The US stock market is rich with dividend aristocrats

Think of this as the continuing soap opera that chronicles the transformation of the Bearbull Income Portfolio, an ageing income portfolio whose long-term performance is better than its past five years. To address this, the fund must shift its outlook from UK-focused to truly international. The first steps have been taken with a capital injection and the acquisition of funds covering Europe and Asia. Now for North America, the world’s most important equity markets.

For starters – and partly because it side-steps the bother of selecting individual stocks – there is much to be said for an exchange-traded fund (ETF) from US asset manager State Street, S&P US Dividend Aristocrats (USDV). This tracks an index of 121 US-listed companies that have earned the ‘aristocrats’ epithet by increasing their dividends every year for at least the past 20. Its performance since its inception in October 2011 is shown in the chart. With dividend income reinvested – although the fund actually distributes dividends on a quarterly basis – the chart line equates to returns of almost spot on 10 per cent year. As shown – and predictably – that can’t match the 13.4 per cent technology-boosted annual return produced by the S&P 500. But it leaves standing the 6.8 per cent total return rate made by London’s FTSE All-Share index.

Sure, the dividend yield on the Dividend Aristocrats ETF is only borderline acceptable for income investors at 2.4 per cent of net asset value over the past 12 months. However, it is odds on the fund’s payout will rise faster than that generated by the components of the All-Share index. So the 1.5 percentage point shortfall on the All-Share’s 3.9 per cent dividend yield will progressively narrow and that takes no account of the likelihood that the long-run value of the aristocrats’ index will rise faster than the All-Share.

Interestingly, the biggest component of the aristocrats’ index – and thus the ETF – is Minnesota-based industrial conglomerate 3M (US:MMM). Interesting because Bearbull flirted with taking a holding in 3M earlier this year (Investors’ Chronicle, 31 March 2023). 3M’s strengths have much in common with global greats such as Procter & Gamble (US:PG), whose shares are also in the index, or Swiss foods group Nestlé (SIX:NESN). It specialises in products that are less price sensitive – and therefore more profitable – than intuition suggests because they are small-ticket must-have items; the likes of Wetordry abrasives or Post-it notes.

3M hasn’t actually fallen on hard times, but it is no longer the growth machine of yesteryear. Annual sales crossed the $30bn threshold back in 2013 and for the year just about to end analysts expect less than $32bn. Something similar has happened to pre-tax profit. That line in the income statement went through $7bn in 2014. The figure peaked at $7.5bn in 2017 but analysts expect just $6.2bn for 2023. Thus 3M’s figures in the table under the sub-heading ‘Annualised 5-year growth’ are disappointing. These are not growth rates per se, but a measure of annualised change over the previous 20 quarters and they show 3M in a poor light compared with the other nine highlighted companies.

Despite the corporate torpor, 3M remains highly profitable. On average, profit margins have been above 20 per cent for the past five years. Granted, the margin fell to 12 per cent in 2022 and one-off charges relating to a $6bn settlement of a lawsuit over defective ear plugs used by the US military will wreck the headline margin in 2023. But in 2023’s third quarter, the underlying margin was 23 per cent and Wall Street analysts expect something just above 20 per cent in 2024.

That its share rating – as measured by the multiple of its share price to forecast earnings – is the lowest of the 10 and its prospective yield the highest arguably says more about 3M’s relegation to value stock status than its recovery potential. True, its bosses are pushing Wall Street analysts towards the top end of their earnings guidance for 2023 and there have been minor signs of shareholders getting restless, but neither factor has ignited the share price. All of which makes me think that if I took a holding in 3M it would be more for its past than for its likely future achievements.

Then again that is almost a generic comment when directed towards companies with the status of ‘dividend aristocrats’. None will ever again grow as fast as it did in its heyday; yet none will quickly fade into oblivion. That comment even applies to ExxonMobil (US:XOM), once the world’s biggest company as measured by stock market value and still its biggest quoted oil company.

In a world supposedly heading for net zero, Exxon’s future should be in doubt. Yet the $77bn pre-tax profit it chalked up in 2022 was the second-biggest in its 112-year history (behind 2008’s $84bn), in large part due to the effects of Russia’s invasion of Ukraine. But 2023 has been pretty good, too. Analysts expect something over $9 in earnings per share, which – apart from 2022 – would be the best since 2012.

Partly, these amounts vindicate Exxon’s bosses, who stuck to a CO2 emissions-rich strategy with relative conviction while the western world’s other integrated oil majors pretended they had no dealings with hydro-carbons. In return for aligning with the reality of a world that still runs on burning fossil fuels, Exxon might have lost the PR battle, but is winning the war for share price gains. At almost $105, its share price is 87 per cent of its five-year high, which is 12 percentage points higher than the average of the S&P dividend aristocrats.

Yet look down the rows of data for the 10 picked out in the table and there is no clear winner. All have plus points and shortcomings. For instance, International Flavors & Fragrances (US:IFF), a global leader in supplying the food and cosmetics industries, is the only one with decent share price momentum. Quite likely that’s because investors increasingly believe the group is in recovery mode following a botched merger in 2020. But its dividend cover is also the weakest and that won’t markedly change until 2025.

So maybe the intuitive thought is the best one – initially put a lump of capital into the Dividend Aristocrats ETF, then siphon that into individual stocks when an assessment comes into focus. To be resumed shortly.

bearbull@ft.com