Why I Look For Dividend Growth, Not Just Dividend Safety

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Includes: ADP, FDX, JNJ, JPM, MMM, MRK, MS, MSFT, NEP, NKE, ORCL, PFE, PG, SPY, V, WMT
by: John Windelborn
Summary

Growth trumps safety (longevity of raises) in my opinion.

Lower current yield is quickly negated over time with high growth.

FedEx is one such dividend growth and value play.

David Van Knapp just came out with a good article about high-quality dividend growth stocks. As I was reading it, I noticed that it placed a large emphasis on safety and number of years that the dividend was increased, but not on the actual dividend growth numbers. There was a mention about how many of these companies have “matured,” leaving their yields and growth relatively low. Many of these companies are perfectly fine to invest in and many have beaten the market over the past three years. However, when I’m evaluating what companies to add to my own dividend growth portfolio, I’m much more interested in growth rates than safety per se.

That sounds foolish if taken at face value, but it’s because growth creates safety, not the other way around. To illustrate this point, let’s consider Company A and Company B. Company A is considered a very safe blue chip dividend stock. Its dividend yield has always been around 3% and has 62 years of dividend growth. Dividend growth over the past 10 years has been 6.3% but has been slowing drastically. Company B is a bank stock that usually yields around 2.5% and had to cut the dividend by 87% during the financial crisis. It would therefore not score highly in relative safety and only has 8 years of continuous dividend growth.

Company A is Procter & Gamble (PG), and Company B is JPMorgan Chase (JPM). Past 10-year total return comes in at 165.2% for PG, 314.5% for SPY, and 430.9% for JPM.

If you invested $10,000 in January 2007, before the market crash, in both companies:

Your PG would have returned an annualized 6.57%, be worth $21,568, your annual dividends received would be approximately $620 for a yield on cost of 6.2%.

Your JPM investment would have returned an annualized 9.24%, be worth $29,078, your annual dividends received would be approximately $884 for a yield on cost of 8.84%.

Not only did JPM trounce PG despite enduring the financial meltdown and an 87% dividend cut, but future prospects are bleak for PG. EPS for JPM is up 10.5% for the past year compared to 5.6% for PG, and the payout ratio is nearly twice as high for PG, coming in at 64.4% compared to 32.4% for JPM. This means that dividend growth will assuredly be significantly higher for JPM in the near future because there is more wiggle room with higher coverage and higher earnings growth. If you invested based on perceived safety quantified only in years, you would be doing very poorly.

Chart Of Highest Quality/Safety Dividend Growth Stocks

Obviously, David understands that you should evaluate companies on many different criteria and that safety means more than just years of raises. People might also suggest that I cherry-picked the above example to suit my article thesis. Let’s look at the following chart that was included in David’s article and that represents the highest quality dividend growth stocks according to his scoring metrics.

Image from David Van Knapp’s article 2/19/19

There are some very good names on this list and I am not suggesting that any of the aforementioned stocks are bad investments today. What I want to do is examine these names and look at their 3-year dividend growth and 3-year total return numbers. Numbers that are bolded beat the S&P 500 (SPY) and numbers in italics are worse.

Company

Ticker

3 Yr Dividend Growth

3 Yr Total Return

3M

MMM

9.96%

46.3%

Automatic Data Processing

ADP

12%

95.8%

Johnson & Johnson

JNJ

6.27%

45.1%

Merck

MRK

6.5%

78.5%

Microsoft

MSFT

10.1%

129%

Nike

NKE

12.24%

56.9%

Oracle

ORCL

10.27%

52.5%

Pfizer

PFE

6.69%

59.9%

Procter & Gamble

PG

2.58%

34%

Visa

V

20.83%

110.6%

Walmart

WMT

2%

63.3%

S&P 500

SPY

6.64%

58.3%

FedEx

FDX

37.54%

43.4%

Morgan Stanley

MS

26%

94.4%

NextEra Energy Partners

NEP

24.38%

84.7%

Table created by author

If you invested three years ago based on safety and you chose Visa, Automatic Data Processing or Microsoft, you did very well. If you chose some of the other companies, it’s possible that you would have been disappointed. Since our original goal was to invest for dividend growth, picking safe stocks like Walmart or Procter and Gamble would not accomplish our goal, having our dividends grow at the same rate of inflation and 3 times as slowly as the broad market.

I included three names at the end of the table that I see as prime candidates for dividend growth investing if you were to invest money today. All three share some common characteristics: their product is not going away any time soon (logistics, money and electricity), they have shown good growth and even better dividend growth, and, unlike much of the market, they are all at the lower ends of their 52-week price range.

I have written frequently about NextEra Energy Partners’ prospects (last article here) so I will not write again about them today. I’ll be looking at Morgan Stanley in a future article, so instead I want to offer a glimpse of why I like FedEx for dividend growth investing.

FedEx

Image from finviz.com

Seeking Alpha contributor Louis Stevens wrote in January about which stock is a better investment, UPS (UPS) or FedEx. In the article, the author does a fantastic job about showing how FedEx has historically invested more money back into its business while UPS has used the money to support a higher dividend and buy back shares.

Image from YCharts and from this article

This investing for growth and future operations has caused FDX to experience 56.2% earnings growth over the past three years. That type of growth has supported the 37.5% average dividend growth in the same time frame, and resulted in a shockingly low payout ratio of 16.2% according to Seeking Alpha.

Image from Seeking Alpha

FedEx may feel the pinch from Amazon's (AMZN) expanding sphere of influence in the logistics business, but UPS is actually more of a direct competitor to Amazon since more of their business comes from domestic operations. Roughly half of FedEx’s revenues are derived from international business. International (and domestic) logistics will continue to flourish in the years to come and drive earnings higher as long as FDX keeps churning money back into the company. The following graph is an estimate of worldwide e-commerce sales.

Image from Statista

Admittedly, the dividend yield of FDX is rather low at 1.45% However, when you consider that shares are off 32.4% from their 52-week highs compared to 5.5% for the broader market, there is definitely value to be had here. In addition, a low yield isn’t as intolerable if the enormous dividend growth is there. Consider investing $10,000 in FDX at a reasonable 20% dividend growth rate on a 1.45% dividend yield.

Image from dividendladder.com

After 5 years of dividend reinvestment, your $10,000 would have grown into $26,431 and your yield on cost would now be a respectable 3.83%. If we run the same calculator with Walmart’s 2% dividend and 2% average annual increase we get $12,175 and a yield on cost of 2.44%.

Summary

Dividend safety is very important, but dividend growth is more important. Since companies usually don’t raise their dividend above what they can support, I find the adage “the safest dividend is the one that has just been raised” to be spot-on. Over a few years, the growth starts to yield ridiculous numbers that the “safer” flat growth companies cannot replicate. FedEx represents one such company and I believe that value and DGI investors should buy it, DRIP it, and forget it.

Disclosure: I am/we are long NEP, VIIIX. 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.