Safe and growing dividends are a cornerstone of many successful long-term investment strategies, and not just for retirees.
Dividend growth investing is a proven way of achieving long-term outperformance and also tends to combine other alpha strategies such as quality, lower volatility, and smaller size (relative to S&P 500's $127 billion average market cap).
We suspect many management teams will be reluctant to cut dividends and be willing to use some cash on hand to support dividends.”
So far in 2020, 133 S&P 500 companies have raised their dividends, they add. Some of those increases, however, occurred before the pandemic blew up in the U.S. in mid-March. For example, Kimberly-Clark (ticker: KMB) on Jan. 23 announced it would pay a quarterly dividend of $1.07 a share, up nearly 4% from $1.03.
By the Morgan Stanley analysts’ count, 38 S&P 500 companies had cut or suspended their payouts year to date. Factoring in cuts, suspensions and increases, dividend payouts are down about 2% this year, according to the research note." - Morgan Stanley, May 5th, 2020
The dividend aristocrats are S&P 500 companies that have 25+ year dividend growth streaks, meaning they easily surpass the Ben Graham standard of quality (20+ year streaks without cuts).
And per Morgan Stanley's research, at the start of May large caps in the S&P 500 had cut dividends at approximately 8X smaller rates than the overall universe of dividend stocks (over 250 cuts at the time).
EPS Consensus Estimates Continue To Fall Every Week...Though At Slower Rates
The rate of EPS downward revisions has been 15X the 15-year average this year, as the unprecedented global lockdowns have hammered nearly every industry and sector.
That includes normally recession-resistant ones like medical device makers, due to elective surgeries being canceled in much of the world.
In the first two months of Q2 downward earnings, revisions totaled 35.9% which FactSet's John Butters explains
This marked the largest decline in the quarterly EPS estimate over the first two months of a quarter since FactSet began tracking this data in Q1 2002. The previous record was -27.8%, which occurred in the first two months of Q1 2009.
At the sector level, all 11 sectors have recorded a decline in their bottom-up EPS estimate during the first two months of the quarter, led by the Energy (-524%), Consumer Discretionary (-112%), and Industrials (-78%) sectors. Overall, 10 sectors recorded a larger decrease in their bottom-up EPS estimate relative to their five-year average, 10-year average, and 15-year average for the first two months of a quarter. The Real Estate sector does not have five years of historical data available yet.
Seven of the 11 sectors have recorded the largest decline in their quarterly EPS estimate over the first two months of a quarter since FactSet began tracking this data in Q1 2002: Communications Services, Consumer Discretionary, Consumer Staples, Energy, Health Care, Industrials, and Real Estate." - FactSet Research, (emphasis added)
Ross Stores (ROST) became the first failed aristocrat of this recession after it suspended its dividend due to the crisis.
Failed Dividend Aristocrats 2007 to 2017
Not even the mighty dividend aristocrats are immune from the ravages of declining fundamentals during severe industry/economic downturns.
My goal, both at Dividend Kings and for regular Seeking Alpha readers, is to help you avoid the next failed aristocrat. Specifically, each month I highlight reasonably or attractively valued
- kings (any company with 50+ year growth streak)
- champions (any company with 25+ year growth streak)
To minimize the risk of owning the next failed aristocrat I use a comprehensive 11 safety metric model that combines qualitative and quantitative assessments of balance sheet and cash flow stability.
- consensus payout ratio vs. safe industry standards (based on historical payout ratio data going back to 1930)
- debt/EBITDA vs safe industry standards (based on guidelines from S&P, Moody's and Fitch)
- interest coverage ratio vs safe industry standards
- debt/capital vs safe industry standards
- S&P credit rating & outlook
- Fitch credit rating & outlook
- Moody's credit rating & outlook
- Dividend Growth Streak (Ben Graham quality metric)
- Piotroski F-score: advanced accounting metric that measures short-term bankruptcy risk
- Altman Z-score: advanced accounting metric that measures long-term bankruptcy risk (84% to 92% effective at predicting bankruptcies from 1969 to 1999)
- Beneish M-score: advanced accounting metric that measures accounting fraud risk (76% accurate at predicting accounting fraud)
I use these 11 metrics to both estimate 30-year bankruptcy risk, based on credit ratings.
(Source: The University of St. Petersberg)
I also use it to estimate the probability of dividend cuts during a historically normal recession and this recession, which is expected by economists to be 4 to 6X as severe as the 1.4% average GDP contraction.
I use a 1 to 5 dividend safety score as part of my overall 11 point quality scoring system.
|Safety Score Out of 5||Dividend Cut Risk (Average Recession)|| |
Dividend Cut Risk This Recession
|2 (below average)||Over 2%||Over 12%|
|3 (average)||2%||8% to 12%|
|4 (above-average)||1%||4% to 6%|
|5 (very safe)||0.5%||2% to 3%|
The goal of every article is to highlight blue chip quality companies or better, with above-average or very safe dividends.
That's because there are three fundamental principles that all investors need to follow to minimize losses and maximize the probability of achieving your long-term financial goals.
- preservation of capital (don't lose money)
- return of your capital (dividends are how will you get your initial investment back)
- return on your capital (long-term profits that compound your wealth...if you avoid losing it first)
Note the order of these, which is to avoid losses first, get your original investment back second, and finally, focus on achieving sufficient investment profits.
So now that you understand how I select blue chip off of the 434 company Dividend Kings Master List, let's take a look at the safest dividend aristocrats, kings, and champions you can buy in June.
The S&P 500 Is Overvalued... But Safe Aristocrats/Champions Are Still Available At Reasonable To Attractive Prices
|Year||EPS Consensus||YOY Growth||Forward PE|| |
(Source: Brian Gilmartin, IBES/Refinitiv/Reuters/Lipper Financial)
The broader market, as measured by forward earnings consensus forecasts, is now in a bubble, meaning it's priced in all earnings growth expected over the next 2.5 years.
(Source: F.A.S.T Graphs, FactSet Research)
If we consider the blended PE then the market only approaches bubble territory. I define a bubble as when forward two to three-year total consensus total return potential is 0% or negative.
What A Bubble Looks Like, Negative Consensus Return Potential On S&P 500
(Source: F.A.S.T Graphs, FactSet Research)
In the tech bubble, the market had deeply negative consensus total return potential, courtesy of the highest valuations in US market history.
The tech crash resulted in a reversion to historical valuation means and horrifyingly accurate total return forecasts that no prudent valuation focused investor was surprised by.
Today the consensus return potential on the S&P 500 is still +3.5% though that's a fraction of the 7% to 9% CAGR that the broader market has historically delivered.
S&P, Dividend Aristocrats & Top Performing DK Phoenix Portfolio Aristocrats Since March 23rd Bottom
The market has been on an absolute tear since the March 23rd lows, with the S&P 500 and dividend aristocrats surging almost 37%.
Some faster-growing aristocrats, such as the ones the Dividend Kings Phoenix Portfolio bought in late March, have done even better, almost tripling the S&P 500's returns in the case of Lowe's (LOW) and Nordson (NDSN).
So the goal in today's "best aristocrats" article is to screen for all 9/11 blue chip quality or better aristocrats/kings/champions with at least 4/5 dividend safety, that are still available at reasonable to attractive prices.
- potential good buy price = discount to fair value (margin of safety) that's 5% to 15% or higher (based on company quality & fundamental risk profile)
- potential reasonable buy = fair value to just below the good buy margin of safety
- From the 434 company Master List, 183 companies in total are potential reasonable buys or better.
- 132 companies are 9+/11 blue chip quality or better (10/11 quality SWANs or 11/11 quality Super SWANs)
- 94 also have 4/5 or 5/5 above-average to very safe dividends (6% or less cut risk in this recession)
- 35 of these reasonably/attractively priced blue chips or better have 25+ year dividend growth streaks
Reasonably/Attractively Valued Blue Chip Quality Or Better Aristocrats/Champions Sorted By Dividend Growth Streak
(Source: Dividend Kings Company Screener) green = potential good buy or better, blue = potential reasonable buy
The team and I at Dividend Kings have spent nearly a year and a combined 10,000 man-hours, constructing a Research Terminal. This valuable tool runs off our Master List, which includes 60 fundamental metrics worth of data for each company (10 more coming soon).
This is what allows our members and me to easily locate the best companies for any potential combination of needs/risk profiles/goals while avoiding overvalued companies that have unnecessarily higher volatility/valuation risk.
To select the 12 safest aristocrats I sorted this 35 company screen by lowest to highest PEG and removed two more speculative names (XOM and NUE), whose cyclical business models are expected to result in FCF payout ratios above 100% (or negative) this year.
This leaves us with 12 dividend aristocrats/champions that represent classic Buffett "wonderful companies at fair prices."
- UGI Corp. (UGI) 33-year dividend growth streak, 1.32 PEG ratio (reasonable buy)
- McGrath Rentcorp (MGRC) 29-year streak, 1.38 PEG (potential reasonable buy)
- Carlisle Companies (CSL) 43-year streak, 1.41 PEG (potential reasonable buy)
- SEI Investments (SEIC), 29-year steak, 1.61 PEG (potential good buy)
- MDU Resources (MDU), 29-year streak, 1.63 PEG (potential good buy)
- Gorman-Rupp (GRC), 48-year steak, 1.64 PEG (potential reasonable buy)
- Altria (MO), 50-year streak, 1.64 PEG
- Franklin Electric (FELE), 28-year streak, 1.67 PEG (potential reasonable buy)
- W.W. Grainger (GWW), 48-year streak, 1.67 PEG (potential reasonable buy)
- General Dynamics (GD), 29-year streak, 1.68 PEG (potential good buy)
- Chubb Limited (CB), 27-year streak, 1.79 PEG (potential reasonable buy)
- Arrow Financial (AROW), 27-year streak, 1.84 PEG (potential reasonable buy)
The PEG ratio is just the forward PE divided by the long-term expected growth rate, in this case, the consensus among analysts, derived from FactSet, Reuters, or YCharts (usually all three).
- 10 PE/ 10% expected growth = PEG of 1.0
- 20 PE/5% expected growth = PEG of 4.0
- S&P 500 PEG ratio: 2.86 vs 2.36 historical PEG ratio (market-determined fair value over 20 years)
- Average Aristocrat PEG ratio: 3.28 vs 3.15 historical PEG ratio (market-determined fair value over 20 years)
1.0 is considered an excellent PEG ratio based on the work of Peter Lynch, one of the greatest investors in history.
The aristocrats tend to trade at a very high premium, with a historical PEG of about 3.15. The broader market's historical fair value PEG is 2.36 as determined by the average paid for by investors over the past 20 years.
These 12 aristocrats & champions represent reasonable to attractive valuations, both on a PEG basis, but also due to their overall quality & safety profiles.
Fundamental Stats On These 12 Aristocrats & Champions
- Average quality score: 9.5/11 Blue chip quality vs. 9.6 average dividend aristocrat
- Average dividend safety score: 4.9/5 vs. 4.6 average dividend aristocrat (about 3% dividend cut risk in this recession)
- Average payout ratio: 42% vs. 61% industry safety guideline
- Average debt/capital: 31% vs. 41% industry safety guideline vs 37% S&P 500
- Average yield: 3.0% vs. 2.0% S&P 500 and 2.5% aristocrats
- Average discount to fair value: 12% vs. 48% overvalued S&P 500
- Average dividend growth streak: 35.2 years vs. 25+ aristocrats, 20+ Graham Standard of Excellence
- Average 5-year dividend growth rate: 7.8% CAGR vs. 8.3% CAGR average aristocrat
- Average long-term analyst growth consensus: 9.8% CAGR vs. 7.1% CAGR average aristocrat, 5% to 7% CAGR S&P 500 historical norm (thriving companies)
- Average forward PE: 15.8 vs. 24.3 S&P 500
- Average earnings yield: 6.3% vs. 4.1% S&P 500
- Average PEG ratio: 1.63 vs. 1.85 historical vs. 2.86 S&P 500
- Average return on capital: 142% (78th% Industry Percentile, High Quality/Wide Moat according to Joel Greenblatt)
- Average 13-year median ROC: 130% (stable moat/quality)
- Average 5-year ROC trend: -2% CAGR (relatively stable moat/quality)
- Average S&P credit rating: A- vs. A- average aristocrat (2.5% 30-year bankruptcy risk)
- Average annual volatility: 25.2% vs. 22.5% average aristocrat (and 26% average Master List stock)
- Average market cap: $19 billion (large-cap)
- Average 5-year total return potential: 3.0% yield + 9.8% CAGR long-term growth + 2.7% CAGR valuation boost = 15.5% CAGR (11% to 20% CAGR with 25% to 30% margin of error)
- Probability weighted expected average 5-year total return: 6% to 16% CAGR vs 1% to 4% S&P 500
Are these safe companies? Absolutely, just look at their average payout ratio of 42% vs. 61% average safe levels for their industries.
Debt/capital is 31% and the average credit rating is A- implying about 2.5% 30-year bankruptcy risk.
Are these high-quality companies? Absolutely, just look at the average return on capital of 142% which is in the top 22% of their respective industries and is stable over the last 13-years.
Are these classic Buffett "wonderful companies at fair prices"? 12% discount to their own historical fair value says "yes".
So let's run them through our fundamental investment risk criteria:
- Capital preservation: very good (2.5% avg 30-year bankruptcy risk)
- Return of capital: above-average, 3% yield is 1% higher than the S&P 500 & analyst consensus dividend growth rate is expected to be close to 10% CAGR vs 5% to 7% S&P 500
- Return on capital: Excellent, 6% to 16% CAGR probability-weighted expected return (11% CAGR mid-range) vs 1% to 4% for S&P 500 (2.5% CAGR mid-range)
These 12 Aristocrats & Champions Since 1994 (Annual Rebalancing)
(Source: Portfolio Visualizer)
These 12 companies, over the past 25 years, have outperformed the S&P 500 by 4% annually, and with basically the same annual volatility.
However, their peak declines during periods of extreme market stress have been far lower.
(Source: Portfolio Visualizer)
The longest an equally weighted portfolio of these 12 aristocrats & champions would have been underwater was just under two years. That's compared to 6.25 years for the S&P 500.
These 12 companies collectively suffered two bear markets over the past quarter-century, while the broader market suffered three more severe ones.
However, just because UGI, MGRC, CSL, SEIC, GRC, MO, FELE, GWW, GD, CB, and AROW represent the safest sound values among the aristocrats and champions today, doesn't mean you should necessarily go "all in" to these 12 stocks today.
How To Build A Well-Diversified And Prudently Risk-Managed Portfolio Around These 12 Aristocrats & Dividend Champions
Long-term investing, like most things in life, is an exercise in managing risk.
These are the risk management guidelines that are being used to run all DK model portfolios and my retirement portfolio.
The reason asset allocation is the first step in proper portfolio construction is that stocks, no matter how high quality, are always "risk assets" and thus only discretionary savings you won't need for five years should be invested in them.
During bear markets, stocks tend to be underwater for around 27 months, historically speaking, and during crashes of 40+%, which occur on average every 25 years or so, about as long as 6.75 years.
Since 1945 in 92% of years that stocks decline bonds are flat or go up.
Bonds are a non-correlated asset that, in combination with cash equivalents (T-bills, savings accounts, money market funds, etc.) are what you rely on to pay expenses without selling stocks.
The first step in constructing a sleep well at night portfolio is having a proper emergency fund.
How large is an adequate emergency fund?
According to economist Emily Gallagher, co-author of the study Rules of Thumb in Household Savings Decisions: Estimation Using Threshold Regression:
The rules of thumb offered by financial advisors regarding how much to hold in liquid reserves vary widely and usually imply far greater sums than low-income households save.
This paper seeks empirically-grounded insights into the minimum liquidity buffer needed by the average low-income household. First, we document diminishing benefits to liquid savings in terms of the likelihood of experiencing financial hardship.
Then, we formalize this relationship with a theory of poverty traps. Finally, to observed data, we fit a regression kink model with an unknown threshold (kink) point that must be estimated.
Our key finding is that the threshold point is $2,467 with a 95% confidence interval of $1,814–$3,011 (in 2019 dollars) or roughly 1 month of income for the average low-income household – which is far less than the savings amounts implied by common rules of thumb (typically 3–6 months of income).
Theoretical evidence suggests that financial advice based on an empirically-estimated threshold point is welfare enhancing for households with naive perceptions of their probability of experiencing financial problems."
The latest research indicates that about 1 month of income is a good rule of thumb for an emergency fund, which is kept entirely separate from your portfolio.
Order Of Expense Funding In Recessions
- emergency fund (1 month worth of income)
- cash + dividends + pensions (SS or private)
- bonds (stable or appreciating in value 92% of the time during recessions)
- stocks (ideally after bear market has ended and a new bull market has begun)
March 16th, 2020 was the 3rd worst day in market history.
March 16th, 3rd Worst Day In Market History... When No Stock Was A Bond Alternative
March 16th saw virtually every stock in the market to sell off hard.
Quality, safety, recession-resistant business model, historical volatility, nothing mattered when market panic was at its peak.
- Utilities like 11/11 quality Super SWAN aristocrat NextEra Energy (NEE), the world's best utility, fell 9%.
- Johnson & Johnson (JNJ), the safest dividend stock in the world, fell 5%
- Dividend aristocrats (NOBL) fell 10%
- Pandemic affected aristocrats like Realty Income (O) fell 25%
- Lowe's (LOW), an 11/11 quality Super SWAN dividend king whose business has NOT been significantly impacted by the pandemic (just 1% decline in 2020 EPS consensus vs. pre-pandemic) also fell 25%
In contrast, long-duration US treasury bonds (EDV and SPLT) rallied 6% that day, in a flight to safety that happens 92% of the time during periods of market stress.
Cash equivalents (VGSH and GBIL) were flat to up slightly, as you'd expect from cash.
Long-term investing success requires you to avoid becoming a forced seller when stocks are crashing.
75% of the reason retail investors have woefully underperformed the broader stock and bond market is due to market timing. Specifically, they sell at the wrong time due to psychological or financial need reasons.
This is why I preach that 'NO dividend stock is a bond alternative" with near-religious zeal and have done so for years. I'll continue doing so until I die because preservation of capital is the 1st step to compounding income and wealth over time.
So here is how you can take these 12 aristocrats/champions and construct a well-diversified and prudently risk-managed portfolio.
Example Of Diversified & Balanced Champion SWAN Portfolio
(Source: Portfolio Visualizer)
These 12 aristocrats & champions have a lot of industrial and financial exposure. So much so that if we simply equally weighted 70/30 stock/bond portfolio we'd exceed 20% sector risk cap guidelines on industrials.
Thus, I diversified this portfolio by including 10% allocation to VIG, a high-quality dividend blue chip ETF, and a proxy for dividend growth stocks in general.
I set bond/cash allocations at 30%, split evenly between long and ultra-short duration US Treasuries.
That's because, as Peter Lynch once quipped "If you could predict the direction of interest rates three times in a row, you'd be a billionaire. Since the world isn't overrun with billionaires, likely no one can predict interest rates."
(Source: Duke University)
A study from Duke University determined that long-bonds are the best passive hedging strategy during a recession.
Think about bonds in terms of protection, not yield. The stock market becomes more important when rates are on the floor but that doesn’t mean you can forsake bonds or cash altogether...
In a negative interest rate world, you have to change the way you think about bonds. Bonds have always acted as a shock absorber to stock market declines but this becomes even more important when the yield is more or less taken out of the equation.
Bonds can provide dry powder to rebalance into the stock market or pay for current expenses when the stock market inevitably goes through a nasty downturn. Bonds keep you in business even if they don’t provide high returns as they have in the past." - Ben Carlson (emphasis original)
Is VIG the best dividend growth ETF in the world? No. Is SPTL or BIL the best long bond, cash equivalent ETFs in the world? No.
I chose them only because doing so allows us to backtest this hypothetical balanced portfolio from January 2008, virtually through the entire Great Recession.
12 Aristocrat Balanced Portfolio Since January 2008 (Annual Rebalancing)
(Source: Portfolio Visualizer)
Since 2008 the S&P 500's annual volatility (standard deviation) has been 15%. This balanced portfolio saw 1/3 less annual volatility thanks to its bond/cash allocation.
And despite being 10% heavier into more volatile stocks than a 60/40 stock/bond portfolio, its peak decline was just 25% vs. 31% for a standard balanced portfolio.
Along with 1.3% annual superior total returns, this portfolio generated 16% superior excess total returns/negative volatility (Sortino ratio).
(Source: Portfolio Visualizer)
In the Great Recession, this 20% industrial aristocrat portfolio was a lot less volatile than a 60/40 balanced portfolio.
In this bear market, it was slightly more volatile, a 13.8% peak decline vs 12.3%. But compare that to the 34% peak decline in the S&P 500 and you can see why I consider this a true SWAN portfolio.
The longest period when the portfolio was underwater was 22 months during the Great Recession, compared to 34 months for a 60/40 balanced portfolio.
Those 12 months could easily have represented the difference between being a forced seller of stocks and being able to ride out the worst bear market since the Great Depression without suffering a realized loss.
This model portfolio is an example of what I mean by "well-diversified and prudently risk-managed portfolio."
Every recommendation I make should be owned in a portfolio such as this, tailored to your specific needs, risk profile, goals, and time horizon.
Bottom Line: Even In This "Hopium"-Fueled Market There Are Still Safe Aristocrats & Champions You Can Buy As Part Of Diversified And Prudently Risk-Managed Portfolios
Is the market overvalued today? Without question.
Are we facing significant risks that could send the market plunging in the coming weeks/months?
Potential Catalysts For Another Correction
- a second wave of the virus in the fall/winter
- economic recovery missing expectations
- earnings missing expectations for 2020/2021
- Congress making fiscal policy mistakes surrounding additional stimulus
- trade/policy mistakes regarding increasing tensions with China
- rising global insolvency risk (for corporations, individuals, emerging market & state governments)
- black swan events we can't even think of today
Here are just some of the numerous bricks in the wall of worry the stock market has been climbing during the "hopium" rally.
Are stocks going to crash soon? No one knows (despite what they may say).
Is a market decline inevitable at some point? Without question.
The Dividend Kings are NOT market timers, but prudent long-term investors, who live by the mantra "quality first and sound valuation & risk-management always."
UGI, MGRC, CSL, SEIC, GRC, MO, FELE, GWW, GD, CB, and AROW represent the 12 safest dividend aristocrats & champions you can buy in June, both from a safe income as well as reasonable to attractive valuation perspective.
By "safe" I do NOT mean "won't fall in a future market downturn" because almost no stocks go up when the market sentiment flips from greed to fear.
Rather I mean that these 12 companies if owned in a well-diversified and prudently risk-managed portfolio offer:
- a good preservation of capital profile
- a good return of capital profile (yield of 3% vs 2% S&P 500 and 2.5% most dividend growth ETFs)
- attractive return on capital profile
Such a portfolio is a true sleep well at night bunker portfolio likely capable of withstanding even the harshest recessions and bear markets.
This is what makes these 12 aristocrats & champions the best choices for discretionary savings in June, in an otherwise frothy and high correction risk broader stock market.
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