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One Dividend Aristocrat Set To Soar And One You Should Ignore

(Source: Imgflip)

The dividend aristocrats are beloved by conservative investors such as retirees and for good reason.

  • dividend champion: any US stock with a 25+ year dividend growth streak
  • dividend aristocrat: any S&P 500 company with a 25+ year dividend growth streak
  • dividend king: any company with a 50+ year dividend growth streak

Ben Graham considered 20 years without a dividend cut as an important measure of quality.

(Source: Imgflip)

If 20 years without a cut is good, then 25+ years of steadily growing dividends, in all economic, industry, and market conditions is a sign of supreme quality and dependability retirees can trust to help pay the bills.

7 Proven Ways To Beat The Market Over Time

(Source: Ploutos) data as of the end of November

What’s more, dividend aristocrats have also beaten the S&P 500 over the long term, which is why they are one of the seven alpha factors.

  • dividend aristocrats tend to be higher-quality companies (another alpha-factor)
  • aristocrats have 23% average annual volatility vs. 28% for the average standalone company (low volatility is another alpha-factor)
  • many dividend aristocrats and champions are small to mid-caps (adding yet another alpha-factor)

The bottom line is that if your goal is a prosperous dividend funded retirement, then it’s hard to go wrong with champions, aristocrats, or kings.

But while the dependability and quality of the average aristocrat are undeniable, we can’t forget what my fellow Dividend King Co-Founder Chuck Carnevale teaches.

An analysis of quality without consideration of valuation is a job half done.”

Most investors focus on volatility risk, which gets all the headlines. But fundamental and valuation risk is actually far more important.

(Source: Imgflip)

Volatility can only hurt you if you become a forced seller, for financial or emotional reasons, during a correction or bear market.

Overpaying for even God’s own company, to a dangerous extent, is a great way to ensure poor returns, and possibly sink your retirement goals. That’s even if the companies’ earnings, cash flow, and dividends grow as expected.

  • average dividend champion is 16% overvalued right now
  • average dividend aristocrat is 18% overvalued
  • average dividend king is 20% overvalued

In this week’s Dividend Kings’ member request article, I wanted to highlight two dividend aristocrats that I just updated for 2021 fundamentals in our Research Terminal and added to our new DK Safety & Quality Tool.

(Source: DK Safety & Quality Tool) sorted by overall quality, green = potential good buy or better, blue = potential reasonable buy, yellow = hold, red = potential trim/sell

This provides the summary safety, dependability, and quality scores and ratings for 102 companies (and counting) including dozens of aristocrats, champions, and kings.

As part of today’s member analysis request article, I was able to update two aristocrats/champions, in particular, Polaris (PII), and S&P Global (SPGI)

  • Polaris is an undervalued dividend champion set to soar
  • S&P Global is a dangerously overvalued aristocrat you should ignore

So let’s take a deeper look at both companies, to see why both are worthy additions to most diversified and prudently risk-managed portfolios…at the right price.

S&P Global: The King Of Financial Data Will Become A Dividend King In 2023

My motto is “quality first and prudent valuation and sound risk management always.” That’s why I begin an analysis of any company by first looking at dividend safety, long-term dependability, and overall company quality.

Dividend Kings Safety Model

1

2019 Payout Ratio vs. safe level for the industry (historical payout ratio vs. dividend cut analysis by industry/sector

2

2020 Consensus Payout Ratio vs. safe level for the industry (historical payout ratio vs. dividend cut analysis by industry/sector)

3

2021 Consensus Payout Ratio vs. safe level for the industry (historical payout ratio vs. dividend cut analysis by industry/sector)

4

2022 Consensus Payout Ratio vs. safe level for the industry (historical payout ratio vs. dividend cut analysis by industry/sector)

5

2023 Consensus Payout Ratio vs. safe level for the industry (historical payout ratio vs. dividend cut analysis by industry/sector)

6

Debt/EBITDA vs. safe level for industry (credit rating agency standards)

7

Historical Debt/EBITDA vs. safe level for industry (credit rating agency standards)

8

Net Debt/EBITDA vs. safe level for industry (credit rating agency standards)

9

Interest coverage ratio vs. safe level for industry (credit rating agency standards)

10

Historical Interest coverage ratio v.s safe level for industry (credit rating agency standards)

11

Debt/Capital vs. safe level for industry (credit rating agency standards)

12

Current Ratio (Total Current Assets/Total Current Liabilities)

13 Historical Current Ratio
14

Quick Ratio (Liquid Assets/current liabilities (to be paid within 12 months)

15 Historical Quick Ratio
16 S&P credit rating
17 S&P rating outlook
18 Fitch credit rating
19 Fitch rating outlook
20 Moody’s credit rating
21 Moody’s rating outlook
22 AM Best rating (insurance)
23 AM Best rating outlook (insurance)
24 DBRS rating (Canadian companies)
25

DBRS rating outlook (Canadian companies)

26 MSCI ESG Score
27 ESG Trend
28 30-year bankruptcy risk
29

Implied credit rating (if not rated, based on average borrowing costs, debt metrics & advanced accounting metrics)

30

Average Interest Cost (cost of capital and verifies the credit rating if not rated)

31

Dividend Growth Streak (vs Ben Graham 20 years of annual dividends standard of excellence)

32

Uninterrupted Dividend Streak (vs Ben Graham 20 years of uninterrupted dividends standard of quality)

33

Dividend Growth Streak since 2008, annual dividend growth including through Great Recession

34

Uninterrupted Dividend Streak since 2008, no dividend cut in Great Recession

35

Dividend Champion status (25+ year dividend growth streak)

36

Dividend King status (50+ year dividend growth streak)

37

Analysts Consensus Expects Steady/Rising Dividends

38

FactSet LT growth consensus

39

YCharts LT growth consensus

40

Reuters’ 5-Year growth consensus

41

Piotroski F-score (advanced accounting metric measuring short-term bankruptcy risk)

42

Historical F-score vs. 4+ safety guideline

43

Altman Z-score (advanced accounting metric measuring long-term bankruptcy risk)

44

Historical Z-score vs. 1.81+ safety guideline

45

Beneish M-score (advanced accounting metric measuring accounting fraud risk)

46

Historical Beneish M-score vs. -2.22 or less safety guideline

47 Speculative: Yes or no
48

Dividend Cut Risk In This Recession (based on blue-chip economist consensus)

49

Dividend Cut Risk in Normal Recession (based on historical S&P dividend cuts during non-crisis downturns)

Not all metrics apply to all companies, industries, and sectors. But the ones that do allow our proprietary safety weighting formula to estimate with relatively high accuracy the risks of a dividend cut in any given economic downturn.

Rating Dividend Kings Safety Score (49 Safety Metric Model) Approximate Dividend Cut Risk (Average Recession)

Approximate Dividend Cut Risk In This Recession

1 (unsafe) 0% to 20% over 4% 16+%
2 (below average) 21% to 40% over 2% 8% to 15%
3 (average) 41% to 60% 2% 4% to 8%
4 (above-average) 61% to 80% 1% 2% to 4%
5 (very safe) 81% to 100% 0.5% 1% to 2%

How do we know our approach works? Because it’s been proven effective during the two worst recessions of the last 75 years.

  • Our safety model predicted about three out of 165 Phoenix list blue-chips would cut their dividends during the Great Recession

  • Four of them actually cut their dividends

  • In the pandemic, our safety model predicted three out of 165 Phoenix list blue-chips would cut their dividends

  • Just one of them has

  • In the worst recessions in 75 years 6 expected Phoenix dividend cuts vs. 5 actual dividend cuts
  • the ultimate baptism by fire vindicating our safety model is why I’m entrusting 100% of my life savings to our safety and quality scores and Phoenix strategy

S&P Global’s dividend safety is impeccable.

S&P Dividend Safety

Rating Dividend Kings Safety Score (49 Safety Metric Model) Approximate Dividend Cut Risk (Average Recession)

Approximate Dividend Cut Risk In This Recession

1 (unsafe) 0% to 20% over 4% 16+%
2 (below average) 21% to 40% over 2% 8% to 15%
3 (average) 41% to 60% 2% 4% to 8%
4 (above-average) 61% to 80% 1% 2% to 4%
5 (very safe) 81% to 100% 0.5% 1% to 2%
SPGI 93% 0.5% 1.4%

(Source: DK Safety & Quality Tool)

(Source: Gurufocus)

  • net debt/EBITDA: 0.4 vs. 3 or less safe for this industry according to rating agencies
  • Q3 debt/EBITDA: 1.6 vs. 3 or less safe
  • 13-year median debt/EBITDA: 1.1 vs. 3 or less safe

S&P Leverage Safety Guidelines For Most Companies

Rating Safe Debt/EBITDA for Most Companies
BBB 3.0 or less
A 2.5 or less
A+ 1.8 or less
AA 1.5 or less
AAA 1.1 or less

This is just one example of the safety guidelines rating agencies use when determining the risk of bond defaults, which are highly correlated to corporate bankruptcies.

Credit Rating 30-Year Bankruptcy Probability
AAA 0.07%
AA+ 0.29%
AA 0.51%
AA- 0.55%
A+ 0.60%
A 0.66%
A- 2.5% (Moody’s equivalent rating for SPGI)
BBB+ 5%
BBB 7.5%
BBB- 11%
BB+ 14%
BB 17%
BB- 21%
B+ 25%
B 37%
B- 45%
CCC+ 52%
CCC 59%
CCC- 65%
CC 70%
C 80%
D 100%

(Source: DK Investment Decision Tool, S&P, University of St. Petersburg)

Long-term bankruptcy risk is the ultimate example of fundamental risk because the stock price goes to zero. Speaking of bankruptcy risk, let’s take a look at SPGI’s Z-score, which is incredibly strong.

(Source: GuruFocus)

  • Altman Z-score is historically 84% to 92% accurate at forecasting bankruptcies over 30 year periods
  • 1.81+ is safe
  • 3+ is very safe
  • SPGI’s Z-score is currently and historically very safe confirming Moody’s A3 stable credit rating (A- S&P and Fitch equivalent)
  • 30-year bankruptcy risk on SPGI: 2.5% = 1 in 40 chance of losing all your money buying this company

How strong is SPGI’s balance sheet?

  • the bond market is willing to lend to it for 40 years at 2.3% interest rates
  • average borrowing cost is 3.0% vs 57% returns on invested capital

Is it any surprise that SPGI, whose 2021 consensus FCF payout ratio is 24% vs. a 60% safety guideline, has a 47-year dividend growth streak?

  • In 2023, SPGI is likely to hit a 50-year streak and become a dividend king

But dividend safety is just the first step in my quality assessment of any company.

Long-Term Dependability: Entrusting Your Savings To Companies That Deserve It

The old management quality/dividend culture 3 point rating is now the 4 point long-term dependability rating which takes into account

  • dividend safety
  • management quality (capital allocation over time)
  • business model (moat and stability)
  • dividend track record (for dividend-paying companies)
  • long-term analyst growth forecasts
  • ESG scores and trends from MSCI
  • whether or not a company is speculative for either short-term or permanent reasons

SPGI Long-Term Dependability

Company DK Long-Term Dependability Score Interpretation Points
S&P 500/Industry Average 58% Average Dependability 2
Non-Dependable Companies 29% or below Poor Dependability 1
Relatively Dependable Companies 30% to 67% Below to Above-Average Dependability 2
Very Dependable Companies 68% to 80% Very Dependable 3
Exceptionally Dependable Companies 81% or higher Exceptional Dependability 4
SPGI 90% Exceptional Dependability 4

(Source: DK Safety & Quality Tool)

SPGI scores 90% exceptional dependability due to

  • some of the industry’s best profitability over time (capital allocation)
  • one of the best management team/corporate cultures in the industry
  • the dividend track record (47-year streak = future dividend king)
  • ESG rating from MSCI of “A” above-average (ESG is considered a critical component of a company’s overall risk profile by S&P, Fitch, Moody’s, AM Best, DBRS, BlackRock (NYSE:BLK), and MSCI)
  • 10.0% to 10.5% CAGR long-term growth consensus from FactSet, YCharts, and Reuters/Refinitiv (a thriving business that analysts expect to continue growing its dividends for the foreseeable future)
  • a non-speculative company (no increased cash flow disruption risk beyond normal industry cyclicality)

A quick note on ESG, which in today’s hyperpolarized political climate may be taken the wrong way by some people.

Companies with strong ESG profiles may be better positioned for future challenges and experience fewer instances of bribery, corruption, and fraud.” – MSCI

ESG is not simply the concern of “woke” and “on-trend” hippy millennials trying to virtue signal to impress Silicon Valley venture capitalists, or social media followers.

According to the world’s best risk-assessors, ESG metrics are a critical component of a company’s overall long-term risk profile. Here’s who considers ESG important and builds it into their rating models.

  • BlackRock
  • MSCI
  • S&P
  • Fitch
  • Moody’s
  • DBRS (Canadian credit rating agency)
  • AM Best (insurance industry rating agency)

The reason some people consider ESG to be political is that some investors consider some industries to be inherently “evil” such as tobacco, energy, big tech, pharma, health insurers, fast-food, snack foods, and defense contractors.

  • such opinions are personal and based on individual ethics
  • ESG scores as calculated by institutions are quantitatively based and focused only on fundamental risks to the underlying business
  • they are compared against industry peers as objectively as can be realistically accomplished

Personal ethical or political opinions are not something rating agencies or asset managers care about.

MSCI rates over 2,800 global companies on 37 ESG metrics, using a quantitative and qualitative approach, just as all the rating agencies do, and Ben Graham recommended.

Our global team of 185 experienced research analysts assesses thousands of data points across 37 ESG Key Issues, focusing on the intersection between a company’s core business and the industry issues that can create significant risks and opportunities for the company. Companies are rated on an AAA-CCC scale relative to the standards and performance of their industry peers…

The MSCI ESG rating model seeks to answer four key questions about companies:

• What are the most significant ESG risks and opportunities facing a company and its industry?

• How exposed is the company to those key risks and/or opportunities?

• How well is the company managing key risks and opportunities?

• What is the overall picture for the company and how does it compare to its global industry peers?” – MSCI

(Source: MSCI)

The ESG scores you get from the best risk-assessors in the world are not opinions based on political correctness. They use a quantitative approach based on fundamental company risk analysis. One steeped in decades of historical data correlated to the risk of fundamental deterioration, bankruptcy, and stock/bond investors getting wiped out.

  • ESG ratings + trends make up about 10% of the overall DK quality model for most companies that have an ESG rating from MSCI

(Source: MSCI)

  • According to MSCI’s 185 industry experts, SPGI is in the top 52% of its peers in terms of long-term sustainability
  • SPGI is improving its long-term sustainability steadily over time

Put it all together and you get one of the most dependable companies on earth.

Overall Quality: Combining Almost 100 Fundamental Metrics So You Can Know Your Money Is In Good Hands

There’s one final piece of the quality puzzle and that’s the quality of the underlying business.

  • Morningstar considers SPGI a “wide moat, stable trend company”
  • I define moatiness by stable profitability over time in the top 25% of a company’s peers

SPGI’s profitability is not just stable or improving but it’s absolutely fantastic.

  • 40% free cash flow margin = top 5% of S&P 500
  • returns on invested capital are almost 60% vs. 13% 2019 S&P 500 average

But there is one profitability metric that, according to Joel Greenblatt, one of the greatest investors in history, is the most valuable in determining a company’s quality.

(Source: Imgflip)

Return on capital is Joel Greenblatt’s gold standard proxy for quality and moatiness.

  • ROC = annual operating profit/operating capital (all the money it takes to run the business)
  • 8% ROC is considered the rule of thumb for average quality companies (because the weighted cost of capital for the S&P 500 is about 8% over time)
  • 80% ROC is the average for 9/12 quality blue-chips
  • 127% ROC is the average for 11/12 quality Super SWANs
  • SPGI’s TTM ROC is 371% in the top 9% of its industry
  • SPGI’s 13-year median ROC is 467% = about 40X that of its peers outside of recessions and industry downturns

(Source: Gurufocus)

Historically for every $1 it takes to run its business, SPGI generates $4.67 in annual operating profit. According to Joel Greenblatt and confirmed by its overall profitability profile over time, SPGI is one of the highest quality companies on earth.

(Source: GuruFocus)

SPGI’s historical profitability, including ROC, is in the top 20% of its peers, indicating this is a wonderful business to buy…at fair value or better.

But don’t just take my word for it. According to Ben Graham, the father of securities analysis, valuation, and Buffett mentor (as well as one of the greatest investors in history) over the long term the market almost always correctly “weighs the substance of a company.”

S&P Global Rolling Returns Since 1986

(Source: Portfolio Visualizer)

Over the last 34 years, a period when 91% of total returns are a function of fundamentals, not luck, S&P has smashed the S&P 500’s returns.

  • average rolling return since 1986 has beaten the market over every time period

This due to superior quality and fundamentals, including faster earnings, cash flow, and dividend growth.

And with the news of the $44 billion IHS Markit acquisition, S&P goes from a dominant name in financial data to the global king of this highly lucrative and steadily growing industry.

Wide moat-rated S&P Global announced on Nov. 30 it would acquire IHS Markit in an all-stock transaction. IHS Markit shareholders will receive 0.2838 shares of S&P Global, which, based on S&P Global’s share price of $341.57, implies a take-out price of $96.94, a modest 5% premium. Based on CapIQ consensus estimates, this equates to 31 times earnings, modestly higher than S&P Global’s current 29 times valuation. Overall, we believe S&P Global valued IHS Markit reasonably and did not overpay for the firm.

We view the deal as a bet on sector deep data as well as a strategic decision to further embed itself in customer workflows. Following the transaction, which is expected to close in the second half of 2021, IHS Markit shareholders will own 32.25% of the combined company. While we appreciate the potential synergies, we are not adjusting our fair value estimate at this time and expect to maintain our wide moat rating.

IHS Markit is a collection of relatively wide moat data-driven businesses with a highly recurring revenue model. Its revenue consists of 41% financial services, 27% transportation, 21% resources, and 11% consolidated markets & solutions or CMS. IHS Markit’s unique data complements S&P Market Intelligence. IHS Markit’s indexes business, which includes iBoxx (fixed income) and iTraxx (credit default swap), expands on S&P Dow Jones Indices. IHS Markit’s resources business expands S&P Platts’ with additional price reporting (through IHS Markit’s OPIS benchmarks) as well as energy data and analytics. Overall, we don’t see much overlap between S&P Ratings and IHS Markit.

S&P Global expects the transaction to be accretive in the second full year after closing; the firm expects $480 million in cost synergies and $350 million in revenue synergies, driven by new products and cross-selling. We believe these targets are reasonable as the cost synergies represent less than 10% of combined expenses and revenue synergies are only about 3% of combined revenue.” – Morningstar (emphasis added)

S&P Overall Quality: 90% = 12/12 Ultra SWAN Dividend Aristocrat

SPGI Final Score Rating
Safety 93% 5
Business Model 80% 3
Dependability 90% 4
Total 90% 12 (Ultra SWAN)

(Source: DK Safety & Quality Tool)

  • SPGI is the 19th highest quality company on the DK Master List

Dividend Kings Quality Rating Scale

Quality Score Meaning Max Invested Capital Risk Recommendation Margin Of Safety Potentially Good Buy Strong Buy Very Strong Buy

Ultra-Value Buy

3 Terrible, Very High Long-Term Bankruptcy Risk 0% NA (avoid) NA (avoid) NA (avoid)

NA (avoid)

4 Very Poor 0% NA (avoid) NA (avoid) NA (avoid)

NA (avoid)

5 Poor 0% NA (avoid) NA (avoid) NA (avoid)

NA (avoid)

6 Below-Average, Fallen Angels (very speculative) 1% 45% 55% 65% 75%
7 Average 2.5% 35% 45% 55% 65%
8 Above-Average 5% (unless speculative then 2.5%) 25% to 30% 35% to 40% 45% to 50%

55% to 60%

9 Blue-Chip 7% (unless speculative then 2.5%) 20% to 25% 30% to 35% 40% to 45%

50% to 55%

10 SWAN (a higher caliber of Blue-Chip) 7% (unless speculative then 2.5%) 15% to 20% 25% to 30% 35% to 40%

45% to 50%

11 Super SWAN (exceptionally dependable blue-chips) 7% (unless speculative then 2.5%) 10% to 15% 20% to 25% 30% to 35%

40% to 45%

12 Ultra SWAN (as close to perfect companies as exist) 7% (unless speculative then 2.5%) 5% to 10% 15% to 20% 25% to 30%

35% to 40%

S&P is a fast-growing, Ultra SWAN quality dividend aristocrat that in 2023 becomes a dividend king.

At the right price, it’s as close to a “must own” company as exists on Wall Street. But today, unfortunately, is not anywhere close to “the right price.”

S&P Global Historical Market-Determined Fair Value

Metric Historical Fair Value Multiple (13-years) 2020 2021 2022
5-Year Average Yield 1.06% $253 $283 $306
13-Year Median Yield 1.34% $200 $224 $242
25-year average yield 1.81% $148 $166 $179
Earnings 20.5 $235 $242 $268
Owner Earnings (Buffett smoothed out FCF) 21.1 $283 $314 NA
Operating Cash Flow 19.8 $261 $264 $273
Free Cash Flow 21.7 $266 $267 $294
EBITDA 11.8 $195 $197 $213
EBIT (operating profit) 12.9 $208 $210 $228
Average $219 $232 $243
Current Price $334.88

Discount To Fair Value

-53% -44% -38%
Upside To Fair Value -34% -31% -27%

Annualized Return Potential (NOT including dividends)

-99% -28% -14%

(Source: F.A.S.T. Graphs, FactSet Research) SPGI’s 2021 average fair value is $223 until the 11% dividend hike analysts expect next quarter

S&P is unquestionably a wonderful company, but it’s priced for several years’ worth of growth, resulting in horrible valuation and volatility risk.

SPGI Peak Declines Since 1986

(Source: Portfolio Visualizer)

If you overpay for even God’s own company you can’t expect to do well in the short to medium term. Which is a period of time that can last as long as 10+ years.

S&P Global 75-Year Monte Carlo Simulation

(Source: Portfolio Visualizer)

  • there is an 80% statistical probability that SPGI will suffer a 46% to 71% bear market sometime in the future
  • buying this 12/12 Ultra SWAN dividend aristocrat at a 50% premium increases the risk of suffering gut-wrenching short-term volatility
  • and potentially becoming a forced seller for emotional or financial reasons, converting volatility and valuation risk into permanent losses

S&P Global 2022 Consensus Total Return Potential

(Source: F.A.S.T. Graphs, FactSet Research)

If SPGI grows as analysts expect and returns to historical mid-range fair value (20.5 PE) by the end of 2022 investors will suffer -9.1% CAGR total returns.

  • vs -3.4% CAGR for the S&P 500

S&P Global 2025 Consensus Return Potential

(Source: F.A.S.T. Graphs, FactSet Research)

If SPGI grows as analysts expect through 2025 and returns to historical mid-range market-determined fair value then investors will enjoy just 2.5% CAGR total returns.

  • vs. 3.4% CAGR for the S&P 500

Over the very long-term, 30+ years, when a study from Princeton found that valuation changes tend to cancel out

  • SPGI very long-term consensus total return: 0.8% yield + 10.5% CAGR growth = 11.3% CAGR total returns
  • vs. 8.0% CAGR S&P 500 and 9.5% CAGR dividend aristocrats

If you buy S&P Global today and hold it for long enough, then you are likely to still beat the market and the dividend aristocrats. But it may take you decades to get there, and you run the risk of up to a 70% bear market along the way.

S&P Global Investment Decision Score

I never recommend a company, much less put my own money at risk, without first knowing exactly how prudent a potential investment it is relative to the S&P 500, most people’s default alternative.

The investment decision score is based on valuation and the three core principles of all successful long-term investors.

Ticker Quality Score Dividend Safety Score Investment Grade Today’s 5Yr RAER
SPGI 12 (Ultra SWAN) 5 (Very Safe) F 0.62%
Goal Scores Scale Interpretation
Valuation 1 Potential Trim/Sell SPGI’s -49.9% discount to fair value earns it a 1-of-4 score for valuation timeliness
Preservation of Capital 7 Excellent SPGI’s credit rating of A- implies a 2.5% chance of bankruptcy risk, and earns it a 7-of-7 score for Preservation of Capital
Return of Capital NA NA (historical yield 1.1%, treated as a growth stock) SPGI’s 5.25% vs. the S&P’s 9.68% 5-year potential for return via dividends earns it an NA-of-10 Return of Capital score
Return on Capital 2 Very Poor SPGI’s .62% vs. the S&P’s 2.4% 5-year risk-adjusted expected return earns it a 2-of-10 Return on Capital score
Total Score 10 Max score of 21 S&P’s Score
Investment Score 48%

Terrible

73/100 = C(Market Average)
Investment Letter Grade F

(Source: Dividend Kings Automated Investment Decision Tool)

SPGI is one of the worst dividend aristocrats you can buy at this time.

But now let’s turn to one of the most reasonable and prudent Ultra SWAN dividend champions you can buy today. A company that I’ve personally bought 10 times over the last few months.

Specifically, let’s see why Polaris is a classic Phoenix company that’s likely to rise from the ashes of this recession and soar to new heights.

Polaris: An Ultra SWAN Hyper-Growth Dividend Champion That’s Actually Benefiting From The Pandemic

Metric 2020 consensus growth 2021 consensus growth

2022 consensus growth

Dividend 2% (official) 2% 3%
EPS 16% 4% 7%
Owner Earnings (Buffett smoothed out FCF) 6% 4% NA
Operating Cash Flow 6% 3% 4%
Free cash flow 41% -23% 3
EBITDA 35% 7% 4%
EBIT (pre-tax profit) 58% 4% 1%

(Source: F.A.S.T. Graphs, FactSet Research)

In a year when the S&P 500 is expected to report -18% EPS growth, Polaris just issued guidance for 16% growth, which analysts expect it to achieve. Free cash-flow is soaring, because of record demand for ATVs, motorcycles, and boats.

  • Polaris remains speculative (2.5% or less max portfolio risk cap recommendation) due to 20% to 25% probability of a double-dip recession according to JPMorgan (NYSE:JPM), most economists, and a recent survey of US CEOs

(Source: PII earnings presentation)

In no recession in history have stimulus flush consumers bought so many Powersports products. Which has caused PII’s consensus estimates to bounce back to an incredible degree.

  • 2020 EPS consensus up 78% in the last six months
  • operating cash flow consensus up 72%
  • free cash flow consensus up 158% in the last three months (a key reason why the dividend safety was upgraded)
  • EBITDA consensus up 34% in the last three months
  • EBIT consensus up 56% in the last six months

(Source: FactSet Research)

PII’s sales in all segments are expected to remain stable or grow through the worst recession in 75 years.

(Source: FactSet Research)

This is why analysts expect net debt to fall by over 50% between 2020 and 2022.

  • current net debt/EBITDA: 1.8 vs. 3.0 or less safe
  • 2021 net debt/EBITDA consensus: 0.7 vs. 3.0 or less safe
  • 2022 net debt/EBITDA consensus: 0.5 vs. 3.0 or less safe

But before I gush too much about PII’s exceptional short-term growth in 2020 and beyond, let’s consider its safety and quality.

Polaris Dividend Safety

Rating Dividend Kings Safety Score (49 Safety Metric Model) Approximate Dividend Cut Risk (Average Recession)

Approximate Dividend Cut Risk In This Recession

1 (unsafe) 0% to 20% over 4% 16+%
2 (below average) 21% to 40% over 2% 8% to 15%
3 (average) 41% to 60% 2% 4% to 8%
4 (above-average) 61% to 80% 1% 2% to 4%
5 (very safe) 81% to 100% 0.5% 1% to 2%
PII 86% 0.5% 1.7%

(Source: DK Safety & Quality Tool)

(Source: GuruFocus)

PII’s balance sheet was crushed early in the pandemic, during the lockdowns.

Net debt/EBITDA has improved from 2.9 in Q2 to 1.8 in Q3, in line with S&P A+ credit rating guidelines. And by the end of next year, analysts expect net leverage to be under 1.0.

  • interest coverage went from 4.0 to 6.0 in just 3 months vs. 8+ safe
  • 2021 consensus interest coverage ratio: 9.5 vs. 8+ safe
  • 2022 consensus interest coverage ratio: 10.9 vs. 8+ safe

(Source: GuruFocus)

  • 13-year median debt/EBITDA: 0.6 vs. 3.0 or less safe
  • 10-year median interest coverage ratio: 63.1 vs. 8+ safe

PII was de-leveraging before this pandemic began. And thanks to record demand for its products, it’s achieved management’s deleveraging targets far earlier than expected.

But just because the current dividend is very safe, barring a return to lockdown conditions over the next few months, is just the first reason I’m so excited to recommend and buy PII for most diversified and prudently risk-managed portfolios.

Polaris Long-Term Dependability

Company DK Long-Term Dependability Score Interpretation Points
S&P 500/Industry Average 58% Average Dependability 2
Non-Dependable Companies 29% or below Poor Dependability 1
Relatively Dependable Companies 30% to 67% Below to Above-Average Dependability 2
Very Dependable Companies 68% to 80% Very Dependable 3
Exceptionally Dependable Companies 81% or higher Exceptional Dependability 4
PII 91% Exceptional Dependability 4

(Source: DK Safety & Quality Tool)

PII scores 91% exceptional dependability based on

  • some of the industry’s best profitability over time (capital allocation)
  • one of the best management team/corporate cultures in the industry (Morningstar rates it “exemplary” and I agree)
  • based on the dividend track record (25-year dividend growth streak that analysts expect to reach 27 years by 2022)
  • 15.0% to 16.0% CAGR long-term growth consensus from FactSet, YCharts, and Reuters/Refinitiv (which makes safe and steadily growing dividends more likely)

Polaris Overall Quality: 87% = 12/12 Speculative Ultra SWAN Dividend Champion

PII Final Score Rating
Safety 86% 5
Business Model 80% 3
Dependability 91% 4
Total 87% 12 (Ultra SWAN) – speculative until pandemic ends

(Source: DK Safety & Quality Tool)

Morningstar considers Polaris a “wide and stable moat” company. So let’s check the objective data to see whether this is so.

Outside of the pandemic lockdowns and recall crisis that began in 2015 and is now behind it, PII’s profitability has remained relatively stable for 30 years.

(Source: GuruFocus)

That profitability has historically been in the top 20% of its peers.

(Source: GuruFocus)

Analysts expect PII’s return on capital, which was just 8% over the past 12 months due to the lockdowns, to return to their historical 106% levels within a few years.

  • in Q3 it was already back to 97%
  • M&A cost synergies are going well, and may result in even better profitability than in the past
  • PII’s historical ROC is 106% or about 15X the industry median outside of recessions and cyclical downturns

Yes indeed PII’s moat is wide, stable and its corporate culture indeed “exemplary.”

  • 30 years of industry-leading profitability proves management knows how to invest shareholder capital very well
  • and adapt and overcome any challenges
  • while paying a steadily growing dividend

But while Polaris and S&P Global have similar safety, dependability, and quality scores, their valuation profiles are nothing alike.

Polaris Historical Market-Determined Fair Value

Metric Historical Fair Value Multiples (19 Years) 2020 2021 2022
5-Year Average Yield 2.58% $96 $98 $101
13-Year Median Yield 2.07% $120 $122 $126
25-Year Average Yield 2.35% $106 $107 $111
Earnings 17.2 $126 $131 $141
Owner Earnings (Buffett Smoothed Out FCF) 15.4 $138 $144 NA
Operating Cash Flow 11.1 $129 $133 $142
Free Cash Flow 18.2 $179 $138 NA
EBITDA 9.6 $132 $141 $146
EBIT (pre-tax profit) 13.3 $136 $141 $142
Average $126 $126 $127
Current Price 98.25

Discount To Fair Value

22% 22% 23%
Upside To Fair Value 28% 28% 30%

Annualized Return Potential (does NOT include dividends)

1501% 25% 13%

(Source: F.A.S.T. Graphs, FactSet Research) PII’s 2021 fair value is $125 until the 2% dividend hike analysts expect in February 2021.

PII is trading at a 22% discount to 2021 consensus fundamentals. How undervalued is PII? Let’s consider its Enterprise value (market cap + net debt)/EBITDA, the so-called “acquirer’s multiple” favored by private equity and hedge funds.

  • Pre-pandemic private equity deals were averaging 12.3X EV/EBITDA.
  • during the first 10 seasons of Shark Tank, the average multiple was 7.0.

(Source: FactSet Research)

PII is now trading at 8.0X 2021 consensus EV/EBITDA, literally private equity/Shark Tank valuations.

  • over the last 13-years, PII’s median EV/EBITDA was 11.0
  • on EV/EBITDA PII is about 27% historically undervalued

What does the opportunity to buy one of the highest-quality dividend growth stocks in the world at such a high discount mean for you?

Polaris 2022 Consensus Return Potential

(Source: F.A.S.T. Graphs, FactSet Research)

If PII grows as expected and returns to historical fair value (18X earnings) by 2022 investors would see 23.0% CAGR total returns.

  • vs. -3.4% CAGR for the S&P 500

Polaris 2025 Consensus Return Potential

(Source: F.A.S.T. Graphs, FactSet Research)

If PII grows as expected and returns to historical fair value (18X earnings) by 2025 investors would see 19.0% CAGR total returns.

  • vs. 3.2% CAGR for the S&P 500

(Source: Portfolio Visualizer)

This isn’t a surprise given that PII is a hyper-growth stock that analysts expect to grow at 15% to 16% CAGR over time, and deliver similar returns as it has in the past.

  • average 15-year return since 1988 18.6% CAGR vs. 8.0% CAGR S&P 500
  • over the very long-term, analysts expect 2.6% yield + 15% to 16% CAGR growth = 17.6% to 18.6% CAGR total returns
  • vs. 8.0% CAGR S&P 500 and 9.5% CAGR dividend aristocrats

Polaris Investment Decision Score

Ticker Quality Score Dividend Safety Score Investment Grade Today’s 5Yr RAER
PII 12 (Ultra SWAN) 5 (Very Safe) A- 13.53%
Goal Scores Scale Interpretation
Valuation 4 Strong Buy PII’s 22.39% discount to fair value earns it a 4-of-4 score for valuation timeliness
Preservation of Capital 5 Average PII’s credit rating of BBB implies a 7.5% chance of bankruptcy risk, and earns it a 5-of-7 score for Preservation of Capital
Return of Capital 9 Excellent PII’s 19.18% vs. the S&P’s 9.67% 5-year potential for return via dividends earns it a 9-of-10 Return of Capital score
Return on Capital 10 Exceptional PII’s 13.53% vs. the S&P’s 2.50% 5-year risk adjusted expected return earns it a 10-of-10 Return on Capital score
Total Score 28 Max score of 31 S&P’s Score
Investment Score 90%

Very Good

73/100 = C(Market Average)
Investment Letter Grade A-

(Source: Dividend Kings Automated Investment Decision Tool)

Polaris is one of the most reasonable and prudent (though speculative in this pandemic) Ultra SWAN quality dividend champion hyper-growth companies you can buy.

  • that’s assuming you are comfortable with the risk profile
  • and own it within a diversified and prudently risk-managed portfolio

Polaris Risk Profile Summary

Polaris faces a number of different risks. Motorcycles, snowmobiles, and ATVs are all big-ticket items, and a widespread slowdown in the global economic environment could hamper the replacement and adoption rates of these products.

A more protracted domestic downturn could also affect financing rates at the dealer (floor plan) and retail levels. In 2019, consumers financed about 32% of the vehicles sold in the U.S. and changes in lending standards could prove problematic.

Polaris faces integration risk, particularly as it has become more acquisitive (TAP, Boat Holdings), and liability risk, as it self-insures against product liability claims. Weather is the biggest factor Polaris cannot control; sales of snowmobiles are correlated with the amount of snowfall generated in any given season, making segment volume more volatile than the others.

Also, persistent recalls can weigh on the firm’s ability to maintain its brand equity. Foreign exchange exposure could prove unpredictable as the firm grows internationally, making sales uncertain. Finally, additional tariffs could further dent profitability.

We remain concerned that the Powersports industry has numerous key players that can compete on price to gain share. In ATVs, competitors like Honda and Deere are formidable players, while Indian has to compete with motorcycle manufacturing giants Honda and Harley-Davidson. All of the aforementioned brands have huge franchises and financial resources, which could cause the environment to become promotional.

Although Polaris has held its ground against these incumbents, competitive winds got the best of the company in 2004 when it sold its personal watercraft business, and the concern remains that it could happen again (we surmise this was a factor in the Victory wind-down decision and could be a factor in Slingshot’s ultimate fate if demand fails to stabilize longer-term with the launch of the automatic transmission models).” – Morningstar

Bottom Line: Polaris Is A Dividend Champion Set To Soar And S&P Global Is An Ultra SWAN Dividend Aristocrat To Ignore… For Now

I can’t tell you what the stock market will do in any given day, month, or year. No one does, and do you know why?

Time Frame (Years)

Total Returns Explained By Fundamentals/Valuations

1 Day 0.04%
1 Month 0.7%
3 Months 2%
6 Months 4%
1 8%
2 18%
3 26%
4 35%
5 44%
6 53%
7 62%
8 70%
9 79%
10+ 90% to 91%

(Sources: Dividend Kings S&P 500 Valuation & Total Return Potential Tool, JPMorgan, Bank of America (NYSE:BAC), Princeton, RIA)

Because in the short term, stock returns have very little to do with fundamentals.

  • which is why I ignore 12-month analyst price targets
  • which are educated guesstimates on what sentiment/luck will do to a stock price

Over the long-term 91% of investment returns are driven by fundamentals, which is why that’s all I focus on. And today the fundamentals are very clear.

  • both SPGI and PII are exceptionally safe, high-quality, and dependable dividend growth stocks
  • SPGI is extremely overvalued
  • PII is trading at a significant discount to its historical, market-determined fair value
  • SPGI is one of the least reasonable and prudent aristocrats you can buy right now
  • PII is one of the best dividend champions you can buy for a diversified and prudently risk-managed portfolio

Whether or not Moody’s is right and 2021 brings with it the start of a multi-year bear market (most blue-chip economists disagree with Moody’s) those who follow sound investing principles focused on the five fundamentals of success will thrive and prosper.

This is what I’ve dedicated my life to teaching my readers and Dividend Kings members.

  • bad long-term investors obsess over short-term volatility and pray for luck in the stock market
  • good long-term investors tolerate short-term volatility and trust in the best performing asset class in history
  • great long-term investors embrace volatility and harness it to make their own luck

(Source: AZ quotes)

For those who focus on quality first and prudent valuation and sound risk management always, long-term success is not a matter of luck. Rather, it’s a function of discipline, time, and collecting your safe and growing dividends while quality companies work hard for you so that one day you won’t have to.

—————————————————————————————-

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Disclosure: I am/we are long PII. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Dividend Kings own PII in our portfolios.

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