T. Rowe Price: Of The 10 Most Beaten-Down Dividend Champs, This Is Our Favorite

Summary

  • Dividends champion stocks are a tough bunch to catch on sale.
  • Recent market sell-off and macroeconomic uncertainties created a rare investment opportunity for long-term-oriented investors.
  • Here we pick the 10 most beaten-down stocks based on a Graham-type screening.
  • Together, they offer an excellent balance of diversification, quality, and attractive return potentials adjusted for risks.
  • And the top one that fits the Graham criteria is T. Rowe Price!
  • Looking for a portfolio of ideas like this one? Members of Envision Early Retirement get exclusive access to our model portfolio. Learn More »
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Thesis and overview

Note: this section and the next section are largely the same as those in our previous article entitled “Meta Platforms: Of the 10 Most Beaten-Down Stocks, This Is The One Graham Would Pick.” These two sections describe the screening method we designed to pick the 10 most beaten-down stocks in the recent selloff. The difference is that in this article, we applied the screener to all the dividend champion stocks, while our previous applied it to the entire stock universe. Here are we are including these two sections to provide ease of reference for readers who have not read our previous article.

In the stock market bible, The Intelligent Investor, Benjamin Graham suggested a set of criteria for stock selection. These timeless criteria have helped and inspired millions of investors worldwide. These criteria turned buying stocks from a speculation into an investment.

However, the dream deals that fit all his original criteria have become almost extinct now (e.g., stock price below 2/3 of tangible book value per share, stock price below 2/3 of Net Current Asset Value, et al). However, from time to time, extreme market panics offer opportunities that almost fit all dream criteria. As you will see in this article, now is one such time.

Here we picked the 10 most beaten-down stocks based on a Graham-type screening. We've designed a screener based on the following criteria:

1. Low PE

2. Earning growth in the past five years

3. YTD loss

Criteria 1 and 2 are completely consistent with Graham’s original thinking. And criterion 3 is designed to capture the recent panic sell-off.

We’ve applied this screener to the dividend champions, those stocks with at least 25 years of consecutive dividend increases. Our final list is the stocks with the highest combined scores on all three criteria. The score is an equal-weighted average of each stock’s ranking on these criteria.

And the results are tabulated below:

10 most beaten-down dividends stocks in recent sell-off

Author

The timeless power of value investing

Before moving on to comment on the details of each selection one by one, let's first take a look at the overall picture. The next table shows the basic statistics of these 10 stocks, their current PE, forward PE, growth expected in the next three to five years, and also the expected returns. A few key observations:

  • First, the recent sell-off is indeed broad. As you can see, stocks from a broad range of market caps (mega, large, medium, and small) across a wide range of sectors have been impacted.
  • Secondly, as you can also see, this set of stocks currently is very reasonably valued – for a group of dividend champions. They're valued at only about 17.4x PE. If we exclude TRI (the outlier with a PE Of 51.6x) from this group, the rest of the selections have an average PE of only 13.6x.
  • Lastly, as a result, combining the growth and the valuation reversion expected, the total projected return in three to five years could be close to 30% (translating to an annualized return of about 7%). Do not be under-impressed by the modest return potential here. Such a return is quite attractive return potentials adjusted for risks considering the diversification, quality, and resilience to market corrections (which is about only ½ of the overall market as detailed next).
10 most beaten-down dividend stocks in recent sell-off

Author based on Seeking Alpha data.

I wouldn't be surprised by such superior returns/risk profit. If it happens, it will be just another demonstration of the timeless power of valuing investing, which has been well documented in so many past studies and also in our own investing journey.

As an example, the following chart shows the excess return of stocks divided into 5 quintiles relative to the S&P 500 index. The first quintile contains stocks with the highest PE ratio, and so on. You can clearly see the positive correlation. Stocks in the first quintile, i.e., with the highest PE ratio in the first 20th percentile, underperformed the S&P 500 equal weight index by 2.08%. The performance almost linearly improves as the PE ratio goes down. And stocks in the fifth quintile, those least expensively valued produced an average annual excess return of 1.41%.

Lower PE returns better

Source: Fat Pitch Financials

The timeless power of dividends

Before diving into the details of these 10 selections, we want to make a comment about the timeless power of dividend investing. Especially the protection and resilience of stocks paying regular dividends for a long time like the dividend champions.

The following table shows the 10 most beaten-down stocks selected by the same set of criteria from the entire stock universe. This table is directly taken from our previous article. And as you can see the average correction of this set of stocks YTD was about 25%. However, in contrast, the average correction for the 10 most beaten-down dividend champions was only about 12%, less than half of those from the general stock universe.

The magic of compounding is such that a 10% loss hurts you more than a 10% gain can help you - it's a simple mathematical fact. So if you are in a withdrawal stage, the protection and resilience offered by these dividends champions can really be crucial for your financial security in the long term.

In the remainder of this article, we will detail our top choice – the T Rowe Price Group Inc. We then will make some brief comments regarding the rest 9 of them.

10 most beaten-down stocks in recent sell-off

Author based on Seeking Alpha data

T. Rowe Price Group (NASDAQ:TROW)

TROW is our favorite one for several good reasons:

  • Very reasonable valuation (about 11x), about 28% discount from its historical average. Such valuation essentially models it to be a stock that will stagnate permanently and never grow.
  • However, the reality is that it has been growing at a double-digit rate in the long term. It has been growing its dividends at about 11% in the past 10 years and about 12% in the past five years. On top of such a double-digit dividend growth rate, it has also managed to pay a special dividend of $3 and $1 in 2021 and 2012, respectively.
  • Its dividend yield spread against 10-year treasury rates is now at a relatively wide level by historical standard. And for such a stable dividend stock, such a wide spread provides several key advantages, especially for accounts seeking current income. The wide spread provides not only a decent current income but also a comfortable cushion against interest rate uncertainties.
  • Superb financial and earning consistency.
  • Lastly, the combination of its valuation, growth, and wide yield spread is very likely to lead to a sizable price appreciation in the near term.

For those who are not familiar with the business yet, TROW provides investment advisory and administrative services to the Price family on a variety of products. They include mutual funds, sponsored investment products, and private accounts.

As can be seen from the following numbers in the table, at its current price level, it's at a sizable discount. It's about 8% undervalued based on historical dividend yield, and about 28% discounted based on historical PE. The company is in super financial shape. It currently has ample cash and no long-term debt on the balance sheet. As such, it can generously reward shareholders with both share repurchases (over $300 million in stock in the first half of 2021), and a whopping 20% increase in dividends this year. Thanks to its robust revenue streams and customer loyalty (Investment advisory fees provided 91% of revenues in recent years), it also boasts an A+ earning consistency.

TROW valuation and safety

Author

Furthermore, its dividend yield spread against 10-year treasury rates is now at a relatively wide level by historical standard. For bond-like equities like TROW that enjoy a stable income and regular dividends, an effective indicator we rely on has been the yield spread. Details of the calculation and application of the yield spread have been provided in our earlier article. In summary, the risk-free rate serves as the gravity on all asset valuations. As a result, the yield spread of a given asset provides a measurement of the risk premium investors are paying for that asset. A large spread provides a higher margin of safety and vice versa.

This next chart shows the yield spread between TROW and the 10-year treasury. The yield spread is defined as the TTM dividend yield (excluding special dividends) of TROW minus the 10-year treasury bond rate. As can be seen, the spread is bounded and tractable. The spread has been in the range between about -1% and 1% the majority of the time, which makes sense for a stable and mature business like TROW. Suggesting that when the spread is near or above 1%, TROW is significantly undervalued relative to 10-year treasury bond (i.e., I would sell treasury bond and buy TROW). In this case, sellers of TROW are willing to sell it (again essentially an equity bond) to me at a yield that is 1% above a risk-free bond. So it is a good bargain for me. And you can clearly see the screaming buy signal during the 2016 and 2020 pandemic panic sales when the yield spread hiked to be near or above 2%. And when the yield spread is near or below -1%, it means the opposite now.

And as of this writing, the yield spread is about 0.9%. In relative terms, it's near the high end of the historical spectrum as seen. In absolute terms, it is in a range that makes it an attractive substitute for treasury bonds. Admittedly, the 10-year rate might further increase (especially given the Fed’s hawkish dot-plot). And when/if the 10-year rate climbs to the 2.5% level, the yield spread would still be positive (about 0.4%) EVEN if there TROW stops increasing its dividends.

As a result, such a wide spread not only provides a decent current income, but also a comfortable cushion against interest rate uncertainties.

TROW wide spread yield and double-digit expected return

Author

The next chart provides a more quantitative evaluation of the risks. This chart shows the next two-year total return on TROW (including price appreciation and dividend, and again special dividends are not included) when the purchase was made under different yield spreads.

As can be clearly seen, first that is a positive trend, indicating that the odds and amount of the total return increases as the yield spread increases. The correlation coefficient is 0.47, suggesting a moderately-strong level of correlation. Particularly as shown in the orange box, when the spread is about 1% or higher as aforementioned, the investment in the next two years has never lost money except for 1 data point (where it suffered a small loss).

Again, the yield spread is currently about 0.9% as shown, close to the thickest level of the historical spectrum. Such a thick spread suggested very low risks in the near term and very favorable odds for near-term price appreciation.

TROW wide spread yield and double-digit expected return

Author

Looking forward, we're very optimistic about its future growth, particularly its wealth management segment. With TROW’s scale, reputation, efficiency, and customer trust, customers are sticky and there is little reason for them to switch. Its assets under management (“AUM”) saw spectacular growth in recent years, growing from $1.21 trillion in 2019 to $1.47 trillion in 2020, and totaling $1.6 trillion in 2021 (a 32% growth in two years or 15% annual CAGR). Profits, both topline and bottom-line, have been growing in tandem at double-digit annual rates. For the next 3~5 years, a double-digit annual growth rate is also expected (near 10.5%). And the total return in the next 3~5 years are projected to be in a range of 27% (the low-end projection) to about 63% (the high-end projection), translating into a healthy 6 %to 13% annual total return.

TROW double-digit annual growth and expected return

Author based on Seeking Alpha data

Franklin Resources (BEN)

Franklin Resources is another Asset Management business that made to this list. It provides investment management and related services. Its assets under management are around $1.5 trillion in the most recent quarter (up 8%, year over year). And it has a global footprint with offices in over 30 countries.

Recent money inflows are encouraging. And its investment product performance is solid vs. benchmarks. The business is also active on the acquisition front. The management just announced in November that it agreed to acquire private-equity investor Lexington for $1 billion in cash upfront, plus an additional $750 million in the three years after the deal’s close.

Looking forward, we're very optimistic about its future growth. Just like the case of TROW, BEN enjoys long-term customer relationships. In the near term, the Lexington acquisition will further expand its capabilities within a broad alternative-investment category.

On the downside, the current stock market is at a near-record high level and the bond market might suffer a correction too given Fed’s hawkish dot-plot. The pressure from both the equity and bond market could weigh on asset levels. The business operation efficiency is not the best among peers too. However, we view these risk factors more than priced in given its current valuation.

Chart
Data by YCharts

Stepan Company (SCL)

SCL produces specialty and intermediate chemicals that are sold to manufacturers. It has three reportable segments. But the top two generate most of the sales: Surfactants generated about 72% of 2020 sales and Polymers about 24%.

2021 has been a good year for SCL. Both topline and bottom-line saw strong growth. And it has also raised the quarterly dividend by 10% to $0.335 per, a strong demonstration of management’s confidence in the business prospects.

Looking forward, we see the special chemical market to continue a strong performance. The top line is expected to benefit from both higher average selling prices and a modest bump in volumes. Furthermore, its acquisition of the polyester polyol business from INVISTA should also begin to contribute to growth.

The main risk in the near term is the supply chain disruptions. Its operating income declined 16% in the September interim largely due to supply disruptions. It is uncertain how long such interruptions will last.

Thomson Reuters (TRI)

TRI is a global e-information and solutions provider for businesses and professionals in the financial, legal, tax and accounting, healthcare, science, and media markets. The Legal Professionals segment accounted for 40% of sales in recent years. Its ‘‘Big 3’’ Legal Professionals, Corporates, and Tax & Accounting divisions posted a healthy 7% sales advance, to $1.2 billion. Another 6% of organic sales growth is expected next year.

Looking forward, we're optimistically expecting full-year sales to increase between 4.5% and 5%, up from its previous guidance of 4% to 4.5%. We also expect solid demand from small and mid-sized firms, as well as government entities for its legal and tax, and accounting divisions.

The main risk we see here is valuation risk and short-term price volatility risk. TRI is valued by the market at about 53x FW PE even after the recent correction. Such a high valuation, combined with the near-record overall market valuation, poses significant short-term price volatility risks.

Lowe’s (LOW)

LOW probably needs no introduction in this group. The recent earnings report from LOW made for good reading. LOW has been an unexpected beneficiary of the COVID pandemic. The pandemic created the need for many people to take on home renovation projects. As people have to stay home, working and schooling remotely, suddenly there is a surge for home renovation (as this author has experienced firsthand). Based on its most recent earnings report, sales rose 3% on a year-over-year basis, and comparable-store sales were up 2.2%.

Looking forward, we expect healthy growth in the mid-single-digit range. Catalysts include margin expansion and stock repurchases, which should facilitate a further uptick in earnings. Furthermore, fixed-cost leverage on the higher comps and expense discipline should also enable the operating margin to further widen.

The main risks in the near term are supply chain disruptions, elevated transportation costs, surging inflation. In the long-term, it's uncertain whether the benefits brought about unexpectedly by COVID are temporary or whether consumer behaviors have been permanently changed and the benefits would last.

Chart
Data by YCharts

NACCO Industries (NC)

NACCO Industries Inc. operates surface mines that supply coal primarily to power generation companies under long-term contracts and provide other services to natural resource companies.

It's a small-cap stock. Its market capitalization is about $220M, the smallest among this list. It's also the stock with the lowest valuation in this group, with an FW PE of only about 6.4x. The main reason for its low valuation lies in its coal business, which is viewed as a dying business on the way to being phased. But the business does have other revenues sources, and it is actively transitioning itself out of the coal business and into other more promising segments (such as Lithium mining).

As a small-cap stock, it's exposed to large short-term volatility risks. Also, its success of transition out of the coal business is also uncertain.

Chart
Data by YCharts

National Fuel Gas (NFG)

National Fuel Gas Company is an oil and gas integrated business. It's engaged in the production, gathering, transportation, distribution, and marketing of natural gas & oil. Its Utility and Energy Marketing segment accounts for 47% of its sales in recent years. Other segments include Exploration/Production (40%) and Pipeline, Storage & Gathering (13%). It recently experienced an 18% increase in total output, and profits jumped more than 60% year over year. It acquired Appalachian assets last year. And overall, this acquisition and the synergies helped bolster recent financials.

Looking forward, its Pipeline & Storage segment has already begun to bear fruit, especially the Empire North Empire expansion. And we're optimistic the growth to be fueled by these expansions.

As a utility business, NFG relies on debt financing (total long-term debt is about $2628 mill). Its current interest expenses are about $50 and total interest coverage is about 3.5x. It can be subject to sizable interest rate risks should the borrow rates begin to rise given the Fed’s hawkish dot-plot.

UMB Financial (UMBF)

UMB Financial is a regional bank. It offers various banking and other financial services in the US. Its services include commercial and consumer banking, treasury management, leasing, foreign exchange, merchant bankcard, wealth management, brokerage, insurance, capital market, investment banking, corporate trust, and correspondent banking services.

The Fed’s QE gave a large boost to its profit and stock price. Both topline and bottom-line saw substantial growth from the numbers a year ago. 2021 EPS is projected to be more than 26% higher than the 2020 level. And the stock price rallied by more than 270% from the bottom of the COVID crash. The stock price has corrected to the current level of $104 amid the sell-off. At its current price, it is valued at about 14.5x FW PE.

Looking forward, there are good reasons to be bullish, including its strong credit quality, better loan growth prospects than many peers, and capital allocation flexibility.

The main risk here (as for banks in general) is the interest rate uncertainties ahead.

Expeditors International (EXPD)

Expeditors International of Washington is an integrated freight and logistics service provider. It provides logistics services globally (including the Americas, North Asia, South Asia, Europe, the Middle East, Africa, and India). Its offerings include air freight (about 47% of sales in recent years) and ocean freight (23%). The company’s recent financials were boosted by the ongoing supply-and-demand imbalance. The revenue gains more than offset higher operating expenses.

Looking forward, we're optimistic about its profits in the near term. The global logistic chain interruption can persist longer. And both air and ocean freight prices are at a really high level now. At the same time, it's proactively chartering planes and purchasing extra space to further profit from these market conditions.

Risks include the pace of the renormalization due to COVID-19-related headwinds, the congestions at ocean ports, and labor and equipment shortages.

Chart
Data by YCharts

Target Corp (TGT)

TGT is another stock that needs no instruction. The iconic US retailer posted another solid campaign in 2021. Revenues and share earnings enjoyed healthy growth, led by improved spending during seasonal affairs like Christmas, Halloween, and the back-to-school period. Revenues and earnings both beat expectations and forecasts for fiscal 2022 were raised accordingly.

TGT was overvalued when we wrote about it last time back in Aug 2021 (at a PE near 21.2x). The correction since then, and especially the recent selloff, has created an entry opportunity for this dividend king. The following chart shows the annual average PE of the stock in the past decade. As seen, the average is 15.5x and the standard deviation is ~3. The current PE of 15.9x is right around the mean.

Looking forward, we're optimistic about its operations, its customer base, and its market share are now noticeably higher. Furthermore, the current average PE for such a stable and well-established stock also invites good odds for a valuation expansion.

The main risks in the near term are supply chain disruptions and inflation pressure. Its CEO stated that Target is absorbing some of the higher costs rather than passing them on to customers. This strategy might work in the short term for customer retention. However, it is a tough balance to strike between customer and profit margin should the inflation pressure persists longer.

TGT PE ratio

Source: Author based on Seeking Alpha data

Summary and final thoughts

Dividends champion stocks are a tough bunch to catch on sale. The recent sell-off created an attractive opportunity for DGI investors. Here we pick the 10 most beaten-down stocks based on a Graham-type screening. Together, they offer an excellent balance of diversification, quality, and outsized return potentials.

In particular,

  • Stocks from a broad range of market caps (large, medium, and small) across a wide range of sectors have been impacted to a substantial degree (the YTD average correction for this selection is almost 12%). It is a great time for DGI investors to better diversify their portfolios with quality stocks from a wide range of sectors.
  • The total projected return in three to five years could be close to 30%, translating to an annualized return of more than 6.5%. However, do not be under-impressed by the modest return potential here. Such a return is quite attractive return potentials adjusted for risks considering the diversification, quality, and resilience to market corrections (which is about only ½ of the overall market).

Thanks for reading and look forward to your comments and thoughts!

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** Disclosure: I am associated with Sensor Unlimited.

** Master of Science, 2004, Stanford University, Stanford, CA 

Department of Management Science and Engineering, with concentration in quantitative investment 

** PhD,  2006, Stanford University, Stanford, CA 

Department of Mechanical Engineering, with concentration in  advanced and renewable energy solutions

** 15 years of investment management experiences 

Since 2006, have been actively analyzing stocks and the overall market, managing various portfolios and accounts and providing investment counseling to many relatives and friends.

** Diverse background and holistic approach 

Combined with Sensor Unlimited, we provide more than 3 decades of hands-on experience in high-tech R&D and consulting, housing market, credit market, and actual portfolio management. We monitor several asset classes for tactical opportunities. Examples include less-covered stocks ideas (such as our past holdings like CRUS and FL), the credit and REIT market, short-term and long-term bond trade opportunities, and gold-silver trade opportunities. 

I also take a holistic view and watch out on aspects (both dangers and opportunities) often neglected – such as tax considerations (always a large chunk of return), fitness with the rest of holdings (no holding is good or bad until it is examined under the context of what we already hold), and allocation across asset classes.

Above all, like many SA readers and writers, I am a curious investor – I look forward to constantly learn, re-learn, and de-learn with this wonderful community.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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