Three Dividend Aristocrats Ben Graham Might Buy
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Most people know of Ben Graham, the Grand-Daddy of Value Investors. Almost a century ago, Graham advised average investors to look to a select set of elite dividend paying companies for safety. The logic is simple: low risk means low losses. Sticking to large companies that consistently raised their dividend every year for years prevented mistakes. A similar list, the Dividend Aristocrats, is still maintained by Standard & Poors. His advice for active investors—“enterprising” investors as Graham called them—was about 250 pages more complicated. One simple tool though is a screening tool Graham devised for finding undervalued stocks. The formula combines a company’s earnings power and book value to calculate an intrinsic fair value. Stocks trading below their “Graham number” warrant a deeper look. Dividend Aristocrats rarely show up in the bargain bin. Right now, three Dividend Aristocrats trade below their Graham number, with another five within 10% of Graham’s fair value. Let’s take a look at the list.
Graham’s formula looks a bit arcane. It blends a company’s book value and earnings power to come up with an estimate of intrinsic value. I used trailing twelve month earnings per share (EPS) and the last quarter’s book value and share count for each Dividend Aristocrat. Here’s the formula Graham devised almost a century ago:
Graham Number = Square Root of (22.5 x EPS x Book Value per Share)
It’s a pretty conservative metric that not many companies currently meet. Back in the early half of the 20th century deep discount stocks that traded at a discount to Graham’s screen were much more common.
Not surprisingly, a couple of insurers make the list, Aflac (NYSE: AFL) and Chubb (NYSE: CB). Low interest rates hit portfolios hard, really cramping investment returns on new money. That’s pushed down valuations on the group. The third is Archer Daniels Midland (NYSE: ADM). Let’s look at the three, starting first with Aflac, the cheapest according to Ben.
Graham Number: $61.16
Current price per share: $46.65
Margin of safety (undervalue): 24%
The margin of safety would be even wider for Aflac, if investment losses had been excluded from EPS. The Yahoo! numbers that I used for this quick screen included one-time losses and impairments on portfolio restructuring. Aflac is up 20% since last June, but retreated slightly after recently retesting its 1-year highs. Operating results have been stellar in Japan, their largest market. However, portfolio restructuring to reduce exposure to Europe weakened GAAP earnings. Solid cash flows from Japan are boosting Aflac’s earnings, but the company still faces challenges structuring its portfolio that they're just starting to address. Morningstar has a $65 fair value and a $114 sale target for this 4 star recommended stock. Aflac has a 29-year string of increased dividends. Expect a raise in Q4.
Archer Daniels Midland
Graham Number: $33.62
Current price per share: $27.48
Margin of safety: 18%
ADM is recovering off its August $25.13 low, but is still well below its 1-year high of $33.50 in May. Shares dropped as the drought drove corn prices sharply up throughout the summer. ADM processes a large percentage of the US corn crop into dozens of products including ethanol, sweeteners and animal feed. High corn prices tighten margins. Ethanol refiners were losing more than 20 cents a gallon mid-summer. Shares are now rising in an uptrend that began in August. Morningstar has a $32 fair value and $56 sale target for ADM, giving the stock 3 of 5 stars. Archer-Daniels Midland has a 36-year string of dividend hikes.
Graham Number: $88.38
Current price per share: $75.52
Margin of safety: 15%
Chubb is the outlier of the group. The stock has been on a three year run since the mid-2009 bottom. It’s basically tracked right up with the S&P500 index. Based solely on the chart, it’s hard to see any case for extreme value here. That said, this property and casualty underwriter that caters to high net worth clients is a solid performer and it certainly trades at a discount to its Dividend Aristocrat peers. Morningstar has an $86 fair value and a sale target of $116 for this 4 star stock. Chubb has an impressive 46-year run of dividend increases.
Others close to fair value by Graham’s formula, but selling at just a slight premium include Cincinnati Financial (CINF), Con Ed (ED), Dover Corporation (DOV), ExxonMobil (XOM) and Walgreen (WAG).
While no formula fits all purposes, Graham’s Number is a simple yardstick that can easily be used by anyone with access to a simple spreadsheet. It’s a simple screen that blends earnings and book value in a quantifiable manner. And the investor has a bit of an amazing track record. One negative is that there’s no easy way to fold future earnings into the equation, but no screen is perfect. Your left to your own judgment on the future.
With the Dividend Aristocrats though, the uncertainty of the future may be of less concern given their long track record. Long term, each and every one of them is an up-and-to-the-right performer on the earnings front. That’s how they got here in the first place. This list of inexpensive overachievers deserves a second look from conservative investors.
The Author owns shares and is short puts of Aflac. The Motley Fool owns shares of Archer Daniels Midland Company. Motley Fool newsletter services recommend Aflac. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.