Harry Domash maintains a variety of model portfolios that are each built around various income inves...
The Dividend Kings: Part 5
06/08/2018 5:00 am EST
Today we continue with our special 6-part report from Ben Reynolds, editor of Sure Dividend — a weekly countdown of the Dividend Kings, an elite group of 24 stocks with 50 or more consecutive years of dividend increases.
If you missed Part 1 of this series you can read it here.
If you missed Part 2 of this series you can read it here.
If you missed Part 3 of this series you can read it here.
If you missed Part 4 of this series you can read it here.
Vectren Corporation (VVC)
Vectren is an energy holding company that was formed through the merger of SIGCORP and Indiana Energy in March of 2000. The company is headquartered in Evansville, Indiana and, through numerous operating subsidiaries, provides gas and electricity to more than 1 million customers in service territories that cover nearly two-thirds of Indiana and one-fifth of Ohio.
Vectren has increased its annual dividend for 58 consecutive years, which more than qualifies it to be a member of the Dividend Kings list.
Vectren has a very attractive industry position in the regulated utility industry. Indeed, there’s plenty to like about the utility business model. It is capital intensive and has very close regulatory oversight, two factors that discourage new competitors and create barriers to entry that benefit Vectren.
In addition, Vectren provides a service (electricity) that is essential to modern life and certain to grow in demand over time. The company’s long-term annualized earnings-per-share growth rate has been around 5%. While 5% earnings growth doesn’t sound overly impressive, we believe that it is attractive on a risk-adjusted basis as this earnings growth has been very stable over time.
Despite these appealing characteristics, now is not a good time for investors to purchase Vectren stock. The company is significantly overvalued at current prices. More specifically, Vectren is trading at a price-to-earnings ratio of 24.5 and its ten-year average price-to-earnings ratio is 17. V
aluation contraction will likely reduce Vectren’s future returns. Investors ought to avoid this company for the time being and either wait for a more attractive entry point or invest in another regulated electric utility.
3M Company (MMM)
3M is a diversified industrial manufacturer that produces more than 60,000 products used in homes, hospitals, office buildings, and schools around the world. The company employs more than 90,000 people and sells its products in more than 200 countries. 3M has increased its dividend for 59 consecutive years and operates through 5 business segments: Industrial, Safety & Graphics, Electronic & Energy, and Consumer.
3M’s long-term growth has been nothing short of remarkable. The company’s success is largely due to its continued focus on innovation. 3M targets research & development spending equivalent to 6% of sales ($2 billion in 2017) in order to create new products that satisfy consumer demand.
This spending has been very beneficial over time. Approximately 30% of last year’s sales came from products that did not exist five years ago. 3M’s commitment to innovation has led to a portfolio of more than 100,000 patents.
The one negative component of 3M’s investment thesis is the firm’s valuation. The company is trading at a noticeable premium to its long-term average price-to-earnings ratio. More specifically, 3M is currently trading at a price-to-earnings ratio of approximately 19.2 and its 10-year average price-to-earnings ratio has been 17.2.
Valuation contraction will present a headwind for 3M’s future returns. Accordingly, we recommend that investors hold their current shares high-quality dividend growth stock, but wait for a better entry point to initiate or add to a position.
Emerson Electric Company (EMR)
Emerson Electric is a global industrial manufacturer with a market capitalization of $45 billion. The company was founded in Missouri in 1890 and, since that time, has grown into a manufacturing leader with two operating segments: Automation Solutions and Commercial & Residential Solutions.
The company generates more than $14 billion in annual revenue. Emerson Electric has increased its dividend for 61 consecutive years, qualifying it for inclusion in the Dividend Kings list.
Emerson Electric’s diversified business model and technical expertise makes it qualitatively attractive for the same reasons as 3M. However, Emerson Electric has not executed nearly as well as 3M. More specifically, 2018’s earnings-per-share are on pace to essentially equal 2008’s earnings-per-share.
This lack of growth over the last decade is troubling, but the company has changed its capital allocation principles to address this. Emerson Electric now seeks to focus more on acquisitions and share repurchases, instead of aggressively growing its per-share dividend payments (which was previously a strong priority).
Still, we are hesitant to believe that the company’s growth trajectory will be able to improve so quickly. To make matters worse, Emerson Electric is yet another Dividend King that is significantly overvalued at current prices. The company is trading at a price-to-earnings ratio of 23.0 and its 10-year average price-to-earnings ratio is around 18.
Accordingly, we believe that a rising valuation will negatively impact Emerson Electric’s future returns. Because of the company’s lackluster historical earnings growth, investors who are looking for exposure to the industrial manufacturing industry would do well to wait for buying opportunities in fellow Dividend King 3M instead.
Parker-Hannifin Corporation (PH)
Parker-Hannifin is a manufacturer of industrial components that work to power the world’s factories and machines. The company was founded in 1918 and has grown to a market capitalization of approximately $23 billion and more than 50,000 employees. Parker-Hannifin’s 61 years of consecutive dividend increases easily qualifies it to be a member of the Dividend Kings.
Parker-Hannifin has compounded its earnings-per-share at about 4% per year over the last decade. We believe that this historical growth rate dramatically understates the company’s potential moving forward. More specifically, we believe that Parker-Hannifin is capable of growing at around 7% per year, driven largely by acquisitions.
As an example, the company recently closed on the $4.3 billion acquisition of CLARCOR, a transaction that is expected to generate $140 million in annual run rate cost synergies three years after closing.
Importantly, the acquisition was immediately accretive to the pro-forma company’s cash flow, earnings-per-share, and EBITDA margins after adjusting for one-time costs. We expect similarly intelligent acquisitions to be implemented moving forward.
Like the other Dividend Kings discussed in this article, Parker-Hannifin is trading at a premium to its long-term average valuation multiples. More specifically, the company is trading at a price-to-earnings ratio of approximately 17.5 and its long-term average price-to-earnings ratio is 15.
Valuation contraction will impair Parker-Hannifin’s future returns if the company’ returns to its 10-year average earnings multiple. Still, investors would do well to keep a close eye on this high-quality business and accumulate shares when the price falls to a more attractive level.
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