Monday, November 29, 2010

Becton Dickinson : A Dividend Star with a Lagging Price

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.

Saturday, November 13, 2010

Since the Subprime Crisis Began, Higher Dividend Growth Has Been Rewarded -- Up to A Point

We recently completed an analysis to determine how companies with rising dividends have fared during the last three years, a time when overall dividend payments by S&P 500 companies were falling. 

We divided all dividend-paying companies in the S&P 500 Index into quintiles ranked according to their average annual dividend growth over the past three years. A sixth group consisted of those companies that do not pay dividends.    We then computed the average total rate of return for each quintile over the three years. 

The results are impressive and a bit surprising.  The seventy companies with the highest average annual  dividend growth rates over the past three years have outperformed 58% of all stocks in the S&P 500.  By contrast, the companies with the lowest average annual dividend growth  rate (actually a loss) only outperformed 28% of the stocks in the S&P 500.  Here's the ranking for all dividend-paying quintiles and non-dividend payers:

  1. Quintile with the highest average 3-year dividend growth outperformed 58% of all S&P 500 stocks.
  2. Second highest quintile outperformed 61% of all stocks. 
  3. Third highest quintile outperformed 53% of all stocks.
  4. Fourth highest quintile outperformed 51% of all stocks.
  5. Fifth highest quintile outperformed 28% of all stocks.
  6. Non dividend paying stocks outperformed 48% of all stocks.
To better understand these data, it is helpful to show the 3-year average annual dividend growth rate for each quintile.
  1. Quintile 1:  3-year average annual dividend growth rate of 21.8%
  2. Quintile 2:  11.3%
  3. Quintile 3:  6.1%
  4. Quintile 4:  0.0%
  5. Quintile 5: -28.0% 
The bottom line is if a company began the period paying a dividend and did not cut it, it would have outperformed at least 51% of all stocks.  A company improved its performance relative to all stocks the more it increased its dividend, except for those companies in quintile 1. 

The surprise in the data is that quintile 2 stocks, with an average 3-year year dividend growth of 11.3%, outperformed quintile 1 stocks, which had a 3-year average annual growth rate of 21.8%.

We have two comments about this surprising asymmetrical result: 1) the very high dividend growth observed in quintile 1 stocks was influenced by many large one-time dividend increases among consumer cyclicals and industrial stocks; 2)  In spite of this, we see a similar asymetrical result when comparing earnings growth versus price growth.  The stocks in the quintile with the highest earnings growth did not outperform those in the second quintile. 

Thus, in looking at both dividends and earnings we see that high growth has not been rewarded with proportionately higher price growth. This is the primary reason that we now believe the sweet spot of the stock market is in the high dividend and earnings growth companies.

We will review a few of these companies in the weeks ahead.

Bloomberg data was used for this analysis.