One of the great long-term benefits that a recession brings is the opportunity to invest in extremely high-quality companies at low valuations. This is especially true of companies that have proven themselves as being highly recession-resistant on an operating basis. In other words, companies whose businesses remain strong even when economic times are difficult, as they have recently been.
We believe that Becton Dickinson & Co. (BDX) represents an opportunity to invest in an extremely high-quality Standard & Poor's Dividend Aristocrat and a David Fish Dividend Champion that has increased its dividend every year for 40 consecutive years. Classified as a healthcare equipment company, Becton Dickinson (BDX) operates in three segments: BD Medical, representing approximately 51% of sales, BD Diagnostics, representing approximately 32% of sales, and the remainder from BD Biosciences. The following excerpt taken from their website summarizes Becton Dickinson:
"BD is a medical technology company that serves healthcare institutions, life science researchers, clinical laboratories, industry and the general public. BD manufactures and sells a broad range of medical supplies, devices, laboratory equipment and diagnostic products. BD is headquartered in the United States and has offices in more than 50 countries worldwide."
Becton Dickinson, as we will soon vividly depict, has a long history of providing their shareholders exceptional operating results and dividend increases. The company is highly regarded for the consistency it has delivered on its shareholders behalf, as evidenced by the following statement from MorningStar:
"Becton Dickinson's needle and surgical tool empire has provided investors with robust returns on capital for years. Now, largely because of the company's decades-long dedication to innovation and wise deployment of capital, its business is prospering and its investors remain amply rewarded even in this challenging economic environment. ~ Morningstar"
Analysts at Value Line Investment Survey also acknowledged this company's quality as well as its ability to provide safety during uncertain economic times. Moreover, they also believe as we do, that this high-quality healthcare company is currently on sale. The following summarizes Value Line's views:
"These shares are appealing. The stock is on sale, relative to historical PE multiples as well as to the level at which we expect BDX to be trading in 2014 to 2016. This, alongside the solid share earnings growth we look for over three to five-year haul, gives this issue worthwhile capital gains potential. The equity is also defensive in nature, which is important during uncertain economic times. Moreover, the stock gets excellent scores for both Price Stability and Earnings Predictability, and it boasts a well below market Beta. ~ Value Line Erik A. Antonson November 25, 2011"
Becton Dickinson - A Multi-Decade Legacy of Operating Excellence and Consistent Growth
The remainder of this article is going to review the "essential fundamentals at a glance" of Becton Dickinson & Co. through the lens of the F.A.S.T. Graphs™ research tool. Our first graph provides a vivid illustration of Becton Dickinson's consistent above-average earnings growth and dividend achievements since calendar year 1993 (19 past years, plus the current year we are in). The orange line on the graph represents a calculation of the company's intrinsic value based on an earnings justified PE ratio of 15. This line represents a value that the stock can be purchased at whereby the buyer is purchasing the company's earnings power at a level that compensates them for the risk they assume. In other words, this valuation represents an earnings yield that is attractive and above average.
The blue shaded area represents dividends paid out of the green shaded earnings area. A primary reason they are stacked on top of earnings is to depict the principle that dividends represent a rate of return in addition to what the market may capitalize earnings at. More simply stated, there are two components of total return that a common stock offers investors.
The first is capital appreciation where the market capitalizes a company's earnings at an appropriate multiple, commonly known as the PE ratio. The long-term historical normal PE ratio that the market has normally applied to companies on average is 15. A PE ratio of 15 implies an earnings yield of approximately 6.7%. This is calculated by dividing a dollar's worth of the company's earnings you are purchasing by the multiple you are paying to purchase them at (one dollar divided by 15 equals 6.66%). The important point here is that the market capitalizes those earnings whether a dividend is paid or not. In other words, this is how the market normally values a dollar's worth of earnings for companies with earnings growth rates ranging from 5% to 15%.
The second component of total return comes when a company pays a dividend, in addition to the capital appreciation from the market capitalizing earnings; investors receive an additional payment in the form of a dividend. Although it is true, that a company's stock will initially be reduced by the exact amount of the dividend payment, this is usually a very short-lived phenomenon that can be negated over a very short period of time as the stock continues to trade (it could be as short as the next hour of trading). Consequently, over the longer run the dividend, as we will illustrate later, in truth represents additional return above and beyond the capital appreciation component.
Becton Dickinson & Co. Earnings and Dividends Only Since 1993
Becton Dickinson & Co. Earnings, Price and Normal PE since 1993
With our next graph, we introduce two important overlays. First we bring in monthly closing stock prices from 1993 plus the previous day's closing price. Here we see that Becton Dickinson's stock price has closely correlated to its earnings growth. Although the market has often applied a quality premium by pricing Becton Dickinson's stock above its earnings justified valuation line (orange line), note how the price inevitably and continuously returns to that level. Simply stated, the stock is fairly priced when the black price line touches the orange earnings justified valuation line, and is overpriced when it is above it and underpriced when it is below it. Clearly, history shows that the best time to purchase the stock is when the price is at or below the orange line. As can be clearly seen, Becton Dickinson's current price is at one of the lowest valuations it has been in almost 2 decades.
When a stock is at or below fair value, this represents an opportune or attractive point in time to invest. However, fair value, although important, is not the primary determinant of the capital appreciation component of total return. Assuming valuation is in alignment, the company's earnings growth rate will be the primary determinant of the rate of capital appreciation that the investor can expect. In other words, if you pay fair value for company that, for example, only offers a 3% growth rate, it's only rational to expect a capital appreciation rate of approximately 3% as well, not including dividends. On the other hand, a 10% to 12% grower like Becton Dickinson, if bought at fair value should generate a rate of return of approximately 10% to 12% consistent with earnings growth, again, not including dividends.
The rate of capital appreciation is an important point worthy of more elaboration. If you pay fair value to buy a slow grower, even though you bought it at a sound valuation, your long-term returns are going to be low. In contrast, if you pay fair value to buy a faster growing company, like Becton Dickinson, then your long-term rate of return will correlate very closely to the company's earnings growth rate achievement. Assuming both are bought at value, ceteris paribus, a faster growing company will generate a higher rate of return than the slower growing company.
This does not negate the importance of investing at sound valuation. Keep in mind, a slower growth rate is easier to achieve and therefore less risky. Consequently, although return may be lower so is your risk of achieving it lower. The point is, you can pay the same PE ratio for two companies with different rates of growth, one fast and the other slow, for example, an average PE of 15, where both purchases represent fair value. What will be different is the amount of risk you are taking and the total return you can expect to receive. Obviously the faster growth rate carries higher risk, but at the same time the potential for a higher return.
The associated performance results with the above earnings and price correlated graph, validates the above discussion regarding the two components of total return, capital appreciation and dividend income. Notice that the black price line was just below the orange earnings justified valuation line at the beginning of 1993, and very similarly valued on January 19, 2012. As a result, the capital appreciation component (closing annualized ROR) 11.5% (see orange circle) is almost identical to the 11.6% annual growth rate seen to the right of the above earnings and price correlated graph (see green circle on graph above). Therefore, it's crystal clear that the earnings growth rate and the capital appreciation component so closely correlate as to be almost identical.
Dividends are included in the return calculation and are assumed paid, but not reinvested. When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 11.5% capital appreciation that closely matches earnings growth; long-term shareholders of Becton Dickinson would have received an additional $121,642 in dividends that increased their total return from 11.5% to 12.3% per annum.
There are two important elements to be considered when evaluating these dividend payments. First, notice that the dividend has increased every year over this 19-year time period growing from $.17 a share in 1993 to $1.64 in calendar year 2011 (blue shaded area). This represents what we call "growth yield" where the dividend yield grew from initially 1.7% per annum to approximately16.7% by calendar year 2011 based on original cost (orange shaded area). This is more commonly referred to as "yield on cost," which recently has been an often hotly debated concept. We like the description "growth yield" because we believe it more accurately reflects how both the annual dividend rate, as well as the total dollars paid in dividends, grow each year. Also, recall that this company has increased its dividend every year for 40 consecutive years.
The following graph looks at Becton Dickinson Co.'s historical PE ratio since 1993 (the dark blue line) correlated to 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is the lowest it has been since 1993.
A further indication that Becton Dickinson & Co. is currently on sale, can be seen by examining their historical price to sales ratio. The red shaded area shows that sales have continued to advance while the price to sales ratio has fallen to their lowest levels in the past two decades. The graph does show that sales growth rate did somewhat flattened during the recession; however, the price reaction appears significantly overdone.
Becton Dickinson & Co. Looking to the Future
Although there is much that we can learn from the past, it's important always to remember that all investing is done in future time. Therefore, we believe it also logically follows that forecasting future earnings growth is the key to future investment success. Becton Dickinson & Co. has clearly produced excellent, and we feel confidence building, results in the past.
Let's now turn our attention to what the future may bring. The following estimated earnings and return calculator shows that 16 analysts reporting to Capital IQ estimate that Becton Dickinson & Co. will grow earnings at the rate of 10% per annum over the next five years. This number is consistent, and actually slightly below Becton Dickinson's historical achievement and these estimates corroborate what both MorningStar and Value Line analysts had to say during the introductory portion of this article.
The estimated earnings and return calculator starts with next year's consensus estimated earnings number and then compounds future expected earnings over the next 5 years at 10% per annum. Consequently, if the company was to achieve this result, and the market applied a normal PE ratio of 15, shareholders could expect to earn a compounded annual return of 12.9% per annum, including dividends. Becton Dickinson's stock price would calculate to $141.54 (See flag on graph).
The following 10-year earnings yield estimates table provides a more detailed explanation of the above graph depicted in numbers. First and foremost, we draw your attention to the fact that next year's earnings yield on Becton Dickinson and Company would be 7.5% increasing by 10% per annum. Second, note that next year's dividend yield of 2.3% is greater than the 2% yield currently available from a 10-year Treasury note. Both of these metrics indicate a very attractive current valuation measurement for such a high-quality company. Note that the brown cell on the target price estimated total return column (Target Prc Est Tot Ret) reflects the five-year estimated total return of 12.9% shown at the top right of the above estimated earnings and return calculator graph.
Conclusions
We believe that the above analysis clearly illustrates that Becton Dickinson & Co. is a blue-chip dividend growth stock that is on sale. Becton Dickinson is also a Dividend Aristocrat and Dividend Champion, that Value Line Investment Survey has awarded high scores for financial strength, price stability, earnings predictability and price growth persistence and a low beta of .65. The company has shown great persistence and strength through the last two recessions, and we believe that estimates for future growth are well reasoned and well defined.
Although we encourage each investor to conduct their own in-depth due diligence, we believe the analysis presented in this article builds a strong case that now is an opportune time to become a shareholder in Becton Dickinson & Co. In addition to all that we presented, the reader should also recognize the demographic opportunity that this company possesses. We believe as it sits today this company offers investors an attractive and growing dividend yield, strong future growth and it can be purchased at a sound valuation. Whether your objective is a growing income or above-average total return, we believe that Becton Dickinson fits the bill.
Disclosure: No positions at the time of writing.
