This Dividend Aristocrat is Electric!
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I'm constantly amazed that in the stock market, the more you learn, the more you realize you don't know. I don't pretend to know everything about stocks, but I have been researching companies for over 19 years. I can honestly say that until this last year, the dividend aristocrat Emerson Electric (NYSE: EMR) has somehow escaped my notice. When I saw the name of the company, I assumed this was an electric utility. However, Emerson is actually in multiple businesses and would more correctly be called an industrial company. The company's streak of at least 25 years of dividend increases attracted me to the firm, but the more I dug into the numbers, the more I liked what I found.
Who Is Emerson Electric?
To understand Emerson's opportunities, you have to understand the different divisions of the company. The best way I can explain Emerson is if a company is doing something, Emerson helps them do it better. A good example is BP (NYSE: BP). BP recently selected Emerson as its contractor of choice for its North Sea Oil & Gas operations. Emerson will provide control and safety systems for five offshore fields in the U.K. BP expects by standardizing to one contractor that the company will realize benefits in the areas of training, maintenance, and project execution.
This is hardly the only division of Emerson, but it gives you an idea of how the company makes money. Emerson also is involved in industrial automation, climate technologies, and commercial & residential solutions. This product and services diversity gives the company multiple revenue streams, and helps the company weather storms in the different industries.
Of course the challenge any company faces by operating multiple divisions is that of multiple competitors. In the area of industrial automation, Emerson faces companies such as ABB Ltd (NYSE: ABB), which is a $35 billion market cap competitor from Switzerland. ABB generated over $2.6 billion in free cash flow last year, and has over $5 billion in cash and investments. With ABB expected to grow by over 11% in EPS, you can see not only is ABB a well-financed competitor, but they are expected to show good growth going forward.
When it comes to commercial solutions, General Electric (NYSE: GE) competes directly with Emerson for projects like the aforementioned BP drilling project. While GE is much more diversified than Emerson, the company is expected to show growth of over 12% in the next few years. GE needs no introduction to most investors, and a fast-growing GE is a real threat in any industry they choose to compete in.
When it comes to climate technologies, the first company that pops to my mind is Johnson Controls (NYSE: JCI). The company is a leader in climate control systems, and has strong relationships with many large corporations. Johnson Controls has been around since 1885 and is expected to grow at over 17% in the next few years. You can see Emerson's competitors are well known, well capitalized, and growing. So with these other choices, why would someone choose Emerson Electric?
One big reason is the company's dividend record. When you are considering whether to buy a stock based on a dividend, the first question is, can the company afford its current payout? For Emerson, the answer to this question is a resounding yes. In the last three years, the company's free cash flow payout ratio has ranged from 36% to 40%. As a dividend aristocrat, investors expect an increase in the payout each year. However, this rate of increase can vary dramatically from company to company. To say that Emerson has increased its dividend growth in the last several years would be an understatement. In the most recent six years, Emerson has increased their dividend on average over 10%. In the prior five years to this streak, the average rate of increase was just over 3%. So with this jump in dividend increases, what should investors expect in the future?
Emerson is expected to grow EPS by over 11% in the next several years. In the last few years, operating cash flow growth has lagged net income growth. If this trend continues, and considering the low payout ratio, I would expect 8-11% dividend increases. Even if cash flow growth lags net income growth, an 11% increase would only slightly raise the company's payout ratio. With a current yield of 3.6% and 11% growth expected, the stock has a good combination of growth and income characteristics.
The best part of the story is the stock's forward P/E ratio today sits at just under 13 times forward earnings. In the last five years the average P/E ratio has been closer to 15.45 so this could mean the stock is undervalued at current prices. This dividend aristocrat has all of the characteristics I look for in the perfect stock -- a good yield, good growth, and a fair price. The fact that the dividend could continue to grow at 10% or so a year is a huge bonus. Use this information as a starting point for your research and see if you should add this electrifying company to your buy list.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of ABB. Motley Fool newsletter services recommend ABB and Emerson Electric Co.. 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.