Payback is the amount of time needed for an investment to earn its cost, undiscounted. Years ago as a young analyst, I was assigned the project of streamlining my employers' acquisition model. As part of this project, I removed the payback calculation. The company's focus was on discounted cash flow and internal rate of return, so I didn't see the need for a payback metric. No one noticed the missing payback calculation, that is, no one except the CEO.
Needless to say, I was a little nervous making the long walk to the corner office to explain why I had removed a metric that he considered both beneficial and important. The CEO's background was not financial, but he had a keen understanding of finance. He was kind in his explanation of how he used payback.
When looking at a 40-year project with literally hundreds of assumptions, payback helped him gauge the risk of missing those assumptions. If the assumptions were little aggressive and the payback was 20 years, the project's sponsor would get a lot of tough questions. A shorter payback and less aggressive assumptions normally indicated a lower risk project.
Applying payback to dividend growth stocks is a little more complicated due to the annual dividend increases. Nothing that can't be quickly modeled in a spreadsheet. Payback is one of the metrics tracked in my database. Companies with a very short payback are often troubled or have been highly discounted due to the market's lack of faith in them. At the other extreme, do you really want to wait 30, 40 or 50 years to earn back your initial investment? As a compromise, a 9 to 13 year payback should be acceptable for most long-term investors.
Once you earn back your investment, some might say you are in a no-lose situation. I wouldn’t go quite that far, but you do have an investment that that has provided a good historical revenue stream, and hopefully it will continue to do so in the future.
This week week, I screened my dividend growth stocks database for select stocks with a 10 to 13 year payback (at the current yield and dividend growth rate) and yield of 3% or more. The results are presented below:
Watsco Inc. (NYSE:WSO) is the largest U.S. distributor of air-conditioning, heating and refrigeration equipment, and related products.
Yield: 3.1% | Payback Years: 11.7
Nucor Corporation (NYSE:NUE) is the largest minimill steelmaker in the U.S., Nucor has one of the most diverse product lines of any steelmaker in the Americas.
Yield: 3.3% | Payback Years: 11.2
ConocoPhillips Co. (NYSE:COP), formed via the 2002 merger of Phillips Petroleum and Conoco, is the fourth largest integrated oil company in the world, and second largest in the U.S.
Yield: 3.5% | Payback Years: 11.0
Meredith Corp. (NYSE:MDP) derives its earnings mainly from magazine publishing (primarily Better Homes and Gardens and Ladies' Home Journal) and ownership of 12 TV stations.
Yield: 3.7% | Payback Years: 12.2
Avista Corp. (NYSE:AVA) generates, transmits and distributes energy as well as engages in energy-related businesses. The company operates in two business segments.
Yield: 4.4% | Payback Years: 12.1
Unisource Energy (UNS), through Tucson Electric Power Co., provides regulated electric service to over 403,000 retail customers in southeastern Arizona.
Yield: 4.5% | Payback Years: 12.5
TC PipeLines LP (NYSE:TCP) has interests in 5,560 interstate natural gas pipelines, including a 46.5% stake in Great Lakes Gas Transmission L.P.
Yield: 6.5% | Payback Years: 12.2
Senior Housing Properties Trust (NASDAQ:SNH), a real estate investment trust (REIT), primarily invests in senior housing properties.
Yield: 6.8% | Payback Years: 12.2
Buckeye Partners LP (NYSE:BPL) is one of the largest independent U.S. pipeline common carriers of refined petroleum products, with over 6,000 miles of pipeline.
Yield: 6.8% | Payback Years: 10.0
Corporate Office Properties (NYSE:OFC) is a real estate investment trust that owns, manages, leases, acquires and develops suburban office properties located in Mid-Atlantic region of the U.S. and other select markets.
Yield: 6.8% | Payback Years: 11.7
Suburban Propane Partners LP (NYSE:SPH) is a limited partnership that markets propane gas and other refined fuels to residential, commercial, industrial, and agricultural customers.
Yield: 6.8% | Payback Years: 12.2
As with past screens, the data presented above is in its raw form. Some of the the companies would be disqualified for poor dividend fundamentals. However some of the others may be worth additional due diligence.
My database, D4L-Data, is an Open Office spreadsheet containing more than 20 columns of information on the 210+ companies that I track. The data is sortable and has built-in buttons and macros to make it easy to use. Companies included in the list are those that have had a history of dividend growth. The D4L-Data spreadsheet is a part of D4L-Premium Services and is updated each Saturday for subscribers.
Full Disclosure: Long COP, NUE in my Dividend Growth Portfolio and long AVA, SNH, MDP, UNS, in my High-Yield portfolio. See a list of all my dividend growth holdings here.
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