Article Thesis
On Thursday, markets experienced a considerable downturn, with declines in high-flying stocks being most pronounced. This does not have to mean anything, but it may be the first sign of a more volatile equity market this fall, following a summer of gains in broad indices. Those investors that want to move out of expensive tech stocks, or that want to reduce risk levels overall, may find the following five Dividend Aristocrats investable, as those trade at rather inexpensive valuations on a relative basis.
Source: imgflip.com
Buying low and selling high has been a great strategy forever, although it sometimes is not really easy to determine whether prices are currently on the low side or the high side - this always is way easier in retrospect for sure. Nevertheless, it looks like many of the stocks that have been driving broad markets to new all-time highs in summer 2020 are quite richly valued right now:
Data byIn this chart, we see that earnings multiples have grown quite a lot this year for high-flyers such as Apple (AAPL), Tesla (TSLA), Salesforce (CRM), Amazon (AMZN), Facebook (FB), and Alphabet (GOOG) (GOOGL). Determining at what P/E multiple those stocks would be fairly valued is no easy task, but it does not seem very logical for these stocks to trade at 1.5 times or 2 times the valuations they traded at one year ago. Share price gains have been driven by multiple expansion, rather than underlying growth, at least over the last couple of quarters. Does this mean that these stocks will come crashing down? Not necessarily, but significant declines cannot be ruled out. On Thursday and Friday, broad markets, and especially some of these high-flyers, saw their prices decline quite meaningfully:
Data byCompared to the rather smooth ride-up during August, this was a surprising dose of volatility, and it may be the first sign of a market that could become more frothy this fall. Factors that could drive downside include the coronavirus itself, reduced stimulus spending, election worries, etc.
All in all, it does not seem like the worst of times to consider exiting equity positions in stocks that have run up a lot and that are expensive, while possibly building out positions in stocks that are inexpensive and that have shown strong resilience versus downturns. Enter the Dividend Aristocrats (NOBL) - these stocks have raised their dividends for at least 25 years in a row, no matter the strength of the underlying economy. It can be expected that at least most of them will continue to raise their payouts during the current climate, thereby providing reliable income growth in a world where yield is otherwise hard to come by. On top of that, their resilience versus equity market downturns is remarkable:
Source: Ploutos' article
Clearly, going into a potential market downturn with some weighting towards Dividend Aristocrats is not the worst of ideas, as they have shown remarkable relative strength compared to the S&P 500 (SPY) during down years. Not all of these Dividend Aristocrats are trading at attractive valuations, however, as some stocks, such as Coca-Cola (KO), Colgate-Palmolive (CL), and Target (TGT), are trading on the expensive side as well:
Data byInstead of just buying the Dividend Aristocrat ETF, buying individual stocks out of the group may thus be advantageous. The following five picks could be attractive, I believe.
1. AT&T
AT&T (T) is a leading telecom company, but its share price has not performed well year to date. Worries about its high debt levels, combined with headwinds for its theater business due to the pandemic, have made shares decline to a quite low level. These fears seem overblown, and I believe that the company offers a lot of value at current prices:
Data byShares are trading for just 9.3 times this year's earnings, despite the impact of the coronavirus crisis on some of its businesses. With an earnings yield of almost 11%, shares are very inexpensive. Shares also offer a dividend yielding 7%, and thanks to very strong cash flows, this dividend looks highly sustainable. Based on free cash flows, the payout ratio is 57%, which means that AT&T has ample cash flows left over after paying its dividend and its capital expenditures. Debt reduction is thus very much possible while AT&T maintains its dividend at the current level. AT&T's current share price of less than $30 also leaves significant upside potential over the medium term. Shares were trading in the high $30s at the beginning of the year, and once the coronavirus crisis has passed, it would not be too much of a surprise to see shares rise back up to that level. Investors thus get a Dividend Aristocrat yielding 7%, while the very low valuation and bombed-out share price could result in considerable upside over the coming years.
2. Aflac
Aflac (AFL) is an insurance company that is primarily active in the life and health businesses. The company does not belong to the biggest players in the industry, but its track record is very solid - the company has raised its dividend for 37 years in a row, spanning all kinds of different economic climates. During the current crisis, its shares have come under pressure along with the broad market, but they have not recovered all of their losses yet - not too much of a surprise due to the fact that the market currently seems to prefer big tech and growth stories, instead of "old industries" and value stocks. This does provide investors with a chance to enter a position at a favorable entry point, however:
Data byBuying shares here equates to entering a position at a highly favorable price to book multiple of just 0.9, versus a historic norm in the 1.2 to 1.5 price to book range. Aflac's price to earnings multiple of just 8.0 is also looking quite attractive, and last but not least, Aflac offers a market-beating dividend yielding 3.0% right here. The last time shares were trading this inexpensively was in early 2009, during the nadir of the Great Recession:
Data byThose who bought shares of Aflac in March 2009 at a similar valuation saw a subsequent 10-year return of 750% (per YCharts), thus history tells us that buying Aflac below book value could be a quite advantageous strategy.
3. Federal Realty Trust
Federal Realty Trust (FRT) is a real estate company primarily invested in high-quality retail properties, but the company also owns some office and residential assets. The company is focused on attractive markets with dense populations and high household income:
Source: Williams Equity Research's article
We see that Federal Realty is at the best position relative to its peers in terms of both population density near its properties, as well as the average income level in its markets. This is why Federal Realty is an attractive landlord - tenants get access to a huge amount of high-spending consumers by placing their store in one of Federal Realty's properties. On top of that, Federal Realty also has a 50+ year dividend growth history and is one of just a few A-rated REITs in the US. Combined, this means that Federal Realty is a reliable, low-risk player in this industry, with meaningful competitive advantages versus weaker players.
Shares are currently offering a yield of 5.2%, which is historically high, while shares are trading at 17 times 2020's FFO. This is a rather low valuation compared to how shares were valued in the past:
Data byWhen we factor in that Federal Realty's FFO during 2020 will be artificially low due to the pandemic impact, and that FFO in 2021 will likely be significantly higher, the valuation looks even lower. It should be noted that the dividend will be covered by FFO even during the current crisis year, with the payout ratio standing at ~89%.
4. Walgreens Boots Alliance
Walgreens Boots Alliance (WBA) is a major pharmacy company, and one of the top 2 players in the US, the other one being CVS Health (CVS). The company has a great dividend growth track record, having raised its dividend for 45 years in a row. During the current pandemic, demand for its services has not suffered a lot. The company generated revenues of $35 billion, up 0.1% year over year. This is not too much of a surprise, as people requiring medication do so no matter what the economy looks like. Walgreens Boots Alliance thus is a quite recession-resilient company. This is also showcased by the fact that its profits declined by less than 10% during 2009, the nadir of the Great Recession. In line with what was said earlier - the market does not care about "old" industries or value stocks right now - shares have not performed well this year, as most investors overlooked reliable, established companies like Walgreens Boots Alliance. This has made the stock very inexpensive:
Data byShares are trading for just above 7 times this year's earnings, and for less than 7 times 2021's forecasted profits. A recession-resilient company with an attractive track record trading with an earnings yield of 14% sounds quite intriguing to us. Investors also get a dividend yield that is at multi-year highs of 5%, factoring in the most recent dividend increase. Although Walgreens Boots Alliance will not be a "growth monster" going forward, shares look quite attractive here, trading at a very inexpensive valuation and offering a yield that is almost three times as high as that of the broad market.
5. Consolidated Edison
Consolidated Edison (ED) is the only utility in this list. The company offers electricity and gas to its customers, most of them in New York City. In recent months, a lot has been said about what the crisis will do to the city in the long run, but I am not too negative. I believe that New York City will remain a huge international hub for commerce and tourism and that this will continue to attract many professionals to the city and its surroundings. The customer base for Consolidated Edison should thus mostly remain in place, I believe. And yet, Consolidated Edison has not performed too well over the last couple of months, but that also is true for other utilities, thus this cannot be explained by company-specific reasons. I believe that what was mentioned above (the market is not too much into what are deemed "old" industries) is the culprit for that. After all, looking at the facts, Consolidated Edison looks quite attractive right here:
Data byThe stock trades at 17 times this year's earnings and at just 16 times next year's earnings. This is not only cheap relative to the broad market but also one of the lowest valuations in years. On top of that, investors get a dividend yield of 4.2%, which is well above the historic norm. Thanks to the resilient business models of regulated utilities and the growing demand for income-generating investments in a yield-less world, the outlook for Consolidated Edison is not bad at all. This will, of course, never be a high-growth enterprise, but even a mid-single digits earnings per share growth rate is quite attractive when combined with a 4%+ dividend yield.
Takeaway
Over the last couple of months, those that bought already-expensive growth stocks such as Tesla were the winners. But this will likely not go on forever, and Thursday's sell-off was a sign of what may come this fall. I believe that buying reliable, recession-resilient companies with proven business models and positive long-term track records can be a good idea to reduce risk.
When this is combined with buying at below-average prices, the outlook is even better. Looking at some of the Dividend Aristocrats could be quite advantageous and may help prepare a portfolio for more volatility ahead.
One Last Word
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