This is the third Dividend Growth Stock of the Month for 2015. In the first two articles, we examined:
• AT&T (T), the classic telephone company (January, 2015)
• Digital Realty Trust (DLR), a Real Estate Investment Trust that specializes in developments for technology applications (February, 2015)
This month we turn to an old-line manufacturing company, Emerson Electric (EMR). Once again, we see that “dividends are where you find them.” Wonderful dividend companies can come from practically any sector or industry.
Emerson’s Dividend Characteristics
What jumps out at you?
• At 3.3%, EMR’s yield is around average for the best dividend growth stocks. The average yield of all 105 Dividend Champions is 2.6%. EMR is considerably higher than that, but I tend to seek higher-yielding stocks in my analysis anyway. Many dividend growth investors would give EMR’s 3.3% yield a higher rating. It all depends on what you are looking for.
• With a dividend increase streak of 58 years, EMR is near the top of the heap. Only a handful of companies in history have delivered longer streaks of dividend increases. The last time Emerson went a year without raising its dividend, John Kennedy was still 3 years away from being elected president.
• EMR’s most recent increase of 9.4% was very good. The average most-recent increase for all Dividend Champions stands at 8.3%.
• The company’s 5-year DGR (dividend growth rate) of 6% is a little below the average for all Dividend Champions (7.3%). Nevertheless, I give it an Average rating, because the average for all Dividend Champions includes many stocks with much lower yields than EMR’s. Stocks with lower yields tend to have higher rates of increases and vice-versa.
Overall, Emerson’s dividend resume is very solid. It certainly demonstrates that returning cash to shareholders via dividends is embedded in the company’s way of doing things.
Company Quality
Emerson is a high quality company. Take a look at these metrics.
Emerson’s ROE (return on equity) is outstanding. Not only is it high currently, it has been above 19% for at least 10 years. The following chart compares EMR’s ROE with that of another famous industrial conglomerate, General Electric (GE).
You can see the fine record that EMR has established. Emerson kept its ROE high even during and after the recession (denoted by the gray band in the chart).
[ad#Google Adsense 336×280-IA]As we discussed last month, ROE is a measure of efficiency.
It tells you how effectively the company uses shareholders’ capital to generate profits.
Currently, EMR’s ROE is almost twice that of GE.
Emerson has grown its earnings per share at about 6% annually for the past 5 years, and analysts’ estimates for the next 5 years are for 8% average annual growth.
This is a solid picture for such a large and mature company.
S&P gives Emerson an investment-grade A credit rating and its highest quality ranking.
EMR’s Story: How Does It Make Money?
Emerson Electric is a 125-year-old diversified manufacturing company. Over the years, it has grown both organically and through acquisitions. Years ago, it was a regional manufacturer. Now it is a global equipment and systems provider with revenue of more than $24.5 Billion. EMR employs over 110,000 employees in 150 locations around the world.
Although EMR retains the word “Electric” in its official name, the company identifies simply as “Emerson” on its website and when speaking about itself.
Emerson is committed to being a well-managed, results-oriented, engineering-driven organization whose people have a passion for progress and a commitment to excellence.
Emerson brings technology and engineering together to provide solutions to customers in the following 5 areas. At the end of each section, I have placed a brief quote about that segment from EMR’s most recent quarterly earnings presentation.
Process Management covers automation, control, and process optimization. Emerson helps its customers cut costs, increase output, reduce energy use and emissions, and improve safety in complex operations by providing both automation technologies and engineering services. “Order trends have remained solid and backlog is strong despite an uncertain outlook in the process industry.”
Industrial Automation covers technologies, electrical, and mechanical systems for manufacturing and power generation. “Market conditions to remain mixed in the near term, with favorable trends in North America and continued weakness in Europe.”
The Network Power segment focuses on protecting and optimizing power and other services needed by data centers and communications networks.
“Business conditions expected to remain mixed, with favorable data center market conditions and reduced levels of telecommunications investment.”
Climate Technologies covers heating, air conditioning, temperature control, and refrigeration solutions for residential, industrial, and commercial applications. “Market conditions expected to remain favorable driven by end-user demand, with continued momentum in North America and Asia.”
Commercial & Residential Solutions covers a broad range of tools, pipe diagnostic systems, storage products, food waste disposers, and appliance solutions for professionals, contractors, and homeowners. “Favorable trends in U.S. residential and commercial construction markets are expected to continue in the near term.”
EMR is focusing on international opportunities to fuel growth. For example, it has been establishing production facilities overseas in order to be closer to its customers (and be more trusted by them). The company estimates that it will be generating about 45% of revenues from emerging markets by 2016.
I see several sources of strength in this business model. First, the diversification among industrial segments in itself provides a solid foundation. As conditions wax and wane in each market, they often fill in for each other to create a smoother overall picture.
Another strength is that many of Emerson’s businesses have high customer switching costs. It is difficult for a customer to change vendors for complex systems. Changing suppliers requires a customer to shut down a facility, replace equipment, and then reintegrate the new system into its operations. Many customers would rather work with Emerson to fine-tune systems than switch out entirely. That makes EMR’s services “sticky.”
Finally, Emerson has been buying back and retiring shares for many years.
The graph shows a share-count reduction of 18% over the past 10 years, almost 3% in 2014 alone. This is good for shareholders, because each remaining share represents a bigger slice of the whole company. Financially, that helps increase earnings per share and makes it easier for the company to grow its dividend per share.
Overall, I would award Emerson 10 points out of a possible 15 for its business model. It is quite an impressive company.
Stock Valuation
I described how I value stocks in Dividend Growth Investing Lesson 11: Valuation. The idea is to interpret how a stock’s actual price compares to what it “ought” to be based on its current financials and growth outlook. I follow 4 steps.
FASTGraphs 1. The first step is to examine the stock’s current price to FASTGraphs’ default fair value, which is what the price would be if the stocks had a P/E (price-to-earnings) ratio of 15. That is the historical long-term P/E ratio of the market as a whole.
As you can see, Emerson’s price has been falling, and as a result it has entered fair valuation territory. Some investment strategies – such as momentun investing – would steer clear of a stock with a falling price. But dividend growth investing, based on valuation principles, is not put off by the falling price. We want to purchase stocks when they have better valuations, and price drops create buying opportunities.
FASTGraphs 2. The second valuation step is to compare EMR’s price to its “normal” long-term average P/E ratio. It turns out that EMR historically has traded at a valuation of more than 15, specifically 18.8.
When we compare Emerson’s price to what it would be if it were trading at its historical valuation, we see that the price is quite a bit below that. So by this measure, EMR’s valuation is good.
Morningstar. Morningstar presently rates Emerson’s value as 4 stars, meaning that they consider it to be undervalued.
Current Yield vs. Historical Yield. As seen in the following graph, Emerson is currently yielding around its 20-year historical average.
As with many dividend growth stocks, EMR’s yield peaked when the market reached its crash low in early 2009. Right now, EMR’s yield is as high as it has been since 2013. That suggests that its valuation is fair to slightly better than fair.
Here is a summary of EMR’s valuation.
Miscellaneous Factors
There are a couple of factors that I like to look at that do not fall neatly into any of the earlier categories.
Beta measures a stock’s price volatility relative to the market as a whole. Most dividend growth investors like to own stocks with low price volatility, because then you are less likely to become emotional about the stock. This is a chink in EMR’s armor. Its price over the past 5 years has been 30% more volatile than the market.
EMR is what is known as a “cyclical” stock, meaning that it is sensitive to the business cycle. As we saw earlier, the variety of EMR’s business segments helps to smooth out its economic fortunes, but there is no mistaking that historically its price has shown more volatility than the market as a whole. Companies that produce machinery, tools, and heavy equipment are usually considered to be cyclical. Because EMR is a global player, the global economy, not just that of the USA, affects it. While the domestic economy is in an uptrend, Europe is still struggling.
If short term price volatility bothers you, EMR may not be the kind of stock that you want. Even if a stock meets all your other requirements, there is no use holding a stock that is going to keep you up at night.
While EMR has a 58-year streak of increasing its dividend, the amount of the increase each year also reflects the company’s cyclicality. This snapshot from the Dividend Champions spreadsheet shows the percentage increase by year.
As you can see, while the 15-year average increase (far right) has been 6.8%, the individual increases have ranged from less than 2% to almost 17%. This not a steady-7%-per-year dividend growth stock.
On the other hand, it is EMR’s price volatility that has brought it into fair-value range right now. It historically has traded at a P/E of 18.8, but you can get it currently for a P/E of 15. That is a 20% discount to its usual valuation, and it is also the reason that EMR’s yield is fairly high at the moment. Value investors like to jump on opportunities like this.
The second miscellaneous factor is analysts’ recommendations. Most analysts are mainly interested in price changes rather than dividend growth.
Nevertheless, I like to see what the consensus ratings are, if for no other reason then to check for red flags that I somehow overlooked. As you can see, 28 analysts cover EMR, and overall they consider it OK right now.
Bottom Line
I think that Emerson Electric is a good dividend growth investment. Its financial metrics are strong. Its business model is well conceived, and it has been well-executed for many years.
The company’s dividend yield is solid at 3.3%, and its 58-year streak of dividend increases is nearly unmatched. EMR clearly has established that it can manage the dividend so as to be able to increase it every year even as the business goes through peaks and valleys.
The only obvious downside is EMR’s price volatility. While in the long run that really makes little difference in overall performance, it is a negative factor for some individual investors.
As I reinvest dividends during the rest of 2015, I will consider EMR as a serious candidate. I do not currently own it, so it would provide me with the opportunity to diversify my portfolios a little bit.
— Dave Van Knapp
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