The 12 Best Dividend Aristocrats: Part 2

02/08/2019 5:00 am EST

Focus: STRATEGIES

Ben Reynolds

CEO, Sure Dividends

In this 4-part series (featured each Friday in February), Ben Reynolds, CEO and editor of Sure Dividend, highlights his 12 favorite dividend aristocrats — a group high quality stocks that have increased their dividend for 25+ consecutive years, meet certain minimum size and liquidity requirements and  are in the S&P 500.

If you missed Part 1 of this report, you can read it here:

Caterpillar (CAT)

Caterpillar manufactures and sells equipment used in the infrastructure and natural resources industries.  The company was founded in 1925 and has grown to reach a market cap of $78 billion. Caterpillar became a Dividend Aristocrat this year, having increased its dividend for 25 consecutive years.

The company’s dividend history stands out in what is a historically cyclical industry. Caterpillar is not immune to cyclicality, but is well managed and remains consistently possible even in the worst of times. As an example, the company both remained profitable and paid rising dividends through The Great Recession.

Caterpillar stock is currently yielding 2.6%, which is above the S&P 500’s yield of 2.0%.  Caterpillar stock has generated solid growth in recent years.  Earnings-per-share surged 63.1% from 2017 to 2018. The company expects adjusted earnings-per-share of $12.25 at its median guidance for fiscal 2019. With a volatile earnings history, dividend growth is a better way to measure the company’s growth.

And the company has not disappointed on that front, compounding dividends-per-share at 7.7% annually from 2009 through 2018. We expect growth to mediate a bit going forward.  Our 5-year target growth estimate for Caterpillar is around 6% annually.

With 6% expected growth and a 2.6% yield, Caterpillar stock is set to deliver solid-if-unspectacular returns of around 8.6% annually ahead before valuation multiple changes. Caterpillar looks undervalued today.

The company is trading for under 11 times expected 2019 adjusted earnings-per-share. The company’s average price-to-earnings ratio since 2010 is around 15.  If Caterpillar reverts to its historical average valuation multiple, shareholders will see a significant boost to total returns. 

An investment in Caterpillar requires the ability to withstand large drawdowns due to the cyclicality of the industry. But investors are likely to be rewarded over the long run by this high-quality dividend growth stock trading at an attractive price.

A.O. Smith (AOS)

A.O. Smith is a leading manufacturer of residential and commercial water heaters, boilers, and water treatment products. The company has an $8 billion market cap, making it one of the smaller Dividend Aristocrats. A.O. Smith has increased its dividend payments for 25 consecutive years.

What immediately stands out about A.O. Smith is its impressive growth record. The company has compounded its earnings-per-share at 18.4% annually from 2009 through 2018. And this wasn’t off of a low base; A.O. Smith grew its earnings-per-share in 2008 and 2009 while many businesses were seeing earnings decline.  The company realized excellent results in fiscal 2018, as adjusted earnings-per-share surged 20.3% versus 2017.

With that said, A.O. Smith is expecting growth to slow significantly in fiscal 2019 to just 4.2% at its guidance midpoint, due to an inventory build up in its China operations.

Note that the company has compounded its Chinese sales at more than 20% annually over the last decade. Still, the long-term future at A.O. Smith is bright. We expect earnings-per-share growth of around 9% annually over the next several years past 2019.

While A.O. Smith’s growth story remains, it isn’t a high yielding stock. The company’s current dividend yield is 1.8%, below the S&P 500’s 2.0% dividend yield. But with a low payout ratio of around 30% and more growth ahead, A.O. Smith’s dividend is very likely to continue rising.

A.O. Smith stock currently trades for around 18 times expected 2019 earnings.  From 2013 through 2018, the company’s average price-to-earnings ratio is 21.7.  We believe A.O. Smith is a bit undervalued today and offers shareholders double-digit expected total returns ahead.

W.W. Grainger (GWW)

W.W. Grainger is one of the world’s largest maintenance, repair, and operations (abbreviated as MRO) parts suppliers. The company was founded in 1927, has a market cap of more than $16 billion, and has increased its dividend every year for a remarkable 46 consecutive years.

Shares of W.W. Grainger have been on a wild ride.  The share price more-or-less hovered around $250 from mid-2013 through 2016. In 2017, share prices fell to lows of around $160 on fears that Amazon (AMZN) would steal significant market share from W.W. Grainger. 

But W.W. Grainger responded by posting all time adjusted earnings-per-share highs in fiscal 2018 — up a remarkable 45.7% versus 2017’s numbers. The share price rebounded as well and is now around $300.

But there’s still upside at W.W. Grainger.  Like A.O. Smith, W.W. Grainger doesn’t have a high dividend yield; it’s sitting at 1.8%. But the company is expecting solid growth ahead. Management’s guidance calls for earnings-per-share growth of around 7% in fiscal 2019. 

The company’s profit growth last year received a boost from a lower tax rate which won’t repeat.  But sales are expecting to continue growing, and W.W. Grainger was able to increase its operating margin in 2018 — and expects further gains in 2019 as the company reduces costs further.

The company is also very shareholder friendly as evidenced not only by its long dividend streak, but also by its extensive share repurchases. The company has reduced its share count by 4.4% annually from 2013 through 2018.

All told, we expect earnings-per-share growth of around 7% annually for W.W. Grainger over the next several years.  This growth combined with the company’s dividend gives expected total returns before valuation multiple changes of around 9% annually.

Each year from 2012 through 2016 W.W. Grainger had an average annual price-to-earnings ratio of 19 or higher. The company is currently trading for less than 17 times expected fiscal 2019 earnings. 

We believe W.W. Grainger to be a bit undervalued at current prices. Expected valuation expansion combined with the company’s dividend yield and growth prospects pushes W.W. Grainger’s expected total returns to 10%+ over the next several years.

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