The Dividend Mailbox

Not Every Stock That Glitters Is Gold, You Have to Dig a Little Deeper

Greg Denewiler Season 1 Episode 10

On the surface, a lot of companies may look like they fit the dividend growth model and could be good candidates. But you have to be careful, they could be duds. As with all investment ideas, it's never a bad thing to dig a little bit deeper into the company. At a minimum, you have to get a clear picture of how the company can sustain its operations, margins, and dividends. If it is hard to see how the company gets from point A to point B, that is a red flag. 

In this episode, Greg uses Whirlpool as an example of a company that deceptively appears to fit the bill, but probably has a high chance of falling short. Later, he takes a look at how much you pay for growth versus value and why it is critical to pay attention.

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Greg Denewiler  0:11  
This is Greg Denewiler, and you're listening to another episode of the dividend mailbox, a podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks and make each year's check larger than the last.

Greg Denewiler  0:38  
Welcome, everyone to the April edition of The Dividend Mailbox. There's definitely a lot going on in the marketplace right now. But the good news is, a lot of the ideas that we look at or that we own are getting a little cheaper. So when you're looking at buying a dividend income, it's always better to pay a little less for it. So, what I want to do today is look at a new investment idea that we've been working on. And I think it will show that just because a stock is cheap, and even has an attractive dividend, it doesn't mean that it will fit our dividend growth strategy. Then we're going to look at a great illustration of growth versus value, and just how expensive growth can be, and the mindset that you need to have. 

Greg Denewiler  1:25  
So, let's quickly review: what are the things we look for when we consider a new investment? Well, the first thing is we want a dividend ideally one that is growing. We also want to see that the company is committed, disciplined, and increasing their dividend long term. In order to get the best return, we want a stock that is at least somewhat cheap. We want to pay a reasonable price based on its fundamentals. And then finally, you want a company that has some form of a moat, and that can come in several different versions. One, it can be either a low-cost producer, they can have brands that dominate their marketplace, they have some form of a competitive advantage. With that in mind, one company we are currently looking at is Whirlpool. Whirlpool owns Maytag, Amana, Kitchenaid, and others. These are all global brands that are somewhat dominant in their marketplace. What brought us to start looking at Whirlpool is it has a 4% dividend. They raised their dividend every year for the last nine years, and they've paid a dividend for several decades. So it definitely checks the dividend box. And now the stock is cheap. Currently, it's around $167. It's come down from over 250 in the last 52 weeks. And then with earnings at $28 a share currently, Whirlpool is trading at about six times earnings, which is less than half of what the market trades at. So that just gives you an idea of how cheap the stock is. You have a big fairly well-known company. Most people recognize the name. They have well-known products. And a 4% dividend, it's more than twice what the S&P 500 is at and it has been growing. So on the face of it, it looks like: hey, this is something that maybe we should own. Should we buy it? Should we consider this as a long-term dividend investment? How do we go through the process of figuring out: Do we really want to own something? Does this have a sustainable dividend story? So a great place to start is just to look at the current dividend. It's $7, which is a dividend yield of, as I've said, a little over 4%. If you take that $7 dividend and you grow it by 6% a year, that means in 2031, you should have a dividend that's up to $11.80 roughly. At that point, if the dividend is $11.80, if the stock stays where it is at $167, you've got a dividend yield that's over 7%. Well, most likely, the stock won't stay at $167. If in fact, the dividend does grow by 6% a year, the stock is going to be somewhat higher. And if you just use a little bit of a margin of error, instead of yielding 4% in 10 years, the stock yields four and a half percent. That would imply that the stock would be at $262. If you add all those 10 years of dividends together growing 6% a year, and then you look at the stock going from 167 up to 262 based on the future projected yield, that's going to give you a ten-year total return of over 110%. And that doesn't even count compounding. So, the big question is, we know what the dividend needs to be in 10 years, but can the company actually get to the point where they can grow their dividend by that much? Well, if you look at earnings right now, they're $20. And next year's estimates are $27. So looking at the dividend that we want, that's only about half or a little less than half of earnings, which initially looks like a pretty good situation. But I think one of the things we have to start doing is dig a little deeper. What did it take to get earnings to where they are? Are we going to get any growth from here on out? Well, first of all, the company has stated that they want to try and maintain their payout at around 30%. If in fact, that holds true over the next decade, then that implies if they're going to pay a dividend of $11.80, we have to have earnings growing to $39, if they're going to maintain that payout. This is where it starts to get more complicated. Companies can grow their earnings in several ways. The most sustainable route is for them to grow revenue. But they can also improve margins, which even though they may have flat revenue, as margins improved, then earnings are gonna go up. If you look at Whirlpool, in the last 12 years, revenue has only grown by 23%, which is a little less than 2% a year. But when you look at earnings, earnings have grown from basically $10 A share to $28 a share, they have grown at a much faster pace. That has come mostly from just margin improvement. So that in and of itself reaches a point where it's not sustainable anymore. You can't improve margins forever, you have to have revenue growth. For the last three decades, pre-tax income has averaged about 4 or 5% of annual revenue. On the high side, it's been around 6%, or slightly higher. Right now, currently, they have a pre-tax income of about a little over 10%. Historically, this is as high as it's been going all the way back to the 1980s. Is this 10% A temporary number? Are they going to revert back to the mean that's closer to 6%? And if they do, and they only have 2% revenue growth going forward, then that creates a problem. Because it just gets virtually impossible to get earnings over $30 without growing revenue faster than 2% a year. So then one question would be: well, what's going to be the catalyst to change that? Because if you look at historically, going back a couple of decades, revenue has grown at a faster rate. In 2001, revenue was around 10 billion, a decade later, revenue had grown to 18 billion. But then when you go out to 2016, revenue had only grown to about 20.9 billion. Six years later, to January of 2022, revenue was just slightly below 22 billion. So the pace of revenue growth has really slowed down in the past decade. We have to realize that in this period where revenue slowed, we had some things that were going well. We had extremely low-interest rates. We had the housing market that was booming. Given that Whirlpool's products benefit from increased homeownership and greater home equity, this should have been a period where revenue grew faster than it did. You really have to figure out how are they going to grow revenue going forward. Now, I will give Whirlpool credit, they do have a decent return on their on their capital. It's not great, but it's averaged 10%, or a little bit more. They've had some years in the low teens. And they've also had some years where they've been down around 8-9%. But that number is high enough to where it at least covers their cost of capital a bit better. And one of the things they've been doing with their free cash flow is they've been purchasing shares back. So that also can help earnings and can help the dividend grow when you don't have as many shares and you're distributing the same amount of cash. But that number is not growing fast enough to overcome this slow revenue growth. But to the casual observer, the stock is priced very reasonably, it's below 10 times earnings. Consequently, when you look at the price to sales ratio- which I like to use a little bit better than PE because sales tend to be more stable than earnings- it's trading at a multi-year low down here around 45%. The problem is, you've got a cheap stock, but I think the stock is cheap for a reason. The market is really questioning whether this company can grow at all in the foreseeable future. And this is another thing to consider, if they continue to grow at 2% a year on the revenue, on the top line, that basically implies that in 2030 to 10 years from now, the revenue is going to be up to around 27 billion. And then if you take the pre-tax margins back down to 6%, which is the high side where they've been for the last few decades, you've only got earnings of around $26, which is a little bit lower than where they are. Now, if you've got a 30% payout ratio, you're not going to get anywhere close to $12 in a dividend, you're going to be down closer to $8. It leaves us with a very difficult path to get to 6% dividend growth, it's not anywhere close. So the temptation is, well, 4% is a great yield now, but long term, to grow the dividend, they have to be a growth stock, they have to grow earnings. You're really expecting growth from the company's equity price too and that's where you get total return that sometimes can match the market or even better. With Whirlpool, it's just a yellow flag going up the pole, for us, that we're potentially going to struggle to see the dividend growth that we want. So in review, on the face of it, you know, we do have a company that pays a good dividend. They've grown it somewhat aggressively in the last several years. It's relatively well known, has well-known products, and it's reasonably profitable. So all that on the face of it looks like this is a good candidate. But where we start to fall short is: can this company grow its dividend over the next 10 years? Do they have room to grow margins? Well, in this case, that's probably not going to happen, they'll be lucky to sustain what they've got, maybe even fall back to the more of the trend, like we've talked about. You know, they could increase their payout ratio, but that's an unknown. Anytime that starts to happen, you just start to lose some of your margin of safety or margin of error. So you just have to question, you know, is this the best place to put capital right now? Or do you want to look for better opportunities? 

Greg Denewiler  12:12  
Speaking of opportunities, let's circle back to Clorox. For those of you that this may be the first show that you've listened to, we've looked at Clorox in the past. And I think that contrasting it to Whirlpool is gonna give you a good idea of how, on the surface, companies may look like good dividend stocks, but when you're looking for a dividend growth story, they don't all work. But with Clorox, we had started to buy it at around $160 a share, we took a more significant position at 144, then we bought some more in the 130s. Now in the last month, the stock has had a low of 127, but it has since come back to about 147, close to what our what our average cost is in the stock. Now one of the first observations I want to make is as the stock was going down to 127. You know, we have to be honest with ourselves, nobody really likes to see the value of their account decline. But the reality is, nothing has happened in the last few months that's really changed the story at all. It's got a little bit of coverage from analysts that shows that they're expecting a weak quarter. You know, we already know that they've got problems with costs right now with inflation and getting their pricing back up. It very likely might be a tough quarter. But if you're focusing on buying a growing cash flow stream at a reasonable price, then the week to week or month to month price action really doesn't make that much difference. And if anything, it just gives you a better opportunity to reinvest your cash flow. We're not interested in the next quarter or two, we're interested in the next decade. So moving on, looking at why we like Clorox versus Whirlpool. If you look at revenue growth over the past 10 years, Clorox has managed 45% growth while Whirlpool sits at only 20%. On the other hand, Clorox's dividend has grown by 112%, and whirlpools, dividend has grown by over 200% in the last 10 years. And what we're concerned about is that dividend going forward. So this is the contrast that really matters. Just looking at margins, Whirlpool's are the best they've ever been. They're way above their historical averages. But when you look at Clorox, it's the exact opposite. Their margins have been very consistent for decades, but currently, they've taken a real hit. So you have to ask yourself regarding both companies, is this a one-off? Or are these levels going to be sustained? With Whirlpool, we just don't have a clear picture of if margins are going to stay as strong as they are. I'm just not willing to risk capital to something that has spent virtually no time with these kinds of levels of profitability. They just don't have a long-term track record yet. So going forward, it's a big unknown. But with Clorox, here you've got a company that spent several decades with margins that have only fluctuated by about 1% of their long-term trend. And that is about four or five percentage points higher than where they are currently. They have the track record of managing through periods in the past and we just have to assume that the culture is there, that they can probably get margins back to their long-term trends. Assuming they do, and they continue to grow revenue at 4 to 5% because they're basically tied to the growth rate of the economy, you've got the 10-year dividend growth that we want. When you look at Whirlpool, currently, it's just a risk that I don't feel comfortable taking. The sustainability of its dividend is a lot harder to justify than it is with Clorox. So we're going to keep an eye on Whirlpool. But at some point, it may get cheap enough that it's a stock we'll consider. But we really need to find a catalyst, because one thing that we have to be careful with is we don't want to buy cigar butts. 

Greg Denewiler  16:23  
Now a big part of success and dividend growth investing is adopting a specific mindset. And we've talked about it a lot in our previous podcasts. But another piece of that is just looking at growth versus value. And at what point do you pay too much for growth? So, along this point, Davis Advisors puts out a great illustration of just what it means and how much you pay for growth versus value. They looked at two groups of companies. One was a growth basket, and one was a value basket. Both had equal market caps of about $2.3 trillion at the time. In order to fill up the growth basket, all you had to have was Tesla, Shopify, and Nvidia. They had revenue of $112 billion and they had earnings of $20 billion. You had a PE of 115 times earnings and a price to sales ratio of 20 times. Well, the second basket, the value basket, there's Berkshire Hathaway, Raytheon technologies, Wells Fargo, Intel, JP Morgan Chase, Applied Materials, Texas Instruments, BNY Mellon, American Express, and Capital One. So you have a diversified portfolio there. But that 2.3 trillion bought you $777 billion of revenue, I mean, which is seven times greater, and you had earnings of $133 billion, which is almost seven times greater also. The PE of that basket was 17 times and the price to sales was three times. So here you have a choice. Let's say you won the "World Lottery" and you had $2.3 trillion. Would you rather go out and own three companies that only generate $20 billion of earnings? Or would you take that same 2.3 trillion and buy a group of companies that are going to pay you $133 billion in earnings? The first basket are probably going to grow faster. But I would much rather have the second group. Which if you look out 10 years from now, you may have one or two value companies that underperform, but that is why you have a diversified portfolio. You still have growth and you get to reinvest a much larger cash flow, which allows for compounding to cover what I call "a multitude of sins" just because of what you earn from compounding. So this illustration is a pretty important factor in our strategy and the mindset that you need to have because rapid growth can look very appealing from the outside. But we want to stay disciplined and find companies that are well established and have a discipline to cash flow being paid to their shareholders. We just think that there's less risk when we get to tap into the power of compounding, and it can make up for a multitude of mistakes.

Greg Denewiler  19:32  
But what I want to leave you with is this: we are always looking for new ideas, but what is as important as finding one that works is knowing why another company may not fit. It's just as important to know why one does as it is to know why one does not. In the end, the goal of this podcast is for your dividend check to grow each year. And that requires going through and looking at some companies that look good dividend payers currently, but after you dig a little deeper (as in the case of Whirlpool), that dividend check may not be growing. You probably have 1000 different financial podcasts that you can listen to. Where we want to be a little different is we want to present ideas to you, but then we want to be accountable and go back and revisit them over time to see how they play out. So we'll not only learn from our success stories, but we'll also learn from our mistakes. Even though we don't own Whirlpool currently, we can come back to it and look and see what has changed and why did it change. Does it fit now? Or was it a good idea to not invest in it? My hope is that you have a better idea of how there are a lot of companies out there that look like good dividend payers, but they don't fit our model. You have to dig a little deeper to see if the growth component is really there. Warren Buffett is known for using a baseball analogy where you get to go up to the plate, and you can stand there and watch as many pitches as you want go by because you're not being called for three strikes. What you're looking for is that fat pitch. You're looking for that company that you think is going to be a home run when you look at dividend growth over time. You're still going to strike out occasionally. But the goal is, if you're waiting for those slow pitches coming right over the middle of the plate, you're probably going to get a lot of hits. 

Greg Denewiler  21:35  
If you enjoyed today's podcast, please leave us a review and follow us on LinkedIn, Instagram, and Facebook. If you would like more information regarding dividend growth or just our style of investing, go to growmydollar.com. There you will find some of our previous podcasts and also our monthly newsletter. If you have any questions or anything to add regarding today's podcast, email ethan@growmydollar.com. Past performance does not guarantee future results. Each investor should consider whether a strategy is right for them and all the risks involved. Dividend Stocks are volatile and can lose money.



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