This is a guest post by Ben Reynolds. Ben runs Sure Dividend which helps individual investors build a portfolio of dividend stocks with strong competitive advantages trading at fair or better prices.
The US Dividend Aristocrats Index is comprised of 51 businesses with 25+ years of consecutive dividend increases. The index is a mini ‘who’s who’ list of high-quality businesses.
For a company to pay increasing dividends for 25+ consecutive years it must have a strong competitive advantage. It should come as no surprise that the high quality blue chip stocks in the Dividend Aristocrats Index have outperformed the market by over 2 percentage points a year over the last decade.
Source: S&P 500 Dividend Aristocrats Fact Sheet
The 5 Dividend Aristocrats analyzed in this article are very dissimilar to one another. They operate in different industries and have different characteristics. Together, these 5 Dividend Aristocrats can form the core of a high-quality dividend income portfolio.
‘Cover Your Bases’ Dividend Aristocrat #1: ExxonMobil
ExxonMobil (XOM) is the largest oil corporation in the world. The company has paid increasing dividends for 33 consecutive years, and uninterrupted dividends since 1911.
The company is well diversified within the oil and gas industry. ExxonMobil operates in 3 segments: Upstream, Downstream, and Chemical. The company’s earnings by segment in its most recent quarter are shown below:
- Downstream earnings of $2.03 billion
- Upstream earnings of $1.36 billion
- Chemical earnings of $1.23 billion
Collapsing oil prices have reduced ExxonMobil’s share price, and caused its dividend yield to rise. ExxonMobil stock currently has a high 3.46% dividend yield. The company is trading for dividend yield highs not seen since the mid 1990’s, as the image below shows.
Source: Dividend Aristocrats In Focus Part 31: ExxonMobil
Going forward, I expect ExxonMobil to generate total returns of around 9% and 13% a year for shareholders before valuation gains when oil prices rise. Total returns will come from the following sources:
- Dividend yield of ~3.5%
- Share repurchases of ~3.0% a year
- Organic growth of 1.0% to 3.0% a year
- Margin improvements of 1.0% to 3.0% a year
Improving technology and a focus on cost controls will help ExxonMobil to increase margins over the long run. The company has averaged share repurchases of around 3% a year over the last 15 years – this trend should continue (once oil prices recover).
Energy demand is expected to increase by around 1.0% a year over the next several decades. ExxonMobil should at least capture this overall growth and has the potential to gain market share as well.
‘Cover Your Bases’ Dividend Aristocrat #2: Procter & Gamble
Procter & Gamble (PG) was founded in 1837. The company has paid increasing dividends for an amazing 59 consecutive years.
Procter & Gamble is a well-diversified consumer goods corporation. The image below breaks down Procter & Gamble’s key brands by category. In total, the company has 21 brands that generate over $1 billion a year in sales.
Source: Procter & Gamble 2015 Shareholder Meeting Presentation, slide 19
Procter & Gamble’s competitive advantage comes from its massive advertising budget and brand strength. The company spends between $8 billion and $9 billion every year on advertising. Very few companies in the world can match this level of advertising spending. All that ad spend buys awareness in potential customer’s minds and builds well-recognized brands.
Going forward, I expect Procter & Gamble (PG) to generate total returns of 10.5% to 12.5% a year, from the following sources:
- Sales growth of 3% to 4% a year
- Share repurchases of ~2% a year
- Margin improvements of 2% to 3% a year
- Dividends of ~3.5% (yield is currently at 3.2%)
The company’s sales growth will come through global advertising and increased brand awareness. Procter & Gamble recently divested a great deal of its non-core brands. This will spur growth by allowing the company to focus on its best-performing brands.
The divestitures – combined with cost-cutting and efficiency programs – will also help Procter & Gamble to improve margins over the next several years.
In addition, the company is very shareholder friendly. Procter & Gamble currently has a 3.2% dividend yield and has historically repurchased around 2% of shares outstanding a year.
The company is currently trading for an adjusted price-to-earnings ratio of 20.1, which is likely fair value for a high-quality company with a strong competitive advantage and favorable total return prospects.
‘Cover Your Bases’ Dividend Aristocrat #3: Abbott Laboratories
Abbott Laboratories (ABT) was also founded in the 1800’s – 1888 to be exact. The company has paid increasing dividends for 43 consecutive years.
The company operates in 4 segments. Each segment is shown below along with the percentage of total revenue generated for Abbott Laboratories during the first 9 months of fiscal 2015:
- Nutrition generated 34% of total revenue
- Medical Devices generated 25% of total revenue
- Diagnostics generated 23% of total revenue
- Established Pharmaceuticals generated 19% of total revenue
Well-known brands of the company include: Ensure, Pedialyte, Similac, Zone Perfect, and Elecare.
Abbott Laboratories stands to benefit from 2 long-term trends: faster growth in emerging markets, and an aging global population.
The company generates 50% of its revenue in emerging markets and another 20% in developed international markets. The company is truly global.
The image below from the United Nation’s World Aging Report shows the massive growth in the 60+ global population through time:
These two trends give Abbott Laboratories an expected earnings-per-share growth rate of around 10% a year. In addition, the company’s stock currently has a 2.51% dividend yield. This gives shareholders of Abbott Laboratories an expected total return of around 12% a year.
Abbott Laboratories stock currently trades for an adjusted price-to-earnings ratio of 19.8. Abbott Laboratories is liking trading around fair value for a high-quality shareholder friendly business with double-digit total return potential.
‘Cover Your Bases’ Dividend Aristocrat #4: AT&T
AT&T (T) is North America’s largest telecommunications company based on its $200+ billion market cap. AT&T has paid increasing dividends for 31 consecutive years. Investors looking for yield should also be enticed by the company’s current 4.87% dividend yield.
The United States wireless telecommunications market is dominated by 4 companies. AT&T, Verizon, Sprint, and T-Mobile have greater than 90% market share. AT&T and Verizon each have over 30% market share.
Competition is reduced when an industry is dominated by only a few large businesses. Lower competition is not good for consumers but great for the few dominant businesses. AT&T and Verizon, in particular, are large enough to reap the lion’s share of profits in the telecommunications industry.
AT&T’s subscription-based revenue model in the wireless telecommunications industry gives the company great earnings stability. AT&T is more similar to high yield utility than the other stocks in this article. AT&T will likely not grow its earnings-per-share rapidly, but the company’s above-average dividend yield gives investors current income.
Additionally, AT&T scores high marks for safety as it has a low stock price standard deviation and predictable earnings.
AT&T stock is trading at a forward price-to-earnings ratio of 13. The company appears to be somewhat undervalued at current prices given its shareholder-friendly management and oligopolistic market position.
‘Cover Your Bases’ Dividend Aristocrat #5: Aflac
Aflac (AFL) is the global leader in cancer insurance. The company sells supplemental life, health, and accident insurance.
Aflac generates about 75% of its premium revenue in Japan. The remaining 25% of premium revenue comes from the United States.
The insurance industry is particularly favorable for long-term investors. Insurance has not changed too much since Lloyd’s of London began selling marine insurance in the 17th century. This lack of change means leading companies can maintain their positions for very long periods of time.
In addition to this stability, the insurance industry also creates negative costs of capital. The negative cost of the capital aspect of insurance is not often discussed. Here’s how it works:
- The best insurers (like Aflac) make a profit on their insurance policies. They collect more in premium revenue than they pay in administration and benefits.
- Premium money that has yet to be paid out for claims is invested. This is called float.
- When you can acquire funds to invest for free or get paid to acquire those funds (like the better insurers do), you are effectively being given a negative interest rate loan that you can use to invest. In other words, you get a negative cost of capital.
Aflac’s stable business model has allowed it to pay increasing dividends for 33 consecutive years. I expect the company to compound earnings-per-share at 5% to 10% a year over the long-run from a mix of organic growth and share repurchases. In addition, Aflac has a dividend yield of 2.6%. The company’s yield combined with its expected earnings-per-share growth rate gives Aflac investors expected total returns of 7.7% to 12.7% year.
The company is currently trading for a price-to-earnings ratio of just 10.7. Aflac appears to be undervalued at current prices given its above-average expected total returns and longevity in the slow-changing insurance industry.
The 5 companies examined above all have long streaks of consecutive dividend increases. They all operate in very different industries, which provides diversification for investors.
- ExxonMobil: Oil and gas
- Procter & Gamble: Consumer goods
- Abbott Laboratories: Healthcare
- AT&T: Telecommunications
- Aflac: Supplemental health insurance
In addition, all 5 are trading at fair or better prices and offer long-term investors strong total return potential.
DISCLOSURE: Please note that I may have a position in one or many of the holdings listed. For a complete list of my holdings, please see my Dividend Portfolio.
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