Updated on April 12th, 2021 by Bob Ciura
Investors looking for high-quality dividend growth stocks should take a closer look at the Dividend Aristocrats. The Dividend Aristocrats are a group of 65 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
You can see a full downloadable spreadsheet of all 65 Dividend Aristocrats, along with several important financial metrics such as price-to-earnings ratios and dividend yields, by clicking on the link below:
We review all 65 Dividend Aristocrats each year. The next stock in the series is aerospace and defense company General Dynamics (GD). General Dynamics is one of the newer members of the Dividend Aristocrats, having joined the list in 2017.
General Dynamics is a leader in the aerospace and defense industry, with a long history of dividend increases and steady growth.
General Dynamics was incorporated in 1952, through the combination of the Electric Boat Company, Canadair, and several others.
The company has evolved over the years, to enter new businesses of the future. The biggest transformation came in the 1990’s, when General Dynamics started buying technology-oriented companies. General Dynamics currently generates annual sales nearing $40 billion.
The company’s revenue stream has been diversified in recent years, and it now no longer relies as much upon the Aerospace segment as it used to.
A breakdown of its segments and their contribution to revenue is below:
- Aerospace (21% of revenue)
- Combat Systems (19% of revenue)
- Technologies (33% of revenue)
- Marine Systems (26% of revenue)
The company’s Aerospace segment is focused on business jets and services while the remainder of the company is defense. The company makes the well–known M1 Abrams tank, Stryker vehicle,Virginia–class submarine, Columbia–class submarine,and Gulfstream business jets. These strong businesses have combined to produce consistent growth for many years.
General Dynamics had a difficult year in 2020, as the coronavirus pandemic weighed heavily on global economic growth, and by extension, the aerospace and defense industry. For the fourth quarter, company-wide revenue declined 2.7% to $10.5 billion, while diluted EPS declined 0.6% to $3.49. Once again the Aerospace segment led the way in the fourth quarter, with a strong bounce-back from the previous quarter.
Source: Investor Presentation
For the year, company-wide revenue declined –3.6% while diluted earnings per share fell –8.2% to $11.00 from $11.98 in the prior year. The declines again resulted from the adverse effects of COVID–19 on company operations. The company-wide backlog is at a record of $89.5 billion, and the unfunded backlog is ~$45.2 billion (the majority in Marine Systems and Technologies). General Dynamics continues to win large contracts and the book–to–bill ratio is 1.1–to–1.
General Dynamics top and bottom lines have grown for many years, due to increasing U.S. defense spending and international sales. General Dynamics has established naval and ground platforms that support maintenance and modernization contracts as well as future prime contract wins. The business jet market is being negatively impacted in the near–term due to COVID–19 and travel restrictions. After 2021, we forecast on average 6% annual earnings per share growth out to 2026.
Competitive Advantages & Recession Performance
General Dynamics has several competitive advantages. First, it operates in defense, which has very high barriers to entry. Defense companies rely on contracts from the U.S. and foreign governments. A small competitor would have difficulty entering the defense industry and trying to take share.
In addition, General Dynamics has industry-leading brands, such as Gulfstream and Stryker. It has built these brands with significant research and development spending, that totals in the hundreds of millions of dollars annually. Indeed, this is part of the significant barriers to entry for potential competitors.
General Dynamics is built to last. The company performed very well during the last recession:
- 2007 earnings-per-share of $5.10
- 2008 earnings-per-share of $6.13 (20% increase)
- 2009 earnings-per-share of $6.20 (1.1% increase)
- 2010 earnings-per-share of $6.82 (10% increase)
As you can see, the company grew earnings in each year of the recession, including two years of double-digit growth. It would not be easy to find many companies that grew earnings-per-share by 20% in 2008, but General Dynamics did it.
One major reason for the company’s excellent recession performance, is because it sees steady demand for its products and services each year. The world has many dangerous places. Global conflicts are not likely to cease any time soon, regardless of the economic climate. This will drive ever-increasing levels of defense spending, the US included.
And, General Dynamics’ revenue is secured by long-term contracts with its customers, and switching costs are very high, sometimes impossibly so. This also keeps earnings intact during recessions.
Valuation & Expected Returns
General Dynamics stock has a price-to-earnings ratio of 16.8, which is above our fair value estimate of 14 times earnings.
If the valuation multiple declines from 16.8 to our fair value estimate of 14, it would reduce annual returns by approximately 3.6% per year over the next five years.
Fortunately, shareholder returns will be boosted by projected earnings-per-share growth of 6% per year, as well as the current dividend yield of 2.6%. The dividend payout is highly secure, with a projected 2021 dividend payout ratio of just 40% which leaves plenty of room for annual dividend increases.
Given all of these factors, we see total annual returns of about 5% in the coming years. This is a decent rate of return, but is not high enough to warrant a buy rating from Sure Dividend due to the overvaluation of the stock. We therefore rate the stock a hold.
General Dynamics is a high-quality business, with a long history of growth. Geopolitical risk remains a constant, which gives the company a long runway of growth going forward.
General Dynamics is also a shareholder-friendly company, and should continue returning significant cash to shareholders through buybacks and dividends. The elevated valuation could limit the stock’s annual returns over the next five years. Still, investors can expect satisfactory returns and annual dividend increases each year, making General Dynamics a hold for dividend growth investors.