Grading Three High Relative Dividend Yield Stocks

This week, I use AAII’s A+ Stock Grades to look at a few promising dividend-paying stocks identified by AAII’s High Relative Dividend Yield screening model.

High Relative Dividend Yield Stocks

A dividend yield strategy can help you to find potentially undervalued stocks with reduced downside risk, provided the dividend is secure.

Screening for high relative dividend yield is based upon the time-honored rule of buying low and selling high. Examining a stock’s dividend yield provides a useful framework to identify potential candidates. To succeed at this strategy, you need to develop a set of tools to not only identify which stocks have relatively high dividend yields, but also which of those stocks have the strength to bounce back.

AAII’s dividend yield strategy seeks companies that have the following characteristics:

• Paid a dividend for each of the last seven years and have never reduced their annual dividend payment during this time
• Dividend has increased over each of the last six fiscal years
• Seven-year growth rate in dividends per share is greater than 3%
• Current dividend yield is greater than the seven-year average dividend yield
• Payout ratio for the last 12 months is less than or equal to 85% for utilities and less than or equal to 50% for companies in other industries
• Total-liabilities-to-assets ratio must be below the norm for the industry
• Three-year growth rate in earnings per share is greater than or equal to the industry’s earnings per share growth over the same period

In addition to satisfying the requirements of the high relative dividend yield strategy, the three companies listed in the table below graded highly based on AAII’s A+ Stock Grades. A+ Stock Grades is a stock-grading system based on percentile rankings of multiple key metrics within five investment factors: growth, momentum, earnings estimate revisions, quality and value. They represent a summary of a company’s fundamentals.

The following table summarizes the stock grades for three companies that pass the high relative dividend yield strategy. The three companies are First American Financial Corp. (FAF), a financial services provider; J.M. Smucker Co. (SJM), which manufactures coffee, peanut butter, fruit spreads, pet food and other consumer food and beverage products; and Telephone Data & Systems Inc. (TDS), a telecommunications services company.

AAII’s A+ Stock Grade Summary for 3 Stocks Passing the High Relative Dividend Yield Screen

Grading Three High Relative Dividend Yield Stocks With A+ Stock Grades

First American Financial Corp.

First American Financial, through its subsidiaries, is engaged in the business of providing financial services. Its title insurance and services segment provides title insurance, closing and/or escrow services and similar or related services domestically and internationally in connection with residential and commercial real estate transactions. The specialty insurance segment issues property and casualty insurance policies and sells home warranty products to residential homeowners and renters for liability losses and typical hazards, such as fire, theft, vandalism and other types of property damage.

First American Financial reported second-quarter adjusted earnings per share of $1.05, beating the I/B/E/S consensus estimate of $0.75 per share by 40.0%. Total revenue for the quarter was up 7% year over year to $1.6 billion, driven by a 160% increase in refinance orders and a 29% increase in closed-title orders. The company’s second-quarter cash flow from operations was $343.8 million, up nearly 29% year over year.

First American Financial has a Value Grade of A, based on its score of 12, which is considered deep value or relatively inexpensive. The Value Grade is the percentile rank of the average of the percentile ranks of the price-to-sales ratio, price-earnings ratio, enterprise-value-to-EBITDA (EV/EBITDA) ratio, shareholder yield, price-to-book-value ratio and price-to-free-cash-flow ratio.

The company’s Value Score ranking ranges from a low of 17 for the price-earnings ratio and enterprise-value-to-EBITDA ratio to a high of 38 for the price-to-book-value ratio.

First American Financial has a D grade when it comes to price momentum based on the weighted four-quarter relative strength, which gives extra weighting to price performance over the last quarter compared to the prior three quarters. Momentum is based on the price change of a stock over a specified period relative to all other stocks.

The A+ Quality Grade is based on how many of the five tests a company passes — management’s use of accruals, asset turnover improvement, buyback yield, dividend growth and earnings estimates. The more tests a company passes, the higher its Quality Grade.

First American Financial has a Quality Grade of A, passing four of the five quality tests.

J.M. Smucker Co.

J.M. Smucker is a marketer and manufacturer of consumer foods and beverages including Smucker’s, Folgers, Jif, Dunkin’ Donuts, Crisco, Cafe Bustelo, R.W. Knudsen Family and Sahale Snacks. J.M. Smucker also operates in the pet food and pet snacks business. These brands include Meow Mix, Milk-Bone, Kibbles ‘n Bits, Natural Balance and Nature’s Recipe.

J.M. Smucker’s main product categories include coffee (32% of fiscal-year 2019 sales), dog food (17%), pet snacks (10%), cat food (10%), peanut butter (10%) and fruit spreads (4%).

The company’s current yield of 3.0% compares to its seven-year average of 2.6%. Revenue for J.M. Smucker has increased at a 6.5% average annual rate over the last five years. Diluted earnings from continuing operations are much stronger, with a five-year annual growth rate of 15.5%. The company’s free cash flow has increased at a 17.6% average annual rate over the last five years. The trailing 12-month operating margin of 16.6% is well above the 4.4% median for the food processing industry.

In recent years, the company has been steadily increasing its dividend, with a seven-year average growth rate of 8.0%. It raised its dividend 2.3% in July 2020. J.M. Smucker has increased its dividend for 17 consecutive years.

J.M. Smucker has been a clear beneficiary of pandemic-driven social distancing mandates, having realized 10.8% sales growth in its most recent quarter along with improved margins. However, this momentum may be short-lived, as a significant portion of the quarter’s growth can be attributed to rebuilding inventories. As the pandemic subsides, it is possible that consumers will return to consuming half of their food outside the home, slowing the company’s retail growth. However, some analysts think that the company’s at-home coffee business will experience lasting benefits as people will continue to work from home more often, even after the pandemic subsides.

Analysts think that the firm faces long-term revenue headwinds. Its food segment is under pressure as consumer preferences shift to fresh, unprocessed products. While the company is attempting to offset this pressure with new products more aligned with consumer trends, such as on-the-go snacking, it will take a few years for these smaller brands to gain traction.

The firm recently acquired the Rachael Ray Nutrish brand, which is in the high-growth premium segment and has significant growth potential as it expands from dog food to cat food. This could help improve the company’s pet segment.

J.M. Smucker has a strong A+ Growth Grade of B, which looks at quarterly year-over-year growth in sales, diluted earnings per share from continuing operations and operating cash, as well as annualized growth over the last five years for these three elements. The company saw operating cash increase by 84.7% for its latest quarter versus one year ago.

The company has a Value Grade of B, based on its score of 38, which is considered to be in the value range J.M Smucker has an average Quality Grade of C, having passed two of the five quality tests.

Telephone & Data Systems, Inc.

Telephone & Data Systems is a diversified telecommunications company. The company conducts its wireless operations through its subsidiary, U.S. Cellular, and provides its wireline services, cable services and hosted and managed services (HMS), through its subsidiary TDS Telecommunications Corp. (TDS Telecom). It operates through four business segments: U.S. Cellular, wireline, cable and HMS. U.S. Cellular provides service to postpaid and prepaid customers. Wireline operations provide retail telecommunications services to both residential and commercial customers, mostly in rural markets. Wireline offers services, including broadband, video, voice and network access services. Cable offers broadband, video and voice services under TDS and BendBroadband brand names. It provides a range of IT services, including colocation and cloud and hosting solutions through its HMS business.

The company’s current yield of 3.6% compares to its seven-year average of 2.1%. Diluted earnings from continuing operations for Telephone & Data Systems has increased at a 23.1% average annual rate over the last five years. Operating cash for the company has a five-year annual growth rate of 20.8%. The trailing 12-month net profit margin of 3.1% is well above the negative 3.2% median for the wireless telecommunications services industry.

In recent years, the company has been steadily increasing its dividend, with a seven-year average growth rate of 4.3%. Telephone & Data Systems has increased its dividend for over 40 consecutive years.

The company has a positive A+ Estimate Revisions Grade of B, which is based on the magnitude of a company’s last two earnings surprises, using the SUE (standardized unexpected earnings) score and percentage change in the consensus estimate for the current fiscal year over the last month and last three months.

Telephone & Data Systems has a Value Grade of A, based on its score of 4, which is considered deep value. The company’s Value Score ranking ranges from a low of 7 for the price-to-book-value ratio to a high of 32 for the price-earnings ratio (remember, the lower the score the better for value).

The company has a D grade when it comes to price momentum based on the weighted four-quarter relative strength. Momentum is based on the price change of a stock over a specified period relative to all other stocks. Telephone & Data Systems has a strong A+ Growth Grade of B, which looks at growth in sales, diluted earnings per share from continuing operations and operating cash.

The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.

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