3 Dividend Aristocrat Bargains

The month of September is almost behind us, thankfully, as the month certainly lived up to its expectations as being the worst month for stocks.

Here is how the three major averages have performed in September:

• Dow Jones Industrial Average: -3.4%
• S&P 500: -4.7%
• Nasdaq: -5.6%

Red across the board, with only two sectors within the S&P 500 finishing the month in the green, Energy and Communication Services.

Here is a look at how all 11 sectors have performed over the past month:

Turning the page on the month of September and we now enter the best performing quarter of the year for stocks, setting up a potential climb into the end of the year.

However, there are still a number of headwinds for stocks, including:

• High inflation
• Rising energy prices
• High interest rates
• Potential recession
• Pending government shutdown (potentially)
• And More

Investors can be optimistic but should be selective when it comes to certain stocks right now.

For me, I tend to always lean towards quality, and that is even more important due to uncertainties rising from the potential headwinds noted above.

As such, in today's article, we are going to cover three high-quality dividend aristocrats that appear to be trading at great valuations.

3 Cheap Dividend Aristocrats

Dividend Aristocrat #1 - McDonald's Corporation

McDonald's Corporation (MCD) has been in the news lately as they recently hiked their royalty fee from 4% to 5%.

The new royalty fee will only apply to new store locations beginning in January 2024.

Although the company has seen pushback from franchisees, as expected, it is only the first hike in the last 30 years.

McDonald's currently has a market cap of $193.5 billion, and shares of MCD have climbed 12% over the past 12 months.

McDonalds, known well for their golden arches and even having a movie, The Founder, detailing how McDonald's came to be, the company is less of a restaurant company and more closely aligned as a real estate company.

After all, more than 80% of all McDonald's restaurants are owned and operated by third-party franchisees.

This means, for that large percentage of the business, McDonald's supports and still operates as an owner with its promotions and new food products, but when it comes to business earnings, for those 80% plus, McDonalds is collecting rent, otherwise known as a royalty fee.

As you can see from the chart above, MCD shares have been backtracking since topping out in July, and some of that has to do with the higher interest rates and return of student loan payments weighing on consumers.

However, I believe this could in fact lead consumers to trading down in value, which could still benefit a fast-food chain like McDonald's.

McDonald's is a dividend aristocrat that has been increasing its dividend for 46 consecutive years, which has them only a few years from becoming a dividend king.

The stock currently yields a dividend of 2.3% and over the past five years, they have increased their dividend at an average annual clip of 8.5%.

Analysts are looking for MCD to increase EPS 7% and 9% over the course of the next two years.

As such, shares of MCD currently trade at a forward price to earnings multiple of 21.4x, which is below their 10-year average of 24.8x.

Dividend Aristocrat #2 - Realty Income

However, the stock has been falling for much of the past year.

For investors that have held shares of O for a while (like me), the fall has been felt, but for long-term investors, this is one of the best opportunities you have had in a number of years.

Realty Income shares currently trade at a market cap of $35 billion and shares have fallen 17.5% over the past 12 months.

Outside of the pandemic related fall, shares of O have not traded this low since 2018, but valuation wise, we have not seen shares this cheap.

Warren Buffett once said:

It is better to buy a wonderful company at a fair price, than it is to buy a fair company at a wonderful price.

Realty Income right now is a wonderful company at a wonderful price.

Since going public in 1994, the stock has generated compound annual returns of 14.2% with a compounded annual growth rate of 4.4% over that same time period.

In addition, the REIT has generated positive earnings growth in 26 out of 27 years.

This is a testament to the company's strong management team and also to their in demand real estate portfolio.

Realty Income leases out their properties to high-quality tenants, with nearly 50% of the portfolio leased out to investment grade tenants.

Here is a look at the REITs top tenants based on annual base rent:

Here is a look at the REITs diversification by property type:

The company has expanded internationally over recent years, and they have been pursuing the gaming sector a lot more as well.

Although it is not included in the diversification table above, the company recently announced a $950 million investment in the Bellagio on the Las Vegas strip, creeping further into VICI Properties territory.

Realty Income is more well-known for their monthly dividend, after all the company has coined themselves "The Monthly Dividend Company."

The REIT is a dividend aristocrat that has hiked their dividend for 29 consecutive years. Realty Income currently yields a high dividend of 6.0%, which is unheard of for this REIT in particular.

As you can imagine with the pullback in shares, valuation looks very intriguing at current levels.

Interest rates will continue to weigh on the sector, but for long-term investors and given that the hiking cycle is nearing the end, now seems like a great entry point.

Analysts are expecting Realty Income to generate AFFO of $4.16 per share next year, which equates to a P/AFFO of just 11.9x.

This is a REIT that on average trades at a multiple above 19x for the past decade plus.

Dividend Aristocrat #3 - Coca-Cola Company

Realty Income is a REIT we just looked at that had a share price falling, and the Coca-Cola Company (KO) has been in the same boat.

The largest beverage company in the world has seen their share price fall 12% since late July, and is in-line with the stock's performance for all of 2023.

KO currently has a market cap of $241 billion.

Defensive stocks have not been a focus for investors in 2023, preferring higher growth and risk on type assets instead.

Coca-Cola is an iconic American company with a global reach. The company continues to generate growth and do so at an efficient rate. Here is a look at the company's EBITDA over the past five years:

• 2022: $13,510
• 2021: $12,890
• 2020: $11,535
• 2019: $11,996
• 2018: $11,289

EBITDA has climbed nearly 20% from 2018 to 2022.

When analyzing the safety of a dividend, one of the key things to look at is how much free cash flow the company is able to generate.

In the case of KO, they generated $9.5 billion in FCF in 2022, which equates to $2.19 per share.

KO pays a dividend of $1.84 per share, which means they have a FCF payout ratio of 84%. This is certainly on the higher side, but also more typical for companies that have been increasing their dividend for as long as Coca-Cola has. Something to certainly keep an eye on.

The company generated $4 billion in FCF through the first half of 2023, of which $2.1 billion was used to pay dividends and another $1 billion was used to buy back stock. The company prioritizes returning money to shareholders.

KO is not only a dividend aristocrat, but they are also a dividend king as they have hiked their dividend for more than 60 years. Shares currently yield a dividend of 3.3%.

In terms of valuation, analysts are estimating 7% EPS growth in 2024 to $2.83 per share.

Using this estimate, shares of KO trade at forward earnings multiple of 19.7x, similar to the current multiple for the S&P 500.

However, over the past decade, shares of KO are accustomed to trading at an average multiple of 23.9x, suggesting shares are currently undervalued.

In Conclusion...

There's a lot of competition for dividend stocks these, as illustrated by the Dividend Aristocrats (NOBL) below:

Not all of the Aristocrats have struggled...

Caterpillar (CAT) is up over 15%:

And Sherwin-Williams (SHW) is up over 7.5%:

However, the three companies referenced in this article are, pound for pound, some of the best Aristocrats in town:

A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world. - Seth Klarman

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