Quick Ideas

In the initial screening process for new investments, it helps to review quick information for multiple companies. I provide regular articles to highlight groups of dividend-paying companies under various themes and concepts so that you can help find investments you're interested in, and you can find them below.
 
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Can You Believe there is a 30% Rebate on Toothpaste?

 

Summary:

52 years of consecutive increasing dividend payment makes CL a strong dividend growth stock

Strong currency headwinds may reduce its double digit dividend growth trend

Dividend Discount Model used shows CL trading at a 30% discount

DSR Quick Stats

Sector: Consumer – Defensive

5 Year Revenue Growth:  2.42%

5 Year EPS Growth: 4.81%

5 Year Dividend Growth: 10.55%

Current Dividend Yield: 2.15%

What Makes Colgate-Palmolive (CL) a Good Business?

Colgate-Palmolive is a consumer products company. The Company provides products for oral care, personal care, home care and pet nutrition:

cl1

CL is the world’s leading producer & manufacturer of toothpaste with 44.8% of the worldwide market share. This is a very important competitive advantage as the world won’t stop brushing their teeth and toothpaste is a highly repetitive buy for any household. CL doesn’t only show a strong market share of toothpaste but it shows a similar profile with regards to toothbrushes with a 33.8% worldwide market share.

Colgate Palmolive is also focusing on employee equity and environmental concerns. They can also claim to promote health with their Oral and Personal care products (who would argue that they can’t help with hygiene in emerging markets through their toothpaste?). In their financial reports, they outline their “Sustainability Strategy” aiming at 5 principles:

  1. Promoting healthier lives
  2. Contributing to the community
  3. Delivering products that respect our planet
  4. Reducing water consumption
  5. Reducing impact on climate and environment

Ratios

Price to Earnings: 26.78
Price to Free Cash Flow: 58.86
Price to Book: 133.37
Return on Equity: 181.40%

Revenue

cl2

Revenue Graph from Ycharts

CL revenue has been greatly affected by currency headwinds. However, the company continues to show strong emerging market sales growth in constant dollars with a +9.5% in 2014 and +6.5% for the first quarter of 20115.

How CL fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve gone through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing . The first four principles are directly linked to company metrics. Let’s take a closer look at them.

cl3

Source: Ycharts

Principle #1: High dividend yield doesn’t equal high returns

I’ve never been a big fan of high dividend yielding stocks. They usually show very small dividend growth as they are imprisoned with a high payout ratio. And if they don’t, their high yield is linked to higher risk (there is no free lunch in finance). Overall, I tend to look at companies with dividend yields between 2% and 4% historically, these are the ones which tend to perform the best.

cl4

Source: data from Ycharts.

While CL has aggressively increased its dividend payment over the past 5 years, the dividend yield has remained relatively low. However, the yield is high enough to fit my first criteria.

Principle#2: If there is one metric, it’s called dividend growth

According to my own experience and much financial research, dividend growth is the most important metric for a dividend investor. Strong dividend growth is a sign of a healthy business generating important cash flow.

CL is showing a strong dividend growth history of 52 consecutive years of increasing its payment. Therefore, the case is pretty much closed regarding this criteria.

Principle #3: A dividend payment today is good, a dividend guaranteed for the next ten years is better

Past dividend growth is very important, but not as important as future dividend growth. In order to determine if a company is able to continue increasing its dividend in the future, I look at the dividends paid and payout ratio trend over the past 5 years:

cl5

As you can see, the payout ratio has increased by 10% over the past 2 years while the dividend payment consistently increased. A part of the reason why the payout ratio is higher today is the strong currency headwinds CL has faced since 2012. However, the payout ratio is far from being a source of concern at the moment. There is plenty of room for the company to continue increasing its payment. The only thing that might change is that it may become a challenge to maintain double digit growth.

Principle #4: The Foundation of a dividend growth stock lies in its business model

I like a company that has a solid economic business model with a relatively wide moat. This is the case with CL where the oral care segment that generates near 50% of its sales is well secured. CL is a leader in this industry and is present across the globe with an even more dominant presence in high growth countries in emerging markets.

This dividend aristocrat shows the perfect profile of a steady money making machine with positive free cash flow each quarter. There is no doubt CL has its place in a dividend growth portfolio.

What Colgate-Palmolive Does With its Cash?

Since 2009, CL has been generating over 2 billion in cash flow each year. More recently, its yearly cash flow is around 2.5 billion (for 2013 and 2014). The first thing management does is to make sure it doesn’t break its 52 years streak of increasing dividends.

Along with a juicy dividend increase each year, the company also spends lots of money on advertising and brand-building activities. Their main focus is emerging markets since there is plenty of room for them to keep growing.

Finally, a good portion of the money is dedicated to improve the current brand portfolio and enhance existing products. This is how CL created its “whitening mega brand” from Colgate products.

Investment Thesis

CL sells primarily consumable products that continually reappear on the buy list of any household. The company is working hard to gain market share in its dominant market and makes sure it offers a variety of products reaching all price points. For example, Colgate toothpaste product is offered in 5 different package/options from the cheapest to the priciest in order to block all entry for possible competitors. Finally, the company makes additional efforts to partner up with dentists to improve dental care awareness around the world. It ensures two complementary goals; to have dentists on their side and to increase the number of individuals caring for their mouths.

Since 1998, the company gross margin has been superior to 50% and has been consistently over 58% since 2011. This is a huge money making machine that has found a way to be highly profitable over the years. The gross margin is even better in emerging markets where its growth rate is the most important.

Finally, the company is present in over 200 countries and has a major leadership position in all fast growing markets. CL is well positioned to benefit from its vast distribution channel in order to penetrate any market.

Risks

CL is making several efforts to develop new products but its range of knowledge is highly limited. Since 46% of its sales come from oral care, there is a limit of numbers of different toothpastes and toothbrushes a household will buy. Chances are the new products within the Colgate brand will only serve to cannibalize a part of their sales + earn a few bps in the market share battle. Their long term growth opportunity is limited by the size of the population at the moment.

Since 80% of CL sales are made outside the US, the company is highly vulnerable to currency volatility. Lately, this has been a major challenge since the US dollar seems to gain more strength each day.

Should You Buy CL at this Value?

In order to determine CL’s value, I will use 2 different methods. The 10 year PE ratio history will tell me how the company has been perceived by the market recently:

cl6

As you can see, there is a growing interest for the company lately. The strong dividend payment increases doubled with miserable bond interest rates might have seduced more than one income seeking investor. So far, the stock seems overpriced but let’s use a more detailed way to value the company.

The dividend discount model (DDM) is often used by dividend investors as it helps to ascertain a value considering the dividend payment potential of a company. Since the company is evolving in a defensive industry and shows strong cash flow, I will use a discount rate of 9%.

Due to strong currency headwinds and the volatility that comes with emerging markets, I will use a dividend growth rate that is lower than what the company has shown more recently. I will conservatively use a 9% growth rate for the first 10 years and reduce it to 7% after. With these numbers, I think I can’t go wrong in the company valuation:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $233.21 $115.82 $76.73
10% Premium $213.77 $106.17 $70.34
Intrinsic Value $194.34 $96.52 $63.94
10% Discount $174.90 $86.87 $57.55
20% Discount $155.47 $77.22 $51.15

Source: Dividend Toolkit calculation spreadsheet.

Wow… 30% discount rate for a company that currently trades over 26 PE… I’ve played around with the numbers and the model gives me a fair value of $64.75 with a 6.50% dividend growth rate. This is far below what has been offered to investors for the past 10 years. Therefore, there is definitely a bargain to be had on CL at the moment.

Final Thoughts on CL – Buy, Hold or Sell?

After doing the DDM calculation, it seems obvious that CL is a good buy for any dividend growth portfolio. The compounding strength of dividend growth will be expressed within these shares and will reward the investor.

The margin of safety is big enough for most investors for anyone to enter in a position even if the PE ratio seems high.

Disclaimer: I do not hold shares of CL at the moment.

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Polaris Industries:  The King of Off-Road Recreational Vehicles

This article is a guest post written by Ben Reynolds of Sure Dividend.  Sure Dividend focuses on high-quality dividend growth stocks suitable for long-term holding.

You may not have heard of Polaris Industries (PII)  – it does not get as much recognition as other dividend growth stocks like McDonald’s (MCD) or Apple (AAPL).  Still, Polaris Industries is the industry leader in off-road vehicles.  Investing in the top company in an industry can produce phenomenal returns.  Case-in-point:  over the last 10 years, Polaris Industries has compounded its earnings-per-share at 16.8% a year.  The company’s share price has increased nearly 400% in the same time period.

With rapid growth, one would expect Polaris Industries to be a relatively new company.  It is not, however.  Polaris Industries was founded in 1954.  The company has paid steady or increasing dividends since 1989, making Polaris Industries a potential candidate to consider when building a dividend growth portfolio.  Polaris Industries’ operations, growth prospects, and dividend are analyzed below.

Business Overview

Polaris Industries Operations are split into 5 segments.  Each segment is shown below along with the percentage of total revenue generated by the segment for Polaris Industries in fiscal 2014:

  • Off-Road Vehicles: 65% of revenue
  • Parts/Garments/Accessories: 17% of revenue
  • Motorcycles: 8% of revenue
  • Snowmobiles: 7% of revenue
  • Small Vehicles: 3% of revenue

The Off-Road Vehicles segment is by far the largest.  The segments sells off road vehicles under the Ranger, RZR, Sportsman, and Ace brands.  Polaris Industries surpassed its competitors to become the market share leader in off-road vehicles in 2010.  Since that time, the company has increased its market share lead every year thanks to its strong brands.

The company’s second largest segment is the Parts/Garments/Accessories segment (hereafter referred to as PG&A).  The PG&A segment generated 53% of revenue from accessories, 39% from parts, and 8% from apparel in fiscal 2014.  69% of total revenue came from off-road vehicle PG&A items.

The company’s other 3 segments accounted for 18% of total revenues in 2014, combined.  The motorcycles segments sells under the Victory, Indian Motorcycles, and Slingshot brands.  The Snowmobiles segment sells the following brands:  RMK, Indy, Rush Pro Ride, and Switchback.  The Small Vehicles segments sells under the GEM, Groupil Industries, Aixam, and Mega brands.

Growth Analysis

Polaris Industries has experienced phenomenal growth over the last 10 years.  The company’s 10 year growth rates over a variety of metrics are shown below:

  • Revenues-Per-Share Growth Rate: 1% per year
  • Earnings-Per-Share Growth Rate: 8% per year
  • Dividends-Per-Share Growth Rate: 7% per year
  • Book-Value-Per-Share Growth Rate: 7% per year

As you can see, Polaris Industries has compounded shareholder wealth at between 12.7% and 16.8% a year over the last decade, depending on what measure you use.  The company’s rapid growth has been driven by finding the ‘right people’, focusing on quality, and building its brands while increasing efficiency.  Over the last decade, profit margins have increased from 7.7% to 10.1% – a significant boost in profitability.

Polaris’ management is expecting 12% sales growth per year and 13% earning-per-share growth per year up to the year 2020.  If the management of most companies announced 13% earnings-per-share growth goals to 2020, investors would be wise to be skeptical.  With Polaris Industries – the opposite is true.  It is very likely the company hits its 13% earnings-per-share growth goals up to 2020.  The company greatly exceeded this level of growth in earnings-per-share over the last decade.  It would take a significant and protracted recession for the company to not grow earnings-per-share at a 13%+ a year going forward.

Polaris Industries will achieve its growth as it gains greater efficiencies through scale.  The company is opening up a new manufacturing plant in the U.S. in the second quarter of 2016.  Additionally, Polaris Industries is seeing strong demand for both in both its Motorcycles segment and its flagship Off-Road Vehicles segment.

Dividend Analysis & Valuation

Polaris Industries currently has a dividend yield of 1.5% and a payout ratio of just 28%.  With a low payout ratio and a high expected growth rate, dividend investors in Polaris Industries should expect dividend growth of at least 13% a year over the next several years, and quite possibly higher.  By 2020, current investors will have a yield on cost around 3% if the company grows its dividend payments at 13% a year.  It is quite possible the company will grow its dividend payments significantly faster.  If management decides to increase its payout ratio over the next several years, dividend investors will see even higher yields-on-cost.

Polaris Industries currently offers shareholders an expected total return of 14.5%.  This return comes from dividends (1.5%) and expected earnings-per-share growth (13%).  With a total return of 14.5%, Polaris industries investors can expect to double their initial investment in just over 5 years.

Somewhat surprisingly given its strong growth history, Polaris Industries does not trade at a nose-bleed price-to-earnings ratio.  The company currently has a price-to-earnings ratio of 21.4 and a forward price-to-earnings ratio of 16.3.  At current prices, Polaris Industries appears fairly valued – if not undervalued – considering the company’s excellent growth prospects.

Dividend Monk’s Note:

I decided to use the Dividend Discount Model to add more on valuation in this article.

Using the Dividend Discount Model with a dividend growth of 13% for the first 10 years  and then a smaller dividend growth rate of 9% and a discount rate of 11% (since the company is not comparable to a giant dividend payer such as MCD), we get the following chart:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
Discount Rate (Horizontal)
Margin of Safety 10.00% 11.00% 12.00%
20% Premium $392.50 $193.86 $127.75
10% Premium $359.79 $177.70 $117.10
Intrinsic Value $327.08 $161.55 $106.46
10% Discount $294.37 $145.39 $95.81
20% Discount $261.67 $129.24 $85.17

The Dividend Toolkit provides me with a two stage DDM calculation and clearly shows the stock trading at a 10% discount. I’ve doubled check my valuation with Morning Star and they value PII at $169. Therefore, my calculation are line with other analysts.

Final Thoughts

Polaris Industries has grown to become the leader in the North American off-road vehicle industry.  The company has experienced somewhat of a renaissance over the last decade – and especially the last 5 years.  Management has done a fantastic job of growing the business while simultaneously increasing margins and paying dividends.

In addition, Polaris Industries scores high marks for safety.  The company is a member of the Dividend Achievers Index; it has increased its dividends each year since 1992 and has paid steady or increasing dividends since 1989.  Polaris Industries has just under $230 million in debt on its books.  The company made $455 million in profits in 2014; Polaris Industries is conservatively financed.  In addition, the company has over $100 million in cash on hand.

Polaris Industries is a conservatively financed industry leader .  The company offers investors solid dividend growth potential with a current yield about 0.3 percentage points below the S&P 500’s current dividend yield.  Polaris Industries shares may be suitable for long-term dividend growth investors focused more on future income than current income.

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Five Dividend Stocks Buying Back Their Own Shares

Top Dividend StocksWhen management of a company is looking to make good use of incoming capital for shareholders, there are various options.

If they have a good expansion opportunity, or believe stronger advertising can provide good returns, then the money may be beneficially reinvested for organic growth. Organic growth is often the best use of capital, but there’s a limit to how quickly a large company can grow in a given amount of time.

Alternatively, if there is a complementary business that management believes is appropriately priced and will strengthen their company, they can make an acquisition. The downside is that, in many industries, acquisitions are often over-priced empire-building activities rather than truly beneficial to shareholders.

And of course, if a company has a weak balance sheet, some incoming capital can be used to pay off debt and add additional liquidity to the balance sheet.

In addition, there are two more direct ways to give money back to shareholders. The most direct way is to pay a dividend, where a company sends a portion of the profits to shareholders, ideally on a regular basis.

Alternatively, or in addition to dividends, company management might want to use some incoming profits to buy back shares of the company, and thus decrease the number of shares outstanding, and therefore increased the percent ownership of each share. All else being equal, share buybacks boost EPS, and are functionally similar to reinvested dividends, but are treated better than dividends under current tax law. The downside to buybacks is that a lot of companies buy back shares when they are expensive and hold tightly onto their money when times are tough, with the end results being similar to a nervous investor that avoids investing in market bottoms and happily invested in market tops.

There are some companies that pay regular growing dividends, and then use any extra cash flow after that and other options, to buy back some shares. The dividend yield and share buyback yield, put together, are the shareholder yield, which gives the investor a decent idea of what rate of return can be expected merely from taking existing profits and giving them back to shareholders, on top of all other growth prospects.

One of the criticisms about the sustainability of capitalism is that it requires constant growth to function, but that’s only partially true. You can get substantial returns from a company that isn’t growing. When a stock is at the right valuation, then a significant number of share buybacks along with dividends can produce a 10% rate of return even when the company is not growing at all, or only growing due to keeping pricing up to pace with inflation. A good example of that is Chubb Corporation (CB), which has no revenue growth, but has boosted EPS, dividends, book value, and the stock price, over the long term.

This is a non-exhaustive list of five more select companies that are both paying dividends and regularly buying back shares.

Becton Dickinson (BDX)

Becton Dickinson is a global medical device company, producing a variety of medical, diagnostic, and bioscience products, with significantly more than half of company revenue coming from outside of the United States.

The company has over four decades of consecutive annual dividend growth, but due to a modest payout ratio and the recent surge in stock price for 2013, the dividend yield is fairly low at only 2%. Much of the capital goes to buybacks, however. In the past nine years, they’ve bought back nearly 25% of the company’s market cap. Recently, the company has bought back over 7% of its market cap in each of two years, but that has largely been due to taking advantage of low interest rates to increase the corporate leverage. More sustainably over the long-term, the company buys back perhaps 3% of its stock per year, while paying a 2-3% dividend yield, and combining that cash return with solid revenue growth.

I view the current valuation of BDX to be reasonable, if not exactly appealing, compared to many other potential investments on the market currently. A full analysis from earlier this year is available here.

Lowe’s Companies (LOW)

I haven’t published a report on Lowe’s in a few years, primarily due to the low dividend yield of only 1.5% (despite five decades of consecutive annual dividend growth). It’s a good mention in a share buyback list, however, since it couples the dividend with serious regular stock buybacks. The company bought back 30% of its market cap in under 8 years, reducing the share count considerably from over 1.6 billion to well under 1.2 billion. The company offers a decent 5% shareholder yield overall, along with solid core growth.

Overall, I’d classify this home improvement retailer as being a bit pricey at the current time after the 2013 run-up.

J.M. Smucker Co. (SJM)

Smuckers, the maker of Jams and Jelly, is an interesting example. Over the past decade, they went on an acquisition-spree buying brands like Folgers coffee and Jif peanut butter to turn Smuckers into a larger, diversified food company. To afford all of this, the company regularly issued new shares, growing the number of outstanding shares in the process. Over the 2005-2010 period alone, the company doubled its number of shares outstanding. The strategy paid off, as per-share metrics had very strong growth and roughly quintupling the investment of their investors over the most recent 12 year period.

Now, the company is using substantial buybacks and decreasing its share count. The current dividend yield is about 2.16%, with another 2-3% buyback yield. I do feel, however, that the valuation is a bit ahead of itself, and it would be better to watch this one for a while.

Target Corporation (TGT)

It’s tough to dig any sort of moat in retail, which is a low margin and hyper-competitive industry. Being a “middle of the road” retailer, avoiding the bargain or luxury extremes, is a particularly dangerous place to be. Target has found a niche at the high end of the budget space- typically a classier shopping experience than Wal-Mart and membership chains, but still with rather low prices. The company’s four and a half decade streak of consecutive annual dividend increases is evidence of the success of this strategy so far, and the current dividend yield is 2.68%.

Target also buys back shares, having bought back nearly 30% of its market cap in the past decade. The company often purchases up to 5% of its market cap in a single year, although it can vary year to year. I view the company as reasonably valued, but with large retail competitors, bulk membership competitors, and disruptive online competitors, I’d like to see a bigger margin of safety.

Texas Instruments (TXN)

Texas Instruments is the largest producer of analog chips in the world. Their products tend to have long life-cycles and high margins, and they supplement those strengths with a particular focus on their large sales team. The headwind for the company is that they’ve been exiting some commodity product lines to focus in their core analog area, and as can expected this decision has impacted revenue.

The company wasn’t much of a dividend payer until the last few years, where it has quickly grown its dividend to a current yield of 2.89%; fairly high for the tech industry. The company bought back 35% of its market cap in the past decade, and continues to buy back ~4% of its shares each year.

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

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