In this article, I present an analysis of a modified list of the Dividend Champions. I analyze all stocks in the list except the Dividend Kings. I track these companies separately due to their long-term success in growing dividends. You can read my recent analysis update on the Dividend Kings. I discuss the top-performing stocks in my ranking stocks in my model. Note that my model tends to have more of a momentum tilt based on trailing earnings and dividend growth but does consider dividend safety and valuation. The top five stocks in order are A.O. Smith (AOS), T. Rowe Price Group (TROW), Walgreens Boots Alliance Inc (WBA), Ross Stores, Inc. (ROST), and BancFirst Corp. (BANF). Of these five stocks, I continue to like T. Rowe Price the best.
This month I want to highlight and focus on the number of small-cap and mid-cap banks that have over 3% yields on the Dividend Champions list. There are seven banks in this category including Cullen/Frost Bankers (CFR), Community Trust Bancorp (CTBI), Arrow Financial Corp. (AROW), People's United Financial (PBCT), United Bankshares Inc. (UBSI), Eagle Financial Services (OTCQX:EFSI), and Southside Bancshares (SBSI). There are several more banks on the Dividend Champions list with a yield between 2% and 3%. In general, bank stocks have not done well since late 2018 due to the slowing economy and stock prices have trended down. This has led to higher yields and lower valuations. Some of these banks are conservatively run and the yields and growing dividends may interest some small investors.
Source: Seeking Alpha
In these analyses, I use nine criteria that permit rapid quantitative screening based on the dividend, earnings growth, dividend growth, dividend safety, and valuation. The nine criteria used in quantitative screening are:
The goal here is to identify stocks for further research and not to make buy or sell decisions. There are often qualitative factors for each stock that must be researched before making an investment decision. For instance, I also evaluate P/E ratio relative to past 5-years or 10-years and dividend-to-FCF ratio. Other qualitative factors can also include management history, recent M&A activity, and effect of tariffs and trade wars on revenue.
The table below lists the stocks in this analysis from the Dividend Champions list in order of consecutive years of paying a growing dividend. These stocks come from a wide range of industries but there are quite a few industrial, chemical, financial, utility, and real estate stocks in the table. The green highlighted rectangles in each column list the five stocks that rank the best in that criteria. The red highlighted rectangles indicate negative growth rates. The yellow highlighted rectangles indicate that the data was not available or not applicable. For example, Kimberly-Clark Co. (KMB) has negative equity, so the D/E ratio is undefined.
List of Dividend Champions
Source: Data from dripinvesting.org as of September 30, 2019
The Dividend Champions that have the most top 5 rankings in this analysis are A.O. Smith Corp, Roper Technologies, Inc. (ROP), and Nucor Corp. (NUE). All three stocks rank highly for three criteria. A.O. Smith, which is a manufacturer and seller of water heaters, has very high 5-year EPS and 5-year and 10-year dividend growth rates. But the stock has relatively high valuation. Roper is now a technology software company and has very high 5-year and 10-year dividend growth rates and also a very low payout ratio. However, the company has a very low yield that is well below the market average and a sky-high valuation of over 30X EPS. Nucor, which is a steelmaker, has a high 5-year EPS growth rate, low payout ratio, low D/E ratio, and very low valuation. On the other hand, Nucor has very low dividend growth rates. Despite the high category rankings, these three stocks may not be suitable for some small investors due to the high betas of all three stocks. In the case of A.O. Smith and Nucor the beta values are over 1.5 indicating high volatility relative to the broader market. Many small investors may not be able to stomach this volatility.
In the following sets of graphs, I plot the dividend yield versus the other criteria. The individual data points are labeled according to their yields and can be cross-referenced with the table above. Stocks that I highlight in this discussion are labeled in the graphs.
In the first graph, I compare dividend yield versus 5-year EPS growth rate. Ideally, a stock should be toward the top right corner of the graph. Three stocks that stand out are Urstadt Biddle Properties (UBA), People's United Financial (PBCT), and Leggett & Platt (LEG). Urstadt-Biddle is a REIT. People's United Financial is mid-cap bank that operates in New England. Leggett & Platt is a diversified industrial manufacturer. People's United Financial is one of the banks I mentioned above, and the bank has a yield over 4.5% and a double-digit trailing 5-year EPS growth rate. Cullen/Frost also has double-digit EPS growth rate. While the other banks do not, they do have positive EPS growth rate that can support dividend growth.
Source: Dividend Power
In the second and third graphs, I compare dividend yield versus 5-year dividend growth rate and also versus 10-year dividend growth rate. In general, Dividend Champions with high yields tend to have low dividend growth rate and those with low yields tend to have higher dividend growth rates. If we focus on stocks that are not REITs, energy, or under duress then maybe Franklin Resources (BEN), the active asset manager, would be of interest due to its decent yield and dividend growth rates. But on the other hand, Franklin Resources competes in an industry facing a secular shift to passive investing. The company is also not a leader in active or passive investing. If we focus on the seven banks, Southside Bancshares has been able to consistently raise the dividend at a double-digit rate between 12% and 14% from the past 5-years and 10-years, respectively. I have written recently on Southside Bancshares in more detail. The other six bank stocks listed above generate low-to-mid single digit dividend growth rates. But this has been consistent over an extended period of time and thus these stocks are of interest to dividend growth investors.
Source: Dividend Power
Source: Dividend Power
In the fourth graph, I compare dividend yield versus D/E ratio as a measure of safety. Ideally, a stock should be in the top left corner of the graph. Stocks with too much long-term debt may not raise the dividend significantly. In the worst case, the dividend may be frozen or cut due to high interest payments or principal payments. All seven of the bank stocks listed above all have conservative D/E ratios that are less than 0.30. Most regional banks tend to grow organically by adding branches or completing small bolt-on acquisitions in overlapping geographic areas. Hence, debt does not tend to increase significantly.
Source: Dividend Power
In the fifth graph, I compare dividend yield versus dividend payout ratio as another measure of dividend safety. Ideally, for this graph, a stock should be in the top left corner. A high yield with a low payout ratio is a reasonably safe dividend. On the other hand, stocks in the bottom right corner should be avoided due to high payout ratios and low yields.
Focusing on the seven banks, all have payout ratios below 65%, which is my benchmark. This suggests these companies have reasonably safe dividends from the perspective of earnings. This is of concern for banks since loan losses and non-performing assets tend to increase during economic slowdowns or recessions. In turn, this negatively impacts the top line and bottom line. If a bank runs into trouble and EPS declines, then the dividend payout may need to be cut. With that said, most of these banks did not have exposure to large amounts of higher risk mortgages, derivatives, and trading risks during the Great Recession. Hence, these banks did not cut or freeze their dividend unlike many large banks during that time. The payout ratios for some smaller banks rose during this time but returned to more sustainable levels once the economy recovered. Ultimately, one needs to look for banks with a cushion for the payout ratio combined with a conservative asset and loan portfolio.
Source: Dividend Power
In the last graph, I compare dividend yield versus trailing P/E ratio as a measure of valuation. In this graph, a stock would ideally be located toward the top left corner. I would like to buy stocks with good yields but low valuations. Stocks that fit this metric have increased in number since last month and include Universal Corp, AT&T, ExxonMobil Corp, People's United Financial, Mercury General, Nucor, Old Republic, Weyco Group, and Leggett & Platt. After screening, one could compare a stock's current valuation relative to the historical P/E multiple. I want to buy low and hold forever.
In general, the seven banks in the above list have reasonable valuations based on trailing P/E ratios and also relative to the broader market. All have trailing twelve-month P/E ratios of ~16.0 or lower and both Community Bancshares and Cullen/Frost Bankers have ratios less than 13.0. These are much lower than the broader market and also their 5-year historical averages. Dividend growth investors may want to consider researching these stocks further.
Source: Dividend Power
In this section, I present a scaled ranking model using the aforesaid nine criteria and weight each one according to their importance to me. The model tends to reward stocks with better dividend growth characteristics. But saying that, stocks with low dividend safety or high valuation multiples tend to rank low.
The model also accounts for a stock's criteria rising above or falling below a critical value. If a criterion is above or below the critical value, then that criterion would be zero. For example, I want stocks that have a payout ratio below 100% but sometimes the payout ratio goes above 100% due to a drop in EPS resulting from economic headwinds or company-specific short-term issues. The model assigns a zero for that specific criterion for these stocks. It is not a sell signal, but the stock will rank low and thus it may not be suitable for adding to the position at that time. Similar logic applies to other criteria.
The top five stocks in the ranking model in order are A.O. Smith, T. Rowe Price Group, Walgreens Boots Alliance, Ross Stores, and BancFirst Corp. These stocks tend to have high 5-year EPS growth rates and dividend growth rates. Again, the lowest ranked stock is Meredith due to the negative 5-year EPS growth rate, high payout ratio, high D/E ratio, high beta, and high valuation. Meredith must integrate its recent acquisition of Time Inc and this is likely resulting headwinds.
This month I provide a summary analysis of T. Rowe Price since it is the No. 2 stock in the ranking model. I also provide a summary analysis of Cullen/Frost since it has relatively high trailing EPS and dividend growth rates and is undervalued.
T. Rowe Price - T. Rowe Price is an active asset manager. Its mutual funds are primarily actively managed no-load equity, bond, hybrid, and money market funds. T. Rowe Price's focus has been retirement accounts and the crown jewel of the company's investment product line-up is arguably the Target Date or Retirement Funds. Currently, T. Rowe Price is one of the few active asset managers that has been successfully able to generate positive net inflows over time. The company's assets under management are roughly $1.126T. Most other active asset managers are struggling in face of the secular shift from active to passive investing. The company's dividend is very safe from the perspective of earnings, free cash flow, and debt. The forward payout ratio is 38.9% based on a dividend of $3.04 and consensus 2019 EPS of $7.82. This ratio is well below my threshold of 65%. Furthermore, the ratio has trended down over the past several years after the recent high of 45% in 2015. The dividend is also well covered from the perspective of free cash flow. In 2018, T. Rowe Price had about $1.45B in free cash flow and the dividend required about $0.69B, giving a dividend-to-FCF ratio of roughly 47.5%. In my opinion, this is a good value and well within my threshold of 70%. The company has no long-term debt. Furthermore, T. Rowe Price is undervalued at the moment. The forward P/E ratio is about 14.1 and the trailing 10-year average is ~17.5 and the trailing 5-year average is about 16.0. The forward P/E ratio is also lower than the broader market average of about 22.0. There are some negatives to owning T. Rowe Price. Both the top and bottom lines are very sensitive to market volatility. In general, fees are compressing for asset managers. Lastly, the stock has an above-market average beta. Some investors may not like this volatility.
Cullen/Frost Bankers - Cullen/Frost is a regional bank that focuses mostly on commercial clients and to a lesser degree on individuals almost completely in Texas. The bank has several advantages in that it operates in comparatively high growth population centers including San Antonio, Houston, Austin, Dallas-Ft. Worth, and Midland/Odessa. These areas all have population growth that exceeds the national average and is expected to be in the mid-to-high single digit range. This should lead to growing top and bottom lines. In addition, Cullen/Frost consistently has had a cost of funding that is lower than other regional banks and credit quality better than its peers, especially during the Great Recession. The bank's dividend is reasonably safe. Note that Cullen/Frost did not cut or freeze the dividend during the Great Recession illustrating the strength of its business model and credit quality. On an earnings basis, the forward payout ratio is only 39.8% based on a forward payout of $2.84 and consensus 2019 EPS of $6.79. This is below my criteria of 65%. On a free cash flow basis, the dividend required $0.17B while FCF was $0.48B giving a dividend-to-FCF ratio of roughly 35%, which is well under my threshold of 70%. The stock is also undervalued with the price declining from almost $121 per share in mid-2018 to ~$90 per share today on concerns about energy prices and a slowing economy. The forward P/E ratio is now ~12.9 versus a 5-year trailing average of 16.4 and a 10-year trailing average of about 16.0. There are some risks in owning Cullen/Frost. The top and bottom lines are obviously tied to the Texas economy and there is always the risk of declining interest rates affecting net interest margin. But the bank also has significant exposure to commercial loans and commercial real estate loans. A broader slowdown in the economy may put more pressure on the stock price.
Of the top five stocks in my rankings, I am currently long only T. Rowe Price. If the stock price drops below $100 and the yield goes over 3%, I will likely add to my position. Regarding Cullen/Frost, I have not yet taken a starter position but remain interested. Despite the quality of the bank, I am in wait-and-see mode due to declining interest rates and the lateness of the business cycle. There are six other banks that have yields greater than 3% and are generally undervalued. For the most part, they are conservatively run., Although, they are all candidates for inclusion into my portfolio I need to research them further before taking a starter position. I did take a deeper dive into Southside Bancshares recently and do think it's a buy.
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Disclosure: I am/we are long MCD, CLX, PEP, MDT, BDX, MKC, WST, TROW, ITW. 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.