Sunday, November 26, 2017

Watsco wins Dividend Machine over 5 others

I need to finish investing the funds dedicated to my 2017 portfolio.  I have another $35,000 to invest and I really don't like buying in this market when everything seems expensive. Since the market seems expensive maybe oversold stocks are where I should look.

I screened about 400 stocks that were considered oversold using R.S.I. (relative strength indicator) of 28 - 30 and who deliver a dividend yield of 2.5% or more.   It was a waste of time. I found out there was a reason why every one of those stocks was in an oversold situation.  Most often they failed on balance sheet issues such as D/E ratio or revenue growth.

What I am looking for to finish my 2017 portfolio

  • More than 5% annual dividend growth over past 3 years
  • Home building materials, services or derivatives
  • Well managed balance sheet as measured by D/E ratio (debt to equity ratio)
  • Revenue growth that supports future dividend increases.

Since that screen didn't expose a great pick, I went back to the same screens I have used since I started writing this blog.   Beginning with yield, and making sure earnings are greater than yield.  I want revenue growth, dividend growth and a decent D/E ratio.


Dividend growth is very important to me and that is because my expenses go up all the time.  I measure these things and I know it is the case no matter what the official measure of inflation suggests.

So I started my new screen with dividend growth in mind.   I don't want anymore retail, or health care.  We have a chip maker in the portfolio and a fast dining option.  (See the portfolio holdings below.)  Energy seems so overpriced and few banks pay enough in dividends to warrant inclusion.

Right off the bat I found WSO as an example of a stock in the industry I like with great dividend growth.  WSO is where I started.


While, dividend growth is the goal, I also know diversification is important.  Just look at my 2014 portfolio and you will see too much emphasis on energy.  Link to 2014 PortfolioSince 2017 is a small portfolio, I looked for stocks selling goods and services for the home.

I looked at Leggett and Platt (symbol LEG) because they make stuff for the home like faucets.  Watsco symbol WSO is in a similar space but they make HVAC equipment and supplies.   Home Depot (symbol HD)  and Lowes (symbol LOW) are another couple of stocks with products for the home.   Then I added in UPS (symbol UPS) and FedEx (symbol FDX)  because the ecommerce growth at both HD and LOW is significant and someone has to shipped that stuff.  These are the six stocks I analyzed for my next Dividend Machine pick.

I am always surprised when I do these comparative analyses.   I have been really excited about Home Depot but when I saw that their debt has exploded to a D/E ratio of over 10, I have to really consider unloading my position and moving into something else.

It won't be hard to beat HD's 2.07% yield but finding a stock with annual dividend growth of 30% will be hard to find.  Certainly Lowe's comes close.  Lowe's balance sheet is better than home depot but still at 2.89 it is a bit high.   I looked at one other big box stock, Big Lots and their D/E ratio is under .40.   Costco's D/E is .62.  Clearly both HD and LOW have more debt then their industry standard.  LOW's dividend growth rate of 26% is very enticing but their meager yield of 1.87% in view of the other criteria leaves me wanting

The UPS and FDX comparisons are interesting.  UPS has the better yield at 2.89% and acceptable dividend growth of 8%.  But, and it is a big but, their debt to equity ratio is more than 12.  This balance sheet is unacceptable to a conservative income investor.   FDX has much better control of its balance sheet with a D/E ratio of .91 and dividend growth of a mighty 50%.  The hair on this stock is the low yield of .78%.

When I see stocks with low yields, but good balance sheets and good yield growth, and good revenue growth I reserve them for my covered call category of income investing even though I cannot include them in a Dividend Machine Portfolio.  Since FDX meets these criteria, I looked for call options but found none to my liking.

This leaves me with Leggett and Platt (LEG) and Watsco (WSO.)  Purely on dividend growth, the first choice is WSO  with annual dividend increases averaging 36%.  Only HD in this list beats that kind of dividend growth. 

LEG as a contender

LEG has the highest yield but the lowest dividend growth of 5%.   With a 5% annual average increase, I can meet the expenses increases I am living through right now so it is respectable.

LEG has a D/E ratio just above 1.  This is not horrible like UPS or HD but it is higher than WSO's very low D/E ratio of .27.  Let's look more carefully at WSO. 

WSO Dividend Machine Fundamentals

Watsco has been of interest to me, the MoneyMadam, for quite a while; WSO is in each of these portfolios 2011, 2012, and 2016.   In 2012 when tax changes were on the horizon and dividends might be taxed at a higher rate, WSO pay five years of dividends early.   As an income investor, they have your back.

I always like to see revenue growth in a dividend growth stock.  For instance CSCO is very intriguing but their revenues are stagnant.  WSO has decent revenue growth.  It is no Nvidia (NVDA); WSO is not that kind of growth stock.  But income investors need to know the top of the funnel is being fed as well cash the end result - dividends.

Watsco is quite a cash machine and they continue to reward their investors by starting up the dividend increases again.  Take a peek at the table below to view the data I use to evaluate WSO.

What stands out to me is the P/E ratio which at 30.2 is a bit high.  Indeed Watsco is close to it's 52 week high.  Not exactly a bargain.  However, I need to invest some money for income and waiting has not been good to me.

WSO is going into the 2017 portfolio.  When the trade executes, I will post the data on the 2017 Portfolio Page.  WSO is a touch short on yield at 2.68% and touch high in price but I am not going to hope for a price pull back so I can say I bought WSO with a 2.75% yield.  The 2.68% yield is good enough when I look at the other fundamentals.

I may have paper losses if WSO corrects but I can live with that as long as my income continues.  Moreover, I can always buy more.

M* MoneyMadam

Disclosure:  Long WSO, LEG, HD

UPDATE:  Trade executed on Monday, 11/27/2017 @ $164.40.