I am susceptible to the bias of “52 week high and 52 week low” syndrome when analyzing investments. As a matter of logic, I know that a stock’s current price in relation to its past price is not determinative of whether it is the most attractive value today. The best long-term investments tend to generate the fastest growing future profits mixed with cumulative dividends, and a stock trading at a high is just as capable of being the best performer as a stock well off its highs. Does anyone really question that Google/Alphabet stock, which has shot up to $800 from $695 after I covered it this summer, will be one of the best performers over the coming decade?
Still, I can’t help but consider it a strong signal of interest when a company is (1) currently and historically profitable; (2) paying out a dividend that is high and has been growing for years; and (3) trading at a valuation that offers a haircut from recent valuations.
That is the basis for why I have been paying attention to old stalwart Emerson Electric lately. Despite a record of raising the dividend every year since the 1960s, a current dividend yield of 3.7%, and a dividend payout ratio that only consumes a bit more than half of profits, the stock has become unfashionable of late.
After quickly recovering from the financial crisis by rebounding from $24 in 2009 to $70 per share in 2013, the stock has traded in the $40 to $60 range during the past three years and currently sits at a price of $51 per share.
I understand why no one is talking about Emerson Electric these days. It completely flunks the “What have you done for me lately?” investment test. Since December 2013, the stock is down 20%. Over that same time, the S&P 500 is up 21%. Every dollar invested into the S&P 500 turned into $1.21 over the past three years; every dollar invested into Emerson turned into $0.80.
But what is interesting to me is that Emerson Electric is now at a point where the dividend yield is high enough to do some real compounding merely through the reinvestment of those cash dividends.
This is really one of those points where I realize I showed up on the investment scene at the wrong time. I would have loved to cover stocks during the 1940s to 1980s when high fixed income returns were taken for granted as an article of normalcy. You could load up on utilities, oil firms, and Philip Morris plus AT&T and collect a 5-7% dividend stream that grew at a rate of 4-6% every year. When you’d put $10,000 into a certificate of deposit at the bank down the street, you’d get $40 to $45 deposited into your account every month as interest. A basket of corporate bonds would get that up to $60 per month.
Heck, your savings account alone would be paying you $35 per month on $10k.
But there’s a lot of sweet advantages that come with the modern era of investing, particularly extreme transparency and access to the analysis of others, as well as low brokerage trading costs that we take for granted but were not historically commonplace, so there is no requirement to wail about the current days too loudly.
As a result, this means that one of the best income investments you will be able to find is something like Emerson Electric yielding 3.7% with a strong possibility of 7.5% annual dividend growth for the long haul.
And that’s not a bad place to be. As a reference point, consider Emerson Electric’s returns since 2003 (the last time that Emerson offered this high of a yield outside of recessionary conditions.)
During the past thirteen years, Emerson’s dividend has risen from $0.79 to $1.90. Assuming absolutely no dividend reinvestment, each share of EMR stock has produced $18.37 in total income. At that the time, the stock traded at $22 per share.
For the past thirteen years, you would have received capital appreciation of $29 plus that $18.37 per share in dividends for a total economic value of $47.37. As in, if you paid $2,200 for 100 shares in 2003, you’d have $4,737 in profit on the current $6,937 in dividend plus capital appreciation value that you received.
And, of course, people don’t usually let money stagnate alone in a brokerage account for thirteen years. If you would have reinvested that money back into shares of Emerson Electric, you would have received $22.84 per share in dividends that got reinvested at an average price of $37.44. In other words, every 100 shares of Emerson Electric purchased in 2003 would have become 161 shares of Emerson Electric today worth $8,211. That’s a $6,011 profit on the initial $2,200 investment.
So what’s the consolidated lesson here? I think it boils down to two facts and then an interpretation.
First, Emerson Electric has delivered 9.24% annual returns since 2003 without any dividend reinvestment.
Second, Emerson Electric has delivered 10.66% since 2003 with full dividend reinvestment.
Third, those return figures may actually be more impressive than they appear because it is my contention that Emerson Electric is trading at a 15% or so discount to its fair value. This skews the long-term results downward. For example, Emerson’s stock traded at $70 per share in 2013. The ten-year compounding from 2003-2013 was about 11.5% without dividends reinvested and almost 13% with dividends reinvested.
The lesson here for investors ought to stress the importance of getting the valuation right. People who bought Emerson in 2007 have only compounded at 2% because the stock was trading at $60 back then. It is dividends alone that have given investors a positive return from 2007 through 2016 because the beginning of the measuring period included high overvaluation and the end of the measuring period included moderate undervaluation.
This is why I suspect there is such a range of opinions regarding Emerson Electric in forum activity. You could have an ownership claim on the profit residue of the exact same electric motors, yet your investment experience would be radically different depending on when you opened your position. Someone that has been around for awhile, perhaps a retiree that bought 1,000 shares in 2003, would happily be earning annual returns in the 9-11% and seeing $790 checks turn into $1,900 checks for what is now a 8.63% annual income return on the initial investment. Or the checks would be over $3,000 annually with dividend reinvestment, for a 13.89% annual income return on the initial investment.
Meanwhile, someone loading up on Emerson in a retirement account in 2007 would have seen a 1,000 share investment decline experience a share price decline of $10,000 while the $15.06 in EMR dividend income would have added $15,060 to only create a $5,060 profit that would lag inflation and make the investor worse off than when he started. And if that money were invested in a taxable account, you’d have to deal with the double whammy insult of having to pay taxes on the dividend income even though there had been no purchasing power gain yet.
With a few investments, like the Visas and Alphabets of the world, it is preferred but not necessary to get the valuation right because it is still possible to get double-digit returns if you overpay. That’s inherent in the nature of a business growing in the 12% to 17% range.
But network, power, electrical, and network processing systems don’t have that kind of growth. This is an industry with 5-7% long-term revenue growth that can convert into 6-10% long-term earnings growth. That doesn’t give you the luxury of botching the valuation, and certainly doesn’t give you the ability to dramatically overpay and still do fine.
But if you get the price right, and hold the shares for the long run, you can beat the S&P 500 by one to three points annually while collecting a dividend payout that is twice as high as what you’d get from an S&P 500 index fund. With a 3.7% dividend yield, and moderately growing earnings, and a P/E ratio of 16, now is one of those times where I’d describe it as a “better opportunity than usual” to add shares of Emerson Electric to account. My guess is that investors will get about 8-11% from here over the next fifteen to twenty years, and will collect a large chunk of cash dividend income as part of their total returns along the way. For someone that would like to build a solid income stream for the late 2020s, Emerson Electric now offers fertile soil.
Originally posted 2016-09-15 19:22:31.
