10 Dividend Growth Stocks For October 2018

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Includes: ATO, AWK, AWR, CPK, D, ED, ES, IDA, NEE, SWX, UGI, WEC, XEL
by: FerdiS
Summary

Every month I rank a selection of the CCC stocks and present 10 stocks for consideration.

Last month, I noted that my ranking system does a poor job of ranking REITs relative to other stocks. I decided to rework my ranking system to address this shortcoming.

This month, I'm debuting my new ranking system. While it is still in development, I wanted to test it out on stocks in the Utilities sector.

The CCC list is a wonderful resource for Dividend Growth Investors. Created by the late Dave Fish and now maintained by Justin Law, the CCC list contains nearly 900 stocks trading on U.S. exchanges with the distinction of having paid higher dividends for at least 5 consecutive years.

With my monthly 10 Dividend Growth Stocks series, I rank a subset of stocks from the CCC list and present the 10 top-ranked stocks for further research.

Last month I ranked 240 stocks, significantly more than I normally do!

Ranking so many stocks revealed a shortcoming in my ranking system. It does a poor job ranking REITs (real estate investment trusts) relative to stocks in other sectors. The main reason is that my ranking system referenced fundamental data in the CCC spreadsheet, which does not provide REIT-appropriate metrics such as NAV (net asset value) and FFO (funds from operations).

One advantage of ranking 240 stocks is that it allowed me to review the top-ranked dividend growth stocks by sector. If you did not read that article, I think it is worth a look! It is particularly useful for dividend growth investors looking to diversify their portfolios by sector.

Seeing the 10 top-ranked stocks by sector was so useful that I decided to rework my ranking system to be sector-focused. In the future, I want to rank stocks relative to sector peers.

This month I'm debuting my new sector-oriented ranking system. While it is still a work in progress, I wanted to test the new ranking system on stocks in the Utilities sector. In the coming months, I'll refine the ranking system and cover stocks in other sectors.

The CCC List: Utilities

The latest CCC list (dated 9/28/18) contains 896 stocks. There are 127 Dividend Champions - stocks trading on U.S. exchanges with higher dividend payments for 25 or more consecutive years - 209 Dividend Contenders (10-24 year streak); and 560 Dividend Challengers (5-9 year streak).

The CCC spreadsheet contains more than 50 Utilities sector stocks. I ranked 54 stocks after excluding stocks with a market capitalization below $1 billion. All stocks in the Utilities sector have dividend yields of at least 1%.

Below is an analysis of these stocks, courtesy of finbox.io:

Collectively, the stocks have a fair value downside of about 14.5% and an average dividend yield of 3.3%. An equal-weighted portfolio would have returned 3.7% in the past year. Furthermore, the stocks have outperformed the S&P 500 by about 25% over the last five years.

The New Ranking System

I ranked the 54 Utilities sector stocks using data available in the CCC spreadsheet and additional sources like Morningstar, F.A.S.T. Graphs, finbox.io, and Simply Safe Dividends.

My new ranking system assigns letter grades to each stock relative to its performance among sector peers, in each of the following four categories:

  1. Consistency and rate of past earnings growth
  2. Dividend Safety and sustainability of payments
  3. Financial Health of the company and quality of the stock
  4. Growth of dividends and earnings (history and outlook)

In the list of 54 stocks, I assigned A, B, D, and F grades to 10 stocks in each category, and C grades to the remaining 14 stocks.

I assign scores to stocks based on different metrics in each category. Metrics are weighted relative to how important I consider them to be. For example, I have one metric in each category with a relative weight of 3, three metrics with weights of 2 each, and several additional metrics with weights of 1 each. The maximum score per category is 25, so the total score for each stock is out of 100.

Stocks are ranked from the highest to the lowest based on total score.

Note that I no longer mix valuation metrics into my ranking system. Instead, my ranking system will attempt to identify top-quality dividend growth stocks regardless of valuation.

As before, I'll provide fair value estimates of the top-ranked stocks to help readers identify potential candidates for further research.

Top 10 Utilities Sector Stocks

Here are the top 10 Utilities Sector stocks according to the new ranking system:

Top 10 Utilities Sector Stocks (October 2018)

Last Month's List: 10 Dividend Growth Stocks (September Edition)

The only stock I own in my DivGro portfolio is highlighted

1. NextEra Energy (NEE)

NEE, formerly known as FPL Group, Inc., is an electric power company with approximately 42,500 MW of generating capacity in 26 states in the United States and 4 provinces in Canada. The company generates electricity from gas, oil, coal, petroleum coke, nuclear, solar and wind. NEE was founded in 1984 and is based in Juno Beach, Florida.

2. WEC Energy (WEC)

Founded in 1981 and based in Milwaukee, Wisconsin, SWITCH is one of the nation's premier energy companies, serving more than 4.4 million customers in Wisconsin, Illinois, Michigan, and Minnesota. WEC's principal utilities are We Energies, Wisconsin Public Service, Peoples Gas, North Shore Gas, Michigan Gas Utilities, Minnesota Energy Resources, and We Power.

3. Atmos Energy (ATO)

Founded in 1906 and headquartered in Dallas, Texas, ATO and its subsidiaries are engaged in the distribution, transmission, and storage of natural gas in the United States. The company delivers natural gas to residential, commercial, public authority and industrial customers in nine states in the southern USA. ATO also operates intrastate gas pipelines in Texas.

4. UGI (UGI)

UGI distributes, stores, transports, and markets energy products and related services. The company distributes propane throughout the United States. It also distributes liquid petroleum gas, natural gas, liquid fuels, and electricity, and operates several electric generation facilities. UGI was founded in 1882 and is based in King of Prussia, Pennsylvania.

5. Southwest Gas (SWX)

Founded in 1931, SWX is an energy holding company based in Las Vegas, Nevada. The company provides natural gas service to residential, commercial, and industrial natural gas customers in Arizona, Nevada, and California. A wholly-owned subsidiary of SWX provides utility companies with trenching and installation, replacement, and maintenance services for energy distribution systems.

6. American States Water (AWR)

Founded in 1929 and based in San Dimas, California, AWR provides water and electric services to residential and industrial customers in California through a holding company, Golden State Water Company. AWR provides water and wastewater services to military installations in the United States through American States Utility Services, another holding company.

7. Chesapeake Utilities (CPK)

CPK is a diversified energy company engaged in regulated and unregulated energy businesses. The company is involved in natural gas distribution and transmission, propane distribution and marketing, advanced information services, and other related businesses. The company serves residential, commercial, industrial, and wholesale customers. CPK was founded in 1859 and is headquartered in Dover, Delaware.

8. American Water Works (AWK)

AWK is the largest publicly-traded water and wastewater utility company in the United States. Through its subsidiaries, the company provides water and wastewater services in 45 states and in Ontario, Canada. The company is headquartered in Voorhees, New Jersey, and was founded in 1886 as the American Water Works & Guarantee Company.

9. Consolidated Edison (ED)

ED delivers electricity, gas, and steam. The company provides electric services to customers in New York City and Westchester County; gas to customers in Manhattan, the Bronx, and parts of Queens and Westchester County; and steam to customers in parts of Manhattan. ED was founded in 1884 and is based in New York, New York.

10. IDACORP (IDA)

Founded in 1915 and headquartered in Boise, Idaho, IDA is a holding company engaged in the generation, transmission, distribution, purchase, and sale of electric energy in the United States. The company operates 17 hydroelectric generating plants in southern Idaho and eastern Oregon, and 3 natural gas-fired plants in southern Idaho.

Please note that the top 10 ranked Utilities Sector stocks are candidates for further analysis, not recommendations.

Below is a finbox.io analysis of the top 10 Utilities Sector stocks for October 2018:

Only one stock is trading below fair value (according to finbox.io) and, overall the stocks have a fair value downside of about 16%. Note also the more modest dividend yield of 2.4%.

On the other hand, these stocks have returned 8.9% in the past year and 114% over the last five years! The 5-year performance is just about double that of the S&P 500 over the same period.

Grades and Key Metrics

The table below presents key metrics from the CCC spreadsheet (unless noted otherwise), a fair value estimate, and letter grades for each stock. The letter grades are for Consistency (C), Safety (S), Health (H), and Growth (G) as described earlier.

In the table, Years are the years of consecutive dividend increases and Payout Ratio is the earnings payout ratio, courtesy of Simply Safe Dividends. When available, I provide Standard & Poor's Credit Rating and the compound dividend growth rate over a 5-year period (5-Yr DGR) from the CCC spreadsheet. I also provide the adjusted operating earnings growth rate for a 10-year period (10-Yr EGR) from F.A.S.T. Graphs and the Safety Score (out of 100) from Simply Safe Dividends. Finally, I present my own estimate of Fair Value.

To estimate fair value, I calculate my own fair value estimates using proprietary implementations of the multi-stage Dividend Discount Model and the Gordon Growth Model. I also reference fair value estimates and target prices from other sources, including finbox.io, Morningstar, and F.A.S.T. Graphs. With up to nine estimates available, my final fair value estimate ignores the lowest and highest, then averages the median and mean of the remaining estimates.

Only SWX is trading below fair value, while NEE, UGI, and ED are trading at about fair value.

Commentary

As mentioned earlier, my new ranking system excludes valuation metrics (such as P/E). Rather, the system is designed to identify top-quality dividend growth stocks for consideration. As one comment on a previous article suggested, first determine what to buy (quality), then when to buy (valuation).

By assigning letter grades to four quality factors (consistency, safety, health, and growth), I'm hoping to provide a more nuanced ranking than one based solely on total score.

The other change I made is taking a sector-oriented approach. Comparing stocks to sector peers simplifies scoring and grading, and avoids the issue of properly ranking REITs relative to other stocks.

Last month, I ranked 240 stocks with my previous ranking system and presented the 10 top-ranked dividend growth stocks by sector. Here are the top-ranked Utilities sector stocks from that article (link provided earlier):

NEE tops both lists, and ED, ATO, WEC, and UGI all "survived" my ranking system change.

Three of the stocks I own, Dominion Resources (D), Xcel Energy (XEL), and Eversource Energy (ES), no longer are in the top 10 list. ES just missed out (rank #12) and XEL is close, too (rank #15), but D dropped way down the list (rank #29).

I'll need to do some digging to see why D is ranked so low and to see what, if anything, I need to do about my position. Of course, owning only one of the top-ranked Utilities sector stocks presents some opportunities, and I'll be looking at several of the candidates in the near future.

Some Good-Looking Charts

Below, I'm including charts from F.A.S.T. Graphs for three of the top-ranked Utilities sector stocks.

In these charts, the black line represents the share price, and the blue line represents the calculated P/E multiple at which the market has tended to value the stock over time. The orange line is the primary valuation reference line. It is based on one of three valuation formulas depending on the earnings growth rate achieved over the time frame in question. (The Adjusted Earnings Growth Rate represents the slope of the orange line in the chart).

NEE's chart is a model of consistency! Over the coverage period of about 10 years, NEE achieved an earnings growth rate of 7.3%. The stock's annualized RoR (rate of return) is even higher at 13.4%. For comparison, the S&P 500 has an RoR of 11.3% over the same period.

Dividends are shown as the light green area above the orange line, but also as the white line within the dark green shaded area and relative to the orange line. The white line graphically represents NEE's payout ratio (also a model of consistency!).

That NEE's share price is trending well above the orange line indicates the willingness of buyers to pay a premium price for the stock. The premise of Earnings and Price Correlated F.A.S.T. Graphs is where earnings go the price is sure to follow. Buying NEE at these levels should be understood to be somewhat risky.

Next, let's look at WEC:

WEC is almost as consistent as NEE and nearly everything I noted about NEE applies. WEC's earnings growth rate is 7.8%, while the stock's RoR is 13.2%.

Finally, consider AWK:

Another model of consistency, and AWK's earnings growth rate (11.0%) and RoR (16.3%) really impress! Based on my fair value estimate, AWK is trading at a 12% premium to fair value.

I highlighted 3 charts here, but, really, every stock in my top 10 list has an impressive chart! That gives me some confidence in the ability of my new ranking system to pick out quality dividend growth stocks. In future articles, I'll target other sectors to see how it holds up.

Concluding Remarks

Following last month's article, I decided to rework my ranking system to remove a few shortcomings.

Specifically, I noted that my previous ranking system did a poor job of ranking REITs relative to other stocks. Additionally, it conflated quality and valuation metrics.

In this article, I debuted my new ranking system by deploying it on stocks in the Utilities sector.

The new ranking system is sector-oriented and introduces letter grades, which provide a more nuanced view of the ranked stocks. The letter grades are assigned to four quality factors: Consistency, Safety, Health, and Growth. In the list of 54 Utilities sector stocks ranked, I assigned A, B, D, and F grades to 10 stocks in each category, and C grades to the remaining 14 stocks.

I don't consider valuation metrics in my new ranking system. Rather, the system is designed to identify top-quality dividend growth stocks regardless of valuation. However, I continue to provide fair value estimates of the ranked stocks.

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Disclosure: I am/we are long D, ES, NEE, XEL. 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.