falling due to currency conversion issues. The 2017 and 2018 EPS projection indicate that the negative times are ending for SNY, only to be followed by anemic times. The Genzyme acquisition plus a good drug pipeline may change that. Keep an eye on the 2018 projection and the CAGR projection for signs of improvement. At this point, it looks like SNY merits is higher yield due to a justified lower growth outlook.

STJ eps 3.01 3.28 2.39 3.76 3.98 3.95 4.33 My 8.25% RRR-yield 7.94%
growth 28.63 8.97 -27.13 57.32 5.85 -0.75 9.62 12.47% 18.49% Last 3 8.03% P/E Ratio 7.47%
div 0.00 0.84 0.92 1.00 1.08 1.16 Nasdaq 7.29% Yahoo Q2-15 10.04%
growth 9.52 8.70 8.00 7.41 Last5 8.98% Yahoo Q1-15 9.37%
div/eps 0% 26% 38% 27% 27% 29% 14.72% Brkr 9.00% Yahoo Q4-14 9.95%

STJ began paying dividends in 2011. The early days of dividend growth tends to be the strongest, and a 8% to 9% trend is a good enough beginning trend. It is also good to see that the dividend growth is slightly below EPS growth. My 8.9% CAGR projection is roughly in alignment with most third party projections. A 28% payout of the 2018 EPS projection of $5.14 results in a dividend of $1.44. That would be 24% dividend growth over the next three years, or an 8% average growth rate.

SYK eps 3.33 3.72 4.07 4.23 4.73 5.03 5.51 My 8.00% RRR-yield 8.07%
growth 12.88 11.71 9.41 3.93 11.82 6.34 9.54 11.58% 17.01% Last 3 17.54% P/E Ratio 7.81%
div 0.60 0.72 0.85 1.06 1.22 1.38 Nasdaq 8.99% Yahoo Q2-15 8.55%
growth 50.00 20.00 18.33 24.41 15.09 13.11 31.59% 102.96% Last5 8.21% Yahoo Q1-15 8.54%
div/eps 18% 19% 21% 25% 26% 27% 18.81% Brkr 9.00% Yahoo Q4-14 8.58%

SYK has a low double-digit trend in EPS growth. With a rising dividend/EPS ratio, forward dividend growth should be more in line with EPS growth. All of the numbers suggest a CAGR between 8% and 9%. SYK has historically provided guidance, and that earnings guidance has been highly accurate. A 27% payout of the 2018 EPS projection of $6.43 results in a dividend of $1.74. That would be 26% dividend growth over the next three years, or a 8.5% average growth rate.

TEVA eps 4.54 4.97 5.35 5.01 5.07 5.23 5.08 My 2.00% RRR-yield 8.27%
growth 35.12 9.47 7.65 -6.36 1.20 3.16 -2.87 39.36% 10.73% Last 3 8.52% P/E Ratio 4.66%
div 0.74 0.86 1.07 1.24 1.30 1.36 Nasdaq 1.97% Yahoo Q2-15 0.01%
growth 25.68 15.59 24.19 16.10 5.16 4.29 17.73% 37.25% Last5 0.56% Yahoo Q1-15 0.44%
div/eps 16% 17% 20% 25% 26% 26% 22.91% Brkr 8.00% Yahoo Q4-14 1.27%

TEVA has a great record of dividend growth, but a last five-year EPS growth rate under 1%. There has not been much EPS growth since 2011. Until you see signs of EPS or third party CAGR projection growth, stay away from TEVA.

TMO eps 2.71 4.16 4.94 5.42 6.96 7.34 8.13 My 9.50% RRR-yield 10.55%
growth 22.62 53.51 18.75 9.72 28.41 5.46 10.76 21.38% 65.28% Last 3 5.13% P/E Ratio 11.25%
div 0.00 0.00 0.52 0.60 0.60 0.60 Nasdaq 9.41% Yahoo Q2-15 9.30%
growth 15.38 0.00 0.00 Last5 14.62% Yahoo Q1-15 10.16%
div/eps 0% 0% 11% 11% 9% 8% 3.84% Brkr 11.00% Yahoo Q4-14 12.35%

TMO is too new to glean meaningful information from trends over such a short period of time. My CAGR projection is roughly in alignment with most third party projections.

ZMH eps 4.33 4.80 5.30 5.75 6.06 6.36 6.75 My 5.00% RRR-yield 8.73%
growth 9.90 10.85 10.42 8.49 5.39 4.95 6.13 NaN% Infinity% Last 3 7.04% P/E Ratio 6.65%
div 0.00 0.00 0.72 0.80 0.80 0.88 Nasdaq 3.38% Yahoo Q2-15 5.15%
growth 11.11 0.00 10.00 Last5 7.08% Yahoo Q1-15 6.88%
div/eps 0% 0% 14% 14% 13% 14% NaN% Brkr 0.00% Yahoo Q4-14 8.73%

ZMH is too new to glean meaningful information from trends over such a short period of time. My CAGR projection is roughly in alignment with most third party projections.

With the CAGR projections set, it is time for the final spreadsheet that uses the CAGRs and RRRs to find under valued stocks that also offer superior dividend growth.

Yield + CAGR Total Return Expectations
The Total Return projection is the yield + dividend CAGR. LT Debt/Mkt Cap is the long-term debt to market cap ratio with the numbers gathered from Yahoo Finance's "key statistics" page at the end of 2014. "EPS Accr" is short for the historical EPS projection accuracy. For this sector, I have less than two years of historical stats. Consensus Ratings are also gathered from Yahoo Finance.


Company Q2-15 Consensus Total Bond Bond LT Debt/ EPS My Total Rtn Consensus Price Implied CAGR
Yield CAGR Return Ratings Yield Mkt Cap Accr RRRs - RRR Ratings RRR-Yld P/E

A 0.94% 4.00% 4.94% BBB+ 3.904 19.27% 2.20 10.00 -5.06 2.3 9.06 11.21%
ABBV 3.12% 8.00% 11.12% A 3.157 13.76% 2.20 9.50 1.49 2.2 6.38 4.13%
ABC 1.02% 11.50% 12.52% A- 3.300 9.91% 2.20 9.80 2.72 2.3 8.78 10.07%
ABT 1.96% 9.00% 10.96% A+ 3.742 12.46% 2.20 9.50 1.46 2.1 7.54 10.13%
AMGN 1.93% 8.40% 10.33% A 3.387 26.32% 1.00 9.50 0.83 2.3 7.57 5.46%
AZN 4.03% 2.00% 6.03% AA- 3.406 10.64% 3.00 8.50 -2.47 2.5 4.47 2.07%
BAX 3.09% 4.50% 7.59% A 3.140 23.65% 1.50 9.50 -1.91 2.6 6.41 5.37%
BAYRY 1.71% 8.00% 9.71% A 3.375 14.81% 3.00 9.40 0.31 3.0 7.69 6.57%
BCR 0.51% 9.50% 10.01% 3.867 11.18% 2.20 10.50 -0.49 2.7 9.99 10.43%
BDX 1.69% 8.50% 10.19% 2.588 14.65% 3.00 10.00 0.19 2.0 8.31 7.09%
BMY 2.17% 11.00% 13.17% A+ 3.059 7.87% 1.00 9.50 3.67 2.3 7.33 23.49%
CAH 1.75% 9.50% 11.25% A- 3.410 14.87% 2.20 9.30 1.75 1.9 7.55 7.43%
DGX 1.91% 8.50% 10.41% BBB+ 3.661 41.78% 2.20 10.70 -0.54 3.0 8.79 8.65%
GILD 1.54% 11.00% 12.54% A- 3.080 8.18% 3.00 11.00 1.54 1.9 9.46 3.97%
GSK 6.14% 2.00% 8.14% A+ 3.040 26.61% 3.00 9.50 -1.36 2.8 3.36 3.98%
JNJ 2.96% 5.20% 8.16% AAA 2.878 5.09% 1.00 8.30 -0.34 2.5 5.34 1.50%
LLY 2.69% 4.20% 6.89% AA- 3.514 7.87% 1.00 8.50 -1.61 2.2 5.81 7.48%
MCK 0.40% 12.00% 12.40% A- 3.186 21.89% 3.00 10.50 1.90 1.8 10.10 10.45%
MDT 1.57% 6.00% 7.57% AA- 3.064 18.96% 2.20 8.50 -0.93 2.0 6.93 3.09%
MRK 3.03% 4.80% 7.83% AA 2.884 13.28% 1.00 8.50 -0.67 2.4 5.47 2.71%
NVO 1.32% 10.00% 11.32% 0.000 40.59% 2.20 10.50 0.82 2.0 9.18 24.09%
NVS 2.71% 7.50% 10.21% AA- 0.000 8.48% 2.20 8.50 1.71 1.8 5.79 5.05%
PFE 3.27% 2.25% 5.52% AA 3.103 18.94% 1.00 8.50 -2.98 2.3 5.23 2.33%
PRGO 0.25% 12.00% 12.25% 3.985 15.00% 1.00 10.00 2.25 2.4 9.75 13.68%
RHHBY 2.94% 7.00% 9.94% AA 0.034 38.49% 2.20 9.00 0.94 1.3 6.06 5.71%
SNY 3.17% 2.00% 5.17% AA- 2.363 12.50% 3.00 8.50 -3.33 1.7 5.33 1.92%
STJ 1.56% 8.25% 9.81% A 3.220 19.90% 2.50 9.50 0.31 2.1 7.94 6.89%
SYK 1.43% 8.00% 9.43% A+ 3.263 20.41% 1.00 9.50 -0.07 1.9 8.07 7.20%
TEVA 2.23% 2.00% 4.23% BBB+ 3.375 30.47% 1.00 10.50 -6.27 2.1 8.27 4.29%
TMO 0.45% 9.50% 9.95% BBB 3.490 29.82% 1.00 11.00 -1.05 1.6 10.55 10.38%
ZMH 0.77% 5.00% 5.77% A- 2.886 3.26% 1.00 9.50 -3.73 1.7 8.73 6.13%
ZTS 0.69% 10.00% 10.69% BBB- 0.000 19.31% 2.20 11.00 -0.31 2.1 10.31 19.39%

Average 2.03% 7.22% 9.25% 9.58 2.18 7.55 7.89

For the buy rated suggestions, I use the formula TR (which is total return, which is also the yield + CAGR) - RRR and find instances where the result is over 0.75. That will be the last data set shown. First I will the parsing of the data between the over valued and the under valued:

The Correlation between TR - RRR and Analyst Ratings:

The following stocks had TR - RRR of less than 0: A, AZN, BAX, BCR, DGX, GSK, JNJ, LLY, MDT, MRK, PFE, SNY, SYK, TEVA, TMO, ZMH and ZTS. Their YTD mean price gain = 4.97% and 4 of the 17 beat the sector mean yearly price gain of 8.22%. Their mean yield = 2.29% and they had an average price/earnings ratio = 18.43. Their mean LTM dividend growth = 3.69% and they had an average CAGR projection of 5.26 and an average RRR assessment of 9.47. They had an average analyst rating projection of 2.26.

The following had TR - RRR of more than 0: ABBV, ABC, ABT, AMGN, BAYRY, BDX, BMY, CAH, GILD, MCK, NVO, NVS, PRGO, RHHBY and STJ. Their YTD mean price gain = 11.90% and 10 of the 15 beat the sector mean yearly price gain. Their mean yield = 1.74%, and they sold at an average price/earnings ratio = 21.68. Their mean LTM dividend growth = 7.86% and they had an average CAGR projection of 9.44 and an average RRR assessment of 9.70. They had an average analyst rating projection of 2.09.

What buy rated looks like: The following had TR - RRR of more than 0.75: ABBV, ABC, ABT, AMGN, BMY, CAH, GILD, MCK, NVO, NVS, PRGO and RHHBY. Their YTD mean price gain = 13.50% and 9 of the 12 beat the sector mean yearly price gain. Their mean yield = 1.76% - and they sold at an average price/earnings ratio = 22.32. Their mean LTM dividend growth = 9.33% and they had an average CAGR projection of 9.74 and an average RRR assessment of 9.72. They had an average analyst rating projection of 2.02.

I write for dividend growth investors who wish to have portfolios that average 4% yields and 6% annual dividend growth. I rule out dividend paying stocks with yields under 1% because it is hard to own them and still have a portfolio average yield over 4%. That rules out MCK and PRGO.

There is a lot of CAGR projection volatility, and that results in price volatility. In making a "one-stock decision," one cannot trust a CAGR projection. Investors who hold a smaller number of stocks, and thus a higher weighting in each stock, is putting a lot of faith when they invest in one or two ultra-high CAGR investments. I strongly invest with CAGR awareness, and if I were investing in units of 5% allocations, I would have trouble investing in ultra-high CAGRs.

There is a simple solution to that problem. Don't invest with high allocations to single stocks when it comes to the high and ultra-high portion of your portfolio. I do not bet on single CAGR projections; I bet on "groupings" of high CAGR projections. As a group, high CAGR projections turn into high CAGR reality. I see that in sector after sector, year after year.

I am not writing that every single stock you own needs to be a one percent weighting. I am suggesting that your high CAGR options should strongly skew that way.

We all should know, as coach Yogi has roughly told us, that "90% of investing in psychological -- the other half is mental." Heck if I know if I should call the "one percent allocation on high CAGRs" rule a mental or psychological thing. It could even be both. It is a rule that works for me.

I know that you will only implement a plan you feel comfortable with. I would strongly suggest that you find the magic allocation that makes you comfortable with some ultra-high CAGR options. Why? Because there are multiple instances of low hanging fruit in the ultra-high CAGR world. Harvest some of that fruit. You may really need to harvest some capital gains when your next high yielding stock cuts its dividends, and you need new money to replenish that dividend income.

Disclosure: The author is long ABC, ABT, AMGN, GILD, NVO, STJ, SYK. 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.