Last time we showed research that revealed that dividend-paying stocks have outperformed non dividend-paying stocks over the last three years. Importantly, the research also showed that the higher the dividend growth of a stock, the higher its total rate of return, up to a point. That point of diminishing returns occurred in the quintile that included companies with the highest dividend growth rates. These companies did not perform as well, pricewise during the period, as did companies in the second quintile of dividend growth.
We have previously offered research showing that among dividend paying stocks that dividend growth is the best indicator of long-term price growth. Thus, companies that are producing high dividend growth and not being rewarded with high price appreciation are of particular interest to us. Our experience has taught us that these kinds of companies will at some point have a price growth spurt that will close the performance gap.
Let us give you an example of what we mean by this:.
Becton Dickinson (BDX) is a global medical technology company that is focused on improving drug therapies, enhancing the quality and speed of diagnosing infectious diseases, and advancing research and discovery of new drugs and vaccines.
Over the past three years, BDX has hiked its dividend by an average of nearly 15% per year. During this time, its stock price has risen by only about 5% per annum. Of course this has been a time when almost all health-care stocks have underperformed the market. However, the difference between BDX and it brethren in the sector are stark. BDX has not only produced dividends and earnings growth much higher than the average stock in the health-care sector, but it has also enjoyed higher dividend and earnings growth than the average stock in the S&P 500. Yet this strong fundamental performance has produced sub-par price gains.
The sub-par price performance of BDX, in the face of its outstanding dividend and earnings growth, has left the stock undervalued in our dividend model by about 17%, as shown on the chart above. The dividend model also reveals that BDX has been undervalued for the last three years.
As we have said many times before, a stock can stay undervalued or overvalued for a long time, but eventually price will seek to close the valuation gap. We often find that three years is about the limit of valuation gaps.
BDX recently announced a dividend increase for the coming year of 11%, the 38th consecutive year the company has raised its dividend. This again is a bigger dividend hike than that of the average stock during the last twelve months. In our minds, BDX's wide valuation gap cannot withstand many more above average dividend hikes. The time for the the market to play some catch up may be near.
We will show you more of these stocks with valuation gaps in the weeks ahead.
We own BDX in our Capital Builder investment style. Do not use this blog for investment advice. Please seek the advice of your own professional investment manager.