The Dividend Growth Index – August 2012 Update

Update: For the Dividend Growth Index – sold position in Staples Inc. (SPLS) on missed earnings and low margins, and purchased a position in Johnson & Johnson (JNJ).

The Office Sector Slump

Staples Inc.While stock markets are on a tear since their declines in May this year, the office supplies retail sector has not been doing so well. Sales, profits and revenues have been declining , leaving the office supply retail sector in a bind. Take the smaller player in the industry Office Depot (ODP), with a 450 million market cap, which last June closed all its Canadian retail locations. Office Depot has a razor thin profit margin of only 1.01%. When I looked at the office supply sector back in May 2011, Office Depot was worth over 1.1 billion dollars.

Then there’s OfficeMax Inc. (OMX) with a market cap of 476 million dollars and a 1.5% dividend yield. It now has a profit margin of only 0.59% and a massive debt-to-equity ratio of 272%. In other words, the company is worth 476 million, but carries over 1.71 billion in total debt on the books, and is virtually unprofitable.

That leaves Staples Inc. (SPLS) which is still the dominant player in the office supplies sector, with a current market cap of 7.6 billion dollars (it was over $12 billion last year). It’s doing far better than its main competitors ODP and OMX, with a profit margin of 3.72%, and a solid debt-to-equity ratio of only 30%. It is also a solid dividend payer with a 3.9% yield, and raised its dividend in March 2012. Staples Inc. definitely is a well managed company, doing the best it can in a slumping retail industry.  In May 2011 I initially wrote about Staples Inc. Value in Office Supplies, and why I felt it had an economic moat in this sector. I also felt that it would make a great value play, even with its low profit margin. Back then SPLS was trading at $16.95 per share after a missed earnings report.

Is Staples a Value Play or Value Trap?

In August 2011, I purchased shares of SPLS for my own portfolio at $14 per share. I then chose Staples Inc. as one of my Stock Picks for the Dividend Growth Index, with its great fundamentals as a pure value play. The one consideration for Staples however, was its thin profit margin, which has become its Achilles heel.  Although I still think Staples is a well run company, and has solid fundamentals compared to many other companies, it’s caught in an industry trend. That trend is an overall decline in the retail sales sector, which has especially hit hard in the retail office supply sector. That trend was recently confirmed, as Staples missed earnings once again on Wednesday Aug. 15th, sending the share price down to a low of $10.99 during the trading day, and closing at $11.49 per share.  In my own portfolio, a stop-loss for Staples was triggered at $12.

In light of the 5% decline in sales for Staples during the last quarter, and declining margins, I consulted with the other Dividend Growth Index (DGI) bloggers. I asked them if they thought it would be prudent to sell SPLS in the Dividend Growth Index at this time, or hang on for the potential value play. I decided I would go with the group decision. All agreed it was prudent to sell SPLS now and purchase another position.

Another blogger I’ve been following, Dividends for the Long Run, recently wrote a great post Opportunity In Staples. He’s crunched some interesting numbers, and also sees a potential value play for Staples Inc. at this price point. However he is cautious with this value play as a whole.  Whether Staples Inc. at this price point is a deep value play or value trap remains to be seen.  ;)

003_johnsonjohnson

Courtesy of Bloomberg Business Week

Johnson & Johnson (JNJ)

In my own portfolio I purchased shares of Coca-Cola (KO) with the proceeds from Staples Inc. However in the Dividend Growth Index, the Dividend Guy has already purchased a position in KO. Obviously we can’t duplicate positions in the index. So I chose the dividend powerhouse Johnson & Johnson (JNJ) as my replacement position.

Johnson & Johnson, together with its subsidiaries, engages in the research and development, manufacture, and sale of various products in the health care field worldwide. This is a 186.7 billion dollar company, with strong brand and global recognition.

Johnson & Johnson has a profit margin of 13.47%, and a debt to equity ratio of only 29.07%. The annual dividend yield is 3.60%. JNJ has a current annual dividend of $2.44 per share, with an annual EPS of $3.14, resulting in a current dividend payout ratio of 77% (other statements show an EPS of $5.04). The fundamentals for JNJ are rock-solid, though the share price is currently trading near its 52 week highs. This is a set-it-and-forget-it dividend champion that will make a great addition to the dividend Growth Index (DGI).

Readers, what’s your take? Would you have sold or held Staples Inc.? Do you hold shares of Johnson & Johnson (JNJ) in your portfolio?

35 Responses to “The Dividend Growth Index – August 2012 Update”

  1. DividendGarden

    Aug 23. 2012

    I have a question on the EPS for JNJ. Finviz shows the ttm EPS at $3.14, which is a big difference from the $5 that you have listed above. Where did you get the $5 EPS?

    Reply to this comment
    • The Dividend Ninja

      Aug 23. 2012

      DividendGarden, many sites show an EPS for JNJ of $3.14 (based on TTM). Other sites and statements such as G&M, YCharts etc. show an EPS of $5.04 – which makes a lot more sense for a company like JNJ.

      I have a hard time believing JNJ has a dividend payout ratio over 77%, but if any one knows and wants to explain, I’m all good for the learning and understanding why. :)

      Cheers!

      Reply to this comment
      • PK

        Sep 05. 2012

        The easiest way to verify in this case is to use TTM P/E numbers. As I type, JNJ is trading at 67.81 and has a P/E of 21.48 = 3.16 (it’s rounded, so YMMV, but 3.14 is closer). The “correct” way is to look at TTM income and divide by outstanding shares: (numbers in millions) 8,738 / 2,782 = 3.1409.

        Hope this helps!

        Reply to this comment
  2. S. B.

    Aug 23. 2012

    Staples is definitely a confusing one. Obviously they are the industry leader. At some point I wonder if they will get a bump when Office Depot and/or Office Max go down, similar to what happened to Bed Bath & Beyond after Linens n Things went out of business. On the other hand, I worry about Amazon same day delivery coming.

    I own a large 1,000 shares of JNJ, so my confidence better not be misplaced.

    Reply to this comment
    • My Own Advisor

      Aug 24. 2012

      Only 1,000 shares owned? Kidding SB, great stuff. :)

      I’m 800 shares behind you!

      I agree with Ninja, I think we can all sleep at night owning this stud.

      If JNJ, KO and PG start going under, the world is in a huge financial mess and it won’t matter what equities or bonds you own.

      Nice call and post Ninja.

      Reply to this comment
  3. The Dividend Ninja

    Aug 23. 2012

    SB, it could well be the office supply sector is becoming obselete, especially with so much other competition – stores like WalMart etc. for school supplies, and the big chains like BestBuy and FutureShop etc. for electronics. Although SPLS is the leader in the office supply industry, and has great fundamentals, its razor thin profit margin could become more problematic. No way to really know here, have to wait and see. ;)

    You can sleep well at night holding JNJ. This company will be around far longer than you and I ever will be.

    But you shouldn’t have any one holding dominating your portfolio, that’s always risky. Try to keep somewhat equal positions in your holdings to smooth out the ride. That way not any one holding will cause you grief. Markets are naturally volatile, but JNJ will always pay its dividend income. :)

    Cheers

    Reply to this comment
  4. Dividend Mantra

    Aug 23. 2012

    Great move Ninja. This is a fine addition to the DGI, and one of my largest personal positions.

    Solid company with great underlying fundamentals. The valuation is a little high right now, but certainly not crazy. The high yield makes up for this, somewhat.

    Best wishes!

    Reply to this comment
    • The Dividend Ninja

      Aug 23. 2012

      Mantra, cheers! Yup I think JNJ makes a great addition for the DGI, and I might say regardless of price. Big blue chip solid and steady wins the day. :)) I really need to get some more JNJ in my personal portfolio as well!!

      Cheers!

      Reply to this comment
  5. andy

    Aug 23. 2012

    I thought the ninja never bought at 52 week highs

    Reply to this comment
    • The Dividend Ninja

      Aug 24. 2012

      Hi Andy,

      Generally I don’t. But with a long-term hold like JNJ, KO, price point is not as important – especially if you hold for the long term!

      Cheers

      Reply to this comment
  6. farcodev

    Aug 23. 2012

    Thanks DN for the highlight about this segment of market (concerning Staples).
    Btw I’m at 1/5 of the book and it’s a realistic and complete how-to, a real bible!

    Greets!

    Reply to this comment
  7. joncosmo

    Aug 24. 2012

    I own shares of JNJ, planning to hold for decades.

    I’ll have to have a look at the office retail sector, never looked much into it.

    Reply to this comment
  8. Peter

    Aug 24. 2012

    Ninja, good decision on the sell. Staples is absolutely going nowhere in my opinion. Buying KO is a safe bet with good international exposure.

    As for JNJ, I only hold 15 shares (I see that someone above holds 1000 shares…. wow, holy smokes). Damn, my holding looks so tiny. I need to start saving and investing in some US equities! But then again, I promised to index, so I am going to keep to that as the core. I have way too much in the exploration side already, in the “core and explore”. Haha.

    Reply to this comment
    • The Dividend Ninja

      Aug 24. 2012

      Peter, thanks for the awesome comment! :) Yes I’m pretty pleased with my purchase of KO and sleep better at night without SPLS. For the DGI I think JNJ is a great pick.

      As for JNJ its awesome! I think we all have a long way to go to get to 1000 shares!

      Cheers

      Reply to this comment
  9. TM @ Young and Thrifty

    Aug 25. 2012

    Pretty tough to wrong with Johnson and Johnson right? If you’re looking for dividend increases over time, I agree that it is tough to see a path for that at Staples with such slim profit margins. Maybe Mitt will retire from the political scene and go back to making Staples more profitable again!

    Reply to this comment
  10. Trader Rob

    Aug 25. 2012

    I agree J and J is the kind of long term hold every investor should have, my only comment would be to try and get it at a better price, ideally an end of season sale:)

    Outside of that I’m undecided if I will hold US stocks or not, my Dad never did and I’m not sure I will either.

    Reply to this comment
    • The Dividend Ninja

      Aug 26. 2012

      Rob, I don’t think companies like JNJ go on sale to often, but yes getting companies like this at a cheaper price is always nice.

      U.S. companies are some of the biggest and most profitable global giants in the world. Why wouldn’t you want to invest them?

      Cheers

      Reply to this comment
  11. Matt Alden

    Aug 25. 2012

    I think it was a good move.

    I’ve been a bit disappointed with JNJ over the last few years, but nonetheless I think it remains a solid investment, and it’s a holding of mine.

    As for staples, I haven’t analyzed their specific case so I have no opinion on that specific stock, but what I’ve found with my own portfolio is that letting go of companies that produce surprising negative news is generally the way to go. Deep-value investing is certainly a viable investing approach, but it takes a strong amount of research to do it right, because otherwise it’s speculating. Healthy stocks at low valuations are great, but troubled stocks at low valuations- often not great.

    Reply to this comment
  12. Dave

    Aug 26. 2012

    DN, solid analysis from the other side of the Staples play. I’ll be sure to link to this post in the one I wrote so readers can get both sides of the story.

    I’ll admit my entering Staples is pretty much pure speculation. Once (if) it recovers in price I’ll be looking to sell. If it doesn’t recover I’ll collect the dividend while looking for other opportunities.

    Reply to this comment
    • The Dividend Ninja

      Aug 26. 2012

      Dave, I thought you wrote an excellent post on Staples (SPLS). Who knows, it may be a great value play, and things often get worse before they get better.

      As Matt said so well above, it was becoming a risky play. I felt it was time to unload this company without hesitation – the stop loss before earnings was in place for a reason. :)

      Cheers

      Reply to this comment
  13. Good move Ninja!
    I find Costco does carry a good selection of office products, and usually cheaper than Staples.

    I already own JNJ.
    Did you buy KO before the stock split?

    Reply to this comment
    • The Dividend Ninja

      Aug 27. 2012

      Hi Kanwal,

      That’s the point, there are other companies biting into Staple’s economic moat – Costco, WalMart, and countless others. I don’t think Staples has the economic moat it once had.

      KO is a new position, but I’m not concerned about price point on this one – buy and hold forever and add new shares in the years to come. :)

      Cheers!

      Reply to this comment
  14. Marvin

    Aug 27. 2012

    I like your JNJ pick! As the baby boomer generation settles into retirement they will need more healthcare products. I was fortunate enough to hold my nose and buy JNJ during the ’08/’09 crash. Like you said, this is a hold it and forget it stock!

    One question though. Are you reinvesting your dividends or taking cash?

    Reply to this comment
    • The Dividend Ninja

      Aug 28. 2012

      Marvin, thanx for dropping by. Nice entry point on JNJ – that was a great time to load up on these big blue-chips! Your site looks interesting, will subscribe…

      In my own portfolio I DRIP everything I can – becuase it compounds my overall growth. For the DGI (to simplify) I believe all dividends are being held in a cash account, though I would have preferred a DRIP for it.

      http://www.dividendninja.com/introducing-the-dividend-growth-index

      Cheers!

      Reply to this comment
      • Marvin

        Aug 28. 2012

        Thanks! I still have a couple kinks I’m working out but hopefully I’ll be able to start rolling on all cylinders by next month.

        Thank you for the link. The dividend growth index was a MARVELOUS idea. I wish I could have come up with an idea and challenge like that. Great job by all participants!

        Reply to this comment
  15. Rock the Casbah

    Aug 27. 2012

    Hey D Ninja.

    Like your choice of JNJ. It’s one of my core positions and I sleep well at nite having it. Solid fundamentals. Valuation is a tad high now but as you point out companies like JNJ and KO are hard to come by “on the cheap” because they are so solid. For this reason, I think they can be a larger % of a portfolio than other stocks. I agree that NO single stock should be dominant but IMO these stalwarts earn a larger share of the pie.

    Also liked your recent purchase of RY. I’ve been a fan of Canadian banks since I bought some in early-mid 2009 shortly after the 2008 financial crisis. As D Mantra observed we don’t have a good selection of solid big banks here “South of the Border” (save WFC).

    By the way, great to see D Mantra back in action, eh?

    Cheers!

    Reply to this comment
    • The Dividend Ninja

      Aug 28. 2012

      Casbah, nice to see you around. I think big blue chips like these are pretty safe bets, but sure there will be price volatility – hence holding for the long-term with these guys just makes sense.

      I’m actually a fan of equal postion weighting within my portfolio for stocks. I believe this is a safer approach and mitigates risk. As soon as one holding gets too high in your portfolio, it acutally creates more volatility. One bad news on an overweighted positon (or industry) can reak havoc in your portfolio.

      Speaking of which I won’t be purchasing more banks for that reason, even though I think they are great investments. All the Canadian Banks trade on the NYSE as well. ;)

      And yes, nice to see Dividend Mantra back! :)

      Cheers!

      Reply to this comment

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