Sunday, December 8

Week 127 - Barron’s 500 Industrial Companies That Are Also Dividend Achievers

Situation: The resumption of strong earnings growth in the industrial sector is a hallmark of recovery from a recession. Those companies do so poorly during a recession that their recovery is well publicized by the press. Retail investors take that to be a sign that they’d better “get on the bandwagon.” Professional investors view the resulting inflow of dollars as just one more worry in an already overheated market. They’re afraid that the additional rise in stock prices won’t be justified by the expected rise in corporate earnings. Message? Nobody wants to see another bubble but you need to prepare for one anyway--by hedging your bets.

Is it a good time to buy stock in one or two of the leading industrial companies? No, you’re too late. But there is never a bad time to start putting ~$60/mo into the stock of any well-researched company by using a Dividend Re-Investment Plan (DRIP). To research industrial companies, first try to understand why they’re doing so well. In a nutshell it is for two basic reasons, “on-shoring” and “fracking.” U.S. exports account for well over 40% of world trade, and those exports are growing. But a lot of the parts for those “widgets” are now being built in Asia. Most manufacturers started doing that 10 yrs ago out of sheer necessity. They had to compete on labor costs or go bankrupt. The downside is the cost (and delay) in moving those parts back to the US for final assembly: Think about moving a Boeing 777 wing from where it is made (Japan) to where the plane is assembled (Seattle). 

Now that wages have more than tripled in China but fallen here in the U.S., there is no longer an overwhelming labor cost advantage to globalization. In addition, one of the main inputs for manufacturing in general and chemicals in particular is natural gas, which has fallen 50% in price here at home but costs 4 times that much in Asia. Result? Companies are bringing production back home in a process called “on-shoring.” There has also been a new-found appreciation for the infrastructure that the U.S. already has in place, as opposed to the almost non-existent infrastructure in Asian locales where wages are still low (Myanmar and inland China). Paved roads, seaports, railroads, electrical wiring, and airports are essential tools of commerce. 

The icing on the cake is that wage growth here in the U.S. has either reversed or stagnated while productivity has kept growing through investment in communication services and information technology. U.S. workers were already the best at interacting with growing automation in the workplace. Then the Great Recession came along and forced companies to double down on robots and automation, producing a dramatic increase in worker productivity. Result? US manufacturing jobs have grown steadily since the third quarter of 2010. This has been the first sustained growth that has occurred since the third quarter of 1998 (U.S. Bureau of Labor Statistics). Message? Build it here. When all is said and done, no other country has a workforce with the talent, creativity, and productivity that is found here in the US.

This week’s Table has all 15 “industrials” found in the Barron’s 500 list of companies with the best records of recent cash flow and sales growth that have also increased dividends annually for at least the past 10 yrs. (Companies with an S&P credit rating of BBB+ or lower were excluded.) All 15 took a hit on earnings during the Lehman Panic but kept growing dividends anyway--out of confidence in the future. Twelve of the 15 showed growth or stability in their cash flow and sales, or maintained their rank in the top 200 on the Barron’s 500 list (see Columns F and G of the Table). Three of those 12 also have good long-term Finance Value (see Column E of the Table): CH Robinson Worldwide (CHRW), Grainger (GWW) and Canadian National Railroad (CNI).

Under BENCHMARKS in the Table, we have added two new features. First, we have included the Vanguard Dividend Growth stock mutual fund (VDIGX) because it prioritizes dividend growth ahead of dividend yield. It also differs from our preference for companies that have 10 or more years of dividend growth by accepting companies with only two years of dividend growth. Second, we have included the sector ETF for industrial stocks (XLI). Red highlights in the Table denote underperformance vs. our benchmark: We use the Vanguard Balanced Index fund (VBINX) that is composed 40% of an investment-grade bond index and 60% of a large-capitalization stock index. That fund lost only 28% during the Lehman Panic vs. 46.5% lost by the S&P 500 index fund (VFINX). We think that hedging against the inevitable bear market for stocks is a fundamental aspect of investing. That is why we have chosen a benchmark (VBINX) that fully hedges the S&P 500 Index fund (VFINX).

The Table also includes 4 columns (O, P, Q, and R) for the Buffett Buy Analysis (see Week 30 & Week 94). That analysis uses for its starting point the 9-yr growth rate for Tangible Book Value (TBV). If that is greater than the nominal rate of GDP growth (5-6%/yr), then the company is said to have a Durable Competitive Advantage (DCA) provided there were no more than 3 yrs in the past 10 when TBV fell. If the stock navigates past those hurdles, its total return over the next 10 yrs is calculated--giving the Buffett Buy Analysis (BBA). That calculation is based on extrapolating core earnings growth over the past 8 or 9 yrs and multiplying that by the worst P/E seen in the past 10 yrs. The current dividend X 10 is added on the assumption that economic conditions won’t allow the company to raise its dividend over the next 10 yrs. The resulting number is the predicted stock price 10 yrs from now; it is compared to the current stock price to arrive at the projected total return/yr over the next decade. If the stock is overpriced now, its BBA will be underwhelming compared to its record of growth in TBV.

Bottom Line: An industrial stock is risky to own because earnings either diminish greatly or disappear in a recession, which is reflected by the stock’s price. But that company is well-positioned to show robust earnings growth when the economy recovers. We find 3 companies that have both long and short term Finance Value (CHRW, GWW and CNI). Grainger (GWW) is too overpriced (P/E = 24) to expect high returns to continue but you might want to see a fuller explanation from Morningstar ( CH Robinson Worldwide (CHRW) has had problems acquiring a competitor in the truck-brokerage business, which has depressed its stock price. Apparently that problem has now been resolved, leading Morningstar to upgrade its recommendation to Buy. The third leader on our list, Canadian National (CNI), is thought to be overpriced by Morningstar but the P/E of 18 doesn’t seem that high to us--given that CNI is generally regarded as “the highest margin railroad by far,” to quote the Morningstar analyst. 

This week’s Table carries more data than usual because its always a nail-biting experience to commit money to stock in an industrial company. 

Risk Rating: 8

Full Disclosure: I own stock in UTX, MMM, CNI, and CAT.

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