By now, it should be no secret to anyone that the stock market has been on a nice run of late. Moreover, this Bull Run has conjured up a lot of discussions that might lead one to believe that stocks in general are overvalued. There are even some that want to play the bubble card because they argue that the S&P 500 (.INX) and/or the Dow Jones Industrial Average are both approaching all-time highs. However, I believe these extremists are confusing value with price.
Investors need to understand and recognize that both a company and/or an index can be trading at an all-time high price, while at the same time be trading at a reasonable or even a low valuation. Additionally, there can be more than one reason for this to occur. For example, if earnings are at an all-time high, the price can also be at an all-time high while the PE ratio is lower than historical norms. Another iteration can manifest because the stock or index was once previously trading at an extreme overvaluation, while it is now fairly valued.
My point is that it is not logical to automatically assume that a stock is overvalued because it is trading at its highest price ever. If earnings growth has also been strong, it is possible that even at its current highest price ever, that the stock is undervalued or fairly valued. For the sake of their long-term performance, it is important that investors understand this distinction, recognize it, and make investment decisions based more on true value than on price.
Currently, I can cite four high profile Dividend Aristocrats that are in this situation: 1. Franklin Resources (BEN) 2. Illinois Tool Works (ITW) 3. Johnson & Johnson (JNJ) 4. 3M Corp. (MMM). The following historical earnings and price correlated FAST Graphs™ on Franklin Resources illustrates my point. Franklin Resources is trading close to its highest price ever, but its current PE ratio of 15 indicates that it is currently fairly valued. In 2007 when its stock price was over $145 per share, its PE ratio was also over 20, and one of the highest PEs that Franklin Resources has ever been awarded.
The Relative Valuation of the Prestigious Standard & Poor’s Dividend Aristocrats
With this article, I am going to review the prestigious Standard & Poor’s Dividend Aristocrats list comprised of 51 blue-chip companies that have increased their dividend every year for 25 or more consecutive years. Furthermore, all of the Dividend Aristocrats are also included in David Fish’s Dividend Champions list comprised of 105 companies that likewise have increased their dividends every year for 25 consecutive years. An update of David’s CCC list can be found here.
However, the reason I chose the Dividend Aristocrats list is simply because not only is it a smaller list, but because I also believe it represents the crème de la crème of companies with a long streak of dividend increases. But even more importantly, I believe this blue-chip list of dividend growth stocks represents the foundational choices that dividend growth investors in or contemplating retirement can depend on as income producers that offer the potential for a raise in pay each year.
Moreover, there have been two strong factors that cause me to generally favor these prestigious blue-chip dividend growth stocks since the great recession of 2008. First of all, after the recession, most of these companies became historically undervalued even though their earnings held up for the most part, and of course their dividends continued to grow. This created a real opportunity for the dividend growth investor to receive an above-average total return, and an above-average current dividend yield while simultaneously enjoying a higher margin of safety than normal valuations typically provide.
Although the recent run-up in stock prices over the past few years has partially closed this incredible window of opportunity, it has not completely slammed it shut. As I will illustrate, extreme bargains are now harder to come by than they were just a few years ago, but there still are bargains to be had if investors are willing to dig deep enough. On the other hand, there are not as many bargains to be found today as there were just a few years ago. But this does not mean that there are not any good investments available. Companies that can be purchased at fair value are also good investments.
In other words, I believe there are still plenty of reasonably priced Dividend Aristocrats available. Although we all love a bargain, we also have to realize that regarding investing in common stocks, we also have to accept what the marketplace is offering us in present time. Nevertheless, I must admit to lamenting about all of the great bargains disappearing. Today, I have to be willing to accept sound investments, also known as fairly valued investments, to invest current monies. To repeat, the truth is that if a company is at fair value it may not be a great bargain, but it still can be a sound and attractive investment.
In order to come to these conclusions, I have reviewed all of the 51 Dividend Aristocrats, one company at a time, in order to ascertain the relative valuation of each individual Dividend Aristocrat. My research came up with seven companies out of the 51 that I considered bargains. I felt that 16 were fairly valued, with an additional 18 that I considered only moderately overvalued.
It’s important to state here that valuation is not a precise measurement. Therefore, I’m comfortable in saying that 31 of the 51 Dividend Aristocrats could be potential candidates for current investment. However, more comprehensive due diligence is indicated. Also, I wrote extensively on the subject of sound valuation in my last article found here.
Additionally, I took some solace in the fact that my research only uncovered 10 Dividend Aristocrats that I considered dangerously overvalued. This is important, because a strong market like we have recently experienced can easily convince people that stocks have become overvalued. I believe it is vitally important to make investment decisions based on fact rather than innuendo. The key is to make the distinction between price and value.
The following lists the seven Dividend Aristocrats that statistically appear to be trading at bargain valuations. One way to measure this, as I have done in the following table, is to compare the current P/E ratio of the company to its historical normal P/E. However, as I will soon illustrate, statistics do not always tell the whole story, and sometimes not even enough of the story to make a rational decision.
Pitney Bowes Inc. (NYSE:PBI) a Bargain or a Trap?
Statistically speaking, Pitney Bowes Inc. (NYSE:PBI) looks like a screaming bargain. Its current PE ratio of 6.6 is less than half of its normal PE ratio of 14.3. Moreover, its current dividend yield is over 11%. Remember, this is a Dividend Aristocrat that has increased its dividend every year for 25 consecutive years (30 to be exact). These are all great statistics. However, a closer look reveals some significant potential dangers that are lurking.
The moral of the story is that I believe prudent investing must go beyond gazing at spreadsheets or simply reviewing data points. It is possible that Pitney Bowes is capable of turning its business around. However, there is no substitute for comprehensive due diligence. Regarding Pitney Bowes Inc. (NYSE:PBI), an article in Barron’s entitled Pitney Bowes' Enticing 10.8% Yield, may shed some light on this company’s future.
Aristocrats at Fair Value
This next table lists the 16 Dividend Aristocrats that appeared to be currently fairly valued. Statistically speaking, each of the 16 candidates appears to be reasonably valued. However, it’s important to remember that rather than a precise measurement, valuation is always indicated as a range of reasonableness. Moreover, I consider fair valuation a measure of soundness and not necessarily an indicator of a high future return.
The following specific examples from my fair value list illustrate how two companies that are both fairly valued can potentially offer entirely different potential future returns. Consolidated Edison is a very slow growth utility stock that offers an attractive dividend yield but very little capital appreciation potential.
The following estimated earnings and return calculator based on the consensus of 13 analysts reporting to Capital IQ indicate that Consolidated Edison, Inc.’s 5-year estimated total return would be 6.7%. However, it’s important to point out that the majority of this return would come from dividends, not growth.
In contrast, Family Dollar Stores, Inc. (NYSE:FDO) is a Dividend Aristocrat that can be purchased at a lower PE ratio than Consolidated Edison, Inc. and also offers a much lower yield. However, the major differentiator with Family Dollar versus Consolidated Edison is Family Dollar Stores, Inc. (NYSE:FDO)’ historical and future growth potential.
The consensus forecast earnings growth by 27 analysts reporting to Capital IQ is