I usually run a screen using my entry criteria over the list of dividend champions regularly. I do this in order to find attractively companies for further research, which could then be added to my portfolio. I ran the screen a few weeks ago for the dividend champions list, which identified approximately fourteen companies for further research. One reader asked me why I hadn’t included Altria (MO) in the list. Check my latest analysis of Altria for more information about the company.
This was a very good question. So good, I decided to write a short post about it.
If you look at a place like Yahoo Finance, or Google Finance, you can see that Altria has a P/E ratio of 11. So this means that this amazing company is cheap, doesn’t it?
Michael Mauboussin Tips From Great Investors [Pt.2]
This is the second part of a short series on Michael J. Mauboussin's research document reflecting on 30 years of Wall Street analysis published in 2016. Q3 2020 hedge fund letters, conferences and more The document outlined Mauboussin's observations of successful investors throughout his three decades on the Street. This article starts at point six. Read More
Well, not so fast. As part of our evaluation of company fundamentals, we review trends in earnings per share, dividends per share, revenues and payout ratios over the past decade. A quick review of the ten year trends in earnings per share shows a bump in 2016. The curious dividend investor would then search for the driver behind the discrepancy.
I went to the Altria’s Investor Relations website, and looked for the quarterly financial press releases. I then obtained the financial press release for the fourth quarter of 2016. I then dug in it, and found the following reconciliation:
We see a one time item for $4.61/share, and total EPS of $3.03/share. This item was driven by the acquisition of SAB Miller by Anheuser-Busch Inbev. Altria had a 27% interest in SAB Miller, which was converted into shares of Anehuser-Busch Inbev, and $4.8 billion dollars in cash. In addition, the company bought some more shares in the latter company, boosting its stake in AB InBev to approximately 10.2%.
The one-time gain was driven by accounting rules where the company recognized the difference between the current share price and cost/book value as a pre-tax gain. In addition, the company had to record a gain on put options against the British pound that it entered into, in order to hedge the expected cash proceeds from the completion of SAB Miller’s acquisition by Anheuser-Busch Inbev. The gain would not be taxable when stock is exchanged for stock, until Altria sells the shares of Anheuser-Busch Inbev it already owns. Altria Group, Inc.’s gain on the Transaction is deferred for United States corporate income tax purposes, except to the extent of the cash consideration received.
If you would like to read in more detail about this transaction, please refer to Note 7 on page 50 of the latest Annual Report for Altria (MO). The company explained it much better than I could:
If we remove the one-time item, the total earnings are $3.03/share. Using those earnings, the P/E on Altria turns out to be 23.90, which is high.
Unfortunately, most dividend paying companies I follow have had a ton of one-time events that have depressed their earnings. It has gotten incredibly tedious to use screens that focus on earnings, since those one-time items could either make earnings worse than they really are or they could make earnings look even better than they should be. Using earnings which are too high or too low also distorts dividend payout ratios as well. It is a double whammy.
One of my favorite shortcuts to use to get around that quickly, is this years expected earnings per share. By using the estimated earnings for this year, in conjunction with the prior year earnings per share, I have a better gauge to quickly go through the one hundred members of the dividend champions index. In Altria’s case, the expectations are that it would earn $3.29/share in 2017. Using the prices shown above, this translates into a P/E multiple of 22 times forward earnings. This is still high in my book. I would be interested on dips below 20 times earnings. If you use past year’s results, you should patiently wait for dips below $60/share. If you choose to use the forward earnings estimates however, you ca patiently wait for dips below $66/share. As I have mentioned before, dividend investing (and all investing in general) is part art, part science. The subtlety of investing analysis makes this field so fascinating to me.
The forward earnings estimates are not without any faults on their own either however. Analysts are always too optimistic when it comes to forward earnings. They frequently show an increase in earnings per share over the next year or two, and have a horrible track record of earnings growth. That being said, you need to be skeptical about estimates. However, I still think that these near term estimates are decent gauges to use in screening one hundred companies at once, since they already discount the effect of one-time events. As an investor, you will get to the fun research part once you have narrowed the list of dividend champions to a more manageable one, and then review companies one at a time for a possible inclusion in your dividend portfolio.
This sort of curiosity has previously helped us snag Johnson & Johnson (JNJ) at a time when everyone thought it was overvalued. We have also shared examples of one-time events affecting valuation by looking at Abbott Labs (ABT), as well as with AT&T (T) and Coca-Cola (KO) a few years ago.
That being said, I am still holding on to my Altria stock, and will continue doing so for years to come as long as the dividend is at least maintained. However, I would not be adding more to my position at this time, given the fact that shares are overvalued. However, I do like the fact that this company has managed to surpass the negative expectations associated with its product, and has managed to grow earnings, dividends and intrinsic values over time. I expect this trend to continue for the foreseeable future.
Full Disclosure: Long MO, JNJ, KO, ABT