Dividend Growth Stock of the Month – Special Edition: Blue Chips in a Pandemic Bear Market

Normally, in this monthly column, I analyze one dividend growth stock. I generally cover companies that are high-quality and fairly valued.

These are not normal times. The Covid-19 pandemic, occurring simultaneously with an oil price war, caused a market crash. That has been followed by federal legislative and financial recovery steps designed to counteract the societal and financial impacts of the virus.

The 11-year bull market has ended.

The S&P 500 reached its highest closing level in history on February 19, 2020 (3386).

It then began falling almost every trading day through Monday, March 23, a little over a month (2237, down 34%).

Then the market reversed again last week, ending Friday up 14% (2541) since Monday’s low.

The total drop through Friday from the high on February 19 has been 25%.

Here’s what looks like in total.

The February 19 high is marked by the red dot. The low is Monday, March 23. The right end of the graph is the close on Friday, March 27, 2020. You can see the jagged trading volatility over the past month for yourself.

The US is now in a National Emergency, and individual states are taking increasingly aggressive steps to keep the virus from spreading, and to try to save lives among people who have already caught it. Millions of people are suddenly out of work.

On Friday, Congress passed, and President Trump signed, a massive financial relief bill. In the prior two weeks, the Fed slashed interest rates to near-zero and announced programs to inject billions of dollars into the banking system.

Still, economic activity has been interrupted in thousands of ways, and a recession seems likely. Indeed it may already have started.

By falling more than 20%, the market satisfied the common definition of a bear market, even though it happened over such a short period of time. There is no way to know whether the climb last week “put in the low” on March 23. But falling stock prices have potential buyers taking notice. Are there intelligent reasons to buy stocks under these conditions?

I can’t answer that question with any degree of confidence. But this month, I present a special edition of DGSM: An examination of nine popular dividend growth blue chips that have been hit, in varying degrees, by the crash. I want to focus on:

• How price volatility has changed their yields.
• Whether their dividends are still safe. Do they still have strong credit ratings and high dividend safety scores?
• Whether their valuations have fallen into attractive territory for potential new purchases.

Important notes on the data: I pulled all of the quantitative data, including charts and graphs, following the close on Friday, March 27, 2020.

I set the number of years on all FASTGraphs to 8 years in order to get five years of data into the calculation of each stock’s “normal” price-to-earnings (P/E) ratio (the blue line on each chart). All of the “default” (orange) valuation lines reflect P/E ratios of 15. Under normal circumstances, the fair value of each stock lies between those two lines.

The projections for future earnings on the FASTGraphs have to be regarded as speculative. When companies begin reporting first-quarter results in April, we can expect numerous revisions in guidance and analyst forecasts. For that reason, I would adopt a conservative mindset when thinking about future earnings and what they imply for valuations now.

AT&T (T)

AT&T Inc. is the world’s largest telecommunications company, largest provider of mobile telephone services, and (since 2018) the parent company of media giant Warner Media. AT&T’s business model has changed from being a telecommunication “pure play” to media conglomerate.

AT&T has been a high-yield, slow-growth DG stock. It has a dividend growth streak of 36 years, and in recent years its dividend growth rate has been 2% per year. AT&T is a holding in my Dividend Growth Portfolio.

The chart below shows AT&T’s price and yield since February 1.

You can see how AT&T’s price has been affected by the market crash, which in turn has caused AT&T’s yield to spike from about 5.5% to 7.2%.

The attractiveness of that yield, of course, presumes that the company can maintain or increase its dividend. That’s why we’re also going to look at credit ratings and dividend safety scores, because we want to get an idea about each company’s probable financial stability.

Ratings:

• S&P has not changed AT&T’s credit rating. It remains at BBB, which is a low investment grade. The rating was affirmed on February 20.
Simply Safe Dividends has not changed AT&T’s dividend safety grade, which remains at 65 points on a 100-point scale, or “Safe.”

Finally, let’s consider valuation. On the chart below, the orange line and blue lines define the stock’s fair-value range, as discussed above. The black line is AT&T’s actual price.

Price being so far below the fair-value reference lines suggests that AT&T is undervalued. That is reinforced by the fact that AT&T’s current yield is 28% above its 5-year average.

I drew the red arrow to suggest that over time, AT&T’s price may recover from its current depressed level. That, of course, depends on AT&T’s business results as well as market conditions over the next few years.

Dominion Energy (D)
Dominion’s history traces back to 1898. Dominion is one of the country’s largest diversified utilities. It has a base of about 7.5 million gas and electric customers in 18 states located mostly in the Midwest and along the Eastern seaboard.

Dominion has been a high-yield, fast-growth stock. It has increased its dividend for 16 straight years, with a growth rate usually in the high single digits. Dominion is in my Dividend Growth Portfolio.

The price crash has taken Dominion’s yield from about 4% to about 5.5%.

Ratings:

• S&P has not changed Dominion’s BBB+ credit rating. That is a low-investment grade rating that it has held since 2016.
• Simply Safe Dividends has maintained Dominion’s dividend safety at 75, which is “Safe.” It affirmed this grade on March 25.

Valuation:

The FASTGraph suggests that the price crash has taken D’s price from high up in its fair-value range to the middle of that range. In other words, it’s not in the bargain bin, but it seems to be no worse than fairly priced.

A peek at Dominion’s average yield, however, suggests that the stock may be undervalued. Its current yield is 30% higher than its 5-year average, and higher than it has been most of the time over the past five years. (The graph is from Simply Safe Dividends.)

Johnson & Johnson (JNJ)

Johnson & Johnson (JNJ) has grown into the world’s largest medical conglomerate. It has more than 250 subsidiaries operating in 60+ countries. It has both a diverse product mix (pharmaceuticals, medical devices, and consumer products) and a global customer spread.

JNJ has been a mid-yield, mid-growth stock. It has increased its dividend for 57 consecutive years. Over the past few years, its increases have been in the 5%-6% range. JNJ has a position in my Dividend Growth Portfolio.

The market’s crash has pulled JNJ’s yield up from about 2.5% to 3.2%.

Ratings:

• S&P has not touched JNJ’s AAA credit rating. Johnson & Johnson is one of only two companies with a triple-A credit rating, which it has held since the late 1980s. AAA is the highest rating available.
• Simply Safe Dividends has maintained JNJ’s dividend safety at 99, which is one point short of maximum and is termed “Very Safe.”

Valuation:

The FASTGraph suggests that while JNJ’s price has not dropped very much, it has gone from the upper end of its fair-value range to being a bit undervalued. For such a high-quality stock as JNJ, it would have to be said that its price is attractive here.

Simply Safe Dividend’s chart reinforces that, showing that JNJ’s dividend yield is 13% above its 5-year average, and just about as high as it’s been at any time over the past five years.

Kimberly-Clark (KMB)

Kimberly-Clark (KMB) is another old (1872) company that has grown into one of the largest manufacturers of tissue and hygiene products. Its two main segments are Personal Care and Consumer Tissue. The company has a host of blockbuster brands, including Huggies, Kleenex, Cottonelle, Scott, and Kotex.

Half of KMB’s sales and 70% of its profits come from North America, but its products are sold globally. It is estimated that a quarter of the world’s population uses KMB’s products, which the company sells to supermarkets, mass merchandisers, drugstores, and other retail outlets.

KMB has been a mid-yield, slow-to-mid-growth stock. Its dividend has been increased for 48 straight years. For the past few years, its increases have been in the 4%-6% range each year. My wife and I hold KMB in our personal portfolio.

The bear market has taken KMB’s yield up from about 2.8% to 3.6%.

Ratings:

• S&P has not changed KMB’s A credit rating, which is a mid-range investment-grade rating. The company has held that rating since 2008.
• Simply Safe Dividends has maintained KMB’s dividend safety at 88, which is in the top quintile of scores and termed “Very Safe.”

Valuation: The bear market has lowered KMB’s price, but it was overvalued to begin with. On FASTGraphs, KMB has gone from being overvalued to being fairly valued. Despite the price dip, KMB is not selling at a bargain or discounted price.

McDonald’s (MCD)

McDonald’s (MCD) is the world’s largest fast-serve restaurant chain. It has more than 38,000 locations in more than 100 countries. Almost all of McDonald’s restaurants are franchises, owned and operated by independent business owners. Under this business model, McDonald’s owns or leases the property and grants the franchise, making money from rent, royalties, and initial fees paid upon the opening of a new restaurant.

McDonald’s is truly global, deriving about 36% of revenue from the USA and 64% from international markets.

McDonald’s has been a mid-yield, fast growth DG company. It has raised its dividend for 44 consecutive years. I own McDonald’s in my Dividend Growth Portfolio.

Since the bull market ended, McDonald’s price has dropped, pulling its yield up from about 2.2% to 3%.

Ratings:

• McDonald’s has held a BBB+ credit rating – which is low investment-grade – since 2015.
• Simply Safe Dividends has a dividend safety score of 77 for MCD, which means “Safe.”

Valuation: As with Kimberly-Clark, McDonald’s stock was overvalued when the bull market ended, and the recent price drop has just brought its valuation into fair territory. It is not a bargain at this price.

Procter & Gamble (PG)

Procter & Gamble (PG) is one of the world’s largest manufacturers of consumer goods. PG sells 65 product brands in more than 180 countries. Many of their leading brands are household names: Pampers, Charmin, Bounty, Downy, Tide, Cascade, Swiffer, Old Spice, Gillette, Braun, and Crest.

PG’s major segments cover a wide range of consumer goods, from home care to beauty and healthcare products. Procter & Gamble sells their products globally, with 45% of sales coming from North America and 23% from Europe.

PG has been a mid-yield, slow-growth DG company. It has delivered increased dividends for 63 straight years, not to mention that it has paid dividends continually since 1890. Its annual rate of dividend growth has been in the 3%-5% range for years. I own PG in my Dividend Growth Portfolio.

The market crash has taken PG’s price down and pulled its yield up from 2.4% to 3%.

Ratings:

• S&P has not changed PG’s excellent AA- credit rating since 2001.
• Simply Safe Dividends rates PG’s dividend safety at 99 out of 100 points, or “Very Safe.”

Valuation: Procter & Gamble became overvalued during the bull market, and despite its recent price slide, it is still overvalued. Its actual price remains above both fair-value reference lines on its FASTGraph.

That view is underscored by PG’s yield graph. The stock’s current yield is actually below its 5-year average yield. PG is not selling at a discount despite the price drop.

3M (MMM)

3M (MMM) started life in 1902 as Minnesota Mining and Manufacturing. It is now a global industrial conglomerate with more than 60,000 products that can be found in homes, businesses, schools, and hospitals around the world.

3M has products in segments ranging from safety to healthcare to electronics. It is classified as an industrial company, but many of its products are for consumers. The company’s global reach shows about 39% of sales coming from the USA; 31% from Asia and Pacific; 21% from Europe, the Middle East, and Africa; and 10% from Latin America and Canada.

With its yield increasing lately, 3M has become a high-yield, mid-growth company. It has raised its annual payout for 62 years, with many recent increases in the high single digits, although its increase earlier this year was just 2.1%

MMM was my Dividend Growth Stock of the Month last June, and I have been adding it to my Dividend Growth Portfolio since then.

The bear market price slide has caused MMM yield to climb from 3.6% to 4.4%. (I label any yield above 4% as “high yield” for the dividend growth strategy.)

On February 24, S&P lowered 3M’s credit rating one notch to A+, which is a mid-range investment-grade rating. In explaining the downgrade, S&P cited such factors as continued weakness in China, automotive, and electronics, coupled with additional debt taken on to finance a recent acquisition.

On top of the credit downgrade, S&P put 3M on “negative outlook,” meaning that S&P could lower the rating again if the company fails to de-lever its balance sheet over the next 12-24 months.

Simply Safe Dividends has maintained 3M’s dividend safety at 75, which is termed “Safe.” It reiterated that rating at the end of January.

Valuation: 3M’s price has actually been under pressure since 2017, and the long-time downward slide has been accelerated by the pandemic bear market. In that timeframe, 3M has gone from being significantly overvalued to dropping right through to the bottom of its fair-value range.

Simply Safe Dividend’s yield chart suggests that 3M is undervalued. Its current yield is much higher than it has been during the past five years, 67% above its 5-year average.

Given its business challenges, whether you consider 3M to be an attractive investment opportunity or a falling knife depends on your judgement about its ability to solve its business challenges over the long term.

PepsiCo (PEP)

PepsiCo (PEP) is another old company, with roots back to 1898. The current beverage + snack conglomerate was formed in 1965 when Pepsi-Cola merged with Frito-Lay. Today, snacks comprise more than half of PepsiCo’s sales. The company’s blockbuster brands span both beverages and snacks: Lay’s, Pepsi, Tropicana, Quaker Oats, Gatorade, Aquafina, Lipton, Doritos, Tostitos, Mountain Dew, Ruffles, Cheetos, and Sierra Mist.

PepsiCo operates globally, although North America accounts for more than 55% of sales and about 75% of operating income.

PepsiCo has been a mid-yield, mid-growth DG company. It has 47 consecutive years of dividend increases under its belt, with recent increases in the 8% range, although last year’s increase was 3%. I own PEP in my Dividend Growth Portfolio.

Pepsi’s price drop since the bull market ended has pulled its yield up from about 2.7% to 3.4%.

Ratings:

• PepsiCo has a solid A+ credit rating since 2015. That is mid-investment grade.
• Simply Safe Dividends’ safety score is a top-quintile 93 for PEP, which means “Very Safe.”

Valuation: As we have seen with a couple other stocks, PepsiCo was overvalued by the time the bull market ended, so its recent price drop has just brought its price barely into fair-value territory. It is not undervalued.

Walt Disney (DIS)
The Walt Disney Company (DIS) was founded in 1923. It has grown relentlessly and innovatively for almost 100 years to become one of the world’s leading entertainment companies.

Disney today is a media conglomerate with the following major segments and blockbuster brands:

• Media Networks provides 38% of sales and 47% of profits. It operates TV networks (ABC, A&E, History, Lifetime, and the ESPN collection) plus radio and television stations. Altogether, Disney has about 100 Disney-branded television channels that are broadcast in 34 languages and 164 countries.
• Parks & Resorts (43% of sales, 49% of profits) started with Disneyworld and now owns theme parks and resorts around the globe.
• Studio Entertainment (13% of sales, 11% of profits) produces live-action and animated films under brands that include Walt Disney Pictures, Walt Disney Animation, Pixar, Marvel, Lucasfilm, and 21st Century Fox.

Disney has been a low-yield, medium-growth DG stock. Its attraction is often to younger investors who willingly trade the low current yield for what they believe will be years and years of well-paced growth.

The company has raised its dividend for 9 straight years, meaning that its dividend did not go up during the Great Recession of 2007-2009. In fact, there have been strings of years when Disney did not increase its dividend, as marked by the red lines in this chart.

[Source]

Disney’s share price has declined steeply since mid-February, pulling its yield up from about 1.2% to almost 1.8%.

Disney has a good A credit rating from S&P. However, the rating’s outlook was downgraded to “negative” on March 12. S&P said at that time:

Disney is exposed to the coronavirus through advertising, film studios, and its theme parks…. Numerous live events across the country have been recently postponed or cancelled. In addition, to stop the spread of the virus, local, state, and the federal governments have started imposing travel bans and bans on public gatherings. This will have a negative effect on sporting events, concerts, theatrical events, and film releases.

The negative outlook on Disney reflects the increased uncertainty around the impact of the coronavirus crisis on the global economy and specifically how it could affect Disney’s ability to reduce its leverage to under 2.5x by the end of fiscal 2021 as previously expected.

We could lower our rating on Disney if it becomes clear that the park closings are extended resulting in lower revenues and cash flow and the economic impact will be more protracted.

Also on March 12, Simply Safe Dividends downgraded Disney’s safety score from “Very Safe” to “Safe,” assigning it 65 points on its 100-point scale (3rd quintile).

Valuation: While Disney’s price has declined steeply over the past few weeks, it was significantly overvalued to begin with. Its recent price drop has just brought the stock barely into fair-value territory.

Simply Safe Dividend’s yield chart, on the other hand, suggests that Disney is undervalued. The company’s current yield is 25% higher than its 5-year average, although it is lower now than it was at the beginning of the 5-year period.

Closing Thoughts
We did not know it at the close of trading on February 19, but that was the end of an 11-year bull market that began in March, 2009.

The price slide since then has brought down the majority of stock prices, but the effect has been uneven, as investors try daily to figure out which businesses are more or less likely to be affected by the pandemic and overall economic conditions.

It’s often heard, “Buy on the dips.” But not every dip presents a good opportunity.

Based on the information presented in this article, these are the stocks that may look most interesting for a nibble, if you are so inclined. They seem to have the best combination of yield, dividend growth prospects, and business resiliency.

• AT&T (T)
• Dominion Energy (D)
• Johnson & Johnson (JNJ)

Nothing in this article is intended to be investment advice. This is not a recommendation to buy, hold, or sell any stock discussed in this article. Always do your own due diligence. Think not only about the company’s quality, yield, dividend growth, business prospects, and general market conditions, but also about your personal financial goals, needs, and risk tolerance.

— Dave Van Knapp

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