This is a guest post written by Ben Reynolds at Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios from Dividend Aristocrats and other dividend stocks with long histories.
The article Dividend Growth Investors: Stay The Course thoughtfully examines the difficulties of investing in dividend growth stocks when stock prices are falling.
The article discusses how important it is to stay the course and continue building your dividend growth portfolio – even when prices are falling. See below for an excerpt:
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“There is a reason why stocks have done much better than bonds in the long-run – they are riskier. With stocks, there is always the chance that there will be violent fluctuations in the price. You can have steep downturns, which can have many weak hands scrambling for the exits. When stock prices go down, many investors assume that something is wrong, they panic and sell. They forget that your upside potential in terms of dividends and capital gains is virtually unlimited.”
The volatility of dividend stocks is what makes staying the course more difficult. The larger the price fluctuations, the harder it is to hold onto a stock.
Think of investing in dividend growth stocks like bull riding. The longer you stay on, the better off you will be. It’s easier to ride a placid bull than an enraged one. The same is true of dividend stocks. Some have wild price fluctuations that threaten to ‘buck off’ investors who are unable to stomach large losses. Other stocks make for an easier ride – they have lower stock price volatility.
This article takes a look at 3 of the lowest volatility non-utility dividend growth stocks around to make your dividend growth journey as smooth as possible.
Johnson & Johnson
Johnson & Johnson (JNJ) is the largest is the largest health care corporation in the world. The company has a market cap of $296 billion. In fact, only 6 other businesses have larger market caps than Johnson & Johnson.
The company has a 10 year stock price standard deviation of just 16.3% – the lowest of any business with 25+ years of dividend payments without a reduction.
Johnson & Johnson’s dividend history shows evidence of its amazing stability. The company has paid increasing dividends for 53 consecutive years. This makes Johnson & Johnson one of just 17 Dividend Kings – Dividend stocks with 50+ years of dividend increases.
The company is still growing despite its massive size and long history. Johnson & Johnson grew earnings-per-share at 5.5% a year over the last decade.
Growth of 5.5% a year is not an eye-popping number. Investors looking for high risk, high return securities should look elsewhere.
With that said, Johnson & Johnson offers solid total return potential. The company currently has a dividend yield of 2.8%. I expect Johnson & Johnson to continue compounding its earnings-per-share at between 5% and 7% a year. This growth combined with the company’s current dividend yield gives investors expected total returns of 7.8% to 9.8% a year.
For comparison, the S&P 500 has returned 9.0% a year over the long run (including dividends). The historical average price-to-earnings ratio and dividend yield of the S&P 500 is 15.6 and 4.4%, respectively. The S&P 500 currently has a 23.90 price-to-earnings ratio and a 2.20% dividend yield. The forward P/E on S&P 500 is 18.10. It is likely that the S&P 500 generates returns under its long-term historical average of 9.0% a year going forward.
This means that it is likely that Johnson & Johnson either matches or exceeds the S&P 500’s total returns going forward – before accounting for changes in its valuation multiple.
Johnson & Johnson currently trades for a price-to-earnings multiple of 20.90. The forward P/E ratio is 17.10 This is below the S&P 500’s price-to-earnings rate. Johnson & Johnson is an ultra-high quality business that should command a price-to-earnings multiple at least equal to that of the S&P 500 – especially considering the total return potential of the two investments.
Johnson & Johnson’s combination of low volatility, safety, and reasonable return make it a compelling choice for dividend growth investors looking for stability.
General Mills (GIS) offers investors above-average total returns coupled with below average stock price volatility. This is a rare combination. Most low volatility stocks (like many utilities) also have below average total returns.
The company’s stock price volatility over the last decade is just 17.2% – one of the lowest of any business. The company’s low volatility is a reflection of its low risk business model.
General Mills is the industry leader in packaged and processed food. The company has a market cap of $36 billion.
The company’s market leadership comes an especially slow changing industry. In many industries (think technology) creative destruction rapidly cycles through business. Most of the large technology companies of just 20 years ago are nowhere near the level of market share they had at that time. Contrast this to packaged and processed foods. People have eaten packaged foods for a very long time – and there appears to be no end in sight. Better packaging and speed-to-market may enhance packaged foods, but the industry as a whole will likely be relatively unchanged 20 years from now.
The stability of the industry is exemplified in General Mills’ amazing dividend history. The company has paid dividends for… 116 years.
Over the last decade General Mills has grown earnings-per-share at 7.8% a year. The company consistently grows earnings through organic growth, acquisitions, efficiency improvements, and share repurchases. I expect General Mills to continue growing earnings-per-share at 7% to 9% a year over the next several years. This growth combined with the company’s current 3.10% dividend yield gives investors expected total returns of 10% to 12% a year – not bad for a low volatility, low risk business that makes staying the course easy.
PepsiCo (PEP) is one of the most well-known businesses around. The company has increased its dividend payments for 43 consecutive years. This is clear evidence of stability and a strong competitive advantage.
The reason PepsiCo is on this list and not its rival Coca-Cola (KO) is because PepsiCo actually has a lower stock price standard deviation over the last decade than Coca-Coal. Coca-Cola is strictly a beverage business, whereas PepsiCo is more diversified.
PepsiCo owns the Quaker and Frito-Lay brands. The Frito-Lay brands in particular are very valuable. PepsiCo actually generates more operating profit from food products than from beverages.
The split business model of PepsiCo makes it slightly more stable than Coca-Cola. This is reflected in the company’s 10 year annualized stock price standard deviation of 17.5%, versus 18.6% for Coca-Cola.
PepsiCo’s growth over the last decade has been below investor expectations. The company has grown earnings-per-share at just 4.7% a year over the last decade.
I expect growth to pick up at PepsiCo over the next decade. The company should be able to compound earnings-per-share at 5.5% to 9% a year from the following sources:
- Share repurchases of 1.5% a year
- Margin expansion of 1.5% to 3% a year
- Revenue growth of 2.5% to 4.5% a year
Revenue growth for PepsiCo will come from a mix of increased international expansion and bolt-on acquisitions. The company spends around $4 billion a year on advertising. This advertising budget allows PepsiCo to quickly scale new, existing, or acquired brands.
In addition, investors will benefit from the company’s current 3% dividend yield. The company’s dividend yield combined with its expected earnings-per-share growth rate gives investors expected total returns of 8.3% to 11.8% a year.
The preferred method of dealing with stock price volatility is to understand that stock price fluctuations do not change your dividend income or your fractional percentage of ownership in a business. They are merely ‘noise’ on your dividend growth journey.
With that said, investing in high quality, low volatility dividend growth stocks makes stock price moves less severe. This can make ‘staying the course’ easier for dividend growth investors. The 3 businesses in this article are among the highest quality around. All 3 offer above average dividend yields and will very likely continue increasing their dividends far into the future, while providing a ‘smoother ride’ thanks to their low stock price volatility.