Wednesday, August 12, 2020

Picking 10 Companies to Hold for 10 Years - Part 3: U.S. Companies

Having establishing my criteria for picking companies to hold for the next 10 years, this post will explain how my five U.S. companies meet, or in one case, doesn't exactly meet, these criteria. Before progressing, I want to give credit to Justin Law for taking up the torch from David Fish and updating the Dividend Champions spreadsheet which can be found on this website. I encourage you to visit the site filled with valuable resources for dividend-focused investors, including the Champions spreadsheet which is updated monthly. 

In case you haven't had a chance to look at the criteria entry, the six criteria I used to pick the five U.S. companies that I would hold for 10 years are:

1. Dividend Yield & Dividend Growth
2. Established Track Record
3. Reasonable Valuation
4. Diversification (across sectors and geographically)
5. Momentum
6. Current Ownership (or high on my watch list)

My five U.S. companies are:

Realty Income:
Wanting to select at least one U.S. REIT, I felt the obvious choice was "The Monthly Dividend Company". Over its 51-year operating history, Realty Income has paid out 601 consecutive months of dividends, raised the distribution 91 times, and provides good geographical exposure across the U.S. through their 600+ tenants. Although the stock in down about 10% in the last year, the price is a reasonable multiple of about 19X trailing FFO. A key risk to consider is the ability of Realty Income's tenant base to continue to pay their rent despite the coronavirus pandemic. The fact that 91.5% of tenants paid their July rent should provide some comfort in that respect.

Johnson and Johnson:
Based on demographics alone, choosing a healthcare company to invest in for the next 10 years seemed like a good choice. What JNJ provides in terms of geographical diversification (almost half their revenue is generated outside the U.S.), product diversification (providing consumer, pharmaceutical and medical devices), along with the potential upside from their covid-19 vaccine make this a worthwhile selection. The 58 consecutive years that company has increased its dividend, and the current ~2.8% yield (despite the 15% YoY increase in share price) help make the pick easy. The downside I see for JNJ is the regulatory risk and possible lawsuits that could materially impact their financial results. Still, I feel comfortable owning shares for the long-term. 

When considering a global technology company to include in my picks, Microsoft seemed obvious for a couple reasons. With about 48% of revenue generated outside the U.S., Microsoft is truly global and nature and has an incredibly strong credit profile reflected in their AAA S&P rating. With the share price up over 55% in the last year, the company has experienced strong momentum. When looking at dividend and valuation metrics, the company has a very modest 1% dividend yield, but has grown their payout annually for 18 consecutive years, including a 7% raise last year. The biggest downside I see with Microsoft is a lofty valuation of 36X trailing earnings, which is hard to justify given the ~13% revenue growth over the last year. 

With 63% of their sales generated outside of the U.S., and one of the most recognized logos in the world, McDonald's seems like a good bet to hold over the next 10 years. With 44 consecutive years of dividend increases (including about 8% last year), and a 2.4% yield, management has proven that returning cash to shareholders is a priority. On the other hand, the stock price is down about 5% over the past year, yet the company continues to trade at a rather lofty 33X trailing earnings. More than another other company in the ten I have selected for this exercise, I think the coronavirus pandemic could have lasting negative effects on McDonald's sales. I do take some comfort in the fact that local McDonald's drive-through was constantly busy during the three months of partial shutdown here in Quebec. 

The strikes against Amazon are pretty obvious: no dividend, trading at 121X trailing earnings, and the only company I don't personally own of the ten selected. Why would I pick it to own for the next 10 years? Momentum is a factor (up almost 80% in the last year), geography/product diversification, and most importantly, market domination. I'm not sure any other single company (possibly Zoom?) stands to benefit more from this pandemic than Amazon. Are people more comfortable shopping online during a pandemic? Are they thankful to be entertained by Amazon Prime movies, shows and video games? Does Amazon web services stand to grow as more businesses move to web-based storage and software? The big risk I see for Amazon is regulation. Hearing Jeff Bezos not guaranteeing to Senators that Amazon didn't use competitor selling data to create their own private label products was alarming. I wouldn't discount having some sort of forced breakup thrust upon the company by a regulatory authority (more than likely outside of North America)...but, Bezos has a way of sniffing out opportunities to profit where others don't follow. I won't bet against him succeeding over the next 10 years.

Do you see any key risks in my five choices above that I overlooked???

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