The Dividend Aristocrats ("DA") is a list of stocks in the S&P 500 which have raised their dividend for at least the last 25 years in a row. For the most part these are large cap stocks and are very familiar to most investors. FerdiS recently wrote an article in which he listed all the DA in order based on their quality. This is an excellent article and I highly recommend it. It shows that almost all of the DA are quality companies, at least based on the definition described by David Van Knapp. This makes sense to me. I figure that if you have raised your dividend every single year for at least the past 25 years you must be a quality company.
But I think we need to look at more than just quality when deciding what stocks to buy. Even quality stocks can be overpriced. In his article FerdiS provided a fair value price for each of the DA, and it demonstrated that even some very quality stocks can be overpriced. We must pay as much attention to the valuation of the stock as well as to the quality. But how do we determine which stocks are under or overpriced? I use a system based on the stocks historical dividend.
In June of 2015, I started a series of articles in which I highlighted the stocks from the Dividend Champions list that have the highest and the lowest Percent Above Average Yield ("PAAY") over the past year and over the past five years. PAAY is a measure of how much a stock is above (high PAAY, undervalued?) or below (low PAAY, overvalued?) its usual yield, and can be an indication that the stock is mis-priced. My article with the most recent list can be found here: Under and overvalued Dividend Champions from August. In this article, similar to how FerdiS ranked the DA based on quality, I will use the PAAY system to rank the DA based on their valuation.
Before I start let me give a quick review of the thought process behind PAAY for those who are not familiar with it. Many stocks can trade within a fairly consistent range of yields over time. But if you find a stock that is trading at a yield higher than it usually does, it may be an indication that it is undervalued. There can be two reasons for an above-average yield: the price is down, or the dividend has increased. Or, of course, it could be a combination of the two. If the price is down, and yet the business prospects are unchanged, then this could be a good buying opportunity. If the dividend has increased, and the stock price has not yet risen to keep up with the increased dividend, this again gives you an opportunity to buy more shares and increase your dividend income at a relatively low price. Therefore, tracking the dividend yield and comparing it to the historical average of that stock can highlight times when it may be undervalued. I call this Percent Above Average Yield. Take the present yield, subtract the historical average yield, and divide the result by the historical average yield (and multiply by 100 to turn it into a percent) to come up with the PAAY. The higher the PAAY, the more undervalued the stock may be. The lower the PAAY, the more overvalued it may be.
When I make my decisions about reinvesting my dividends, I use the one-year PAAY to determine which of my stocks are most undervalued. The stocks in question are ones I already own, and I am therefore looking for opportunities where one or more of my stocks is down for a short period of time but may be expected to rebound. I'm looking to take advantage of short-term opportunities to add more shares. But other investors may be looking for longer-term trends. They may think that a longer-term yield average is more significant in terms of looking for investment opportunities and would therefore want to use a five-year average. On the other hand, they may be thinking that some stocks may be overvalued and should be sold. In this case, the PAAY would be low.
So, in this article, I present the list of all the Dividend Aristocrats as ranked by their valuation as determined by PAAY. The higher the PAAY the more undervalued the stock may be based purely on its historical yield. Please note, nothing I present here should be considered a recommendation to buy or sell any stock. This is just meant to be a possible starting place for further research. Everybody should do their own due diligence when making transaction decisions. Just because a stock is high or low on this list does not mean it definitely should be bought or sold.
So, without further ado, here is the list of Dividend Aristocrats as of Aug 3th, as ranked by their PAAY, with comments on some of them of particular interest. To further tie it in with the article by FerdiS I have included the quality scores he provided in his article, the fair market value as calculated by Morningstar, and the discount to that fair market value.
All of the PAAY calculations you see below have been calculated by me using a spreadsheet I use to track each of the stocks. I update the spreadsheet every week.
August’s Dividend Aristocrats PAAY lists using the 1 year average yield
The average PAAY for group #1 is 17.69% and the average discount to fair value is 14.66%. This would be an indication that as a group they are fairly significantly undervalued.
ABBV is down 31.47% over the past year, yet its dividend has increased 11.45%. This explains why its 1 year PAAY is so high. Morningstar also has it significantly undervalued.
The average PAAY for group #2 is 7.76% and the average discount to fair value is 2.21%. Still undervalued, but less so. As the PAAY decreases less and less stocks are considered to be undervalued, which is confirmed by their fair market price.
Out of this group of stocks only CLX and HRL are up this year, but they have an average dividend increase of 5.89%. This is a group of stocks which have trailed the market this past year, but continue to raise their dividend by a decent amount.
The average PAAY for group #3 is 1.19% and the average discount to fair value is -1.824%.
In this group we see that the PAAY has turned negative, meaning that the stocks are actually becoming somewhat overvalued. At the same time the discount to fair price is also getting more negative.
PPG is up 6.08% over a one year time period, and the dividend is up 6.66%. With the price and the dividend increasing by about the same amount you would expect the PAAY to be about zero. This is confirmed by a PAAY of only 1.34%.
The average PAAY for group #4 is -3.83% and the average discount to fair value is -7.02%. The stocks are turning more and more negative, and therefore more and more overvalued.
LIN is up 22% over the past year while the dividend is only up 5.7%. The price seems to have gotten a little ahead of itself based on its dividend growth. Morningstar has it right about fair value at this price.
The average PAAY for group #5 is -7.37% and the average discount to fair value is -11.34%.
MCD is up 38% over the past year! But the dividend is up “only” 14.85% (still a very nice increase!) MCD, after nice run up, might be due for a pause while it gives its dividend a chance to catch up.
The average PAAY for group #6 is -15.22% and the average discount to fair value is -24.33%. As a whole this group appears to be significantly overvalued.
PG is up 42% over the past year! But its dividend is only up 3.88%. This explains the negative PAAY of -18.67%. Morningstar has it at a -18.82% discount, matching the PAAY quite closely.
Notice that of the top ten stocks listed above 9 of them are also considered undervalued based on Morningstar’s fair value price. And as you’ll see on the first list below, out of the top 10 most undervalued stocks based on their 5 year PAAY, 8 of them are also considered to be undervalued based on Morningstar’s fair value price. So, the two valuation systems seem to confirm each other’s conclusions. I think that’s pretty cool, and quite satisfying to me and my PAAY system. On a quick eye ball test of the correlation between the PAAY of the stocks above and their discount to fair value it looks like they might go hand in hand. Stocks with higher PAAY tend to be more discounted in price, ie undervalued. This is confirmed by the graph below which shows the correlation between the 1 year PAAY and the fair market discount.
August’s Dividend Aristocrats PAAY lists using the 5 year average yield
The average PAAY for group #1 is 47.88% and the average discount to fair value is 14.55%. Similar to group #1 on the 1 year list, this first group of stocks appears to be significantly undervalued.
WBA had been as high as $96.00 in 2015, but since then has fallen 44%. In the meantime, the dividend is up 22%. This explains the very high PAAY of 63.71%. It has fallen, in part, due to fear of competition from Amazon.com. But the dividend keeps rising, so this may be a great buying opportunity.
The average PAAY for group #2 is 12.21% and the average discount to fair value is -2.98%.
GD has dropped from $230 in March of 2018 to $184 today, a drop of 20%. In the same time the dividend is up 9.6%. Morningstar has it at a discount of 12.09%, very similar to the PAAY of 17.27%.
The average PAAY for group #3 is 2.96% and the average discount to fair value is 4.00%.
EMR dropped to a price of $43 in early 2016, up to $78 in Sept of 2018, and back down to around $60 at the present time. It has been on a roller coaster ride which has led to basically no over-all change in price. The dividend over this time period, although up, has risen very slowly, only going up 16% in those 5 years (about 3% per year). This helps explain why the PAAY is very close to zero (-0.97%). Neither the price nor the dividend has changed very much. However, to be fair, Morningstar has EMR undervalued by 23.88%.
The average PAAY for group #4 is -6.15% and the average discount to fair value is -2.61%.
UTX is up 24% over the past 5 years, and the dividend is up 24.5% over the same time period. This leads to a PAAY that is only slightly negative (-4.31%)
The average PAAY for group #5 is -15.80% and the average discount to fair value is -12.69%.
SHW is up 150% over the past 5 years. The dividend, although up quite a bit (105%), still trails the price appreciation. Hence the PAAY of -10.06% and the discount of -54.69% by Morningstar. Stocks which rise significantly faster than their dividend (too fast?) will show a negative PAAY.
The average PAAY for group #6 is -26.56% and the average discount to fair value is -28.88%. As a group it appears that this group of stocks is significantly over valued, both based on PAAY and on the fair market price.
CTAS is up over 300% since summer of 2014! Wow! However, over the same time period the dividend is only up 20%. The explains the PAAY of -35% and the price discount of 83%. This one may be significantly overpriced.
Summarizing all the stocks in the 5-year PAAY charts, as with the graph of the one year PAAY vs the price discount, the graph for the 5 year PAAY shows the same correlation between the PAAY and the fair market price discount.
These two graphs obviously don’t prove that stocks with high PAAY truly are undervalued. It only shows a general agreement with a fairly reputable source, Morningstar. Only time will tell if they really were undervalued. This is why, moving forward, I will keep track of the highest PAAY stocks over time and watch how they perform relative to the market and to the lowest PAAY stocks.
My back tests on the DA have shown that, as a whole they are worthy of investment, either by buying all of them individually (regardless of their valuation), or by buying the Proshares Dividend Aristocrats ETF (NOBL), which gives you exposure to all of the DA. I believe that this has been a successful investment technique in the past because, as FerdiS showed, almost all of the DA are high quality companies, and they all have a strong dividend culture and an exemplary dividend payment history.
But my tests have also shown that by buying the DA with the highest PAAY, the most undervalued ones, you can improve your results over simply buying all the DA. My recent study showed that from 2001 through the middle of 2019 buying the top 15 DA each year based on PAAY, holding them for one year, selling them, and then repeating the process at the start of the next year, would have produced an annual return of 9.53%. Buying the lowest ranked DA based on PAAY, the most overvalued ones, would have produced an annual return of 7.64%. And during this time period the S&P 500 produced an annual return of 5.82%. To me this shows that the DA in general are a better investment than the S&P 500, but by buying the most undervalued ones, the highest PAAY ones, you will get the best returns. This is why I use PAAY to determine which of the DA are the most undervalued.
People must decide for themselves what stocks to invest in. And what information they wish to use to make those decisions. But I believe that the quality of the DA and the valuation shown by the PAAY is a great place to start. A stock's present yield, when compared to its historical yield (either one-year or five-year), can be an indicator of either undervaluation or overvaluation. Yes, the yield for any of these stocks may be up because the business prospects for that company are in decline, and the inevitable dividend cut is soon to come. But considering the dividend history of the DA, and the quality of the companies, this is unlikely. More likely the yield is up simply because the price is down due to global market forces unrelated to the business prospects of that particular company, or the company may have hit a weak patch from which it will soon recover. Conversely the company may simply have recently raised its dividend and the stock price has not caught up yet to the increased payout. In any case buying the most undervalued DA has led to strong returns in the past, and there’s no reason to believe it shouldn’t continue to do so going forward. By combining the under valuation that can be discovered by using PAAY, with the quality of the DA universe of stocks, I believe an investor can achieve market beating results. In any case, however you choose to use this information (or not), the valuation of the stock, as well as the quality of the company, must be part of your decision making process. And calculating the PAAY to determine the valuation, and ranking all the DA based on the PAAY, is, for me, the first step in this process.
Thank you for reading my article. I welcome your comments and criticisms.
Disclosure: I am/we are long NOBL. 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: I am long all the stocks mentioned in this article.