I was looking through the portfolio after I put the finishing touches on my last article and realized that the consumer discretionary sector was a little bit light. In fact as I type this it is only 7.3% of my stock portfolio.
One of my favorite companies, Home Depot Inc (HD), is trading very near its 52 week low and is certainly a position I would love to add to. But I also was looking for a third consumer discretionary stock. Is there something better out there? Should I add to my Home Depot position at these levels, or should I hold off and add a third consumer discretionary stock? That is what I will attempt to answer in this article.
To find a new candidate I decided to look at all of the stocks in this sector that are classified as "Dividend Champions". That is, all the stocks with more than 25 straight years of higher dividends. Using The DRiP Investing Resource Center, I filtered the Champions tab to arrive at this table. I have listed all of the consumer discretionary stocks that are also champions below, while the dividend yield I updated at current yields:
|Name||Symbol||# of Yrs||Div Yield|
|Genuine Parts Co.||GPC||62||2.79|
|John Wiley & Sons Inc.||JW-A||25||2.44|
|Leggett & Platt Inc.||LEG||47||3.96|
|Weyco Group Inc.||WEYS||37||2.88|
Let's see... I already own the stock with the longest streak in this sector, Genuine Parts Co (GPC), and it is actually faring pretty well in this market so far. I'm not looking to add to it at these levels. Lowe's Companies (LOW) seems like it would be pretty redundant since I already own HD. Also their current dividend yield is actually lower than that of HD at just over 2%.
I could look at Target Corp. (TGT), but I already have a position in Walmart Stores Inc (WMT) though for some reason WMT is considered a consumer staple. Leggett & Platt Inc. (LEG) has a long 47 year history of raising their dividend and almost a 4% yield. Wait, who? I know. If you are not a dividend growth investor (DGI) chances are good you have never heard of them. Let me take a closer look at them and while we're at it we'll revisit HD since it's been well over a year since I opened that position and did the due diligence on it.
I'll go through my guidelines and we'll see which stock comes out ahead. I may add some LEG or add to my shares of HD depending on how this turns out.
Guideline #1 - Growing Revenues Per Share
Both LEG and HD show growing revenues per share, though Home Depot's revenue might be a little bit seasonal, don't you think? LEG had revenues of $3.8B in FY14 (ended December 31, 2014), and the trailing twelve months (NYSE:TTM) they had revenues of $4.2B, an 11% increase, so they definitely show growing sales numbers.
Home Depot on the other hand had sales of $83.2B in FY15, which ended January 31, 2015 (one month later than LEG reported). Their revenues over the TTM are $105.6B, which means they have grown sales 27% since the end of January 2015. Home Depot has the upper hand for now. Obviously they are growing their revenues much faster, but let's continue.
Guideline #2 - Growing Book Value Per Share
Book value is the tangible assets of the business less the liabilities of a business. Or another way to think about it is what would investors receive if the company ceased operations and was just liquidated. That is why I like to see the book value of a company growing.
It is fairly obvious by the above chart that Home Depot's book value is not growing. Now there is a very good explanation for this. HD is buying back their own stock at a furious rate. $7 or 8 billion per year for the last four or five years. Unfortunately their free cash flow does not allow them to both pay their dividend and repurchase that much stock without tapping into the credit markets.
Their total liabilities are going up faster than their total assets, which is driving stockholder's equity lower and lower. In fact stockholder's equity has decreased from $18B in 2013 to $1.3B as of the end of October. Yes, they are reducing the shares outstanding, but not fast enough to make the book value per share number look good.
LEG's book value per share has been growing lately but I wouldn't say it is terribly consistent at doing so. They are also buying back shares but they aren't doing so quite as aggressively and their free cash flow generally covers both their dividend payment and the repurchase of stock.
Neither one of these excites me as far as this measurement goes, but the advantage here goes to LEG.
Guideline #3 - Quality Rating
Data from Value Line (subscription required)
Pretty cut and dried here. Home Depot has the highest safety rating and financial strength rating that Value Line awards. LEG, while not by any stretch of the imagination bad, did receive slightly lower ratings in both categories. Chalk up another win for HD.
Guideline #4 - Debt to Equity
Here is where we see again the results of Home Depot's ever increasing debt load. Home Depot has 19.5x more debt than they do shareholder's equity. I strongly dislike this, and share buybacks don't seem to be a good enough reason to run up this kind of debt.
LEG has seen their ratio run up slightly over the last few years, but a debt to equity ratio of 1.2 is nothing to be alarmed about. You have to give this round to LEG.
Guideline #5 - FCF and Payout Ratio
Both of these companies generate a significant amount of free cash flow, but they are very different in terms of size. HD is the much larger company so it is not surprising that they generate a lot more cash. HD pumps out billions of dollars of free cash flow per year compared to LEG which "only" generates a couple hundred million.
One way to measure this which is fair to both companies is to find the "free cash flow yield". Basically, if each company paid out all of their free cash flow as a dividend, what would the dividend yield of the stock be? The data in the table below is taken from Marketwatch.com and uses data from December 2017 for LEG and January 2018 for HD. These are the most recent full year numbers we have.
Table created by author
So as you can see, for each dollar of whatever stock I end up choosing, I am buying about a nickel of free cash flow. That is very acceptable.
I actually ran these same numbers using the most recent quarterly numbers for share count and the TTM cash flow, but there was not a substantial difference. If anything the two yields got a little closer together.
Now what are they doing with that free cash flow? Well we already talked about both of them buying back shares of their own stock. But they also pay a dividend. As we can see below, LEG pays about two thirds of their free cash flow out as a dividend and HD pays out somewhere between 40-50%. Based strictly on the lower payout ratio, where I consider anything below 50% to be excellent, I have to give the edge to HD, though 66% is certainly quite a safe payout ratio.
Guideline #6 - Common Shares Outstanding
We've already beaten to death the fact that HD is aggressively buying back their shares, but the below chart does not make it clear that HD is being so much more aggressive than LEG.
So I put together the following table using data from Morningstar.com (subscription required):
Here you can see that in about the last five years HD has retired 20% of their own shares while LEG has retired 8%. I actually prefer the speed with which LEG is doing this, but in assigning a "winner" for the company that is reducing their share count I have to give it to HD here.
Guideline #7 - Show Me the Money!
You already know I was looking for a "Dividend Champion", and LEG is just a few years away of reaching "King" status. The thing that initially drew me to HD was the spectacular rate they are increasing the dividend. Take a look at the details below.
Table assembled by author with data from The DRiP Investing Resource Center
Where do you go from here? I love both of these stories. I like having both the high yield stock with not as much dividend growth (like a utility) and I also like having the lower yielding stock with a very high growth rate (like a Hormel Foods Corp (HRL)). In fact I would argue you should have both kinds of stock in your portfolio.
I would say this is as close to a push as we have, but I will give the edge to LEG because the 4.4% growth rate is not terrible (beats inflation) and the juicy yield to start is slightly more attractive to me.
Guideline #8 - P/E Ratio
While both HD and LEG are consumer discretionary stocks, they are in different industries. I like to look at their price to earnings ratio vs. the P/E of the industry they are a part of. For these two stocks, they actually appear to be trading within a hair of their industry average.
While this is a very close call, I have to give the edge to LEG because over the trailing twelve months they were trading below the P/E ratio of the industry average while HD was slightly above.
Results and Conclusion
Tie ball game. I like both stocks and for different reasons. So what do I do now? I honestly don't know. I finished writing this article after the market closed and before my decision was made so there is no telling what if anything I will be buying in the near term. I do think I would like to eventually own some shares of LEG. It might happen this month, or it might have to wait a little bit. Part of the decision might come down to what happens the next time the market is open.
What do you all think? Do I pick up a new consumer discretionary stock, a true dividend champion that is quickly approaching "King" status, or do I add to my Home Depot position? Truly interested in hearing your thoughts.
Thanks for reading, and as always good luck!
Disclosure: I am/we are long GPC, HD, HRL, WMT. 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.