In the past year or so, I’ve written many articles about assessing the quality of dividend growth stocks. I use DVK Quality Snapshots, an elegant and effective system that employs five widely used quality indicators from independent sources. The system assigns 0-5 points to each quality indicator, for a maximum of 25 points.

Since May, I’ve been using Dividend Radar as my primary watch list of dividend growth stocks. Dividend Radar tracks stocks with dividend increase streaks of at least five years and is updated and published every Friday.

While Dividend Radar provides a multitude of metrics of interest to dividend growth investors, including fundamental data and added value metrics, I calculate quality scores and consider them when screening candidates for further research and possible investment.

The latest edition of Dividend Radar (dated August 21, 2020) contains 751 stocks. Of those, only seven stocks have a perfect quality score of 25. I rate these stocks Exceptional and I happen to own all of them in my DivGro portfolio.

Stocks with quality scores of 23-24 are rated Excellent, and there are 31 in Dividend Radar. Nineteen have quality scores of 24, and twelve have quality scores of 23. I own 26 of these stocks, so there are only five that I don’t own.

This article explains why I don’t own these stocks, despite their high-quality scores and Excellent rating, and what would need to change before I would consider buying shares.

Excellent Stocks I Don’t Own, Ranked

I rank stocks by sorting them by descending quality scores, and then using the following tie-breaking metrics, in turn:

  1. SSD Dividend Safety Scores
  2. S&P Credit Ratings
  3. Dividend Yield

When two stocks with the same quality score have the same Dividend Safety Score, I next compare their S&P Credit Ratings, ranking the one with the better Credit Rating higher. I rarely need to break ties with Dividend Yield.

Rank

Ticker

Company

Sector

1

LLY

Eli Lilly

Health Care

2

CL

Colgate-Palmolive

Consumer Staples

3

WMT

Walmart

Consumer Staples

4

ECL

Ecolab

Materials

5

EMR

Emerson Electric

Industrials

Key Metrics and Quality Scores

The table below presents key metrics of interest to dividend growth investors, along with quality indicators and fair value estimates. These include the years of consecutive dividend increases (Yrs), the dividend Yield for a recent Price, and the 5-year compound annual dividend growth rate (5-Yr DGR).

I also include the Chowder Number (CDN), a popular metric for screening dividend growth stocks for possible investment. The CDN column is color-coded to indicate the likelihood of delivering annualized returns of at least 8%. Green means likely, yellow means less-likely, and red means unlikely. I consider green CDNs favorable.

Table created by the author with data sourced from Dividend Radar, Value Line, Morningstar, S&P Capital, Simply Safe Dividends, and Google Finance.

The fair value column (Fair Val.) shows my fair value estimates, determined from fair value estimates and price targets from several sources, including Morningstar and Finbox. Additionally, I estimate fair value using the 5-year average dividend yield of each stock using data from Simply Safe Dividends.

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Commentary

While these stocks are high-quality stocks according to DVK Quality Snapshots, there are problems of note that keep me on the proverbial sidelines.

Except for LLY, the stocks are trading below my fair value estimates (and LLY only recently dropped into discounted territory). I actually don’t mind paying even a slight premium for high-quality stocks, but then other metrics and the investment thesis need to be compelling.

All five stocks have CDNs indicating that they likely would not deliver returns of at least 8%. According to the Chowder rule, stocks yielding less than 3% require a CDN of at least 15 and none of these stocks come even close. The CDN is not one of my stock selection criteria, though I use it as a guide when comparing candidates. There are several high-quality stocks in my portfolio with favorable CDNs, and I prefer to add to those stocks rather than to open new positions in stocks with “red” CDNs.

I should note that the stocks have really impressive dividend histories. CL and EMR are Dividend Kings, a very exclusive group of stocks with at least 50 consecutive years of dividend increases. Furthermore, except for LLY, the stocks are Dividend Champions with dividend streaks of at least 25 years. Even LLY, a Dividend Challenger, has a streak of no cuts spanning more than 30 years.

Let’s look at these stocks individually, in turn, to see what would need to change before I would consider opening a position.

Eli Lilly

While the stock has dropped 13% from its 52-week high of $170.75, I’d like to see an even more compelling entry point at or below $124. At that price, LLY would yield 2.39%, which is the current 5-year average dividend yield of the stock:

Source: Portfolio Insight

A yield of 2.39% certainly would make LLY more attractive, especially given the stock’s most recent dividend increases of 14.7% and 8.2%. Another strong dividend increase next year would certainly help to improve LLY’s 5-yr DGR and, therefore, also its CDN.

Source: Portfolio Insight

With earnings growth estimates of 19% and 9% for the next two years, it is quite possible that we could see double-digit percentage dividend increases in 2021 and 2022.

Source: Portfolio Insight

Colgate-Palmolive

After trading below $59 in March, the stock has recovered remarkably well and now trades at all-time highs! This action pushed the yield down to 6% below its current 5-year average yield of 2.36%:

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Source: Portfolio Insight

A price of $74.58 would represent a yield equal to the current 5-year average yield of 2.36%. This price is about 4% above my fair value estimate, so I would favor an entry point below $73.

Source: Portfolio Insight

The problem with CL is its growth prospects. Dividend growth is very slow and, looking at the earnings chart below, it seems unlikely that we’ll see dividend increases much above 2% in the foreseeable future.

Source: Portfolio Insight

CL is a Dividend King and offers a very safe dividend, but I’m looking for better growth prospects, which CL is not offering at this time.

Walmart

WMT yields only 1.54% and is trading 19% above my fair value estimate. And when comparing WMT’s current yield with its 5-year average yield of 2.39%, the stock seems to be trading at an even larger premium.

Source: Portfolio Insight

At a price of $90.37, WMT would yield 2.39% to match its current 5-year average yield.

Unfortunately, WMT’s dividend growth is anemic at only about 2% per year for the past 5 years.

Source: Portfolio Insight

If the stock’s earnings estimates for the next two years materialize, perhaps WMT would consider higher dividend increases, but I won’t hold my breath for that.

Source: Portfolio Insight

Ecolab

ECL is overvalued by at least 11%, based on my fair value estimate, and about 16% when comparing its current yield to the current 5-year average yield:

Source: Portfolio Insight

A yield of less than 1% is not compelling, and I would need to see a dividend growth rate near 15% before this Material sector stock would interest me. Even below $170, ECL would yield only about 1.11%.

ECL’s dividend growth is quite impressive and very consistent.

Source: Portfolio Insight

For the most part, the stock’s earnings are growing at a comparable rate, though earnings estimates for fiscal years 2020 and 2021 seem out of sort:

Source: Portfolio Insight

So, I don’t expect much higher dividend increases than about 10% from ECL, which is just not enough to compensate for its very low yield.

Emerson Electric

EMR offers the highest yield of 2.83%, but an unimpressive 5-year dividend growth rate of only 1.6%. The stock’s 5-year average yield is 3.22%, which suggests a price of $62.11 would be a good entry point.

Source: Portfolio Insight

As mentioned, EMR’s dividend growth is unimpressive and the stock’s earnings are somewhat inconsistent. I don’t expect a significant increase in EMR’s dividend payments, unfortunately.

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Source: Portfolio Insight

Source: Portfolio Insight

EMR is a Dividend King that will likely remain outside my portfolio.

Possible Trades

As mentioned above, several things would need to change before I’d be willing to buy shares of these stocks. But that doesn’t preclude all trades. While I’m a dividend growth investor first and foremost, I also dabble in options trading and, specifically, selling options to boost the dividend income I receive from my DivGro portfolio.

For LLY, it is possible to collect options income that more than doubles the stock’s current dividend on an annualized basis. For example, the $125 put that expires on November 20 sells for about $1.80 per share. The trade would deliver options income of $180, for an annualized options yield of 5.14% (versus LLY’s current yield of 1.98%).

Source: Author’s Options Calculator

If the option is exercised, the options seller would have to buy 100 shares of LLY at a cost basis of $123.19 per share, a discount of 17.6% to today’s price of $149.50 per share.

For EMR, it appears that I could sell a $57.50 put option for about $1.32 per share. The trade would deliver options income of $132, for an annualized options yield of 6.10% (versus EMR’s current yield of 2.83%).

Source: Author’s Options Calculator

If the option is exercised, I would need to buy 100 shares of EMR at a cost basis of $56.17 per share, a discount of 20.50% to today’s price of $70.65.

Concluding Remarks

The article presented 5 high-quality dividend growth stocks that are not in my DivGro portfolio, along with indications of what would need to change before I would consider buying shares.

The stocks are rated Exceptional (perfect quality scores) or Excellent (quality scores: 23-24) and they all have long histories of dividend payments. Currently, the stocks are not trading at attractive valuations and their Chowder Numbers are quite low, meaning they’re unlikely to deliver annualized returns that top 8%.

I’m considering two short put options trades, which, if assigned, would deliver 100 shares of LLY and EMR at discounts of 17.6% and 20.5%, respectively.

As always, I encourage readers to do their own due diligence before investing.

Thanks for reading and happy investing!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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