Dividend Yield Theory And The Case For FedEx

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About: FedEx Corporation (FDX)
by: Dividend Yield Theorist
Summary

What is dividend yield theory and how you can develop an investment strategy using its principles.

Build a stock screener that will identify the most undervalued stocks based on historical dividend yields.

FedEx is the most potentially undervalued stock for February 2019 and has plenty more room to grow.

Editor's note: Seeking Alpha is proud to welcome Dividend Yield Theorist as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to the SA PRO archive. Click here to find out more »

Dividend Yield Theory

Dividend yield theory works under the assumption that dividend-paying stocks over time revert to their historical average dividend yield. They are presumably undervalued when their dividend yield is historically high and conversely overvalued when their dividend yield is historically low. Sounds simple, buy stocks when the dividend yield is high and sell when the dividend yield is low. More often than not, a simple strategy like this one works just as good if not better when compared to sophisticated complex algorithms. Its best advantage is that it is easy to follow and replicate. The aim of this article is to show you how I have adopted a version of the dividend yield theory to develop a screen for stock selection.

The biggest problem I have come across with all my previous stock screeners was that I did not always like the stocks my screeners showed as the best opportunities. Sometimes I didn't like the company, the industry, or simply didn't know enough about the stock to confidently make a purchase. The fact that I let my emotions dictate my decisions was a huge handicap when the time came to pull the trigger. To compensate, I would tighten the parameters of the screeners to eliminate the undesirable companies, which, in hindsight, just sounds ridiculous and also brought on a whole new set of fears that I was going to eliminate great companies along with the undesirable ones. This was the biggest hurdle I had to overcome when developing my dividend yield theory screener. The best method to overcome this dilemma was to simply start with a universe of stocks that I already knew and liked. Sure there may be great opportunities out there I may miss by limiting myself to 40 or 50 companies, but I figured I would rather miss an opportunity than invest in a company I don't like or understand. The long-term plan is to keep expanding this universe with new companies after they are carefully reviewed and fit into my overall investing strategy.

Developing a stock screener

This screener will identify the most undervalued companies that will be further evaluated to ensure their fundamentals and future prospects are favorable. I will be using this strategy to initiate or add to existing positions in my portfolio on a monthly basis. However, for an investor who is just starting out, here is a hypothetical strategy to build a long-term portfolio using this screener. Each month initiate a new position in the most undervalued stock, working your way down the list until you have at least 10-20 unique positions. 10 unique positions are probably the minimum you want to have to add diversification to your portfolio. To add further diversification, you should also own stocks across multiple different sectors and set a maximum weight per position. Diversification is extremely difficult to accomplish especially early on in the development of a portfolio; however, over time, you will be able to grow the portfolio to at least 20-30 unique positions adding at opportunistic prices. The biggest advantage to this strategy is initiating or adding to existing positions at favorable market prices which over time should increase portfolio returns when stock prices return to normal price levels. A potential weakness may be the lack of undervalued stocks during certain months in which case an investor can either temporarily sit on their cash or invest in the highest ranked fairly valued stock. Additionally, like all other valuation methods, this measure of value is not an exact science and therefore, requires an investor to do their due diligence on the future prospects of each company prior to initiating a position.

The starting place for this screener, like many of my prior screeners, was the CCC list developed by the late David Fish. From the All CCC tab, I filtered for companies with a payout ratio smaller than 60% and the following DGR percentages: at least 7% growth for the last 3- and 5-year periods. I then sorted the file by the number of years of growth (descending order) and started looking at each company from the top. If I already knew the company and liked, it was added to the list; if I didn't know the company, I would do a quick search on Seeking Alpha and read some of the latest articles to help make the decision whether the company should be included or not. The main focus was to include companies whose business I can understand and/or I believe will be profitable for years to come. Obviously, this is a very biased judgment call on my part and therefore, each company should be further evaluated before an actual position is initiated. After I had 52 companies selected, it was time to compute their historical dividend yields. Manually computing historical dividend yields was going to be time consuming, so 52 stocks were plenty to start. One additional test was added prior to actually computing historical dividend yields. I wanted to ensure each of the selected stocks had a dividend growth rate for a 3-, 5-, 10-, and 15-year period of at least 7% if applicable. Stocks that did not have a 15- or 10-year dividend history were not penalized, but all stocks in my universe will be removed if any of their above-mentioned dividend growth rates fall below 7%. Here is a list of all 52 companies with their 3-, 5-, 10-, and 15-year dividend growth rates in the order I reviewed them.

Company Name

Ticker

3Y DGR

5Y DGR

10Y DGR

15Y DGR

Lancaster Colony Corp.

LANC

9.23%

8.63%

8.09%

7.48%

Lowe's Companies

LOW

20.39%

21.22%

18.36%

26.48%

Nordson Corp.

NDSN

12.22%

14.52%

13.54%

10.15%

Hormel Foods Corp.

HRL

14.52%

17.17%

15.04%

14.02%

VF Corp.

VFC

12.43%

15.61%

12.49%

14.36%

S&P Global Inc.

SPGI

14.86%

12.30%

8.56%

9.12%

Illinois Tool Works

ITW

18.54%

16.45%

11.25%

14.05%

Carlisle Companies

CSL

11.87%

12.89%

9.88%

8.79%

Medtronic plc

MDT

11.91%

12.20%

11.88%

13.97%

Air Products & Chemicals

APD

9.92%

8.94%

9.60%

11.07%

Cintas Corp.

CTAS

24.98%

21.63%

16.12%

14.47%

Brown-Forman Class B

BF.B

7.58%

8.69%

8.23%

9.68%

McCormick & Co.

MKC

9.14%

8.87%

8.98%

10.58%

Jack Henry & Associates

JKHY

13.96%

15.18%

17.30%

17.02%

SEI Investments Company

SEIC

9.49%

12.47%

15.43%

16.35%

General Dynamics

GD

10.51%

10.63%

10.48%

12.38%

Roper Technologies Inc.

ROP

18.12%

20.08%

18.98%

16.08%

Stryker Corp.

SYK

10.86%

12.14%

19.00%

25.82%

A.O. Smith Corp.

AOS

25.99%

27.00%

19.98%

14.71%

Brown & Brown Inc.

BRO

10.51%

10.52%

7.87%

11.70%

NextEra Energy Inc.

NEE

12.97%

10.96%

9.57%

9.11%

Ross Stores Inc.

ROST

24.18%

21.49%

25.21%

25.74%

International Business Machines

IBM

7.49%

10.91%

12.57%

16.48%

Bank OZK

OZK

13.07%

17.17%

20.32%

19.07%

Church & Dwight

CHD

9.18%

9.26%

26.21%

20.68%

Graco Inc.

GGG

9.70%

9.64%

7.91%

14.04%

TJX Companies Inc.

TJX

30.67%

26.70%

23.94%

24.45%

Canadian National Railway

CNI

12.15%

10.88%

12.35%

15.18%

FactSet Research System Inc.

FDS

13.19%

12.77%

14.15%

20.41%

Prosperity Bancshares

PB

9.73%

10.86%

11.16%

12.61%

FedEx Corp.

FDX

36.72%

31.72%

18.26%

17.30%

Microsoft Corp.

MSFT

10.06%

12.14%

14.10%

14.03%

Nike Inc.

NKE

13.56%

14.32%

13.31%

17.03%

International Flavors & Fragrances

IFF

12.97%

15.03%

11.69%

10.68%

Lockheed Martin

LMT

10.06%

11.40%

16.18%

19.31%

Tiffany & Company

TIF

11.29%

10.25%

12.88%

17.98%

Best Buy Corp.

BBY

26.94%

21.49%

13.01%

Costco Wholesale

COST

12.43%

12.90%

13.46%

Northrop Grumman

NOC

14.88%

14.58%

12.73%

13.29%

Westlake Chemical Corp.

WLK

9.91%

17.40%

24.54%

Ameriprise Financial Inc.

AMP

10.87%

11.92%

18.26%

CSX Corp.

CSX

7.93%

8.32%

13.11%

Hanover Insurance Group (THE)

THG

9.52%

10.30%

17.30%

Raytheon Company

RTN

9.90%

10.06%

12.23%

Travelers Companies

TRV

8.38%

9.10%

9.80%

American Financial Group Inc.

AFG

12.08%

12.49%

11.23%

Broadridge Financial Solutions Inc.

BR

15.27%

17.78%

21.13%

Union Pacific

UNP

11.63%

15.64%

20.73%

18.83%

Comcast Corp.

CMCSA

14.28%

14.25%

22.74%

Visa Inc.

V

20.74%

20.42%

32.57%

Principal Financial Group Inc.

PFG

11.87%

16.47%

16.65%

10.82%

Prudential Financial Inc.

PRU

13.84%

15.78%

20.03%

14.07%

I decided to choose the last 10 years as the time period for calculating historical yields. I extracted monthly historical price data from Yahoo Finance for a 10-year period for each stock. Next, I pulled the historical dividends paid and adjusted for any stock splits. Then, I combined the two files assigning the corresponding forward dividend to each monthly close price. I computed the dividend yield for each of the last 120 months by dividing the forward dividend by the close price. To compute the average historical dividend yield, I simply found the average of all the dividend yields for all 120 months. I computed this for each of the stocks in my universe and created a summary.

Most undervalued stocks for February 2019

By comparing the current dividend yield to the historical dividend yield, I was able to identify which stocks may be undervalued and potentially by how much. Of course, there are many factors that may cause a stock to currently have a historically high dividend yield and therefore, this method should only be used to identify stocks for further review. It is not recommended to make investment decision based on this metric alone. Each month, I update the historical dividend yields and start reviewing the most potentially undervalued stocks. Here is the summary for February 2019 (prices are as of close 2/8/19).

Undervalued

Quarterly

Annual

Historical

Company Name

Ticker

Overvalued

Price

Dividend

Yield

Yield

FedEx Corp.

FDX

-53.29%

177.24

0.6500

1.47%

0.69%

International Business Machines

IBM

-42.84%

133.71

1.5700

4.70%

2.68%

Bank OZK

OZK

-41.84%

31.04

0.2200

2.84%

1.65%

Prudential Financial Inc.

PRU

-40.47%

90.99

1.0000

4.40%

2.62%

Principal Financial Group Inc.

PFG

-39.13%

47.83

0.5400

4.52%

2.75%

Westlake Chemical Corp.

WLK

-29.99%

73.54

0.2500

1.36%

0.95%

A.O. Smith Corp.

AOS

-25.62%

49.26

0.2200

1.79%

1.33%

Tiffany & Company

TIF

-22.61%

88.08

0.5500

2.50%

1.93%

Ameriprise Financial Inc.

AMP

-22.18%

125.57

0.9000

2.87%

2.23%

TJX Companies Inc.

TJX

-20.11%

48.94

0.1950

1.59%

1.27%

Best Buy Corp.

BBY

-19.84%

58.95

0.4500

3.05%

2.45%

Illinois Tool Works

ITW

-18.75%

135.72

1.0000

2.95%

2.39%

SEI Investments Company

SEIC

-17.00%

49.33

0.3300

2.68%

2.22%

Prosperity Bancshares

PB

-15.61%

73.00

0.4100

2.25%

1.90%

Canadian National Railway

CNI

-12.69%

82.68

0.4550

2.20%

1.92%

Lowe's Companies

LOW

-11.84%

97.17

0.4800

1.98%

1.74%

Comcast Corp.

CMCSA

-11.11%

37.60

0.1900

2.02%

1.80%

Hormel Foods Corp.

HRL

-7.13%

42.94

0.2100

1.96%

1.82%

Roper Technologies Inc.

ROP

-5.25%

300.16

0.4630

0.62%

0.58%

Medtronic plc

MDT

-3.95%

89.01

0.5000

2.25%

2.16%

Air Products & Chem.

APD

-3.42%

165.90

1.1000

2.65%

2.56%

International Flavors & Fragrances

IFF

-2.26%

141.77

0.7300

2.06%

2.01%

VF Corp.

VFC

-0.67%

85.78

0.5100

2.38%

2.36%

Travelers Companies

TRV

-0.46%

125.79

0.7700

2.45%

2.44%

Visa Inc.

V

-0.17%

140.38

0.2500

0.71%

0.71%

American Financial Group Inc.

AFG

1.61%

96.07

0.4000

1.67%

1.69%

Union Pacific

UNP

2.36%

161.72

0.8000

1.98%

2.03%

Nordson Corp.

NDSN

2.74%

132.59

0.3500

1.06%

1.08%

FactSet Research System Inc.

FDS

3.32%

221.34

0.6400

1.16%

1.20%

Ross Stores Inc.

ROST

3.46%

92.95

0.2250

0.97%

1.00%

Costco Wholesale

COST

4.04%

207.75

0.5700

1.10%

1.14%

General Dynamics

GD

4.98%

172.12

0.9300

2.16%

2.27%

Church & Dwight

CHD

8.14%

63.34

0.2180

1.38%

1.49%

Carlisle Companies

CSL

8.55%

119.31

0.4000

1.34%

1.46%

Broadridge Financial Solutions Inc.

BR

13.12%

97.53

0.4850

1.99%

2.25%

Brown-Forman Class B

BF.B

14.32%

48.12

0.1660

1.38%

1.58%

Lockheed Martin

LMT

15.06%

301.50

2.2000

2.92%

3.36%

Brown & Brown Inc.

BRO

15.77%

27.83

0.0800

1.15%

1.33%

Hanover Insurance Group (THE)

THG

16.23%

114.93

0.6000

2.09%

2.43%

Stryker Corp.

SYK

16.45%

182.66

0.5200

1.14%

1.33%

McCormick & Co.

MKC

18.54%

126.69

0.5700

1.80%

2.13%

Jack Henry & Associates

JKHY

20.73%

132.67

0.3700

1.12%

1.35%

Lancaster Colony Corp.

LANC

21.58%

160.91

0.6500

1.62%

1.96%

Nike Inc.

NKE

22.27%

82.36

0.2200

1.07%

1.31%

Cintas Corp.

CTAS

23.75%

194.23

2.0500

1.06%

1.31%

Graco Inc.

GGG

24.45%

44.21

0.1600

1.45%

1.80%

NextEra Energy Inc.

NEE

31.83%

183.01

1.1100

2.43%

3.20%

Raytheon Company

RTN

33.14%

175.92

0.8680

1.97%

2.63%

Microsoft Corp.

MSFT

39.40%

105.67

0.4600

1.74%

2.43%

Northrop Grumman

NOC

44.60%

280.62

1.2000

1.71%

2.47%

CSX Corp.

CSX

60.29%

68.75

0.2200

1.28%

2.05%

S&P Global Inc.

SPGI

75.56%

193.59

0.5000

1.03%

1.81%

Potential reasons why a stock may currently have a historically high dividend yield are: negative news/performance that has caused the stock price to drop or the company has grown their dividend rapidly and their stock price has not kept up. Both of these scenarios would present great opportunities for purchase if we can favorably validate the long-term prospects of the business. Of course, there may be numerous other factors that have caused the dividend yield to exceed historical averages and therefore, each stock must be evaluated further to ensure we don't end up investing in a sinking ship. A great way to start the evaluation process is by researching the stock here on Seeking Alpha or by reviewing the company's latest earnings and annual reports.

Another great tool I have added to my screener is a graph of a company's historical dividend yield. By looking at a graph of the dividend yield compared to the historical average, we can see how long the dividend yield has been under/overvalued. Below is the graph for FedEx Corp., the number one undervalued stock on February's list. The two additional green lines in the graph are the one and two standard deviation measures of the historical dividend yield.

Review of FedEx Corp.

Source: Self-prepared using data from Yahoo Finance

As you can see from the graph, the dividend yield for FedEx has grown rapidly from mid-2016 and is currently at the highest level in the last 10 years. This can be explained by two reasons. First, FedEx has ramped up their dividend growth in the last five years. In the table below, you can see that starting in 2014 FedEx started increasing their dividend by at least 20% each year. A clearer picture is painted by looking at the running 5-year annualized dividend growth rate which has grown from 8.29% in 2014 to 26.86% in 2018. The second explanation for the currently high dividend yield is their recent price drop. The price peaked in early 2018 at around $260 but has pulled back to a recent low around $160 during December of 2018. There is also the possibility that due to their recent high dividend growth, FedEx is plateauing at a new normal dividend yield and will not return to their historical average.

Year

Dividend

Growth

5 Year Annualized Growth

2003

0.21

2004

0.27

28.57%

2005

0.31

14.81%

2006

0.35

12.90%

2007

0.39

11.43%

13.18%

2008

0.43

10.26%

9.75%

2009

0.44

2.33%

7.26%

2010

0.47

6.82%

6.07%

2011

0.51

8.51%

5.51%

2012

0.54

5.88%

4.66%

2013

0.58

7.41%

5.68%

2014

0.70

20.69%

8.29%

2015

0.90

28.57%

12.03%

2016

1.30

44.44%

19.21%

2017

1.80

38.46%

25.42%

2018

2.30

27.78%

26.86%

Upon further analysis of FedEx, we can see in the chart below, they have grown their revenue at a CAGR of 8.37% over the last 4 years while also growing operating income at a CAGR of 25.11% during that same period. The number of shares outstanding has remained relatively stable; therefore, we can safely assume they are not trying to display growth through buybacks.

Year

Revenue

Operating Income

Shares Outs.

2015

47,453

2,143

287

2016

50,365

3,077

279

2017

60,319

5,037

270

2018

65,450

5,250

272

CAGR

8.37%

25.11%

-1.33%

In the table below, we can see earnings per share have grown at a CAGR of 46.45% over the last 4 years. This is quite fast especially for a large company and definitely not sustainable over a longer term. A quick review of their recent financials shows that FedEx has been spending approximately $4 billion to $5 billion annually over the last 4 years on capital expenditures mainly funded by issuance of new debt. This can explain the recent uptick in earnings growth and there is nothing wrong with growth through debt. However, investors should keep a close eye on debt levels in the future. Also, in the table below, we can see that the payout ratio for FedEx has been getting smaller and therefore, provides sufficient room for future dividend growth.

Year

Eps (diluted)

Dividends

Payout Ratio

2015

3.65

0.90

24.66%

2016

6.51

1.30

19.97%

2017

11.07

1.80

16.26%

2018

16.79

2.30

13.70%

CAGR

46.45%

26.44%

A quick review of margin rates for FedEx shows they have maintained a steady gross margin around 22% over the last 4 years. Their operating margin has grown from 4.52% to slightly over 8% which points to improvements in their operations. The net margin has also seen improvement; however, part of the 2018 net margin increase is most likely attributed to recent tax code changes.

Year

Gross Margin

Operating Margin

Net Margin

FCF Margin

2015

22.65%

4.52%

2.21%

2.15%

2016

23.48%

6.11%

3.61%

1.77%

2017

22.82%

8.35%

4.97%

-0.31%

2018

22.24%

8.02%

6.99%

-1.51%

Bonus Graphs for February 2019

Here are the graphs for the remaining top 5 stocks in my screener.

International Business Machine

Source: Self-prepared using data from Yahoo Finance

Bank OZK

Source: Self-prepared using data from Yahoo Finance

Prudential Financial Inc.

Source: Self-prepared using data from Yahoo Finance

Principal Financial Group Inc.

Source: Self-prepared using data from Yahoo Finance

Summary

To summarize, dividend yield theory can be a useful tool in developing a stock screener that can identify when companies are potentially undervalued. I have tailored it to work for me by limiting my starting universe and self-computing the historical dividend yields to control the time period I prefer. Investors can use this simple strategy and screener to identify undervalued stocks that can be added to their portfolios. Investing in undervalued stocks increases the likelihood of increasing overall returns when stock prices return to their fair market values. For February 2019, FedEx was identified as potentially the most undervalued stock with a dividend yield exceeding 2 standard deviations above their 10-year trailing dividend yield. After a brief review of their financials, we have determined that FedEx has pumped large amounts of cash, funded by new debt, into capital expenditures that helped them speed up growth of their operating income and bottom line earnings. Based on their recent growth and a low payout ratio, I expect their amazing dividend growth to continue into the future and their stock price to return to full valuation rewarding long-term investors.

Disclosure: I am/we are long AOS, FDX, IBM, ITW, LOW, NOC, OZK, PRU, TJX, V. 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.