The first selection for the newly launched Inflation-Protected Income Growth Portfolio is industrial conglomerate United Technologies . The maker of products as diverse as aircraft engines, elevators, fire suppression systems, and air conditioning makes a great foundational pick for a portfolio dedicated to the preservation of purchasing power.
With a history of rising dividends that stretches back to the mid-1990s, the company exhibits shareholder-friendly behavior that predates the Bush dividend tax cuts and thus will likely not be derailed if they expire. With six distinct multibillion-dollar business units and a decent balance sheet, even if its defense business gets curtailed if we fall over the fiscal cliff, the overall company should survive. And with a respectably low payout ratio of 38.6%, it has considerable coverage even if things do go bad.
Why it's worth owning in the iPIG Portfolio
To earn a spot in the portfolio, a company has to pass a series of tests related to its dividends, its balance sheet and valuation, and how it fits from a portfolio diversification perspective.
- Payment: The company's annual dividend currently sits at $2.14 a share, a yield of 2.7% based on Tuesday's closing price.
- Growth history: The company has paid higher dividends every year since 1995, when it moved its dividend from $0.06 per quarter to $0.07. Unlike many companies that regularly raise their dividends on an annual schedule, though, United Technologies tends to announce its increases every five quarters.
- Reason to believe the growth can continue: With a payout ratio of 38.6%, the company retains more than 60% of its income to reinvest for future growth. That low payout ratio also means the dividend can continue to move up for several years, even if the business stagnates.
Balance sheet and valuation:
- Balance sheet: A debt-to-equity ratio of 1.1 indicates that the company does use debt but hasn't overleveraged itself to the point where a financial hiccup would derail it.
- Valuation: By a discounted cash flow analysis, the company looks to be worth around $93.5 billion, making its recent market price of $73.5 billion look like something of a bargain. Of course, there's something of a conglomerate discount baked into its market price that makes reaching a full valuation unlikely, but that won't affect the dividends this portfolio is most interested in.
- As the first company selected, it fits without question. That said, picking United Technologies means that other conglomerates and defense contractors will face an uphill battle before being allowed into the portfolio.
What are the risks?
As a conglomerate, United Technologies is at risk of the same sort of hubris that almost destroyed fellow conglomerate General Electric when the financial market imploded a few years ago. With diverse business lines, it's easy to start justifying extra debt to enter new markets or industries or just to juice perceived returns. That sort of thinking tends to work until it doesn't, and then it fails dramatically. Keeping an eye on its debt levels will help it stave off another GE-like implosion.
Also, a decent chunk of United Technologies' business is tied to federal spending and the defense industry. If the country falls off the fiscal cliff, that part of its business could slow. That said, its conglomerate diversification does protect it better than companies like Northrup Grumman and Lockheed Martin that are more tightly coupled to defense spending. Still, if the fiscal cliff crisis is averted, that same protection will somewhat mute any relief rally that would otherwise help United Technologies' shares.
Additionally, part of United Technologies' Otis elevator, Carrier air conditioning, and UTC Fire & Security businesses depends on construction. Though it's not as tied to new construction as heavy-machinery magnate Caterpillar is, new installations and long-term growth for those United Technologies business units are easier to come by when new buildings are going up.
What comes next?
When the Fool's disclosure policy allows, I plan to buy United Technologies stock for the Inflation-Protected Income Growth portfolio, as long as its share price remains below $83. I expect to invest around $1,500 in the selection, giving it a 5% allocation in the portfolio, with the other 95% of the portfolio still remaining cash. Watch my article feed for details of the next pick, coming soon.
More expert advice from The Motley Fool
Caterpillar is the market share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. Read all about Caterpillar's strengths and weaknesses in our brand-new report. Just click here to access it now.
Copyright © 2009 The Motley Fool, LLC. All rights reserved.