Thursday, June 11, 2020

My Favorite Exercise As A Dividend Growth Investor

One of my favorite exercises is reviewing the list of dividend increases.

As a dividend growth investor, I buy companies with an established track record of annual dividend increases. I usually require a minimum of 10 consecutive years of annual dividend increases, before I even look at a company. This minimum streak merely gets a company on my watchlist for further review and screening.

My review looks at trends in earnings, dividends, payout ratios, and valuation. I try to review qualitative, as well as quantitative characteristics, while remaining objective. Each company is unique, and it has to fit in to the overall goals and objectives of my portfolio as well. I want to determine if the company would be able to continue growing earnings and growing those dividends. I also want to determine how secure is the dividend, by looking at the payout ratio and trends in earnings per share.

The next part is valuation, which is difficult, because it is not a clear cut process. I look at stability of earnings throughout the economic cycle, versus P/E ratios and past and expected growth. I have tried to codify it, but I also don’t want to be overly prescriptive, because the opportunities available vary from one month to the next. I do not want to end up being too strict, and missing out on future dividend growth and total returns merely because I didn’t want to overpay by 1 cent/share. I also do not want to be too lenient either.

With dividend growth investing, a lot of the work done before investing my money is done up front. I receive a lifetime of growing dividend income due to a decision made years ago. Once I set up a dividend income stream, by investing in a company, I just buckle up and enjoy the ride. I am paid regular dividends to own quality companies. Every 90 days or so, I receive a cash deposit for a decision that I may have made years or decades ago. Dividend growth investing is the gift that keeps on giving me cold hard cash every year, and dividend increases every year. Hopefully, the investment works, and I continue receiving dividend increases every year for the duration of my investment. I do not micromanage my investments, and just let them do their own thing.

When I receive dividend increases, this is a testament that my original plan is still working. This action by management shows me that they are confident in the near terms prospects of the business, enough so that they dedicate a certain portion of their cash flows to dividends. When management teams set a dividend, they know that shareholders are now expecting at least a stable dividend payment. That’s why management teams are usually conservative on the amount of dividends they will distribute to shareholders, because they view it as a commitment. Usually, the amount of dividends is determined after a careful evaluation of the business needs, the competitive environment, future investments and the amounts that the business does not require for its needs. In other words, dividends are paid by excess cash flows. If these are growing, management teams would likely grow those dividend payments as well. This is why a dividend increase shows me that my original investment thesis is still working, since the companies are still paying more due to growth in the business.

During the past week, there were three companies that raised dividends to shareholders. I own shares in one of these three companies. The companies include:

Alexandria Real Estate Equities, Inc. (ARE) is a real estate investment trust that invests in office buildings and laboratories leased to tenants in the life science and technology industries.

The REIT declared a quarterly dividend of $1.06/share, which is a 2.90% increase over the previous dividend payment, and a full 6% increase over the dividend paid during the same time last year. This marked the 11th consecutive year of annual dividend increases. During the past decade, Alexandria Real Estate Equities has increased dividends at an annualized rate of 5.50%.

The REIT has managed to increase FFO/share from $3.55 in 2010 to $7.80 in 2019. This dividend achiever is expected to generate $7.30/share in FFO in 2020 and $7.75/share in FFO in 2021.
This REIT is richly priced at 21.70 times forward FFO, and offers a dividend yield of 2.70%.

UnitedHealth Group Incorporated (UNH) is an American for-profit managed health care company based in Minnetonka, Minnesota. It offers health care products and insurance services.

The health insurer increased its quarterly dividend by 15.70% to $1.25/share. This marked the 11th consecutive annual dividend increase for this dividend achiever. During the past decade, the company has managed to grow distributions at an annualized rate of 66.70%.

UnitedHealth has managed to grow earnings per share by a factor of 6 over the past decade. Earnings grew from $3.24/share in 2009 to $14.33/share in 2019. The company is expected to earn $16.24/share in 2020.

I find the stock to be fairly valued at 19.20 times forward earnings and a forward yield of 1.60%. Check my analysis of UnitedHealth Group for more information about the company.

Universal Health Realty Income Trust (UHT) is a real estate investment trust that invests in healthcare and human service-related facilities including acute care hospitals, rehabilitation hospitals, sub-acute care facilities, medical/office buildings, free-standing emergency departments and childcare centers.

The real estate investment trust increased its quarterly dividend by 0.70% to 69 cents/share. This is the second dividend increase over the past 12 months. The new distribution is 1.50% higher than the distribution paid during the same time last year. This real estate investment trust has managed to increase annual dividends for 34 years in a row. During the past decade, this dividend champion has managed to boost shareholder distributions at an annualized rate of 1.30%.

FFO/share grew from $2.80 in 2009 to $3.20 in 2019. This is a very slow rate of dividend growth.

I sold UHT in 2013, because of its slow rate of dividend growth, high payout ratio and what I perceived to be a high valuation. I was wrong apparently, since the stock price has doubled since then, while the dividend is still rising at a snails pace. I replaced it with Digital Realty Trust (DLR) and Omega Healthcare (OHI).

And I believe that the stock is even more overvalued today at 31.60 times forward earnings and yields 2.70%. The FFO Payout ratio is at 86.25%, which is high.

Relevant Articles:

How to analyze dividend stocks
My screening criteria for dividend growth stocks
Rising Earnings – The Source of Future Dividend Growth
Let dividends do the heavy lifting for your retirement

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