2 Overvalued Dividend Aristocrats to Buy on a Pullback

A look at 2 dividend growth stocks I would like to own more of - at lower prices

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Nathan Parsh
Mar 29, 2021
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The Dividend Aristocrats are those stocks in the S&P 500 that have raised dividends for a minimum of 25 consecutive years. Attaining membership in this exclusive group is not easy as just 65 companies are in the Dividend Aristocrats.

Companies in this index have managed to grow dividends for at least a quarter of a century because their business models work in all portions of the economic cycle. They often provide goods or services that customers cannot do without, even in a recession.

The market as a whole is expensive at the moment, as evidenced by the S&P 500's trailing twelve-month price-earnings ratio of 39. Many Dividend Aristocrats are also trading at an elevated valuation. I have no issue over paying for quality, and 25+ years of dividend growth is quality to me, but I would prefer to make additions to my portfolio at lower prices.

In this article, we will examine two of my favorite Dividend Aristocrats that I would like to own more of a better price.

Automatic Data Processing

Automatic Data Processing (

ADP, Financial) is a global leader in the area of business services outsourcing. The company offers human resource technology, payroll services and various other business operations. Automatic Data Processing has more than 700K corporate customers, generated revenue of $14.6 billion over the last four quarters and has a market capitalization of $82.5 billion.

Covid-19 has been a headwind for the company given the job losses that have taken place over the last year or so as a result of the pandemic. Still, Automatic Data Processing's most recent quarter showed a 1% increase in revenue from the prior year. The prior two quarters saw declines of 0.7% and 3.5%, respectively, showing that the underlying business has remained resilient.

Given its relative strength in difficult times, it is not surprising then that Automatic Data Processing has flourished under much better circumstances. Earnings per share have compounded at a rate of 9% over the last 10 years. Share repurchases have aided this growth slightly, but net income has still improved at a rate of 7.4% annually over the last decade.

This strong growth has generally led to excellent dividend growth as well. Shareholders have received a dividend increase for 46 years following a 2.2% raise for the upcoming April 1 payment. The most recent raise is well below the 9.5% average increase from 2011 to 2020. Given the uncertain environment, this smaller increase appears sensible. Shares yield 1.9% today, which is below the 10-year average yield of 2.5%.

Shareholders have enjoyed a 41% gain over the last year, which has elevated the valuation. The stock closed Friday's trading session at $192.69. According to Wall Street analysts surveyed by Yahoo Finance, Automatic Data Processing is expected to earn $5.93 in fiscal 2021 (the company's fiscal year ends June 30), equating to a forward price-earnings ratio of 32.5. Shares have typically traded with a premium valuation, with an average multiple of 25.3 times earnings over the last 10 years. To put the current valuation in context, this would be Automatic Data Processing's highest price-earnings ratio since at least 2004 if averaged for the whole year.

The stock is also trading in excess of its intrinsic value as calculated by the GuruFocus Value chart.

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Automatic Data Processing has a GF Value of $163.84 at present, giving shares a price-to-GF-Value ratio of 1.18 using the most recent closing price. Reverting to its GF Value would mean a 15% decrease from current levels. As you can see in the chart above, Automatic Data Processing hasn't been this far above its GF Value in quite some time. The stock is rated as modestly overvalued by GuruFocus.

I don't mind overpaying for stocks with sound business models and lengthy dividend growth streaks, but I would prefer a lower price in Automatic Data Processing due to its forward earnings multiple and elevated price-to-GF-Value ratio. We have purchased Automatic Data Processing three times since late September of last year at an average price of $150. Closer to that price and we would be buyers again.

McDonald's

McDonald's Corporation (

MCD, Financial) is one of the largest quick service restaurants in the world, with nearly 39,000 locations globally. The vast majority of restaurants are independently owned and operated. McDonald's has a market capitalization of $168 billion and produced revenue of $19.2 billion in 2020.

McDonald's has also felt the sting of the Covid-19 pandemic as sales fell 10% last year, with the decline more severe in company-owned stores (approximately ~7% of total stores). Much of the weakness was felt in international markets, especially in Europe.

Overall, comparable sales fell 7.7% in 2020. Sales in the U.S. were slightly better as same-store sales were up 0.4%. The last two quarters showed growth of 5.5% and 4.6%, respectively, showing that there is demand for the company's offerings.

McDonald's earnings per share have a CAGR of just 1.4% over the last 10 years. This, of course, includes last year's results, which were severely impacted by the pandemic. Looking at 2010 to 2019, the growth rate expands to 7.4% as the company's innovations, like all day breakfast, have allowed McDonald's to see significant growth over the last few years. The refranchising of more than 90% of its restaurants have also allowed the company to transition to an asset-light business while lowering its costs. Analysts do expect McDonald's to make a major recovery in 2021, with average earnings per share estimates of $8.44.

McDonald's has a long history of dividend growth. After raising its dividend 3.2% in October of last year, the company has 45 consecutive years of dividend growth. Dividend growth since 2011 is 7.1%. McDonald's offers a 2.3% yield at the moment, compared to its 10-year average yield of 2.9%.

Shares of the company have gained 35% over the last year. The stock closed the week trading at $225.21, giving McDonald's a forward price-earnings ratio of 26.7. This is higher than the 10-year average price-earnings ratio of 21.4, but much closer to the five-year average price-earnings ratio of 24.6.

The stock trades at a much steeper premium to its GF Value:

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McDonald's has a GF Value of $186.51, resulting in a price-to-GF-Value ratio of 1.21 based off the most recent market close. Shares would have to decline more than 17% to trade in-line with its GF Value. As with Automatic Data Processing, McDonald's is considerably higher than its GF Value. The stock is also rated as modestly overvalued.

As stated above, I don't mind paying above fair value for companies performing well and demonstrating a long track record of dividend growth. I added to my position in McDonald's in early December of last year at $208 and it could be stated that the stock wasn't cheap then either. However, shares are higher than I am willing to pay at the moment. A reversion closer to $200 and I would consider buying more of McDonald's.

Final thoughts

When it comes to investing, quality often comes at a price. Both Automatic Data Processing and McDonald's are leaders in their respective sectors. Both names faced some headwinds from the Covid-19 pandemic, but have enjoyed long-term growth. Each company has almost five decades of dividend growth as well, something that very much appeals to income orientated investors.

That said, both stocks trade above their long-term historical average valuations as well as with a premium to their GF Value. While I want to own more of both stocks, I also would prefer a lower price point. I would be a buyer of both names on a pullback, but I view both Automatic Data Processing and McDonald's as a hold today due to valuation.

Author disclosure: the author maintains a long position in Automatic Data Processing and McDonald's.

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I am originally from the Detroit, Michigan area, before moving to Maryland to begin a career as an educator. This is my 15th year teaching. My wife and I have two young children who keep us on our toes.