The Prudent Investor

Letting Dividends Do Their Work

Most Recent Articles

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Dogs of the DOW is a dividend investing strategy that has held up over time.  There are many published variations of this strategy, some that outperform and others that do not.  I also have an idea to consideration for improvement.
Dividend Investing Strategies – Dogs of the DOW
Dogs of the DOW is a dividend investing strategy that has shown itself to hold up over time, comparing well against the S&P 500 and DJI benchmarks.
Dividend Banking Stocks in Jeopardy
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Dividend Investing for the Housebound

by George L Smyth

We are almost certainly in a recession. With the fall of stock prices throughout the economy, numerous prudent investment possibilities are there for the taking. However, rushing into things could result in overlooked opportunities.

The effects of social distancing are different for each person.  Some have plenty to do at home while others have run out of projects.  I am fortunate to be in the former group but can sympathize with the latter.  Regardless of one's situation, there is one thing that every dividend investor should be doing at this point and that is to research prospective companies.  There are numerous bargains available but immediately being drawn to the shiniest object could be a mistake.

As I write this I see that about six and a half million Americans filed for unemployment benefits last week.  The real number is certainly higher, as I have an out of work electrician friend who has not been able to get through the deluge of other recently unemployed people to file himself.  The number of others in a similar situation is difficult to guess, but it is reasonable to believe that the unemployment rate is at least 10%. This is a situation that will take a long time to resolve itself.

An Impossible Scenario

Let us consider an impossible scenario.  I do this because an unrealistic outlook gives us a starting point.  Assume that tomorrow the pandemic is over, everyone who has been hospitalized is released, and businesses open back up.  Everyone leaves their house and resumes life as they had this past winter. 

In this impractical scene, how long might it take for the economy to rebound?  Those with suspended jobs need to catch up on the debt they had accumulated, employees who had worked for failed businesses need to find new jobs and businesses that survived need to consider the resources available to them as they move forward.  

There are numerous chains of events that unfold even in this unrealistic best-case outline that allow one to realize that it will be a long time before the stock market can get back on track.  The reality is that it will take longer for the market to pick up from where it left off than this impossible scenario.

Eventually, the DOW will move back toward 30,000, but the unknown is how long it will take.  Until that happens, generally speaking, pretty much everything is on sale.  Recessions are a time to take advantage of the panic selling in which others are engaged.  Unlike the people I noted in Lessons Learned who decided to move their 401(k)s to cash, we have an opportunity to make purchases at excellent prices.  But this is not a situation where we need to act immediately.  We have the opportunity to take a breath, do our homework, and act on informed decisions.

Homework for the Homebound

Those who are sitting at home with extra time on their hands can spend some of it researching companies to add to their portfolios.  I suggest looking at one company per day.  Get familiar with what they have to offer, evaluate their products/services, gain an appreciation for the company’s history and their plans for the future, and consider whether or not it is a company that may be a welcome addition to your portfolio if the price is right.

I like to start with companies that have a long history of dividend growth.  These are companies that have not only weathered the past two recessions but have increased their dividend during those difficult times, so I have more confidence that they will survive this one.  Going through all of these companies in a thorough fashion is aspirational, so it is more reasonable to reduce the list to something more attainable by creating a screen.

We all have ways of doing things that work for us and I will offer an example of one of mine.

For this exercise I begin with the of Dividend Aristocrats.  I first want to select a company that has a dividend worth caring about.  The current dividend yield of the S&P 500 is 2.14% so I select companies that offer at least this amount.  I also like to see a P/E under the average of the S&P 500, which is currently 21.  Finally, I want a company with positive cash flow.

There are various means of screening for these criteria - I happen to use Stock Rover by creating a screener, scoring a Dividend Aristocrats watch list, and exporting the results to a spreadsheet.  The result yields 23 companies, which can be examined one a day for about three weeks.  I will be housebound for at least that long.

Here is my list of companies.

AbbVie Lowe's Companies
A.O. Smith 3M
Caterpillar Nucor
Chubb People's United Financial
Cincinnati Financial Pentair
Dover Stanley Black & Decker
Emerson Electric Sysco
Federal Realty Investment Target
General Dynamics T. Rowe Price Group
Genuine Parts VF Corp
Illinois Tool Works Walgreens Boots Alliance
Leggett & Platt

 

I will take a look at the first one on the list, AbbVie, as an example.

AbbVie

AbbVie is not a Dividend Champion but is a Dividend Aristocrat.  One may properly think that since Dividend Champions have a consecutive dividend growth history of 25 years and Dividend Aristocrats are in the same group but additionally have membership in the S&P 500, that the latter is necessarily a subset of the former.  The issue in this specific situation is that AbbVie spun off from Abbott Laboratories in 2013.  Before the spinoff, Abbott had had an impressive streak of dividend growth.  AbbVie has only been around for seven years but Abbott has had 48 years of dividend growth.  Depending upon one wishes to define things, AbbVie is a Champion/Aristocrat or not – I choose it to be one having been part of Abbott.

The spin-off came about because Abbott wanted to concentrate their efforts on medical devices and allow AbbVie to focus on research-based pharmaceuticals.

AbbVie is a biopharmaceutical company that has been very successful with the drug Humira, an arthritis, Crohn's disease, and plaque psoriasis drug.  While this has been a hit, there have been lawsuits blaming Humira for injuries and death.  Also – and this is key - the patent for the drug will expire in 2023, so its replacement is essential as it currently provides over half of the company’s total revenue.

AbbVie develops numerous other drugs, including those related to cancer, autoimmune diseases, virology, and neurological disorders.  One of their HIV drugs – Kaletra - is being tested in relation to the current coronavirus epidemic.

AbbVie’s dividend yield of 5.9% is the highest in the group of 23 selected.  This is an impressive and attractive yield but it is high because of the drop in stock price due to competition from generics, which is why their announced acquisition of Allergan is so important.  Although they are working on many promising drugs, the acquisition will give the company a dual pipeline, which should offer a better chance for them to compete.

Although the company has explicitly stressed the importance of maintaining its dividend, this could be difficult in the future.  A glance at the financials shows that the company’s debt may not be well covered by its operating cash flow.  There is sometimes a difference between wanting to continue increasing the dividend and being able to do so.

With this knowledge, considering AbbVie for the short term could make sense, especially if they continue to increase their dividend.  The long term is a more difficult proposition, as making up for the impending loss of the exclusivity of Humira is unsure.  The purchase of Allergan is set for May, though delays caused by the COVID-19 outbreak may push that back.  More information will come available at the beginning of May with the company’s first-quarter earnings conference call. 

Halfway Done

Notice that other than a glance at their debt and cash flows I have not delved into the financials of the company.  That is the second half of the evaluation and I will leave it for later.  That is because I have not decided to look into the company at this point.  I find that learning about a company is not only quicker than investing time understanding the financials but is knowledge I can return to in the future.

In the article Stock Tips are Bunk I noted that a stock that is a proper fit for one person’s portfolio may not work with another’s.  Now that we have a basic understanding of AbbVie we can determine if the company fits into one’s profile.

This is a company in transition, not an old established entity cranking out the same series of products.  Those who are willing to risk that AbbVie can successfully replace Humira may be more comfortable with the numerous unknowns.  The acquisition of Allergan will certainly smooth some concerns, but the economic toll could be worrisome if the pipeline is not as fertile as hoped.

If AbbVie has not been discarded by now then its financials can be closely examined to determine whether or not the price point is suitable for investment.  I have read that its current valuation is very attractive, but as there is no hurry I am setting the company aside to consider in the future.

Finishing Up

One company per day for three weeks will result in three lists - one list of companies with which I have no interest, one where I have some interest, and the third where I am very interested.  In the immediacy, I am sure the market will bounce around in a frenzy, which it normally does anyway, but will do so now with greater force as uncertainty multiplies the movements.

A close inspection of the financials and the current stock price will help me with a decision at a later time.  But desire and valuation are not the entire game.  Assume that I decide that AbbVie is a company worthy of investment.  I already have a sizeable stake in Johnson & Johnson, which is in a similar space, so do I want to tilt my portfolio even more in that direction?  Healthcare is the least affected sector so far during this recession so perhaps overweighting might make sense, or perhaps I should diversify into a less highly invested sector.

I’ve got plenty of time to work these questions out, but if you are staying at home like me then there is ample opportunity to do your homework and weigh the options that fit your personal needs.

Other Articles of Interest

Dividend Champions, Achievers, Kings and Aristocrats – A Comparison against the Indexes

Lessons Learned

Stock Tips are Bunk

 

 



This website is maintained by George L Smyth