Reports of the Best Dividend Stocks

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

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American Water Works; I’m Raising My Glass to its Growth

Summary

  • American Water Works operates a small monopoly and sells essential products.
  • The water treatment business is highly fragmented.
  • There are lots of room for dividend growth in the upcoming years.

What Makes American Water Works (AWK) a Good Business?

American Water Works sell the perfect product: water. This utility company provides regulated and market-based drinking water, wastewater services and other related services to an estimated 15 million people in 47 states and in Ontario, Canada. The best part of it, AWK still has lots of room for growth as its market is highly fragmented in the U.S.:

Source: AWK website

Revenue & Earnings

Revenue Graph from Y-charts

The company is on solid ground to keep up its growth in the upcoming years. Management aims at a 7-10% annualized EPS growth based on regular investments, regulated acquisitions and organic growth.

Source: Ycharts

How AWK 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.

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.

Source: data from Ycharts.

AWK was once a high yielding stocks but that was right after following the financial crisis. Ever since then, the company has increased its dividend payouts while its yield went ever lower. This is mainly due to the fact that AWK stock price went up by over 125% over the past 5 years (as at October 10th 2017).

AWK meets my 1st investing principles.

Principle#2: Focus on Dividend Growth

Speaking of which, 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?

Source: Ycharts

American Water Works has successfully increased its dividend payments for the pat 8 years. It is only missing 2 more years to become a Dividend Achiever. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

While the company ran into some problems back in the 2000’s the business now seems under control.

AWK 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.

Source: data from Ycharts.

While I respect management commitment to keep its payout ratio between 50% and 60%, its cash payout ratio is all over the place. You would think that a water company would be a strong cash flow business. Unfortunately, AWK has to invest massively in its water pipe network to improve its quality. Such significant CAPEX hurt the business cash flow.

AWK meets my 3rd investing principle… but it is still under watch

Principle #4: The Business Model Ensure Future Growth

AWK business model is quite simple: people need to drink water to live. This situation is not likely to change in the future. The water industry in the U.S. is highly fragmented with many cities struggling with their own water treatment system. Once a company manages a water treatment plan, it operates a small monopoly. As the largest player in this industry, AWK is in a strong position to acquire smaller players and benefit from its expertise and economy of scale. There is no doubt this business will continue to grow in the next decades.

Potential downsides

On a more negative note (because not everything is pink in this world), the investment required to upgrade water connections is more than significant. Expenses to improve the water network could get out of control. As I noted in my 3rd investing principle, the company is bleeding cash to improve this network. Therefore, it has to borrow more money to finance its activities (and dividend payments).  Raise of interest rates could hurt AWK profitability has its debt level increased significantly over the past decade.

Source: Ycharts

AWK still shows a strong business model and meets my 4th investing principle.

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

I think the perfect timing 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 a 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:

Source: data from Ycharts.

Unfortunately, according to the PE valuation, there isn’t any deal with AWK at this price. The company has never traded at a higher multiplier in the past decade.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I rather see companies like big money making machine and assess their value as such.

Following the company’s previous dividend growth history, I’ve used an 8% growth rate for the first 10 years and reduced it to 7% afterward. I believe there is lots of room for growth in this market and investors will be rewarded accordingly.

Here are the details of my calculations:

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.66
Enter Expected Dividend Growth Rate Years 1-10: 8.00%
Enter Expected Terminal Dividend Growth Rate: 7.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $233.06 $116.13 $77.17
10% Premium $213.64 $106.45 $70.74
Intrinsic Value $194.22 $96.78 $64.31
10% Discount $174.80 $87.10 $57.88
20% Discount $155.38 $77.42 $51.45

Source: how to use the Dividend Discount Model

In the light of this analysis, I can see that AWK offers some upside potential.  The stock value more than doubled over the past 5 years, but the hype around water utilities is not about to finish. There is definitely a little speculation around such pricing, but the industry is promising.

AWK meet my 5th investing principle with a potential upside of 15%

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 not valid anymore, I sell and never look back.

Investment thesis

The investment thesis in such company is simple: you are buying shares of a monopoly selling an essential product with repetitive purchases. With a highly fragmented industry and the urgent need for massive investment in water connections, a leader with the size of AWK will find a way to grow its business.

Water needs will continue increase as population grows and there are no substitutes for it. It is also a recession proof business. Finally, AWK is real money making machine with constantly increasing cash flow:

Source: AWK presentation

AWK shows a solid investment thesis and meet 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).

While AWK shows consistent growth pattern due to its business model, I would tend to add a position in a more conservative portfolio. The hype around the water industry may fade at one point and what will remain is a strong dividend payment. In a decade from now, this is the type of company that will pay a higher yield, but with limited stock growth perspective.

AWK is a core holding.

Final Thoughts on AWK – Buy, Hold or Sell?

Overall, I like the business model and the company. I think there will be lots of room in the next decade for growth and the demand for water is indisputable. While the PE valuation seems high, AWK still shows enough dividend growth power under its hood to fuel a higher stock price. AWK is a buy.

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

 

Apple: A Growth or Dividend Growth Stock?

Summary:

#1 AAPL stock price rose by 65.37% over the past 5 year lagging the S&P 500 by about 9%.

#2 However, the company has also increased its dividend by 65.36% for a 10.58% CAGR.

#3 Combined together, AAPL stock outperformed the market.

When I first purchased shares of Apple (AAPL), it was way after their original stock surge. I added AAPL to my portfolio once they raised their dividend for the first time, right before the stock split. At that time, there were lots of concerns around the company’s ability to “survive” in the smartphone industry and continue to generate growth. After a thorough analysis, I made the bet that AAPL would become another Microsoft (MSFT); a company generating strong cash flow and increasing its dividend generously. Almost 5 years after my first trade, let’s look at Apple and its dividend growth potential.

What Makes Apple a Good Business?

Apple is an icon of the techno which survived the techno bust in 1999. Their products are made with great attention and aim at perfection. While its products are not perfect (yet), it has built a perfect product ecosystem. Your MacBook, iPad, iPhone, and your Apple Watch all blend together. You can share your pictures, favorite songs, and applications with any device. Apple has succeeded to have fans instead of customers.

Revenue

Revenue Graph from Ycharts

The company is still highly dependent of how their iPhones sales are going. For example, during their latest quarter (Q3 2017), the company shows 55% of its sales coming from the iconic smartphone:

Author’s chart, AAPL Q3 2017 numbers

While this seems like a red flag to many investors, I see something else: a year ago, iPhones were 65% of its revenue (source MarketWatch). Considering the iPhone 7 was launched in September 2016 (after the MarketWatch article has been written), we see the company is reaching serious momentum in their Services division. Over the past 12 months, this sector has increased its revenue by 22%.

How AAPL 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.

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.

Source: data from Ycharts.

As far as my first principle goes, we can’t tell AAPL has a high dividend yield! This is probably what an income seeking investor will tell you if you asked about their opinion on this stock. Unfortunately, a 1.50%-2% yield doesn’t attract the dividend-growth crowd. After all, don’t forget that MSFT started just like that:

Source: Ycharts.

AAPL meets my 1st investing principles.

Principle#2: Focus on Dividend Growth

Speaking of which, 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?

Source: Ycharts

What really matters to me is the dividend growth. While AAPL dividend growth history is relatively new, it shows the kind of trend I’m looking for. With a 10.58% CAGR dividend growth rate over the past 5 years, AAPL is up to a great start to become a Dividend Achiever in no time.

AAPL 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.

Source: data from Ycharts.

While management’s committed to provide shareholders with ever-growing dividends, the company has lots of room to meet its promise. You can expect a double-digit dividend growth for the next decade.

AAPL meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

I don’t think Apple is a one trick pony at all. It used to rely on its MacBook sales for a while, then it invented the iPod and surfed on this wave for a while. The current “new trick pony” is the iPhone, but Apple is already working on various other products. In the meantime management can enjoy what is the most important thing for any company… cash flow!

Source: Ycharts

Apple is an innovative company that has the resources and the will to continue in this path.

AAPL still shows a strong business model and meets my 4th investing principle.

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

I think the perfect timing 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 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:

Source: data from Ycharts.

After being given a very low multiple for about 2 years, AAPL seems to be back to its average valuation. Mind you, I think there is still room for a higher multiple considering the current market valuation.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend-growth investor, I’d rather see companies like big money-making machines and assess their value as such.

Here are the details of my calculations:

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $2.52
Enter Expected Dividend Growth Rate Years 1-10: 10.00%
Enter Expected Terminal Dividend Growth Rate: 8.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $389.63 $193.54 $128.23
10% Premium $357.16 $177.41 $117.54
Intrinsic Value $324.69 $161.28 $106.86
10% Discount $292.22 $145.15 $96.17
20% Discount $259.75 $129.02 $85.48

Please read the Dividend Discount Model limitations to fully understand my calculations.

According to the DDM, AAPL currently trades at its fair market value. However, if I had to initiate a position in AAPL, I would gladly do it at fair market value. This is the type of company that will show a great combination of dividend growth and capital growth in the future.

AAPL meet my 5th investing principle but with limited upside potential.

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 of whether the company confirms my investment thesis or not. Once the reasons (my investment thesis) of why I purchase shares of a company are not valid anymore, I sell and never look back.

Investment thesis

The company is already evolving to find other sources of revenue to stop being “the iPhone company”. Apple TV, iWatch, Apple Music, and Apple Pay are their most recent innovations. The company continues to offer a great product ecosystem and add more products that can connect to each other. This perfect ecosystem continues to attract more customers away from Androids to connect with Apple products.

Potential Risks

When you look at any “techno stock”, there is always a great risk. What is a premium product (the iPhone) today could become the next joke amongst geeks in the span of 12 months. It happened to BlackBerry (BBRY) and it could happen to Apple at any time.

AAPL shows a solid investment thesis and meet 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).

As previously mentioned in this analysis, AAPL shows a combination of both capital and dividend appreciation. While we are looking at a very solid company, AAPL still evolves in the technology sector. For this reason, AAPL stock could definitely go up or down rapidly upon shocking news. For this reason, I think AAPL would be a better fit in a growth portfolio than in a core one.

AAPL is a growth holding.

Final Thoughts on AAPL – Buy, Hold or Sell?

I’ve been a happy AAPL shareholder for many years now and I would not hesitate to enter into a new position if I was building another portfolio. AAPL is definitely a buy until it goes to a ridiculous value such as $200…

Disclaimer: I do hold AAPL in my DividendStocksRock portfolios.

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.

REITs on the radar: Realty Income Corp

What Makes Realty Income (O) a Good Business?

Realty Income is a Real Estate Income Trust (REIT) operating mainly in the retail business (79.5% of rental income) along with a small diversification in industrial and office businesses. The company focuses on acquiring freestanding, single-tenant properties under long-term, net lease agreements. It has built the bulk of their business through purchasing Real Estate from potential client to lease them back to them.

Realty Income owns over 4,900 properties with 47 different lines of businesses. Their three largest segments of business in term of rental income are Drug Stores (11.1%), Convenience Stores (9.9%) and Dollar Stores (8.0%). Their three most important states are Texas (9.7%), California (9.4%) and Florida (5.9%).

Revenue

Revenue Graph from Ycharts

As you can see, O is on a solid streak for growth since 2012. The company is using a growth by acquisition strategy and has been increasing its asset size by $9.3 billions since 2010 with $1.86 billions acquisition in 2016. Management still has access to a $2 billion acquisition credit facility for future purchases. While the 2013-2017 growth trend is unsustainable, you can expect O to continue showing stronger revenues in the upcoming years.

How O 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.

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 come with dividend growth and this is what I am seeking most.

Source: Data from Ycharts.

Realty Income has maintained a relatively high yield since 2012, but nothing seems out of control. In fact, the recent stock price rise since 2014 brought the dividend yield below the 5% level while the dividend payment continued to raise.

O meets my 1st investing principles.

Principle #2: Focus on Dividend Growth

Speaking of which, 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?

Source: Ycharts

O shows an impressive track record of almost 47 years with dividend payments along with 21 consecutives years with a dividend increase. During this period, O is showing a compound average annual growth rate of 4.7%. This is more than enough to beat inflation. Another nice feature for income seeking investors is that O pays its dividend on a monthly basis making it easier to manage one’s budget.

O 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.

Source: data from Ycharts.

It is a little bit more different to analyse REIT than other stocks. While I consider the payout and cash payout ratio for other companies, I must focus on FFO (funds from operations) and AFFO payout ratios. The first graph shows you that management makes a good job raising the dividend according to the FFO trend.

The following graph has been created from O 2016 financial statements. It shows that their payout ratios are not only under control, but they are both decreasing from 92% and 91% in 2009 to 83% for both ratios in 2016.

O meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

I like Realty Income diversification model where management leaves very little room for uncertainty. Their top 20 tenants represent 53% of their rental income spread across 11 different industries. It also shows a steady occupancy rate in the 98’s with a 99% recapture of expiring rents rate since 1996.

Beyond the REIT diversification, I like its growth by acquisition strategy ensuring higher revenues and dividend payment over time even more. O has developed a strong expertise in growing their property portfolio on a steady and sustainable manner. Through this strategy, they roughly double the number of property owned every 10 years.

Finally, the big talk about the retail REIT industry right now is all about finding ecommerce resilient tenants. We are very aware of classic stores such as Walmart (WMT) and Target (TGT) growth challenges by Amazon (AMZN) of this world. In this category, O is making an effort and shows an interesting mix of tenants. This is not the most ecommerce proof REIT I’ve seen (NNN is definitely ahead in this category), but it still makes good figures.

O still shows a strong business model and meets my 4th investing principle.

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

I think the perfect timing 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 a 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:

Source: data from Ycharts.

While the PE ratio is not exactly the best metrics to evaluate a REIT, you can see how it makes little sense to purchase a stock at a 50 multiplier. The stock price seems high considering its historical valuation.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I rather see companies like big money-making machine and assess their value as such. I used a 4.5% dividend growth rate for the first 10 years which is in line with the company history growth rate.  As the business will have a hard time continue growing at the past 4 years pace, I expect the terminal growth rate to reduce to 4%.

Here are the details of my calculations:

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

As we often see on the market, there is a price to pay for quality stocks. This seems to be the case for O as both valuation methods show it is currently overvalued.

O DOES NOT my 5th investing principle with a potential upside of 33%

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 not valid anymore, I sell and never look back.

Investment thesis

While O is currently overvalued according to our model, an investment in this company today still makes sense. If you are looking for a steady high yielder in your portfolio, an investment in O makes total sense. You will benefit from a company that is geographically diversified and that has focused on tenants with limited exposure to ecommerce threats.

Realty Income shows a stellar dividend growth history leading me to think the payout will continue to increase in the rage of 4% to 4.5% each year for several years to come. O seems a great fit for any income seeking investors.

O shows a solid investment thesis and meet 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).

When you purchase a REIT, you don’t expect its stock price to compete against AAPL growth. Realty Income does use a growth by acquisition strategy to generate value for its shareholders but don’t expect the stock price to soar anytime soon, especially with the current valuation. However, you can expect O to pay a better yield than most bonds with a nice increase each year.

O is a core holding.

Final Thoughts on O – Buy, Hold or Sell?

In the light of my analysis, I conclude that O is a very interesting company but not at this valuation. I think that if you are in the search for additional income in your portfolio, it should be on your watch list, but you could certainly benefit from a better entry point in the future.

 

Disclaimer: I do not hold O in my DividendStocksRock portfolios but intend to purchase the stock.

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.