Best Buy: The Best Stock To Protect Against Inflationary Environment

1. Investment Thesis

Ukraine-Russia War. Inflation. Rate increases Supply chain problems. Oil prices rose to $140 per barrel. Oil prices fell to $100 per barrel. China tightened regulations for internet platforms that make money from teenagers. China pledged to support the markets.

Investors don’t like uncertainty when it comes investing. Uncertainties lead to unexpected market shocks which tank stock prices regardless the fundamentals. Nobody wants to catch falling knives and certainly nobody likes to watch the stock price continue to fall despite repeated attempts at dollar-cost average reductions. Yes, I’ve been there. However, turbulent times can often offer golden investment opportunities for those who are brave. When your portfolio is in decline, the key is to stay the course and capitalize on the revaluation. This means focusing on quality and best of breed companies.

A portion of your portfolio that can weather all sorts of situations while still generating steady, rising, inflation-beating earnings will not only help investors stay calm and not panic-sell, but also provide long-term returns. The Dividend Contenders are introduced with this preamble.

2. Who are The Dividend Contestants?

Ken Faulkenberry, the founder of Arbor Investment Planner,

Dividend Contenders List is an attempt to identify all U.S. businesses that have increased their dividend for at least 10 years but not more than 25 years.

I used a method to screen 335 Dividend Contestants to find 7 that pay dividends at double-digit growth rates. These 7 were then further whittled down into the Best Buy (NYSE): NYSE:BBY). Before I explain why Best Buy is the best, let us first look at why dividend payers should be part of an investor’s portfolio and why Dividend Champions and Dividend Aristocrats don’t recommend them.

3. Dividend paying companies work well in times of high inflation and excess money printing

Research has shown that dividend-paying businesses can make a significant contribution to portfolio overall returns. Based on a Morgan Stanley’s researchDividends account for more than 40% in total returns over the past 91 years, from 1930 to 2021.

However, I must mention that the contributions of dividends to total returns did not always match up throughout this period.

Dividends were more influential in certain decades than others. They accounted for 44% of total returns in 1960s, 73% in 1970s ().!) in the 1970s and 28% in the 1980s. Why was this so? The reason is that the above-mentioned periods coincided with what was called The Great Inflation (see graph).

Inflation was just a little higher than 1 percent each year in 1964. It had been around this level for the six previous years. Inflation started to climb in the mid-1960s. It reached 14 percent in 1980. It dropped to a low of 3.5 percent in 1980’s second half.

Although economists debate the relative importance and causes of inflation over the past decade, there is little disagreement about the source. Policies that allowed excessive growth in the money supply were the origins of the Great Inflation. Federal Reserve policies.

Source: Federal Reserve History

These facts will take a while to sink in. The best dividend returns have been historically achieved during the winter. Periods of high inflation Excessive growth in the money supply. Sounds familiar? Are you familiar with the situation? Inflation at 40-years high7.9%, and is just emerging after two years of intense money printing. It is actually estimated that this amount is around 7.9%. 80% of all US dollarsIn circulation were copies from the past two years. Despite all these uncertainties, the market continues to trade 66% higherIt is lower than its historical average.

If we are heading towards a period where the market performs poorly, be it sideways trading for a prolonged period, or worse, enter a bear market. Dividend paying stocks will provide returns even if stocks do not appreciate in value.

4. Not all dividend-paying stocks are worth the stock-picking effort (and money)

I am a long-term, cautious bull. A realist who sees the market trading sideways for a few more years until overvalued companies have high valuations and can increase earnings to justify their high P/E ratios. In such a scenario it will be dividends, not capital appreciation, that will make up the bulk real returns.

Spoiler Alert 1 – Most Dividend Payers are Overvalued

But not all dividend-paying stock is eligible. Many income-seeking investors will gravitate towards the Dividend AristocratsThe Dividend championsCompanies that have paid dividends over a period of 25 years or more. This is the highest quality names in dividend universe. But, I think that most of these names are already overvalued. See the table below.

Source: Data sourced from FAST Graphs

It is evident that these Dividend Aristocrats are trading at elevated levels if you compare their current P/E ratio to their historical P/E.

Neither will investing in the highest-yielding Dividend Aristocrats nor Dividend Champions. For example, the Enterprise Products Partners (EPD) is the highest yielding Dividend Champion at 7.69%. EPD didn’t make it onto my list due to its meagre dividend growth rate over 20 years. It has slowed to a mere 2.52% for 5 years.

You can also use Seeking Alpha’s Valuer Grades on all 64 Dividend Aristocrats in order to determine if stocks are undervalued. 7 companies were found with grades between B- and A-. Seeking Alpha’s Value Grade deems that only 10.9% of Dividend Aristocrats is undervalued. These 7 will be examined in detail next.

Spoiler Alert 2, Dividend Growth Rates Slowing

These 7 companies could they achieve the investment goal of growing dividends that beat inflation? Below is a table.

Source: Author’s. Data from Seeking Alpha and Fast Graphs

6 of 7 Dividend Aristocrats report declining dividend growth rates. Only Nucor (NUE), however, has increased dividend growth rates over a decade. However, the yield is so low that it doesn’t meet my investment goal of producing sufficient income quickly enough. Nucor has cut dividends in the past, but that doesn’t give me confidence that it won’t again.

There are Dividend Aristocrats such as Cintas Corporation, (CTAS), with its eye-popping double digit average dividend growth rate (18.17% for the last 20 years) which accelerated to 39.18% over the past five years. CTAS is trading at a very high valuation compared to its historical norms. As a value-investor I cannot recommend it.

Spoiler Alert 3 – Total Returns Underperform S&P

Leggett & Platt is now out of the initial 7 undervalued Dividend Aristocrats. The current dividend yield is higher than the 4-year average. These three companies could be a good choice for investors looking for a steady dividend yield that increases every year. However, they don’t meet my expectations on two accounts.

Source: Author’s. Data from FAST Graphs

The first is a decline in dividend growth. This suggests a concern about the companies’ ability create enough free cash flow in order to cover growing dividends. Secondly, these companies have outperformed the S&P 500 over a 20-year to 10-year and 5-year span, even after accounting dividends. Maybe I’m asking too much of dividend-paying companies, but I want them to at most market-perform. If they do not, why would you bother to choose stock when the index provides superior returns?

5. Selection Methodology

I used these selection criteria to reduce my search to 7 Dividend Contenders from 335, and it is now down to 1.

After looking through the best Dividend Aristocrats’ names, and having rejected them (oops), my next stop was the Dividend Contenders. These are U.S. businesses that have increased their dividends for at least 10 years, but not more than 25 years.

1. The average dividend growth rateTo beat inflation easily, it must be at least 7 percent
2. The 1-year dividend growth rateTo have some assurance that the company is determined to grow dividends at the same rate, it should be at least equal the 3-year and 10-year rates
3. The Ratio P/EThe company’s historical normal P/E must be less than the current one
4. The company is committed in rewarding shareholders. Companies with a history of cutting dividends or diluting shareholders will be rejected
5. The business must be financially viable, so long-term earnings and revenue have to rise.
6. The business should be considered investment-grade, meaning that it must have a minimum BBB- rating.
7. Dividend payouts should be manageable. They can also be covered by free cash flow.

I identified the following 7 companies using the criteria above.

Source: Author’s. Data from FAST graphs and Seeking Alpha

Williams-Sonoma and Best Buy are my favorites. WSM has been covered separately by me, which you can read here. I will now examine the 6 remaining names.

What about GS, MS? JEF, DKS, AND BC

There are many interesting options, such as Goldman Sachs (NYSE GS), Morgan Stanley(NYSE: MS), and Jefferies Financial Groups (NYSE – JEF).

Both GS and MS have been rated BBB+ as investment grade companies, while JEF has been rated BBB. All three companies did not outperform S&P 500 for a 20-year span, mainly because of the financial crisis of 2008-2009. S&P was beaten by Goldman Sachs by a small margin over a 10-year period, while Morgan Stanley outperformed by 6.5% over the same 10-year span. Jefferies however, managed to market-perform.

Goldman Sachs has been increasing its dividend growth rate. It has only 5 years worth of records for dividend growth, so there is a risk that the management will stop growing dividends like it did in 2002, 2003, 2005-2006 and 2010-2013.

Morgan Stanley has also grown dividends over the past eight years. It has halted dividend growth in the past (2001-2003 and 2005-2006, respectively) so there is the possibility that MS’s management might repeat the past if they feel they need to save cash.

For the past two years, Jefferies has not been increasing dividends. It has also halted dividend growth in the past (2006-2007 and 2010,-2016), so there is a risk that Jefferies’s Management will consider stopping dividend increases if they feel they need to.

These are the reasons I won’t consider investing in these companies.

Brunswick Corporation (NYSE: BC)

This company produces leisure products, including parts and actual boats. Some of the brands include Crestliner, Boston Whaler and Bayliner.

This is a cyclical industry, and as you can see in the chart below, there have also been many periods of ups or downs in earnings. There have even been years of negative earnings.

Plus, it has had to reduce the dividend by 91% in the past. That is a deal breaker.

The pandemic caused a renewed interest in its products which resulted in a surge in revenue of $1.5billion between 2020-2021. Analysts are projecting more growth over the next two years. I disagree with their assessment. First, earnings projections of BC analysts have never been reliable.

Secondly, the pandemic is under control so it is more likely that interest in Brunswick’s boats will revert to pre-pandemic levels.

As you can see, BC’s prepandemic operating revenue growth was quite anemic. It grew only slightly from $3.72 Billion in 2012 to $4.11 Billion in 2019, and I believe that revenue will return back to those levels.

Long-term investors like me are not attracted to the uncertainty and unreliability of BC’s prospects and business.

Dick’s Sporting Goods (NYSE : DKS) was almost on my buy-list.

Dick’s Sporting Goods, a retailer of sporting goods, has 730 stores across the eastern United States. It has been growing its dividend for eight consecutive fiscal years. Although the 1.7% dividend yield may seem small, the average dividend growth rate over five years of 21.72% is quite impressive. If it can be sustained, this can compound and double in just 3.5 years. The company’s 5-year operating earnings rate growth rate (21.06%), which beats the earning growth rate for mature technology companies like Apple (AAPL), Facebook (15.24%), and Microsoft (MSFT (20.98%), is nothing short of remarkable.

DKS’s EPS growth is however positive from an earnings perspective. pre-pandemicThis was not an impressive result. Average EPS growth was 9.88% between 2012 and 2019.

In this same period, the company actually performed below S&P 500. DKS was able to benefit from the pandemic by increasing its orders for sports, fishing and camping equipment, among other things. Analysts predict that EPS growth will decline sharply by 20% in 2022 to $12.55 per shares, following the impressive 66% growth in 2020. That assessment is correct.

Keep in mind that, despite the projected decline of EPS, the expected earnings per share of $12.55 in 2022 is still nearly double that of 2021 and more than three times that of 2020. This is great on both counts. If DKS traded at a P/E of 7 to 8, each share could be worth $87.85-100.40, which would indicate a 12.4% to 23.4% price drop by 2022.

The same conditions that led DKS to its explosive EPS growth in 2020-2021 and 2021, are no longer necessary to sustain double-digit growth in 2022-2023. DKS’s price dropped from $142 in September 2021, to $97 in February 2022. This was a realization by the market. DKS is slightly too expensive here. It can still be attractive if it drops further to below $100.

DKS is currently on my watchlist. The only company I have left to look at is Best Buy. Best Buy has been paying dividends since 2004, and has not once reduced its dividend during the financial crisis of 2008/2009 or the pandemic of 2020-2021.

6. A brief overview of the Best Buys

The excellent article written by Stone Fox Capital for Best Buy is worth reading. Here is my view on the company’s core principles.

According to YCharts

Best Buy is the largest pure play consumer electronics retailer in America, accounting for nearly 10% of the total market and 40% of offline sales. This figure is based on Euromonitor data, CTA industry data, and our calculations. The bulk of the firm’s sales are made in-store. Its three largest categories include mobile phones, tablets, computers, appliances, and computers. Recent investments in ecommerce fulfillment have seen the U.S. channel nearly double since pre-pandemic levels. Management estimates that it will account for a mid-30% of future sales.

Corie Barry, who was previously Best Buy’s CFO took over as the CEO in June 2019. She replaced Hubert Joly. She had a lot to do as she was hit by the pandemic shortly after she started her new position. But she was able to navigate the situation well. CEO Corie stated that permanent changes have occurred in customer shopping behavior since customers increasingly shop online. Under her leadership, online sales soared to 43.1% of the total domestic online revenue by 2021 from 19% in 2020.

The company’s earnings increased from $5.20/share in February 2019 to $19.84/share by January 2022.

Best Buy’s 5-year record has been outstanding. Accounting for dividends, Best Buy managed a remarkable annual return of 19.2% and a 121% increase in share price.

Best Buy’s business has become a cash cow. It almost doubled its cashflow from operations from $2.57Billion in 2020, to $4.93Billion in 2021.

An investment of $10000 five years ago in Best Buy would have outperformed S&P 500. Dividends contribute to 2.48% of the annualized rate return.

The average dividend growth rate for BBY has varied between 17.84% and 27.27%, and it is trending upwards.

Extrapolating the 17.84% figure out to five years gives us a yield on cost that could go up from the current 3.55% in 2022, to as high as 6.84% by 2026. Even if the dividend growth rate drops to 10% per year, the yield cost will still rise to 5.19%. This makes Best Buy a compelling dividend growth stock.

7. Valuation

If Best Buy trades at a 10.4 P/E, which is below its historical 12.84 P/E, it could still have a higher value at $132 over three years. Once dividends have been added, the gains could be $11.01 per share for the 3-year period.

Best Buy trades at a P/E 10.04, which is lower that its historical P/E 11.48. This means that Best Buy’s stock is not too cheap, but it is not overvalued.

According to Morningstar analyst Sean DunlopBBY’s fair market value is approximately $116 He also noted the following:

We are positive about Best Buy’s fourth quarter earnings and analyst day presentation for narrow-moat. All signs point to a structurally stronger retailer after the pandemic. Quarterly earnings were solid but not extraordinary, with $51.8 billion in annual revenue and $9.84 in diluted EPS. These numbers narrowly exceeded our previous forecasts of $9.71 and $51.7, respectively. More importantly, a digital company that has nearly doubled its prepandemic run rate (to 34% of sales or $17.5 billion), significant sales leverage, and upside from Totaltech loyalty program, nascent ads business, and Health segment point towards a solid future. All these factors point to a solid future ahead for the consumer electronics stalwart. We expect to increase our $116 fair-value estimate by approximately 10%. About 4% of this change is due to the elimination of our previous expectation for a 5-point increase in the U.S. taxes rate.

However, I consider the expected decline in earnings of 10% this years and assume a 13% earnings increase for the next nine years (which is not unreasonable considering the average earnings growth of 13.1% from 2003 to 2021). Therefore, I calculate the fair market value of BBY at $97.94 now, which is just below the current trading price and offers no margins of safety.

Finally, Best Buy’s current Price-to-Sales metric of 0.49 is in line its 5-year average of 0.48. This means it is fair priced.

8. Risques

The reason I recommend BBY is because of its ability to continue paying a dividend that will grow significantly and quickly over time to provide real returns during times of uncertainty such as now.

In terms of payout ratio, BBY’s dividend payout has been very manageable at 25% to 33%. So I don’t see any problem there so long BBY can generate sufficient cash flow to pay the growing distributions.

It can seem alarming to look at BBY’s Dividend Grade on Seeking Alpha.

However, I’m not concerned because the companies BBY is compared to are not the most relevant.

BBY is a pure-play retailer of consumer electronics, while CONN sells mattresses and furniture, and offers financing. RCII leases household durable products to customers on a lease–to-own basis. There are four revenue streams: Acima, Mexico and Rent-A-Center Business. Finally, the GME sells both new and preowned video games platforms, gaming accessories, such as controllers and gaming headsets, virtual reality products and memory cards, aswell as new and preowned video gaming software.

The peer comparisons are mostly irrelevant so I will ignore the D grade for Dividend Growth category. I will also disregard the D grade in Dividend Consistency. It was a grade BBY received because it had 8 recent years of dividend-growth against a background of paying dividends every 17 years. It will improve with a few more years worth of dividend growth.

9. Conclusion

Dividend-paying stocks are great in an inflationary climate because they provide real returns. Even dividend paying stocks, particularly those of the Dividend Champions or Dividend Aristocrats, can be overvalued due to equities trading at high levels. Best Buy was selected from the list as a Dividend Contender to be a worthy candidate.

Best Buy is a company that I enjoy as a business. They offer real returns in a volatile market. Real returns that are healthy at 3.55% and an average of 20% dividend yield.

It is difficult to be a pure-play retailer of consumer electronics against Walmart (WMT). This is a tough, low-margin business. BBY’s net profit margin is only 4.47% compared to AMZN’s 7.1% and Dell’s 5.5%. Best Buy is a favorite among customers. JD Power’s survey on customer satisfaction with appliance satisfaction places Best Buy ahead of Lowe’s and Home Depot (HD).

Best Buy is well-known for its outstanding service and product knowledge, but it is also known to be a great place to shop. Price Match Guarantee.

Smart customers know that Best Buy is the best choice, regardless of the economic climate. It guarantees to match all major competitors’ prices. This means that BBY will have a better business in an inflationary climate because budget-conscious consumers will choose to shop where they can find the best deals.

Best Buy is a great company for value investors looking for bargains in an overvalued market. I will be considering opening a position to begin collecting dividends. I will continue to add to it if the price goes down further. Best Buy is a reliable dividend payer, growing dividends at double-digit rates. These real returns are what I need in an inflationary environment.