Costco Dividend Stock Analysis for 2013

Costco Wholesale (COST) is a large membership warehouse retailer that sells a variety of bulk goods in several countries.

-Seven Year Revenue Growth Rate: 9.4% 
-Seven Year EPS Growth Rate: 8.6%
-Seven Year Dividend Growth Rate: 13.3%
-Current Dividend Yield: 1.08%
-Balance Sheet Strength: Strong

Costco is one of the lowest yielding stocks that I publish analysis articles on when not taking into account their recent huge one-time special dividend.

Overall, much like last year, I think Costco is a fantastic company and a respectable stock for long-term capital appreciation, but at the current time, I view it as fully valued with little or no margin of safety, and it doesn’t offer a very appealing regular dividend yield.

Overview

Founded in 1983, Costco Wholesale (NASDAQ: COST) is a large warehouse-based retailer, primarily located throughout North America but with a presence in Europe and Asia as well.

With over 170,000 employees, Costco operates 622 warehouses. Of these, 448 are in the US and Puerto Rico, 85 are in Canada, 32 are in Mexico, 23 are in the UK, 13 are in Japan, 9 are in Taiwan, 9 are in Korea, and 3 are in Australia. In addition, Costco operates its large online retail site.

Category Sales

Costco warehouses offer various items, clothes, food, electronics, glasses, pharmacy drugs, gasoline, car-washes, and more. There are bulk items for cheap shopping, but there are select higher-end items.

Sundries (cleaning supplies, tobacco, alcohol, candy, snacks, etc.) accounted for 22% of 2011 sales.

Hardlines (electronics, hardware, office supplies, beauty supplies, furniture, garden, etc.) accounted for 16% of sales.

Food accounted for 21% of sales.

Softlines (clothing, housewares, small appliances, jewelry, etc.) accounted for 10% of sales.

Fresh food accounted for 13% of sales.

Ancillary and other (gas, pharmacy, food court, optical, etc.) accounted for 18% of sales. (This is their fastest growing segment, as they put more of these areas in newer Costcos.)

Ratios

Price to Earnings: 25
Price to Free Cash Flow: 24
Price to Book: 3.5
Return on Equity: 15%

Revenue

(Chart Source: DividendMonk.com)

Revenue growth over this period has been particularly strong at 9.4% per year, which is quite substantial for a large and consistent company. Every year except 2009 had strong revenue growth

Earnings and Dividends

(Chart Source: DividendMonk.com)

EPS has grown by an average of 8.6% per year over this period. The growth has been fairly smooth with the exception of 2009.

Costco has a low dividend yield of only 1.08% as of this writing, and a dividend growth rate averaging 13.3% per year over the last seven years. I rarely cover companies with a yield that low, but Costco is an exception because the company quantitatively has all the characteristics of a dividend growth stock despite the fact that it will fall significantly below many income investors’ yield minimums. The payout ratio is on the low side at only around 25%, but as a comparison, that’s higher than Exxon Mobil and Aflac, and only a bit below Chevron, which are all classic dividend growth stocks that I publish reports on.

The low yield is the result of a combination of this fairly modest dividend yield and a fairly high valuation (PE of 25) rather than due purely to an extremely low payout ratio.

How Does Costco Spend Its Cash?
For the fiscal years 2010, 2011, and 2012, Costco brought in a total of approximately $5.2 billion in free cash flow. Over the same period, the company spent under $1.2 billion on dividends, $1.8 on net share buybacks, and under $1 billion on acquisitions. The company has reduced its share count by a bit over 10% over the last seven years, which isn’t a very large amount due the consistently robust valuation of the stock.

Unfortunately, in my Dividends vs. Share Repurchases article which I often reference, I use Costco as a prime example of a well-run company that makes suboptimal share repurchase decisions. Few would argue that Costco has not been exceptionally well-managed since it’s founding overall, and yet it is quantitatively demonstrable that the company is not making the best possible use of its cash when it comes to these buybacks. Costco is not alone in this; it’s the corporate norm.

For example, the Costco stock price has been on a smooth upward trajectory over the last 10 years, with the one big exception being during the financial crisis between late 2008 and throughout 2009 and into early 2010. The year of 2009 was a particularly low year for the stock. And yet, when one looks through their history of share repurchases, it turns out management spent a considerable amount of money on share repurchases every year since 2005, with the exception of 2009. When the stock price was at its lowest, Costco was hording cash and not buying, but when times are better, cash is flowing, and the stock valuation is higher, Costco liberally buys back more shares.

This is a consistent theme with American blue chip stocks. A Credit Suisse research study showed that broadly speaking across the market, share buyback amounts are positively correlated with stock price. In other words, the higher the stock value, the more companies are buying their shares back.

While Costco management has done a tremendous job in terms of total shareholder returns, wise shareholders would likely be slightly better off if the payout ratio was increased to a more moderate figure; perhaps in the 40-55% payout ratio range, at the cost of reduced share buybacks. Shareholders can decide to reinvest that money or not.

The recent $7 special dividend was in my opinion a good use of cash for shareholders. This won’t be a common thing, since it was based on the political environment and was worth a couple years worth of free cash flow generation by the company.

Balance Sheet

Before the special dividend, Costco had a very strong balance sheet with a total debt/equity ratio of under 11%. The total amount of debt was lower than the annual income and the interest coverage ratio was well over 30. Due to Costco’s low acquisition activity, goodwill hasn’t accumulated on the balance sheet.

The company tapped into this battery of capital to pay a huge $7 special dividend at the end of 2012 that is not yet reflected in a quarterly report. That was before there was a ‘Fiscal Cliff’ deal and changes in dividend tax rates were uncertain. It was prudent to pay a larger dividend while tax rates were known to be low. The company offered over $3 billion in debt to fund this dividend which cost over $3 billion to pay all shareholders. Based on the addition of debt and the subtraction from shareholder equity, Costco’s balance sheet will be a bit more leveraged but still fairly conservative.

A dividend of this magnitude shows specifically why a strong or weak balance sheet should be taken into account when valuing a stock. A strong balance sheet can act as a battery for shareholder returns should the opportunity arise, either in the form of dividends, buybacks, acquisitions, or core growth. When analyzing a stock with the Dividend Discount Model or Discounted Cash Flow Analysis, I generally take the strength of the balance sheet into account by allowing for a smaller margin of safety or by allowing for a slightly reduced discount rate.

Investment Thesis

Costco’s business model is meant to maximize efficiency. The warehouse format keeps costs low, as they buy and sell items in bulk. Shoppers (both consumers and small business owners) pay membership fees, and in return receive exceptionally low prices. The warehouse model also generally operates moderately reduced hours compared to typical retailers. Although Costco offers a large range of products, they limit their selections in each category to only the best-selling ones, so the number of individual products is actually lower than many other retailers (as in, less than 10% as many items as in a Walmart store) and they can maximize their purchasing power for these items. This further streamlines their business.

Costco’s memberships keep customers loyal, and they have a high renewal rate. Costco can keep its prices reasonably competitive with Wal-Mart by maintaining such a low profit margin. The company gets most of its profit from membership fees while its goods are sold at very low markups or even at losses.

Growth

Year	Warehouses	Gold Star Members	Business Members
2012	622	26.736 million	6.442 million
2011	592	25.028 million	6.352 million
2010	540	22.539 million	5.789 million
2009	527	21.445 million	5.719 million
2008	512	20.181 million	5.594 million
2007	488	18.619 million	5.401 million

Each year in this snapshot, as well as in many previous years, Costco increased their number of warehouses, and saw an increase in both gold star members and business members. As of the most recent report, Coscto has 622 warehouses as of the end of their fiscal year 2012.

Despite Costco’s mild setback in 2009 due to the recession, Costco became the 3rd largest retailer in the US compared to its spot at 5th in 2008, and is one of the largest retailers in the world as well.

Two Points for Bullishness

There are a couple key things I want to highlight that, in my view, make Costco not (quite) as overvalued as it seems.

1. Revenue growth is outstanding. Most large businesses aren’t growing revenue at nearly the pace of Costco. Costco’s number of stores is growing, their number of members is growing, and they have repeatedly demonstrated the ability to raise their membership prices without substantial drop-off rates.

2. Low profit margins can mean eventual upside. Costco is currently sacrificing profitability for solid ethics and market share growth. Costco is a viable competitor to even Walmart, and yet has only existed since the 1980′s. The larger the revenue becomes, the more pricing power they have, and the denser their store locations get, the more efficient they become. The net margin is currently under 2% compared to Walmart that has a profit margin of over 3%. The retail industry competes on price and has low profit margins across the board, so an increase of 25-50 basis points has a huge impact on the bottom line. Costco’s business of model of high employee pay and selling a larger amount of fewer products has resulted in extremely strong sales per square foot of retail space.

Risks

As a retailer, Costco is a middle-man, with limited pricing power, and the retail industry is incredibly competitive. Costco faces competition from warehouses like BJ’s and Sam’s Club (owned by Wal-Mart), general retailers like Wal-Mart, Target, and Kohls, as well as from online competitors like Amazon.

In addition, since the stock has a fairly high valuation, there is considerable risk of poor stock performance if Costco doesn’t continue to outperform as a company.

Conclusion and Valuation

Based on DCF analysis with a 10% discount rate, the current market cap of around $44 billion is justified if the company can grow free cash flow by 8% per year over the next 10 years followed by 4% per year perpetually thereafter, which is a rather aggressive estimate.

Alternatively, if those estimates are toned down to 7% growth for 10 years followed by 3% perpetual growth with a discount rate reduced to 9%, the current market cap is fair.

These estimates demonstrate that while the current valuation may not represent an overvalued stock, it likely doesn’t offer any significant margin of safety either.

With such a low yield, the stock is obviously not an ideal selection for investors that desire current income as part of their financial freedom. For investors that appreciate the qualities of Costco that make it a similar quantitative and qualitative investment to other dividend growth stocks but with a reduced yield, it may be a decent selection for long term capital appreciation.

I believe Costco stock will continue to increase in price over the long-term, but at the current time with the stock a bit over $102/share, I observe that there are likely better (and significantly higher yielding) dividend growth investments out there.

Full Disclosure: As of this writing, I have no position in COST.
You can see my dividend portfolio here.

This article was written by Dividend Monk. If you enjoyed this article, please subscribe to my feed [RSS]

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Look beyond P/E ratios dividend investors

One of the typical valuation tools used by investors is the price earnings ratio. Price earnings ratio is calculated by dividing stock price over earnings.

Just as there are different investors, there are many ways that this otherwise seemingly simple indicator is calculated. Price is usually easily accessible in our information age, and it is typically the easiest input to be obtained online. Earnings per share is an indicator which often requires a little bit of additional research before applying in the equation. One of the first questions that investors need to ask themselves before looking at P/E ratios is to gain an understanding of the denominator in the equation.

I typically focus on earnings from continuing operations. I tend to exclude one-time accounting items such as goodwill impairment charges for example. The reason is that I focus on earnings stream that the company will generate from recurring operations. The fact that the company overpaid for a subsidiary five years ago is irrelevant for my investing decision, as long as this does not affect earnings from continuing operation. As a result, by normalizing earnings per share (EPS), I sometimes arrive at different P/E ratio figures than what you might usually see on Yahoo! Finance for example. Johnson & Johnson (JNJ) is a great case in point. While Yahoo Finance shows EPS of $3.86, my analysis calculated EPS to be $4.89/share.

Another question that investors should ask themselves is whether earnings per share are sustainable. I usually prefer to focus on companies that have the potential to grow earnings over time. A company with low P/E ratio could look undervalued. If analysts expect EPS to drop 50% however, and remain low, then it could end up being a value trap for investors. Apple (AAPL) currently trades at ten times earnings. However, this reflects the overall bearishness on the company's ability to maintain profits going forward, given the intensely competitive nature of the smartphone market. Sales of smartphones have accounted for a large part of Apple's growth over the past five years. Competition from Samsung, LG, and HTC has eroded Apple's market share.

If earnings per share are not steadily increasing over time, this could mean stock prices and dividends per share cannot sustainably grow. Investors should be advised to avoid such enterprises, as their dividend income is likely to remain stagnant. They would be much better off in fixed income, since they have a better chance of recovering principal.

One case in point is Intel Corporation (INTC). Over the past five years this tech juggernaut has suffered from low EPS growth. This has been caused by slowing sales in traditional computing devices. The company needs to expand presence in mobile devices chips. Thus shares appear undervalued, but without growth in earnings, investors returns are limited to the current yield. If earnings per share decline, the dividend payout ratio might become unsustainably high, and dividends might be cut. Either way, without earnings growth, future dividend growth will be limited. In addition, if Intel decides to spend more in R&D or buy its way in the market for mobile device chips, management might even decide to sacrifice the high dividend payments.

Full Disclosure: Long JNJ

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Evaluating Dividend Growth Stocks – The Missing Ingredient

Over the past few years, I had developed and employed a stock selection strategy based on three criterion. These included screening for valuation, using a set of criteria such as minimum yields, dividend payout ratios and dividend growth. After I had a manageable list of stocks to focus on, I would do an analysis of company fundamentals for quality, while assessing the likelihood of future earnings growth.

The more time I spent running my screen and analyzing companies in detail, the more I realized that there was a partial disconnect between the two. I was more of an intuitive investor, who focused on dividend growth and yield, but could not really explain well why I had preference on one company over another in the pre-screened stock list.

The parameters for screening of dividend champions for example included:

1) P/E below 20
2) Current yield above 2.50%
3) Dividend Payout Ratio below 60%
4) At least a decade of consistent dividend growth

The missing ingredient was evaluating companies on a case by case basis, based on the yield and growth characteristics they employed. For example, should I select a company yielding 2.50% that is growing distributions at 12%/year (BDX), or should I select a company yielding 4% that grows dividends at 6% (KMB)? If these growth rates are expected to continue for the foreseeable future (5 years from today), which company is a better candidate? Assuming that only one of the two can be purchased at a time, I usually bought the first in month one and the second in the next month. However, this still didn't really provide for an answer that would allow me to evaluate companies in a more standardized way, other than on a one-by-one basis.

This problem was also present when evaluating my dividend growth portfolio. Should I keep a stock yielding 4% that grows distributions at 1% per year or replace it with a company that yields 3% but grows distributions by 6% annually? This decision is particularly complicated given the uncertainty of projecting past dividend growth rates into the future, coupled with evaluating dividend payout ratios, valuation and prospects for earnings growth.

Some investors add the five or ten year average annual dividend growth to the current yield, and select the stock with the highest score. For example let’s assume that an investor had to choose between Yum! Brands  (YUM) with a 5 year dividend growth rate of 17.80% and a yield of 2%, and McDonald’s (MCD) with a 13.90% growth and a 3.40% yield. The score for Yum! is 19.80 , while the score for McDonald’s is 17.30. The clear favorite in this scenario is Yum! Brands.

When looking at dividend growth rates however, the length of the dividend boosting streak is important if it exceeds ten years, but after that it should not be a differentiating factor. In other words, if all else is equal, a company that raised distributions for 35 years is not any better than a company that has raised them for 15 years. On the contrary, it could be argued that companies in the early days of their dividend achiever status might have more time to grow the dividend, in comparison to a mature dividend champion. Looking at Yum! Brands versus McDonald’s (MCD) however, then the latter earns more points, since it has been raising them for over 36 years, while the former only has a nine year record of dividend growth.

In addition, when we look at valuation, one might notice that McDonald’s is trading at 17.30 times earnings, whereas Yum! is valued at a P/E of 19.70. A big factor in Yum’s stronger dividend growth could have been the expansion in the dividend payout ratio, whereas it had been more stable at McDonald's.

On the other hand, future expected growth at Yum! is much higher than that for McDonald’s, as KFC franchises are opened at an increasing rate across the globe. Chinese market is in particular much more receptive to KFC than to McDonald’s restaurants, which is where a large portion of Yum!’s growth can be delivered over the next couple of decades.

The comparison becomes much easier when comparing a company such as Con Edison (ED) and an MLP such as ONEOK Partners (OKS). Con Edison has a five year dividend growth rate below 1% (0.90% to be exact), and it yields close to 4.30%. ONEOK Partners on the other hand yields over 4.70% and has a much high distribution growth rate of 5.40%/year. In addition, the growth prospects behind the partnership are much brighter than those for the New York State based utility, despite the much shorter streak of consecutive distribution increases for the MLP (38 years for ConEd versus 7 years for ONEOK Partners).

Overall, as part of my screening criteria going forward, I would use the sum of ten year annual dividend growth and current yield when comparing two or more separate investments. However, in my individual analyses of companies’ fundamentals, valuation and growth prospects, I would continue scrutinizing every aspect in order to come up with an investing decision. Unfortunately, one can only automate their investing to a certain extent, but then investors still need to evaluate qualitative characteristics based on their own investment experiences. Investing is part art and part science, which is why investing needs to be a mixture of hard data coupled with common sense and a dose of luck.

Full Disclosure: Long MCD, YUM, OKS, ED,KMB

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Realty Income (O) Raises Dividends by a Record 19.20%

Realty Income Corporation engages in the acquisition and ownership of commercial retail real estate properties in the United States. This dividend achiever has paid dividends every year since going public in 1994, and raised them for 19 years in a row.

The company raised its monthly dividend by 19.20% to 18.09 cents/share following the completion of the acquisition on American Realty Capital Trust. This was the highest increase in distributions done by the monthly dividend company. The new annual dividend at the current rate is at $2.171/share. The current yield is up to 5% after the increase. Check my previous analysis of the REIT for more information on Realty Income.

The REIT cites increase in revenues and profitability as a result of 2012 property purchases as well as the recently completed acquisition of American Realty Capital Trust. Realty Income expects Normalized FFO/share to range between $2.32 - $2.38/share in 2013. In comparison, Normalized FFO/share for 2012 is estimated to be between $2 - $2.04/share. The new monthly dividend brings the FFO payout ratio to a range between 91% - 93%, which is high. This might limit future distribution growth for the next few years.

As a result of the merger, Realty Income has added 515 properties, which are under a triple-net lease. This brings the total number of properties owned by Realty Income to 3,528. In addition, the acquisition is increasing the proportion of lease revenue derived by investment grade lessors from 19% to 34%. The average lease term is approximately 11 years. A triple-net lease is typically a long-term contract ranging anywhere between 15 and 20 years, which specifies the rent due, periodic increases in rents. The tenants are usually responsible for most operating expenses for these properties, including taxes and utilities, in addition to paying rent to Realty Income.

Realty Income was one of the few Real Estate Investment Trusts which didn't cut or eliminate distributions during the financial crisis of 2007 – 2009. In fact, the company kept raising them a few times per year, albeit at a very slow rate. I find the current increase to leave little to no room for dividend increases for the next few years above maybe a couple cents/share. That being said however, I like the fact that the company is looking for different ways to only pay the monthly dividend to loyal shareholders, but also to find new ways to generate cash-flow to hike it regularly.

Full Disclosure: Long O

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ConocoPhillips (COP) Dividend Stock Analysis

ConocoPhillips (COP) explores for, produces, transports, and markets crude oil, natural gas, natural gas liquids, liquefied natural gas and bitumen on a worldwide basis. This dividend achiever has paid dividends since 1934, and has increased them for 12 years in a row.

Back on May 1, 2012 ConocoPhillips split in two separately traded companies – ConocoPhillips (COP) and Phillips 66 (PSX). The data presented below shows the ten year financial trends for legacy ConocoPhillips, as accounting records had not been updated going back 10 years for just ConocoPhillips. ConocoPhillips is the upstream operations, which are involved in exploration and production of oil and natural gas. Phillips 66 (PSX) represented downstream operations such as operating refineries in US and abroad, as well as transportation assets such as pipelines.

The company’s peer group includes Exxon Mobil (XOM), Chevron (CVX)) and British Petroleum (BP).

Over the past decade this dividend growth stock has delivered an annualized total return of 15.50% to its shareholders.

The company has managed to increase EPS from $0.74/share in 2002 to $8.97 by 2011. Analysts expect ConocoPhillips to earn $6.06 per share in 2012 and $6.26 per share in 2013.

ConocoPhillips plans to spend $15 billion per year through 2016. Some of its investments will be in oil rich fields in North America including Bakken Shale, Eagle Ford and Permian Basin. The goal is to reach a reserve replacement ratio of 100%. The nature of the oil business is such, that for every barrel of oil pumped out of the ground, your reserves decrease by one barrel. With advancements in technology however, it is possible to obtain more oil from existing and new wells than before. In addition, oil and gas companies spend large amounts of money on seismic activity studies, in order to increase their chances of striking oil. With the amount of funds spent to achieve a reserve replacement ratio above 100%, the company is also targeting production growth of 3% - 5%/year as well.

Over the past three years, the company has sold off a lot of assets, raising billions of dollars in the process. Examples include selling off its stake in Lukoil, the proceeds from which were used to repurchase stock. Currently, it is in the process of selling off its stake in the Kashagan project in Kazakhstan. ConocoPhillips expects to raise somewhere between $8 - $10 billion through 2013 by the sale of these non-core assets.

The average return on equity has remained around 20% for most of the time, with the exception of the 200 7 -2008 run up in oil prices, followed by the 2008 – 2009 decline. Since then, it has increased back up to 20% in 2011. I generally want to see at least a stable return on equity over time.

The annual dividend payment has increased by 14.20% per year over the past decade, which is lower than the growth in EPS.

A 14% growth in distributions translates into the dividend payment doubling every five years on average. If we look at historical data, going as far back as 1982, one would notice that the company has actually managed to double distributions every ten years on average. Management has expressed willingness to distribute 20% - 25% of cashflows for dividends each year, which should be appealing to income investors.

The dividend payout ratio has mostly remained below 50%, with the exception of 2002 and 2008- 2009 periods. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently ConocoPhillips is attractively valued at 8.10 times earnings, yields 4.40%, and has a sustainable distribution. In comparison Exxon Mobil trades at 9.70 times earnings and yields 2.50%, while Chevron trades at 9.50 times earnings and yields 3.10%. I have recently replaced Exxon Mobil with ConocoPhillips.

Full Disclosure: Long COP and CVX

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This article was featured in Carnival of Wealth, And Stay Out Edition

The Dividend Kings List Keeps Expanding

Many income investors are aware of the Dividend Achievers, Dividend Champions and Dividend Aristocrats stock lists of dividend growth stocks. These lists typically focus on companies which have raised dividends for at least 10 or 25 years in a row. There exists another list of dividend growth stocks however, every one of which has managed to boost distributions for at least fifty consecutive years. This is particularly interesting, since this period covered several recessions, a few oil shocks and one embargo, a few wars, inflation and a lot of change in the global economy. These companies not only managed to prosper during that tumultuous period, by adapting and embracing change, but also did not forget to reward their loyal shareholders with a dividend raise. For at least 50 consecutive years that is.

In 2012, there were four additions to the list, and no deletions. The list of dividend king companies includes:

Diebold, Incorporated (DBD) provides integrated self-service delivery and security systems and services primarily to the financial, commercial, government, and retail markets worldwide. The company has raised dividends for 59 years in a row. The ten year dividend growth is 5.60%/year. Yield: 3.50% (analysis)

American States Water Company (AWR), together with its subsidiaries, provides water, electric, and contracted services in the United States. The company has raised dividends for 58 years in a row. The ten year dividend growth is 3.80%/year. Yield: 2.80%

Dover Corporation (DOV) manufactures and sells a range of specialized products and components, and provides related services and consumables. The company has raised dividends for 57 years in a row. The ten year dividend growth is 9.40%/year. Yield: 2.10%

Northwest Natural Gas Company (NWN) stores and distributes natural gas primarily in Oregon, Washington, and California. The company has raised dividends for 57 years in a row. The ten year dividend growth is 3.60%/year. Yield: 4.20%

Emerson Electric Co. (EMR), a diversified technology company, engages in designing and supplying products and technology, and providing engineering services and solutions to the industrial, commercial, and consumer markets worldwide. The company has raised dividends for 56 years in a row. The ten year dividend growth is 7.50%/year. Yield: 3% (analysis)

Genuine Parts Company (GPC) distributes automotive replacement parts, industrial replacement parts, office products, and electrical/electronic materials in the United States, Puerto Rico, Canada, and Mexico. The company has raised dividends for 56 years in a row. The ten year dividend growth is 5.30%/year. Yield: 3%(analysis)

Parker Hannifin Corporation (PH) manufactures fluid power systems, electromechanical controls, and related components worldwide. The company has raised dividends for 56 years in a row. The ten year dividend growth is 12.90%/year. Yield: 1.80%

The Procter & Gamble Company (PG), together with its subsidiaries, engages in the manufacture and sale of a range of branded consumer packaged goods. The company has raised dividends for 56 years in a row. The ten year dividend growth is 10.80%/year. Yield: 3.20% (analysis)

3M Company (MMM) operates as a diversified technology company worldwide. The company has raised dividends for 54 years in a row. The ten year dividend growth is 6.60%/year. Yield: 2.40%  (analysis)

Vectren Corporation (VVC), through its subsidiaries, provides energy delivery services to residential, commercial, and industrial and other contract customers in Indiana and west central Ohio. The company has raised dividends for 53 years in a row. The ten year dividend growth is 2.80%/year. Yield: 4.60%

Cincinnati Financial Corporation (CINF) engages in the property casualty insurance business in the United States. The company has raised dividends for 52 years in a row. The ten year dividend growth is 7.30%/year. Yield: 3.90%

The four new additions in 2012 include Coca-Cola, Johnson & Johnson, Lancaster Colony and Lowe's.

The Coca-Cola Company (KO), a beverage company, engages in the manufacture, marketing, and sale of nonalcoholic beverages worldwide. The company has raised dividends for 50 years in a row. The ten year dividend growth is 9.80%/year. Yield: 2.70% (analysis)

Johnson & Johnson (JNJ), together with its subsidiaries, engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company has raised dividends for 50 years in a row. The ten year dividend growth is 11.70%/year. Yield: 3.30% (analysis)

Lancaster Colony Corporation (LANC) engages in the manufacture and marketing of consumer products focusing primarily on specialty foods for the retail and foodservice markets in the United States. The company has raised dividends for 50 years in a row. The ten year dividend growth is 6.70%/year. Yield: 2.10%

Lowe’s Companies, Inc. (LOW), together with its subsidiaries, operates as a home improvement retailer. The company has raised dividends for 50 years in a row. The ten year dividend growth is 31.10%/year. Yield: 1.70% (analysis)

The companies which I expect to join the ranks of the dividend kings in 2013 include Colgate-Palmolive (CL), Nordson Corporation (NDSN) and Illinois Toolworks (ITW).

The list of dividend kings has been expanding since 2007, despite the financial crisis. Only two companies have been dropped out of the list since then. The companies include Integrys Energy Group (TEG), which has not raised dividends since 2009 and Masco (MAS), which cut them in 2009. Since 2007, the list has outperformed S&P 500 in three out of five years. It is a small sample of years of course, so future results might vary.

Portfolio/Year	2008	2009	2010	2011	2012
Dividend Kings TR	-18.48%	17.49%	23.31%	3.51%	14.09%
S&P 500 TR	-36.80%	26.36%	15.05%	1.90%	15.99%
Difference	18.32%	-8.87%	8.26%	1.61%	-1.89%

There are 105 dividend champions and 183 dividend contenders. As a result, the achievements of these fifteen companies are no small task. These companies are not buy recommendations. Instead, every dividend investor worth their salt should study each one of these companies in order to identify the characteristics that lead to these long histories of dividend increases. The lessons learned should hopefully pay huge dividends for decades to come.

Full Disclosure: Long EMR, PG, MMM, KO, JNJ, LOW, CL

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This article was included in the Carnival of Personal Finance #397 - Favorite Superbowl Commercials Edition

Fourteen Dividend Paying Machines for Further Research

Every week I review the list of dividend increases in order to feel the pulse of cash distributions by corporate America. I also use this list in order to learn about dividend increases or dividend cuts by companies I own. In addition, I use the list in order to gauge the momentum in dividend increases for companies I am considering for addition in my portfolio or to identify prominent dividend growers for further research.

Over the past week the following companies announced dividend hikes. I focused on the ones that have managed to boost distributions for at least five years in a row below:

Enterprise Products Partners L.P. (EPD) provides midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, refined products, and petrochemicals in the United States and internationally. The partnership boosted quarterly distributions from 65 to 66 cents/unit. This dividend achiever has regularly boosted distributions for 15 years in a row. Over the past 10 years, Enterprise Products Partners has managed to boost annual distributions by 6.70%/year. Yield: 4.90% Check my analysis of the partnership.

Kinder Morgan Energy Partners, L.P. (KMP) operates as a pipeline transportation and energy storage company in North America. The partnership boosted quarterly distributions from $1.26 to $1.29/unit. This dividend achiever has regularly boosted distributions for 16 years in a row. Over the past 10 years, Kinder Morgan Energy Partners has managed to boost annual distributions by 7.50%/year. Yield: 5.90%. Check my analysis of the partnership.

Kinder Morgan, Inc. (KMI) owns and operates energy transportation and storage assets in the United States and Canada. The company boosted quarterly distributions from 36 to 37 cents/share. The general partner of Kinder Morgan Partners has boosted dividends five times since going public in 2011. Yield: 4%

ONEOK, Inc. (OKE), a diversified energy company, engages in the gathering, processing, storage, and transportation of natural gas and natural gas liquids in the United States. The company boosted quarterly distributions from 33 to 36 cents/share. This dividend achiever has regularly boosted distributions for 10 years in a row. Over the past 10 years, ONEOK, Inc has managed to boost annual dividends by 15.10%/year. Yield: 3.10%. Check my analysis of the stock.

ONEOK Partners, L.P. (OKS) engages in the gathering, processing, storage, and transportation of natural gas in the United States. The partnership boosted quarterly distributions from 68.50 to 71 cents/unit. This MLP has regularly boosted distributions for 7 years in a row. Over the past 10 years, ONEOK Partners, L.P.has managed to boost annual distributions by 4.90%/year. Yield: 4.90%

Targa Resources Partners LP (NGLS) provides midstream natural gas and natural gas liquid (NGL) services in the United States. The partnership boosted quarterly distributions from 66 to 68 cents/unit. This MLP has regularly boosted distributions for 5 years in a row. Over the past 5 years, Targa Resources Partners has managed to boost annual distributions by 24.60%/year. Yield: 6.90%

Genesis Energy, L.P. (GEL) operates in the midstream segment of the oil and gas industry in the Gulf Coast region of the United States. The partnership boosted quarterly distributions from 47.25 to 48.50 cents/unit. This dividend achiever has regularly boosted distributions for 10 years in a row. Over the past 10 years, Genesis Energy has managed to boost annual distributions by 11.60%/year. Yield: 5.20%

The Williams Companies, Inc. (WMB) operates as an energy infrastructure company in the United States. The company boosted quarterly distributions from 32.50 to 33.875 cents/share. This dividend stock has regularly boosted distributions for 9 years in a row. Over the past 10 years, Williams Companies has managed to boost annual dividends by 11%/year. Yield: 3.90%

Omega Healthcare Investors, Inc. (OHI) operates as a real estate investment trust (REIT) in the United States. The company boosted quarterly distributions from 44 to 45 cents/share. This dividend achiever has regularly boosted distributions for 10 years in a row. Over the past 5 years, Omega Healthcare Investors has managed to boost annual dividends by 9.40%/year. Yield: 7.10%

Wisconsin Energy Corporation (WEC) generates and distributes electric energy, as well as distributes natural gas. The company boosted quarterly distributions from 30 to 34 cents/share. This dividend achiever has regularly boosted distributions for 11 years in a row. Over the past 10 years, Wisconsin Energy Corporation has managed to boost annual dividends by 11.60%/year. Yield: 3.60%

AptarGroup, Inc. (ATR) engages in the design, development, manufacture, and sale of consumer product dispensing systems in North America, Europe, Asia, and South America. The company boosted quarterly distributions from 10 to 12 cents/share. This dividend achiever has regularly boosted distributions for 19 years in a row. Over the past 10 years, AptarGroup Corporation has managed to boost annual dividends by 22%/year. Yield: 1.70%

The Finish Line, Inc. (FINL), together with its subsidiaries, operates as a mall-based specialty retailer in the United States. The company boosted quarterly distributions from 6 to 7 cents/share. This dividend stock has regularly boosted distributions for 6 years in a row. Over the past 5 years, Finish Line has managed to boost annual dividends by 36.90%/year. Yield: 1.70%

Alliant Energy Corporation (LNT), a utility holding company, provides regulated electricity and natural gas services to residential, commercial, and industrial customers in the Midwest region of the United States. The company boosted quarterly distributions from 45 to 47 cents/share. This dividend achiever has regularly boosted distributions for 11 years in a row. Over the past 5 years, Alliant Energy Corporation has managed to boost annual dividends by 7.40%/year. Yield: 4.10%

Shaw Communications Inc. (SJR) provides broadband cable television, Internet, home phone, telecommunication, and satellite direct-to-home services in Canada and the United States. The company raised its annual dividends by 5% C$1.02/share for Class “B” shares. This translates into a monthly dividend of 8.50 Canadian cents. This international dividend achiever has regularly boosted its monthly distributions for 11 years in a row. Yield: 4.30%

The list was dominated by Master Limited Partnerships, and many of their general partners. The two companies that I plan to research further include Omega Healthcare Investors (OHI) and Shaw Communications (SJR). I am considering increasing my exposure to real estate, through REITs. In addition, I am also interested in increasing my exposure to technology companies with sustainable competitive advantages. However, I am not going to diversify at all costs, as I thoroughly analyze each candidate before considering it worthy for inclusion in my portfolio.

Full Disclosure: Long KMI, EPD, KMR, OKS

Relevant Articles:

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- Master Limited Partnerships (MLPs)

V.F. Corporation (VFC) Dividend Stock Analysis

V.F. Corporation (VFC) designs and manufactures, or sources from independent contractors various apparel and footwear products primarily in the United States and Europe. This dividend champion has paid dividends since 1941, and has been able to boost them for 40 years in a row.

The company’s last dividend increase was in October 2012 when the Board of Directors approved a 20.80% increase to 87 cents/share. The company’s peer group includes Coach (COH), Ralph Lauren (RL) and PVH Corp (PVH).

Over the past decade this dividend growth stock has delivered an annualized total return of 18.70% to its shareholders.

The company has managed to deliver an 10.50% average increase in annual EPS since 2002. Analysts expect VF Corp to earn $9.54 per share in 2012 and $10.99 per share in 2013. In comparison, the company earned $7.98/share in 2011.

The company has transformed itself into a designer and marketer of casual lifestyle brands for the US population. The company focuses on its Outdoor & Action sports, Sportswear and Contemporary brands lifestyle businesses, as rhey are projected to reach 60% of sales by 2015. Increasingly, I see many people wearing jackets with the “North Face” logo, either at work or in the streets. In 2011, the company outlined in its strategy the goal to generate $5 billion in additional sales and $5 in additional earnings per share by 2015, from 2010 levels. Over the near term, profits are going to come from increase I profit margins as denim costs decrease. Another growth factor could be expansion into international markets, as well as strategic shifting of focus to more profitable brands. The company expects to grow international sales by 15%/year, until they reach 40% of total sales. The company has a history of making acquisitions work, as evidenced by Vans and North Face deals in the early 2000s. The deal for Timberland brand is expected to be accretive to earnings as well. The company delivers a quality product at an attractive price point for consumers.

Another factor that could contribute to revenue growth is increase in the direct to consumer channels of sales. This will be achieved by increasing number of retail stores in US and Internationally as well as through online sales.

The return on equity has decreased from 22% in 2002 to 12.50% by 2009. Since then, it has increased back up to 21.20% in 2011. I generally want to see at least a stable return on equity over time.

The annual dividend payment has increased by 10.90% per year over the past decade, which is lower than the growth in EPS.

An 11% growth in distributions translates into the dividend payment doubling every six and a half years on average. If we look at historical data, going as far back as 1988, one would notice that the company has actually managed to double distributions every eight years on average.

The dividend payout ratio has increased from 30% in 2002 to 57% in 2009, before decreasing to 33% by 2011. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently VF Corp is attractively valued at 16.50 times earnings and has a sustainable distribution. However, given the low yield of 2.30%, I would consider initiating a position in the stock on dips below $140.

Full Disclosure: None

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My Dividend Growth Stock Wish List

In a previous article I outlined three basic types of dividend growth stocks. One group of stocks included companies which are rapidly growing earnings through expansion. This could be through organic growth, acquisitions or through a combination of both. Most of these enterprises tend to reinvest a large portion of their earnings back into the business, which helps them to further generate higher profits. As a result, these companies tend to yield less than the average yield for S&P 500. In addition to that, because of their strong earnings growth, investors typically bid up these shares and they trade at rich valuations.

During recession however, investors start discounting future growth and indiscriminately start selling stocks off. This typically is the best time to purchase quality dividend growth stocks at attractive valuations. The tricky part is determining whether the long-term growth picture for the company is still intact. If investors manage to purchase these shares at attractive valuations, they stand a strong chance of generating market beating total returns as well as double or even triple digit yields on cost.

For example, investors who purchased $1,000 worth of shares of Wal-Mart Stores (WMT) at the end of 1984, and spent distributions each quarter, would be generating $1,321/year in dividends. By the end of 1984, Wal-Mart Stores had managed to boost dividends for ten consecutive years.

The companies on my wish list include:

Casey’s General Stores, Inc. (CASY), together with its subsidiaries, operates convenience stores under the Casey’s General Store, HandiMart, and Just Diesel names in 11 Midwestern states, primarily Iowa, Missouri, and Illinois. The company has raised dividends for 13 years in a row. Over the past decade, it has managed to boost distributions by 20.20%/year. Earnings per share are expected to grow by 11.50%/year over the next five years. The company trades at 18.30 times earnings and yields 1.20%. (analysis)

Family Dollar Stores, Inc. (FDO) operates a chain of self-service retail discount stores primarily for low and middle income consumers in the United States. The company has raised dividends for 36 years in a row. Over the past decade, it has managed to boost distributions by 12.70%/year. Earnings per share are expected to grow by 11%/year over the next five years. The company trades at 15.70 times earnings and yields 1.50%. (analysis)


YUM! Brands, Inc. (YUM), together with its subsidiaries, operates as a quick service restaurant company in the United States and internationally. The company has raised dividends for 9 years in a row. Over the past five years, it has managed to boost distributions by 17.80%/year. Earnings per share are expected to grow by 13.60%/year over the next five years. The company trades at 19.70 times earnings and yields 2%

Visa Inc. (V), a payments technology company, engages in the operation of retail electronic payments network worldwide. The company has raised dividends for 5 years in a row. Earnings per share are expected to grow by 18.30%/year over the next five years. The company trades at 51 times earnings and yields 0.80%.


These companies have shown solid earnings and dividend growth over the past decade. In addition, their earnings prospects for the foreseeable future look bright. This has made shares perennially overvalued, and thus makes it difficult to add to existing positions. If the market were to decline, it could probably bring these companies down to my value territory. If any of these companies stumbles in the short-term however, their stock prices could also fall to value territory. However, if any of these companies manages to raise dividends while the stock price remains flat or declines, they would be in buy territory for me. Buy territory would occur when stocks yields above 2.50% and trade at less than 20 times earnings.

Full disclosure: Long FDO, CASY, YUM, V, WMT

Relevant Articles:

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Spring Cleaning My Dividend Portfolio

Most articles on dividend investing focus on buying the best dividend stocks, reinvesting dividends and living happily ever after. They dazzle you with elaborate analysis and entry criteria, yet spend little in analyzing factors that cause one to sell.

In a long term dividend portfolio, I expect that there will be lots of change occurring over time in both company’s business prospects and portfolio composition triggered by the business environment changes. As a result even if you picked the best stock in the world at the best price, you might still need to consider selling for one reason or another.

I have tried addressing this issue in previous articles, where I identified three reasons where I will make me sell. The three reasons include dividend cuts, company being bought out for cash or position being too high relative to other portfolio components. The only automatic rule is selling after a dividend cut or if I get bought out for cash when a stock is acquired. In the process of my portfolio reviews, I have uncovered another guideline that would recommend selling a certain type of companies on a stock per stock basis.

In the past year, I have sold three companies, which have kept growing their distributions. I then replaced these with companies which had better earnings and growth prospects.

In the middle of 2012, I replaced most of my Con Edison (ED) shares with units of ONEOK Partners (OKS). Con Edison was growing earnings and distributions very slowly, and looked overvalued based on the low future expected growth in earnings. ONEOK Partners on the other hand had much better growth prospects and a higher yield. The more time I spent researching the industry, the more I view utilities as poor long-term dividend growth stocks with their tendency to pay high current yields but to cut distributions every once in a while.

At the very end of 2012, I sold my position in Exxon-Mobil (XOM) and purchased shares in ConocoPhillips (COP). Exxon-Mobil has one of the stingiest dividend payouts in the oil and gas industry, and it tends to prefer stock buybacks to cash distributions. ConocoPhillips on the other hand has a better payout, and looked like a better value. I wanted to maintain my energy exposure, which is why I bought shares of ConocoPhillips.

The third trade I recently made was selling my position in Cincinnati Financial (CINF) and purchasing shares in five Canadian banks. These banks included Toronto-Dominion Bank (TD), Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CM) and Royal Bank of Canada (RY). Cincinnati Financial had raised distributions at a very slow rate over the past five years, had a high dividend payout ratio and earnings were not expected to grow by much in the foreseeable future. The yield was high due to indiscriminate yield chasing by yield hungry investors, and the P/E ratio is close to 18. With the funds received, I purchased the five Canadian banks mentioned above in order to maintain exposure to financials in my portfolio. In addition, they had slightly higher yields on average, and better earnings and growth prospects than Cincinnati Financial.

Another trade I have made includes replacing Universal (UVV) with Phillip Morris International (PM) stock. Both companies have similar yields, although Universal has a lower P/E ratio relative to PMI. However, I view PMI’s growth prospects to be much brighter than those for Universal. In my last analysis of Universal, I  realized that the company might experience declines in earnings going forward.

In general, I reviewed each company’s prospects on a company per company basis before making a decision to sell. I viewed low growth in earnings, dividends and poor near-term growth prospects as negatives. I then tried to look for a replacement in the same sector, or a close substitute.

Full Disclosure: Long PM, BMO, CM, BNS, RY, TD, COP, OKS, ED

Relevant Articles:

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Sixteen Great Dividend Champions on Sale

My favorite list of quality dividend stocks that I use in my research is the list of dividend champions updated every month by David Fish. It is the most comprehensive list of US dividend growth stocks available. I also like David’s additional lists of the Contenders, while the Challengers provide another list of upcoming dividend growth stars. Without these lists, I would have been stuck in the dark days of following the Dividend Aristocrats and the Dividend Achievers indices, which exclude stocks based on stock market volume or the fact that they are not included in the S&P 1500 index.

I use the list to routinely scour the market for attractively valued stocks for further research. Every month, I run the following parameters:

1) At least 25 years of consecutive dividend increases

Only companies which have a solid business that generates extra cash flows are usually able to boost dividends for 25 years in a row. A company that cannot boost profitability will be unable to raise dividends over time. This does not ensure future success, but narrows the list for further research down significantly.

2) Price/Earnings ratio below 20

Even the best dividend stocks are not worth owning at any price. Investors who purchased Wal-Mart (WMT) in the year 2000 did not earn much in returns over the past 12 years, except for the dividend checks they cashed along the way. The business boomed since then, but because the price investors paid was expensive, stocks prices remained flat.

3) Dividend Yield above 2.50%

I like to purchase stocks that pay me at least a decent amount of dividend yield to hold on to their stock. If the dividend doubles over a decade for example, then the income I receive will be noticeable. If a company didn't pay a very high dividend and yielded only 1%, then dividends would have to increase substantially in order for me to generate a decent amount of dividend income. In addition, when stock prices fall in the next recession, a 2.50% yielder would provide a higher level of comfort than a 1% yielder.

4) Dividend Payout Ratio below 60%

I try to avoid companies paying more than 60% of earnings out in the form of dividends for safety. Earnings fluctuate every year, which is why a well-covered dividend can be sustained even in the event of a recession that leads to a temporary dip in profitability.

5) Ten year annual dividend growth rate above 6%

I usually look for a company that grows earnings and dividends at roughly the same percentages. The 6% dividend growth rate is slightly higher than the 5.50% dividend growth rate in the Dow Jones Index between 1920 – 2005 that I observed in this analysis. However, the premium is warranted because the companies I focus on have managed dividend policies.

The list I came up with, after applying the five criteria on the dividend champions group includes:

(The screen was run last week, and prices and information above reflect that)

I use this list only as a starting point for further research. Before investing your money in a business, you need to gain a very good understanding of it. One needs to understand how the business makes money and whether it has any competitive advantages such as recognizable brand names, which can translate into strong pricing power. In addition, investors also need to look at trends in revenues, earnings and dividends, and then try to assess whether profits can increase over time. A company that targets earnings growth should also be analyzed to see if it has a plan to achieve this.

Full Disclosure: Long AFL, APD, CLX, KO, MCD, PEP, SYY, WAG, WMT

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Stryker Corporation (SYK) Dividend Stock Analysis

Stryker Corporation (SYK), together with its subsidiaries, operates as a medical technology company. The company operates in three segments: Reconstructive, MedSurg, and Neurotechnology and Spine. The company is a member of the dividend achievers index, and has been able to boost distributions for 20 years in a row.

The company’s last dividend increase was in December 2012 when the Board of Directors approved a 24.70% increase to 26.50 cents/share. The company’s peer group includes Johnson & Johnson (JNJ), Zimmer Holdings (ZMH) and Smith & Nephew (SNN).

Over the past decade this dividend growth stock has delivered an annualized total return of 6% to its shareholders.

The company has managed to deliver an 11% average increase in annual EPS since 2002. Analysts expect Stryker to earn $4.04 per share in 2012 and $4.30 per share in 2013. In comparison, the company earned $3.45/share in 2011.

The medical device sales tax that will be introduced in 2013 might reduce near term earnings. Softer hospital budgets might also be unfavorable to earnings growth. The market for US reconstructive sales is expected to recover, thus boosting Stryker’s revenues, and hopefully offsetting any softness from Europe. The company’s future growth could come from acquisitions as well as new product launches. It spends 17%/year in R&D expenses per year in an effort to maintain market share in an increasingly competitive marketplace.

The return on equity has decreased from 27% in 2002 to 18% by 2012. I generally want to see at least a stable return on equity over time.

The annual dividend payment has increased by 33.50% per year over the past decade, which is higher than the growth in EPS.

A 33% growth in distributions translates into the dividend payment doubling every two years on average. If we look at historical data, going as far back as 1993, one would notice that the company has actually managed to double distributions every three years on average.

The dividend payout ratio has increased from 6% in 2002 to 21% in 2011. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Stryker is attractively valued at 14.70 times earnings and has a sustainable distribution. However, given the low yield of 2%, I would consider initiating a position in the stock on dips below $43.

Full Disclosure: Long JNJ

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