Dividend Aristocrats are a select group of S&P 500 companies that have increased their dividend payouts for at least 25 consecutive years. This impressive track record demonstrates a commitment to shareholder returns and typically indicates a stable, profitable business model. For income-focused investors, Dividend Aristocrats offer a compelling blend of reliable cash flow and potential for capital appreciation.

Validea’s interpretation of Warren Buffett’s investment strategy is based on the book “Buffettology” by Mary Buffett. This model seeks companies with:

1. Consistent and predictable earnings growth
2. Strong return on equity (ROE) and return on total capital (ROTC)
3. Ability to pay off debt with earnings
4. Conservative financing
5. Efficient use of retained earnings
6. Share repurchases (as a bonus factor)

The model also evaluates the potential long-term return an investor might expect based on current valuation and growth projections.

Aligning Dividend Aristocrats with Buffett’s Principles

There’s a natural synergy between Dividend Aristocrats and Buffett’s investment philosophy. Companies that consistently raise dividends for decades often exhibit many of the qualities Buffett seeks:

• Earnings Stability: Consistent dividend growth requires stable and growing earnings.
• Strong Financials: High ROE and ROTC are often necessary to support dividend increases.
• Conservative Management: Both dividend consistency and Buffett’s model favor companies that manage capital efficiently.
• Competitive Advantage: Long-term dividend growth often indicates a durable competitive edge.

Let’s examine three Dividend Aristocrats that also score highly on Validea’s Buffett model:

1. W.W. Grainger, Inc. (GWW)

W.W. Grainger, a leading distributor of maintenance, repair, and operating (MRO) products, scores an impressive 100% on Validea’s Buffett model.

Why GWW Passes the Buffett Model:

• Earnings Predictability: GWW’s earnings have grown consistently over the past decade, with only minor dips.
• Strong Returns: The company boasts an average ROE of 41.9% over the last ten years, well above Buffett’s 15% threshold.
• Debt Management: GWW could pay off its debt with less than two years of earnings, demonstrating conservative financing.
• Efficient Capital Allocation: Management has delivered a 21.6% return on retained earnings over the past decade.
• Share Repurchases: GWW has reduced its outstanding shares, indicating a focus on shareholder value.

The model projects a potential 18.5% average annual return for GWW over the next decade, based on current fundamentals. This aligns well with its status as a Dividend Aristocrat, having increased dividends for 52 consecutive years.

GWW also scores highly (88%) on Validea’s Twin Momentum model, indicating strong fundamental and price momentum.

2. Illinois Tool Works Inc. (ITW)

Illinois Tool Works, a diversified manufacturer of industrial products and equipment, achieves an 89% score on the Buffett model.

Why ITW Passes the Buffett Model:

• Consistent Earnings: Despite some fluctuations, ITW has maintained overall earnings growth.
• Impressive Returns: The company’s average ROE of 65.0% over the last decade is exceptional.
• Debt Management: While not as strong as GWW, ITW can pay off its debt with less than five years of earnings.
• Capital Efficiency: ITW has delivered a 13.9% return on retained earnings, which is solid though slightly below Buffett’s ideal.
• Share Buybacks: The company has consistently reduced its outstanding shares.

The model projects a potential 16.2% average annual return for ITW over the next ten years. As a Dividend Aristocrat, ITW has increased its dividend for 51 consecutive years.

ITW also scores well (68%) on Validea’s Multi-Factor model, which looks for low volatility stocks with strong shareholder yields and momentum.

3. Automatic Data Processing, Inc. (ADP)

Automatic Data Processing, a leading provider of human resources management software and services, scores 93% on the Buffett model.

Why ADP Passes the Buffett Model:

• Earnings Growth: ADP has shown consistent earnings growth over the past decade.
• Strong Returns: The company’s average ROE of 54.7% over the last ten years is impressive.
• Excellent Debt Management: ADP could pay off its debt in less than two years with current earnings.
• Efficient Use of Capital: Management has delivered a 26.2% return on retained earnings over the past decade.
• Share Repurchases: ADP has reduced its outstanding shares over the past five years.

The model projects a potential 14.0% average annual return for ADP over the next decade. ADP has increased its dividend for 49 consecutive years, placing it firmly among the Dividend Aristocrats.

ADP also performs well (77%) on Validea’s P/B Growth model, which identifies growth stocks trading at attractive valuations.

Dividend Aristocrats that align with Warren Buffett’s investment principles offer an interesting combination of fundamentals. These companies demonstrate consistent profitability, strong financial management, and a commitment to shareholder returns. By combining the reliability of Dividend Aristocrats with the rigorous criteria of Validea’s Buffett model, investors can identify high-quality stocks with the potential for sustained growth and income.