All three stocks I’ll look at today are dividend aristocrats, stocks that have increased the dividend for at least 25 consecutive years.
A minty fresh dividend?
Colgate-Palmolive Company (NYSE:CL) is best known for its namesake toothpaste, but the company makes some other products as well. The Irish Spring brand of bar soap, Speed Stick deodorant, and Softsoap hand soap fill out the company’s personal care product line. In home care products the company sells Palmolive dishwashing liquid, AJAX cleaners, and Suavitel fabric softener. And a bit out of its core competency, Colgate-Palmolive Company (NYSE:CL) also sells a few brands of dog and cat food such as Science Diet.
Most of these are strong, established, well known brands, and the company certainly has an economic moat in the oral care market. The stock currently yields about 2.3%, quite low for a mature company like Colgate-Palmolive Company (NYSE:CL). The dividend has grown at a reasonable clip over the past decade, with annualized growth of 11.7% over that period. This is faster than other similar companies, like The Clorox Company (NYSE:CLX) for example, but the yield is also far lower.
While the dividend has nearly tripled over ten years the company’s free cash flow hasn’t quite doubled, meaning that the payout ratio has expanded. In 2003 the payout ratio as a percentage of the free cash flow was just 34.8%, growing to 44.5% by 2012. This is actually still fairly low and has more room to expand. Until the payout ratio reaches the mid 50’s I wouldn’t be concerned.
The payout ratio was partially kept in check by share repurchases, reducing the share count by 15.4% over the past decade. Without these buybacks the payout ratio would be 52.6%, significantly higher than the current value. These repurchases should continue, reducing the growth of the payout ratio and making room for more dividend growth.
I think that the past growth rate of about 11% can likely continue, at least for a while. I’ll do a simple dividend discount model calculation to estimate the fair value of a share of Colgate-Palmolive Company (NYSE:CL) given this assumption.
The fair value of a share of Colgate-Palmolive Company (NYSE:CL) is about $53, 10% below the current market price. The stock has fallen from $62 already, but another 10% decline seems unlikely anytime soon. Nevertheless, I’ll put Colgate on the watchlist with a $53 buy target.
Big Oil, not so big dividend
Exxon Mobil Corporation (NYSE:XOM) isn’t my favorite big oil stock, partially because it’s so big and partially because it has a lower dividend yield than most of its peers. The price will certainly need to come down for the stock to be a good investment. After a 10.5% dividend hike in May the stock currently yields 2.76%, not quite as high as Chevron Corporation (NYSE:CVX).
The dividend has grown at an annualized rate of 9.3% over the past decade as earnings per share have more than tripled. There is, however, a big discrepancy between net income and free cash flow. Because Exxon Mobil Corporation (NYSE:XOM) has greatly increased its capital expenditures over the past few years, now more than double 2007 levels, the free cash flow is significantly less than the net income. So although in 2012 the payout ratio with respect to the net income was a lowly 22.5%, it was a much higher 46% of the free cash flow.
As it gets harder and more expensive to find new oil, reserves companies like Exxon Mobil Corporation (NYSE:XOM) will have to continue to spend more and more money in order to maintain their production. I don’t see any real reason for the capital expenditures to fall anytime soon, so it seems that free cash flow is far more important here than net income. A payout ratio of 46% isn’t too high, and the company spends much more on buybacks which will keep the payout ratio in check. In the last ten years the share count has been reduced by 30%.
In terms of future dividend growth, I think the historical rate of about 9% is a reasonable estimate. Under that assumption the fair value of a share of Exxon Mobil Corporation (NYSE:XOM) is around $84, 8% below the current share price. Chevron Corporation (NYSE:CVX) is a better choice at today’s prices, with a 3% yield and similar growth prospects. I’ll add an entry in the watchlist for Exxon Mobil Corporation (NYSE:XOM) with a buy target of $84 per share.
Not spicy enough
McCormick & Company, Incorporated (NYSE:MKC) is an interesting company. With a dominant share of the North American spice market the company generates solid and consistent profits. What’s more, in addition to selling premium, higher-priced spice products the company is also the leader in the private-label spice market. This gives the company exposure to those who buy cheaper spices.
McCormick & Company, Incorporated (NYSE:MKC) has been growing steadily, even through the financial crisis, with revenue growing at an annualized rate of 6.5% over the past decade. Net income has grown a bit faster at a rate of 7.6% annualized, and the dividend has grown by 11.6% per year. The yield, however, is quite low at just 1.92%.
The dividend eats up about 48% of the free cash flow, with buybacks recently eating up almost as much. For a company like McCormick, which currently trades at a premium multiple, I think buybacks aren’t the best idea. Raising the dividend would be a better use of the free cash flow, increasing the yield and making the stock more attractive. With the stock trading at over 20 times earnings the buybacks are likely wasting a lot of money.
The historical rate of about 11% dividend growth looks like it can be sustained. Under that assumption the fair value of a share of McCormick is around $53. This is far below the current stock price, a full 25%, and just goes to show how overvalued McCormick is right now.
McCormick is one of those companies that I’d love to own, but not at the current price. I’ll add McCormick to the watchlist with a buy target of $53.
The article Wait for These Overpriced Dividend Stocks to Fall originally appeared on Fool.com and is written by Timothy Green.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends McCormick. Timothy is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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