Fix Your Roof While The Sun Is Shining: The Dividend Aristocrats Are (Sorta) On Sale

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Includes: ABBV, ABT, ADM, ADP, AFL, AOS, APD, BDX, BEN, CAH, CINF, CL, CLX, CTAS, CVX, DOV, ECL, ED, EMR, FRT, GD, GPC, GWW, HRL, ITW, JNJ, KMB, KO, LEG, LOW, MCD, MDT, MKC, MMM, NUE, PEP, PG, PNR, PX, ROP, SHW, SWK, SYY, T, TGT, TROW, VFC, WBA, WMT, XOM
by: Investing Doc

Summary

Dividend investors on Seeking Alpha love the Dividend Aristocrats, and for good reason.

But after years of trading at a premium, these high-quality stocks have had a hard go of it over the past few months.

Is this due to weakening fundamentals? Are their dividends in danger? And if not, should I buy the Dividend Aristocrats now?

A large number of articles on Seeking Alpha are dedicated to dividend growth investing, and one finds no shortage of articles exhorting investors to consider the Dividend Aristocrats. To Seeking Alpha readers, these stocks need no introduction, but as regular contributor Ploutos reminds us in a recent overview, these are those select few companies (around 50 or so in number) that have increased their dividend payouts for 25 or more consecutive years.

These stocks appeal for a variety of reasons, chief among them having delivered excellent (and even market-beating) risk-adjusted total returns over the past few decades. But any investor buying the Dividend Aristocrats—say, through a tracking ETF like NOBL (BATS:NOBL)—would have to be mightily disappointed with the results so far this year.

Chart NOBL Total Return Price data by YCharts

The graph isn’t appealing, and the numbers bear it out. Total returns for the Dividend Aristocrats, inclusive of dividends, has been a middling 0.5% YTD, versus a total return (including dividends) of about 5% so far for the broader S&P 500. Citing historical precedent, Ploutos points out that this underperformance could “signal that the bull market is over-extended.” If that’s the case, it would behoove careful investors to begin hedging their bets.

As a person who is looking to add some more stability to his portfolio, it makes me wonder: are the Dividend Aristocrats the answer? Are investors shifting away from dividend-yielding stocks because of the end of a low-interest rate regime? Or are there more fundamental problems with the Dividend Aristocrats themselves that should make investors wary? And if not—should a retail investor like me really consider adding money to these names?

While answering the first question is a bit above my pay grade—I think anybody who says they know exactly why the broader market does anything is dressing up speculation as solid fact—I at least can offer some quantitative data as to the second. I can chart the movement of analyst consensus estimates for forward earnings and earnings growth, as well as their recommendations over this timeframe. While this isn’t a formal fundamental analysis per se, these estimates serve as a handy proxy for both the companies’ performance and prospects. As to the last question, for me, that comes down to a matter of valuation, and here, I think, both contemporary valuations (based on current fundamentals) and historical behavior can be helpful.

Are the Dividend Aristocrats in Trouble?

I started tracking publicly available analyst consensus data from Finviz and Zacks earlier last June 2017 for all the stocks in the S&P 900. I recorded—among other things—price, consensus targets, earnings estimates, and recommendations. I use this in combination with 10-year historical income and balance sheet data to generate fair value estimates for each company using a statistically-weighted average of a variety of valuation methods. Taking the market-cap weighted average price over time and comparing it to both the market-weighted analyst target (and my own fair value estimates) yields the following:

Source: Financial data from Morningstar; Analyst consensus data from Finviz and Zacks; interest rate forecast data from Forecasts.org; Historical interest data from Treasury.gov; all calculations by author.

Following the passage of corporate tax cuts, analysts consistently jacked up their price targets on the Dividend Aristocrats and appear to have maintained these targets ever since. Despite this, shares of the Aristocrats fell in concert with the broader market, and don’t appear to have recovered since that time. It’s possible this decline was due to interest rate fears; my own fair value estimates, I note, also fell during this time, as the model I use relies on forecasted interest rates, which steadily increased during this time.

Interestingly, I now see that my fair value estimates have since recovered in concert with a drop in the forecast 10-year rate in Dec 2018, down a few dozen basis points to 2.65% (see below), and the gap between price to my own fair value estimates is now basically closed. Also of considerable note is that the gap between price to analyst target is as large as it’s ever been—with targets implying a discount of nearly 11%!

Source: www.forecasts.org

But perhaps it was more than interest rate fears—which appear to have been justifiable—causing the drop in prices. Perhaps investors feared deteriorating fundamentals or increasing risks of dividend cuts. To answer that, I turn my attention now to analyst earnings estimates.

Source: Analyst consensus data from Finviz and Zacks; all calculations by author.

Here, the chart makes clear that if anything the fundamentals of the Dividend aristocrats are felt to have improved since late last year. Forward earnings per share jumped nearly 10% following passage of tax cuts, and these estimates have—like analyst targets—also remained steady at this higher level.

Estimates of forward growth rates, though, tell a slightly different story. While these also remain comfortably higher than they were several months ago, growth rate estimates peaked in late January before crashing several dozen basis points back to earth. Though these have started creeping back up again, the timing of this sudden change in conjunction with the broader market correction doesn’t seem coincidental. That this broad-based forecast fell so sharply without any change in short-term earnings estimates suggests to me a concern about economic conditions on a more “macro” level.

Overall, though, earnings estimates appear intact. What about dividends?

Source: Financial Data from Morningstar; Analyst consensus data from Finviz and Zacks; all calculations by author.

The sudden drop in prices in late January resulted in a spike in yields for the group, but at least based upon projected earnings dividends all seem strongly covered at this point. With about an additional 70 basis points of room to run to expand dividend payouts, the groups’ 3% yield looks more attractive.

Consistent with the progressive rise in earnings estimates and growth rates in combination with falling prices, analyst recommendations have steadily shifted in a more positive direction.

Source: Analyst consensus data from Finviz and Zacks; all calculations by author.

In short, analysts don’t appear to perceive a solid fundamental reason for the drop in share prices, though I surmise that macroeconomic concerns—be they a looming recession, trade wars, or rising interest rates—may be weighing on sentiment. That said, with investors apparently more pessimistic about the Dividend Aristocrats in general, and yields looking both more attractive and still comfortably covered, are the Dividend Aristocrats fairly valued?

Are the Dividend Aristocrats Fairly Valued?

While a simple glance at analyst targets would suggest that the answer to that question is an unequivocal “YES”, it’s worth noting that analysts have, in my previous analyses, consistently published price targets about 8-10% above contemporary prices, and are prone to being overly optimistic with forward estimates. A discount of 11%, then, is not as considerable as it first appears. With that in mind, perhaps it will help to look at how the Dividend Aristocrats have performed over the past decade.

Source: Financial data from Morningstar; Analyst consensus data from Finviz and Zacks; interest rate forecast data from Forecasts.org; Historical interest data from Treasury.gov; all calculations by author.

Above, for example, is the valuation model applied to dividend stalwart 3M (NYSE:MMM). To develop these data, I applied my valuation model to 10-year historical financial data for each company on consecutive 2-week intervals and weighted each estimate by contemporaneous market capitalization. The chart suggests that the runup in 3M shares was probably investors getting ahead of their skis, and that the recent correction back to fair value was probably overdue. What then appears is a remarkable demonstration of Warren Buffett’s axiom that the market, in the short term, is a voting machine, but in the long-term acts as a weighing machine.

The model appears to work equally well to more volatile or cyclical issues. Here is the long-term chart for fellow Aristocrat, W.W. Grainger (NYSE:GWW):

Source: Financial data from Morningstar; Analyst consensus data from Finviz and Zacks; interest rate forecast data from Forecasts.org; Historical interest data from Treasury.gov; all calculations by author.

When the Dividend Aristocrats are in turn viewed together, a pattern of remarkable predictability emerges.

Source: Financial data from Morningstar; Analyst consensus data from Finviz and Zacks; interest rate forecast data from Forecasts.org; Historical interest data from Treasury.gov; all calculations by author.

The Dividend Aristocrats appear to have been available for a hefty 20% discount for a few years following the financial crisis, but this discount disappeared by 2013. Nevertheless, the companies have compounded their intrinsic value at a steady 6.25% CAGR since the financial crisis, and one gets a sense from this graph of the companies’ spectacular consistency.

This consistency appears to have a price; since share prices recovered back to fair value in 2013, the Dividend Aristocrats have generally traded at about a 2-3% premium to fair value. Any falls in share price have been largely arrested at or about the fair value line, which appears to act as some measure of technical support. This certainly appears to be the case over the past few months—after the price premium hit a high of some 17% in late January, it has since come back down to earth and as of last month was around the more usual 2-3% level.

So how about now?

Based upon my own fair value estimate calculations, the group looks to be trading at a relatively unusual discount (albeit only a small one). Certainly, analysts appear to be more optimistic. Either way, the Dividend Aristocrats look to be trading at a fair to better-than-fair value, and their fundamentals are at least perceived to be intact. In short, these companies look as wonderful as ever, and are trading at a fair price.

I should admit that in a recession, it is possible—even likely—that even some of these high-quality companies might come upon some dire straits and be forced to suspend dividend increases (or even, gasp, suspend their dividends). In that scenario, the historical outperformance in bear markets of these stocks is certainly not assured. But even with that in mind, it would appear that—for the most part—these companies have sufficient wiggle room to continue with their dividend policies and appear to be priced with some of these risks in mind. With signs of a late bull market starting to appear—increasing numbers of IPOs, increased retail investor exposure, elevated consumer and margin debt, and of course, a yield curve that continues to descend towards inversion, it might be time for the savvy investor to take closer look at these high-quality companies to add protection to their portfolios. As they say, it’s always better to fix your roof when the sun is shining.

I’ll end with a final summary of analyst targets and my own fair value estimates for each Dividend Aristocrat that I'll use on my own to determine a margin of safety. Some still look overvalued, despite recent declines in stock prices, but others are now trading at considerable discounts. Names probably I’ll probably investigate further include Franklin Resources (NYSE:BEN), AbbVie (NYSE:ABBV), and Pentair (NYSE:PNR).

The Dividend Aristocrats: Prices, Consensus Estimates, Targets, and my Fair Value Estimates

Company Name

Company Ticker

Price

Analyst Target

FVE

FEPS

5-Y Growth Estimate

Forward PEG

Beta

3M Co

MMM

$201.25

$227.00

$189.02

$10.88

7.60%

2.43

0.89

Aflac Inc

AFL

$42.91

$47.25

$48.37

$4.05

10.67%

0.99

0.86

AbbVie Inc

ABBV

$97.75

$116.31

$111.24

$8.37

17.06%

0.68

1.07

Abbott Laboratories

ABT

$63.04

$68.81

$54.69

$3.04

11.54%

1.80

1.11

Air Products & Chemicals Inc

APD

$156.64

$184.14

$201.65

$7.78

14.53%

1.39

0.97

A.O. Smith Corp

AOS

$59.87

$71.00

$59.98

$2.76

12.92%

1.68

1.27

Archer-Daniels Midland Co

ADM

$46.71

$45.11

$44.01

$3.19

-10.33%

-1.42

0.97

AT&T Inc

T

$32.68

$38.37

$37.13

$3.47

8.73%

1.08

0.62

Automatic Data Processing Inc

ADP

$134.22

$136.46

$123.02

$4.72

8.65%

3.29

0.99

Becton, Dickinson and Co

BDX

$242.86

$251.93

$224.54

$11.81

12.90%

1.59

0.86

Cardinal Health Inc

CAH

$49.94

$59.10

$59.12

$5.07

5.23%

1.88

0.96

Chevron Corp

CVX

$125.24

$148.00

$133.56

$8.54

41.24%

0.36

1.11

Cincinnati Financial Corp

CINF

$68.85

$65.00

$66.74

$3.13

5.77%

3.81

0.87

Cintas Corp

CTAS

$192.29

$172.40

$166.16

$6.45

14.65%

2.03

0.92

Clorox Co

CLX

$134.05

$124.88

$138.09

$6.31

7.41%

2.87

0.50

Coca-Cola Co

KO

$44.65

$48.71

$40.41

$2.17

7.20%

2.86

0.55

Colgate-Palmolive Co

CL

$65.11

$71.44

$68.83

$3.25

7.68%

2.61

0.63

Consolidated Edison Inc

ED

$78.64

$77.33

$76.30

$4.36

3.52%

5.13

0.25

Dover Corp

DOV

$74.28

$95.50

$89.17

$5.10

13.54%

1.08

1.16

Ecolab Inc

ECL

$142.13

$151.41

$157.12

$5.70

12.66%

1.97

0.93

Emerson Electric Co

EMR

$70.07

$77.13

$68.58

$3.40

10.50%

1.96

1.13

Exxon Mobil Corp

XOM

$82.63

$88.89

$84.96

$5.18

15.00%

1.06

0.93

Federal Realty Investment Trust

FRT

$126.64

$137.00

$135.31

$4.74

5.77%

4.63

0.61

Franklin Resources Inc

BEN

$32.08

$37.11

$44.53

$3.20

4.84%

2.07

1.36

General Dynamics Corp

GD

$191.80

$248.08

$205.51

$11.77

16.28%

1.00

0.87

Genuine Parts Co

GPC

$92.54

$98.25

$103.84

$5.77

7.88%

2.04

0.89

W.W. Grainger Inc

GWW

$304.27

$296.40

$293.90

$15.84

10.37%

1.85

0.84

Hormel Foods Corp

HRL

$37.20

$37.43

$43.19

$1.86

11.34%

1.76

0.61

Illinois Tool Works Inc

ITW

$143.85

$174.30

$128.25

$8.09

11.91%

1.49

1.05

Johnson & Johnson

JNJ

$125.96

$143.93

$116.26

$8.35

7.70%

1.96

0.72

Kimberly-Clark Corp

KMB

$106.08

$103.11

$111.44

$7.04

6.66%

2.26

0.64

Leggett & Platt Inc

LEG

$45.48

$49.40

$49.75

$2.83

10.91%

1.47

0.95

Lowe's Companies Inc

LOW

$97.08

$105.14

$109.55

$5.79

15.04%

1.12

1.00

McCormick & Co Inc Non-Voting

MKC

$119.63

$111.83

$107.84

$5.18

10.61%

2.18

0.64

McDonald's Corp

MCD

$159.83

$186.05

$147.93

$7.97

7.70%

2.61

0.69

Medtronic PLC

MDT

$86.99

$93.33

$86.08

$5.33

6.70%

2.44

0.85

Nucor Corp

NUE

$63.73

$74.71

$75.45

$6.35

14.04%

0.71

1.32

PepsiCo Inc

PEP

$108.54

$116.33

$97.41

$5.86

5.98%

3.10

0.57

Pentair PLC

PNR

$43.04

$55.67

$52.43

$2.60

40.81%

0.41

1.20

Praxair Inc

PX

$165.60

$175.30

$149.18

$7.07

8.71%

2.69

0.98

Procter & Gamble Co

PG

$77.86

$79.39

$100.87

$4.31

6.61%

2.73

0.59

Roper Technologies Inc

ROP

$280.62

$310.90

$284.91

$11.73

12.64%

1.89

1.01

Sherwin-Williams Co

SHW

$415.78

$436.00

$469.81

$20.32

14.91%

1.37

0.98

Stanley Black & Decker Inc

SWK

$136.55

$182.46

$147.94

$8.94

11.18%

1.37

1.06

Sysco Corp

SYY

$69.29

$65.38

$62.16

$3.24

10.42%

2.05

0.63

T. Rowe Price Group Inc

TROW

$117.32

$122.60

$128.38

$7.44

13.25%

1.19

1.21

Target Corp

TGT

$77.90

$77.71

$82.33

$5.38

7.20%

2.01

0.69

VF Corp

VFC

$82.25

$83.62

$68.81

$3.76

9.62%

2.27

0.89

Walmart Inc

WMT

$86.09

$98.29

$83.69

$4.91

5.32%

3.30

0.62

Walgreens Boots Alliance Inc

WBA

$64.18

$74.82

$85.27

$6.21

10.96%

0.94

0.94

Disclosure: I am/we are long PG, WMT, CAH, GD, PEP.

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.

Additional disclosure: Not investment advice. I am not a professional investment adviser.