Consumer cyclical dividend stocks – January purchase #1

The Consumer Cyclical sector was the lowest weighted sector in my dividend stock Portfolio in the first week of the year. The last purchase I made in this sector was in September last year when I purchased MCD.

The Consumer Cyclical sector, also known as Consumer Discretionary, is a general grouping of companies that sell ‘nice to have’ items; this includes automotive, housing, entertainment and retail industries. The performance of the sector is linked to the economy, since more luxury products are bought when times are good and fewer when times are bad. Its counterpart is the Consumer Defensive sector which is grouped around more mandatory items that in theory is less impacted by the economy since everyone needs soap and other essentials.

One recent discussion about the lower oil prices is the likelihood of deflation which is considered a bad thing for the economy. Deflation is when prices are falling which you think would be a good thing, but it’s not so good for the larger economy. If deflation does take hold and the theory of people delaying purchases as they wait on prices to drop further holds true, then the Consumer Cyclical sector could be one of the harder hit sectors in the next year or two.

My Portfolio

Here’s my portfolio as of 4-January, showing the sectors and their current weights. The Consumer Cyclical sector is the lowest and outside the +/- 10% range, followed by Basic Materials then Consumer Defensive. For once it’s nice not to see Energy as the lowest valued which has been a recurring theme of late.

My dividend stock portfolio as of 04-Jan-15 showing Consumer Cyclical as the lowest sector by weight, followed by Basic Materials then Consumer Defensive.
My dividend stock portfolio as of 04-Jan-15 showing Consumer Cyclical as the lowest sector by weight, followed by Basic Materials then Consumer Defensive.

I’m using my dividend investing rules to guide my selection.

My Consumer Cyclical dividend stocks

I have currently have positions in MCD, HD, MAR and LB in the Consumer Cyclical sector.

L Brands (LB)

L Brands (LB) is a $25B retail company selling clothing lines, personal care and beauty products. Its biggest brands are Victoria’s Secret and Bath & Body Works.

The company pays a 1.6% dividend, having increased it for the last 3 years starting 2011. Its payout ratio is 41% (ignoring the special dividend they paid last year) which is in-line with the yearly values since 2005, with the exception of 2009 when low earnings increased the ratio to 92%. The annualized dividend growth over the last 5 years is the third highest in this round-up at 18%.

Its P/E of 26 is higher than both the industry average of 24.4 and the S&P 500 average of 18.6 (and much higher than its P/E of 20 last September’s). Since 2012 LB’s P/E has always been higher than the S&P 500 although the gap is increasing. Projected EPS growth over the next 5 years is 11%.

The company isn’t on the US Dividend Champion list; I bought this stock originally in early 2013 solely because of its strong brand name and retail / media presence. It is prone to paying out special dividends (2010-12 & 2014) in addition to its ordinary dividends. Their sales numbers over Christmas beat expectations and they’ve had good 3rd quarter results so I’m expecting to see another dividend increase in their February declaration.

Home Depot (HD)

Home Depot (HD) is the world’s largest home improvement retailer with a market cap of $136B. It operates 2,200 stores in the United States, Canada and Mexico.

Home Depot is a 5 year Dividend Challenger with a current yield of 1.8%. The dividend has increased with a 5 year dividend growth rate of 16% – the third highest rate in this roundup. The payout ratio is a steady 42% which it’s held since 2011.

HD has a P/E of 24 vs. the industry average of 23.1 and the S&P of 18.6. The P/E has been higher than the S&P each year since 2008 with the biggest gap of 7 points seen in 2012. Estimated 5 year EPS growth is 16% which is the second highest in this review.

McDonalds (MCD)

McDonalds (MCD) is the world’s leading global foodservice retailer. With a market cap of $91B, it operates 35,000 locations serving approximately 70 million customers in over 100 countries every day.

The current dividend yield is 3.5%. The current 64% payout ratio has been slowly increasing from a low of 43% in 2008. MCD’s dividend growth over the last 5 years has been about 10%.

The company has a P/E of 18.4 which is less than the Industry average of 23.8 and the S&P’s 18.6. Starting from 2006, the P/E of 17.5 in 2013 was the first year since 2009 that the P/E decreased below the S&P’s average. Projected 5 year EPS growth is 5.2%, and the estimate is down 1% since September.

Marriott International (MAR)

Marriott International (MAR) is a $22B company operating several hotel chains across different price levels: Residence Inn, Courtyard, Fairfield Inn, Marriott and Renaissance among others.

MAR pays a 1% dividend which has been increasing over the last four years at a 55% annualized rate (the highest rate of increase in this review although high % growth can be misleading when the dividend payment is a small value per share). The payout ratio is 32%, a value held since 2012. Low earnings per share of $0.55 raised the P/E to 70% in 2011, but otherwise the P/O has been below 34 since 2004.

MAR is an expensive stock. It has a current P/E of 31, which is lower than the industry average of 33 but almost double the S&P Index average of 18.6. This follows a historical trend however; the P/E has been higher than the S&P for each year since 2004. Projected EPS growth for the next 5 years is 18%, the highest in this roundup.

I originally bought MAR back in 2013 when I was travelling more and staying in hotels; it wouldn’t qualify as a new purchase based on my current screener. I am interested to see where its dividend goes in the future so I’m not considering to sell it at this time. Plus I’ve always wanted to own a hotel ever since playing Monopoly.

Choosing new stocks to consider

I already have 4 stocks in this sector, with 5 being my maximum allotment so I’m not in a hurry to fill the fifth slot.

My initial screening of the Dividends Champion List is as follows:

  • Include only stocks from Champions, Challengers and Contenders filtered by the sector I’m interested in (Consumer Cyclical)
  • Include only stocks which have projected positive growth in both the next 1 and 5 years
  • Include only stocks with a dividend yield above 2%
  • Include only stocks with EPS Payout Ratio < 90%
  • Include only US domestics stocks

Of the 15 companies matching that filter, I added the following 4 dividend champions to see how they compare.

Target Corp. (TGT)

Target Corp. (TGT) is a $38B retailer operating approximately 1800 stores in the US and 130 in Canada. It was excluded from the screener this week due to its high payout ratio..

Its dividend yield is 2.8% with a payout ratio of 79% and it has increased its dividend each year for the last 47 years. The higher payout ratios of the last two years are a marked contrast to the more typical levels of 13-25% seen since 2005. The annualized dividend growth over the last 5 years is the second highest in this roundup at 26%.

With a P/E of 31.9, TGT beats both the Industry average of 21 and the S&P average of 18.6. The P/E value in 2014 is a significant departure from the pattern since 2007 when TGT’s P/E was typically 2 points lower than the S&P average. Estimated 5 year EPS growth is 12%.

Wal-Mart Stores inc. (WMT)

Wal-Mart Stores inc. (WMT) is the world’s largest retailer with a market cap of %250B and around 10,000 stores globally with its Wal-Mart and Sam’s Club stores.

It’s another Dividend Champion having increased its dividend each year for the last 41 years. Its current dividend yield is 2.2% with a payout ratio of 40%. The current payout ratio has been fairly flat since 2004, typically in the high twenties / low thirties range with the biggest increase occurring last year to 38%. The annualized dividend growth over the last 5 years is 12%.

The P/E ratio of 17.6 is below both the industry average of 21 and the S&P’s 18.6. 2014 saw a relatively large increase in P/E, putting it back to a more typical value that’s close to the S&P’s average P/E. Estimated EPS growth over the next 5 years is 5.7%.

Genuine Parts Co. (GPC)

Genuine Parts Co. (GPC) is a leading distributer of replacement automotive parts with a $13.5B market cap, primarily in the US and Canada. It also distributes industrial and office replacement parts.

Its dividend yield is 2.2% with a payout ratio of 51%. GPC is a Dividend Champion and has increased its dividend each year for the last 58 years. The Payout Ratio is holding steady at 50% and the historical trend is largely flat with 50% being the typical level since 2004. The annualized dividend growth over the last 5 years has been 7.5%.

Its P/E of 23.7 is lower than the industry average of 50 but higher than the S&P average of 18.6. The P/E has tracked the S&P’s average value fairly well since 2004; however 2014’s value is a much larger increase than the last two years. Estimated 5 year EPS growth is 7.2%.

Honorable mentions

Leggett & Platt Inc (LEG)

Leggett & Platt Inc (LEG) is a $4.5B diversified manufacturer that designs and manufactures products found in homes, offices, retail stores and automobiles. It operates in 4 segments: Residential Furnishings, Commercial Fixturing & Components, Industrial Materials and Specialized Products. The company was excluded by the screening criteria due to its high payout ratio.

The current dividend yield is 2.8% and the company has grown the dividend for each of the last 43 years. The payout ratio is 214% and it’s had some high values over the last 10 years including 278% in 2007, 137% in both 2008 & 9 and 105% in 2011. The 5 year annualized growth is 3.3%.

P/E is high at 75, beating both the industry average of 43.9 and the S&P 500 average of 18.6. The P/E has been typically higher than the S&P since 2007 but lower earnings in 2014 have pushed the P/E much higher than usual. Estimated 5 year EPS growth is 15%.

Coach (COH)

Coach is a popular dividend stock in the Apparel industry; It has a 5 year dividend history with a yield of 3.6%.

Cracker Barrel Old Country (CBRL)

I used to love eating at Cracker Barrel when I lived in Alabama and it was nearly always packed. There’s not one very close to where I live now so I’ve had to cut back on my Cracker Barrel fix which is much better for my weight. It has a 12 year history with a yield just under 4%.

What to buy?

Looking at all 7 companies, my criteria of requiring a 5 year dividend growth history eliminates LB and MAR from the start.

I’m increasing my minimum dividend yield threshold to 2.25% this year from last year’s 2% threshold. This eliminates HD with its 2.1% yield. Despite its higher growth prospect, I’m willing to wait for a lower price.

This leaves a shortlist of 4: MCD, TGT, WMT & GPC which all match my minimum criteria.

With its amazing 58 year dividend growth history, GPC loses points due to a low dividend growth rate and a fairly low yield leading to a lower projected income value.

Likewise WMT also loses points due to a lower projected income value with a low starting yield and single digit growth.

It’s more or less equal between MCD and TGT; both have the same projected income with MCD’s higher current yield offset by TGT’s higher potential growth. At 47 years TGT has the better growth history but MCD has a better payout ratio.

Here is the comparison visually.

Yield #Yr DivGr5 P/O% EstGr5 Projected Stable Score Status
MCD 3.5 38 10.1 64.6 5.2 21 5 45 Buy
TGT 2.8 47 25.9 79.8 12.1 19 5 44 Buy
WMT 2.2 41 11.9 39.4 5.7 13 5 42 Buy
GPC 2.2 58 7.5 51.1 7.2 13 5 41 Buy
HD 1.8 5 15.9 42.9 15.9 13 2 0 Hold
LB 1.6 3 17.8 41.9 11.3 10 4 0 Hold
MAR 1.0 4 55.3 32.8 18.6 8 4 0 Hold

My purchases this week

I decided to go with MCD for my Sharebuilder purchase earlier this week. MCD does have issues with a flat revenue and a larger trend towards healthier eating. It’s recently announced plans to introduce new packaging, launch social media campaigns and other initiatives to take attention away from its brand name. I think its dividend remains safe for now and the company is still committed to increasing shareholder value.

Total purchases this week are:

  • $300 Individual Stocks (MCD)

These investments should increase my yearly dividend income by about $11.

Full disclosure: I am long HD, MCD, MAR & LB.
 

Quote of the day

Some people are making such thorough preparation for rainy days that they aren’t enjoying today’s sunshine.

0 thoughts on “Consumer cyclical dividend stocks – January purchase #1”

  1. Hi DL,
    Is your portfolio you list in dollars or number of shares (sorry if I asked you this before)? Just curios how you weight things. Both MCD and Target are excellent companies to own. Tough call on which one to buy and I think you made the right call. Entry yield is pretty important and should have a slightly higher weight.
    After reading one of Henry’s Living at Home book reviews I wonder if your very balanced portfolio will generate you good returns over the long run. Should you focus on the best quality each month regardless of the sector? I am interested in your opinion on that type of investing.
    Thanks,
    DFG

    1. Hi DFG,

      Currently I weight based on market value, so I multiply each share in a sector by its price which gives a total value for each sector, and calculate that as a percentage of the sum of all sectors. I then typically look at the ‘cheapest’ one and add to it each week.

      My original thought behind this was quite simple (like most of my thoughts!) – the lowest sector each week should contain the ‘cheapest’ stocks…the new capital added each week distorts this because of the increased cost basis but as the portfolio size gets larger, the effect of new capital is over-shadowed by market price movements. I’ve recently changed my opinion on this and I’ll get to that in a minute but not because I think it’ll perform worse.

      The S&P 500 and other indexes are weighted by market value – they have an unequal weighting of sectors. There’s even some argument that “fundamental indexes” perform better than the standard market value indexes, though how long that theory holds true is anybody’s guess.

      Holding a different portfolio weight to an index simply means that the portfolio will have different results than the index. Maybe better results, maybe worse, depending on how each sector performs. I’m assuming when you mention “good returns” that you mean a high level of ‘total returns’ in both dividends and capital gains.

      But I’m more interested in dividend income than capital gains on stocks that I don’t plan to sell. I don’t know that my dividend income will necessarily be more “at risk” for holding (say) more Utility stocks than the S&P 500 does. It’s possibly less risky since some of the stocks comprising the 15% weight in Financials held by the S&P are more likely to implode and cut their dividends than the 3% of Utilities stocks that it holds.

      Anyway, I’m starting to change my strategy since I am more focused on dividend income but I’m still working out the details. The real “risk” I’m looking to mitigate is the impact of a stock cutting its dividend – for example the Communications sector is ~ 8% of my portfolio in market weight, yet pays 17% of my total stock dividends in just two stocks (T & VZ). If T stops paying a dividend it’d affect 14% of my income, so I won’t be buying more T for a long time until it’s down below 5% of dividend income, regardless of its ‘quality’.

      So this is still a ‘work in progress’ answer to your question which is a good one – I lean towards using dividend contributions as a more useful weighting mechanism for a dividend income portfolio.

      Best wishes,
      -DL

Leave a Reply

Your email address will not be published. Required fields are marked *