With interest rates hovering near all-time lows, investors needing income are faced with very limited choices. The traditional high yield available from bonds and other fixed income vehicles are no longer available to meet the needs of retirees needing income to live off. Moreover, it is almost a certainty that today’s low yields are not adequate enough to fight inflation. Consequently, there is a growing investor interest in dividend-paying common stocks, especially those that have a long record of increasing their dividend every year. This has led many lay, and even many professional investors, to assume that dividend-paying common stocks are becoming overvalued. In addition to being too general to be relevant, these assumptions do not stand up to closer scrutiny.
Our research indicates this to be a fallacy, because in truth we have discovered numerous dividend-paying enterprises that are trading at historically low valuations. But even more importantly, in addition to being historically low, we have identified numerous blue-chip companies that are trading below their intrinsic values based on fundamentals, primarily earnings and cash flows. Today’s growing interest has yet to compensate for the enormous aversion to equities that most investors have after being traumatized by the great recession of 2008 and the precipitous drop in stock prices that accompanied it.
On the other hand, not all dividend-paying common stocks are the same. Therefore, we believe that potential investors need to be very discerning regarding the type and quality of the dividend paying stocks they are willing to invest in. This is especially true for those investors seeking to either augment or replace their fixed income investments with common stocks. Since the major attractions and benefits of fixed income in addition to yield, are safety and low risk, it only makes logical sense that a dividend-paying strategy being considered to replace or supplant it should focus heavily on the same issues.
Dividend paying common stocks come in many different flavors and range from very aggressive to very conservative. When considering alternatives to fixed income because of today’s low yields, we would argue that the emphasis should be on the most conservative dividend paying common stocks possible. In this vein, the reliability and predictability of a given dividend payment should rank high in importance. With that said, a logical place to begin looking is at companies that have long histories of paying dividends, and even better, a long history of increasing them each year. Although there is no guarantee that this will continue, a long track record certainly instills confidence.
One of the best sources available for identifying companies with long histories of dividend excellence is with David Fish’s CCC lists of Dividend Champions, Contenders and Challengersfound here. The Champions list is comprised of companies that have increased their dividend every year for at least 25 consecutive years, the Contenders list is comprised of companies that have raised their dividends for 10 to 24 years, and finally, the Challengers list is comprised of companies that have increased their dividends every year for between five to nine consecutive years.
It’s important to point out here that in theory at least, the Champions list is a more conservative group than the Contenders list which in turn is more conservative than the Challengers list. As a general statement, we believe this is true, but like most statements that are too general, the devil is in the details. Consequently, even though the Champions list is in theory the most conservative, we believe that there are names on the Contenders list that are even better quality, and therefore, more conservative than some of the names on the Champions list, and vice versa. Our last article dealt with the Dividend Champions that we believe are on sale. This is important because low prices and valuations are great attributes that mitigate risk in their own right. Here is a link to that article. This article will look at 42 Dividend Contenders that we believe are reasonably priced, too in some cases, significantly undervalued.
42 Dividend Contenders on Sale
This list of Dividend Contenders, like the list of Dividend Champions before, is offered as a prescreened resource made available prior to engaging in a more comprehensive analysis. However, there is a difference between these lists and the traditional lists that are sorted by mere numbers or statistics. Currently, there are only 102 Dividend Champions and only 146 Dividend Contenders. Therefore, we were able to quickly and easily evaluate each company on the lists by running a F.A.S.T. Graphs™ on each company that provides essential fundamentals at a glance. Therefore, we feel that this screen is more comprehensive than one based simply on statistical analysis.
Instead of bothering you with a long iteration using words and numbers to articulate what we screened for, we let a few pictures tell a few thousand words instead. The premium version ofF.A.S.T. Graphs™ has David Fish’s lists pre-loaded, with his permission of course. Therefore, it was a simple matter of scrolling through each company to determine whether or not it met our criteria of fair value, and whether or not it possessed the quality characteristics of predictability, reliability and consistency that we could be comfortable with. With our first run through, we took price out of the equation so as to only reveal the essential fundamentals of earnings and dividends on each company at a glance. Then we ran through the exercise again, only this time we added monthly closing stock prices to the graphs.
Remembering that we are coveting consistency and predictability with compiling our list of Dividend Contenders on sale, let’s review two graphs showing earnings (orange line with white triangles) and dividends (blue shaded area paid out of but stacked on top of earnings) exclusive of stock price.
Two Contenders Rejected because of a Lack of Consistency
Alterra Capital Holdings Ltd. (ALTE)
Our first example, Alterra Capital Holdings Ltd. (ALTE) is a Bermuda-based holding company created by the merger between Max Capital Group and Harbour Point Limited in May of 2010. Max was a holding company formed in 1999 that went public in May of 2001 and paid a dividend that increased every year since (see DIV listed at the bottom of the graph). Although this 11-year record of increasing dividends qualifies it as a Dividend Contender, it was excluded due to the enormous cyclicality and unpredictability of its earnings (see red box at bottom). Simply stated, we didn’t feel it was conservative enough to be considered as a potential fixed income replacement.
RenaissanceRe Holdings Ltd. (RNR)
Our second example, RenaissanceRe Holdings Ltd. (RNR) is a property catastrophic reinsurance company that has increased its dividend every year for 19 consecutive years (see DIV at bottom of the graph). Once again, the severe cyclicality and unpredictability of their earnings growth caused them to be excluded from our conservative list, even though their record of dividend increases has been long. This decision was made instantly by simply reviewing their earnings record (orange line).
In addition to highly cyclical names like the two examples above, we also excluded MLPs and REITs, as we consider these typically high-yield vehicles too risky to be considered as fixed income substitutes. However, there are many who would disagree with that position on these asset classes.
Two Quintessential Examples of What We Were Looking For
Stryker Corp. (SYK)
Stryker Corp. (SYK) has raised their dividend for 19 consecutive years in conjunction with an impeccable record of consistently increasing their earnings at the above-average rate of 18.4%. With very little debt on the balance sheet, this company represents the quintessential example of the type of predictable high-quality business we were seeking.
International Business Machines Corp. (IBM)
Affectionately known as Big Blue, IBM is arguably one of the bluest of all blue-chip technology stocks. The record of consistently increasing earnings at the above-average rate of 11% per annum since 1998 coincides with increasing their dividend for 16 consecutive years. Once again, IBM represents the classic earnings pattern and fundamental qualities that we were seeking.
Bringing It All Together
Some Contenders Are Fairly Valued
With our United Technologies Corp. (UTX) example below we put it all together by adding monthly closing stock prices (black line) to the earnings and dividend graphs. In order to make our list of Dividend Contenders on sale, the company’s stock price had to sit at or below its intrinsic value (the orange line) as United Technologies Corp.’s price clearly does.
In addition to just pure dividend income, this article is further focused on total return. Since, under normal circumstances, there is more risk owning equities than owning fixed income, it is important that our candidates offered the opportunity for an attractive total return to compensate for the risk. One of the most overlooked elements of risk is valuation (overvaluation). Even though United Technologies (UTX) is currently moderately undervalued based on our calculation of intrinsic value (the orange line), it nevertheless generated a very attractive long-term total return for shareholders because valuation was sound at the beginning of 1998, and