December 9, 2016
OUR FAVORITE DIVIDEND ARISTOCRATS
By Mike Halloran, CFA Investment Strategist
We view high quality, dividend paying stocks as key assets for maintaining purchasing power and building
wealth. However, with stocks reaching new highs while earnings have been weak, stock selection is now
more important than ever. This piece reviews our criteria for selecting high quality dividend payers and
concludes with a list of dividend aristocrats.
Dividend Aristocrats: Dividend Aristocrats are companies that have increased their dividends every year for the
last several decades. These Dividend Aristocrats are typically blue chip companies from diverse industries. Stocks
that have been able to increase their dividends for such a long period of time often have very durable business
models and have demonstrated consistent earnings growth. These attributes have enabled many of these stocks to
outperform the market during good times and to hold up better during periods of market weakness. This makes the
Dividend Aristocrats very attractive as core portfolio holdings.
In the current low interest rate environment, the stable, growing income stream these stocks provide have made
them very popular as an alternative to traditional fixed-income assets like bonds and cash. This has also caused
valuations to become stretched in some cases. Meanwhile, corporate earnings that support dividends have been
weak for many industries since oil prices collapsed in late 2014 and the U.S. dollar strengthened ahead of the
Federal Reserve raising interest rates. This earnings pressure, and the related pressure on the dividend, is being
felt the most by energy-related firms and firms that rely heavily on exports. Consequently, understanding which of
the current Aristocrats are best positioned for the coming years is more important than ever.
In the following section we review our stock selection criteria and the factors that support a sustainable, growing
dividend and conclude with a list of dividend aristocrats.
Stock Selection Criteria:
While sustainably growing dividends over a long period of time points to a well-run
firm with a durable business model, we also focus on many other key fundamental and technical factors to find well
positioned companies. These factors have become even more critical with a high stock market valuation and weak
earnings growth.
Valuation:
Valuation is a key fundamental starting point for stock selection and answers the question: How
much am I paying for a stock’s future earnings or dividends? While investors use many valuation metrics, probably
the most looked at valuation parameter is the stock’s price-to-earnings ratio or P/E. This is simply the stock’s price
divided by the earnings-per-share. The earnings-per-share used in the calculation can be the trailing 12-months, the
future 12-months (estimated by Wall Street analysts), or the current or next calendar year – making consistent
comparisons is the key. A stock’s P/E ratio can be compared to the market’s P/E, an industry peer group’s P/E, or
the stock’s own historical P/E ratio. Everything else being equal, we prefer stocks that have low P/E ratios relative
to the market, their industry peer group, or their own trading history.
Free cash flow yield is the cash flow per share, after all expenses and necessary capital expenditures (reinvestment
into the business), divided by the stock price. The advantage of using cash flow is that it is harder to manipulate
MIKE HALLORAN, CFA
INVESTMENT STRATEGIST [email protected] 412.562.8062
WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC
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through accounting maneuvers. Many studies show the benefit of using this metric for measuring the performance
of a company since it avoids using net income and the associated potential for accounting adjustments.
The free cash flow yield also gives an indication of dividend sustainability. A stock with a free cash flow
yield that is sustainably higher than the dividend yield suggests that future dividends can be sustained.
Earnings Quality and Growth: Reported earnings should represent the underlying economics of the business and
be both persistent and predictable. Are there regularly “one-time items” included in the firm’s earnings reports? Are
accounting manipulations being used to mask weak underlying earnings? A firm’s financial statements need to be
studied to ensure that reported earnings reflect the true, underlying economics of the business.
Operating and net income margins (a firm’s income as a percentage of sales) are also critical metrics. Does the firm
generate significant income as a percentage of sales? It doesn’t take much of a shock to a low margin firm to
significantly impact profitability while the opposite is true for a high margin firm. Increasing or decreasing margins
over time are also very important to a firm’s outlook.
The direction of earnings is a powerful signal for stocks. Are earnings growing faster than the market and the
company’s peer group? In addition, earnings increasing faster or slower than the market expects (direction of
earnings revisions) typically has a significant impact on a stock’s price.
The company’s credit rating can also be used as a guide to the quality of the firm and its earnings. Highly-rated
investment grade credits typically produce steady earnings and are considered to have durable business models.
Dividend Sustainability:
In addition to a high and sustainable free cash flow yield, we look at the dividend
payout ratio to determine whether future dividends can be supported by the company’s cash generation capabilities.
The dividend payout ratio is simply the percentage of earnings paid to shareholders in dividends (remaining
earnings are plowed back into the firm to maintain and grow future earnings and dividends).
A payout ratio that is low suggests that a firm can support and grow future dividends. A payout ratio that is too high
can indicate that a firm may have trouble maintaining, let alone growing the dividend. A high payout ratio also can
be an indication that a firm is limited in its ability to reinvest and may be sacrificing future growth opportunities for
the sake of its current dividend. This is not conducive for future dividend growth.
Technical Analysis:
While fundamental analysis involves analyzing the characteristics of a company in
order to estimate its value, technical analysis studies supply and demand of a stock in an attempt to determine what
direction, or trend, will continue for the stock’s price in the future. A stock’s price is ultimately determined by the
equilibrium of supply and demand for the stock and technical analysis is the tool for this analysis.
Movement in a stock’s price typically precedes news announcements from or about the company. If a stock is
outperforming or underperforming the market or its peer group, there is most likely a reason for this that
fundamental analysis may be late to see.
Many studies support the importance of using technical analysis in evaluating potential market opportunities. We
combine technical and fundamental analysis into our overall investment analysis process. Stocks or markets that
look favorable from both a fundamental and technical standpoint typically stand a good chance of outperforming.
MIKE HALLORAN, CFA
INVESTMENT STRATEGIST [email protected] 412.562.8062
WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC
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Diversification:
We also recommend maintaining a well-diversified portfolio that offers exposure to a widerange of economic sectors. Cyclical sectors (Consumer Discretionary, Energy, Financials, Industrials, Real Estate,
Technology and Materials) typically perform well with improving earnings as economic conditions improve.
Defensive sectors (Consumer Staples, Health Care, Telecom and Utilities) tend to see their performance and
earnings hold up better during tough economic times.
There is significant variation in sector performance over any given time frame and we recommend diverse exposure
across sectors. This can reduce volatility and produce more consistent investment results.
Dividend Aristocrats for the Next Ten Years
Consumer:
Lowe’s, Wal-Mart, Walgreens Boots Alliance, and PepsiCo are preferred for our consumer
exposure with all of them playing into favorable secular themes. Lowe’s offers exposure to housing and we see it
benefitting from significant pent-up housing demand and a healthy consumer and banking system. Walgreens
benefits from a healthy consumer and aging demographics. Wal-Mart and PepsiCo’s consumers are benefitting
from nascent wage growth and low energy prices.
Lowe’s has increased its dividend for 53 straight years, Wal-Mart for 42 years, while PepsiCo and Walgreens have
increased theirs 43 and 40 years, respectively. All of these firms are U.S. centric and stand to benefit from solid
U.S. economic growth while offering insulation from the strong dollar impact on international profitability.
Energy:
Exxon Mobil and Chevron are bellwethers of the energy patch, and have increased dividends for
33 and 28 straight years, respectively. They both benefit from improving global economic growth and stabilizing
energy prices. While their current payout and free cash flow yields screen poorly on current earnings, we see these
metrics improving with stabilizing energy prices.
Financials:
Cullen/Frost and T. Rowe Price should benefit from a stronger economy and normalizing interest
rates with the Federal Reserve moving away from its zero interest rate policy. They also stand to benefit from a
lighter regulatory touch under a Trump administration. T. Rowe has increased its dividend for 29 straight years
while Cullen/Frost has increased their dividend for 23 straight years.
Health Care: Johnson & Johnson is a leader in the pharmaceutical, medical device, and consumer products
industries that has raised the dividend for 53 straight years. While facing some competitive pricing pressures,
Cardinal Health is a leading distributor of pharmaceuticals and medical supplies with the majority of sales based in
the U.S. Cardinal’s valuation is now reasonable and the dividend looks well supported. Both firms are well
positioned for the favorable secular backdrop of an aging demographic and the demand for increased health care.
A Trump Presidency should also provide a more favorable regulatory environment for the Health Care sector.
Industrials:
W W Grainger is the largest global distributor of industrial and commercial supplies, and derives
the majority of its sales in the U.S. They have grown the dividend for 44 straight years and are well positioned for an
improving U.S. economy.
MIKE HALLORAN, CFA
INVESTMENT STRATEGIST [email protected] 412.562.8062
WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC
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Technology: Automatic Data Processing provides data processing services for payroll and human resources
and is well positioned for further economic growth. While the stock is expensive, the dividend is well supported by
quality earnings growth with the firm growing the dividend for 41 straight years.
Materials:
Sherwin-Williams is the largest U.S. producer of paints and is participating in the housing market
recovery with the majority of sales coming from the U.S. The dividend is well supported and they have grown it for
37 straight years.
Telecom:
AT&T is majority U.S. based and benefits from better economic growth, a friendlier regulatory
environment, and potential corporate tax cuts under the Trump administration. While they have a relatively high
payout ratio, the firm has traditionally produced steady earnings in a defensive sector and has grown the dividend
for 32 straight years.
Table 1: Dividend Aristocrats that are well positioned for the next decade.
Dividend Aristocrat
18.4
Projected 3-Yr
Earnings
Growth Rate 2
16.0%
S&P
Quality
Rank3
A-
16.3
17.1
21.1
20.6
84.8
18.5
17.5
6.0%
12.0%
8.0%
9.0%
23.0%
6.0%
2.0%
A
AA
AB+
AA-
Pharmaceuticals
2.89%
4.5%
47.5%
16.5
7.0%
Health Care Distributor
2.54%
10.2%
32.7%
12.8
13.0%
Industrial Distributor
2.06%
4.7%
41.9%
20.6
8.0%
Data Processing &
2.39%
4.3%
63.7%
26.6
11.0%
Outsourced Services
Specialty Chemicals
1.27%
5.4%
27.1%
21.9
12.0%
Telecommunication
4.85%
7.4%
68.8%
14.2
6.0%
Services
Footnotes: 1) Forward P/E Ratio is stock price divided by next 12-months analyst’s earnings estimates
2) Projected 3-Yr Earnings Growth Rate is S&P Capital IQ estimate of future three years earnings growth rate.
3) S&P Quality Rank is an estimated ranking of earnings and dividend stability determined by S&P Capital IQ.
A
B+
A+
A
Lowe’s (LOW)
Wal-Mart Stores (WMT)
Walgreens Boots (WBA)
PepsiCo Inc (PEP)
Exxon Mobil (XOM)
Chevron (CVX)
Cullen/Frost Bankers (CFR)
T. Rowe Price Group
(TROW)
Johnson & Johnson (JNJ)
Cardinal Health (CAH)
W W Grainger (GWW)
Automatic Data Processing
(ADP)
Sherwin-Williams (SHW)
AT&T (T)
Sector or Industry
Dividend
Yield
Free Cash
Flow Yield
Payout
Ratio
Forward
P/E Ratio 1
Consumer
Discretionary
Consumer Staples
Consumer Staples
Consumer Staples
Energy
Energy
Regional Bank
Asset Management
1.93%
6.6%
39.0%
2.82%
1.76%
2.99%
3.43%
3.80%
2.52%
2.86%
9.7%
6.5%
4.9%
0.4%
-5.5%
14.4%
2.6%
46.0%
35.3%
63.2%
133.3%
175.0%
46.7%
42.8%
Source: Janney ISG and Bloomberg
A
B+
Table Data as of 12/8/2016
Past performance is no guarantee of future performance and future returns are not guaranteed. There are risks associated with investing in stocks such as a loss of original
capital or a decrease in the value of your investment. A company may decide to decrease or cancel a dividend payment at any time without notice. For additional information
or questions, please consult with your Financial Advisor.
This report is provided for informational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities. The information
described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions
expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the
securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such
securities on a principal basis.
MIKE HALLORAN, CFA
INVESTMENT STRATEGIST [email protected] 412.562.8062
WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC
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