Updated on March 10th, 2021 by Bob Ciura
Investors looking for the best dividend growth stocks should consider the Dividend Aristocrats. We believe these are the “cream of the crop” when it comes to dividend growth stocks.
Out of the 500 stocks in the S&P 500 Index, there are just 65 Dividend Aristocrats, who have raised their dividends for 25+ consecutive years.
To raise dividends for 25 consecutive years, a company must possess a strong business model, with steady growth and the ability to generate profits even during recessions. Therefore, it is relatively difficult to become a Dividend Aristocrat.
You can see a full list of all 65 Dividend Aristocrats, along with important financial metrics like dividend yields and price-to-earnings ratios, by clicking on the link below:
Each year, we individually review all of the Dividend Aristocrats. The next installment in the series is industrial giant Emerson Electric (EMR).
Emerson is not just a Dividend Aristocrat; it is also a Dividend King, which is an even smaller group of just 31 companies with 50+ consecutive years of dividend increases. You can see all the Dividend Kings here.
Emerson has increased its dividend for a staggering 64 years in a row. This means Emerson has one of the longest dividend growth streaks in the entire stock market. This article will discuss Emerson’s business model, growth prospects, and whether the stock is a buy right now 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 manufacturing reliable electric motors. The two brothers received a start-up investment from John Wesley Emerson, a former Union army officer, judge, and lawyer. Together, the three formed The Emerson Manufacturing Company.
Since its founding, Emerson has evolved through organic growth, as well as strategic acquisitions and divestitures, from a regional manufacturer of electric motors and fans into a diversified global leader in technology and engineering. Its global customer base affords it $16+ billion in annual revenue and a current market capitalization of $54 billion.
Emerson is organized into two major reporting segments called Automation Solutions and Commercial & Residential Solutions. Automation Solutions helps manufacturers minimize energy usage, waste, and other costs in their processes.
The Commercial & Residential Solutions segment makes products that protect food quality and safety, as well as boost efficiency in the production process. The company prides itself on solving complex engineering tasks for its customers, which leads to high customer retention rates as Emerson provides unique solutions to its customers’ problems.
Emerson is emerging from of a period of intense transition. The company has endured a difficult few years due to a number of headwinds including a strong U.S. dollar, slowing economic growth rates in China, and the steep decline 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 larger issue. Many of Emerson’s customers are in the energy sector, which is why low oil and gas prices affect the company negatively.
As a result, Emerson’s revenue results have been very weak in recent years. In response, Emerson has undertaken a significant restructuring of its business model. Emerson has not been afraid to reshape itself over the course of its history, to adapt to changes in the business climate.
Source: Investor Presentation
First, it slashed costs to boost profits. The most recent restructuring has resulted in hundreds of millions in additional operating profits hitting Emerson’s bottom line. This has helped boost Emerson’s earnings-per-share significantly in the past few years.
2020 was a difficult year, not just for the above reasons, but also because of the coronavirus pandemic and the ensuing impact on the global economy. And yet, Emerson remained highly profitable, which allowed it to continue increasing its dividend.
The company recently concluded its fiscal 2021 first quarter. Total sales were flat year-over-year and underlying sales were down -2%, excluding favorable currency translation of +1%, and a further +1% from acquisitions. Emerson noted it continued to see strong sales in residential North American markets, while core automation markets were weak, essentially offsetting each other.
Underlying orders were down -4.5% in December, the last month of the quarter, which was ahead of expectations. Residential and commercial orders were strong at up 15%, while Automation Solutions orders fell -13%. Gross profit came to 41.4% of revenue during the quarter, down 100 basis points year-over-year, primarily from deleveraging and unfavorable mix. Earnings-per-share came to $0.83 in Q1, up 24% year-over-year.
Cost reductions, combined with organic sales growth, acquisitions, and share repurchases, are expected to fuel 5% annual earnings growth over the next five years.
Competitive Advantages & Recession Performance
Emerson’s two main competitive advantages are its global scale, and proprietary technology. Emerson generates high margins and returns on capital thanks to its enormous global distribution network.
Emerson’s constant investment in new technology – totaling hundreds of millions of dollars annually – has given the company a leadership position across its two product segments. Its competitive advantages also allow it to navigate recessions better than most industrials.
Emerson’s earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $2.66
- 2008 earnings-per-share of $3.11 (17% increase)
- 2009 earnings-per-share of $2.27 (27% decline)
- 2010 earnings-per-share of $2.60 (15% increase)
- 2011 earnings-per-share of $3.24 (25% increase, new post-recession high)
Emerson performed relatively well during the Great Recession, with only one year of declining earnings. Normally, industrial manufacturers are tied to the health of the global economy. Its resilience during the Great Recession is a credit to its competitive advantages. However, we note that Emerson can see cycle tops without a recession, as has been the case in the past.
Valuation & Expected Returns
Emerson’s valuation has increased significantly due to its impressive stock price rally over the past year. It is now trading well above our estimate of fair value. Sells for 24.4 times the midpoint of fiscal 2021 expected EPS, which compares to our estimate of fair value at 19 times earnings.
Today, the stock is meaningfully overvalued. A declining P/E ratio from 24.4 to 19 over the next five years could reduce annual returns by -4.9% per year. This will be offset by 5% expected EPS growth and the 2.2% dividend yield, but total returns are expected at just 2.3% per year over the next five years.
Given this move up in the stock valuation over the past year, we see Emerson as much less attractive for investors considering the stock today.
As a result, while we like Emerson’s outstanding dividend history, we think the stock is substantially overvalued, and that growth is at or near a top for this cycle. Given this, we rate Emerson a hold due to its market-beating dividend yield and annual dividend increases, but the stock is not a buy right now due to valuation.
Emerson is a high-quality business, 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 may not be the best buying opportunity for the stock. The valuation has expanded thanks to a sharp rally in the stock, so investors that want to initiate a position would do well to wait for a lower price.