These 3 Dividend Aristocrats Have Room to Run

By Markets Fool.com


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Dividend Aristocrats -- companies that have raised their dividend for at least 25 consecutive years -- are great investments for those interested in dividend growth stocks. A long streak of dividend increases is a strong motivator for management to continue raising its dividend every year; it takes 25 years to become a Dividend Aristocrat and just one year to get kicked off the list.

But Foolish investors won't just settle for buying any old Dividend Aristocrat. They want stocks that offer increased potential for capital gains on top of dividend growth. Here are three Dividend Aristocrats that fit this profile.

Emerson Electric

The global industrial growth slowdown certainly impacted Emerson Electric , but investors may have been more drastic in selling its stock. That's just the nature of cyclical stocks. While shares have bounced back nicely from their low point in January, Emerson still appears underpriced.

The worst seems to be over for Emerson, which managed to beat earnings expectations in its first and second quarters. Management forecast that the first half of 2016 would contain its toughest quarters, and that appears to be true, as oil prices have climbed to almost $50 per barrel from below $30 in January. The company expects adjusted earnings per share in the third quarter to come in flat compared to last year.

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Emerson is looking to spin off its lagging network power division. The business has been under pressure for several years as enterprises consolidate their servers, reducing the need for power and cooling. It's also considering the sale of its industrial automation group. Sales of the division declined 16% during the fiscal second quarter and net income declined 20%.

Those moves will cost Emerson an estimated $250 million to $300 million in restructuring costs, impacting earnings per share by $0.37 to $0.44 for the year. Management's outlook is for adjusted EPS of $3.05 to $3.25, giving it an earnings multiple of just 16.6 at its midpoint. What's more, getting rid of its lagging assets will leave Emerson with a pile of cash (to either invest in new businesses or return to shareholders) and a leaner, higher-margin business.

Procter & Gamble

Shares of Procter & Gamble may be trading near their all-time high, but there's still room for the stock to climb. The company is in the midst of what executives describe as the largest transformation in the company's history, which will see it focus on its most profitable brands in the fastest-growing product categories while ditching unprofitable sales -- like its toilet paper line in Mexico.

P&G is cutting costs wherever it can. Not only is it getting rid of non-core products, it's also slashing expenses related to material costs from product designs, its supply chain, and marketing overhead. The company is targeting $10 billion in cost cuts over the next five years.

The results of these initiatives ought to show up in improved cash flow, operating margin, and organic sales growth in the next few years. Organic sales have been lagging over the last year or so, averaging less than 1% over the last five quarters. That growth has largely come from price increases instead of higher volumes. As P&G continues to shift its focus toward faster growing brands, volume should start growing as well, enabling it to boost organic sales faster than the industry average.

Despite trading near its all-time high stock price, shares of P&G still look cheap around $83 per share. Its free cash flow yield of 5% is about average for where the stock has traded over the past year and it's closer to its five-year high than its five-year low. For investors most interested in dividend growth, this is a good sign that P&G's cash flows (the thing that funds dividends) are selling for cheap.

With analysts expecting much stronger earnings growth over the next five years (6.13%) compared to the previous five years (0.38%) P&G deserves to be trading at historically high earnings multiples of 23 times forward earnings and 15 times enterprise value to EBITDA. Still, there's room for further multiple expansion as P&G becomes a leaner and more profitable company.

McDonald's

McDonald's is undergoing a transformation of its own, much like Procter & Gamble. CEO Steve Easterbrook reorganized the company at the beginning of 2015, separating it into four operating segments, with plans to refranchise 4,000 locations by 2018, while targeting a $500 million reduction in annual SG&A expenses. The stock responded, increasing more than 30% since the beginning of last year.

Despite that increase in stock price, McDonald's still appears to be undervalued at a share price around $120 despite its all-time high near $132 earlier this year.

Earnings per share climbed 26% last quarter even after accounting for the additional cost of strategic initiatives in the first quarter last year. Part of that increase stems from a share buyback that reduced its outstanding share count by 70 million units. Net income still increased a healthy 9.1% on an adjusted basis, and 35% on an unadjusted basis.

McDonald's also has strong potential to increase its operating margin spurred by same-store sales growth and lower commodity costs. Same-store sales increased 6.2% in the first quarter, and U.S. commodity prices declined 3%. Management expects commodity prices to decline 3.5% to 4.5% overall this year. Combined with higher menu prices and refranchising efforts, McDonald's should be able to grow its earnings at a fairly strong clip. Analysts are projecting 10.6% annual earnings growth over the next five years compared to -1.2% over the previous five years.

Shares are currently trading around 22 times forward earnings estimates and it has a 14-times EV-EBITDA ratio. That's about in line with Yum! Brands, butMcDonald's dividend yield of 2.9% makes it much more attractive compared to Yum's 2.2% yield.

With strong earnings and cash flow growth ahead from its restructuring and strategic initiatives, McDonald's looks like a good company to own at this price.

The article These 3 Dividend Aristocrats Have Room to Run originally appeared on Fool.com.

Adam Levy owns shares of Emerson Electric and Procter and Gamble. The Motley Fool recommends Emerson Electric and Procter and Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.