Dividend Aristocrats In The Defensive Sectors

Sep. 29, 2020 9:00 AM ETABT, ADM, ATO, BDX, BF.A, BF.B, CARR, CL, CLX, ED, HRL, JNJ, KMB, KO, MDT, MKC, MKC.V, OTIS, PEP, PG, RTX, WMT60 Comments
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FerdiS
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Summary

  • The S&P 500 Dividend Aristocrats Index is a list of companies in the S&P 500 that have increased their dividends for at least 25 consecutive years.
  • I ranked the 65 Dividend Aristocrats using DVK Quality Snapshots and tie-breaking metrics.
  • This article presents the rankings of 21 Dividend Aristocrats in the defensive sectors: Consumer Staples, Health Care, and Utilities.
  • Upcoming articles will present the rankings of 44 additional Dividend Aristocrats in other sectors.

Dividend Aristocrats

This article provides an update to the article I wrote in March:

Since my March article, several changes have been made to the Dividend Aristocrats, and the stock market has mostly recovered from the crash in late February and early March.

There are now 65 Dividend Aristocrats and, given growing speculations of another market crash (see for example, here and here), I decided to present this update in three articles, with the first covering stocks in the Consumer Staples, Health Care, and Utilities sectors, traditionally considered the defensive sectors.

Readers may want to consider increasing their defensive exposure depending on their risk tolerance.

The Dividend Aristocrats

The S&P 500 Dividend Aristocrats Index is a list of companies in the S&P 500 that have increased their dividends for at least 25 consecutive years. The list is maintained by S&P Dow Jones Indices and is updated annually in January.

To be included in the list, stocks must meet several criteria:

  1. Be a member of the S&P 500.
  2. Have a dividend increase streak of at least 25 years.
  3. Have a market capitalization of at least $3 billion.
  4. Average at least $5 million in daily trade value for the trailing three months.

If a company suspends or cuts its dividend or if it is removed from the S&P 500 index, the company automatically is removed from the list of Dividend Aristocrats as well.

Changes in 2020

In January, the list was increased to 64 companies with the addition of seven new Dividend Aristocrats:

Source: S&P News Release

In early April, the list changed again when United Technologies and Raytheon merged to form Raytheon Technologies Corporation (RTX). Before the merger, UTX spun off Otis Worldwide Corporation (OTIS) and Carrier Global Corporation (CARR). The Dividend Aristocrats briefly grew to a list of 66 companies with the addition of RTX, OTIS, and CARR and the removal of United Technologies.

Then, effective July 1, Ross Stores, Inc. (ROST) was removed from the Dividend Aristocrats list because it suspended its dividend.

So, currently, there are 65 Dividend Aristocrats.

Defensive, Cyclical, and Sensitive Sectors

There are at least three classification systems that group stocks based on sectors or industries. I use the Global Industry Classification Standard (GICS), a market-based system also employed by the S&P 500 Index.

Sectors can be further categorized into super sectors based on how they tend to perform during different phases of the business cycle, a pattern of cyclical fluctuations in the economy over a few years:

Defensive Sectors are not closely tied to the economy because companies in these sectors provide goods and services that are always in demand.

  • Consumer Staples: food and beverage, household goods, personal products, tobacco
  • Health Care: biotech, hospitals, medical devices, pharmaceuticals
  • Utilities: electric, gas, water

Cyclical Sectors are closely tied to the ups and downs of the economy. When the economy is thriving, companies in cyclical sectors do well because unemployment is low and wages are increasing. In downturns, though, companies in cyclical sectors tend to struggle as consumers are less confident about the future.

  • Consumer Discretionary: auto, entertainment, media, lodging, retailers, restaurants
  • Financials: asset management, banks, insurance, investment funds, loans
  • Materials: building materials, chemicals, mining, paper products, raw materials
  • Real Estate: commercial, industrial, residential real estate

Sensitive Sectors are sectors that ebb and flow with the overall economy but to a limited degree. Companies in these sectors are not immune to a poor economy, but they also may not be as severely impacted by economic downturns.

  • Communication Services: cable wireless, internet providers
  • Energy: gas, oil, pipeline operators, power, refineries
  • Industrials: aerospace, construction, defense, hand-held tools, machinery, transportation
  • Information Technology: computer equipment, data storage, electronics, semiconductors, software

A business cycle approach to sector investing can provide a useful framework for investing in sectors based on the likelihood that they will outperform or underperform. According to Fidelity's latest business cycle analysis, the United States is in the recession phase:

Source: Fidelity Investments

Investors should focus on the most defensive, historically stable sectors when the business cycle is in the recession phase.

Assessing Quality and Ranking Stocks

I use DVK Quality Snapshots to assess the quality of stocks. First introduced by David Van Knapp, the system employs five quality indicators and assigns 0-5 points to each quality indicator, for a maximum of 25 points.

While we both use Quality Snapshots, I have different rating and ranking systems:DVK Quality Snapshots scoring system and the author's rating system

My rating system maps to different quality score ranges. Ratings are Exceptional (25), Excellent (23-24), Fine (19-22), Decent (15-18), Poor (10-14), and Inferior (0-9). Furthermore, Investment Grade ratings correspond to quality scores in the range 15-25, while Speculative Grade ratings have quality scores below 15 points.

To rank stocks, I sort them by descending quality scores and use the following tie-breaking metrics, in turn:

  1. SSD Dividend Safety Scores
  2. S&P Credit Ratings
  3. Dividend Yield

When two stocks with the same quality score have the same Dividend Safety Scores, I next compare their S&P Credit Ratings, ranking the one with the better Credit Rating higher. I rarely need to break ties with Dividend Yield.

Key Metrics and Fair Value Estimates

In the tables below, I present key metrics of interest to dividend growth investors, along with quality indicators and fair value estimates. These include the years of consecutive dividend increases (Yrs), the dividend Yield for a recent Price, and the 5-year compound annual dividend growth rate (5-Yr DGR).

I also include the so-called Chowder Number (CDN), a popular metric for screening dividend growth stocks for possible investment. The CDN column is color-coded to indicate the likelihood of delivering annualized returns of at least 8%. Green means likely, yellow means less-likely, and red means unlikely. I consider green CDNs favorable.

The fair value column (Fair Val.) shows my fair value estimates, determined using fair value estimates and price targets from several sources, including Morningstar and Finbox. Additionally, I estimate fair value using each stock's 5-year average dividend yield.

With several estimates and targets available, I ignore the outliers (the lowest and highest values) and use the average of the median and mean of the remaining values as my fair value estimate. The last column shows the discount (Disc.) or premium (Prem.) of the recent price to my fair value estimate.

The second table in each group shows the Company name and the Sector of each stock.

Defensive Dividend Aristocrats rated Exceptional

The first table contains the Dividend Aristocrats in the defensive sectors that have perfect quality scores.

Table created by the author and includes data sourced from Dividend Radar

Stocks I own in my DivGro portfolio are highlighted in the Ticker column.

Rank out of 65 Company (Ticker) Sector
1 Johnson & Johnson (JNJ) Health Care
2 The Procter & Gamble Company (PG) Consumer Staples

The market values both of these stocks highly. Only JNJ is trading at a small discount to my fair value estimate.

My JNJ position is smaller than a full-size position, which, somewhat arbitrarily, I define as about 1% of total portfolio value. I can add about 57 shares of JNJ to turn it into a full-size position.

JNJ's current yield of 2.77% is about 3% higher than its 5-year average yield of 2.70%, meaning JNJ is presenting a reasonable entry point compared to the past.

Source: Portfolio Insight

However, when correlating JNJ's price with earnings, as illustrated in the following FASTGraphs chart, it appears that JNJ may be trading a little above fair value:

Source: FASTGraphs

When I look at FASTGraph charts, I prefer to see a 13-year time frame. This usually includes about ten years of price and earnings history and about three years of earnings estimates. As a long-term dividend growth investor, seeing the projected earnings is important. I like to see a general continuation of an upward trend, which certainly is the case for JNJ. With that confirmation, I don't mind paying a small premium for a quality stock such as JNJ.

My position in PG also is smaller than a full-size position, but I'm not interested in adding shares to my PG position given the stock's premium valuation.

Defensive Dividend Aristocrats rated Excellent

This table contains Dividend Aristocrats in the defensive sectors that I rate Excellent.

Table created by the author and includes data sourced from Dividend Radar

Rank out of 65 Company (Ticker) Sector
4 Medtronic plc (MDT) Health Care
6 PepsiCo, Inc. (PEP) Consumer Staples
7 Colgate-Palmolive Company (CL) Consumer Staples
8 Walmart Inc. (WMT) Consumer Staples
12 The Coca-Cola Company (KO) Consumer Staples

Only two stocks are trading at discounts to my fair value estimates, MDT and PEP. I happen to own both stocks in my portfolio.

My PEP position is smaller than a full-size position and I would need to add about 18 shares to make it a full-size position.

I'm not looking to add to my MDT position as it already is a full-size position. But the stock presents a good opportunity for investors looking to increase their defensive exposure. MDT currently yields 2.25% at $103.16 per share, about 5% above its 5-year average yield:

Source: Portfolio Insight

On the other hand, MDT's P/E ratio of 22.47 is well above its 5-year average of 17.84, meaning the stock is somewhat expensive compared to how it has been valued in recent years:

Source: Portfolio Insight

I also own positions in PG and KO, which are both smaller than full-size positions. Of course, I'm not interested in adding shares to these positions, as both stocks are trading at premium valuations.

I covered CL and WMT in an article on high-quality dividend growth stocks I don't own. These stocks are trading at premium valuations and their CDNs are quite low, meaning they're unlikely to deliver annualized returns topping 8%.

Defensive Dividend Aristocrats rated Fine

Stocks in the next table are high-quality Dividend Aristocrats in the defensive sectors.

Table created by the author and includes data sourced from Dividend Radar

Rank out of 65 Company (Ticker) Sector
18 Hormel Foods Corporation (HRL) Consumer Staples
19 Brown-Forman Corporation (BF.B) Consumer Staples
21 Atmos Energy Corporation (ATO) Utilities
24 Becton, Dickinson, and Company (BDX) Health Care
25 Kimberly-Clark Corporation (KMB) Consumer Staples
27 Abbott Laboratories (ABT) Health Care
32 McCormick & Company, Incorporated (MKC) Consumer Staples
35 Consolidated Edison, Inc. (ED) Utilities
37 The Clorox Company (CLX) Consumer Staples
39 Archer-Daniels-Midland Company (ADM) Consumer Staples

I own only two stocks in this group, HRL, and ADM. While HRL is trading well above my fair value estimate, ADM is trading at a slight discount. This is unfortunate, as my ADM position is full-sized but my HRL position is only about half of a full-sized position. Certainly, I'm not interested in buying HRL at a premium price of 17%!

Of the stocks I don't own, ATO and ED seem to offer the best opportunities.

ATO has a higher quality score and is ranked #21 out of the 65 Dividend Aristocrats. While its yield is modest at 2.41%, the stock's recent dividend growth is quite impressive:

Source: Simply Safe Dividends

ATO's current yield of 2.41% is 10% above its 5-year average yield of 2.22% and its P/E ratio of 18.9 is below its 5-year average of 22.1. So, ATO is discounted compared to how the market has valued it in recent years.

Source: Simply Safe Dividends

In comparison, ED is ranked #35 out of the 65 Dividend Aristocrats and offers a higher yield of 4.04% at $75.77 per share. The stock's 5-Yr DGR is more modest at 3.3%.

ED's current yield of 4.04% is 12% above its 5-year average of 3.59% and its P/E ratio of 17.5 is slightly below its 5-year average of 18.6. So, ETO is also discounted compared to how the market has valued it in recent years.

Source: Simply Safe Dividends

The only other stock in this group that is trading below fair value is BDX. Personally, I look for stocks with more favorable CDNs, so BDX does not interest me due to its low CDN of 7.

Defensive Dividend Aristocrats rated Decent

Stocks in the last table are lower-quality (though still Investment Grade) Dividend Aristocrats in the defensive sectors.

Rank out of 65 Company (Ticker) Sector
49 Walgreens Boots Alliance, Inc. (WBA) Consumer Staples
50 Cardinal Health, Inc. (CAH) Health Care
55 Sysco Corporation (SYY) Consumer Staples
56 AbbVie Inc. (ABBV) Health Care

Three stocks in this group at trading well below my fair value estimates, WBA, CAH, and ABBV.

I have full-sized positions of WBA and ABBV in my portfolio, so I'm not looking to add more shares at this time, despite the deep discounts.

CAH looks interesting now that it yields 4.09%, significantly above its 5-year average yield of 3.06%:

Source: Portfolio Insight

My one concern with CAH remains its slowing DGR:

Source: Simply Safe Dividends

CAH has diversified its business through debt-funded acquisitions (of about $8 billion) of medical devices businesses. As a result, the company's balance sheet has taken a hit and dividend growth is expected to remain very weak while the company works to reduce its debt and protects its credit rating.

Concluding Remarks

The 65 Dividend Aristocrats are high-quality stocks of companies with strong and durable competitive advantages. I ranked the Dividend Aristocrats using DVK Quality Snapshots and tie-breaking metrics.

This article presented the rankings of 21 Dividend Aristocrats in the defensive sectors: Consumer Staples, Health Care, and Utilities. Upcoming articles will present the rankings of Dividend Aristocrats in cyclical and sensitive sectors.

A business cycle approach to sector investing can provide a useful framework for investing in sectors based on the likelihood that they will outperform or underperform. The United States is presently in the recession phase of the business cycle, which calls for shifting focus to more defensive and historically stable sectors of the stock market.

The article highlighted some defensive Dividend Aristocrats trading at favorable valuations. In my view, these stocks are suitable for further research and possible investment, especially for investors looking to increase their exposure to defensive sectors. These include MDT, ATO, ED, and CAH.

Personally, I'm more interested in rounding out my JNJ and PEP positions to full-sized positions than considering adding new positions to my portfolio. However, ATO, ED, and CAH present interesting opportunities.

As always, I encourage readers to do their own due diligence before investing.

Thanks for reading and happy investing!

This article was written by

FerdiS profile picture
26.27K Followers
FerdiS invests in dividend growth stocks and writes options to boost dividend income. He manages DivGro, a portfolio of mainly dividend growth stocks created in January 2013. With investment and trading experience spanning nearly 20 years, FerdiS enjoys writing articles about dividend growth investing, options trading, stock selection, portfolio management, and passive income generation. His DivGro blog hosts more than 1,000 posts and a live, public spreadsheet with full details of his DivGro portfolio, allowing readers to follow along in his investment journey. FerdiS is collaborating with the founders of Portfolio Insight, an online platform for portfolio management and investment analysis. Together, we maintain and publish Dividend Radar, a free spreadsheet of dividend growth stocks, on a weekly basis.

Disclosure: I am/we are long ABBV, ADM, HRL, JNJ, KO, MDT, PEP, PG, WBA. 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.

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