One of the great long-term benefits that a recession brings is the opportunity to invest in extremely high-quality companies at low valuations. This is especially true of companies that have proven themselves as being highly recession-resistant on an operating basis. In other words, companies whose businesses remain strong even when economic times are difficult, as they have recently been.
We believe that Becton Dickinson & Co. (BDX) represents an opportunity to invest in an extremely high-quality Standard & Poor’s Dividend Aristocrat and a David Fish Dividend Champion that has increased its dividend every year for 40 consecutive years. Classified as a healthcare equipment company, Becton Dickinson (BDX) operates in three segments: BD Medical, representing approximately 51% of sales, BD Diagnostics, representing approximately 32% of sales, and the remainder from BD Biosciences. The following excerpt taken from their website summarizes Becton Dickinson:
“BD is a medical technology company that serves healthcare institutions, life science researchers, clinical laboratories, industry and the general public. BD manufactures and sells a broad range of medical supplies, devices, laboratory equipment and diagnostic products. BD is headquartered in the United States and has offices in more than 50 countries worldwide.”
Becton Dickinson, as we will soon vividly depict, has a long history of providing their shareholders exceptional operating results and dividend increases. The company is highly regarded for the consistency it has delivered on its shareholders behalf, as evidenced by the following statement from MorningStar:
“Becton Dickinson’s needle and surgical tool empire has provided investors with robust returns on capital for years. Now, largely because of the company’s decades-long dedication to innovation and wise deployment of capital, its business is prospering and its investors remain amply rewarded even in this challenging economic environment. Morningstar”
Analysts at Value Line Investment Survey also acknowledged this company’s quality as well as its ability to provide safety during uncertain economic times. Moreover, they also believe as we do, that this high-quality healthcare company is currently on sale. The following summarizes Value Line’s views:
“These shares are appealing. The stock is on sale, relative to historical PE multiples as well as to the level at which we expect BDX to be trading in 2014 to 2016. This, alongside the solid share earnings growth we look for over three to five-year haul, gives this issue worthwhile capital gains potential. The equity is also defensive in nature, which is important during uncertain economic times. Moreover, the stock gets excellent scores for both Price Stability and Earnings Predictability, and it boasts a well below market Beta. Value Line Erik A. Antonson November 25, 2011”
Becton Dickinson – A Multi-Decade Legacy of Operating Excellence and Consistent Growth
The remainder of this article is going to review the “essential fundamentals at a glance” of Becton Dickinson & Co. through the lens of the F.A.S.T. Graphs™ research tool. Our first graph provides a vivid illustration of Becton Dickinson’s consistent above-average earnings growth and dividend achievements since calendar year 1993 (19 past years, plus the current year we are in). The orange line on the graph represents a calculation of the company’s intrinsic value based on an earnings justified PE ratio of 15. This line represents a value that the stock can be purchased at whereby the buyer is purchasing the company’s earnings power at a level that compensates them for the risk they assume. In other words, this valuation represents an earnings yield that is attractive and above average.
The blue shaded area represents dividends paid out of the green shaded earnings area. A primary reason they are stacked on top of earnings is to depict the principle that dividends represent a rate of return in addition to what the market may capitalize earnings at. More simply stated, there are two components of total return that a common stock offers investors.
The first is capital appreciation where the market capitalizes a company’s earnings at an appropriate multiple, commonly known as the PE ratio. The long-term historical normal PE ratio that the market has normally applied to companies on average is 15. A PE ratio of 15 implies an earnings yield of approximately 6.7%. This is calculated by dividing a dollar’s worth of the company’s earnings you are purchasing by the multiple you are paying to purchase them at (one dollar divided by 15 equals 6.66%). The important point here is that the market capitalizes those earnings whether a dividend is paid or not. In other words, this is how the market normally values a dollar’s worth of earnings for companies with earnings growth rates ranging from 5% to 15%.
The second component of total return comes when a company pays a dividend, in addition to the capital appreciation from the market capitalizing earnings; investors receive an additional payment in the form of a dividend. Although it is true, that a company’s stock will initially be reduced by the exact amount of the dividend payment, this is usually a very short-lived phenomenon that can be negated over a very short period of time as the stock continues to trade (it could be as short as the next hour of trading). Consequently, over the longer run the dividend, as we will illustrate later, in truth represents additional return above and beyond the capital appreciation component.
Becton Dickinson & Co. Earnings and Dividends Only Since 1993
Becton Dickinson & Co. Earnings, Price and Normal PE since 1993
With our next graph, we introduce two important overlays. First we bring in monthly closing stock prices from 1993 plus the previous day’s closing price. Here we see that Becton Dickinson’s stock price has closely correlated to its earnings growth. Although the market has often applied a quality premium by pricing Becton Dickinson’s stock above its earnings justified valuation line (orange line), note how the price inevitably and continuously returns to that level. Simply stated, the stock is fairly priced when the black price line touches the orange earnings justified valuation line, and is overpriced when it is above it and underpriced when it is below it. Clearly, history shows that the best time to purchase the stock is when the price is at or below the orange line. As can be clearly seen, Becton Dickinson’s current price is at one of the lowest valuations it has been in almost 2 decades.
When a stock is at or below fair value, this represents an opportune or attractive point in time to invest. However, fair value, although important, is not the primary determinant of the capital appreciation component of total return. Assuming valuation is in alignment, the company’s earnings growth rate will be the primary determinant of the rate of capital appreciation that the investor can expect. In other words, if you pay fair value for company that, for example, only offers a 3% growth rate, it’s only rational to expect a capital appreciation rate of approximately 3% as well, not including dividends. On the other hand, a 10% to 12% grower like Becton Dickinson, if bought at fair value should generate a rate of return of approximately 10% to 12% consistent with earnings growth, again, not including dividends.
The rate of capital appreciation is an important point worthy of more elaboration. If you pay fair value to