This post was written by Ben Reynolds who runs Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to help individual investors systematically build their high quality dividend growth portfolio.
The Canadian market is home to many high quality dividend growth stocks. Royal Bank of Canada (RY) and Toronto Dominion Bank (TD) stand out as excellent businesses with strong competitive advantages.
There are also many opportunities for Canadian stock investors willing to look south, to the United States. This article takes a look at what I believe are three top U.S. stocks for income investors. All these businesses have dividend yields above 3% and a competitive advantage.
Let’s take a look…
U.S. Stock #1: Flowers Foods
Flowers Foods (FLO) is the second largest baker in the United States, behind only Grupo Bimbo. The company has a market cap of $3.7 billion and was founded in 1919. Well known Flowers Foods brands include: Wonder Bread, Nature’s Own, Dave’s Killer Bread, and Tasty Kake (among others).
At the time of this article Flowers Foods has a dividend yield of 3.6% and a forward price-to-earnings ratio of 16.6. The company appears undervalued relative to other packaged foods companies like:
- General Mills (GIS) – forward price-to-earnings ratio of 20.5.
- Kellogg (K) – forward price-to-earnings ratio of 20.8.
- Campbell Soup (CPB) – forward price-to-earnings ratio of 19.5.
(A recap: forward price-to-earnings ratios are used to estimate future earnings, for the next 12 months or the next full fiscal-year. A quick example: if company A trades for $1 and company B trades for $2 within the same sector, it means the market values company B more than A; it can also mean company B could be overvalued more than company A).
The reason I believe Flowers Foods is trading at a discount is because the company is facing litigation. Flowers Foods uses independent distributors to stock bread in grocery stores. 190 out of 5,100 distributors are claiming the company is underpaying. Flowers Foods is vigorously fighting these complaints. Legal trouble is weighing on this otherwise solid stock. Over the long-run, whatever happens with litigation will not change Flowers Foods’ market position or its long-term growth prospects. The company has paid steady or increasing dividends for 29 consecutive years. This trend is very likely to continue. Flowers Foods currently has a payout ratio of 65%, which seems reasonable for a stable consumer goods business.
U.S. Stock #2: Target
Canadians may remember Target’s botched expansion into Canada. The company lost $2 billion in the process – and didn’t see its valuation multiples rise with much of the rest of the market as a result.
Despite the company’s failure in Canada, Target remains a high quality business in the U.S. Case-in-point: the company has paid increasing dividends for 45 consecutive years. This makes Target one of just 50 Dividend Aristocrats – S&P 500 stocks with 25+ consecutive annual dividend increases. You can see the complete (and historical) Dividend Aristocrats List here.
At the time of this article, Target trades for a market cap of $44.8 billion. The company has a modest yield of 3.2%, and a price-to-earnings ratio of just 14.2. The company’s price-to-earnings ratio seems especially low when one considers Target relative to the ‘average’ S&P 500 stock, and the current S&P 500’s price-to-earnings multiple of 25.2. In this light, Target appears very cheap.
Target has a reputation for cheap prices (but not quite as cheap as Wal-Mart), with clean stores and fashionable (for a discount retailer) merchandise. The company serves consumers that are typically a bit wealthier than Wal-Mart (WMT) consumers; median household income for Target shoppers is $64,000, versus $53,000 at Wal-Mart.
Target’s reputation for quality merchandise at a discount, combined with its economies of scale, provides some competitive advantage. After exiting Canada, Target is realizing strong growth. The company saw adjusted earnings-per-share grow 16.5% in its latest quarter versus the same quarter a year ago. E-commerce sales grew even faster – at 23% versus the same quarter a year ago.
Target’s Canadian struggles hide the company’s strength in the United States. I believe this undervalued Dividend Aristocrat will very likely reward shareholders with rising dividends for years to come. The company has plenty of room to do so, with a fairly low payout ratio of just 41%.
U.S. Stock #3: Phillips 66
Phillips 66 (PSX) is the largest refining corporation in the United States based on its $40.5 billion market cap. The company was created in April of 2012 when ConocoPhillips spun-off its refining division.
Phillips 66 is more than just a pure play refiner, however. The company also owns a large chemical business in joint (50% – 50%) partnership with Chevron (CVX) called CP Chemical. Phillips 66 also has a partial ownership in midstream assets via Phillips 66 Partners (PSXP). In addition, the company distributes gasoline under the Phillips 66, Conoco, and 76 brands.
Warren Buffett’s Berkshire Hathaway (BRK.A) has recently taken a large position in Phillips 66. Berkshire currently owns 15% of the company. It’s easy to see why Buffett is buying into Phillips 66. The company is an industry leader with a low price-to-earnings ratio of just 13.4. Phillips 66 also has a 3.3% dividend yield. Both numbers are better than market averages in this low yield, high price-to-earnings ratio climate.
Phillips 66 has better growth prospects than most pure play refiners. The company’s diverse business units allow the company to reinvest refining profits into chemical operations, as an example. There are two potential catalysts at Phillips 66 that could cause the company to increase in value. One is the possible acquisition of Chevron’s 50% ownership of the chemical division. Chevron is having serious cash flow issues due to low oil prices. Refiners are not affected by low oil prices. If Chevron continues to sell off assets, its Chemical ownership could be up for grabs. If Phillips 66 were to acquire it, the company could push for faster growth in the segment. The second potential valuation increase opportunity with Phillips 66 involves Berkshire Hathaway. Berkshire already has a 15% stake in the company. Berkshire may be considering buying Phillips 66 outright. An acquisition would push the share price significantly higher.
Both of the catalysts above are far from certain. When a company has a low price-to-earnings ratio, good news can send shares higher while bad news is already ‘priced in’. This gives investors a favorable risk-reward profile; and with 3%+ dividends, you get paid to wait.
There is more to the Canadian market that just quality bank stocks. Remember all good portfolios have diversification. Consider adding to the U.S. portion of your portfolio with quality dividend paying stocks after your further research, due diligence and as Mark often writes about – ensuring this approach fits with your financial plan.
Ben Reynolds is a fan of dividend paying stocks and runs Sure Dividend. My Own Advisor has currently no positions in any of these stocks. As always, please consider consulting with a financial professional before making any major investing decisions.