Autumn 2015 Dividend Stock Newsletter

This has been an interesting time for markets. China’s market crashed, and global markets around the world responded with milder crashes and volatile rides.

And yet the US still has a highly valued market.

According to historical valuation assessments of the broad market, such as the Shiller P/E, the U.S. stock market is still valued at a premium compared to its historical mean. This is probably partially the result of the unusually long stretch of low interest rates. And when discounted cash flow analysis, or other versions of that like the dividend discount model, are performed on individual stocks, many of them have been valued at a premium lately.

There are a lot of long term problematic trends. Trends that are decades in the making, larger than individual bull and bear cycles in the market. The U.S. has a weak middle class along with increasing political polarization and public debt, Europe has ongoing problems with their shared currency, debt levels, and unemployment, Russia’s economy is in shambles due to their concentration in the energy sector and the fallen energy prices, China’s stock bubble just burst, and Japan has an aging, shrinking population and the world’s highest national debt level as measured by the debt to GDP ratio. These large drivers of the global economy all have substantial long-term problems. And yet U.S. stock market valuations are historically high.

Needless to say, I’m not surprised to see a market correction, and wouldn’t be surprised to see a bigger one on the way. We’re certainly due for one. And yet, I’ll still be putting money into the market. This season’s newsletter will focus on how to build a dividend portfolio to weather economic storms, including some stock ideas I think look reasonably valued at the moment.

Keys to Defensive, Successful Investing

Investing is simple, but not easy. Many investors buy and sell on emotion, as evidenced by the fact that large cash flows into the market are observed to occur at market peaks, and large cash flows out of the market are observed to occur towards market bottoms. I think that readers of dividend sites like this one tend to do better, fortunately. I’m preaching to the choir a bit in this section.

The healthiest, longest lived populations in the world, such as those living in Okinawa Japan or Icaria Greece, tend to have the simplest, most obvious diets and lifestyles. And most of the world doesn’t follow them, despite their simplicity and pleasure. In places like that, the people eat whole fresh food like wild fish and legumes, plenty of vegetables and fruits and herbs and spices, socialize with family and friends as a cultural priority, drink tea or wine in moderation, get plenty of slow exercise from walking to and from their jobs and neighbors homes and doing manual work, and don’t rush or experience much stress. And many of them are dancing and hiking and laughing and staying mentally sharp into their 90’s and 100’s, while spending a fraction of what we do on health care. It’s not complicated for them.

Successful investing is a lot like that. Simple, but rare. Obvious, yet rarely followed.

Check your Balance
This is a good time to check your asset balance. Do you have the ratio of stocks, bonds, cash, and other investments that you target?

Having a diversified portfolio reduces volatility because by ocassionally rebalancing, you’ll naturally shift money from bonds/cash to stocks when stocks are cheaper, and shift money from stocks to bonds/cash when stocks are expensive, simply due to returning to your target balance from time to time.

Invest Over time
If you determine the suitability of an investment by calculating a fair intrinsic value, don’t worry too much about trying to predict the future. If the price is reasonable now, a few months from now might be even better. Or it might be worse. Neither of us know. By putting money into attractively priced investments on a regular basis, you even out your chances.

There are plenty of people I know that dabble in investing as a hobby rather than as a consistent means of building wealth. What this means is that they maintain a little portfolio of some hot stocks, and enjoy discussing performance with colleagues and friends. Five years later, their portfolios are still small, because individual stock performance is a lot less important than shoveling money into a portfolio month after month.

Stock, Country, and Sector Concentration
Consider how much money you’d be willing to lose in a single investment, and then invest accordingly.

Regardless of how prudent we may be, an investment could go sour. We don’t have access to all the current information, nor do we have the ability to see the future. Plus, a shared event could bring down all stock prices in a sector, such as a reduction in the price of a barrel of oil, or a housing bubble. And a single country could have poor governance or economic stagnation. It’s often a good idea to maintain diversification among companies, sectors, and countries.

As long term investors, we don’t really care about stock prices themselves, because all else being equal, low stock prices just mean more buying opportunities. But we do care about tangible financial damage to a company including things that could lead to dividend cuts, so diversification is important.

Concentration into a few companies, or a major sector, could lead to outperformance compared to a diversified portfolio. But it could also lead to disaster, wiping away a decade of portfolio growth. Deep concentration sometimes makes sense for professional investors, but rarely is ideal for casual investors who are building wealth for their families.

Four Stocks to Consider

Texas Instruments (TXN)
Texas Instruments has fallen from a high of nearly $60 down to under $50 per share, and I believe it may be a solid investment at this price level.

Over the last decade, the company has not had any revenue growth, and a big reason was that they completely exited the wireless market to focus on analog and embedded chips, which was a transition they completed in 2013. Despite the lack of revenue growth, the company has increased free cash flow margins and reduced their share count substantially from share repurchases, resulting in 13% free cash flow per share growth over the last decade. They’ve also increased their dividend for eleven consecutive years now. All of their free cash flow goes to dividends and share repurchases, and only 4% of revenue has to be invested back into the company for capital expenditures.

Looking forward, with no major transitions ahead, Texas Instruments is the largest analog chipmaker in the world and should be set to finally grow. In addition, their transition from 200mm to 300mm wafers should cut their costs significantly, further increasing their profit margin. As they continue giving all the free cash flows back to shareholders, investors should do well.

An issue that some dividend portfolios face is that they lack much investment in the technology sector. Dividend growth companies are rare in the sector, and as an investing demographic, we tend to prefer stability. A company like Coca Cola will be selling pretty much the same products ten years from now as they do now, but Apple will be selling absolutely nothing of what they currently sell in ten years. A company that has to continually reinvent itself is harder to predict for the long holding periods that dividend investors tend to prefer.

But a handful of tech companies are blue chip companies with decent dividend payouts, and Texas Instruments is one of them. The dividend yield is currently 2.8% with a high dividend growth rate, and the overall shareholder yield is over 7%. Analog chips, which measure things like temperature and pressure and convert them into digital information, are hard to design, have very long product lifecycles (years, and sometimes decades), and as a result offer high profit margins for the designers. Embedded systems, like microcontrollers, also have long lifecycles and similar profitability levels. If there’s a tech stock out there that’s good enough for a dividend portfolio, the world’s largest analog maker is a top contender.

Chipmakers exist in a cyclical industry, and competition is significant, so Texas Instruments is not without risk.

Using the last twelve months of dividends ($1.36), along with a conservative estimate of 7% dividend growth going forward (quite low, compared to their 13% free cash flow growth per share over the past decade and their high recent dividend growth rate), and lastly a slightly market beating 10% target rate of return (discount rate), we can arrive at an estimate of fair value:


For investors that use options, Texas Instruments is also a decent stock to write a long term covered put for. If you want to pick up shares of the company at a lower cost basis than what is currently available, you can write puts at a strike price you desire, and get paid to wait. For example, you can write January 2017 puts at a strike price of $47, and receive about $6 per share as a premium for doing so. If, in the next 16.5 months, Texas Instruments goes below $47/share, you’ll have to buy at $47/share, and your actual cost basis would be about $41. On the other hand, if Texas Instruments stays above $47, you’ll have been paid a fairly high rate of return simply to wait, without buying, and then you can use your capital elsewhere, or write another put.

Chevron Corporation (CVX)
Chevron stock was absolutely slammed and has since rebounded a bit.

In my previous newsletter from three months ago, I stated that Chevron stock was fairly valued. Not overvalued or undervalued, but fair. A couple months after I wrote that, crude oil prices dropped like a rock from $60/barrel to $40/barrel, which naturally brought oil stocks down, including Chevron. This is an example of where not putting too much money into one stock, and having a habit of investing money every month, helps ease things a bit. Recently, crude went back up to about $50, easing Chevron’s problems.

Chevron is in a particularly vulnerable state, because they have a high dividend payout for the industry, and they’re right in the middle of an investment cycle where they are spending a lot of money on investments and waiting for large LNG projects to fully come online and start producing major revenue. Having oil prices fall and their profit cut away, is a major blow to the company.

The big question for dividend investors is whether or not the dividend is safe. The company has raised its dividend for 27 consecutive years and now is being looked at as a potential dividend cut. After this stock price drop, the dividend yield is at a lofty 5.3%.

The official position of the company, based on their most recent investor presentation and words from their chief financial officer during the last earnings announcement, is that their number one priority is to cover the dividend with free cash flow by 2017. This is because their major LNG investments are coming online, and capital expenditures are expected to fall dramatically when their period of massive investment will be finished, and the fruits will be harvested. The next year and a half though, until 2017, will be rough. At these oil prices, free cash flow won’t cover the dividend, and so the company is issuing debt to pay for it. Obviously that’s not sustainable.

The company currently has about $30 billion in long term debt, and shareholder equity minus goodwill of about $150 billion. This is a LT debt-to-equality ratio of about 20%, which is a very strong balance sheet. The company currently pays out about $8 billion per year in dividends, so if the company uses debt to fund the dividend for 18 months, that would require about $12 billion. This would boost long term debt to $42 billion for the dividend alone, resulting in a LT debt-to-equity ratio of around 30%, which is still a very strong balance sheet. As a comparison, Conoco Phillips currently has a LT debt-to-equity ratio of about 50%. So, Chevron could fuel its dividend with debt until its LNG operations help it fully cover its dividend with free cash flow in 2017, and still have a stronger balance sheet than Conoco Phillips.

Does Chevron have to cut its dividend? Absolutely not. Will they? Who knows. In a world without dividend champion lists, and investors that rely on dividends for income, cutting the dividend for a year or two and then restarting it at a higher rate when they are in a better position, would be financially prudent. But when reputation matters, the executives seem as though they want to hold onto it.

The way I see Chevron currently, is that gas prices won’t stay this low forever, and five years from now, Chevron at $80/share or Exxon Mobile at $75/share will be seen as steals. But in the near term, a dividend cut is not out of the question, especially for Chevron. I wouldn’t rely on Chevron for current income, but I’d look at it as a potential bargain stock for the long haul.

Toronto-Dominion Bank (TD)
The Canadian housing market is highly priced, and Canadians have record levels of household debt relative to disposable income, at over 160%. This is higher than US household debt levels right before the housing crash in the mid 2000’s, when we were at 130% on average, down to under 110% now after some household deleveraging.

Vancouver is a particularly interesting case, because much of the demand for housing comes from outside their local labor market. A significant chunk of luxury property in the city is purchased by people from mainland China, and many Chinese people just lost a lot of wealth on paper from their stock market crash.

Plus, oil prices have fallen far, and Canada’s economy has a lot of concentration in this sector. If there’s something that could cause a housing bubble to burst, something like this might do it.

Needless to say, some investors are shorting companies that have exposure to the Canadian housing market. I can see why. And yet, I don’t think investors necessarily have to avoid this industry. TD in particular is in a decent position.

The Canadian banking system works in a fundamentally different way than the US banking system. In Canada, it’s a lot harder to simply walk away from a mortgage when the price of a house drops. As a result, even before the U.S. housing crash, Canadians have had a much lower rate of mortgage delinquency than Americans. In addition, many residential mortgages held by Canadian banks are insured by the government, limiting their own losses.

Toronto Dominion bank is one of the largest banks in Canada, and is the sixth largest bank in North America. Their business model involves borrowing money mainly from depositors and lending that money at higher interest rates to customers for mortgages, auto loans, and other types of loans. The bank has expanded strongly into the United States along the east coast, resulting in the bank having 15 million Canadian customers and 8 million American customers and growing. The bank’s focus is on retail banking, aiming to offer top quality customer service compared to competitors. At a time when banking is starting to shift from physical to online banking, TD is going against that trend by focusing on expanding their physical footprint and offering longer banking hours than competitors.

Compared to their peers, TD has a larger portion of their Canadian mortgages insured. Slightly over 2/3rds of their Canadian residential mortgages are insured. For that other third, the average mortgage-to-value of the loans is 70%, meaning that a fairly large housing correction would have to occur before those mortgages would be underwater. Unfortunately by some estimates, the Canadian housing market may indeed be that far overvalued, with that far to fall. Overall though, it can be said that TD is in a stronger position than American banks were before the US housing crisis, and is also in a stronger position than many of the other large banks in Canada. The credit agencies currently assign TD bank with high credit ratings (Aa1, AA-, and AA respectively by Moody’s, S&P, and DBRS), and those credit agencies are taking into account the risks embedded in the current Canadian housing market.

Historically, TD’s performance has been excellent. The company has had 12% average dividend growth over the past 20 years, and currently has a solid 3.8% dividend yield. Over the past 10 years, the bank’s revenue has climbed from under 12 billion CAD to over 30 billion CAD, while EPS has grown at a similar rate, despite some share dilution.

Their most recent investor presentation states that the bank expects to increase adjusted EPS by 7-10% per year over the medium term. In combination with a nearly 4% dividend yield, this is a good potential investment. However, given the state of household debt and housing prices in Canada, I’ll use a more conservative growth estimate in my dividend growth expectation.

Here’s the estimated fair value, in CAD, using a 6% long term dividend growth rate and a 10% discount rate:


That’s in CAD on the TSE, not in USD on the NYSE. Currently, the price is about equal to the estimated fair value. And that’s using a dividend growth rate that is below the low end of the company’s estimated EPS growth rate; 6% compared to 7-10%, because I’d prefer to be pessimistic on this. If you believe the company will hit its estimates, or if you’re willing to settle for a lower 8% or 9% rate of return, the fair value to you would be substantially higher than the current price.

Overall, I believe TD represents a fair buy at this time. There are risks in the Canadian housing market, but the stock is trading at a price that seems to take that into account. TD has protection in the form insurance for a majority of its residential mortgage portfolio as well as diversification into the US lending market.

Aflac Incorporated (AFL)
Aflac sells supplemental health insurance in the United States and Japan. While primary health insurance companies will cover various specific procedures, usually by paying the health care provider rather than the policyholder, Aflac’s main business model instead is to pay cash to policyholders that file claims for certain health problems, like cancer. This way, when customers face income loss or other financial problems due to a health problem, Aflac provides them with cash to get through those difficult times while their primary health insurance company covers the actual medical expenses.

The company experienced strong top line growth between 2005 and 2012, climbing from $14.3 billion in revenue to $25.3 billion in revenue. During that time, the dollar was weakening compared to the yen, giving the company a strong tailwind. Then, from 2012 to now, the revenue has fallen from that height of $25.3 billion to $21.7 billion, this time due to the dollar strengthening compared to the yen, giving the company a major headwind. EPS has followed a similar pattern over that period of time.

So, this has been a tough few years for Aflac. The positive part of the story, however, is that their core business is doing very well when exchange rates are excluded. Between 2005 and 2014, the amount of premiums they have generated in Japan has increased every single year, from about 1 trillion yen in 2005 to about 1.6 trillion yen in 2014. The story is similar for their US business; premiums have increased from $3.7 billion to over $5.6 billion during that period, and every single year saw an increase in premiums compared to the previous year.

Japan has an aging population, and the universal health care system is conservative in its payouts. Japan has the longest life expectancy in the world and pays considerably less than half of what the US pays per capita on health care each year. This gives Aflac plenty of room for continued growth for the forseeable future, because their role as a supplemental insurer should only grow stronger.

The long-term bearishness of Japan’s economy, along with their very high national debt, is a risk to be aware of. However, Japan’s debt is held in its own currency to its own citizens, giving the country considerable flexibility in avoiding default in most foreseeable scenarios.

Although predicting exchange rates is not something I care to do, the fact that the dollar has already had a four-year surge relative to the yen (going from fewer than 80 yen per dollar in 2012 to over 120 yen per dollar currently in late 2015), and the dollar has surged relative to foreign currencies in general, implies that the company probably doesn’t have too much to worry about from continued currency headwinds over the long term, at least. I believe the worst of their currency troubles are probably behind them, and if not, the company is doing fine anyway, albeit with reduced profitability, and they can safely ride out the currency problems.

Aflack stock currently trades for a P/E of just under 10. They have raised their dividend for 32 consecutive years, but their payout ratio is on the low side, and the dividend yield is about 2.7%. They also repurchase a lot of shares, and between 2005 and the current quarter, their total share count has fallen from 508 million to 444 million. This is a business model I like; a large portion of the returns comes from the dividend and from the company reducing its share count by buying cheap shares, while also enjoying moderate premium growth and a growing customer base in two countries.

Aflac’s dividend has historically risen at a double-digit rate, but during the recent problem with currency exchange rates, Aflac’s dividend growth rate has fallen below 6%. In 2015, the company expects to repurchase $1.3 billion worth of stock, which is 5% of the market cap. The board of directors this past month increased the authorization for the amount that the company can repurchase, up to 56 million shares, or over 12% of the existing number of shares outstanding. Repurchasing the shares is one way to accelerate dividend growth, because reducing the share count allows the company to continue to pay out more and more per share. With shares so cheap, the company gets a good rate of return on their purchases, although I’d like to see a moderately higher dividend payout ratio, personally.

Given historical dividend growth rates, recent growth rates, share repurchase rates, core company performance, and an assumption of reducing currency problems over the next 5 years, I’ll use 7% dividend growth as an estimate for the long term. The estimated fair value ends up being around $55:


As you can see, with the fairly low yield, the estimated fair value is very sensitive to adjustments in the estimated dividend growth rate and the discount rate. Overall, with a low P/E, a long history of dividend growth, a modest current dividend yield, and a fairly safe business, I believe Aflac represents a decent purchase at these prices levels, especially with many other stocks being valued at much higher earnings multiples.

 Dividend Insights Newsletter

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First Newsletter

Hello, Matt here. And with a fresh dividend newsletter issue for June.

It’s been a while since I’ve written on Dividend Monk. And as I’m sure people that have been reading the new articles over the last few weeks know, I’ve sold the blog to Mike, who I’m glad to see is running it well. It’s good see that this style of stock analysis will persist beyond me doing the writing.

I want to thank all the readers that emailed me asking where I was, and asking if I was okay, over the last year. That means a lot to me. And for my part, I wasn’t very good at getting back to most people about my status. I know it can be unnerving to see a popular multi-year blog suddenly stop posting.

The fact is, I’ve had a multitude of family issues and personal health issues to deal with, including two deaths in the family, so I stopped posting articles and newsletters for quite a while due to my time and attention being needed elsewhere. I did continue to check email from readers, mainly at least to make sure customers of the Dividend Toolkit were satisfied and had any technical questions answered, as that continued to have strong sales despite my absence. But for most everything else, I was rather absent.

I’m back to normalcy now, but decided to sell the site so that it can be operated with the attention it deserves, and that the readers deserve. And for now, I’ll continue to publish quarterly newsletters, and I’m excited to do so, starting with this one here.

Thanks everyone,

-Matt Alden S., founder of Dividend Monk

May 2015: The Market is Overvalued

The current Shiller P/E of the market is about 27. For those that are not familiar with this measurement, you can see an explanation here and the chart here. It’s one of the most useful measures of the valuation of the S&P 500, and tells us whether the market as is undervalued, overvalued, or fairly valued compared to historical norms.

To put a Shiller P/E of 27 into perspective, it was about 32 in 1929 when Black Tuesday occurred. The highest ever was about 45 at the peak of the Dot Com bubble. Those are the only two times in history when the market had a noticeably higher Shiller P/E than right now. The mid-2000’s, the time before the Great Recession, were about equal to the current value, around 27. All other times in history, it was lower than it is now. Usually significantly lower. We’ve had a six year bull market at this point.

But long term investors are not worried about market corrections. Most of us rather like them, since they are like sales for us, or like a pressure valve being released on lofty valuations. And we don’t try to predict them, as that would be a distraction. What we’re worried about is an overvalued market where it’s challenging to find undervalued stocks, for however long that period lasts. And that’s kind of where we are right now. A sea of mediocre and expensive stock valuations.

Diamonds in the Rough: 5 Attractive Stocks

Fortunately, even in an expensive market, there are usually reasonable values to be found. Just about any financially healthy company will be trading at a sizable valuation these days, so drastically undervalued stocks in the dividend space are all but nonexistent.

But modestly undervalued or fairly valued stocks? Those still do exist, and I’ll describe five companies below that I believe match that description. Some of them offer substantial long-term returns at these price points, in my view. As always, do your own homework and make sure you are comfortable with your investment decisions.

Brookfield Infrastructure Partners (BIP)

BIP is a publicly traded partnership that owns and operates a globally diversified portfolio of infrastructure assets shown in the operations map below and offers investors a 4.8% distribution yield with significant growth. The partnership organizes itself under three main segments: Utilities, Transport, and Energy.


The Utilities segment produces 44% of BIP’s total cash flow and consists of 10,800 kilometers of electricity transmission lines in North and South America, 2.1 million natural gas and electricity distribution connections, and 85 mpta of coal handling capacity in Australia.

The Transport segment produces 48% of BIP’s total cash flow and consists of 9,100 kilometers of rail track in Australia and South America, 3,200 kilometers of toll roads in South America, and 30 shipping ports in North America and Europe.

The Energy segment produces the remaining 8% of BIP’s total cash flow and consists of 14,800 kilometers of natural gas distribution pipelines in the US, 40,000 natural gas customers in the UK, and 370 billion cubic feet of natural gas storage in North America.

BIP management expects to raise the distribution over the long term by 5-9% per year. This figure comes from their expectation to raise prices at or above inflation by 3-4% per year, have natural volume expansion in line with GDP growth of 1-2% per year, and reinvest cash flows for another 2-3% per year in the form of expansion projects and acquisitions. An example of organic growth opportunity is their plan to spend $650 million over three years to increase capacity of ports, rails, and toll roads. Over the last several years BIP has been expanding its various segments when it has been profitable to do so, and has been making new acquisitions when appropriate.

A 2013 report by McKinsey & Company estimated that the global investment in infrastructure needed between 2013 and 2030 will be $57 trillion. BIP has had no problems finding appealing ways to spend capital over the last several years and there should be an immense amount of opportunities for the foreseeable future for them to carve a small piece of that huge pie for themselves, even if there may be some bumps along the way.

I first began recommending BIP units five years ago when they were trading for $18 and the distribution yield was over 6%. Over time, BIP has sailed up to around $45/share and although they have continued to grow distributions, the yield is down to under 5% due to a heftier valuation from an overall more highly valued market. Along this time I’ve been less enthused about their valuation than I was in the cheap days, but overall I still find it’s one of the more attractive investments on the market in terms of risk-adjusted return potential.

Although BIP has a wide moat due to the regulated and asset-heavy investments they own, they face risks from the state of the global economy. Most of their assets are not subject to competition, such as their electricity transmission business that serves 98% of the population of Chile, or their toll roads, or their rails and ports, etc. Instead their risk is mainly related to volume changes based on the economy.

Back in 2010 when BIP units were cheap, investors were worried about how much exposure they had to the troubled Chinese economy due to their large Australian coal export terminals that mainly went to China. And back then there were also worries about their European shipping ports. Like any business, BIP will face headwinds if the economy sinks in the form of reduced volume at some of their locations. But they’ll also likely have opportunities to snatch up cheap assets from financially troubled companies, should that occur.

To help mitigate risk in investor minds, BIP has stable debt levels and prudent management, and most of their cash flow is protected, meaning that 90% is regulated or contracted, 70% is indexed to inflation, and 60% has no volume risk. The partnership pays out just under two-thirds of its FFO as distributions, which gives a lot of room for flexibility in keeping the distribution payouts safe and growing.

Based on $1.97 in distributions paid over the last 12 months, this is the valuation table for Brookfield Infrastructure Partners using the Dividend Discount Model to figure out what prices we’d look to pay for different estimates of distribution growth and different target rates of return:


Source: Dividend Toolkit Valuation Spreadsheet

If they grow the distribution at an average of 7%/year for the foreseeable future, in line with the middle of management’s growth estimate, then even with a fairly aggressive discount rate (aka target rate of return in our case) of 11%, the valuation is over $50 per unit. A similar valuation can come from using the lower end of their distribution growth estimate (6%) and “only” a 10% target rate of return discount rate. If the growth is as low as 5%, then a target rate of return of 9% still yields a valuation of over $50.

At the current unit price of around $44, BIP’s distribution growth would have to seriously underperform management estimates for the current price to result in poor long-term returns for investors. So, while BIP may not be quite as undervalued as it once was, I do believe it continues to be a decent value in today’s market even if BIP’s performance is in the low end of their estimated range. And if their performance is towards the higher end, then even better.

Chevron Corporation (CVX)

As everyone knows, gas prices have been relatively low lately across the world. This oil price crash has been large enough to wreck Russia’s energy-focused economy. When oil prices fall, it still takes about the same amount of money to get it out of the ground as it did when oil was expensive, and yet they can’t sell it for as much, so the profit margin is narrower. Companies like Chevron and Exxon Mobil take a hit to both revenue and profit.

And that’s when it’s nice to buy them. XOM has fallen from its 52 week high of over $104 to its current price of around $88. CVX has fallen from its 52 week high of around $135 to its current price of around $112. Earnings for both oil giants have dropped as well, but their dividends will keep growing because they keep their payout ratio low for cycles like this. Chevron currently offers an attractive 3.8% dividend yield and XOM’s is a bit lower at 3.1%. In comparison, the Vanguard “High Dividend Yield” ETF offers only about 2.8%. Both XOM and CVX are solid dividend payers; especially Chevron.

A March 2015 investor presentation by Chevron stated that they expect global energy demand to increase by 40% between 2015 and 2035, and that natural gas will have the biggest increase of 45% compared to liquids at 20%. The long-term case for the large energy companies remains strong, especially as they have expanded into gas.

For Chevron specifically, they plan to reduce spending for 2014-2017 as their large liquified natural gas projects are coming online and as they divest certain assets. Spending is still high currently, though. And in spite of this eventual reduced spending, their daily production in 2017 is expected to be 20% higher than it was in 2014 due to these online projects.


The major energy companies face a variety of risks, including the increasing difficulty of acquiring oil and gas reserves at appealing prices. But Chevron currently produces 2.6 million barrels of oil equivalent per day and has proved reserves of over 11 billion barrels of oil equivalent. The company also has a strong balance sheet.

Another long-term risk for companies that deal primarily with fossil fuels is the rise of renewable energy, particularly solar. Unlike most forms of grid energy that use mechanical energy to spin a turbine (and therefore inevitably lose some energy in each step), solar photovoltaic panels turn sunlight directly into electricity. Plus, because solar can be placed closer to the source of use, such as on top of a home that uses the energy it generates, there isn’t as much energy lost in the transmission process over long distances. Solar prices seem to be dipping down to competitive levels for electricity production, and since solar easily fits for both residential and commercial projects, it’s a prime candidate to provide the electricity if (and it’s still a big if) electric cars start to take off years and decades down the line with all the associated infrastructure like charging or battery replacement stations everywhere.



Installation costs now constitute a larger and larger portion of total solar costs, although those installation costs are dropping as well as the industry matures.

International usage of abundant energy-dense coal for electricity generation may remain very strong as well, unless regulatory action severely limits it. In many emerging economies, regulation for that might remain light. This only is competition against oil and gas for grid power rather than in vehicles.

The abundance of coal and the increasing competitiveness of solar and other renewables potentially threaten the business model of the major energy companies, but it’s a gradual threat. Even rather optimistic predictions rarely show solar and other renewables being a true threat to fossil fuels in the next couple decades. Major energy companies dealing in oil and gas seem to have a place for the foreseeable future, which can be extended if they adapt to whatever the market happens to be doing at any given time. An example was their switched focus from oil to gas, although other switches would be less clear-cut than this transition was.

Chevron is a dividend champion with 27 straight years of dividend increases. The current yield is over 3.8%.

Based on the valuation table below, Chevron looks fairly valued. Not overvalued but not undervalued either:


Source: Dividend Toolkit Valuation Spreadsheet

I currently consider Chevron a decent place to put some long-term money as part of a diversified portfolio. The current market price of about $111 is fair if we expect 6% dividend growth and have a target rate of return of 10%. There’s not much of a margin of safety though, so compared to many other investments its solid but I don’t consider it the top of my list.

Emerson Electric (EMR)

Emerson has increased its dividend for 58 consecutive years at an average long-term rate of 11% per year. This makes it one of the longest-running dividend champions around.

I don’t expect full-on 11% dividend growth going forward, and I’m not going to use that figure for my valuation estimate, but I do think EMR looks like a solid investment right now.

The company is broken into five segments: Process Management, Industrial Automation, Network Power, Climate Technologies, and Appliances/Tools. But Emerson is more than the sum of its parts. Most of Emerson’s customers are businesses, and the company often sells a total system solution where Emerson engineers will apply a range of technologies to solve a customer problem and get paid a premium for this mix of service and product. This is what separates them from more commodity-like competition with little product differentiation.

More than half of company sales come from outside of North America as Emerson has expanded its geographical footprint aggressively.


About a third of Emerson’s sales come from the energy sector. That’s another reason why I mention this company. It’s being pulled down in the moderate-term by the same forces dragging on Chevron. The company has underperformed the market over the last five years, although this was only the latest hit to their growth.

Most of the free cash flow of the company goes back to investors in the form of dividends and share buybacks. The outstanding share count is falling, dividends per share keep going up, revenue has gone up modestly over the last five years, but earnings have remained flat which has kept the stock price flat. The segments for Network Power and Industrial Automation have not been as successful as they ideally could be, and Emerson’s Process Management segment is facing headwinds from the difficult energy sector, where a lot of the customers are.

Emerson is adjusting by managing their segments like a portfolio, divesting non-core businesses and making acquisitions to strengthen the areas they are already strong in. Companies go through periods of strength and weakness, and while Emerson’s performance hasn’t been great, that’s exactly the reason why current valuation isn’t as lofty as it might otherwise be, and gives long-term investors an opportunity to invest at reasonable prices if they think the company is well-positioned overall.

This is the valuation table:


Source: Dividend Toolkit Valuation Spreadsheet

The current price of about $59/share looks pretty good and offers a 3.2% dividend yield. Based on the current valuation we can expect a long term rate of return of around 9 or 10 percent based on a long term dividend growth rate of 6 or 7 percent.

A more conservative way to take a position in Emerson would be to sell a covered put option with the intention of buying if exercised. This would lower the cost basis of the purchase at the cost of limiting your short term upside potential. That’s a good tradeoff for a long-term investor in this high-valued market, in my opinion.

For example, selling a January 2016 put option for $5/share at a strike price of $60 would mean one of two things.

Scenario One is that the share price ends at under $60/share before mid-January 2016, and the option is excised, meaning you buy the shares for exactly $60 each regardless of what the share price is at that time, while also having been paid $5/share, resulting in entering a position in EMR at a cost basis of $55/share.

Scenario Two is that the share price ends over $60, so the option buyer does not exercise the option and it expires without value. This would mean you pocket $5/share and can then sell another option if you want. This would be a 8.3% return over 8.5 months.

Oneok Inc. (OKE)

In my article, What To Look for in a MLP, I listed three types of partnerships that are particularly appealing to buy. The second item on the list is publicly traded general partners, which is what Oneok Inc is. This company Oneok Inc. (OKE) owns the general partner interest (GP) of Oneok Partners LP (OKS) and about a third of the limited partner units (LP), and both OKE and OKS are publicly traded. When given the choice, I usually prefer owning shares or units of the general partner for my portfolio in this sort of arrangement, rather than owning limited partner units, for reasons described in that article I linked to.

To quantify it in this case, here it is:


In 2010, Oneok Inc. received $191 million in distributions from the limited partner units they own of OKS. In the same year, 2010, Oneok Inc. received only $120 million from its holding of the general partner of OKS. Fast forward to 2015 estimated numbers, and Oneok Inc. should receive $292 million in distributions from its limited partner units and $402 million from its general partner holding. GP income grew much faster than LP income. The income they get from holding the general partner of a successfully growing partnership compounds like wildfire.

OKS offers a high distribution yield at around 7.5% and a modest distribution growth rate. OKE offers a lower dividend yield of about 5% but higher dividend growth. Analysts at Morningstar predict a 10% dividend growth rate going forward for at least the next few years for OKE.

Oneok Partners, and by extension Oneok Inc., is involved in midstream energy. They gather, process, and transport natural gas. According to a recent investor presentation, they have a $4-$5 billion backlog of growth projects, with 60% of that in the form of natural gas liquids, 15% natural gas gathering and processing, and the remaining 25% in natural gas pipelines.

Because Oneok operates expensive infrastructure across multiple states in central USA between Texas and North Dakota, it is well-protected from competitors. They face risks from shifts in energy usage and can face headwinds from what the energy market is doing at any given time. Like any pipeline business, they need to use substantial leverage to fund their projects, which means they are sensitive to interest rate changes.

Here’s a valuation table:


Source: Dividend Toolkit Valuation Spreadsheet

The current price of OKE is under $49/share. Compared to the estimated valuations derived from different dividend growth rates and target rates of return, the company appears to be attractively valued under just about any reasonably-performing scenario.

Kinder Morgan Inc. (KMI)

Does 10% annual dividend growth and a 4.5% dividend yield sound pretty good? And in an otherwise expensive market? It does to me, if the company can perform as expected.

Kinder Morgan Inc. used to be another publicly traded general partnership like Oneok Inc., except much larger and more complex, until they recently consolidated. Analyzing it was a nightmare regardless of experience level due to the multi-level hierarchy they had and the sheer quantity of information to go through. Now, Kinder Morgan operates in a much simpler and cleaner structure. The P/E ratio is still not a useful metric to analyze this company by, however, due to its asset-heavy nature. Even though it’s no longer in an MLP structure it’s still financially similar to one. The focus of investors should be on its ability to generate cash flow and pay growing dividends while maintaining a stable credit rating.

KMI’s infrastructure spans across the entire United States, and they’re the largest midstream energy company in the country and the third largest overall energy company in the country. But unlike oil majors, Kinder Morgan focuses on being an energy toll road. Their revenue is fee-based for transporting energy and providing other midstream services. 85% of their cash flow is fee-based and about half of the remaining 15% is hedged, leaving the company with less sensitivity to energy prices. Slightly over half of their cash flow comes from natural gas pipelines, and the remaining half comes from a variety of terminals and other pipelines.


The company still faces risk, in part because their huge size dictates massive expansion profits or acquisitions each year to continue their growth. Environmental regulatory risk can reduce their ability to pursue certain projects. There’s a tradeoff between delivering consumers the energy they want and preserving the natural landscape and ecological purity of the land they transport it over.

Ten percent is the annual dividend growth rate that KMI management has stated that they expect to achieve between 2015 and 2020. That would mean a 60% increase in the annual dividend over a five year period. This is expected to come from ongoing acquisitions and their $18 billion backlog of growth projects.

Richard Kinder, founder and CEO of Kinder Morgan since 1997 has $10 billion personally invested in the company and receives annual compensation of $1 to run the company. His wealth is self-made from his long-term outperformance in this sector over nearly two decades now and his real income comes from his dividends from the portion of KMI he owns. This is something long-term investors should love to see- a CEO whose financial incentive is entirely derived from long-term company performance rather than derived from short-term performance. He has little incentive to pursue quarter-by-quarter profits and instead has the luxury and the incentive to sit back and take action for the long-term strategic profitable growth of his company. If there is a Warren Buffet of pipelines, Richard Kinder is him.

Here’s a valuation table for KMI:


Source: Dividend Toolkit Valuation Spreadsheet

Using long-term estimated dividend growth of 7%/year (compared to 10%/year for at least the next five years as expected by management), the current price of $43/share appears poised to offer great returns if operations go well.

For KMI here, I’ll provide a two-stage Dividend Discount model valuation table as well for another valuation check:


Source: Dividend Toolkit Valuation Spreadsheet

That table used a 9% dividend growth rate for the next 10 years followed by 5% forever after that, and is centered on a 10% discount rate / target rate of return.


The market is currently at a higher-than-usual average P/E ratio, but valuation estimates show that under reasonable scenarios, some stocks in the infrastructure sector appear modestly undervalued and some energy and engineering companies are in good shape for investors too.

There are always a variety of risks, including an unexpectedly bad recession at some point, or unfavorable interest rates (particularly for infrastructure companies that need a lot of leverage), but what most of these companies share in common is that they have competitive advantages. Particularly for the infrastructure examples (BIP, OKE, and KMI), their asset-heavy toll-road-like business models (and literally including toll roads in BIP’s case), act as a sturdy foundation for dividends and distributions, and if managed well and not over-leveraged, can weather most types of economic troubles. The world has a lot of infrastructure development coming in future decades, and so pipelines, ports, roads, terminals, transmission lines, and other sorts of capital-heavy assets are a reasonable place to put money for good dividend/distribution yields, in my view.

-M. Alden

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JM Smucker: Fair at $100

-Seven Year Average Revenue Growth Rate: 15.4% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 10.7%
-Seven Year Average Dividend Growth Rate: 9.5%
-Current Dividend Yield: 2.29%
-Balance Sheet Strength: Strong

For solid if not impressive risk-adjusted returns, J.M. Smucker seems well-positioned and fairly valued.


The J.M. Smucker Company (symbol: SJM) was founded in 1897, is headquartered in Ohio, and is still run by the Smuckers family.

The company produces jam, jelly, preserves, peanut butter, sandwich products, ice cream toppings, baking products, oil, juices, and coffee. The company draws its revenue mostly from North America, but has international ambitions as well. The company focuses primarily on having the #1 brand in any given category.

For coffee brands, Smuckers has gone on a buying spree. They acquired the large Folgers brand of coffee from Procter and Gamble, and they also sell Dunkin Donuts coffee for retail markets. They now sell Millstone, Cafe Bustelo, and Pilon coffee, with the last two being popular among Hispanic demographics, statistically speaking.

K-Cups are becoming more popular, and Smuckers has offerings in this area, including from their Folgers Gourmet Selections brand. Smuckers does face strong coffee competition from several brands, with Starbucks and Green Mountain Coffee Roasters being the two most worth mentioning.

Coffee contributes 39% of SJM sales.

U.S. Retail Consumer Foods
The company’s original flagship product is their line of Smuckers fruit spreads: jams, jellies, and preserves. They were smart to acquire the Jif peanut butter brand as well, and they also control or license other brands like Crisco, Pillsbury, and Hungry Jack.

This segment contributes 38% of SJM sales.

International, Foodservice, and “Natural” Foods
Some of the company’s largest brands compete internationally, and they also have brands dedicated to certain markets, like Canada. For “natural foods” in this category, they have Santa Cruz Organic and R.W. Krudsen Family. In fiscal year 2012, the company invested in Seamild, a leading provider of oats products throughout China.

This segment contributes the remaining 23% of sales.

Valuation Metrics

Price to Earnings: 19
Price to Free Cash Flow: 22
Price to Book: 2.1


Smuckers Revenue
(Chart Source:

The revenue growth rate is high at 15.4% per year averaged over the past 7 years. This is because the company issued new shares for capital to make acquisitions up until 2010.

Earnings and Dividends

Smuckers Dividends
(Chart Source:

Over the same 7 year period, EPS growth was 10.7% per year while dividend growth was close behind at 9.5% per year. The most recent dividend increase was 11.5%.

The current dividend payout ratio from earnings is about 40%, so the dividend is well-covered and has room to grow.

Approximate historical dividend yield at beginning of each year:

Year Yield
Current 2.3%
2013 2.3%
2012 2.5%
2011 2.6%
2010 2.3%
2009 2.9%
2008 2.4%
2007 2.3%
2006 2.3%

As can be seen by the chart, except for certain points of volatility, Smuckers stock has maintained a fairly consistent mediocre dividend yield. The price of the stock has risen at almost exactly the same rate as the dividend growth.

How Does SJM Spend Its Cash?

Over the past three years combined, Smuckers brought in about $1,300 million in reported free cash flow. About half of that, or $630 million, was spent on dividends. Over $1 billion was spent to buy back stock, and the outstanding share count has decreased by nearly 8% cumulatively over the past three years. Approximately $730 million was spent on acquisitions.

Balance Sheet

Smuckers has a total debt/equity ratio of under 45%, although goodwill makes up about 60% of existing shareholder equity due to acquisitions. The total debt/income ratio is about 4x. The interest coverage ratio is just over 10x, indicating that Smuckers can easily pay all debt interest.

Overall, the balance sheet is in a strong position. Management has used leverage appropriately and conservatively.

Investment Thesis

Smuckers has substantially outperformed the market over the last 15 years due to a series of large successful acquisitions and good management of their capital. A diverse set of top brands gives the company a steady, defensive position while outperforming, and therefore the risk-adjusted returns have been particularly good.

Looking to the future, management aims for sales growth of 6% per year (organic growth of 3-4% and acquisition growth of 2-3%), and EPS growth of 8% driven primarily from that sales growth plus share buybacks. With the dividend, this would lead to total returns of 10-10.5% or so, which is higher than the S&P 500 historical average.

The internal strategic efforts appear to be a page out of Pepsico’s current playbook with their “Healthy for You”, “Good for You” and “Fun for You” levels of products representing the spectrum of how bad for you a given product is. Smuckers has “Good for You”, “Easy for You” and “Makes You Smile”.

Overall focus of the company includes concentrating on North America and China rather than expanding everywhere, focusing on health products such as ones with natural ingredients or special-diet options such as gluten free products, and continuing to look for bolt-on acquisitions to complement their previous transformational acquisitions.


Like any company, SJM has risks. Being a food company, they are a defensive stock, but they always face risk in two main forms: commodity costs and cheaper private label competition. In addition, in contrast to many large American companies, Smuckers has most of its sales and operations in North America, meaning it is geographically concentrated.

Packaged food is a competitive business, and Smuckers expects flat volume growth and a 1% sales reduction in 2014, but decent EPS and dividend growth.

Conclusion and Valuation

With the DJIA and S&P 500 continuing to hit new records, stocks at a decent valuation are difficult to find, and this is especially so for relatively stable blue-chips that you can buy and set aside for a while. In addition to increasing risk and reducing overall returns, this pushes dividend yields lower across the market, which reduces the amount of dividend income you can buy with any given amount of cash.

That being said, SJM neither appears to be a clear value or a clear overvaluation. While the markets soared upward throughout 2013, SJM actually fell over ten bucks from its mid-year high.

The earnings multiple approach should work well for valuating the company. If management is successful and raises EPS by 8% per year over the next 10 years, then the EPS figure will be $10.57 at that time. Putting an earnings multiple of 16 on that EPS figure in ten years (compared to an earnings multiple of 19 now) puts the stock price at about $169. If dividends continue to be paid with a payout ratio of 40%, that’ll be about $30 in cumulative dividends over those ten years, or about $42 if they are reinvested into the stock. So, $169 + $42 = $211 in value in ten years.

That’s an annualized rate of return of about 7.5% from the current price of $101, which is neither particularly appealing, nor particularly bad for a defensive company in a highly valued market, and assumes a significant drop in valuation. If instead the valuation remains constant at a P/E of about 19, the rate of return under the same conditions would be about 9% per year, which is in line with historical S&P 500 growth.

Excluding any major company missteps, it seems unlikely that investors would be disappointed having invested in Smuckers stock at the current price over the long-term, and so I view the company as a reasonable, if not appealing, buy. There is of course a large risk of near or mid-term stock price declines during a market correction.

Full Disclosure: As of this writing, I am long SJM.
You can see my dividend portfolio here.

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