Are The Dividend Aristocrats A Good Deal? A Look At Earnings, Dividends, And Payout Ratios

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Includes: BEN, CTAS, MCD, NOBL, SHW, TROW
by: Investing Doc

Summary

The Dividend Aristocrats are the subject of intense interest here at Seeking Alpha for their ability to help generate reliable dividend income.

Yet these dividend streams may be at risk, as earnings growth has generally stalled and payout ratios have increased.

Though some of the Dividend Aristocrats may still offer a reliable income stream in the future, investors might be better served to be choosy instead of buying these stocks blindly.

Dividend Stocks have gotten a lot of attention recently, and on Seeking Alpha especially they seem remarkably popular. This perhaps isn't terribly surprising given the low-yield environment, as investors appear to be looking for more reliable sources of income wherever they can. The Dividend Aristocrats - companies that have successfully raised their dividends yearly for 20 or more years - seem to be particularly attractive given their aura of safety and the promise of continued dividend raises in the years to come.

But there's no such thing as a free lunch, and an analysis of the Dividend Aristocrats as a whole suggests that the good days for the Dividend Aristocrats -as they're currently constituted - may be numbered. The venerable Aristocrats have, in general, been taking on increasing amounts of debt, while earnings growth has in turn been flat. In the meantime, investors' search for yield has driven the prices of these issues to hitherto unexplored realms.

The financial data seem fairly clear in what they show:

  1. That the earnings-per-share growth of the Dividend Aristocrats has plateaued in recent years;
  2. That payout ratios have steadily climbed as companies have continued to issue dividend raises despite stagnant earnings;
  3. That these companies as a whole have taken on increasing amounts of debt;
  4. That despite this increasing leverage, companies have curtailed capital investments that may be required in future business cycles; and
  5. That despite the slowdown in earnings growth, increasing risk of dividend cuts or freezes, and increasing financial leverage, investors now pay hefty premiums for the privilege of owning these companies.

It seems to me that these trends are simply not sustainable. Moreover, while the wider market (as suggested by an analysis of the Dow) is pretty much fully valued as compared to analyst targets, the Dividend Aristocrats are even more fully valued relative to those same targets. While analysts project 5-year earnings growth for these companies that, as a whole, they have not achieved before, these optimistic projections are already fully priced into the shares of these companies. Failure of the companies to meet analyst projections, or perhaps worse - failure to maintain dividend growth as investors have come to expect may expose potential buyers at these levels to capital loss. In other words: there's no margin of safety here.

This will be a two-part article, with the first focused on points 1 and 2. Examination of overall debt and valuation considerations will be in Part 2.

Point 1: Earnings-per-share growth of the Dividend Aristocrats has plateaued in recent years.

I started by gathering the 10-year financial data and analyst projections for the Dividend Aristocrats (a list of which can be found here). With this information in hand, I started by looking at the yearly EPS for each of these companies over the past decade.

Source: 10-year financial data from Morningstar.

The scatter plot shows the relative percent EPS growth from 2006 to 2016. For ease of viewing, these values are normalized to show relative growth. In recent years, while some companies have succeeded in increasing EPS relatively well, a large bulk of them have started to see EPS declines. Looking at the median makes this trend a bit clearer:

Source: 10-year financial data from Morningstar.

Median Dividend Aristocrat EPS growth has barely budged since 2012. Breaking down the list by individual companies into the highest-performing and lowest-performing thirds does show some trends.

Highest Performing Companies:

Symbol

Company Name

Sector

Industry

10-Y EPS Change

MKC

McCormick & Company, Incorporated

Consumer Goods

Processed & Packaged Goods

119.33%

CTAS

Cintas Corporation

Services

Business Services

207.73%

ECL

Ecolab Inc. Common Stock

Consumer Goods

Cleaning Products

132.87%

MCD

McDonald's Corporation Common Stock

Services

Restaurants

83.75%

GWW

W.W. Grainger, Inc. Common Stock

Services

Industrial Equipment Wholesale

170.52%

SHW

Sherwin-Williams Corp.

Basic Materials

Specialty Chemicals

171.60%

TROW

T. Rowe Price Group, Inc.

Financial

Asset Management

144.74%

VFC

V.F. Corporation Common Stock

Consumer Goods

Textile - Apparel Clothing

136.44%

PPG

PPG Industries, Inc. Common Stock

Basic Materials

Specialty Chemicals

148.83%

HRL

Hormel Foods Corporation Common

Consumer Goods

Meat Products

170.59%

Lowest Performing Companies:

Symbol

Company Name

Sector

Industry

10-Y EPS Change

SYY

Sysco Corporation Common Stock

Services

Food Wholesale

1.47%

BCR

C.R. Bard, Inc. Common Stock

Healthcare

Medical Instruments & Supplies

-41.96%

CINF

Cincinnati Financial Corporation

Financial

Property & Casualty Insurance

-20.94%

XOM

Exxon Mobil Corporation Common

Basic Materials

Major Integrated Oil & Gas

-53.02%

PNR

Pentair plc. Ordinary Share

Industrial Goods

Industrial Equipment & Components

-125.41%

MDT

Medtronic plc. Ordinary Shares

Healthcare

Medical Appliances & Equipment

-18.66%

ADM

Archer-Daniels Midland

Consumer Goods

Farm Products

-21.21%

KMB

Kimberly-Clark Corp

Consumer Goods

Personal Products

-8.31%

PG

Procter & Gamble Company (The)

Consumer Goods

Personal Products

16.67%

PEP

PepsiCo, Inc. Common Stock

Consumer Goods

Beverages - Soft Drinks

4.79%

CVX

Chevron Corporation Common Stock

Basic Materials

Major Integrated Oil & Gas

-91.15%

APD

Air Products and Chemicals, Inc

Basic Materials

Chemicals - Major Diversified

-20.13%

NUE

Nucor Corporation Common Stock

Basic Materials

Steel & Iron

-80.11%

Source: 10-year financial data from Morningstar. Industry classification from Zacks.

The lowest-performing companies are predominated by commodity-sensitive companies like Exxon and Chevron, whose recent woes hardly require a review here. In comparison, companies that rely on more "human capital," such as services companies like Cintas, have generally fared somewhat better. Though it might be reasonable to expect some degree of EPS rebound for energy companies, with many now expecting oil prices to be "lower for longer" at this point - and with the prices of energy companies having generally outpaced the wider market for the past few months - investors might be well-advised to curb their enthusiasm.

Point 2: Payout ratios have steadily climbed as companies have continued to issue dividend raises despite stagnant earnings.

Dividend Aristocrats are so named for a reason: they've continually issued dividend raises for the past few decades. The math is unforgiving, though: as earnings growth has declined and dividends have grown, payout ratios have necessarily increased as a result.

Source: 10-year financial data from Morningstar.

In comparison to companies' 10-yr EPS histories, their dividend histories tell a pretty clear tale. But the picture looks less rosy when we compare dividend growth to EPS growth directly:

This divergence in paths has led to a sharp increase in payout ratios over the past few years.

Though there is some evidence to suggest that for high-quality companies with predictable earnings growth, a target payout ratio in the 40-60% range may be optimal, it is generally accepted that payout ratios that are too high may be a sign that dividends may not be sustainable.

It is therefore somewhat distressing to see that as time has gone on, the number of Dividend Aristocrats with payout ratios over 70% (or less than zero) has grown significantly since 2013 after hovering fairly steady for most of the previous decade.

Highest Payout Ratios:

Symbol

Company Name

Sector

Industry

Payout Ratio

XOM

Exxon Mobil Corporation Common

Basic Materials

Major Integrated Oil & Gas

93.89%

CL

Colgate-Palmolive Corp

Consumer Goods

Personal Products

100.00%

KMB

Kimberly-Clark Corporation

Consumer Goods

Personal Products

119.46%

CVX

Chevron Corporation Common Stock

Basic Materials

Major Integrated Oil & Gas

620.29%

APD

Air Products and Chemicals, Inc

Basic Materials

Chemicals - Major Diversified

129.53%

NUE

Nucor Corporation Common Stock

Basic Materials

Steel & Iron

132.74%

Lowest Payout Ratios:

Symbol

Company Name

Sector

Industry

Payout Ratio

CTAS

Cintas Corporation

Services

Business Services

17.59%

SWK

Stanley Black & Decker, Inc. Co

Industrial Goods

Machine Tools & Accessories

35.87%

SHW

Sherwin

Basic Materials

Specialty Chemicals

25.04%

DOV

Dover Corporation Common Stock

Industrial Goods

Diversified Machinery

34.37%

PPG

PPG Industries, Inc. Common Stock

Basic Materials

Specialty Chemicals

27.17%

HRL

Hormel Foods Corporation Common

Consumer Goods

Meat Products

37.68%

CAH

Cardinal Health, Inc. Common St

Services

Drugs Wholesale

36.90%

BEN

Franklin Resources, Inc. Common

Financial

Asset Management

23.91%

Source: 10-year financial data from Morningstar. Industry classification from Zacks.

Again there is a predisposition towards higher payout ratios in commodity-sensitive companies. In the meantime, higher dividend growth rates are seen with companies in the Services sector, with lower dividend growth rates associated with companies involved with Consumer Goods:

Highest Historical Dividend Growth Rate:

Symbol

Company Name

Sector

Industry

10-Y Dividend Growth CAGR

LOW

Lowe's Companies, Inc. Common S

Services

Home Improvement Stores

19.51%

BDX

Becton, Dickinson and Company C

Healthcare

Medical Instruments & Supplies

11.35%

CTAS

Cintas Corporation

Services

Business Services

11.61%

MDT

Medtronic plc. Ordinary Shares

Healthcare

Medical Appliances & Equipment

14.03%

WMT

Wal-mart

Services

Discount, Variety Stores

11.33%

ECL

Ecolab Inc. Common Stock

Consumer Goods

Cleaning Products

12.74%

MCD

McDonald's Corporation Common S

Services

Restaurants

13.28%

GWW

W.W. Grainger, Inc. Common Stock

Services

Industrial Equipment Wholesale

15.48%

SHW

Sherwin-Williams Corp

Basic Materials

Specialty Chemicals

11.04%

TROW

T. Rowe Price Group, Inc.

Financial

Asset Management

13.54%

Lowest Historical Dividend Growth Rate:

Symbol

Company Name

Sector

Industry

10-Y Dividend Growth CAGR

SYY

Sysco Corporation Common Stock

Services

Food Wholesale

6.34%

BCR

C.R. Bard, Inc. Common Stock

Healthcare

Medical Instruments & Supplies

5.70%

CINF

Cincinnati Financial Corporation

Financial

Property & Casualty Insurance

3.33%

MKC

McCormick & Company, Incorporated

Consumer Goods

Processed & Packaged Goods

8.51%

XOM

Exxon Mobil Corporation Common

Basic Materials

Major Integrated Oil & Gas

8.60%

LEG

Leggett & Platt, Incorporated C

Consumer Goods

Home Furnishings & Fixtures

6.60%

PNR

Pentair plc. Ordinary Share

Industrial Goods

Industrial Equipment & Components

8.70%

SWK

Stanley Black & Decker, Inc. Co

Industrial Goods

Machine Tools & Accessories

6.28%

T

AT&T Inc.

Technology

Telecom Services - Domestic

3.48%

ED

Consolidated Edison, Inc. Common

Utilities

Electric Utilities

1.31%

JNJ

Johnson & Johnson Common Stock

Healthcare

Drug Manufacturers - Major

7.47%

KMB

Kimberly

Consumer Goods

Personal Products

6.15%

PG

Procter & Gamble Company (The)

Consumer Goods

Personal Products

8.71%

Source: 10-year financial data from Morningstar. Industry classification from Zacks.

Interim Conclusion:

Though I won't get into valuation considerations here, the data gathered so far seem to suggest that there is limited room at this point for the Dividend Aristocrats as a group to continue growing their dividends successfully without a sharp acceleration in earnings growth. Payout ratios simply cannot be expected to climb forever. While a sizable amount of the climb in payout ratios is associated with the recent fall in energy prices (and the earnings of commodity-sensitive companies), the fall in oil prices isn't the full explanation. Indeed, it is striking that some of the companies with the highest dividend growth rates still sport some of the lowest payout ratios (such as Sherwin-Williams and Cintas, for example), while other companies like Kimberly-Clark and Colgate-Palmolive have both high payout ratios and low amounts of dividend growth.

It would seem that if one insists upon getting into the Dividend Aristocrats at this point, one would be better served by picking and choosing one's targets, rather than simply buying a basket of the entire group such as the Dividend Aristocrats ETF (NYSEARCA:NOBL). Targeting companies with sustained growth in earnings (without a recent or forecasted plateau), lower payout ratios, and higher dividend growth rates would seem to be a better strategy than blindly purchasing those whose earnings growth has stalled, have high payout ratios and lower historical dividend growth rates. Companies satisfying all 3 of these criteria are services company Cintas (NASDAQ:CTAS) and chemicals company Sherwin-Williams (NYSE:SHW). Other companies that may merit additional research based upon their historical earnings growth and dividend growth reliability include financial firms Franklin Resources (NYSE:BEN) and T. Rowe Price (NASDAQ:TROW) as well as restaurateur McDonald's (NYSE:MCD).

But how to choose from those? Valuation and a margin of safety are still important considerations, even for ostensibly "safe" stocks like these. I intend to explore these areas in part 2.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.