Updated on March 5th, 2021 by Bob Ciura
Investors looking for high-quality dividend growth stocks should focus in part, on companies that maintain long histories of dividend increases. Steady dividend raises from year to year, regardless of the economic climate, is a sign of a company with durable competitive advantages and long-term growth potential.
With that in mind, every year we review each of the Dividend Aristocrats, a group of 65 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases. You can download your copy of the Dividend Aristocrats list, including important metrics like dividend yields and price-to-earnings ratios, by clicking on the link below:
The next Dividend Aristocrat in the series, is healthcare giant Medtronic (MDT).
Medtronic has an impressive history of dividend growth. The company has increased its dividend for 43 years in a row. With a 2% yield, Medtronic is not exactly a high-yield stock. In fact, the stock’s yield is still higher than the average yield of the S&P 500.
But Medtronic typically raises its dividend at a high rate each year, thanks to its strong earnings and leadership position within the medical devices industry. According to the company, Medtronic has increased its dividend by 17% compounded annually over its 43 years of annual increases. These qualities make Medtronic an attractive dividend growth stock for long-term investors.
Medtronic was founded in 1949 as a medical equipment repair shop by Earl Bakken and his brother-in-law, Palmer Hermundslie. Today, Medtronic is one of the largest healthcare companies in the world. Medtronic is a large-cap stock with a market capitalization of ~$160 billion.
Medtronic PLC is the largest manufacturer of biomedical devices and implantable technologies in the world. Medtronic currently has four operating segments: Cardiac and Vascular Group, Minimally Invasive Therapies Group (MITG), Diabetes Group, and Restorative Therapies Group.
Source: Investor Presentation
On February 23rd, 2020 Medtronic reported Q3 fiscal year 2021 results for the period ending January 29th, 2021 (Medtronic’s fiscal year ends the Friday closest to April 30th). For the quarter, Medtronic reported sales of $7.775 billion, a 0.8% increase compared to the same quarter last year. Sales in the Cardiac and Vascular Group, Minimally Invasive Therapies Group (MITG), Diabetes Group and Restorative Therapies Group were down -4.0%, up 6.3%, up 3.3% and up 0.7%, respectively.
Adjusted net income equaled $1.753 billion or $1.29 per share, a -10% year-over-year decline. Given the uncertainty of the COVID-19 pandemic, management reiterated that it is not providing guidance at this time.
The coronavirus pandemic has had a negative impact on the company’s results, but we view the downturn as temporary. Due to a variety of factors including the favorable economics of the U.S. healthcare industry, Medtronic should enjoy many years of growth up ahead.
Medtronic is investing in growth, both organically and through acquisitions. The first catalyst for Medtronic is the aging population. There are ~70 million Baby Boomers in the U.S., those aged 51-69 years. Thousands of people are entering retirement every day. Combined with longer life expectancy and rising healthcare spending, the operating environment is very attractive for Medtronic.
The company has had many approvals of new products which have great potential for future growth.
Source: Investor Presentation
Medtronic also has a major growth opportunity in new geographic markets. Specifically, Medtronic has a presence in several emerging markets, such as China, India, Africa, and more. These countries have large populations and high economic growth rates.
Medtronic’s emerging market revenue has consistently grown at a double-digit rate for many years. On a constant-currency basis, the emerging markets were the only geographic segment to produce revenue growth for Medtronic in the most recent quarter. Emerging market constant-currency revenue increased 0.8%, while the U.S. and the non-U.S. developed markets declined 2.0% and 0.2%, respectively.
While the U.S. currently accounts for over half of Medtronic’s revenue, the emerging markets represent just 17% of total company sales. This leaves plenty of growth potential left for Medtronic in the developing world.
Another growth catalyst for Medtronic is acquisitions. The largest single acquisition for Medtronic was its $50 billion acquisition of Covidien in 2015. The acquisition presented significant growth potential for Medtronic.
Covidien is also a medical device maker, with a focus on hospital supplies. The deal lets Medtronic broaden and diversify its product portfolio.
Medtronic has a long history of successful acquisitions. In fiscal 2017, Medtronic completed 5 bolt-on acquisitions, for a total of $1.5 billion. More recently, Medtronic acquired Titan Spine, which added $16 million to third quarter revenues. Acquisitions are an important part of Medtronic’s growth strategy.
Competitive Advantages & Recession Performance
The main competitive advantage for Medtronic is its research and development capabilities. The company spends heavily on R&D each year, which provides it with product innovation. Medtronic’s R&D investments over the past few years are as follows:
- FY 2016 R&D expense of $2.2 billion
- FY 2017 R&D expense of $2.2 billion
- FY 2018 R&D expense of $2.3 billion
- FY 2019 R&D expense of $2.3 billion
- FY 2020 R&D expense of $2.3 billion
The result of all this spending is that the company has a huge intellectual property portfolio with over 45,000 awarded patents. This has allowed Medtronic to build a strong product pipeline across each of its business segments.
In addition, Medtronic benefits tremendously from global scale. The company operates in over 150 countries around the world. It has the operational flexibility to generate industry-leading profit margins, which helps fuel its growth.
Another competitive advantage for Medtronic is that it operates in a defensive industry. Consumers often cannot choose to forego medical treatments, even when the economy goes into recession.
Medtronic’s earnings-per-share during the Great Recession are as follows:
- 2007 earnings-per-share of $2.61
- 2008 earnings-per-share of $2.92 (12% increase)
- 2009 earnings-per-share of $3.22 (10% increase)
- 2010 earnings-per-share of $3.37 (5% increase)
Medtronic had the rare achievement of earnings growth each year during the recession. This demonstrates its recession-resistant business model. Medtronic should be able to continue growing its dividend each year, in both economic recessions and expansions.
Valuation & Expected Returns
Based on the recent share price of $116 and expected earnings-per-share of $4.25 in fiscal 2020, Medtronic stock trades for a price-to-earnings ratio of 27.2. The current valuation of the stock is below that of the broader S&P 500 Index, but Medtronic’s valuation is above its own long-term average.
From 2013 through 2019, it had been typical to see Medtronic stock trade hands in the 15 to 19 times earnings range, even bumping up to 20 times earnings a couple of times; this despite the idea that the firm has been exceptionally consistent through that entire period. Our expectation assumes a fair multiple of 17 times earnings.
As a result, Medtronic shares appear to be overvalued today. If the stock valuation retraces to our fair value estimate by 2026, the corresponding multiple contraction would reduce annual shareholder returns by approximately 9.0% per year over this period of time.
This will nearly wipe out the benefit of future earnings-per-share growth and dividends. We expect 8% annual earnings growth for Medtronic through 2026, and the stock has a 2% dividend yield. There is plenty of room for continued dividend increases each year. With a dividend payout ratio below 60%, and a positive earnings growth outlook, Medtronic should continue its streak of annual dividend increases.
Total returns would consist of the following:
- 8.0% earnings growth rate
- -9.0% multiple reversion
- 2.0% dividend yield
Medtronic is expected to return just 1.0% annually over the next five years. Medtronic is yet another example of a high-quality business trading at an unappealing valuation. With the stock market near a record high, it is difficult for investors to find strong dividend growth stocks trading at compelling discounts.
Medtronic has virtually all of the qualities dividend growth investors should look for. It possesses a highly profitable business, a leadership position in its core markets, and long-term growth potential. It also has multiple catalysts for future growth, and the ability to keep growing its dividend even during recessions.
Medtronic has increased its dividend for more than four decades, including a strong 7% increase in 2020, which is highly impressive given the steep economic downturn due to the coronavirus pandemic.
The only negative aspect of investing in Medtronic stock today is the valuation. We believe Medtronic is overvalued right now. As a result, value investors should wait for a pullback before buying the stock. That said, Medtronic remains a high-quality holding for long-term dividend growth investors.