Editor's Note: This post is a guest post by Ben Reynolds from Sure Dividend. All opinions within this post are his alone and do not reflect TrackYourDividends or Market Aggregate Inc.
The spread of [the illness] has had a significant impact on the global economy in 2020. Nearly one-third of the entire planet is under some form of social distancing or shelter-in-place order. This has caused a severe sell-off in the S&P 500 over the past several weeks.
The first quarter of 2020 was the worst quarter on record for the Dow Jones Industrial Average. The index dropped more than 23% during the first three months of the year. The S&P 500 had a 20% decline over this period of time, its worst performance in 12 years. It is not surprising that investors sold stocks across the board given the magnitude of the decline in the indexes.
However, long-term investors have an opportunity to pick up shares of quality companies trading far below their fair value. Income investors with a long-term view of the markets could do well buying the Dividend Aristocrats , an exclusive group of S&P 500 stocks that have at least 25 consecutive years of dividend growth, that are now worth far less than their fair value.
We believe the following three Dividend Aristocrats are trading the furthest below their fair value right now, and as a result could generate strong returns to shareholders over the long run.
Emerson Electric can trace its founding back to the late 1800s, when it began manufacturing electric motors and fans. Today, Emerson is a global company and has a market capitalization of more than $28 billion. The company supplies products to commercial, industrial and consumer markets.
Emerson’s products are used in climate control systems and production optimization, but the company’s revenue has a large exposure to the oil and gas industry as well. Investors have fled the stock due to the collapse in the price of oil over the past few months, sending shares lower by nearly 37% year-to-date.
That said, not all is lost for shareholders of Emerson as the company has multiple factors working in its favor. First, the impact of [the illness] is having a negative impact on the economy, but it is also spurring governments around the world to pass stimulus funding in order to aid the economy. The U.S. passed a $2 trillion package last week and there is already talk of another round of funding. This money should have some ability to support economic activity. The Federal Reserve also lowered interest rates to 0% and has stated that they will supply markets with liquidity as needed.
Second, Saudi Arabia and Russia could come to an agreement to end their oil price war. If an agreement could be struck to drastically reduce oil production then energy prices could stabilize. Lastly, Emerson has a long history of building customer relationships and engineering excellence. Emerson has been so successful at navigating difficult economic environments that is has raised its dividend for the past 62 consecutive years, making the company one of just 30 Dividend Kings. Dividend Kings are those stocks with at least 50 years of dividend growth.
Emerson has one of the longest dividend growth streaks in the entire marketplace. Shares yield 4.2% today, more than a full percentage point above the stock’s 10-year average dividend yield of 3.1%. The company’s dividend appears very safe as well, as the payout ratio is expected to be 55% for 2020, slightly below its 10-year average payout ratio of 58%. The low payout ratio, lengthy dividend growth streak and the company’s competitive advantages make it very likely that the dividend will continue to grow despite short term headwinds.
Shares of Emerson trade for $48 at the moment. Using earnings-per-share estimates of $3.65, and a 2025 target price-to-earnings ratio of 18, we estimate that Emerson is worth $66 per share. This means that the current price is more than 27% below our estimated fair value. Investors looking for a quality industrial leader that is prone to bounce back with stabilization of energy prices should consider Emerson Electric.
Walgreens is the largest retail pharmacy chain in both the U.S. and Europe and has a presence in more than 25 countries. The company has approximately ~18,750 stores and has one of the largest global pharmaceutical wholesale and distribution networks. The company trades with a market capitalization of $36 billion. Shares of Walgreens have not been immune to the downturn in markets as the stock has fallen 31.6% so far in 2020.
Walgreens’ biggest competitive advantage is its ability to distribute pharmaceuticals through its vast healthcare network. The company has the size and scale to deliver pharmaceuticals to nearly 230,000 pharmacies, hospitals and doctors per year. This creates a steady source of revenue that is likely to grow in the coming years as the world’s population continues to age. As consumers grow older, they often require an increased number of prescriptions. This should bode well for Walgreens as consumers will likely continue to seek out treatment for aliments even in a recession.
While not yet a Dividend King, Walgreens boasts an impressive dividend growth streak of 44 years. The company has been through several difficult economic periods and still managed to raise its dividend. Shares yield 4.5%, which is more than double the decade long average yield of 2.2%. The company has an expected payout ratio of 31% for 2020, slightly below its long-term average payout ratio of 34%. The company’s dividend is well-covered even in the event of a severe recession.
Walgreens stock trades at a recent price of $40 per share. We believe fair value for the stock is $72 based on expected EPS of $6.00 for the year, and a valuation target of 12x those earnings. Therefore, the current price is 44% below our fair value estimate. Investors looking for an “accidently high yielder” with a low payout ratio and plenty of upside potential should find Walgreens stock attractive.
Founded in 1947, Franklin Resources has a long and successful history in the investment management business where it makes the majority of its revenue. The company also offers related products such as insurance, distribution and shareholder servicing. Franklin Resources had $698.3 billion in assets under management as of the end of 2019. The company has a market capitalization of $8 billion. The stock has dropped more than 38% this year.
Despite a difficult trading market in the first quarter of the year, Franklin Resources is a well-respected leader in investment management business. The company has experienced multiple bull and bear markets and continued to perform well.
The company also has a strong balance sheet. As of the last quarter, Franklin Resources had nearly $6 billion in cash and $15 billion in total assets against just $3.4 billion in total liabilities. This should allow Franklin Resources to continue to grow its dividend, which it has done for 40 years. The stock has a high dividend yield of 6.8%.
While extremely high yields are often a troublesome sign, this isn’t the case for Franklin Resources as it is poised to continue growing its dividend due to its payout ratio is very low. The company is projected to distribute just 38% of profits in the form of dividends this year. Even a drastic drop in earnings would still leave room for dividend growth.
Franklin Resources trades at $16 currently, but we feel that the stock’s fair value is $30. We arrive at this figure due to earnings-per-share guidance of $2.75 for the year, 2% earnings growth and a 2025 price-to-earnings target of 11. Using these targets, Franklin Resources trades at just 53% of our fair value estimate. This gives Franklin Resources a very large differential between current price and fair value price.
Very few stocks have managed to avoid the carnage that has taken place in the markets over the first three months of the year. In a market wide sell off, companies of all stripes are sold off. But this gives the opportunistic investor a chance to purchase stocks trading well-below their fair values. Those with an eye for years, and not days or months, down the road can use this time to add high quality names offering safe, generous dividend yields for a fraction of what they are truly worth.
Emerson Electric, Walgreens Boots Alliance and Franklin Resources are the three Dividend Aristocrats that are trading the furthest below their respective fair values. With attractive valuations and elevated dividend yields, these three dividend growth stocks could generate strong returns over the next several years.