Reports of the Best Dividend Stocks

This category contains listings of the most recently published stock analysis reports.

For the full list, see the alphabetical listing of stock reports.

Cummins

Summary

It’s key advantage is CMI’s expertise in the design of lower emission generating engines.
CMI is working with its clients to meet new regulation requirements from the Environmental Protection Agency.
CMI’s ability to protect its know-how in designing more eco-friendly engines will open doors to markets such as India and China.

DSR Quick Stats

Sector: industrials
5 Year Revenue Growth: 7.64%
5 Year EPS Growth: 18.13%
5 Year Dividend Growth: 32.03%
Current Dividend Yield: 3.43%

What Makes Cummins (CMI) a Good Business?

Cummins Inc., a global power leader, is a corporation of complementary business units that design, manufacture, distribute and service diesel and natural gas engines and related technologies, including fuel systems, controls, air handling, filtration, emission solutions and electrical power generation systems.

The company is divided into 4 business segments:
CMI business segmentsSource: author’s table, data from Cummins financial reports

Cummins’ business model is closely related to the transportation, mining and infrastructure industries as 42% of its sales come from its engine division. The demand for heavy-duty and medium-duty trucks/bus engines are the two biggest sectors of this division with $631M in sales (-17%) and $549M (-10%) respectively during their latest quarter.

The company has a long time expertise in building efficient engines with low emissions. As environmental regulations increase each year, we can see a strong economic moat for Cummings.

Ratios

Price to Earnings: 15.06
Price to Free Cash Flow: 14.09
Price to Book: 2.2798
Return on Equity: 17.71%

Revenue

CMI revenueRevenue Graph from Ycharts

The demand for engines in North America and Brazil has been lower than in previous years and this is mainly why Cummins shows a decrease in its revenue in 2016. Management expects revenue to drop by 5 to 9% yoy for 2016.

How CMI fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.
CMISource: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.
CMI div paid yieldSource: data from Ycharts.

As you can see, CMI dividend yield has been low historically. Besides the 2008 crisis, the company used to pay a yield between 1% and 2% for most of the decade. The stock yield has recently increased due to a very steep dividend growth increase rate and a recent drop in the stock price.

Most industrials have the bad habit of following cyclical trends. The good news is when you didn’t buy it yet, it opens great opportunities for new investors. Entering a position in CMI at 3.43% dividend yield seems like a good deal so far.
CMI meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

CMI has been more than generous with its shareholders over the past 5 years. In fact, the company shows a dividend growth rate of 32.03% CAGR. It has successfully increased its dividend for the past 6 years in a row after taking a small pause of 1 year in 2009 following the latest recession. With their recent strong dividend increase, management has made a solid statement that dividend growth was a priority for them too. CMI meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company.As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.
CMI payout ratioSource: data from Ycharts.

While the company has been increasing their dividend aggressively over the past 5 years, you can see that this wasn’t an operation to simply look good. Management was able to maintain both the payout ratio and cash payout ratio under 50% until recently. It would be unrealistic to expect a double digit dividend growth rate forever. The company has simply positioned itself in the dividend basket to attract more investors. Further on, we can expect a slower but solid dividend growth rate. CMI meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

Cummins sells consumable products with a strong brand name. The best part is that there is an important evolution in most of its products. The company is the largest manufacturer of natural gas and hybrid bus engines in the USA. As environmental regulations move forward, we will see an increase in the demand for such products. Being a leader in a changing industry is a very good thing only if you can put the money in R&D to make sure you follow the trend.

What Cummins does with its cash?
The company increased its operating cash flow from $173M to $263M for their first quarter of the year. This improvement was due to lower working capital required. As previously mentioned, management has been quite generous with its shareholders and a good part of CMI cash flow went into dividend payments.

Besides paying back its shareholders, CMI has also used a lot of money to improve its products and remain the leader in low emission engines. This is how they will remain on the top of their game and gain additional market share in the future.
CMI has a strong business model and meets my 4th investment principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is some evaluation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:
CMI PE ratioSource: data from Ycharts.

As is the case with most industrials, CMI is demonstrates a cyclical PE ratio depending on which environment it evolves. The company recently saw its PE going up as earnings dropped faster than its price due to slower demand. Nonetheless, I don’t think that such a strong company is overvalued at a 15 PE ratio.

I’ve also used the dividend discount model to give a more precise value to CMI with a dividend growth investor perspective. As I’ve mentioned before, I don’t expect CMI to keep up its double digit dividend growth policy. This is why I’ve used an 8% growth rate for the first 10 years and dropped it to 6% for the years after. Since the company is evolving in a cyclical industry and is dependent on other cyclical industries such as mining, I’m using a 10% discount rate.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $3.92
Enter Expected Dividend Growth Rate Years 1-10: 8.00%
Enter Expected Terminal Dividend Growth Rate: 6.00%
Enter Discount Rate: 10.00%

Here’s what the calculation give me:

CMI intrinsic value

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

As the stock is currently trading around $113, we have a small discount as its intrinsic value should be more around $121. Considering both analysis, CMI meets my 5th investing principle.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company are no longer valid, I sell and never look back.

Investment thesis
An investment in CMI is based on its ability to protect its know-how in designing more eco-friendly engines. New markets are slowly but surely opening to Cummins due to this specific expertise. Europe in the upcoming years and later China & India will also improve their environmental rules with regards to emissions. They will then open the doors to companies such as Cummins to benefit from their expertise. CMI has already created partnerships with important clients such as TATA in India.

It is very difficult for its competitors to catch up on 10 years of massive R&D investments to develop such technology. This is how Cummins should keep its competitive advantage for a while. An investment in CMI right now, is also an investment in a lowered valued stock paying a healthy dividend around 3.50%.

Risks
Nothing is perfect for Cummins and it will face additional competition in the future. One of its largest clients, Paccar started to sell its own engine in North America. This has obviously slowed down CMI’s growth potential in the US while also hurting its margins.

The company also might have to make partnerships with Chinese companies to conquer this market. While this is very positive for the future growth of the company, CMI might also put at risk its best asset: intellectual property. They will have to remain very cautious about their offshore partnerships.

Overall, there is more goods than bad and CMI meets my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segments helps me to categorize my investments into a “conservative” or “core” section or into a “growth” section. I then know exactly what to expect from it; a steady dividend payment or higher fluctuations with a greater growth potential.

Cummins is clearly a good holding for a core portfolio. They will continue to pay a steady and increasing dividend but the stock growth is limited. While I would not buy CMI as my first stock for a portfolio, Cummins offer a great addition for a stable conservative portfolio. CMI is a core holding.

Final Thoughts on CMI– Buy, Hold or Sell?

Considering the very few opportunities in the current market, I think CMI could be a good addition for any dividend growth investors. Don’t expect to see the stock skyrocket in the upcoming year, but you can rest assured to receive an increasing dividend payment. I’m not overly confident in the company’s growth perspective, but I would gladly give them a moderate buy rating. What do you think?

Disclaimer: I do not hold CMI in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Aflac – Steady As She Goes

 

Summary:

  • Aflac revenues have suffered from the strong US currency over the past 3 years. Now that the biggest part of the USD impact is behind us, AFL might post some interesting numbers.
  • Aflac benefits from a strong core business in Japan, but sales growth won’t be astonishing in the upcoming years due to low interest yield in that country.
  • Aflac shows all the characteristics of a strong core dividend growth portfolio holding. However, it looks overvalued.

DSR Quick Stats

  • Sector: Financial (Financial Services)
  • 5 Year Revenue Growth: 0.13%
  • 5 Year EPS Growth: 3.51%
  • 5 Year Dividend Growth: 6.75%
  • Current Dividend Yield: 2.67%

What Makes Aflac (AFL) a Good Business?

AFLAC Incorporated (NYSE: AFL) is a large international supplemental insurer. They provide cash that can cover several types of expenses to those receiving payouts due to illness or death. This is supplementary to primary medical insurance which helps cover medical expenses but leaves other expenses without a solution. This Fortune 500 company was founded in 1955, and has a large presence in Japan and the US. AFLAC stands for the American Family Life Assurance Company.

The company made a big move in Japan in the 1970s by selling insurance against the risk of cancer when people were becoming particularly mindful of cancer. Decades later, approximately three-quarters of Aflac’s diverse premiums now come from Japan.

Aflac primarily targets places of employment for its insurance products, rather than individuals outside of work. The company offers plans to employers that allow them to provide Aflac insurance as part of their benefits package to employees without paying any cost themselves.

The premise behind an insurance company is that they spread risk out over a wide number of people and businesses. They collect premiums (payments) from clients and in return those clients are covered in case of serious loss. From an insurance business standpoint, it’s ideal to collect more in premiums than you pay out for losses. This is not the primary form of earnings, though. An insurance business, after collecting all of the premiums, hold a great deal of assets that, over time, are paid out for client losses. An insurance company constantly receives premiums and pays out for losses, so as long as they are prudent with their business, they get to constantly keep this large sum of stored-up assets. As any investor reading this knows, a great sum of money can be used to generate income from investments, and that’s how an insurance company really makes money. Aflac invests its collected of assets primarily in fixed income securities to receive upwards of $3.4 billion in annual investment income.

Ratios

Price to Earnings: 10.21
Price to Free Cash Flow: 3.7
Price to Book: 1.418
Return on Equity: 14.24%

Revenue

afl1

Revenue Graph from Ycharts

It is no surprise that revenues are down since 2013. The company makes 75% of its revenue in Japan. The USD/YEN has just been terrible for Aflac:

afl2

Source: ycharts

We can expect a lower currency impact moving forward.

How AFL fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

afl3

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly comes with dividend growth and this is what I am seeking most.

afl4

Source: data from Ycharts.

Aflac has kept a dividend yield between 2.50% and 3.50% since the financial crisis. At the same time, the dividend payment has never stopped increasing. This is a very good sign to see a company showing a relatively stable yield with a strong trend of payment increases. There are no signs the dividend payment is at risk for now.

AFL meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Aflac is part of the selective group of dividend aristocrats. These companies have successfully increased their dividend for at least 25 consecutive years. AFL is now showing 33 years of consecutive dividend increases. Over the past 5 years, the company has increased its payout by 6.75% CAGR making its dividend payment double every 10 years on average.

AFL meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

afl5

Source: data from Ycharts.

With a loyal client base, this company is an impressive cash flow machine. You can see how the company is keeping a very low payout ratio, but an even lower cash payout ratio. The dividend payment is set for continuous growth for many years. It’s not by chance that AFL became a dividend aristocrat. The management team is very cautious with its cash flow and makes sure the dividend growth will continue.

AFL meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

Aflac has a notable business model. Rather than targeting individuals, Aflac insurance agents target businesses. Aflac works with employers to give employees the option to purchase Aflac Insurance via payroll deductions, similar to their other benefits. This “cluster-selling” technique keeps costs comparatively low, and gives the company a major competitive price advantage. It creates a win-win situation with employers it does business with.

By focusing on supplemental insurance for illnesses such as cancer, the company has hit an ever growing niche for now. The company enjoys strong cash flow coming from Japan as it enjoys a great brand recognition. This should help the company to increase its presence in the USA in the upcoming years. Growing in the States will ultimately hurt its margin, but the company need to find another growth driver.

In my opinion, Aflac doesn’t own the strongest business model. Other competitors could hit AFL on the cancer insurance playground to slow the company down. Because of its expertise in its niche, AFL currently meets my 4th investing principle but it needs to be on the watch list.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings put aside. There is valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

afl6

Source: data from Ycharts.

As you can see, there used to be a hype around AFL a few years ago in terms of stock valuation. The market used to pay a higher multiplier (up to 19 at its peak) over the past 10 years. After 2012, this is another story as the USD currency gained strength and hurt AFL revenues over the past 3 years. The stock price looks cheap overall if we compared to its multiple prior to 2008. However, this doesn’t tell me much about its current and future value. This is why I’m also using a double stage dividend discount model:

 

 

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.64
Enter Expected Dividend Growth Rate Years 1-10: 6.75%
Enter Expected Terminal Dividend Growth Rate: 5.00%
Enter Discount Rate: 9.00%

 

Since the company evolves in a very stable environment, I use a 9% discount rate. I’ve selected a 6.75% growth rate for the next 10 years which is a similar rate to what the company showed in the past 5 years. However, I reduced it to 5% afterward to keep a conservative valuation.

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
  Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $79.78 $59.51 $47.37
10% Premium $73.13 $54.55 $43.42
Intrinsic Value $66.48 $49.59 $39.47
10% Discount $59.84 $44.63 $35.53
20% Discount $53.19 $39.68 $31.58

 

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

Unfortunately, the company stock appears to be overvalued by 20% at the moment. I would need to increase my dividend growth rate after 10 years from 5 to 6% in order to have a fair value. If the company shows a stronger dividend growth potential, then it seems to be at best fairly valued.

AFL doesn’t meet my 5th investing principle.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found one of the biggest investor struggles is to know when to buy and when to sell their holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchased shares of a company  are not valid anymore, I sell and never look back.

Investment thesis

Aflac works in a very interesting niche. A while ago, AFL specialized in supplemental policies for specific diseases and illnesses. Since it was a side product for many insurers, Aflac was able to developed an expertise and grow this business under the radar of many. Today, the company benefits from cheaper pricing and strong underwriting margins since they know their markets and are able to assess their risk better than any other companies in this specific niche.

Second, Aflac’s main core business comes from Japan. This country generates 75% of its revenue. What is interesting is that 95% of Japanese keep their policy and the average “client’s life” with Aflac products is 20 years. This means a lots of premiums paid each month! More recently, Aflac was able to enter into banks and post offices to sell their products, two places where the Japanese are used to purchasing such products. This should help support their sales in the upcoming years.

Risks

The deregulation in Japan that enabled AFL to enter banks and post offices doesn’t only bring sweet candies. There is a sour taste to it. In fact, this deregulation also enabled other insurance companies to compete directly with Aflac on its own ground. While the company has built a strong expertise in its niche, it won’t be long before other businesses will do the same.

While the company is pretty strong in Japan, it is another story in the US. It is harder for AFL to keeps its client (75% of Americans tend to switch policies at one point in time). This leads to inevitable margin reduction.

Aflac has a sound business model and meets my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segments helps me to categorize my investments into a “conservative” or “core” section or into a “growth” section. I then know exactly what to expect from it; a steady dividend payment or greater fluctuations with an improved growth potential.

Aflac is a dividend aristocrat evolving in a relatively conventional market.  I believe the company will be able to grow its revenues and earnings but will definitely not explode at one point in time. This why I believe AFL should be part of a core portfolio.

Final Thoughts on AFL – Buy, Hold or Sell?

Overall, I think a purchase of AFL is a purchase of a solid and increasing dividend. However, do not expect anything else from AFL for the upcoming years. In comparison, the stock price rose 10% over the past 5 years while the S&P 500 rose 52%.

Then again, AFL is a very strong core portfolio holding showing clockwork dividend increase potential. I think that at this point, AFL is a hold.

Disclaimer: I hold AFL in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Procter & Gamble – Don’t Get Fooled by the High PE Ratio; This Company Has Potential

 

Summary:

PG’s brand cutting plan will start to pay off in 2016 with stronger earnings.

The brand portfolio and distribution network improvements show better than expected results so far.

The recent stock price drop brings the yield to 3.50% and makes the company very interesting to buy.

DSR Quick Stats

Sector: Consumer Defensive

5 Year Revenue Growth: -0.68%

5 Year EPS Growth: -2.82%

5 Year Dividend Growth: 7.56%

Current Dividend Yield: 3.51%

What Makes Procter & Gamble (PG) a Good Business?

Procter & Gamble (NYSE:PG) is one of the largest and best-known companies in the world. It operates in over 180 countries, and the company has divided its widely-diversified operations into 5 divisions:

PG1

 

(Source: PG Investor Relations)

pg2

The company had made the decision to cut its brand portfolio and “reshuffle” its product categories for a better focus. They now have 10 products categories (baby, feminine, family, fabric, home, hair, skin & personal care, grooming,  oral and personal health care) that include 65 brands.

Since the global economy is slowing down and the USD is strengthening every day, the company has focused heavily on improving its productivity over the past three years. This focus will result in $7 billion saved between 2012 and 2016 (expected) (source: PG investor presentation). They have made important efforts to simplify their distribution channels as they show in their presentation:

pg3

Ratios

Price to Earnings: 29.16
Price to Free Cash Flow: 18.45
Price to Book: 3.332
Return on Equity: 12.25%

Revenue

pg4

Revenue Graph from Ycharts

Changing major brand management is being done without hurting results. The company shows lower revenue volumes over the past three years for two good reasons: #1) PG is exiting underperforming brands. While this has a positive effect on profitability, the gross sales numbers are down. #2) the company makes 41% of their sales in North America, the rest of their sales are in foreign currencies. The currency impact on the September 30th closing quarter was -9% and ***** on December 31st closing quarter.

How PG fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

pg5

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investor rule: I try to avoid most companies with a dividend yield over 5%. Very few investments will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly ever comes with dividend growth and this is why I am seeking most.

pg6

Source: data from Ycharts.

Procter & Gamble’s dividend yield has always been under the 5% bar where I define the line to consider a “high dividend yield stock”. In fact, the company has been paying a healthy 3%-3.5% yield since 2009. When you combine the dividend growth year after year, you notice the company is able to maintain the same yield. This shows that the stock price is also increasing. PG meets my first principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It doesn’t only prove management’s trust in the company’s future but it is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?
pg7

source Ycharts

When you think of a dividend growth stock, PG should be at the top of your list. The company has been paying a dividend for the past 125 years and successfully increased its payment for 59 consecutive years. The company has been increasing its dividend with a CAGR of 7.5% of the past 5 years leading to a dividend payment doubling every 10 years or so.

It is very rare to see such a “perfect dividend stairway”. The dividend is being increased like clockwork for decades now. PG definitely meets my second principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

pg8

Source: data from Ycharts.

As previously mentioned, the company has gone through major restructuring in both its distribution channels and product offerings. This had affected its earnings (hence the payout ratio) but not its cash flow by much. This is the reason why I find interesting to cross reference both data. The cash dividend payout ratio is  more than reasonable at 66%.

PG started to see its productivity efforts paying off in 2015 and it should continue into 2016. The company expects its EPS rising back to original post productivity plan levels in 2016 as the batteries & transitioning beauty businesses is being accounted for as discontinued operations.  Therefore, we should see the payout ratio going back to a more acceptable level. PG’s dividend growth is not at risk and it will continue to pursue its path to a 60th consecutive increase. PG meets my third principle.

Principle #4: The Business Model Ensure Future Growth

PG sells consumable products all over the world. Its brand portfolio is more diversified than most mutual funds. With 65 brands and sales in 180 countries, PG owns and masters its economic moat. The short term future comes with its load of uncertainties and challenges.

About 38% of PG’s revenues are coming from developed markets. The global economic slowdown will definitely affect this important revenue segment (in addition to the currency impact). Growth perspectives for 2016 are very limited, but the business is currently working on its profitability during this tough period. The mid term perspectives seem promising as the company will be in a very good position to tap any economic rebound with an enhanced distribution network and a better managed brand portfolio.

What Procter & Gamble does with its cash?

pg9

The company’s main focus is to remain a shareholder friendly company. PG intends to buyback shares with 8 to 9 billion dollars and to distribute 7 billion in dividends for 2016. Overall, they expect to return between 15 – 16 billion to shareholders in the upcoming year.

Their focus on cash flow and productivity make such numbers possible. This also shows management’s great confidence in the company’s cash flow generating ability. PG has a solid business model that is designed to generate cash flow month after month ensuring a great stability for dividend payments. PG meets my fourth principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings put aside. There is valuation work to be done. In order to achieve this task, I will start by looking at how the stock market has valued the stock over the past 10 years by looking at its PE ratio:

pg10

Source: data from Ycharts.

I can appreciate the fact that the EPS dropped drastically over the past 2 years considering the business reductions. However, a PE ratio over 22 always seem a high price to pay, even for a top notch dividend grower. It seems here that the company is on the radar of too many income seeking investors and this is why its valuation is going up. I will need to dig deeper to see if the company shows some value at this price…

Using a second method, I will use a double stage dividend discount model. I will use a 9% discount rate as the company shows a very stable and strong business model. As far as dividend growth goes, I will use a 5% for the first 10 years and then 6% afterwards. The reason why I don’t use the past 5 years CAGR of 7.5% is that I believe harsher economic conditions will lead management to be more cautious about their dividend policy. Over time, the modifications they have made will improve the earnings and I think the company can maintain a 6% dividend growth in the future.

 

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $153.90 $102.96 $77.47
10% Premium $141.08 $94.38 $71.01
Intrinsic Value $128.25 $85.80 $64.56
10% Discount $115.43 $77.22 $58.10
20% Discount $102.60 $68.64 $51.65

 

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

As you can see, the company is currently undervalued by about $10. This is quite interesting even though the PE ratio seems pricy, if you consider the company for what is it; a dividend cash generator, there is still room for the stock to grow. At a 3.5% yield, the company almost looks like a bargain! PG meets my fifth principle.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found one of the biggest investor’s struggles is to know when to buy and when to sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms, or not, my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company  are not valid anymore, I sell and never look back.

Investment thesis

I think that PG should be at the center of any core dividend growth portfolio. This company shows a perfect combination of diversification and dividend growth potential. This is not an exciting stock, but it is a company that will generate ever increasing distributions in your portfolio.

Out of its 65 brands, 23 generate over $1 billion in sales per year and 14 generate between $500 million and $1 billion in sales. Owning shares of PG is definitely like owning 65 companies at the same time. This is a perfect match for any smaller portfolio you wish to start without taking on too much volatility.

The current stock drop of 16% over the past 12 months and the yield at 3.50% makes it very appealing. The PE ratio is a small concern as this number will greatly drop once 2016 numbers will show the “new lean and improved” business.

Risks

Thinking that PG is a perfect company is being naive. There are still some concerns around the company’s business. For the long haul, it will be a great challenge to show sales growth over 3%. There is a limit to the shampoo, razors and diapers one household can buy throughout the year. Therefore, once all markets are well penetrated, there is little room for more growth.

The other factor to consider is local competition. In many developing markets, we see the arrival of local competitors that makes PG’s life harder to sell and margins smaller at the same time. This is far from being a threat to the business model, but it may be harder to repeat the past 10-15 years of growing revenues while all consumer companies were developing emerging markets.

PG definitely shows a strong investment thesis and meet my sixth investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segment helps me to categorize my investments into a “conservative” or “core” section or into the “growth” section. I then know exactly what to expect from it; a steady dividend payment or greater fluctuations with a higher growth potential.

Procter & Gamble is definitely not part of any growth segment (besides the “dividend one”!). I don’t see how the company could crank up its revenues and earnings by double digits for several years in a row. but this doesn’t make it a bad investment. In fact, PG is a perfect candidate for a core dividend growth portfolio. You will earn steady and increasing dividend payments while the company as a whole will remain relatively stable. Short term price slump creates buying opportunities and I believe we are currently in one.

Final Thoughts on PG – Buy, Hold or Sell?

Overall, PG will always remain on the best dividend growth stock list of many investors and there are many reasons why. First, their stellar dividend payment history make a point of buying this company by itself. The impressive brand portfolio and its wide diversification (products and geography wise) makes it a very stable company through time. Most of their products have and will always be bought by households and the company has the ability and the will to follow and initiate any innovations. PG is a buy.

Disclaimer: I hold PG in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.