In a rising rate environment, dividend bearing stocks are decidedly out of favor. Although the S&P 500 is up by double-digits in 2023, dividend stocks suffered the worst first-half performance since 2019.
Count me as one that seeks to invest in top-notch companies when they are shunned by the market. And where can one find stronger candidates than from a list composed of Dividend Kings and Dividend Aristocrats?
Abbott Laboratories (ABT) is a Dividend Aristocrat trading near 52-week lows. ABT shares are down nearly 11% year-to-date. The drop in the stock is largely due to the loss of revenue associated with the slowdown in COVID testing. However, the company is otherwise recording strong organic growth.
Lowe's (LOW) is a Dividend King. The stock is up for the year, but the shares still lag the S&P by double-digits. The current housing market is weighing on the home improvement retail industry. Nonetheless, Lowe's is reporting solid results, and management is making moves that should serve investors well.
Despite the poor share price performance of the two, I will posit that each company faces transitory headwinds and that both have solid long-term growth prospects.
But First, Why Invest in Dividend Stocks?
There are two primary arguments against investing in dividend stocks. One is that investors should focus on growth names. The other is that treasury bills, treasury bonds and other interest-bearing investments offer solid returns with zero risk.
However, I would like to provide a counter argument. There is a great deal of research that proves dividend stocks outperform over the long haul. The next two charts provide a succinct argument for investing in dividend stocks.
The first shows how reinvesting dividends juices total returns.
The second chart provides evidence of how dividend paying stocks, especially those in the first and second quintile, provide the highest returns. Note the period in question is from 1984 through 2022.
Additional research indicates Dividend Aristocrats tend to outperform the broader market over extended time frames. A study by S&P Global shows the S&P Dividend Aristocrats outperformed the S&P 500 over an extended period. From Dec. 29, 1989, to July 31, 2023, the Aristocrats provided an annual average return of 11.8% versus 10.2% by the S&P 500.
There are those that would smirk at the prospect of a mere 1.6% difference in annual performance. However, ponder this: a $10,000 investment in the S&P 20 years ago would now be worth $69,764.08. The same sum with an 11.8% annual return would be worth $93,075.65.
Now let us consider the claim that T-bills and T-bonds are better investments than stocks.
From 1928 through 2021, stocks averaged an annual return of 11.82%, T-bills averaged an annual return of 3.33%, and T-bonds averaged an annual return of 5.11%.
Of course, some would claim that things are different now and that stocks are “risky” while bonds are safe. I’ll refer you to a very recent Wall Street Journal piece, entitled “Bonds Track Toward Another Year of Dismal Returns” to refute that claim. The following is an excerpt from that article.
After bonds posted a historically bad 2022, many on Wall Street argued that this year would mark a decisive rebound. Instead, the widely tracked Bloomberg U.S. Aggregate bond index has lost 1.1% through Thursday, including price changes and interest payments—putting it on track for its third consecutive year of negative returns.
Losses happen in investing. But bonds are often touted as a safe option for investors, particularly those nearing retirement. Before 2022, the Bloomberg index had never delivered negative returns for even two consecutive years.
Overall, “it’s gone from OK to terrible” for bonds this year, said Sonu Varghese, global macro strategist at Carson Group, a financial advisory firm.
The following chart from JP Morgan provides additional evidence that bonds provide markedly lower returns over the long haul.
Don’t misinterpret my intent. I am not against placing a portion of one’s funds in interest bearing investments. I am simply pointing out that over long time frames, bonds and the like underperform the market by a very wide margin. I must also question if investing heavily in bonds at this juncture is a form of market timing.
I am also taken aback by investors eschewing high quality dividend stocks when they are selling at desirable valuations.
Abbott The Aristocrat
The COVID-19 crisis weighed heavily on sales of Abbott’s (ABT) medical device products as many elective procedures were delayed. Even so, the company more than made up for that shortfall during the pandemic with sales of its COVID tests.
Revenue from COVID-19 testing has since fallen from $2.237 billion a year a year ago to $263 million in 2Q23. Through the first half of this fiscal year, Abbott recorded $19.7 billion in revenue, a drop of 14.8% from the first half of FY 2022.
Last quarter, Abbott's organic revenue fell 9.2% due to a 45% decline in diagnostics, the segment associated with COVID testing. However, each of the other three segments, Nutrition, Established Pharmaceuticals, and Medical Devices delivered double-digit growth. Excluding sales of COVID-19 tests, organic sales surged by 11.5%.
Abbott’s Established Pharmaceuticals segment markets a portfolio of branded generics. That segment reported +12.5% sales growth. The increase was spurred by strength in gastroenterology, women's health, and central nervous system/pain management products.
The Nutrition segment generated a 6% increase in revenue. Much of this was from the recovery of 75% of the U.S. pediatric nutrition business, which was up 22.5%. That had lagged due to the shutdown of a manufacturing facility that produced infant formula.
Although revenue for the Diagnostics segment fell 44.7% due to the aforementioned decline in COVID-19 testing, if COVID-19 is excluded, organic sales increased 7.1% for that segment.
The Medical Devices segment reported a 14.2% increase in organic revenue. This was on the back of double-digit increases in diabetes care, electrophysiology, structural heart and neuromodulation.
Abbott has a blockbuster in the FreeStyle Libre continuous glucose monitor (CGM). Abbott holds about a two-thirds share of the CGM market, and the FreeStyle Libre notched $1.3 billion in sales last quarter, a near 25% increase.
Abbott hopes to capitalize on the FreeStyle Libre’s success through a different market. The company’s new wearable sensor called Lingo is now available in the U.K., and management hopes to bring it to the US market in 2024.
Lingo tracks glucose levels. Along with an associated app, Lingo provides recommendations to improve diet, sleep, and exercise. Lingo will primarily target the fitness focused crowd.
Aside from Abbott’s strong sales related to its CGM products, there is evidence that the Medical Devices segment has an enduring tailwind. During Goldman Sachs recent annual healthcare conference, attendees cited MedTech as being the most likely healthcare sub sector to outperform in the coming year.
Approximately 70% of Abbott’s 2022 revenue stemmed from diagnostic and medical devices, so strong sales in MedTech could bode well for the company.
Removing COVID tests from the mix would result in first-half revenue up 10.7%. Management also raised full-year guidance for organic sales growth to low double-digits versus the high single-digits forecast in the first quarter.
It could be argued that some have lost sight that Abbott has increased revenue each year for a decade.
Abbott’s average yield over the last four years is 1.57%. The stock has a current yield of 2.90%, a payout ratio of 46.62%, and a 5-year dividend growth rate of 12.6%. Combining that with the company's AA- credit ratings indicate the dividend is safe and likely to continue to grow.
Abbott has a forward P/E ratio of 30.10x versus the 5-year average P/E of 37.18x. With the shares near 52-week lows, you must go back to the summer of 2020 to find Abbott consistently trading at or below the current valuation levels.
Crown The King: Lowe's
Designated as providers of essential services, Lowe's benefited from pandemic restrictions. The company's revenues surged as many other retailers were shuttered. Consumers confined to their homes spent their money, which included government handouts, on home remodels. The work-from-home movement also spurred remodeling projects.
But the COVID crisis is behind us. The same phenomenon that led consumers to patch up and improve their homes also made them stir-crazy.
Nowadays, folks are focused on experiences and travel. Furthermore, rising interest rates have many homeowners that might have placed their house on the market remaining in place. Since home sales are a primary driver of the home improvement market, Lowe’s is facing a significant headwind.
Nonetheless, Lowe’s is arguably one of the safest long-term investments one can make.
While home sales have slowed due to rising interest rates, the demand for home improvement projects will likely remain robust over the long term. That is because millennials are moving into the homebuying market, Baby Boomers are aging in place, the US is chronically short of homes, and housing stock is aging.
About half of US homes are over 41 years old, and the median age of a U.S. house is 39 years. It is estimated that 24 million homes are in need of repairs and/or upgrades.
Here is the take from Eric Finnigan, the VP at John Burns Real Estate Consulting, on the state of the home remodeling market:
[These homes are] basically going to go through a complete sort of facelift. A home enters its "prime modeling years" when it reaches about 20-40 years old.
We're seeing a big wave of homes entering that cohort, [those] sort of prime remodeling years.
There are fewer listings out there, fewer listings of homes, fewer homes sold, but underlying demand for remodeling is higher than it's been probably for a decade. And it's going to be higher for longer.
Another trend that should drive remodeling demand is the surge of Millennials into the housing market.
The surge in Millennial buyers isn’t projected to peak until 2032. At the same time, it is estimated that the US is short 6.5 million homes.
All of these trends point to long-term robust demand for home remodeling projects.
Another positive when considering an investment in the company is that Lowe’s is a member of a near duopoly, a stage it shares with Home Depot (HD). And unlike many retailers, Lowe’s has an ecommerce resistant business model.
Nonetheless, the company is working on an omnichannel approach that doubled ecommerce sales from 2018 through 2022.
Lowe’s scale provides cost advantages with vendors, advertisers, and throughout the company's logistics network logistics. The resulting leverage generates higher profits and pricing power. However, that is not the only cost advantage the company wields. Lowe's owns 84% of its stores, including those on leased land.
Additional positives include that two-thirds of Lowe’s sales are non-discretionary in nature. A toilet, water heater, or air conditioner that is out of service cannot be ignored. Nor can a leaky roof or shattered window.
Lowe’s has a solid history of rewarding shareholders with double-digit dividend growth and a robust share repurchase program. In 2010 LOW had over 1.4 billion shares. In 2023 the company had 631 million shares outstanding.
The current yield is 2.17%, the payout ratio is 30.84%, and the 5-year dividend growth rate is a hair below 20%. Lowe’s debt is rated BBB+. Consequently, Lowe’s dividend is safe and likely to continue to grow.
Lowe’s has a forward P/E of 15.09x versus the 5-year average for the stock of 18.14x. The 5-year PEG of 1.18x is a bit above the 5-year average PEG ratio of 1.18x.
Summing It All Up
While Abbott’s loss of COVID-19 testing revenue is an undeniable drag on the share valuation, the company has otherwise generated robust growth. Abbott is also well diversified in terms of its product mix and its geographic reach.
This year alone, the Food and Drug Administration approved Aveir, the world's first dual-chamber leadless pacemaker, a cardiac monitor, a hematology instrument, and an ablation catheter for treating abnormal heart rhythms, just to name a few of the company’s new products.
Abbott's FreeStyle Libre is a blockbuster product. With 11.3% of the U.S. population diagnosed as diabetic, and the disease's prevalence increasing worldwide, demand for FreeStyle should remain robust.
The health care equipment sector recorded one of the worst first-half performances in three decades this year. Abbott is caught up in that decline, but it is a top-quality company with a variety of growth initiatives.
Therefore, I rate ABT a BUY, but with a caveat.
I think it more likely than not that the shares will either track downward or remain in a fairly tight trading range for the short to mid-term. Consequently, as I do not own shares of Abbott, I plan to initiate a position post haste but slowly accumulate shares in the months ahead.
I have long considered Lowe’s a top-quality company, and it comprises the second largest position in my portfolio.
I point to the company’s status as a duopoly, the fact that it is largely ecommerce proof, that two thirds of its products are non-discretionary, and that the current lull in the home improvement market likely represents a calm before the storm, as several factors that draw me to the stock.
I will add that Lowe’s only holds about a 10% share of the $1 trillion US home improvement market, leaving room for the company to gain market share and a long growth runway.
Consequently, I also rate LOW as a BUY.
Unlike ABT, I think now is an opportune time to invest in LOW. By that I am not claiming that the stock will appreciate markedly anytime soon. I simply believe that investing in Lowe’s at this juncture presents less risk than investing in Abbott.
I can understand the argument that neither of these stocks is trading at a deep discount. However, I maintain that both are high quality companies, and that quality presents a higher valuation hurdle.
Evidence of that lies in the fact that Abbott generated a ten-year total return of 231%, while Lowe’s has a ten-year total return of 396%. Both are well above the S&P 500 returns over the last decade.
I also maintain that successful investors buy high quality stocks with durable competitive advantages, and I believe Abbott and Lowe’s both fit that mold.