(Published by Nick McCullum on July 20)
The law of large numbers tells us that business growth tends to slow down as a company becomes larger in size.
Accordingly, it is rare for large businesses to grow their revenues at double-digit percentage rates.
Dover Corp. (DOV, Financial) is an exception to this rule. Dover has a market capitalization of ~$13 billion, firmly entrenching it in the universe of large-cap Standard & Poor's 500 stocks.
Despite its size, Dover is growing at a rapid rate. The company’s recent second quarter earnings release reported 18% revenue growth, and the company increased its full-year revenue growth guidance to 12% to 14%.
Dover stands out because it is an exceptionally shareholder-friendly business. With 61 years of consecutive dividend increases, Dover is a Dividend Aristocrat and a Dividend King, which are groups of stocks with 25-plus and 50-plus years of consecutive dividend increases.
Dover’s strong recent financial performance with its spectacular dividend history make it appealing to dividend growth investors.
Business overview and current events
Dover is a diversified industrial manufacturer with a market capitalization of approximately $13 billion.
Founded in 1955 in New York, Dover is presently headquartered in Downers Grove, Illinois, and has more than 26,000 employees.
Dover is divided into four distinct operating segments for reporting purposes:
- Engineered Systems ($2.5 billion of expected 2017 revenue).
- Fluids ($2.3 billion of expected 2017 revenue).
- Refrigeration & Food Equipment ($1.6 billion of expected 2017 revenue).
- Energy ($1.4 billion of expected 2017 revenue).
More details about each operating segment can be seen below.
Source: Dover Corp. Midyear Investor Presentation, slide 6
As mentioned in the introduction, Dover recently reported excellent financial results for the second quarter of fiscal 2017.
Here are a few operational highlights:
- Quarterly revenue up 18% year over year.
- Diluted EPS up 37% year over year.
- Increased full-year revenue growth forecast to 12% to 14%.
- Increased EPS guidance to $4.23 to $4.33 from $4.05 to $4.20.
Additional details about Dover’s second quarter can be seen below.
Source: Dover Corp. Second Quarter Earnings Presentation, slide 3
There was no single driver of Dover’s impressive performance. Rather, the company’s strong results were driven by broad-based organic growth and the impact of previous acquisitions.
The only operating segment that experienced notable organic growth was the energy segment. This was certainly because of rebounding oil prices over the same period a year ago.
Source: Dover Corp. Second Quarter Earnings Presentation, slide 4
Fundamentally, this has driven continued improvement in U.S. rig counts as well as increased well completions. This benefits Dover as it increases Bearings & Compression sales.
Source: Dover Corp. Second Quarter Earnings Presentation, slide 8
All said, it was "business as usual" at Dover, with the company’s performance experiencing a tailwind from rebounding oil prices.
We continue to view Dover as one of the most well-managed industrial manufacturing firms, holding appeal for long-term investors at the right prices.
Growth prospects
Dover’s recent torrid pace of growth shows no sign of slowing down.
Roughly half of the company’s future growth is expected to be generated internally.
The company’s management team does a phenomenal job of communicating the growth opportunities of each specific operating segment in the following slide.
Source: Dover Corp. Midyear Investor Presentation, slide 7
Across the entire Dover enterprise, the positive effects of geographic expansion will continue to be felt as the company grows.
Right now, developing economies are contributing less than 20% of Dover’s revenue.
The company will also continue to benefit from product innovation and an increase in recurring revenue, which contributes ~30% of Dover’s top line.
Source: Dover Corp. Midyear Investor Presentation, slide 8
Dover’s quantitative future growth prospects can be assessed by considering the company’s long-term earnings-per-share trajectory, which is shown below.
Source: Value Line
Even despite the company’s poor performance in recent years, Dover has still managed to compound its adjusted earnings per share at a rate of 9.6% since 2001.
Over full economic cycles, Dover is likely to continue delivering the same level of 8% to 10% earnings growth, though growth may be even faster in the near term if oil prices continue to rebound to previous highs after experiencing lows in 2016.
Competitive advantage and recession performance
Dover’s competitive advantage comes from being one of the largest diversified industrial manufacturers in the industry. This allows the company to realize significant cost synergies, permitting it to increase profits and reinvest cash flow in future growth projects.
With that said, Dover is sensitive to swings in the global economy. The company is not the most recession-resistant Dividend Aristocrat.
Dover’s adjusted earnings-per-share performance during the last recession can be seen below.
- 2007 adjusted earnings per share: $3.22.
- 2008 adjusted earnings per share: $3.67 (14.0% increase).
- 2009 adjusted earnings per share: $2.00 (45.5% decrease).
- 2010 adjusted earnings per share: $3.48 (74% increase).
- 2011 adjusted earnings per share: $4.49 (29% increase – new high).
Dover’s earnings fell sharply during the Great Recession but rebounded shortly afterward. Accordingly, do not expect this security to be your portfolio’s best performer during future recessions.
Valuation and expected total returns
The trouble with investing in high-growth businesses like Dover is that often these companies carry excessively high valuations, which reduces future investor returns even if the underlying business continues to grow at an adequate pace.
“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.” – Warren Buffett
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Accordingly, it is very important to perform a detailed valuation analysis before blindly investing in an expanding company like Dover.
Dover is currently trading at $84.15 on the New York Stock Exchange. Using the company’s 2016 adjusted earnings per share of $3.25, Dover is trading at a price-earnings (P/E) ratio of 25.9. This is a rather rich valuation for an industrial company, even in today’s overheated stock market.
With that said, Dover’s financial performance is expected to rebound significantly in the coming year. In its second-quarter earnings release, Dover updated fiscal 2017 earnings guidance. The company now expects earnings-per-share of $4.23 to $4.33 for full-year 2017, a significant increase from 2016’s $3.25 figure.
Using the midpoint of the new 2017 guidance range ($4.28) combined with Dover’s current stock price of $84.15 gives a P/E ratio of 19.7. A P/E ratio of ~20 is reasonable for a high-quality business like Dover, and it is likely trading somewhere near fair value based on 2017’s earnings.
With that said, it’s important to consider the company’s typical valuation before making an investment.
The following diagram compares Dover’s current valuation (using both 2016 earnings and 2017’s expected earnings) to its long-term historical average.
Source: Value Line
Dover’s average P/E ratio since 2001 is 19.4. The company is trading around that level right now, which suggests it may be a buy for long-term investors.
Since Dover is trading near fair value, valuation changes are unlikely to have a meaningful effect on shareholder returns moving forward.
Instead, returns will come from earnings-per-share growth combined with the company’s dividend yield.
Dover stands a good chance of delivering 8% to 10% growth over full economic cycles. In addition, the company’s dividend yield is currently 2.1%, slightly above the average dividend yield in the S&P 500 index.
So, in aggregate, Dover’s future shareholder returns will be composed of:
- 8% to 10% earnings-per-share growth.
- 2.1% dividend yield.
For expected total returns of 10.1% to 12.1% before the impact of valuation changes.
Final thoughts
Dover has many of the characteristics of a high-quality business:
- Long history of steadily increasing dividends.
- Impressive revenue growth.
- Earnings growth that exceeds revenue growth, which indicates disciplined cost management.
All said, Dover’s fundamental business is appealing for long-term investors.
The company’s valuation is also reasonable, although it is not a screaming buy at today’s prices. Buying high-quality businesses at or near fair value and holding them for the long run has tremendous potential to build long-term wealth.
With that in mind, Dover is a potential buy for investors with long (five-plus years) time horizons.
Disclosure: I am not long any of the stocks mentioned in this article.
