Debt is often thought of as something to be avoided at all costs, but companies that use debt wisely can grow their business. At the same time, investors need to be aware of how much debt a company is carrying as this can be a foreshadowing of trouble down the road.
One way to quickly evaluate a company’s debt is to use the debt-to-equity ratio. This ratio divides the total debt a business owes by its shareholder equity. For example, if a company has $3 billion of debt and $1.5 billion of shareholder equity, then the debt-to-equity ratio is 2.0.
Generally speaking, a debt-to-equity ratio below 2 is considered to be healthy. In an effort to identify high-quality businesses, we will examine three companies with a debt-to-equity ratio below 1.0. In addition, each of these names is a member of the Dividend Aristocrat index, meaning that they have raised their dividends for at least a quarter of a century.
Atmos Energy
Atmos Energy Corp. (ATO, Financial) distributes and markets natural gas to more than three million customers in eight U.S. states. The company is valued at $12.7 billion and generated revenue of $2.8 billion in its fiscal year 2020, which ended Sept. 30.
Atmos Energy has a debt-to-equity ratio of 0.94. According to GuruFocus, this ratio is below 53% of the 485 companies in the regulated utility industry. That said, the ratio is near the lower end of Atmos Energy’s 10-year range.
The company has raised its dividend for 37 consecutive years, earning it membership within the Dividend Aristocrat index. Atmos Energy has a dividend compound annual growth rate (CAGR) of 5.3% over the last decade. Shares yield 2.6% currently, which is below the stock’s 10-year average yield of 2.9%, but superior to the five-year average yield of 2.2%. Atmos Energy’s yield is also more than a full percentage point higher than the 1.3% average yield of the S&P 500 index.
According to Yahoo Finance, Wall Street analysts expect that Atmos Energy will report earnings per share of $5.11 in fiscal year 2021. With a recent closing price of $97.11, shares have a forward price-earnings ratio of 19. This matches the stock’s 10-year average price-earnings ratio of 19.
Atmos Energy is trading below its intrinsic value according to the GuruFocus Value chart.
With a GF Value of $106.54, Atmos Energy has a price-to-GF-Value ratio of 0.91 using the current price. Shares would return 9.7% were they to reach the GF Value. Adding in the dividend, total returns would be in the low double-digit range.
Atmos Energy’s debt-to-equity ratio is in the middle of the pack for its industry, but at the low end of the company’s long-term performance. The company also has a strong dividend growth history and appears to be undervalued against its intrinsic value. A solid debt-to-equity ratio combined with total return possibilities make Atmos Energy an intriguing option for investors looking for exposure to the utility sector.
Cincinnati Financial
Cincinnati Financial Corp. (CINF, Financial) is an insurance company that specializes in property, life and health insurance. The company is valued at $19 billion and had revenue of $6.6 billion last year.
The company has an extremely low debt-to-equity ratio of 0.08, topping more than 69% of the 378 companies in the insurance industry. This mark is also closer to the low end of Cincinnati Financial’s decade-long historical range.
At 60 years, Cincinnati Financial has one of the longest dividend growth streaks in the entire market. Cincinnati Financial is a member of the Dividend Kings, a group of 31 companies with at least five decades of dividend growth. The dividend has compounded at a rate of 4.1% per year since 2011. Shareholders are being paid a 3.8% yield to own the stock, which is superior to the stock’s five- and 10-year average yields of 2.8% and 3.5%, respectively.
Cincinnati Financial is projected to earn $4.40 per share this year. Shares finished the week at $117.84, giving the stock a forward price-earnings ratio of 26.8. Excluding 2011 due to a severe decline in earnings per share, Cincinnati Financial has an average price-earnings ratio of 20.6 over the last decade, implying that the forward multiple places the stock in overvalued territory compared to its historical average.
However, Cincinnati Financial is trading below its GF Value.
Cincinnati Financial has a GF Value of $123.45, resulting in a price-to-GF-Value ratio of 0.95. Shares could climb 4.8% from current levels, giving shareholders a total return of more than 8% when factoring in the dividend.
The company also enjoys a very low debt-to-equity ratio that outperforms the vast majority of its peer group. Despite an 82% increase in share price over the last year, Cincinnati Financial still pays a very handsome yield that tops even its own historical averages. Investors looking for a stable income name in the insurance industry could do well owning Cincinnati Financial.
Walmart
Walmart Inc. (WMT, Financial) is the largest retail chain in the world with more than 5,300 stores in the U.S. and an additional 6,100 stores around the globe. The company welcomes more than 230 million customers to its stores every week. Walmart is valued at just under $393 billion and produced revenue of $555 billion in 2020.
Walmart’s debt-to-equity ratio of 0.80 is almost exactly in the middle of the 276 companies in the defensive retail industry. The ratio is slightly above the median of its 10-year range. Even so, the debt-to-equity ratio remains low enough that I am not very concerned about this metric.
The company has grown its dividend for 48 consecutive years, placing Walmart within striking distance of attaining Dividend Kings status. Walmart’s dividend has a CAGR of 3.6% over the last 10 years. The yield of 1.6% is below both its five-year average yield of 2.2% and its 10-year average yield of 2.4%. Averaging this yield for an entire year would tie last year’s average yield for the lowest since 2006. Still, Walmart’s yield is above that of the S&P 500 index.
Analyst expect Walmart to earn $5.97 per share this year. Using Friday’s closing price of $140.11, Walmart has a forward price-earnings ratio of 23.5. Though the stock has averaged a 20+ earnings multiple over the past few years, the long-term average price-earnings ratio is just over 17.
Walmart also sits above its intrinsic value according to the GF Value chart.
Walmart’s GF Value is $128.29 currently, giving the stock a price-to-GF-Value ratio of 1.09. Shares would decline 8.4% if it were to trade with its GF Value.
Walmart’s debt-to-equity ratio is very low even if it is somewhat higher than usual for the company. That said, the company has a long history of dividend growth, though the yield isn’t as robust as investors are accustomed to. The stock looks ahead of itself both using the company’s historical price-earnings ratios as well as its intrinsic value. Therefore, I would wait for a pullback prior to adding Walmart to my portfolio.
Final thoughts
The debt-to-equity ratio can give investors a quick snapshot of a company’s debt burden, helping investors separate high-quality companies from those that could be in financial trouble.
Atmos Energy, Cincinnati Financial and Walmart all have a debt-to-equity ratio below 1.0. This has undoubtedly played a key role in each company’s ability to grow its dividend over long periods of time. At current prices, Atmos Energy looks to have the highest total return potential, followed by Cincinnati Financial. Walmart looks pricey, but not to a severe extreme. In any case, Atmos Energy, Cincinnati Financial and Walmart all appear to be on sound financial footing and have paid a growing dividend to shareholders for decades, making each name a high-quality investment in my opinion.
Author disclosure: the author has no position in any stock mentioned in this article.
Become a Premium Member to See This: (Free Trial):
