Editors' Pick: Originally published Feb. 17.
On May 15, 2015 the Dow Jones closed at 18,272. That is it's all time high. Since then, the Dow Jones has fallen by 10% to 16,412.
The VIX Index, often called the "fear index," measures market volatility and is now up. On May 15, 2015 the VIX closed at 12.4. It has nearly doubled since that time. Today the VIX is at 22.9.
What should investors do when fear rises and the stock market falls?
Invest in high quality dividend paying businesses at reduced prices. Warren Buffett knows this well. It is one of the ways he has grown his fortune to over $60 billion.
"Be fearful when others are greedy and greedy when others are fearful"
- Warren Buffett
This article examines 10 high quality dividend growth stocks that have seen their stock price fall 20% or more from highs.
The 10 stocks in this article are the 10 highest ranked stocks using The 8 Rules of Dividend Investing that also have 20% or greater declines off of highs.DIS data by YCharts
10. Disney (DIS)
Founded in 1923, Disney is a gigantic corporation with a very long corporate history. The company has a market cap near $150 billion.
Most giant old corporations don't see rapid growth. Disney is the exception. The company has compounded its earnings-per-share at 18.8% a year over the last five years. To put that into perspective, Google grew earnings-per-share (EPS) at 15.4% a year over the same time period.
Disney has grown faster than Google over the last five years. With that type of growth, you would expect Disney to have a high price-to-earnings ratio. After all, Google has a price-to-earnings ratio of 28.7. Disney has a price-to-earnings ratio of just 17. The company saw earnings-per-share grow 28% in its most recent quarter.
Disney's stock price has declined 24% from highs reached in November of 2015. The company's decline is being driven by declining income from ESPN.
Disney's Media Networks segment as a whole saw operating income decline 6% versus the same quarter a year ago. The Media Networks segment is responsible for 33% of Disney's operating income.
The Media Networks segment will likely slowly decline as viewers continue to move away from cable and toward online streaming options. This is a medium-term trend.
In the long-run Disney's prospects are very favorable. The core of the company's competitive advantage is its phenomenal intellectual property. Disney owns Marvel (X-Men, Avengers), LucasFilm (Star Wars), ESPN, ABC, Pixar, and traditional Disney brands (Mickey Mouse, Frozen, etc.).
The method of content distribution may change from cable television to online streaming. What won't change is people's willingness to pay for the brands, shows, and characters they love.
We live in a period of increased content consumption. Disney is one of the best content creators on the planet. The company's long-term prospects remain bright. Now is an excellent time to buy shares of Disney at a discount.
9. Pentair (PNR)
Pentair is an diversified manufacturing company based in Ireland (since 2014).
The company has a tax advantage from its Irish headquarters. Pentair uses this advantage to acquire other manufacturers and boost the bottom line through lower taxes.
In full fiscal 2016 the company's tax rate is expected to be around 23%. The effective tax rate for several of Pentair's competitors is shown below:
- Parker-Hannifin had a 2014 tax rate of 28.5%
- Flowserve had a 2014 tax rate of 28.9%
- Dover had a 2014 tax rate of 29.6%
For every $1 of profit Pentair earns, it generates an extra $0.05 to $0.06 of after-tax profit more than its competitors just because it is based in Ireland.
Pentair classifies itself as "a global provider of systems and solutions to serve the world's food, water, and energy needs." The company generates 50% of its sales in the United States and Canada and operates in four segments:
- Water Quality Systems
- Valves & Controls
- Flow & Filtration Solutions
- Technical Solutions
Pentair has paid increasing dividends for 39 consecutive years. This qualifies the company to be one of only 50 Dividend Aristocrats. To be a Dividend Aristocrat a company must have paid increasing dividends for 25 or more consecutive years. Click here to see all 50 Dividend Aristocrats. The company's long dividend streak is evidence of a sustainable competitive advantage.
Pentair's competitive advantage comes from its lean manufacturing processes and ability to redeploy capital form lower margin businesses into higher margin businesses.
Pentair is highly focused on lean manufacturing and continuous improvement. Most businesses talk about increasing efficiency. Pentair has results to back this up. The company has grown its net profit margin by 3.5% a year over the last decade.
Pentair is currently trading at an adjusted price-to-earnings ratio of just 12.3. The company is not priced for growth but it has excellent long-term growth potential.
Pentair's management believes it can compound earnings-per-share at 15% a year. The company plans to accomplish this through organic growth, acquisitions, efficiency gains, and share repurchases.
Even if Pentair does not grow at 15% a year it is deeply undervalued. The company's stock is low due to the global growth slowdown which has hurt the stock price of much of the manufacturing sector. The company makes a timely purchase at current prices.
8. Cummins (CMI)
Cummins is the world's largest manufacturer of diesel engines. The company has:
- 78% market share in mid-duty (MD) diesel truck engines in North America
- 34% in heavy-duty (HD) diesel truck engines in North America
- 42% MD & HD market share in truck diesel engines in India
- 17% MD & HD market share in truck diesel engines in China
Cummins full year 2015 results showed adjusted earnings-per-share of $8.93. This is a slight decline from $9.13 the previous year.
The company is expecting further earnings-per-share declines of between 2% and 10% in 2016 due to general weakness in the diesel engine industry brought about by the global growth slow down and the strong U.S. dollar.
The growth slowdown has caused Cummins stock to fall around 35% from highs of over $150 per share reached in the Summer of 2014. The market has greatly overreacted.
- Share price declines of about 35%
- Expected earnings-per-share declines of 12% at worst
This is great news for investors looking to build a position in Cummins. The company has paid steady or increasing dividends for 25 consecutive years. It must have strong and durable competitive advantage to have dominant market share and such a long dividend streak.
The company's competitive advantage is its large research and development spending on diesel engines. The company has spent over $2 billion in the last three years on research and development.
The diesel engine industry may not sound like fertile ground for double-digit earnings-per-share growth, but Cummins has managed to grow its earnings-per-share at 11.3% a year over the last decade.
The company will likely manage double-digit earnings-per-share growth over the long-run through further international expansion, purchasing and consolidating its independent distributors, and share repurchases.
Cummins' price-to-earnings ratio (P/E) has averaged about 15 over the last two years. The company is currently trading for a P/E ratio (using adjusted earnings) of just 11.2 -- and earnings are depressed. When the company's operating environment improves and margins normalize, the company will have earnings-per-share of about $10. Fair value for Cummins stock is around $150. It is currently trading for around $100 per share.
7. Wal-Mart (WMT)
It is difficult to overstate Wal-Mart's dominance in the discount retail industry. If Wal-Mart were a country (assuming revenue is about equal to GDP), it would be the 28th largest in the world based on its annual revenue of $484 billion.
Wal-Mart's share price has declined 25% since highs reached in January of 2015. The company had earnings-per-share of $5.07 in fiscal 2014. Wal-Mart is expecting earnings-per-share of $4.10 in fiscal 2016 -- a 19% decline.
Wal-Mart is a blue-chip stock trading at a discount to fair value.
The company's decline is temporary. It is brought about by the following factors:
- Wage increases for employees
- Increased investment in digital business
The wage increase will not cause Wal-Mart to continuously lose ground. The company will not hike wages indefinitely for its associates. Digital sales investments have been ramped up recently, but will also not continue indefinitely at their above average pace.
Wal-Mart's competitive advantage is what drives long-term value for the company and Wal-Mart's competitive advantage remains intact.
Investors should expect total returns of 8%-to-10% a year from Wal-Mart. Total returns will come from: 3%-to-4% sales growth each year; 2%-to-3% share repurchases each year; and a dividend yield of about 3%.
Wal-Mart's competitive advantage comes from its scale and operating efficiency. Its size allows it to command the best prices from its suppliers. The company pressures suppliers to lower their prices and then passes savings on to consumers, resulting in a positive feedback loop.
One of the advantages to Wal-Mart stock is that it has historically performed well during recessions. The Great Recession of 2007-to-2009 did not impede operations. Wal-Mart grew revenue, earnings, and dividends each year through the recession. When the S&P 500 fell 38% in 2008, Wal-Mart gained 18%.
Wal-Mart shares are trading near all time dividend-yield highs. Before late 2015 investors never had the opportunity to pick up Wal-Mart at dividend yields of around 3% or higher. Wal-Mart is Warren Buffett's 20 highest yielding holdings.
The company's stock is likely undervalued due to negative headwinds surrounding the company. Investors looking to build a position in the global leader in discount retailer can lock in yields of around 3% by investing in Wal-Mart.
6. Flowers Foods (FLO)
Flowers Foods sells bread and cake products under the following brands (among others)
- Nature's Own
- Dave's Killer Bread
- Alpine Valley Bread
The company has a market cap of $3.3 billion and an above average dividend yield of 3.7%. Flowers Foods has paid steady or increasing dividends since 1987. The company's stability comes from its strong brands in the slow changing bread and cake industries.
Flowers Foods competitive advantage is a mix of its well-known brands and its large baking and bread distribution network. The company is the second-largest bread maker in the United States, behind only Grupo Bimbo.
Flowers Foods shares have collapsed 40% since highs reached in October of 2015. What is amazing about this collapse is that the company is still growing its earnings-per-share. Flowers Foods grew adjusted earnings-per-share 2.2% in fiscal 2015.
The reason Flowers Foods share price has collapsed is because the company experienced a sales slowdown in the fourth quarter of fiscal 2015. Sales fell 2.2% and earnings-per-share plunged 20% on the quarter. The company was not expecting sales to decline, which resulted in the company failing to control costs and ultimately seeing earnings-per-share decline significantly.
The company is expecting earnings-per-share growth of 6.5% to 13.0% in fiscal 2016. These are not the metrics of a struggling company.
Over the last decade Flowers Foods has compounded earnings-per-share at 11% a year. The company will likely compound earnings-per-share at between 7% and 11% a year going forward. This growth combined with the company's 3.7% dividend yield gives investors in Flowers Foods expected total returns of 10.7% to 14.7% a year going forward.
The company has maintained a price-to-earnings above 20 for much of the last five years. The company is currently trading for a price-to-earnings ratio of 17.7. The fourth quarter sales decline is likely temporary -- but it does provide an excellent entry point to buy shares of Flowers Foods.
5. Parker-Hannifin (PH)
Parker-Hannifin is the world's leading manufacturer of motion and control technologies. The company was founded in 1918 and now has a market cap over $13 billion.
Parker-Hannifin has one of the longest streaks of consecutive dividend payments of any business. The company has paid increasing dividends for 59 consecutive years. This makes Parker-Hannifin a member of the exclusive Dividend Kings Index. To be a Dividend King, a stock must have paid increasing dividends for 50 or more consecutive years. Click here to see all 17 Dividend Kings.
Parker-Hannifin saw its adjusted earnings-per-share decline 17.4% on a constant currency basis in its most recent quarter. The company's customers are struggling due to low oil prices. This is resulting in fewer sales at Parker-Hannifin. The company's share price is down over 20% since highs reached in December of 2014.
Parker-Hannifin's business is cyclical. The company saw earnings-per-share declines when oil prices plummeted in 2009. Despite this the company produces solid long term results. Parker-Hannifin has compounded its earnings-per-share at 8.2% a year over the last decade.
Expect the company to grow earnings-per-share at 7%-to-9% a year over the next decade. This growth combined with the company's current 2.5% dividend yield gives investors expected returns of 9.5%-to-11.5% a year before valuation multiple changes.
Parker-Hannifin's average price-to-earnings multiple over the last six years is 14.7. The company is currently trading for an adjusted price-to-earnings ratio of around 13.7-times peak earnings. The company is likely somewhat undervalued at current prices. Rising oil prices will likely be the catalyst that propels Parker-Hannifin's earnings forward.
4. Johnson Controls (JCI)
Johnson Controls manufactures car interiors and components, building control systems and power solutions, and battery systems. The company was founded in 1885 and has paid steady or increasing dividends for 38 consecutive years.
Johnson Controls has the following automotive market shares by region:
- 44% in China
- 38% in Europe
- 36% in North & South America
- 13% in South East Asia, Japan, and Korea
No company gains large market share and pays steady or increasing dividends for 3-plus decades without a competitive advantage.
Johnson Controls' history and size give it a competitive advantage in the automotive manufacturing market. The company's global reach and large market share in China make it difficult for new entrants to compete with Johnson Controls.
The company's stock has declined over 30% sine highs reached in the summer of 2015. The global growth slowdown (especially in Asia) is negatively affecting the company's share price.
Despite the slowdown, Johnson Controls continues to post solid results. The company saw adjusted earnings-per-share increase 11% in its most recent quarter due to revenue growth, rising margins, and share repurchases.
When earnings-per-share are up 11% while the stock is down 30%, it is very likely the investing crowd has overreacted.
The company's long-term growth driver is population growth in emerging markets -- especially China. Greater need for energy storage due to variable solar and wind power generation will also provide favorable tailwinds for the company's power and battery solution systems.
Johnson Controls is expecting 8%-to-14% EPS growth in 2016. Over the long-run, expect EPS growth of between 7% and 9%, in line with historical averages. This growth combined with the company's 3.3% dividend yield gives investors expected returns of 10.3%-to-12.3% a year.
The company is undergoing a transformation. Johnson Controls plans to spin-off its automotive business in October of 2016. The company recently announced the name of this spin-off: Adient. The spin-off will allow Johnson Control's two primary business units to pursue independent strategies, which will benefit shareholders.
In addition to the spin-off, Johnson Controls is also merging with Tyco. The merger will relocate Johnson Controls to Ireland to take advantage of lower corporate tax rates in the country. The merger will also create cost-cutting synergies and greatly expand Johnson Controls manufacturing capabilities and product offerings.
Johnson Controls is currently trading for a price-to-earnings-ratio of just 10.1, using adjusted earnings. The company's historical average price-to-earnings ratio is 13.5 (which seems to low). Shares of the company are trading for about $35. Using its historical average price-to-earnings ratio, Johnson Controls shares should be trading for $46 not counting the company's above average growth prospects from the Tyco merger.
The company's historical average P/E ratio is about 13.5. Johnson Controls is currently trading for a P/E ratio of 10.2. Shares of the company are trading for $35.78; fair value is likely around $46 per share for a 22% margin of safety.
3. Abbott Laboratories (ABT)
Abbott Laboratories is a diversified health care company that manufactures and sells nutrition products, medical devices, diagnostic equipment, and pharmaceuticals.
Abbott Laboratories stock is down 25% versus highs reached in the Summer of 2015. Investors are worried about potential earnings declines from the growth slowdown in emerging markets.
Abbott Laboratories full fiscal 2015 results showed adjusted earnings-per-share growth of $2.15 for the full year, growth of 8.6% versus the previous year. Obviously there is quite a discrepancy between the 25% market decline and 8.6% earnings-per-share growth.
With such a big decline, you'd think Abbott Laboratories announced a horrendous 2016 outlook.
The company is expecting adjusted earnings-per-share of $2.10 to $2.20 in fiscal 2016. Excluding issues in Venezuela from the company's currency and negative currency effects from the strong United States dollar, Abbott Laboratories is projecting 10% Adjusted earnings-per-share growth. This is far from troubling news -- especially considering the poor global economic state.
Abbott Laboratories has paid increasing dividends for 44 consecutive years. The company has invested heavily in emerging markets. The company emphasizes manufacturing its products in the same country in which the products are sold. This reduces currency fluctuation risks and builds connections with communities, companies, and governments. The company also owns many of the most trusted global brands in infant, child, and elderly nutrition.
Abbott Laboratories generates 70% of its revenue in international markets. The company has large operations in several key emerging markets. This international exposure gives Abbott excellent long-term growth prospects as it benefits from faster emerging market growth and global aging populations. The company stands to benefit from China's lifting of the "one child policy"; this should boost formula sales for Abbott Laboratories over the next several years.
Abbott Laboratories is trading at an adjusted price-to-earnings ratio of around 17.5. The company's price-to-earnings ratio has averaged around 20 over the last several years. Abbott Laboratories is likely trading at a 12.5% discount to fair value at current prices. Now is a rare opportunity to pick up this high quality medical company for a reasonable price.
2. United Technologies (UTX)
United Technologies is a large diversified manufacturer that owns the following:
- Otis elevators
- Kidde smoke alarms
- Carrier air conditioning
- Pratt & Whitney aircraft propulsion
- UTC Aerospace Systems (aircraft components)
United Technologies saw constant currency adjusted earnings-per-share rise 1% in its most recent quarter. Much of the manufacturing sector is slowing; United Technologies is no exception.
While growth has slowed, the company's share price has plunged around 27% since highs reached in February of 2015.
The company's management is taking action. United Technologies is undertaking a $1.5 billion restructuring plan that will go through 2018 and provide an estimated $900 million a year in savings.
United Technologies has grown earnings-per-share at around 9% a year over the last decade. When the global economy returns to normal, expect the company to grow EPS at 8% to 11% per year.
United Technologies is expecting adjusted EPS growth of 0%-to-5% in 2016. The company is targeting $3 billion in share repurchases in 2016, approximately 4% of market cap. In addition, United Technologies has a 3% dividend. Share repurchases, margin improvements, organic growth, and dividends give investors an expected total return of 11%-to-14% per year over the long run.
The company has a long history of success. United Technologies has paid steady or increasing dividends 46 years. The company's competitive advantage comes from a mix of its size and scale combined with lean manufacturing, technological know-how, and existing contracts and relationships with large government customers.
Over the last decade (excluding the Great Recession period), United Technologies P/E ratio has averaged around 16. It is currently at around 14. Fair value for the company's stock is around $100. The company's stock is currently trading for about $88 a share.
1. Archer-Daniels-Midland (ADM)
Archer-Daniels-Midland was founded in 1902. The company has grown tremendously since that time. Today ADM employs 33,000 people in 140 countries. The company is the largest farm products corporation in the world based on its $20 billion market cap.
ADM's business is cyclical and is currently in a downturn. The company saw earnings-per-share of $0.61 in its most recent quarter versus $1.00 in the same quarter a year ago. The company's share price has declined around 35% since highs reached in the summer of 2015.
A downturn in grain prices and oil have caused the company's stock price and earnings decline. Oil prices effect ADM because the company is a leading producer of ethanol. When oil prices are low, ethanol demand drops. When oil prices are high, ethanol demand rises.
These declines are temporary. ADM's earnings and stock price will recover when grain and oil prices rise.
ADM's dividend is safe despite the downturn. The company recently increased its dividend 7%. This is a sign of good faith from management that company's dividend is not at risk. History is on the company's side. ADM has increased its dividends for 41 consecutive years. For a company to increase its dividend every year over such a long time period it must have a strong competitive advantage.
ADM's competitive advantage comes from its excellent global distribution network. The company owns the following: 283 processing plants, 413 procurement facilities, about 250 warehouses, and many rail cars, trucks, and ocean vessels for transportation. It would take an enormous upfront capital investment for a competitor to come close to matching the scale and distribution network of ADM.
ADM has compounded its earnings-per-share at 13.6% a year from 1999 through 2015. The long-term growth driver for ADM is increased food consumption from growing global populations.
Expect the company to grow earnings-per-share at between 7% and 10% a year, going forward. This growth combined with the company's current 3.6% dividend yield gives ADM investors an expected total return of 10.6%-to-13.6% a year before valuation multiple changes.
ADM's cyclical downturn has made the stock a bargain. ADM is currently trading for an adjusted price-to-earnings ratio of just around 11.3. ADM's historical median price-to-earnings ratio over the last decade is around 13.5. Earnings are depressed at $2.98 per share. EPS under normal economic conditions would be about $3.50. Using "normal" EPS of $3.50 and the company's median average P/E ratio of 13.5 implies a fair value of about $47 per share. The company is currently trading at about $33.50 per share.