I Know First Research | December 15th 2013

With significant growth in the three major indices, each up at least 20% YTD, this past year has rewarded equity investments. Depending on the type of investor you are, a dividend stock may benefit your portfolio by adding additional returns on top of capital gains. Dividend stocks are subject to the market just like growth stocks, but behave differently.

By using the I Know First algorithm, we screened over 1,400 markets and we identified two companies with suitable dividends prone to growth next year. The first company we are confident about is Microsoft (MSFT). Microsoft develops and sells a variety of products used by businesses and consumers. This conglomerates core products are the omnipresent Office software and Windows PC operating system. Acer, Lenovo, Toshiba, Hewlett-Packard, and Dell all pre-install Microsoft Office on their devices. The firm sell’s a long list of products directly to retailers and online. Microsoft also designs mobile phone software and they are acquiring Nokia’s (NOK) handset business, which is further elaborated in Nokia: Refocused and Resurgent. The second company projected for growth with a compelling dividend is ConocoPhillips (COP). They are the largest independent exploration and production company in the world based on reserves and oil production, currently owning 13.8 million net acres in the US. They reconnoiter for gas and oil in over 30 countries. COP explores, transports, and markets crude oil, liquefied natural gas (LNG), natural gas liquids (NGLs), bitumen, and natural gas. ConocoPhillips has one of the highest dividend yields of the US based energy conglomerates at 4% where the industry average is 2%.

Dividend Stock Synopsis

Some companies, such as utilities, because their business is inherently predictable and has limited growth potential, do not reinvest their profits in the business, but pay out regular dividends. Other, faster growing companies don’t pay dividends initially, but prefer to reinvest the profits to grow the business. They too, could reach a plateau, where the growth is slowing, thus they prefer to pay out extra profits as dividends. However not all dividend stocks are equal. Beware that some pay high dividends not because the corporation is very profitable, but because the firm is in trouble. This is because the company decides dividends, but market forces determine the stock price. As the troubled company’s stock goes down, the dividend per share automatically increases.

Dividend Payout Ratio

The dividend payout ratio is a crucial indicator for dividend stocks giving insight of how well a company effectively manages its capital and growth. This ratio is the percentage of a company’s net earnings that a firm pays as dividends to investors. When looking for a great dividend to enhance your portfolios income, corporations should generally have a payout ratio somewhere between 25%-50% however, it also depends on market conditions and the sector of the listed company. For example, Microsoft has a payout ratio of 34.4% and ConocoPhillips ratio is 39.73%. When combined with earnings growth and net dividend levels, this metric delivers excellent information for investors. Before investing, recognize what the dividends are and how sustainable the payments will be. Determine whether the dividend has been rising over time and of course review the firms other financials and business model as you would with any other asset. Ultimately, finding a stock with a preferable payout ratio really depends on the individual investors’ needs and overall strategy, including how long they want to be invested.

Reasons To Be Bullish On Microsoft

Microsoft’s revenue is at $80,370 (mil) TTM. This revenue comes from a multitude of products, and their customer base consists of businesses and as well as private patrons. This company is well grounded and very liquid if it were to ever get into trouble. These liquidity ratios in Chart 1 show Microsoft’s ability to pay off its short-term debts. The quick ratio measures whether assets are readily convertible into cash. A ratio of 1 is generally considered to be satisfactory.



Microsoft’s quick ratio has improved since 2008. Both the quick ratio and current ratio have remained consistent with each other over the past 8 years. Microsoft’s free cash flow per share indicates their ability to pay dividends, pay debt, facilitate growth and buy back stocks. Their dividend payout ratio is 34.4%, a safe number for investors looking for a solid blue chip with a dividend in their portfolio. In Chart 2, free cash flow per share is in an upward trend although there is a slight decrease towards the end.

Earnings-per-share is one of the most important variables in determining share price. From 2004 until 2013, the overall trend is positive. Microsoft is also amongst eight other technology conglomerates including Twitter (TWTR), AOL (AOL), LinkedIn (LNKD), Google (GOOG), Facebook (FB), Apple (APPL), and Yahoo (YHOO) in a campaign to limit online government surveillance in order to prevent losses due to Edward Snowden’s disclosures of the National Security Agency’s PRISM project. These leaks according to Forrester Research projected that these government data collection practices could cost the US cloud computing industry $180 billion by 2016.

Chart 3 shows MSFT performance over the past two years. The thick blue line shows the actual price. The thin broken color lines on the chart are the signal lines.



The positive or negative (up or down) signals of the forecast were added to the actual last known price at the time of forecast. When the signal line is above the actual line, it means “buy” and if below, then “sell”. Each point on this chart was taken from the actual daily forecast published in the morning before the next market open. Each forecast consists of six forecasts for six time horizons, from three days to one year ahead.

Reasons To Be Bullish On ConocoPhillips

ConocoPhillips is up over 20% is YTD. Over the next five years, the oil sands projects in Canada, compound annual growth rate are anticipated to grow 20%. 3Q13 adjusted earnings increased 7% versus 3Q12 and 4% versus 2Q13. The debt to capital ratio is 30%, which signifies that the company is in a comfortable position not needing to take big risks. This is especially important in the energy sector where there is a lot of volatility from government intervention, limited oil reserves, expensive exploration for energy, and adapting to new technology such as extracting shale gas. Investors can take further comfort knowing that ConocoPhillips beta is .95 according to Yahoo finance, which is still less volatile than the market. Chart 3 shows the five-year cumulative total stockholders returns versus ConocoPhillips old peers and new peers as well as against the S&P 500. Released on September 30th 2013, according to ConocoPhillips investor relations the old peer group includes BP (BP), Chevron (CVX), Royal Dutch Shell (RDS.A), and Total (TOT). The new peers include the old peers plus Anadarko (APC), Apache (APA), BG Group plc. (BG.L), Devon (DVN), and Occidental (OXY). The time frame of the chart is from December 31st 2007 until December 31st 2012.

Integrated oil companies are oil capital intensive as their key activities include drilling, production, acquiring leases, and property, etc. This makes the return on capital employed or ROCE a very reliable indicator for corporate performance. The return on capital employed for COP is 11%. ConocoPhillips calculates ROCE, as the numerator of which is net income plus after-tax expense, and the denominator is the average plus total debt. Recently releasing their 2014 capital budget, ConocoPhillips plans to spend $16.7 billion to explore and develop gas and oil around the world. The budget is broken down into four sections. 13% will be spent on exploration and appraisal with another 13% to be spent on base maintenance. 39% will go towards developmental drilling programs, and finally major projects will account for 35% of the capital budget. ConocoPhillips will focus 90% of its development drilling funding in North America as they see this region adding 600,000 BOE/d by 2017. ConocoPhillips also has very interesting projects abroad such as they project to have 50,000 BOE/d in Libya. In Europe they have projects in Norway and the U.K. and a few projects in the Asia-Pacific region. ConocoPhillips capital plan positions the company to reach targets to increase margins by 3%-5% through 2017.

I Know First Prediction

I Know First utilizes an advanced algorithm based on artificial intelligence and machine learning to predict market performance for over 1,400 markets including stock forecasts, world indices, commodities, interest rates, ETFs, and currencies. The system follows the flow of money from one market into another. Essentially, the algorithm identifies stocks trading in ranges that deviate drastically from the trends the algorithm deems rational. The algorithm’s methodology is discussed in more detail in Citigroup’s Competitive Advantage under the section titled Algorithmic Prediction for Citigroup. Chart 5 shows I Know First’s predictions for MSFT and COP in the 1-month, 3-month and 1-year time horizons from December 11, 2013. These stocks were selected from December 11th’s Best Dividend Stocks Forecast. Predictions with a greater time horizon such as the 1-year tend to be more accurate than the shorter predictions such as 1-month or 3-month predictions. ConocoPhillips has a consistently stronger predictability than Microsoft in all three-time horizons.



The number in the middle of the box (flush right) is the signal. The signal expresses the predicted direction and magnitude the algorithm believes an asset will move, not a percentage or specific target price. A bigger number signifies a stronger signal. The signal also dictates the color and location an asset is on the heat map. If the asset has a positive signal it will be in a grey/green box denoting a long position and if the signal is very strong the asset will be in a lime green box demonstrating that the algorithm is strongly bullish. The same is true for a negative signal with the pink and red respectively denoting a short position. Assets with the strongest positive signals will be closer to the top left of the heat map while, the strongest negative signals will be towards the bottom right of the heat map. In addition to monitoring the signal, it is imperative to take into consideration the predictability. This is the “strength” of the prediction, which ranges theoretically between minus 1 to plus 1. The predictability shows us another independent indication regarding how foreseeable the market or asset is as different markets/assets are not equal. ConocoPhillips has a consistently stronger predictability than Microsoft in all three-time horizons.

Conclusion

These two dividend stocks can be great additions to a well-diversified portfolio contributing excess returns in the form of dividends. Microsoft has a dividend of 3% and ConocoPhillips has a dividend of 3.7%. Both assets have suitable dividend payout ratios’ as Microsoft payout ratio is 34.4% and ConocoPhillips ratio is 39.73%. Expect growth from these assets through 2014, as their dividends are only part of the reason why they are both sound investments.

I Know First Research is the analytic branch of I Know First, a financial startup company that specializes in quantitatively predicting the stock market. This article was written by Joshua Martin one of our interns. We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article.

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