Stock Picking Based on Company History

When you are choosing dividends so that you can begin building an income stream, it is important to consider your options and choose carefully. There are a few items you should consider as you look for the best dividend stocks, and one of them is payment history. You want to follow the trends in dividend payment at the company so that you can get an idea of whether or not the company is likely to continue at the same rate.

Some of the things to pay attention to when considering the dividend payment history of a company include:

Dividend Yield Average

The dividend yield average can tell you a lot about a company’s dividend. When a stock is trading with a yield above its average it could possible be considered undervalued, or under bought. When a stocks is trading with a yield less than its average it may be over bought. The yield average can also help you get a quick idea of where the stock stands now compared to recent years. Stocks with a dividend yield far above its average may be in trouble unless this higher than average yield is due to significant dividend growth.

Dividend Growth Rate

One of the things you can do is look at the dividend growth rate over a period of five years. You can get this number annualized, but year to year there may be more volatility. If you want a number that smooths the volatility, the five-year dividend growth rate can be helpful. The hope, of course, is that you see an increase in dividends over time. Our general target is to find stocks that have a dividend growth rate of 5% or more.

Dividend Payment History

Another thing you can do is check to see how long the company has kept with its schedule. Has the company been paying out dividends at a steady rate for the last five years? 10 years? 25 years? The long the company has of solid dividends, the better off you are likely to be. Our safe dividend list covers companies that have increased its dividend for 25 years or more.

Dividend Cuts

Also look at the history of dividend cuts. During times of economic trouble, it is common to see cuts, but you want to see also that the dividend was raised against after the trouble eased. A red flag is if you look and see that dividends cuts have proceeded even thought the rest of the industry is doing well, or if economic growth is happening.

Net Income Growth Rate

This is a look at the rate at which the company’s income grows. Understanding how the company’s income is increase is important. This is because dividends are based on profits. If a company’s past performance shows that the net income is decreasing, it could be a sign that dividends will be cut soon.

Industry Performance

You also want know the outlook and performance of the industry as a whole. Look at the past performance of the industry to get an idea of whether or not things have been moving steadily forward. Next, consider the possible prospects for the future. If the company is in a company that has seen steady growth for the last few years, and has good prospects to continue on course, then it is likely that the company will see success and the dividends will keep coming.

In the end, there’s no way to completely predict what any company will do with its dividends. However, if you look at the company’s past performance, you can get clues as to what might happen next. We also like to use analyst ratings to help predict future price targets on the highest yielding dividend stocks.

Top 25 Dividend Growth Stocks With Income Growth

We are launching a new series of blog posts this week that highlight the best dividend growth stocks. Today’s list reveals the top 25 stocks that yield 2% or more and have increased their dividend for 15 consecutive years. The stocks are ranked by their 3 year income growth percentage.

Dividend growth is a key driver for stock performance and ROI. Income growth is of course the fuel that drives dividend growth. Without it companies have to cut their way to growth.




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NameSymbolYrs of Div
Increases
IndustryYield5yr Div
Growth %
3yr Income
Growth %
Payout
Ratio
Cardinal Health Inc.CAH20Healthcare2.2815.0162.2740.48
Tanger Factory OutletSKT23REIT3.87.258.342.3
RPM International Inc.RPM43Chemicals2.225.3853.2370.75
Telephone & Data Sys.TDS42Telecom26.3838.83136.05
WGL Holdings Inc.WGL40Utilities2.364.5627.4658.16
Vector Group Ltd.VGR18Tobacco6.95524.57262.99
Tompkins Financial Corp.TMP30Banks2.034.5623.1446.56
AT&T Inc.T33Telecom4.72.2622.4881.36
Eversource EnergyES18Utilities3.210.2618.6562.37
United Bankshares Inc.UBSI43Banks3.011.4618.6467.35
Conn. Water ServiceCTWS47Utilities2.122.6818.6149.77
Cincinnati FinancialCINF56Insurance2.712.9614.6248.84
Polaris IndustriesPII21Vehicles2.621.5213.3955.05
NextEra EnergyNEE22Utilities2.819.0212.9364.02
Atmos EnergyATO33Utilities2.274.3212.9149.7
Johnson & JohnsonJNJ54Healthcare2.786.9312.3954.39
Middlesex Water Co.MSEX44Utilities2.241.4511.6354.45
National Retail PropertiesNNN27REIT4.12.511.6139
Flowers FoodsFLO15Food3.110.511.670.11
Federal Realty Inv. TrustFRT49REIT2.66.311.4126.6
Bemis CompanyBMS33Packaging2.394.0111.2547.52
Archer Daniels MidlandADM41Agricultural2.7312.6910.3845.04
UGI Corp.UGI29Utilities2.026.469.4644.71
Leggett & Platt Inc.LEG45Home2.763.529.4150.97
Sonoco Products Co.SON34Packaging2.664.38.662.07

Dividend Stocks With Income And Revenue Growth

There has been a lot of uncertainty in the markets lately. Many analyst are out there broadly pushing dividend stocks as the safest place to put your money. While it is true that dividend payers as a whole are a solid place to park your cash for cash flow and long term investment we have seen a nasty trend emerge over the last few years. Many companies have been using cheap debt to buy back shares and boost EPS. Others have used debt to maintain business as usual and grow dividend distributions.






We have run a screen to find dividend paying stocks that are growing both revenue and net income while maintaining a low payout ratio. Less than 50 stocks met our test and most are in the financial industry. To make this list stocks has to have a dividend yield over 2%, 5 year dividend growth over 5%, 1 and 3 year revenue growth over 5%, 1 and 3 year net income growth over 5% and a payout ratio under 70%. If you have questions about why those metrics are important just let us know. This is not a recommendation to buy list. This is for informational purposes only. Please see our disclaimer link at the bottom of this page for more information.

Here is the list. Everyone has access to the name and yields on this list. Premium members have access to each data point. Data in this list was last updated 6/17/2016.

Dividends, Revenue and Income Growth

NameSymbolIndustryP/EYieldFree Cash
Flow Yield
5yr Div
Growth %
3yr Income
Growth %
Payout
Ratio
1 Year
Return %
East West Bancorp IncEWBCBanks - Global13.052.2610.22Members OnlyMembers OnlyMembers OnlyMembers Only
ICICI Bank LtdIBNBanks - Asia10.882.08-10.08Members OnlyMembers OnlyMembers OnlyMembers Only
BanColombia SACIBBanks - Latin10.533.373.47Members OnlyMembers OnlyMembers OnlyMembers Only
Banc of California IncBANCBanks - US12.952.51-30.7Members OnlyMembers OnlyMembers OnlyMembers Only
Bank of South Carolina CorpBKSCBanks - US16.753.167.26Members OnlyMembers OnlyMembers OnlyMembers Only
Columbia Banking System IncCOLBBanks - US16.842.628.24Members OnlyMembers OnlyMembers OnlyMembers Only
First Community CorpFCCOBanks - US15.082.1615.2Members OnlyMembers OnlyMembers OnlyMembers Only
First Financial Bankshares IncFFINBanks - US20.412.085.76Members OnlyMembers OnlyMembers OnlyMembers Only
First of Long Island CorpFLICBanks - US15.972.636.23Members OnlyMembers OnlyMembers OnlyMembers Only
Independent Bank CorpINDBBanks - US16.12.366.02Members OnlyMembers OnlyMembers OnlyMembers Only
Landmark Bancorp IncLARKBanks - US9.239.65Members OnlyMembers OnlyMembers OnlyMembers Only
LegacyTexas Financial Group InLTXBBanks - US16.052.1210.33Members OnlyMembers OnlyMembers OnlyMembers Only
MB Financial IncMBFIBanks - US16.562.027.57Members OnlyMembers OnlyMembers OnlyMembers Only
Mercantile Bank CorpMBWMBanks - US13.592.529.67Members OnlyMembers OnlyMembers OnlyMembers Only
MidWestOne Financial Group IncMOFGBanks - US12.612.126.47Members OnlyMembers OnlyMembers OnlyMembers Only
Old National BancorpONBBanks - US11.634.033.81Members OnlyMembers OnlyMembers OnlyMembers Only
Oritani Financial CorpORITBanks - US12.54.336.41Members OnlyMembers OnlyMembers OnlyMembers Only
Pacific Continental CorpPCBKBanks - US15.152.689.27Members OnlyMembers OnlyMembers OnlyMembers Only
Southside Bancshares IncSBSIBanks - US16.313.019.48Members OnlyMembers OnlyMembers OnlyMembers Only
TriCo BancsharesTCBKBanks - US13.892.085.32Members OnlyMembers OnlyMembers OnlyMembers Only
Umpqua Holdings CorpUMPQBanks - US15.064.1511.46Members OnlyMembers OnlyMembers OnlyMembers Only
Wesbanco IncWSBCBanks - US13.193.067.19Members OnlyMembers OnlyMembers OnlyMembers Only
ESSA Bancorp IncESSAFinance15.852.711.84Members OnlyMembers OnlyMembers OnlyMembers Only
Provident Financial Services IPFSFinance14.473.59.03Members OnlyMembers OnlyMembers OnlyMembers Only
United Financial Bancorp IncUBNKFinance13.33.685.82Members OnlyMembers OnlyMembers OnlyMembers Only
Robert Half International IncRHIStaffing13.932.196.98Members OnlyMembers OnlyMembers OnlyMembers Only
Knoll IncKNLBusiness Eq17.762.378.82Members OnlyMembers OnlyMembers OnlyMembers Only
WPP PLCWPPGYAdvertising17.123.055.97Members OnlyMembers OnlyMembers OnlyMembers Only
L Brands IncLBApparel17.363.245.79Members OnlyMembers OnlyMembers OnlyMembers Only
Toyota Motor CorpTMAuto Manuf7.323.572.03Members OnlyMembers OnlyMembers OnlyMembers Only
Douglas Dynamics IncPLOWAuto Parts10.58410.44Members OnlyMembers OnlyMembers OnlyMembers Only
Gentex CorpGNTXAuto Parts14.512.146.37Members OnlyMembers OnlyMembers OnlyMembers Only
Miller Industries Inc.MLRAuto Parts15.52.97-2.74Members OnlyMembers OnlyMembers OnlyMembers Only
The Home Depot IncHDHome Impr22.372.015.11Members OnlyMembers OnlyMembers OnlyMembers Only
Principal Financial Group IncPFGInsurance10.753.6336.8Members OnlyMembers OnlyMembers OnlyMembers Only
AmTrust Financial Services IncAFSIInsurance10.262.330.19Members OnlyMembers OnlyMembers OnlyMembers Only
HCI Group IncHCIInsurance7.14.174.19Members OnlyMembers OnlyMembers OnlyMembers Only
United Fire Group IncUFCSInsurance12.022.1819.23Members OnlyMembers OnlyMembers OnlyMembers Only
Universal Insurance Holdings IUVEInsurance6.12.7929.78Members OnlyMembers OnlyMembers OnlyMembers Only
XL Group PLCXLInsurance8.142.474.45Members OnlyMembers OnlyMembers OnlyMembers Only
Maiden Holdings LtdMHLDInsurance11.674.1849.5Members OnlyMembers OnlyMembers OnlyMembers Only
Ultrapar Participacoes SAUGPOil & Gas25.512.192.98Members OnlyMembers OnlyMembers OnlyMembers Only
Cal-Maine Foods IncCALMFoods5.56.0515.83Members OnlyMembers OnlyMembers OnlyMembers Only
Meredith CorpMDPPublishing13.793.759.55Members OnlyMembers OnlyMembers OnlyMembers Only
Reynolds American IncRAITobacco10.73.080.08Members OnlyMembers OnlyMembers OnlyMembers Only
WEC Energy Group IncWECUtilities23.642.661.18Members OnlyMembers OnlyMembers OnlyMembers Only

Praxair: Long-term Growth Story That Is Still Cheap

Praxair Investment Highlights

• Excellent sector diversification means Praxair can withstand weakness in any one or two segments while still generating good cash flow
• Management is committed to shareholder cash return through dividends and repurchases
• The company is highly leveraged with almost two-thirds the capital structure in debt but still carries a good debt rating and sufficient liquidity

Praxair (NYSE: PX) is one of the world’s largest suppliers of gases used for industrial purposes and the largest in North America and South America. Industrial gases are used in nearly every sector and the company has built a real advantage in its diversification across customer.

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The plunge in energy and mining has hit Praxair with 30% of sales from the two sectors but stronger gains are being booked in manufacturing and healthcare. The company’s business in Latin America has also been hit with the slowdown in the region but should still pay off over the long-term.

The company has been building a strong competitive advantage in emerging markets, most notably in South America, over the last few years. The recent drop in currencies and economic growth has hit shares but I still see good long-term potential from growth. Industrial gases usually account for a small portion of costs for buyers so they don’t switch providers much and contracts typically run for decades.

I like that Praxair is taking advantage of weakness in some markets to keep growing. The company recently announced the acquisition of the remaining stake from Europe’s Yara in a joint venture for the region’s CO2 business, valued at $350 million. The company also recently acquired Tecnogas, a 50-year old supplier in Peru with annual revenue of $10 million. Both acquisitions are being made when regional prices are fairly low but long-term upside should validate the deals.

Praxair Stock Fundamentals

Sales have been hit over the last few quarters as almost the entire commodities sector suffers from lower prices. Praxair is a key supplier to energy and metals mining, providing gases used in drilling injection and refinery operations. Operating income has fallen slightly faster because some costs, mostly administration, are more fixed than others.

Operating costs should start coming down on the company’s restructuring that will trim staff by 5% and cut expenses by an estimated $75 million starting in the fourth quarter. Revenue has been hit by weaker foreign currencies as well, especially in emerging markets.

Praxair is more heavily leveraged than other competitors. The company carries more than $9.2 billion of debt on its balance sheet for nearly two-thirds its capital structure. This shouldn’t be a problem though and Praxair just recently received an A-rating for $750 million in debt.

Against the weaker sales environment, Praxair has been able to protect cash flow by cutting capital expenditures slightly. The company still spends more than $1.6 billion a year in capital investment but has managed to stabilize free cash flow.

Praxair Dividend and Growth

Despite the weak environment for shares, Praxair has maintained its dividend growth. The shares pay a 2.8% yield above the 2.2% average over the last five years. The dividend payout ratio has increased to 54% against a five-year average of 44% so some slowdown in dividend growth could be expected if industry fundamentals don’t turn around.

Praxair has grown the dividend in-line with earnings at a compound rate of 19% over the last 22 years and management intends to keep the pace going. Capital expenditures have been cut to protect cash flow and keep returning cash to investors.

Praxair has always been an aggressive buyer of its own shares and has stepped up its repurchase program over the last year. The company repurchased $862 million in shares in the last fiscal

How to Pick Dividend Stocks with a Time Machine

If you’re like me, you spend a fair amount of time thinking about the stocks that got away. Those times in the market when you wish you had the foresight to buy into a sector or even into a specific stock. The times when all the economic data and analysis was right there in front of you but you just didn’t put it together.

In short, you wish you had a time machine.

Ok, so it does not good to sit around and regret past decisions. The best you can do is learn from them and be a better investor for it. Don’t beat yourself up over the past. That’s what I would normally say but it turns out you may now have the opportunity to do a little time travel investing!

Charge the Flux Capacitor and Set the Way-Back Machine

Remember back in September 2012, when the Federal Open Market Committee (FOMC) announced its third round of quantitative easing? The economy had been rebounding for a few years but at a very slow pace and wage growth was still nonexistent.

The Fed had provided two earlier programs, ending in 2010 and 2011, that had helped but more still needed to be done. We won’t go into the details of how the Fed buys bonds with money that is then pumped into the economy. The demand for bonds pushes rates down and credit becomes cheaper, hopefully jumpstarting the economy.

There are some that question whether central bank monetary programs actually help promote economic growth. What is less questionable is that they drive asset prices higher. During the two years that the Fed was buying upwards of $85 billion in bonds each month, the S&P 500 climbed nearly 37% and you could argue that gains before the program were attributable on anticipation.

Fast-forward to where we are today. The European Central Bank announced in January its own program of bond-buying that subsequently started in March. The ECB will buy a little over $60 billion a month in government and asset-backed bonds through September of 2016, injecting more than a trillion dollars into the economy.

Like the U.S. in 2012, the ECB had tried other bond-buying and fiscal programs. The programs in Europe have been much more targeted to reducing deficits and less about monetary easing, and the economy is in much worse shape than where the U.S. was in 2012 but it is a close analogy.

While the STOXX Europe 600 index is well off its 2009 low, it is just recently passed its pre-recession high and has lagged the S&P 500 by more than 40% since the start of QE3 in 2012. On a price of about 18 times earnings of corporations in the index, the index sells at a 12% discount to the U.S. index.

3

Besides a monetary boost, European companies are likely to benefit from the weaker euro over the next year. You don’t normally see depreciation of 20% in a major currency over the course of a year but that is exactly what has happened to the euro against the dollar. Exports are significantly cheaper and recent economic data is looking stronger.

While there are certainly good individual stocks out there, I like a few exchange traded funds for the broader theme. The Vanguard FTSE Europe (NYSE: VGK) holds shares of 529 companies in the region with a median market cap of $48.8 billion. The fund sells for just 17 times earnings and the 0.12% expense ratio is one of the lowest available. European stocks typically pay higher dividends than their American counterparts and the Vanguard fund delivers with a 3.4% annual yield. Companies from the United Kingdom accounts for 32% of the portfolio but the rest is fairly well-diversified across the region.

I also like the iShares MSCI Europe Financials (Nasdaq: EUFN) and its exposure to 105 financial institutions from the region. Financials in the U.K. again make up nearly a third of the portfolio but it still provides a diversified exposure across 13 countries. Shares pay a 3.2% dividend yield and are priced at 15.7 times trailing earnings, a 6% discount to the companies in the Financial Select Sector SPDR (NYSE: XLF) of U.S. financials. I like European financials because banks provide a larger share of capital to businesses in Europe compared to the United States where the markets provide more capital. As the economy improves, banks will benefit on loan growth.

The ECB monetary program may not have the exact affect on stocks as the prior program had in the United States. Some members of the European Union are much more hesitant to employ monetary measures and may pull back on the program if the economy starts looking much better. Still, the scenario should lead to higher asset prices as it did for U.S. markets over the last couple of years. That combined with healthy dividend payments should make for returns likely in the double-digits.

For me, I’ll take double-digits and you can keep the time machine.

 

AT&T: Expansion Plans should support Sales Growth and Shares

AT&T (NYSE: T) is the second-largest U.S. wireless carrier with nearly 100 million customers across a broad mix of telecommunications services. AT&T still offers local phone services in 22 states as well as internet, television, data services and web hosting. The company books 55% of sales from wireless services, followed by wireline data and managed IT services (29%) and 16% from wireline voice services.

The company made a huge announcement in May when it agreed to acquire DirecTV for $48.5 billion to expand AT&T’s reach into pay-television. DirecTV has more than 20 million customers in the U.S. but brings enviable geographic diversification with its 18 million customers in Latin America. The deal would help the company push bundled services, especially across DirecTV’s existing network of retail stores. The deal still needs regulatory approval but AT&T has promised to expand broadband service to 15 million homes if it is approved.

AT&T is also expanding its geographic reach with the recent purchase of Grupo Lusacel SA for $2.5 billion. Lusacel is the third-largest wireless operator in Mexico that has struggled to compete with America Movil (AMOV). A new telecommunications reform law signed four months ago could make it easier for smaller firms to compete and AT&T’s purchase may come at just the right time. The deal is expected to close in the first quarter of 2015.

Fundamentals

Sales growth has moderated over the last few years with the U.S. market for wireless services reaching maturity. The company has been expanding into international markets and has had to compete aggressively in the domestic market, which has hit operating income as costs increase.

A current ratio of 0.65, meaning that near-term liabilities far exceed current assets, would normally be a red flag but its not likely to be a problem with AT&T. The company is a cash generating powerhouse with $11.3 billion in free cash flow over the past four quarters and would not have a problem raising money for operational needs. The company has issued more debt than it has repaid in four of the last six fiscal years and funds 45% of its capital structure through debt.

As with other financials, cash flow has been strong over the long-term but has fallen off over the last few years. Besides lower cash flows from operations, due to slightly lower earnings, AT&T increased capital spending by $1.3 billion over the last year which has hit free cash flow.

Dividends and Growth

Shares pay an extremely high 5.2% yield, just slightly lower than the 5.5% average yield over the last five years but well above the market’s current sub-2% yield. AT&T has paid a dividend since 1881 and has increased its dividend for 30 years.

One-time items caused the company’s net income to plummet in 2011 and 2012 and the company paid out more than 100% of earnings in dividends. Excluding the two outlier years, the company’s current payout ratio of 56% is just below the average of 60% since 2009. Dividends have been increased at a compound rate of 2.3% over the last five years.

The company regularly repurchases shares though it has slowed the buyback over the last year to $3.5 billion versus $13.0 billion in fiscal 2013. Cash return to shareholders will likely remain subdued over the next year or two as the company digests its massive acquisition of DirecTV but cash returns could increase substantially afterwards.

Valuation

Shares of AT&T trade for a relatively inexpensive 10.8 times trailing earnings, well under the average of 16.1 times for the industry. Earnings are expected to increase at a modest 1.1% to $2.60 per share in 2015 on sales growth of 2.4% to $135.77 billion. While the company typically meets expectations pretty closely, I believe there is some upside potential as the company refocuses on cost control after the big DirecTV acquisition. A multiple of 14.5 times on $2.65 per share earnings would bring the stock to $38.42 per share.

Discounting future cash flows confirms a shares being slightly undervalued as well. Assuming a cost of capital of 5.9% and a sustainable dividend growth rate of 2.5% into perpetuity, yields a fair value of $39.65 per share. This growth rate in dividends is only slightly above the average over the last five years and I think there is a good chance the company can beat it over the next several years.

I like the diversification the company gets from its DirecTV acquisition and the stability in sales on other products. The dividend yield on the shares is outstanding, especially considering yields available in the market right now. While dividend growth and the buyback will probably be limited as the company integrates recent acquisitions, cash return to shareholders could jump in later years. I think investors can buy shares now ahead of stronger sales and eventually stronger operational performance.

Clorox: A great company but a not-so-great investment

With a market capitalization of $11.5 billion, the Clorox Company (CLX) is the smaller of the mega-cap consumer products companies. Clorox is more focused than competitors, only competing in three segments: cleaning products (approximately 40% of sales), household products (35%) and lifestyle (25%). The company is slightly less internationally diversified than peers with 78% of sales from the United States and international sales concentrated in two countries.

Clorox derives over a quarter of its $1.2 billion in international sales from Argentina and Venezuela. While this still only accounts for about 5.7% of total sales, price controls and currency depreciation in the two countries are a constant hurdle to profitability. Argentina depreciated its currency in January and is likely to depreciate again later this year after a technical default on its bonds last month.

This weakness was blamed for a 7% decline in profit reported in the fourth quarter against the same quarter last year. Net income fell to $1.29 per share on a 2% decrease in revenue to $1.51 billion. International sales were down 8% from the comparable quarter. Management held its earnings target for between $4.35 and $4.50 per share for the fiscal year on flat sales growth.

If Clorox lacks diversification in products and geographic reach, it more than makes up for it in brand identity. Nearly 90% of its brands are the number one or two top-sellers in their respective category. This brand identity comes through in higher prices and the company’s margins are close to those of larger peers, despite smaller economies of scale.

Fundamentals

Sales growth increased last year but has been stagnant over the last three due to slow wage growth and slight shift to less expensive brands. Weakness in sales hit operating income over the three-year period as management focused on its marketing spend and neglected cost-cutting measures. Last year saw a new campaign for cost management and the operating margin improved.

Despite having terrific brands and a long history of profits, the company’s balance sheet worries me. Cash flow from operations and free cash flow has fallen over the three- and ten-year period. While sales have rebounded slightly, they are not likely to grow more than 2% or 3% over the long-term. Debt is an astonishing 98% of the company’s capital structure though it does not seem to be spooking the capital markets too much. Clorox has $875 million in debt due in 2015 with $575 million due in January but should be able to issue longer-dated debt to raise the funds needed. The company issues ten-year bonds for approximately 3.15%, less than a percent above the rate on the ten-year Treasury Bond.

Dividends and Growth

Clorox is included in the list of S&P 500 Dividend Aristocrats with 37 consecutive years of increasing dividends and a payment since 1968. The current yield of 3.3% is slightly above the 3.2% average over the last five years. The payout ratio of 67% is below the average of 69% over the last five years and the company should have no problem sustaining the dividend.

The company has increased the dividend by an average of 8.8% annually over the last five years and has recently increased cash returned through the buyback program. Clorox repurchased $388 million in shares over the last year, above the four-year average of $298 million annually.

Volatile growth in sales and cash flows, combined with an over-leveraged balance sheet, make me a little hesitant to say that Clorox can keep up its pace of dividend growth. While the company should still be able to increase the cash return significantly every year, they will eventually need to focus on using cash to pay down debt.

Valuation

Shares of Clorox are trading for 20.3 times trailing earnings, just under the industry average of 21.8 times but above the company’s five-year average of 19.1 times.

Earnings are expected at $4.42 over the next four quarters, around the midpoint of management estimates and 3.8% higher than the previous four quarters. The company has missed expectations for earnings over the last three quarters and sales are expected flat for the coming year. It could be difficult for Clorox to meet expectations for earnings and this could weigh on the shares which are already trading for a slight premium to its price multiple.

The shares look a little undervalued on a discounted cash flows basis though only slightly. I am assuming that the company can grow the dividend payment by 7% a year over the long-term with a 3.5% terminal rate. The reliance on debt to fund the company benefits Clorox with a low cost of capital but this could increase if interest rates go up when the company needs to issue bonds.

I am conflicted on shares of Clorox. The company holds some of the top spots in products it sells and should be able to return significant cash to shareholders well into the future. The shares are a little expensive and near-term problems with international sales and slow growth in the U.S. make me hesitant to sound the all clear for buyers. The stock is not a sell if you have a position but I would wait for at least a 5% pullback to buy any more.

After a Strong Increase, Cisco Shares May Still be A Buy

Cisco is the leader in its core market of switches and routers for network connectivity but has also made significant progress to expand its product offers into other categories. The company’s other business lines include data center, enterprise wireless and security. In the past, these were primarily ancillary offerings that were basically add-ons to the core products but have grown to be relatively healthy stand-alone businesses.

High costs to change a company’s network infrastructure mean that Cisco benefits from stable revenues and has strong bargaining power with customers. Cisco has a proven track record for quality and connectivity and enterprise customers are reluctant to switch to an unproven vendor even for a price discount. Cisco was a quick mover in industry certifications and the Cisco Certification is the standard for networking credentials. With much of the industry trained on Cisco products, it creates a continual supply of technicians that will push for their business IT departments to use Cisco products.

Growth in China has been called into question lately on an escalation of tensions between the United States and the country over cyber-spying. China recently accused Cisco of deliberately installing backdoor surveillance tools into China’s internet infrastructure that enable U.S. cyber-spying. While near-term revenue in China may need to be evaluated, Cisco’s long-term growth in the country is probably more secure.

Fundamentals

Corporate spending on networking solutions has remained relatively strong compared to other IT spending and Cisco has been able to grow revenue by an annualized 6.6% over the last three years. The company has done a good job managing operating expenses, which have only increased at a 3.4% pace over the period, but the amount the company pays its suppliers has increased at a much faster 9.9% annual pace. Overall, operating income has grown nearly 7% a year and the company continues to produce strong cash flows from operations.

Balance sheet health is not normally an issue with mega-cap companies anyway but Cisco’s balance sheet looks especially strong. The company has amassed more than $50 billion in cash against long-term debt of just $20 billion. In fact, nearly 40% of the company’s $126 billion market capitalization is backed by cash on the balance sheet. Current liabilities are under $20 billion and the company booked free cash flow of $11.4 billion over the last four quarters.

Over the past five years, Cisco has spent an average of $1.1 billion a year on capital expenditures and $41.1 billion a year on investments in technology and other companies. Even on aggressive spending for future growth, cash has consistently increased and the balance sheet.

Dividends and Growth

The company initiated its first dividend in March 2011 with a payment of $0.06 per share. The quarterly dividend has been boosted by more than three-fold since then for a growth rate of 46% over the three-year period. Strong cash flows should allow Cisco to keep increasing its payment but that rate of growth is not sustainable. In its last increase this April, the company increased its annual dividend per share by 11.7% from the year ago payment.

Even on a brief history, Cisco’s 3.1% dividend yield is attractive and well above others like Microsoft (MSFT) and Apple (AAPL). The company is paying out approximately 47% of its earnings out as dividends, relatively high for a technology company so may limit dividend growth sooner than cash flow would imply. More likely, Cisco will use its large cash reserves to buy back shares and only gradually increase the dividend payout. Cisco has decreased its share count through repurchases by an annualized 2.3% over the last five years.

As we have seen in most of the large tech companies over the past year, the risk to Cisco shares is a shift in product demand and the lack of flexibility. Many of the tech giants have seen their shares plummet or stagnate on the shift from desktop computers to mobile technology and cloud-based applications. Cisco
Cisco recently dropped its WebEx enterprise social service and will start selling services from Jive Software (JIVE) as it improves its offering to help employees collaborate at work. The companies will also work together on joint product engineering and could eventually mean the smaller company is folded into Cisco through an acquisition. Cisco recently acquired mobile connectivity company Collaborate.com in its push to expand its reach into mobile and social.

It is through partnerships and acquisitions like these that Cisco has been able to expand its product line into other categories and decrease the risk that weakness in any one category will significantly reduce cash flows.

Valuation

Shares of Cisco are trading at 16.6 times trailing earnings and only just above the average multiple of 16.0 times over the last five years. While the stock trades well below the industry price-earnings average, it trades more closely with other mega-cap technology companies like Intel (INTC) and Microsoft (MSFT) due to their more mature product categories and slower growth.

While the shares may be fairly valued on a price-earnings basis, there is reason to believe that upside exists when you look at future cash flows. The high amount of cash on the balance sheet is worth more than simply its potential use for acquisitions and earnings growth. Cisco has more than enough cash on hand and it will likely need to start returning it to shareholders at a faster rate.

For the analysis below, a conservative 14% dividend growth rate was used for the first five years. This was estimated as roughly 12% dividend growth and 2% share repurchase. The growth rate was reduced to 10% for the second period and 3% into perpetuity. Cisco has a slightly higher cost of capital compared to other tech firms its size, largely due to higher stock volatility and a higher cost of equity. The company finances 27% of its capital structure with debt and issues 10-year notes at a 3.5% rate.

Even after a strong 12% increase in the share price since the beginning of this year, Cisco is still undervalued on a discounted cash flow basis. The amount of cash on the company’s balance sheet and regular free cash flow make it probable that the company will increase its cash return policy aggressively. This may happen through a higher share repurchase, a special dividend or simply through a strong increase in the quarterly dividend over the next few years. Beyond the immediate ability to return more cash, the company also has a strong diversity of products that should provide a safety net to cash flows if weakness hits any particular product group.

Best of Breed Dividend Investing

Sometimes, it seems there are more methods to pick stocks than there are stocks themselves. Investors have to decide whether to focus on top-down or bottom-up analysis then must continuously monitor the economy and events internal and external to the companies in their portfolio. Investing in Best of Breed companies makes the whole process a little easier. While past results are no guarantee of future performance, companies that have outperformed peers in sales growth and asset returns in the past may be able to build momentum in operational efficiency.

Best of Breed Investing

What is the difference between Best Buy (BBY) and RadioShack (RSH)? Both have fallen victim to consumer trends and have seen their shares plummet in recent years. Only Best Buy has been able to claw its way back and will report positive earnings this year while RadioShack faces an expected loss of more than $200 million. The difference is that Best Buy has been able to right the ship through better strategic positioning and operational efficiency. Best Buy is a Best of Breed in its sector.

Through all the financial statement analysis, ratios and research one of the best investment ideas is to put your money in the Best of Breed within each sector. These companies that have been able to beat the peer average for revenue growth and asset returns are the ones that will best be able to provide investment returns in any market.

There is no definite criteria for selecting leaders but I like to look to three areas: revenue growth, return on assets, and operating margins. Revenue growth has been hard to come by for most companies over the last couple of years. According to FactSet data, sales growth for companies in the S&P 500 was just 0.7% in the fourth quarter. Earnings growth is good but companies need to also be able to grow their top-line. I like to see three-year average revenue growth above the sector average and most recent year’s revenue growth above a company’s own three-year average. This tells me that sales have been growing faster than peers and the trend is improving.

I consider return on assets (ROA) as a more pure measure than the more popular return on equity (ROE). Return on equity can be skewed higher by a higher use of leverage which can get a company in trouble if the market for their products turns south. Return on assets is what management is able to produce off of the resources they have, without having to leverage those assets. If a company is a Best of Breed, then it should be able to generate a higher-than-average return on its assets.

Two Sectors, Two Strong Companies

AvalonBay Communities (AVB) is a $16.8 billion developer and owner of multi-family communities in the United States. The company’s return on assets of 1.3% doesn’t sound so strong until you consider apartment REITs have an average return less than half that at 0.5%. Revenues grew by 41% in the last fiscal year and have averaged 18.7% growth over the last three years. Shares pay a 3.6% dividend yield and trade for 1.94 times book value.

The company has been aggressively developing properties lately, rather than acquiring already developed communities. This is a riskier strategy but also drives higher earnings and management has the experience to be successful with the program. The company will need this advantage as home ownership rates may be as low as they are going to go. Apartment REITs have done well over the last few years as millenials and baby boomers chose multi-family living rather than their own homes but the trend may reverse eventually. A Best of Breed like AvalonBay should outperform peers when it does.

Duke Energy (DUK) is a $49.5 billion utility operating in the United States and Latin America. Management is able to produce a 3% return on assets, well above the 2% average for the sector. Revenue grew by 25% in 2013 and has average 20% growth over the last three years. The shares pay a 4.4% yield and trade for just 1.2 times book value.

Duke Energy is expected to sell 13 power plants in the Midwest after regulators denied a rate increase. Analysts expect other companies to follow suit as a lower industrial demand and cheaper gas weigh on returns for producers in the region. The sale should improve the company’s financial position and return metrics.

The biggest hurdle with investing in Best of Breed companies is that you must keep an eye on management and developments within the company. While the shares should continue to outperform peers around external forces, management still needs to execute on its plans. Once a company has outperformed peers for a while, the corporate culture of success and efficiency advantages helps keep the momentum going.

Take A Look At These Dividend Stocking-Stuffers

Stocking gifts are not the only good things that come in small packages. Small-cap stocks can offer investors market-beating growth and still provide a regular dividend stream. Look for companies with strong sales growth, a return on assets above 10% and a positive history of increasing cash returns.

Can small companies be good dividend plays?

You don’t normally hear small-cap and dividends in the same sentence but the total return on these stocks can be more than enough to compensate for the higher risk. You do need to be a little more watchful to changes in the company’s business model and there are a few criteria that are a must for inclusion.

Even though most definitions for small-cap include companies between $250 million and $1 billion, I like to focus on companies of at least $500 million and up to $1.5 billion. This helps to avoid those that continuously need to raise funds yet still gives them the flexibility of a small grower. Besides market cap, I use fundamental analysis to screen for financially healthy companies.

Beyond all the ratios and cash flow analysis, sales growth is one of the most simple and important metrics. Annual sales do not have to be higher every year but a general upward trend is definitely a must.

Most investors look to Return on Equity (ROE) as their preferred profits metric but I like Return on Assets (ROA) because it removes the effect of leverage. I want to make sure that management can make money off of its resources without having to take on a dangerously high level of debt. Generally, I will look for an ROA of at least 10% but may accept a lower return depending on the industry average.

As a dividend investor, I want to see a yield of at least 2% but am skeptical of companies that pay more than an 8% yield. Outside of REITs and other special situations, it is tough to pay an 8%+ yield and still retain enough cash to grow the company. A history of dividend increases is important to gauge management’s commitment to cash returns.

American Railcar Industries (ARII) designs, manufactures and sells railcars as well as provides after-market servicing. The company provides cars for transportation of a range of products but the real growth is coming from energy transportation. The boom in oil & gas production is outpacing pipeline growth and rail transport will be strong for years to come.

Sales have increased for the last three consecutive years but are still below their 2008 high. The company has been investing heavily over the past couple of years and posts a 12% return on assets.

The shares pay a 2.3% yield but should increase over the next few years on higher free cash flow as capital expenditures slow. Mexico just passed an historic bill to increase its own energy production and the rest of North America is on track for record production over the next decade. Pipeline growth is being held back by environmental groups and rail transportation is the only other viable mode.

National CineMedia (NCMI) operates a theatre advertising network in the United States, segmented by Fathom Events and traditional advertising. The company’s reach spans more than 19,000 screens in 48 states and the District of Columbia. As viewer engagement becomes increasingly difficult in an online world, movie-goers remain one of the last captive audiences for advertisers.

Sales have increased for seven consecutive years, a strong accomplishment for an entertainment company through the 2009 recession. The company’s is able to squeeze a return of almost 14% on its assets and has $127 million of cash on the balance sheet.

The shares pay a 4.6% yield and the payout has increased by an annualized 7% since 2007. While the 2013 movie lineup was not particularly strong, there are enough blockbusters planned for 2014 and 2015 that the company could see strong sales growth.

Of the almost 2,000 small-cap stocks in my screening universe, 500 of them pay dividend yields of between 2% and 8% but only half of those are able to boast a return on assets of 10% or more. The list of potential candidates gets extremely thin when you add sales and dividend growth to the search but resist the urge to weaken your criteria. Small cap stocks can provide both growth and cash returns but the higher risk has to be managed with a closer analysis.