To a patient dividend growth investor, bear markets are a bargain-hunting dream. It can sometimes feel like a fire sale at the mall, or maybe I should say Prime Day on Amazon. Everything appears to be a great deal! But not every apparent sale is a bargain, so an investor should have a method of separating the wheat from the chaff.
During the flash crash, nearly every dividend growth stock fell by at least 30%. The market hit growth stocks, high yield, and small caps harder, presenting some of the best deals at the time. For this reason, an investor should maintain an open mind as to what companies might make sense to add to their portfolio during a downturn.
Consider Air Products and Chemicals (APD). This company is a high-quality dividend growth stock, with over 40 years of dividend growth and consistent five and 10-year dividend growth rates of over 10%. Many investors would love to add this company at a bargain price. In March of 2020, the price fell by 27%, in line with most of the market. However, did this make the company a bargain?
As shown in the above Fastgraph, entering the Flashcrash, APD was sporting a PE ratio of over 30. During the crash, the ratio fell to just under 23. However, the historical average PE for APD is right at 20. Even shortening the timeframes to account for the higher ratio the market has given APD since 2014 still shows an average PE of 24, making the Flash Crash price look not that attractive.
Taking a look at APD at this time from a dividend yield perspective tells a similar story. APD entered the crash yielding 1.8%, near an all-time low and rocketed up to 2.65% with the price drop. The table below shows the average, minimum, and maximum yields for APD from 2012 to 2022. Notice that in nearly every year before 2020, APD was available at a higher yield than was offered during the flash crash.
While the Flash Crash was not a historically great time to enter APD, it turned out well for short-term traders, as the company’s price blew up over 60% in short order, making a nice gain for the short-term trader. However, as most dividend growth investors are long-term investors, many will likely have missed out on better deals.
Consider, for example, Home Depot (HD). Home Depot doesn’t have as long of a dividend growth streak as APD, at only 13 years, having frozen the dividend during the GFC. Home Depot crashed 38% during the Flash Crash, causing the PE to fall from about 24 to 15, as shown below. This compares favorably to the 20-year average PE of just over 19, and even better to the more recent average of 22 the market has given Home Depot.
Taking a look at the historical yields of Home Depot would tell a similar story, as shown in the table below. During the Flash Crash, the high yield in 2020 stands out as a significant opportunity as opposed to the preceding years. You would have to go back to the GFC to find better or similar yields on Home Depot. It’s also worth considering that if we enter a recession, Home Depot will likely reach these yields again.
Recently, Home Depot has fallen nearly 30% from its high. However, historical PE ratios would indicate that it is not a significant bargain. Only considering a recent fall in price as an indicator of a deal is a common mistake and can falsely lead investors. For high-quality dividend growth stocks, the current PE and yield should be considered on their own in a historical context.
Because every bear market is unique, and you never know what companies will be offering the best bargains, having a list of potential bear market buys is the best bet. I currently maintain a list of about 60 companies that I would consider adding at the right price. My list comprises mostly fast dividend growers, some top-quality dividend growth names, and a few high-yielders.
I generally use dividend yields to indicate possible bargains and follow up with a little more research before making any big purchases. However, I prescreen most companies before adding them to my list as stocks that fit my requirements. Rather than using just the most recent ten years of dividend yields for a company, I look at all available data, consider the bear market peaks, and weigh any significant changes in dividend yields over time.
My list uses three buy points. The first buy point generally represents the top 25% of a company’s yield. The second is the top 10-15%. The final buy-point is generally only reached in bear markets, when the industry is well out of favor, or there are specific concerns about the company; usually, it takes a combination of events to reach these yields.
Having different buy points allows me to scale into a position and rate deals against one another. The table below shows the current status of bargains in the companies I track.
At present, there are 19 companies at my first buy points and only two at my third. During the flash crash, the table was lit up with green, although many companies never reached my first buy point. Currently, nearly 1/3 of the companies would need to drop by over 20% to catch my first buy point, and several would need to drop over 40%.
3rd Buy Point Companies
T. Rowe Price (TROW) and Starbucks (SBUX) are the only companies currently at the third buy point. TROW is in a beaten-down industry and suffers from specific concerns about its actively managed funds business. Meanwhile, Starbucks is facing a few question marks with ongoing union drives and the buyback suspension.
TROW is a dividend champion with 36 years of consecutive increases. It has a double-digit 10-year dividend growth rate, including this year. With such a long streak, the company has a demonstrated ability to raise through many economic situations.
SBUX has a 12-year dividend growth streak. Its dividend growth has been decelerating but is still managing to provide close to 10% increases. While 2022 looks to be a down year for the company, long-term forecasts still indicate the company could continue double-digit growth.
2nd Buy Point Companies
Currently, there are four companies at the second buy point. Although after the significant downturn on May 9th, if we experience a bounce, Texas Instruments (TXN) will likely be above this point. TXN has bounced into my second by point a few times, but usually just briefly.
Best Buy (BBY) and Tractor Supply Company (TSCO) are in the retail sector and could offer better prices should we enter a recession. BBY has been in bargain territory for most of a year, while TSCO rarely reaches bargain prices. It’s essential to recognize that Best Buy raised the dividend through the GFC, something few retailers were able to accomplish. Both Tractor Supply and Best Buy have had monster dividend growth rates over the last ten years. Tractor Supply’s most recent increase of 77% is a large driver for the yield being pushed high enough to make this list.
Nexstar Media Group (NXST) is an attractive value play. The Fastgraph below shows the significant undervaluation of this company. The company only has a 10-year dividend growth history. However, these have been massive! NXST has 3, 5, and 10-year growth rates, all close to 25%, including its most recent increase of over 28%.
1st Buy Point Companies
In a normal market, companies offer compelling buys at the first buy point. Even today, I believe these companies provide good starting points for the long-term investor. However, given the current state of the market, I am adding to these in small increments. Nibbling here and there, but primarily hedging in case better prices lie ahead. For most of last year, there were an average of fewer than three companies at my first buy point, but there is usually something.
At the current prices, I find BlackRock (BLK), Aflac (AFL), and Broadcom (AVGO) most compelling, although I would like to see these reach my second buy point before adding any more. Home Depot (HD) is in the same boat similar to Best Buy; it just started from a position of significant overvaluation and might take a while to fall. Visa (V) and Mastercard (MA) still look overvalued from a PE standpoint, even though they have made the list on historical yield.