Berkshire Hathaway’s Most Undervalued Dividend Stalwarts

Both Procter & Gamble and International Business Machines are experiencing multi-year transformations. It is exactly for that reason that both are trading at historically high yields, and patient investors can start dollar-cost averaging into these dividend stalwarts with at least 20 years of dividend growth history.

Introduction

On reviewing Berkshire Hathaway’s top 15 holdings listed in its 2014 letter to shareholders, I found out the two most undervalued companies are actually a couple of my core holdings. They are Procter & Gamble Co (NYSE:PG) and International Business Machines Corp (NYSE:IBM). They are cheap for a reason though. Both are experiencing multi-year transformations.

Procter & Gamble’s Transformation

Transformation is a slow process. Especially for a huge company such as P&G, it could take several years to unfold. Procter & Gamble intends to shed off roughly 100 non-core brands, over half of its existing brand portfolio, in an attempt to focus on its core brands, such as the 23 brands that generate over $1 billion in annual revenue.

For example, in July 2015, Procter & Gamble accepted an offer of $12.5 billion from Coty to merge 43 P&G products with Coty. This transaction is tax-efficient in nature, and P&G estimates the one-time gain to be from $5 to $7 billion depending on the final deal value when it closes.

Due to this transaction and the Duracell sale to Warren Buffett for around $4.7 billion, Procter & Gamble intends to return $70 billion to shareholders from fiscal year 2016 to 2019 in dividends and share retirement, while maintaining its current credit ratings.

You can learn more about the Coty transaction.

Procter & Gamble’s Valuation

In today’s market, it’s rare to find Morningstar rating a company 5 stars indicating extreme undervaluation. Well, Procter & Gamble gained that status.

Cross-checking with F.A.S.T. Graphs, Procter & Gamble is also undervalued based on the price-to-cash-flow ratio. The graph indicates the shares are at least 7% undervalued.

PG valuation graph

Procter & Gamble: A Dividend Stalwart of 59 Years

Around $70 per share, its yield of 3.77% is historically high for the company. The chart below shows the fiscal year-end yields, and the highest yield shown is 3.5%.

PG yield graph

Procter & Gamble has increased dividends for 59 consecutive years. Its 3-year, 5-year, and 10-year dividend growth rates has been between 7 and 10%. Its hike in 2015 was only 3%. However, I think the company did the right thing in lowering the growth rate because its payout ratio is getting high up there around 87%.

Procter & Gamble’s dividend remains safe to grow for now because of the non-core brands shed off. From what was mentioned before, some of the capital from the sales would be used for dividend hikes and share buybacks. I understand the company wants to focus on the transformation right now, but as a shareholder, I’d like to see more organic growth eventually.

International Business Machines Corp’s Transformation

Transformation is a slow process, especially for a technology company with complicated systems and has a market cap of over $145 billion. The transformation could take several years to unfold.

Amidst its attempt to change, in August 2015, IBM announced to acquire Merge Healthcare Inc. (NASDAQ:MRGE), a business that handles and processes medical images. This technology combined with IBM’s Watson artificial intelligence could be very powerful.

Other IBM transformations include developing ecosystems and strategic partnerships with leaders such as Apple, Facebook, Twitter, SAP, and Tencent, as well as making its POWER microprocessor customizable.

International Business Machines Corp’s Valuation

IBM normally trades at a P/E of 15, but because of the recent negative earnings growth, it is trading around a P/E of less than 10. When growth resumes after the transformation, it could trade back at the normal P/E for substantial gains.

IBM valuation graph

International Business Machines Corp: A Dividend Stalwart of 20 Years

Around $148 per share, its yield of 3.5% is historically high for the company. The chart below shows the fiscal year-end yields, and the highest yield shown is 2.6%.

IBM yield graph

IBM has increased dividends for 20 consecutive years. The past 10 years’ dividend growth rates were typically between 13-15%. Its hike in 2015 was 18%, showing the company’s commitment to paying shareholders.

The company’s payout ratio is around 35% which seems low at first, but is actually the highest it has been in a decade. Like Procter & Gamble, I’d like to see IBM experience more organic growth and not just earnings stagnation reliant on stock buybacks.

If you’re interested in learning more about the other top holdings in Berkshire Hathaway that are also undervalued, you can check out this Seeking Alpha article: Top 15 Holdings In Berkshire Hathaway: Which Is Priced For Value?

In Conclusion

Both Procter & Gamble and International Business Machines are experiencing multi-year transformations. Procter & Gamble has increased dividends for 59 years, while IBM has increased dividends for 20 years in a row. So, I’m willing to bet these dividend stalwarts will continue increasing dividends in the new year.

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Disclosure: At the time of writing, I am long PG and IBM.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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