3 Dividends to Feed Your Portfolio

By Chad Henage - October 1, 2012 | Tickers: CAG, DEO, UL | 0 Comments

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Recently I was looking for new investing ideas, and wanted companies that paid a good dividend, can grow earnings, and were relatively low risk. To come up with these names, I ran a screen on CAPS with the following criteria: 3% plus yield, 4 to 5 stars, and in the food and beverage industry. There were several names that appeared, but three caught my eye due to their established brand names.

From the screen, the three companies I selected to compare are ConAgra (NYSE: CAG), Diageo (NYSE: DEO), and Unilever (NYSE: UL). Since they each sell food or beverages, they serve as a good recession hedge. Their products are in demand no matter what the economic climate. Plus, all three companies are well-established brand names, and have significant depth to their product lines.

Whether it's ConAgra's Healthy Choice, Peter Pan, Chef Boyardee, or other brands, you know shoppers everywhere will be buying something that the company sells. Diageo has significant brands in the alcoholic beverage industry with well-known names such as Smirnoff, Johnnie Walker, and Bailey's. Unilever is sometimes referred to as the English equivalent of Procter & Gamble. The company produces brands like Axe, Dove, Pond's, but also sells food and drinks under the Lipton and Slim Fast labels. As you can see, whether customers are trying to lose weight, drink up, or find something for their kids to eat, these three companies have them covered.

Each company offers an attractive investment for different reasons. However, I want to know which company offers the best combination of traits. Most investors first look at a company’s expected earnings growth and its valuation. Take a look at how at least three companies compare on these bases. 

You can see that none of the companies is exactly what you would call a "fast grower,” but they each are expecting positive earnings growth over the next few years. The market obviously shows great respect for each, as all three companies sell for a P/E ratio that is a good bit higher than their expected growth rate. While it's a close race between the three, at this time ConAgra looks like the best value with the second highest growth rate and the lowest P/E ratio. (ConAgra – 3, Diageo – 2, Unilever – 1)

Since each of these companies offers an attractive dividend yield, some investors might choose the highest yield and expect that that would be the best investment. However, looking at dividends without looking at the company's payout ratio is a big mistake. For example, Diageo pays the lowest current yield at just over 3%, but its free cash flow payout ratio is nearly 72%. By contrast, while Unilever and ConAgra's yield looks just about the same at about 3.5%, ConAgra pays out just 57% of free cash flow whereas Unilever pays out nearly 90% of its free cash flow.

ConAgra, with a 3.5% yield and the lowest free cash flow payout ratio, appears to offer the best deal. Although Diageo pays a lower yield than Unilever, the latter's much higher free cash flow payout ratio worries me. Looking primarily at their free cash flow payout ratios, I would rank Diageo second and Unilever third. (ConAgra – 3, Diageo – 2, Unilever – 1)

Maybe nothing gives a better insight into a company's ability to reward shareholders than a look at its free cash flow. To measure this across companies I use free cash flow per $1 of sales. This allows the investor to compare different-sized companies on an apples to apples basis.

By this measure, Diageo's focus on the beverage industry serves the company well. It generates more free cash flow than either ConAgra or Unilever. Diageo generated $0.15 of free cash flow per $1 of sales in the company's most recent quarter. Unilever generated about $0.07 of free cash flow, and ConAgra only generated $0.05 by the same measure. In theory, Diageo's superior free cash flow generation should enable the company to return more dividends and repurchase more shares, both of which benefit the company's shareholders. (ConAgra – 1, Diageo – 3, Unilever – 2)

As a final test, let's take a look at each of the companies’ balance sheets to determine which of them is the best positioned to withstand difficulties that might arise. Using the measure of debt-to-equity, Unilever is the leader with a ratio of 0.53. ConAgra places second with a debt-to-equity ratio of 0.64, and Diageo comes in last with a ratio of 1.32.

This tells us that not only is Unilever the least leveraged, but also reveals why Diageo needs its higher free cash flow: the company needs to service its higher debt level. With less leverage comes more financial flexibility, which gives Unilever the win for this category. (ConAgra – 2, Diageo – 1, Unilever – 3)

Adding up the totals, we find ConAgra – 9, Diageo – 8, Unilever – 7. Given that ConAgra showed the best relative valuation, the best combination of dividend and yield, and the second strongest balance sheet, this win makes sense. That being said, this isn't meant to serve as a formal recommendation, but rather as a guide to begin your own research. I would suggest adding at least one, if not all three, to your Watchlist to keep up with developments.

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