Updated March 10, 2021 by Bob Ciura
Investors looking for the best dividend growth stocks should consider the Dividend Aristocrats. We believe this is the “crème de la crème” when it comes to dividend growth stocks.
Of the 500 stocks in the S&P 500 Index, there are only 65 Dividend Aristocrats who have increased their dividends over 25 consecutive years.
To earn dividends for 25 years in a row, a company must have a strong business model with steady growth and the ability to generate profits even in recessions. Hence, it is relatively difficult to become a dividend aristocrat.
For a full list of all 65 Dividend Aristocrats, plus key financial metrics such as dividend yields and price / earnings ratios, click the link below:
Every year we review all Dividend Aristocrats individually. The next installment in the series is industrial giant Emerson Electric (EMR).
Emerson is not just a dividend aristocrat; It’s also a dividend king, an even smaller group of just 31 companies with more than 50 consecutive years of dividend increases. You can see all of the dividend kings here.
Emerson has increased its dividend for an astonishing 64 straight years. This means that Emerson has one of the longest dividend growth streaks in the entire stock market. This article discusses Emerson’s business model, growth outlook, and whether the stock is currently a buy based on these factors.
Emerson Electric was founded in Missouri in 1890 by two Scottish brothers, Charles and Alexander Meston, who saw a potential business opportunity in the manufacture of reliable electric motors. The two brothers received an initial investment from John Wesley Emerson, a former Union Army officer, judge, and lawyer. Together the three founded the Emerson Manufacturing Company.
Since its inception, Emerson has grown from a regional manufacturer of electric motors and fans to a diversified global technology and engineering leader through organic growth and strategic acquisitions and divestitures. Its global customer base has annual sales of over $ 16 billion and a current market capitalization of $ 54 billion.
Emerson is divided into two major reporting segments: Automation Solutions and Commercial & Residential Solutions. Automation Solutions helps manufacturers minimize energy consumption, waste and other costs in their processes.
The Commercial & Residential Solutions segment manufactures products that protect the quality and safety of food and increase efficiency in the production process. The company prides itself on solving complex engineering tasks for its customers, resulting in high retention rates as Emerson provides unique solutions to its customers’ problems.
Emerson is in a period of intense transition. The company has weathered some difficult years due to a number of headwinds including a strong US dollar, slow economic growth rates in China, and the sharp drop in oil and gas prices. All of these factors weighed on Emerson to varying degrees, and more recently oil and gas prices have been a bigger problem. Many of Emerson’s customers are in the energy sector, which is why low oil and gas prices are negatively impacting the company.
As a result, Emerson’s sales results have been very poor in recent years. In response, Emerson undertook a major reorganization of its business model. Emerson wasn’t afraid to reshape and adapt to changes in the business climate throughout its history.
Source: Investor Presentation
First, costs were lowered in order to increase profits. The recent reorganization has resulted in Emerson’s operating results dropping hundreds of millions of additional operating profits. This has helped Emerson’s earnings per share grow significantly over the past few years.
2020 was a difficult year, not only for the reasons mentioned above, but also because of the coronavirus pandemic and the resulting impact on the global economy. Still, Emerson remained highly profitable, which allowed him to keep raising his dividend.
The company recently closed the first quarter of fiscal 2021. Total sales were unchanged from the previous year, and underlying sales were down -2%, excluding favorable currency translation of + 1% and another + 1% from acquisitions. Emerson noted that North American residential real estate markets continued to have strong sales while core automation markets were weak and essentially canceling each other out.
Underlying orders were down -4.5% in December, the final month of the quarter, which was above expectations. Orders for residential and commercial real estate rose 15% while orders for Automation Solutions fell -13%. Gross profit for the quarter was 41.4% of sales, a decrease of 100 basis points year over year. This is mainly due to deleveraging and the unfavorable mix. Earnings per share were $ 0.83 for the first quarter, up 24% year over year.
Cost reductions combined with organic sales growth, acquisitions and share buybacks are expected to result in 5% annual earnings growth over the next five years.
Competitive advantage and recession performance
Emerson’s two main competitive advantages are global size and proprietary technology. Emerson has high margins and returns on investment thanks to its vast global distribution network.
Emerson’s continued investment in new technology – hundreds of millions of dollars totaled annually – has put the company at the forefront of both of its product segments. Its competitive advantages also enable it to weather recessions better than most industrial companies.
Emerson’s earnings per share during the Great Recession are listed below:
- 2007 earnings per share of $ 2.66
- 2008 earnings per share of $ 3.11, up 17%
- 2009 earnings per share of $ 2.27, down 27%
- 2010 earnings per share of $ 2.60, up 15%
- 2011 earnings per share of $ 3.24 (25% up, new high after recession)
Emerson did relatively well during the Great Recession, with only a year of declining earnings. Usually industrial manufacturers are tied to the health of the world economy. Its resilience during the Great Recession is due to its competitive advantages. However, we note that as in the past, Emerson can see bike spikes without a recession.
Valuation and expected return
Emerson’s valuation has risen significantly on the back of its impressive share price rally over the past year. It is now trading well above our fair value estimate. Shares for 24.4 times expected fiscal 2021 EPS, compared to our fair value estimate at 19 times earnings.
Today the stock is significantly overvalued. A decline in PER from 24.4 to 19 over the next five years could lower the annual return by -4.9% per year. This is offset by an expected EPS growth of 5% and a dividend yield of 2.2%. However, a total return of only 2.3% per year is expected over the next five years.
Given this surge in stock valuation over the past year, we see Emerson as much less attractive to investors given its stock today.
While we like Emerson’s stellar dividend history, we think the stock is significantly overvalued and that growth is at or near a spike this cycle. With that in mind, we rate Emerson as held based on its market dividend yield and annual dividend increase, but the stock is currently not a buy based on the valuation.
Emerson is a high quality company with a long history of steady growth. It has rewarded shareholders along the way with more than six decades of annual dividend growth.
Right now, this may not be the best buying opportunity for the stock. Valuation has widened thanks to a strong rally in the stock, so investors looking to open a position should wait for a lower price.
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