Due to the timing of contributions to our IRAs, my wife and I were able to make three new stock purchases over the last two weeks. We invest nearly all of our retirement capital in dividend growth stocks, as we plan to live off dividend income when we are able to retire in 20 years or so.
When selecting investments, we look at dividend growth stocks stocks trading below the 10-year average valuation, which gives a margin of safety. Here are the purchases we made and our reasons for doing so.
Pfizer
We purchased shares of Pfizer Inc. (PFE, Financial) on April 30 at the price of $38.15, just a few days after the company had reported its first quarter earnings results.
Pfizer had declines on the top and bottom-line in Q1, but this was primarily due to the company’s consumer healthcare division joint venture with GlaxoSmithKline (GSK, Financial). Accounting for this, revenue was lower by 1% year-over-year.
What we liked about the company is that it had 12% operational growth form its Biopharma segment. Notable in this segment was a 29% overall increase in sales for Eliquis, with sales volume growing 34% in the U.S. alone. Ibrance improved profits 11% overall, with a 25% volume growth in international markets and a 15% increase in sales in the U.S. The Covid-19 pandemic had a positive impact on sterile injectables, which were higher by 15%.
As discussed in one of my previous articles on GuruFocus, Pfizer has a long history of paying dividends. Though the company cut its dividend in 2009 and 2010 as it completed its $68 billion purchase of Wyeth, Pfizer has increased its dividend for 10 consecutive years. In total, the company has raised its dividend 51 out of the last 53 years. Shares yielded 4% at the time of our purchase, slightly above the 10-year average yield of 3.7%.
Using our purchase price and predicted earnings-per-share of $2.86, shares traded at a forward price-earnings ratio of 13.3. This is a significant discount to the 20.3 price-earnings ratio that shares have traded at over the last decade. Even removing two years where the valuation was unusually elevated (2015 and 2016) drops this ratio to 18.1.
Raytheon Technologies Corporation
We also purchased Raytheon Technologies Corporation (RTX, Financial) at $64.89. The current company came to be by way of an April 3 merger between Raytheon Corporation and United Technologies. The new company would have had $74 billion of sales in 2019, which would have made it the second largest seller of defense products in the world.
Raytheon Technologies reported essentially flat sales in the first quarter, though this beat estimates by $720 million. Earnings-per-share beat estimates by $0.45.
Raytheon Technologies’ Pratt & Whitney segment grew 11%, while Commercial Aftermarket increased 4%. The Collins Aerospace segment was down 1%, but had 10% growth in military sales. The legacy Raytheon segments added a combined $7.4 billion in sales for the quarter. These segments had especially strong bookings in the quarter as the company ended March with a record backlog of $51.3 billion. This was a 25% improvement from the previous year.
I am very bullish on the aerospace and defense sector long-term, especially the defense portion. Many of these contracts have a long project life, and a downturn in the economy isn’t likely to lead to a cancelation of deals.
Prior to the merger, United Technologies had 26 years of dividend growth and Raytheon had 15. The new company yielded 2.9% at the time of our purchase. Since we added to our position, the stock has decreased nearly 17% in value. The current yield is nearly 3.4%.
Analysts expect Raytheon Technologies to generate $3.49 per share in 2020. At our purchase price, this equates to a price-earnings ratio of 18.6. This is not a cheap multiple compared to other defense contractors. We were willing to buy at this multiple, as Raytheon Technologies was the smallest holding in our portfolio and we have wanted to increase its size for some time.
The stock closed Wednesday’s trading session at $54.10. Had we waited to buy until then, we would have paid a price-earnings ratio of 15.5 for the stock. The current valuation is much more attractive than it was two weeks ago, and Raytheon Technologies remains high on my watch due to the business model and dividend yield.
Aflac Incorporated
We added to our Aflac Inc. (AFL, Financial) position on May 13 at $32.21. The company had a decline on both the top and bottom-line in the first quarter. A major contributor to the decline was a tough year-over-year comparison, as Q1 2020 had significant investment losses while Q1 2019 had a high return on investments. Adjusting for this, earnings-per-share actually increased 8%.
Aflac has increased its dividend for 38 consecutive years. Even with 70% of earnings coming from Japan and results subject to currency exchange, the company hasn’t failed to raise its dividend for nearly four decades.
Aflac’s stock has been hit hard from the market sell-off related to the pandemic. The dividend yield was a robust 3.5% at the time of our purchase. For comparison purposes, the stock has averaged a 2.4% yield over the last 10 years.
We also thought that the stock was extremely undervalued compared to its historical average. Using our purchase price and estimates of $4.34 in earnings-per-share for 2020, the stock has a forward price-earnings ratio of 7.4. This compares quite favorably to the 10-year average price-earnings ratio of 10.2. The last time Aflac averaged a valuation this low was in 2012.
Final thoughts
As dividend growth investors, we are always looking to add to companies with long track records of dividend growth. Even better, we prefer to buy them when they offer a solid yield and a decent valuation.
Pfizer and Aflac fit both criteria in our opinion, making purchasing both names rather easy for us. Raytheon Technologies, which did offer a solid yield, was expensive at the time of purchase, but that buy was perhaps too much influenced by our desire to increase the size of the holding, providing an example of confirmation bias. However, we like the company long-term and think it is more fairly valued after its recent price drop.
Author disclosure: The author is long Aflac, Pfizer and Raytheon Technologies.
Read more here:
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