Are The Dividend Aristocrats Overvalued Now?

Inflation is running at a multi-decade high, the US economy is in a recession, and there are several macro troubles brewing, including the Russia-Ukraine war and a potentially escalating Taiwan conflict. Equity markets are volatile, but fixed-income investments such as treasuries do not seem like a good choice, either.

Investors that want solid inflation protection and resilience versus recessions may be interested in the Dividend Aristocrats, a group of stocks that have managed to raise their dividends for at least 25 years in a row.

Since that means that these companies must have raised their payouts even during the pandemic, the Great Recession, the bursting of the dot com bubble, and so on, the average Dividend Aristocrat must have above-average resilience characteristics.

Depending on the individual Dividend Aristocrat, the reasons for this resilience are different. Some are active in very non-cyclical industries, such as consumer staples -- think beverages (Coca-Cola (KO)) or tobacco, where Altria (MO) and Philip Morris (PM) are noteworthy examples. In other cases, the resilience stems from wide-scale diversification, which is the case with 3M (MMM), for example, thanks to the company's more than 60,000 different products that it sells in 200 countries.

The Dividend Aristocrats also naturally must have solid management teams with a longer-term focus and a fitting corporate culture -- otherwise, their success over several decades wouldn't be possible. That being said, there is no guarantee that Dividend Aristocrats will continue to raise their payouts forever. Once in a while, a Dividend Aristocrat reduces the dividend or fails to raise it, which forces them to lose their Dividend Aristocrat status. AT&T (T) is an example of a former Dividend Aristocrat that has lost this status due to reducing its dividend as part of the spin-off of its media business.

Dividend Aristocrats in general can thus be compelling longer-term investments for investors that seek reliable income and below-average vulnerability to recessions and other macro shocks. That being said, not all of the Dividend Aristocrats are necessary a buy at a specific time -- valuations should be considered.

Are The Dividend Aristocrats Too Expensive?

There are currently 65 Dividend Aristocrats, and looking at the valuations of all of these would be excessive. We can look at a couple of noteworthy examples and at the Dividend Aristocrat ETF (NOBL) in order to gauge whether now is a good or bad time to invest broadly in the Dividend Aristocrat universe.

Based on the payout over the last twelve months, the Dividend Aristocrat ETF that owns positions in all 65 individual Dividend Aristocrats offers a dividend yield of 1.94% right now. That is almost perfectly in line with the longer-term average, as the ETF's dividend yield has been fluctuating around the 2% level in recent years. During bear markets, the yield is higher, which implies an especially good time to buy, whereas the yield is lower during times when the market is on the euphoric side.

Today, the ETF seems relatively fairly valued as its current dividend yield is pretty much in line with the historic average. The Dividend Aristocrat ETF, which serves as a proxy for the Dividend Aristocrats as a group, is currently trading around 10% below its 52-week high while also trading around 10% above its 52-week low. This, again, suggests a relatively fair valuation -- it is neither an especially favorable nor an especially unfavorable time to enter a position here.

We can also look at the top Dividend Aristocrats by market capitalization. The top 5 companies are Johnson & Johnson (JNJ), Exxon Mobil (XOM), Walmart (WMT), Procter & Gamble (PG), and Chevron (CVX), which have raised their dividends for 50 years in a row, on average.

Looking at the enterprise value to EBITDA multiples of these five companies, the largest Dividend Aristocrats, we see that they are trading around fair value, on average. Looking at EV/EBITDA instead of the earnings multiple (P/E ratio) has the advantage to account for changes in debt usage.

By that metric, Johnson & Johnson is trading in line with its 10-year median valuation, while Walmart and Procter & Gamble are trading around 20% above the historic average today. Exxon Mobil and Chevron, on the other side, trade at discounts to their historic valuation norm right now. This is partially due to their above-average profitability in the current environment, as they benefit from high oil and natural gas prices.

One can argue that this distorts the picture to some degree, which is why we can also look at the next two largest Dividend Aristocrats instead of Exxon Mobil and Chevron. Those would be AbbVie (ABBV) and PepsiCo (PEP). Looking at their respective enterprise value to EBITDA multiples, AbbVie seems to be undervalued by around 30% relative to the historic valuation norm, while PepsiCo is trading at a 20% premium relative to how it used to trade in the past.

Looking at the current share price relative to the highs and lows over the last year, the top 10 Dividend Aristocrats (the aforementioned plus McDonald's (MCD) Abbott Laboratories (ABT), and Coca-Cola (KO)) trade 24% above their 52-week lows and 15% below their 52-week highs. The individual stocks are more volatile than the Dividend Aristocrats ETF, of course, which is why there are bigger variances here.

We can thus summarize that the largest Dividend Aristocrats are generally not trading too far off their historic valuations. Some are trading a little ahead of where they were trading historically, while the two energy names are trading at discounts compared to the past. Overall, this aligns relatively well with the conclusion from looking at the dividend yield of the group -- the Dividend Aristocrats are trading broadly in line with their historic valuations. They do not seem overly expensive, nor are the Dividend Aristocrats an especially attractive bargain today.

That being said, there are always single Dividend Aristocrats that trade well below or well ahead of fair value. Looking for these individual picks can pay off, as determining which Dividend Aristocrat is trading at an especially attractive valuation at a specific time allows investors to beat the broader market, and the broad Dividend Aristocrat group, over time. Today, V.F. Corporation (VFC) and 3M are among the noteworthy stocks due to their pretty low valuations that make us believe that they have a high chance of delivering outsized returns in the 14%-18% range going forward.

This guest article was written by our friends at Sure Dividend.