In This Issue Dial M for Merger...Medtronic/Covidien and the Walgreens/ Alliance Boots deals won’t have capital gains tax implications for the sharehold-ers of the acquiring companies,

Dial M for MergerFive DI companies are now in merger and acquisition talks. Wisconsin Energy

Corp. (WEC) intends to acquire Integrys Energy Group Inc. (TEG), Medtronic Inc. (MDT) wants to buy Covidien plc (COV), Apple Inc. (AAPL) is taking over Beats Electronics, AT&T Inc. (T) is seeking approval to take over DirecTV (DTV) and Walgreen Co. (WAG) is negotiating to purchase the 55% of Boots Alliance it does not currently own. Yes, there is a lot of “Let’s Make a Deal” being played. We’re going to use this month’s report to give you a summary overview of the pending mergers to give you a better understanding of what’s going on.

Before we start, we have one deletion to announce. This week we received two shares of Veritiv Corp. (VRTV) from a Reverse Morris trust transaction com-pleted by International Paper (IP). Since our intent is to hold International Paper, we will be selling our very small stake in Veritiv.

Now, back to those mergers.The Wisconsin Energy/Integrys Energy Group tie-up would expand Wisconsin

Energy’s geographic reach and market share. Integrys Energy serves areas in Illinois, Michigan, Minnesota and Wisconsin. The company also holds a stake in American Transmission Co., a privately owned electric transmission utility. Post-merger, the new WEC Energy Group would have majority ownership of American Transmission Co., a move some analysts see as a positive since it would give the company more control over transmission.

This deal seems like a case of “get bigger or get acquired” for Wisconsin Energy. Wisconsin Energy executives, including CEO Gale Klappa, will oversee the merged company. The deal requires the approval of state and federal utility regulators in addition to the traditional antitrust reviews. The merger is expected to be completed by summer 2015. Since the two companies’ geographic areas do not overlap, we do not think regulators will oppose the merger.

Medtronic hopes to create a company close in size to medical-device busi-ness industry leader Johnson & Johnson (JNJ) by acquiring Covidien. Covidien makes devices used in weight-loss surgery, laparoscopic procedures and a range of other surgical procedures. The expansion should allow Medtronic to better compete for business from hospitals, particularly in the U.S. where health care reform efforts and shrinking government reimbursement for medical procedures has kept pressure on device pricing. Analysts believe the disparate businesses should alleviate any significant antitrust concerns. Since this a cross-border health care merger, it requires approval from both U.S. and international regula-tors. Medtronic expects the deal to close in the fourth quarter of 2014 or early 2015.

Covidien is based in Ireland and the combined company would be headquar-tered in Dublin. This fact is causing raised eyebrows even though Medtronic CEO Omar Ishrak says his company’s corporate tax rate won’t change much. Ishrak does say Ireland’s tax code would allow Medtronic to better use profits it has realized outside of the U.S., however.

The Wall Street Journal pointed out that a tax inversion will not free Medtronic from U.S. taxes. If the new, foreign-based Medtronic plc wants to transfer foreign assets and future cash flows out from under the U.S. tax net and over to the

AAII Dividend Investing is produced by AAII. “The American Association of Individual Investors is an independent nonprofit corporation formed in 1978 for the purpose of assisting individuals in becoming effective managers of their own assets through programs of education, information and research.”

In This Issue

DI TablesPortfolio Alerts This Month 2Portfolio Holdings 3Performance of DI Portfolio 4Recent Earnings Announcements 5Dividend Payments 6Dividend Analysis 7

In-Depth Stock ReportsBaxter International Inc. (BAX) 8

Leading global health care company trading with an above-average dividend yield.

Chevron Corp. (CVX) 10Oil “supermajor” has improved returns by restructuring its downstream operations and selling underperforming assets.

Medtronic, Inc. (MDT) 12Acquisition of Covidien should help medical-device maker boost growth, hike its dividend and reduce taxes.

Wells Fargo & Co. (WFC) 14Bank holding company experiencing rising earnings, a growing dividend and an attractive valuation.

DI Article Operating Cash Flows: Measuring Day-to-Day Profitability 16

If cash is king, then cash from operations is his head knight.

Next Publication Date: August 8, 2014

July 2014Volume III Issue 7

www.AAIIDividendInvesting.com

TM

2 July 2014

new Ireland-based parent, it will likely face a tax bill from the U.S. on the fair market value of those assets. A compa-ny can also arrange an asset sale at fair market value between its subsidiaries without incurring U.S. taxes, but pro-ceeds from the sale would accrue to the U.S. foreign subsidiary, possibly defeat-ing the purpose of the inversion.

Apple’s proposed acquisition of Beats Electronics should be completed in the fourth quarter, barring any regula-tory or due diligence surprises. Beats is a privately held corporation based in California. Since there isn’t much direct competitive overlap between the two companies, we expect regulatory approval. The combination gives Apple a popular line of headphones and, more importantly, two executives with big reach and influence in the music industry.

The AT&T/DirecTV deal faces a much higher degree of scrutiny. Just last week, AT&T’s CEO Randall Stephenson was on Capital Hill making an argument to allow the merger to go through. AT&T currently offers cable-type TV ser-vices, but it does not have the national footprint DirecTV has. Nonetheless, the

acquisition would remove one provider of broadcast and cable TV service from the national market, and this is where objections could be raised. Similar argu-ments are likely to be raised over the proposed Comcast Corp. (CMCSA)/Time Warner Cable Inc. (TWC) tie-up.

AT&T says purchasing DirecTV would allow it to better compete against Comcast. Stephenson further argues that the merger would allow AT&T to “price all of our services more com-petitively,” and will lead to lower prices from competitors; expand high-speed broadband service to at least 15 million customer locations, most of them rural, within four years of the transaction clos-ing; and propel the development of new “over the top” video services.

AT&T previously made the expansion into rural areas as a selling point in its failed attempt to acquire T-Mobile US Inc. (TMUS). As far as competitive pric-ing is concerned, Bloomberg noted that Stephenson wouldn’t commit to cutting customer bills; he only told a U.S. House committee that “price increases can be ‘mitigated.’”

From a shareholder standpoint, DirecTV would give AT&T an immediate

infusion of cash. Last year, DirecTV realized $4.72 per share in free cash. This will both help cover the tele-com’s dividend and help pay down any additional debt taken on to finance the transaction.

The timeline for com-pleting this merger is late spring or early summer of 2015. Given the high level of regulatory scrutiny the deal is receiving and the concurrent Comcast/Time

Warner deal, we’re cautious about mak-ing any prediction about the likelihood of it being approved.

Walgreens acquired a 45% equity interest in Alliance Boots in August 2012. The American drugstore retailer has a call option to acquire the remain-ing 55% stake in the Switzerland-based pharmacy during a six-month period beginning on February 2, 2015. If Wal-greens does not exercise the call option, it may be required to return a 3% inter-est in Alliance Boots in exchange for a nominal amount.

Some investors are pressuring Wal-greens to relocate its corporate home to Switzerland by exercising the call option and completing a tax inversion. The move is perceived as lowering the American company’s tax bill. It would also recharacterize the dividend from being paid by a domestic corporation to being paid by a Swiss corporation.

Beyond the tax issue, the merger would give Walgreens complete control over Alliance Boots. It would also fully give it international reach, particularly in Europe. Walgreens is expected to announce its plans in a conference call in the coming weeks, according to The

Published monthly by the American Association of Individual Investors 625 N. Michigan Ave., Chicago, IL 60611 312-280-0170, www.aaii.com. Annual DI subscription, $199.

AAII Dividend Investing™ (DI) is not a registered investment adviser or a broker/dealer. This report is issued solely for informational purposes and should not be construed as an offer to sell or the solicitation of an offer to buy securities.

The opinions and analyses included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty, expressed or implied, is made as to their accuracy, completeness, timeliness, or correctness. Neither we nor our information providers shall be liable for any errors or inaccuracies, regardless of cause,

or the lack of timeliness of, or any delay or interruptions in, the transmission thereof to the users. All information contained in this report should be independently verified with the companies mentioned.

© American Association of Individual Investors, 2014. AAII Dividend Investing is a trademark and service mark of the American Association of Individual Investors—All rights reserved. This publication may not be reproduced in whole or in part by any means without prior written consent.

“The American Association of Individual Investors is an independent nonprofit corporation formed in 1978 for the purpose of assisting individuals in becoming effective managers of their own assets through programs of education, information and research.”

Printed in the U.S.A.

Portfolio Alerts This MonthJuly Portfolio Deletions

Portfolio Stock Total Index TotalAddition Return Since Return Since

Date Price Alert Date Purchase Purchaseno portfolio deletions for July

Sale of Spin-Off Shares from International Paper:Veritiv Corporation (VRTV)

July Portfolio Additions

Latest DividendCompany (Ticker) Price Yield Sector: Industryno portfolio additions for July

Portfolio Deletion AlertCompany (Ticker)

business-to-business distribution company

July2014 3

AAII DIvIDeND INvesTINg

Wall Street Journal.The tax implications for DI subscrib-

ers vary with each deal. The AT&T/Di-rectTV, the Apple/Beats Electronics and the Wisconsin Energy/Integrys Energy mergers will not have any tax implica-tions for shareholders of the acquiring companies. The tax characteristics of the dividends paid by the acquiring companies will not change either. The Medtronic/Covidien and the Walgreens/Alliance Boots deals won’t have capital gains tax implications for the sharehold-ers of the acquiring companies, but they will make the dividends foreign and this will have post-merger tax implications. DI holding Eaton Corp. (ETN) incurred a similar situation when it moved its offices to Ireland, but the company also started paying dividends as a return of capital instead of from earnings. We are waiting to see what the implications for Medtronic’s and potentially Walgreens’ dividends will actually be.

There is another important point we want to make about the pending mergers: Each deal has a life of its own. Mergers require approval by regula-tors. Deals involving two publicly traded companies also require the approval

of many shareholders. Due diligence, changes in business conditions and terms written into the merger agree-ment also can cause a proposed merger to fall apart. The called-off merger be-tween DI holding Omnicom Group Inc. (OMC) and Publicis earlier this year pro-vided a great example of a how a deal is never done until it is done. Among the deals currently pending, AT&T can walk away if DirecTV fails to renew its NFL Sunday Ticket deal, and Medtronic has cancellation rights if new tax laws are passed.

DI Portfolio AlertsAs previously stated, we are deleting

the shares in Veritiv Corp. that we re-ceived in the DI tracking portfolio as the result of International Paper’s Reverse Morris Trust transaction.

Medtronic, Norfolk Southern Corp. (NSC), and United Technologies (UTX) are all trading below their respective five-year average low yields. Walgreens has the lowest absolute yield of any DI stock at 1.7%. It is also trading right at its five-year average low, and it has the highest price-earnings ratio of any DI stock at 25.2. We’d consider replac-

ing one of these if we could find stocks with a better potential for total return upside, but the record highs being established by the S&P 500 index are making it tough to do so. Several of the stocks we’re seeing trading above their five-year average relative yields face short-term hurdles with uncertain out-comes. This is why we felt that the best decision was to not make any additional changes.

Special Shares Deletion: Veritiv Corp. (VRTV)

Shareholders of record of Internation-al Paper as of June 20, 2014, received 0.019118445 share of Veritiv common stock for each share of International Pa-per common stock. However, fractional shares of Veritiv were not distributed to International Paper shareholders. Rath-er, fractional shares of Veritiv common stock will be aggregated and sold in the open market, with the net proceeds to be distributed pro rata in cash pay-ments. The share distribution is tax-free to International Paper shareholders, ex-cept for the gain or loss attributable to cash received in lieu of fractional shares of Veritiv common stock. See (“The Tax

DI Pur- Latest Junchase Price Gain/ Div

Ticker Company Date Price Price (6/30/14) (Loss) Stock Index Yield IndustryAFL AFLAC Incorporated 12/31/11 $43.26 $45.04 $62.25 1.7% 47.6% 62.4% 2.4% Insurance (Accident & Health)AAPL Apple Inc. 4/4/14 $75.97 $75.26 $92.93 2.8% 24.2% 6.7% 2.0% Computer HardwareT AT&T Inc. 12/31/11 $30.24 $30.48 $35.36 (0.3%) 32.3% 62.4% 5.2% Communications ServicesBAX Baxter International 9/6/13 $70.01 $71.34 $72.30 (2.8%) 3.6% 18.1% 2.9% Medical Equipment & SuppliesCVX Chevron Corporation 12/31/11 $106.40 $110.91 $130.55 6.3% 27.9% 62.4% 3.3% Oil & Gas - IntegratedDE Deere & Company 2/7/14 $86.56 $87.59 $90.55 (0.7%) 4.7% 8.2% 2.7% Construction & Agricul MachineryETN Eaton Corporation 12/31/11 $43.53 $45.52 $77.18 4.7% 82.0% 62.4% 2.5% Electronic Instruments & ControlsIP International Paper Co. 4/4/14 $45.81 $45.69 $50.47 6.0% 11.3% 6.7% 2.8% Paper & Paper ProductsIVZ Invesco Ltd. 6/6/14 $38.18 $37.82 $37.75 2.9% (0.2%) 0.9% 2.6% Investment ServicesMCD McDonald's Corp. 12/31/11 $100.33 $99.19 $100.74 (0.7%) 10.0% 62.4% 3.2% RestaurantsMDT Medtronic, Inc. 12/31/11 $38.25 $38.89 $63.76 4.5% 74.4% 62.4% 1.9% Medical Equipment & SuppliesMSFT Microsoft Corp. 12/31/11 $25.96 $26.94 $41.70 1.9% 66.4% 62.4% 2.7% Software & ProgrammingNSC Norfolk Southern Corp. 12/31/11 $72.86 $74.18 $103.03 2.3% 48.3% 62.4% 2.1% RailroadsOMC Omnicom Group Inc. 6/7/13 $63.93 $63.33 $71.22 0.1% 15.9% 22.2% 2.8% AdvertisingPEP PepsiCo, Inc. 12/31/11 $66.35 $66.66 $89.34 1.1% 44.2% 62.4% 2.9% Beverages (Non-Alcoholic)PG Procter & Gamble Co. 12/7/12 $70.29 $70.89 $78.59 (2.7%) 16.1% 42.2% 3.3% Personal & Household ProductsTGT Target Corporation 12/31/11 $51.22 $51.28 $57.95 2.1% 20.1% 62.4% 3.6% Retail (Department & Discount)TXN Texas Instruments 4/5/13 $34.20 $34.80 $47.79 1.7% 42.3% 28.7% 2.5% SemiconductorsTRV Travelers Companies 9/7/12 $65.21 $65.60 $94.07 0.7% 48.8% 43.0% 2.3% Insurance (Property & Casualty)TUP Tupperware Brands 11/8/13 $86.51 $86.94 $83.70 (0.0%) (1.5%) 12.1% 3.2% Personal & Household ProductsUTX United Technologies 12/31/11 $73.09 $74.97 $115.45 (0.7%) 63.2% 62.4% 2.0% Aerospace and DefenseWAG Walgreen Company 2/8/13 $41.40 $41.57 $74.13 3.1% 84.4% 32.9% 1.7% Retail (Drugs)WFC Wells Fargo & Co. 12/7/12 $33.23 $33.40 $52.56 3.5% 64.2% 42.2% 2.7% Regional BanksWEC Wisconsin Energy Corp. 12/31/11 $34.96 $34.68 $46.92 3.1% 47.3% 62.4% 3.3% Electric UtilitiesData as of 6/30/2014. Sources: AAII Stock Investor Pro, Thomson Reuters, I/B/E/S and company releases.

Portfolio AlertTotal Return

Since Purchase

Portfolio Holdings

4 July 2014

Performance

Dividend Yield %6.1%7.2

TotalReturn

IncomeReturn

CapitalGain/(Loss)

TotalReturn

IncomeReturn

CapitalGain/(Loss)

June 1.9% 0.3% 1.6% 2.3% 0.4% 1.9%2014 YTD 6.2% 1.4% 4.8% 7.0% 0.8% 6.2%2013 36.5% 3.6% 32.9% 32.6% 2.3% 30.3%2012* 10.2% 3.5% 6.7% 14.3% 2.2% 12.1%From Inception 59.6% 11.1% 48.5% 62.4% 7.3% 55.1%Performance as of 6/30/2014

Dow Jones U.S. Index (IYY)Dividend Investing Portfolio*

*The AAII Dividend Investing portfolio started on January 3, 2012. The portfolio is run as if managed by a subscriber and includes delays in reaction time to portfolio alerts, actual commissions and bid-ask spreads.

Dividend Investing Portfolio Dow Jones U.S. Index (IYY)

AAII Dividend Inves�ng Por�olio

Performance of DI Portfolio

Consequences of Stock Splits, Mergers and Spin-Offs” in the June 2014 AAII Journal for more information on how to determine your tax exposure.)

The Veritiv shares were the result of In-ternational Paper’s Reverse Morris Trust transaction. This type of transaction involves a parent company (International Paper) selling some of its assets (distribu-tion solutions business unit xpedx) to a smaller company (UWW Holdings). The parent company then creates a subsid-iary that in turn merges with the smaller company to create a new company (Veri-tiv). This complicated type of transaction

allows the parent company to avoid incurring taxes on the transaction.

June DI Portfolio PerformanceThe DI tracking portfolio gained 1.9%

last month, its fifth consecutive monthly gain. The portfolio realized capital gains of 1.6% and income return of 0.3%. Our benchmark, the Dow Jones U.S. Index fund (IYY), fared slightly better with a gain of 2.3%. The fund’s return was made up of 1.9% in capital gains and 0.4% in income return. The fund paid its quarterly distribution last month.

June was a good month for the DI

portfolio with 17 out of our 24 stocks gaining. We had a few big winners, most notably Chevron Corp. (CVX) and Inter-national Paper. More importantly, none of our holdings lagged considerably. The worst performer, Baxter International (BAX), was down just 2.8% last month.

We’re in the midst of another good year for stocks. If the returns for the first half of the year can be duplicated in the second, we’ll see double-digit gains for the DI portfolio and our benchmark. Whether this happens is something no one can forecast. We can tell you that the third quarter has historically been the bumpiest for the stock market, so to see some type of decline would not be shocking. Then again, the market could well continue to “melt up.” We’re hoping for the latter, while focusing on controlling the things we can control and not worrying about what Mr. Mar-ket will or will not do.

Year-to-date as of June 30, the DI tracking portfolio is up 6.2%. The Dow Jones U.S. Index (IYY) is faring even better, up 7.0% year-to-date. The DI portfolio is lagging on a capital gains basis, up 4.8% versus 6.2%, but beating on an income return basis, 1.4% versus 0.8% year-to-date.

Portfolio News

Strongest Stocks in JuneChevron Corp. (CVX) outpaced all

other DI stocks in June, posting a 6.3% gain. The primary driving force behind the gains was oil prices driven higher by global instability, particularly in Iraq, where ISIS (the Islamic State of Iraq and Syria) took over large parts of both Iraq and Syria. While the group captured a significant gas refining facility, most oil facilities have remained out of reach. Over the medium and longer term, it is likely that traders will recognize this and push oil prices back down, but for the moment energy is being bid up. The higher price of oil supports companies that are sellers of energy, while hurting those that are buyers of energy.

Additionally, Chevron has been divest-ing underperforming assets, such as

Performance

Dividend Yield %6.1%7.2

TotalReturn

IncomeReturn

CapitalGain/(Loss)

TotalReturn

IncomeReturn

CapitalGain/(Loss)

June 1.9% 0.3% 1.6% 2.3% 0.4% 1.9%2014 YTD 6.2% 1.4% 4.8% 7.0% 0.8% 6.2%2013 36.5% 3.6% 32.9% 32.6% 2.3% 30.3%2012* 10.2% 3.5% 6.7% 14.3% 2.2% 12.1%From Inception 59.6% 11.1% 48.5% 62.4% 7.3% 55.1%Performance as of 6/30/2014

Dow Jones U.S. Index (IYY)Dividend Investing Portfolio*

*The AAII Dividend Investing portfolio started on January 3, 2012. The portfolio is run as if managed by a subscriber and includes delays in reaction time to portfolio alerts, actual commissions and bid-ask spreads.

Dividend Investing Portfolio Dow Jones U.S. Index (IYY)

AAII Dividend Inves�ng Por�olio

July2014 5


selling its oil interests in Chad, which raised $1.3 billion and closed a few weeks ago.

Shares of Chevron remain attractive on a valuation basis despite the recent rise. While the current yield is near its five-year average, it ranks in the top fifth of all S&P 500 stocks.

Additional information on Chevron is provided on pages 10 and 11.

Shares of International Paper Co. (IP) gained 6.0% during June as the compa-ny completed the spin-off of its distribu-tion solutions business, xpedx. Inter-national Paper will get $400 million in cash and maintain a 51% ownership in the new company, which merged with UWW Holdings to form a new company Veritiv Corp. (VRTV).

International Paper has indicated that it plans to eventually pay out between 30% and 40% of its free cash flow. In a Barron’s article, CEO John Faraci noted that he sees the “potential for the divi-dend to increase to a sustainable level of between $1.80 and $2.00 a share.” He was further quoted in the article as saying, “Our approach to raising the dividend will be periodic and incremen-tal, but it will be meaningful.” Interna-tional Paper currently pays an indicated annual dividend of $1.40 per share and trades with a yield of 2.8%.

Eaton Corp. (ETN) stock gained 4.7% during June as it closed the book on open legal issues. First, it signed an agreement with Triumph Group (TGI) that completely resolves all litigation issues between them with respect to actions pending in Mississippi and North Carolina. Eaton will pay $147.5 million as part of the settlement; the other terms are confidential. Eaton filed suit in 2004 in Mississippi against Frisby Aerospace LLC, now a Triumph Group subsidiary, alleging trade secret misap-propriation involving engineers who once worked for Eaton. North Carolina-based Frisby Aerospace denied charges and later filed suit against Eaton in North Carolina and Mississippi, alleging anti-competitive behavior. As part of this case, Eaton was also found guilty of having knowledge that the law firm they hired illegally contacted and bribed

Mississippi Judge Bobby DeLaughter, and was fined $1.5 million.

Separately, Eaton reached a settle-ment with auto-parts companies Meritor Inc. and Germany’s ZF Friedrich-shafen. Eaton faced up to $2.4 billion in damages for squeezing rivals out of the truck-transmission market by rewarding commercial truck makers with generous rebates for using its own transmissions. Meritor Inc. and ZF Friedrichshafen were seeking between $475 million and $800 million in lost profits and lost business opportunities in this antitrust case. Due to the antitrust nature of the suit, the damages would have been tripled and the payout range would inflate to $1.4 billion to $2.4 billion. With the settlement, Eaton will pay out $500 million. This settlement proves to be very beneficial for Eaton, as a significant amount of financial risk has been reduced due the uncertain out-come they would have faced in a trial. Legal experts have stated that Meritor accepted the settlement on grounds of avoiding a trial, possible appeal and the chance a jury or judge would produce a lower-than-anticipated award.

Medtronic Inc. (MDT) was the fourth-best performer among DI stocks in June after it gained 4.5%. On June 16, the company announced that it had agreed to buy Covidien plc (COV) for $42.9 billion in cash and stock and move its executive base to Ireland, in a bid to lower its corporate tax rate. As previ-ously noted, the expansion should allow Medtronic to better compete for busi-ness from hospitals, particularly in the U.S. where health care reform efforts and shrinking government reimburse-ment for medical procedures has kept pressure on device pricing.

The deal values each Covidien share at $93.22, paid for by $35.19 in cash and 0.956 Medtronic shares. The trans-action represents a 29% premium to Covidien’s closing stock price on Friday,

June 13, Medtronic said. Following the merger announcement,

several analysts weighed in and up-graded shares of Medtronic. J.P. Morgan called the deal “by far the biggest and boldest move” of CEO Omar Ishrak’s tenure and claimed that the acquisition “creates immediate shareholder value” for Medtronic. Institutional broker BTIG believes the scale and cross-selling opportunities are important and that the acquisition was driven by expected scale and future cash use and not by tax benefits. Investment firm RBC Capital predicts that the merger will enable Medtronic to deliver growth above that of its peers.

Medtronic also raised its dividend by 9% to $0.305 per share. The increase was in line with the company’s recent increases, which have averaged 7.6% a year over the last three years and 8.4% a year over the last five years. It also marks the 37th consecutive year of increased dividend payments. This dividend increase, however, only pushed Medtronic’s yield to 1.9%, which is about 20% below the five-year average yield. We continue to monitor Medtronic’s valuation situation, which may lead us to replace the company with one that has a more attractive yield or higher dividend growth.

Additional information on Medtronic is provided on pages 12 and 13.

Weakest Stocks in JuneShares of Baxter International (BAX)

declined 2.8% during June as competi-tor Biogen Idec (BIIB) announced that the U.S. Food and Drug Administra-tion (FDA) approved its Eloctate for the control and prevention of bleed-ing episodes, perioperative (surgical) management and routine prophylaxis in adults and children with hemophilia A. This clears the way for Biogen to launch Eloctate in the U.S. next month. Six analysts polled by Reuters forecast $1.5

Recent earnings AnnouncementsDate Reported Expected Surprise

Ticker Company Reported Earnings Earnings %WAG Walgreen Company Jun 24 $0.910 $0.935 (2.7%)Data as of 6/30/2014. Sources: I/B/E/S and company releases.

6 July 2014

l'nnAshtnoMPIRDtceriDviDdnIetaDdnediviD-xEdnediviD

Ticker Company Paid Date Payable Div Yield Invest PlanAFL AFLAC Incorporated 3, 6, 9, 12 Mon May 19, 2014 Mon Jun 2, 2014 $0.3700 $1.48 2.4% Yes YesAAPL Apple Inc. 2, 5, 8, 11 Thu May 8, 2014 Thu May 15, 2014 $0.4700 � $1.88 2.0% -- --T AT&T Inc. 2, 5, 8, 11 Tue Jul 8, 2014 Fri Aug 1, 2014 $0.4600 $1.84 5.2% Yes YesBAX Baxter International 1,4,7,10 Wed Jun 4, 2014 Tue Jul 1, 2014 $0.5200 � $2.08 2.9% Yes YesCVX Chevron Corporation 3, 6, 9, 12 Thu May 15, 2014 Tue Jun 10, 2014 $1.0700 � $4.28 3.3% Yes YesDE Deere & Company 2,5,8,11 Thu Jun 26, 2014 Fri Aug 1, 2014 $0.6000 � $2.40 2.7% Yes YesETN Eaton Corporation 3, 5, 8, 11 Thu May 1, 2014 Fri May 23, 2014 $0.4900 $1.96 2.5% Yes YesIP International Paper Co. 3, 6, 9, 12 Wed May 21, 2014 Mon Jun 16, 2014 $0.3500 $1.40 2.8% Yes YesIVZ Invesco Ltd. 3, 6, 9, 12 Wed May 14, 2014 Fri Jun 6, 2014 $0.2500 $1.00 2.6% Yes YesMCD McDonald's Corp. 3, 6, 9, 12 Thu May 29, 2014 Mon Jun 16, 2014 $0.8100 $3.24 3.2% Yes YesMDT Medtronic, Inc. 1, 4, 7, 10 Tue Jul 1, 2014 Fri Jul 25, 2014 $0.3050 � $1.22 1.9% Yes YesMSFT Microsoft Corp. 3, 6, 9, 12 Tue Aug 19, 2014 Thu Sep 11, 2014 $0.2800 $1.12 2.7% Yes YesNSC Norfolk Southern Corp. 3, 6, 9, 12 Wed Apr 30, 2014 Tue Jun 10, 2014 $0.5400 $2.16 2.1% Yes YesOMC Omnicom Group Inc. 1, 4, 7, 10 Wed Jun 11, 2014 Thu Jul 10, 2014 $0.5000 � $2.00 2.8% Yes YesPEP PepsiCo, Inc. 1, 3, 6, 9 Wed Jun 4, 2014 Mon Jun 30, 2014 $0.6550 � $2.62 2.9% Yes YesPG Procter & Gamble Co. 2, 5, 8, 11 Wed Apr 23, 2014 Thu May 15, 2014 $0.6436 � $2.57 3.3% Yes YesTGT Target Corporation 3, 6, 9, 12 Mon Aug 18, 2014 Wed Sep 10, 2014 $0.5200 � $2.08 3.6% Yes YesTXN Texas Instruments 2, 5, 8, 11 Mon Apr 28, 2014 Mon May 19, 2014 $0.3000 $1.20 2.5% Yes YesTRV Travelers Companies 3, 6, 9, 12 Fri Jun 6, 2014 Mon Jun 30, 2014 $0.5500 � $2.20 2.3% -- YesTUP Tupperware Brands 1, 4, 7, 10 Mon Jun 16, 2014 Mon Jul 7, 2014 $0.6800 $2.72 3.2% -- --UTX United Technologies 3, 6, 9, 12 Wed Aug 13, 2014 Wed Sep 10, 2014 $0.5900 $2.36 2.0% Yes YesWAG Walgreen Company 3, 6, 9, 12 Mon May 19, 2014 Thu Jun 12, 2014 $0.3150 $1.26 1.7% Yes YesWFC Wells Fargo & Co. 3, 6, 9, 12 Wed May 7, 2014 Sun Jun 1, 2014 $0.3500 � $1.40 2.7% Yes YesWEC Wisconsin Energy Corp. 3, 6, 9, 12 Mon May 12, 2014 Sun Jun 1, 2014 $0.3900 $1.56 3.3% Yes Yes

� .htnom siht gnirud snoitca dnedivid etacidni setad dloB.retrauq roirp morf desaercni dnedivid ylretrauQ� Quarterly dividend decreased from prior quarter. Sources: AAII Stock Investor Pro, Thomson Reuters, I/B/E/S and company releases.

Data as of 6/30/2014.

Quarterly Dividend PaymentPaymentAmount

Dividend Payments

billion in annual sales by 2019. Baxter’s current hemophilia A treat-

ment Advate is a big seller for the company. Hemophilia sales totaled $3.4 billion for Baxter during 2013. Baxter plans to spin off its biopharmaceutical segment into a separate publicly traded company in 2015.

Additional information on Baxter is provided on pages 8 and 9.

Shares of Procter & Gamble Co. (PG) fell 2.7% in June, making it the second-worst performer in the DI portfolio. There was very little news for the com-pany over the month, so we attribute its weakness to that of the overall sector. The Consumer Staples Select SPDR ETF (XLP) fell 2.2% in June, making it the worst-performing S&P sector for the month.

Procter & Gamble did revise its third-quarter net sales to $20.178 billion, down from its previously reported $20.559 billion figure, but the lowered

figure reflects changes tied to the company’s exit from producing pet care products.

McDonald’s Corp. (MCD) saw its shares slip 0.7% in June. The company reported a small rise in global sales at established restaurants for May, after a rebound in China helped offset another month of disappointing results from the fast-food chain’s home market of the U.S. McDonald’s U.S. sales at restaurants open at least 13 months were down 1%, marking the seventh straight month of declines. Analysts polled by Consen-sus Metrix had expected May same-restaurant sales to rise 0.1% for the U.S. The company said worldwide sales at restaurants open at least 13 months rose 0.9%, slightly better than the 0.8% gain analysts expected. Same-store sales grew 2.5% in the Asia-Pacific, Middle East and Africa (APMEA) region, which includes China. That result easily topped analysts’ average forecast for a 0.7%

gain. Europe, which contributed 40% of revenue last year and is McDonald’s top region for sales, saw gains of 0.4%, just short of the 0.5% increase analysts expected.

Deere & Co. (DE) also declined 0.7% last month. The company reported a bigger drop in May sales of row-crop tractors, four-wheel drive tractors and combines than its competitors. The an-nouncement led to a mid-month decline in the stock price. Though traders were disappointed, analysts kept their earn-ings estimates for the current quarter and for fiscal 2014 unchanged.

The upside of the recent underper-formance is that Deere remains attrac-tively valued. The current yield of 2.7% is more than a full percentage point above the DI portfolio’s benchmark and is above the stock’s five-year average of 2.2%. Deere’s current price-earnings ratio of 9.9 is also attractive on both an absolute and a relative basis. ▪

July2014 7


Ann’l Ind Div: The total dollar amount of cash dividends forecast to be paid over the next 12 months.Consecutive Years Div Raised: The number of current years the company has continuously increased the annual dollar amount of the dividend.Date Payable: The date a company will distribute (or has distributed) the most recent quarterly dividend.DI Purchase Price: The average cost basis per share of the stocks purchased for the real DI tracking portfolio. The average cost basis includes any commissions incurred for the purchase and is adjusted for stock splits and spin-offs, if appropriate.Direct Invest: Denotes companies that offer a direct investment program, which allows investors to buy their initial shares directly from a company, without having to go through a broker. Div Growth Rate (5 Yr): The compound annual percentage change in dividends per share over the past five years. Positive numbers show an increase in the dollar amount of dividends paid.Div Yield (or Current Dividend Yield): Projected dividend payments for the next 12 months divided by the current stock price. This number shows, in percentage form, how much income can be expected relative to the current stock price. Dividend Yield—1 Year Ago: The stock’s dividend yield (dividends divided by price) from

one year ago. 5 Year Average: The stock’s average dividend yield over the past five years.DRIP Plan: Denotes companies that offer a dividend reinvestment plan, which allows shareholders to use cash dividends to acquire additional shares of stocks, including partial amounts. Est EPS Growth Rate (3-5 Yr): The forecast annual growth rate in earnings per share for the next three to five years.Ex-Dividend Date: The date used by the exchanges to determine who owns shares of a company. This is two trading days before the record date. Investors must purchase shares prior to the ex-dividend date to receive the dividend.First Year Dividend Paid: The first year a company paid its dividend. If a dividend was suspended, the date is the first year the dividend was reinstated.Liab to Assets: Total liabilities divided by total assets. A measure of balance sheet strength, lower percentages signal a lower proportionate amount of debt.Market Cap (Mil): A measure of company size, this is the current share price multiplied by the number of shares outstanding, expressed in millions of dollars.Months Dividends Paid: The calendar months the company has typically paid dividends to shareholders (1 = January, 2 = February, 3 = March, etc.).

tuoyaP-cesnoCtsE:oitaRevitutsriFviDSPE

htworGhtworGE/P Year Years FCFPS Liab MarketRatio 1 Yr 5 Yr Rate Rate Div Div 12 5 Yr (12 to Cap

Ticker (TTM) Current Ago Avg (3-5 Yr) (5 Yr) Paid Raised Month Avg Month) Assets (Mil)AFL 9.7 2.4% 2.5% 2.8% 4.8% 8.1% 1973 30 22% 26% 8% 87% $28,271AAPL 15.5 2.0% 3.1% na 13.0% na 1987 2 29% 7% 23% 42% $560,338T 10.3 5.2% 5.1% 5.8% 5.6% 2.3% 1984 31 53% 118% 73% 68% $183,518BAX 19.6 2.9% 2.8% 2.4% 7.3% 16.0% 1934 8 53% 40% 62% 66% $39,230CVX 12.7 3.3% 3.4% 3.4% 5.3% 9.0% 1912 27 39% 33% na 42% $248,523DE 9.9 2.7% 2.5% 2.2% 8.0% 13.4% 1971 11 22% 30% 30% 83% $32,942ETN 19.2 2.5% 2.7% 3.1% 11.2% 10.9% 1923 5 43% 49% 52% 52% $36,792IP 23.6 2.8% 3.6% 2.6% 14.0% 4.6% 2000 4 44% 35% 33% 75% $21,863IVZ 19.9 2.6% 3.4% 2.4% 14.4% 10.3% 1994 10 35% 42% 41% 59% $16,334MCD 18.3 3.2% 3.2% 3.2% 7.6% 13.9% 1976 37 57% 51% 68% 56% $99,573MDT 21.1 1.9% 2.2% 2.4% 6.7% 8.4% 1977 37 37% 31% 25% 49% $63,490MSFT 15.6 2.7% 3.1% 2.4% 6.8% 15.9% 2003 3 40% 31% 39% 44% $344,459NSC 17.7 2.1% 2.9% 2.7% 10.0% 10.8% 1901 13 35% 37% 66% 64% $31,903OMC 19.1 2.8% 3.0% 2.2% 6.7% 20.1% 1998 5 36% 31% 30% 82% $18,406PEP 20.2 2.9% 3.4% 3.1% 7.2% 6.3% 1952 42 63% 50% 68% 71% $135,444PG 21.2 3.3% 3.1% 3.2% 8.4% 9.5% 1890 58 62% 48% 68% 52% $212,661TGT 19.6 3.6% 2.4% 2.1% 11.9% 20.6% 1967 44 55% 30% 150% 63% $36,723TXN 23.5 2.5% 3.3% 2.2% 10.5% 21.1% 1962 10 57% 38% 41% 44% $51,582TRV 9.1 2.3% 2.5% 2.7% 6.6% 10.5% 2003 9 19% 27% 18% 76% $32,687TUP 16.1 3.2% 2.9% 2.5% 12.0% 20.3% 1996 5 25% 36% 37% 86% $4,223UTX 18.8 2.0% 2.4% 2.5% 11.6% 10.2% 1936 20 36% 35% 40% 65% $105,837WAG 25.2 1.7% 2.9% 2.1% 15.3% 23.5% 1932 38 42% 32% 49% 43% $70,745WFC 13.1 2.7% 2.9% 2.1% 10.1% (2.4%) 1939 4 29% 22% 12% 89% $276,837WEC 17.6 3.3% 3.6% 3.1% 5.2% 15.4% 1939 11 56% 44% 56% 71% $10,581Data as of 6/30/2014. Sources: AAII Stock Investor Pro, Thomson Reuters, I/B/E/S and company releases.

Payout Ratio:SPEdleiY dnediviD

Dividend Analysis

Definitions of Terms Used in Tables

Payment Amount: The dollar amount of the current quarterly dividend payment. An up arrow () indicates that the dividend is higher than that paid last quarter. If no arrow is displayed, the dividend has not changed from the prior quarter.Payout Ratio: EPS—12 Month: The percentage of earnings paid out as dividends over the latest 12-month period. 5 Year Average: The average payout ratio for the previous five years. A payout ratio of 100% means the dollar amount of dividends paid equals the dollar amount of profits earned.Payout Ratio: FCFPS (12 Month): The percentage of free cash flow per share paid out as dividends over the latest 12-month period. Free cash flow is cash flow from operating activities less capital expenditures. A measure of a company’s ability to both pay dividends and increase its cash balance.P/E Ratio (TTM): The price-earnings ratio (price divided by earnings) based on reported earnings per share for the previous 12 months (trailing 12 months). Total Return Since Purchase—Stock: The change in a stock’s price plus the value of all dividends received during the holding period divided by the commission-adjusted purchase price. Index: The total return of the benchmark index since the stock was added to the DI tracking portfolio, expressed as a percentage.

8 July 2014

Baxter International was founded in 1931 as the first manu-facturer of commercially prepared intravenous (IV) solutions. Over the years, Baxter helped to develop blood banking tech-nology, blood plasma separation systems, dialysis machines, clotting factors for hemophiliacs and blood oxygenators for open heart surgery. Baxter has grown organically and through acquisition, and it became a broad-based distributor of health care products before refocusing its efforts on its core technol-ogies of renal technology, biotechnology and medication de-livery by spinning off Allegiance Corporation in 1996 and Ed-wards Lifesciences in 2000. On March 27, 2014, it announced a spin-off of its biopharmaceuticals segment, which will leave just its medical products unit under the Baxter name.

The medical products segment had 2013 sales of $9.4 bil-lion with around 60% of sales outside of the U.S. and 25% of sales in emerging markets. Baxter’s CEO & chairman, Rob-ert Parkinson Jr., will lead the group. The medical products business provides renal care ($3.1 billion in 2013 sales), fluid systems ($3.1 billion), specialty pharmaceuticals ($1.5 billion), biopharmaceutical solutions ($1.0 billion) and biosurgery products ($0.7 billion).

The biopharmaceuticals segment had 2013 sales of $5.8 billion with around 50% of sales outside of the U.S. and 15% of sales in emerging markets. The bioscience segment develops, manufactures and markets products for people with hemophilia ($3.4 billion in 2013 sales) and biotherapeutics ($2.1 billion) including immune disorders, infectious diseases, cancer, burns and trauma, and other chronic and acute medi-cal conditions.

The spin-off would be a tax-free distribution to Baxter shareholders of publicly traded stock in a new biopharma-ceuticals company, which is expected to be completed by mid-year 2015.

Why Own BAX?Demographic expansion of older patients bodes well for

medical products largely immune from economic cycles.

Baxter is a financially sound, large-cap company trading at a reasonable valuation and with a yield above its historical norm. The company consistently generates free cash flow. The stock trades at a price-earnings ratio of 19.6 times trailing earnings, but earnings reflect special charges related to the acquisition of Gambro AB. Analysts project earnings to reach $5.14 per share this year, which translates into a forward price-earnings ratio of 14.1. The medical equipment & sup-plies industry median is 24.6.

During 2013, Baxter generated cash flows from operations of approximately $3.2 billion. Baxter returned more than $1.9 billion to shareholders during the year, through share repur-chases of $913 million (or approximately 13 million shares) and dividends totaling more than $1.0 billion. The company raised its quarterly dividend by 6.1% to $0.52 per share in May 2014.

Baxter’s current return on equity (ROE) of 25.1% is above its industry median of 7.1%.

Dividend AnalysisBaxter currently yields 2.9%. This is above the five-year

average yield of 2.4%, as well as above the historical five-year range (average low of 2.1% and average high of 2.8%).

Baxter has raised its dividend each year since 2007, after holding it steady while it was spinning off companies and refocusing its efforts. During the past five years, the annual growth rate has averaged 16.0%. Baxter pays out 52.7% of its earnings and 61.9% of its free cash flow in dividends.

During the first quarter of 2014, the company repurchased 3.7 million shares for $250 million.

RisksBaxter operates in a competitive medical industry that de-

mands research and development investments to stay ahead of competitors.

Baxter’s biopharmaceutical segment faces pressure from competitors such as Novo Nordisk and Biogen, which are go-ing after Baxter’s Advate hemophilia drug and regime. These firms offer hemophiliacs a less-frequent dosing schedule of medication and are ahead of Baxter in this area. The expecta-tion of increased competition had depressed Baxter’s stock price until the announcement of the spin-off.

Baxter acquired Gambro for $4 billion. This Swedish maker of dialysis products expanded Baxter’s presence in established markets such as Europe, while expanding Gambro’s reach in high-growth regions of Latin America and Asia-Pacific. Gam-bro has not had the same high level of growth as the biophar-maceutical segment.

Baxter operates in an industry that is highly regulated. It must deal with reimbursement rates and decisions by the government and insurance companies. Liability risks are pres-ent should a manufacturing defect lead to harmed patients.

Though Baxter has raised its dividend since 2007, it has, at times, simply maintained its dividend for years. ▪

Baxter International (BAX)

Bullish Factors• Financially sound, with a strong balance sheet and

history of profitability and free cash flow• Offers diverse portfolio of medical products and

procedures that require repeated use• The spin-off will leave investors with two large global

health care companies

Bearish Factors• Facing disruptive threat to Advate hemophilia treatment• Research and development efforts are costly and do not

guarantee successful products• Purchase of Gambro AB must be integrated to achieve

planned synergies

July2014 9


BAX $72.30 ($75.88 - $62.80)Addition Alert Date: 9/6/2013Price at Alert: $70.01 Risk Index: 1.19Market Cap (Million): $40,038.5Avg Daily Dollar Volume (Million): $246.1Primary Sector: Health CarePrimary Industry: Medical Equipment & Supplies

Indicated Annual Dividend: $2.08 9002/210102/211102/212102/213102/21tnerruCselpitluMLatest Dividend Increase: Date Dividend Yield (%): Avg 2.9 2.8 2.7 2.3 2.3 2.0Latest Dividend Increase: % 4.29.27.22.31.3hgiH :)%( dleiY dnediviD %1.6Dividend Yield: Current 2.9% 8.19.10.23.26.2woL :)%( dleiY dnediviD Dividend Yield: 5-Year Avg (High-Low) 8.414.122.411.418.816.91sgninraE/ecirPDividend Paid Since: 1934 Price/Earnings (Industry) 24.6 21.8 20.3 21.6 20.6 17.4Number of Years of Div Increases: 5.46.48.47.44.46.4eulaV kooB/ecirP8Direct Invest Option: 6.24.23.23.24.25.2selaS/ecirPseYDRIP Plan: Yes 9002/210102/211102/212102/213102/21tnerruCsoitaRDeclared Ex-Div Date Payable Amount Payout Ratio: EPS (%) 52.7 51.8 37.2 32.4 49.0 29.5

$0.5200 Payout Ratio: FCFPS (%) 61.9 62.3 44.5 38.8 34.1 34.3$0.4900 Gross Margin (%) 49.6 50.7 51.9 51.4 46.4 51.9$0.4900 Operating Margin (%) 19.0 17.3 20.5 20.0 14.7 21.8$0.4900 Operating Margin (%) (Ind) (4.8) (6.1) (4.2) (0.6) (3.2) (3.0)

6.711.110.614.612.318.21)%( nigraM teN0094.0$9.236.028.334.431.621.52)%( EOR0054.0$

Rel Strgth ROE (%) (Industry) 7.1 6.0 2.6 4.9 4.8 4.3Rank 5.312.82.218.117.81.8)%( AOR

9.10.28.19.17.17.1oitaR tnerruC%82keeW 46.855.265.560.663.767.56)%( stessA ot seitilibaiL%77keeW 31

%95keeW 62 Liab to Assets (%) (Ind) 48.6 44.6 47.4 43.5 40.8 39.68.07.08.07.07.06.0revonruT tessA%74keeW 25

Financial Statements TTM 12/2013 12/2012 12/2011 12/2010 12/2009raeY 5 htworG 265,21348,21398,31091,41952,51267,51)M$( selaS

525,6859,5141,7363,7047,7218,7)M$( emocnI ssorG%0.61sdnediviD------------)M$( noitaicerpeD%3.4selaS

301992634091076653)M$( artxE/lausunU%0.0emocnI teN437,2098,1187,2309,2046,2999,2)M$( emocnI gnitarepO%9.2cisaB SPE371181231561522251)M$( esnepxE tseretnI%0.3tnoC liD SPE

Pretax Income ($M) 2,565 2,549 2,889 2,809 1,890 2,734SUE Score Net Income ($M) 2,016 2,012 2,326 2,224 1,420 2,205

10.30 Operating Cash Flow ($M) 3,371 3,198 3,106 2,817 3,003 2,9090.80 Investing Cash Flow ($M) (5,397) (5,362) (1,569) (1,427) (1,264) (1,146)

Annual Financing Cash Flow ($M) 1,393 1,645 (1,115) (1,137) (1,716) (1,012)12/2015 Capital Expenditures ($M) 1,654 1,525 1,161 960 963 1,014

19 Net Cash Flow ($M) (640) (537) 365 220 (101) 65536.314.219.322.417.327.3)$( cisaB SPE44.5$

$5.44 EPS Diluted Cont ($) 3.68 3.66 4.18 3.88 2.39 3.59)%( ghC raeY/raeY CD SPE0pU veR # (11.1) (12.4) 7.7 62.3 (33.4) 13.6

70.181.172.175.129.169.1)$( erahS/sdnediviD0nwoD veR # 2.713.012.71.423.223.61)%( ghC raeY/raeY dnediviD84.5$ogA .soM eerhT21.364.362.335.380.371.3)$( erahS/wolF hsaC eerF%9.5ghC raeY/raeY

3/2014 12/2013 9/2013 6/2013 Total 687,2586,2509,2072,3337,2940,2)M$( hsaC$1.01 $0.60 $0.99 $1.07 $3.67 Goodwill/Intangibles ($M) 6,495 6,499 3,316 3,143 2,515 2,338$1.00 $0.89 $1.06 $1.20 $4.15 Total Assets ($M) 25,261 25,869 20,390 19,073 17,489 17,354

Long-Term Debt ($M) 7,517 8,126 5,580 4,749 4,363 3,4403/2014 12/2013 9/2013 6/2013 Total Total Liabilities ($M) 16,590 17,406 13,452 12,488 10,922 10,163$7.29 $8.04 $6.95 $6.76 $29.04 Book Value/Share ($) 16.00 15.59 12.59 11.57 11.13 11.85$6.33 $6.86 $6.34 $6.49 $26.03 Avg Shares Outst'g (M) 542.00 543.00 551.00 569.00 590.00 607.00

Sources: AAII Stock Investor Pro, Thomson Reuters and I/B/E/S. Data as of 6/30/2014.

18

00

$1.28

0

$5.13

$1.22 $5.14$1.22 $5.14

Year Ago

TTM

TTMSales/Sh (Qtr)

3102 ,1 luJ3102 ,6 yaMFeb 19, 2013 Mar 6, 2013 Apr 1, 2013

Year Ago

CurrentMonth Ago

Est Surprise

EPS Estimates# of Estimates

Jan 23, 2014

% Surp9.5%0.6%

EPS (Qtr)

Quarterly6/2014

16

0

Annual12/2014

(11.1%)

EPS$1.19$1.26

5.9%12.3%15.5%

10.6%(12.0%)(10.8%)

Baxter Int'l is a global, diversified health care company. Baxter develops, manufactures and markets products that save and sustain the lives of people with hemophilia, immune disorders, infectious diseases, kidney disease, trauma and other chronic and acute medical conditions. The company operates in two segments, bioscience and medication delivery, which are set to be divided into two companies in 2015. It is engaged in medical devices, pharmaceuticals and biotechnology to create products that advance patient care. These products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors' offices, clinical laboratories, and patients at home under physician supervision.

Jul 23, 2013

Apr 17, 2014

Sep 4, 2013

(1%)9%8%8%

Stock

17.6%

May 5, 2014Feb 28, 2014Nov 12, 2013 Dec 4, 2013

Mar 5, 2014Jun 4, 2014

May 5, 2014

1.000.88

3 Year

Jul 1, 2014Apr 1, 2014Jan 3, 2014

0.96

Oct 1, 2013

Rel Strgth

13.6% 40.3%

2.4% (2.8% - 2.1%)

1.04

Gain Index

Jun 5, 2013

TTM16.3%

15.3%

$0

$10

$20

$30

$40

$50

$60

$70

$80

Share Price

0%

1%

2%

3%

4%

5%

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Jul 2009 Jul 2010 Jul 2011 Jul 2012 Jul 2013

Div

iden

d Yi

eld

10 July 2014

Chevron is one of the world’s largest integrated energy companies, operating in two segments: upstream (28% of 2013 revenues and 97% of income) and downstream. The upstream segment is involved in the exploration, develop-ment and production of crude oil and natural gas; liquefac-tion, transportation and regasification of liquid natural gas; transportation of crude oil through pipelines; and processing, transportation, storage and marketing of natural gas. In 2013, Chevron’s worldwide net oil-equivalent production averaged nearly 2.6 million barrels per day, with about 25% of produc-tion coming from the U.S.

Chevron’s downstream segment engages in refining crude oil into petroleum products; marketing crude oil and refined prod-ucts; transporting crude oil and refined products; and manu-facturing and marketing commodity petrochemicals and fuel and lubricant additives, as well as plastics for industrial uses.

Why Own CVX?Chevron is the second-largest U.S. oil company and fifth-

largest publicly traded oil company in the world. This “super-major” is active in more than 180 countries. It is one of the few companies engaged in every aspect of the oil and gas energy industry.

Over the past few years, energy-rich countries have been spending money to drill for oil, creating opportunities for large oil companies such as Chevron that can provide deep-water exploration expertise. Chevron has had success in areas such as the Gulf of Mexico, northwest Australia and the Gulf of Thailand.

The company’s two liquefied natural gas (LNG) projects in Australia are nearing completion and will be the primary driv-ers of growth in the next few years.

In recent years the company has improved returns by restructuring its downstream operations, which tend to have higher earnings volatility. Chevron also is shifting downstream capital to higher-return chemical operations to fund projects.

In addition, in order to boost shareholder returns, Chevron

has begun selling off underperforming assets such as its inter-ests in seven oil fields in Chad and pipelines in Cameroon.

Chevron continues to show solid fundamentals along with a very reasonable valuation. Its current price-earnings ratio of 12.7 is below the 20.4 median for the energy sector and the 15.1 median for the integrated oil and gas industry.

While valuations remain reasonable, sales and earnings remain a sore point. Management insists that oil production will increase 30% by 2017, but production has fallen of late. Sales have declined at a 3.6% annual rate over the last five years, while net income has declined at a 2.2% annual rate and diluted earnings per share from continuing operations have fallen at a 1.0% annual rate. The company has a buyback yield of 1.8%, which is well above its five-year average of 1.2% and supportive of shares.

Nonetheless, Chevron produces a huge amount of cash from operations each year, which can be used to manage any short-term bumps in the road.

Dividend AnalysisChevron has an aggressive dividend payment program,

more than doubling its payout over the last eight years. Chevron currently trades with a 3.3% dividend yield, near its five-year average of 3.4%. Chevron has paid a dividend every year since 1912 and has increased its annual payout for 27 consecutive years. On April 30, 2014, the company an-nounced an 7.0% dividend increase to an annual rate of $4.28 per share. Chevron’s current earnings payout ratio of 38.6% is in line with its historical trend. Its annual dividend payment has increased by 11.2% over the last three years and by 9.0% over the last five years. Going forward, we expect Chevron to be able to maintain its dividend increases.

RisksChevron’s upstream business profitability is closely aligned

with the prices of oil and natural gas, which are subject to external factors, such as demand, global economic conditions and production quotas. Damage to production facilities can severely affect production and increase operating expenses. Downstream earnings are affected by margins on refining, manufacturing and marketing of products such as gasoline and diesel and jet fuel.

While still in its infancy, the growing adoption of electric ve-hicles is something that Chevron is vulnerable to should they ever gain broader market acceptance.

Chevron is also affected by inflation and currency exchange risk. Specifically, the company upwardly revised the cost of its two Australian projects based on currency appreciation and materials inflation.

Chevron management has also stuck its neck out by virtu-ally guaranteeing a 30% increase in oil production by 2017. Shares are vulnerable to any hint that that production level might not come to pass.

Chevron also faces the risk of litigation and fines. ▪

Bullish Factors• Long history of dividend payments and increases• Moderate payout ratio and aggressive share repurchase

program• Selling off underperforming assets

Bearish Factors• High capital expenditures may continue longer than

expected to meet management goals• Profitability depends largely on price of oil, over which

the company has no control• Continued success depends on finding new oil fields and

managing reserves, while deep-water exploration can be risky and capital-intensive

Chevron Corporation (CvX)

July2014 11


Addition Alert Date: 12/31/2011Price at Alert: $106.40 Risk Index: 1.35Market Cap (Million): $251,930.8Avg Daily Dollar Volume (Million): $780.0Primary Sector: EnergyPrimary Industry: Oil & Gas - Integrated

Indicated Annual Dividend: $4.28 9002/210102/211102/212102/213102/21tnerruCselpitluMLatest Dividend Increase: Date Dividend Yield (%): Avg 3.3 3.3 3.3 3.1 3.6 3.9Latest Dividend Increase: % 7.42.46.37.36.3hgiH :)%( dleiY dnediviD %0.7Dividend Yield: Current 3.3% 3.31.38.20.31.3woL :)%( dleiY dnediviD Dividend Yield: 5-Year Avg (High-Low) 0.314.83.70.87.017.21sgninraE/ecirPDividend Paid Since: 1912 Price/Earnings (Industry) 15.1 11.3 15.3 13.1 14.3 13.1Number of Years of Div Increases: 27 Price/Book Value 1.7 1.5 1.5 1.6 1.5 1.5Direct Invest Option: 8.08.08.09.00.12.1selaS/ecirPseYDRIP Plan: Yes 9002/210102/211102/212102/213102/21tnerruCsoitaRDeclared Ex-Div Date Payable Amount Payout Ratio: EPS (%) 38.6 34.9 26.1 22.8 29.8 50.6

$1.0700 Payout Ratio: FCFPS (%) (1,199.4) (250.6) 86.9 42.1 48.3 (1,127.4)$1.0000 Gross Margin (%) 35.0 38.9 39.0 32.3 32.1 30.0$1.0000 Operating Margin (%) 12.2 12.6 17.1 16.5 13.3 9.1$1.0000 Operating Margin (%) (Ind) 18.7 12.5 12.0 16.5 17.9 10.9

3.66.90.114.117.91.9)%( nigraM teN0000.1$7.113.918.323.020.515.31)%( EOR0009.0$


4.17.16.16.15.14.1oitaR tnerruC%37keeW 42.441.341.244.142.147.14)%( stessA ot seitilibaiL%58keeW 31



851,05045,36028,87378,98546,58898,57)M$( emocnI ssorG%0.9sdnediviDSales (3.6%) Depreciation ($M) 14,835 14,186 13,413 12,911 13,063 12,110Net Income (2.2%) Unusual/Extra ($M) 0 0 0 0 0 0EPS Basic (1.0%) Operating Income ($M) 26,486 27,726 39,492 40,271 26,418 15,212EPS Dil Cont (1.0%) Interest Expense ($M) 0 0 242 576 584 574


(1.50) Operating Cash Flow ($M) 37,705 35,002 38,812 41,095 31,354 19,373(0.10) Investing Cash Flow ($M) (35,730) (35,609) (24,796) (27,489) (20,915) (16,572)

Annual Financing Cash Flow ($M) (3,477) (3,821) (8,980) (11,769) (5,165) (3,546)12/2015 Capital Expenditures ($M) 38,337 37,985 30,938 26,500 19,612 19,843

25 Net Cash Flow ($M) (1,762) (4,694) 5,075 1,804 5,344 (631)62.535.945.3134.3181.1153.01)$( cisaB SPE32.11$

$11.24 EPS Diluted Cont ($) 10.27 11.09 13.32 13.44 9.48 5.24)%( ghC raeY/raeY CD SPE6pU veR # (22.4) (16.7) (0.9) 41.8 80.9 (55.1)

66.248.290.315.309.300.4)$( erahS/sdnediviD6nwoD veR # 1.58.68.86.311.111.11)%( ghC raeY/raeY dnediviD12.11$ogA .soM eerhT

)$( erahS/wolF hsaC eerF%7.4ghC raeY/raeY (0.33) (1.56) 4.04 7.35 5.88 (0.24)3/2014 12/2013 9/2013 6/2013 Total 228,8070,71170,02319,12615,61381,61)M$( hsaC$2.36 $2.57 $2.56 $2.77 $10.26 Goodwill/Intangibles ($M) 4,639 4,639 4,640 4,642 4,617 4,618$3.18 $3.71 $2.68 $3.66 $13.23 Total Assets ($M) 258,238 253,753 232,982 209,474 184,769 164,621

Long-Term Debt ($M) 20,046 20,057 12,065 9,812 11,289 10,1303/2014 12/2013 9/2013 6/2013 Total Total Liabilities ($M) 107,577 104,640 96,458 88,092 79,688 72,707

$26.85 $28.37 $29.62 $28.73 $113.56 Book Value/Share ($) 79.50 77.78 70.01 61.10 52.63 46.14$28.19 $29.00 $28.71 $30.47 $116.37 Avg Shares Outst'g (M) 1,895.03 1,917.00 1,950.00 1,986.48 1,996.79 1,992.00


3.4% (4% - 3%)

1.091.000.91

Jun 10, 2014Mar 10, 2014Dec 10, 2013Sep 10, 2013

Rel Strgth

(1.9%) (3.3%)

3 Year

Apr 30, 2014Jan 29, 2014Oct 30, 2013 Nov 14, 2013

Feb 12, 2014May 15, 2014

(4.1%)

Chevron is engaged in petroleum operations, chemicals operations, mining operations, power generation and energy services. Upstreamoperations consist of exploring for, developing and producing crude oil and natural gas; transporting crude oil by international oil export pipelines; transporting, storage and marketing of natural gas; and a gas-to-liquids project. Downstream operations consist of refining of crude oil into petroleum products and marketing of crude oil and refined products. In 2012, Chevron's average net production was 2.6 million barrels of oil-equivalent per day. About 75% of that production occurred outside the U.S. Chevron had a global refining capacity of 1.7 million barrels of oil per day at the end of 2012.

Jul 31, 2013 Aug 15, 2013

7%14%8%

12%

Stock

1.04Index

May 15, 2013

TTM11.2%11.1%

Gain

3.6%4.0%5.5%

% Surp(6.1%)(0.1%)

(23.7%)(22.4%)(22.4%) 5.4%

$2.72

EPS$2.36$2.57

EPS (Qtr)

Year Ago

Annual12/2014

21$10.73Current

Month Ago $2.71 $10.80

Est Surprise

EPS Estimates# of Estimates

May 2, 2014Jan 31, 2014

3102 ,01 nuJ3102 ,42 rpAJan 30, 2013 Feb 13, 2013 Mar 11, 2013

Year Ago

TTM

TTMSales/Sh (Qtr)

Apr 30, 2014

7$11.10

61

$2.79

6

Quarterly6/2014

18

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CvX $130.55 ($133.57 - $109.27)

12 July 2014

Medtronic is one of the world’s leading medical technology companies and is the world’s largest manufacturer of implantable biomedical devices. Roughly 47% of the company’s revenues come from outside the U.S., and this number is expected to rise as the company focuses on emerging markets as growth drivers. The company operates in two primary groups: cardiac and vascular group, and restorative therapies group. These are divided into the following segments: cardiac rhythm disease management (29.4% of fiscal-2014 (April) sales), coronary (9.7%), structural heart (7.1%), endovascular and peripheral (5.3%), spine (17.9%), neuromodulation (11.2%), diabetes (9.7%) and surgical technologies (7.7%).

Why Own MDT?On June 15 the company announced it was buying Ireland-

based Covidien for $42.9 billion, a 29% premium based on Covidien’s stock price at the time of the announcement. The deal is subject to regulatory approval in a number of jurisdic-tions around the world.

Covidien operates businesses with strong competitive advantages in the medical devices segment, including brand recognition, technological innovation, and substantial scale. The company is a top-five manufacturer of devices by sales; with a sales force of more than 4,000 representatives, the company has a sizable presence in hospitals worldwide.

Covidien’s broad portfolio of hospital supplies, from surgi-cal staplers to ventilators, will allow Medtronic to expand its global reach and add diversity to its product lines. With a broader array of products, hospitals may be more likely to do business with the combined company.

Medtronic is the largest medical equipment maker, with roughly 50% market share in its core heart devices. The com-pany also has market-leading positions in spinal products, in-sulin pumps and neuromodulation for chronic pain treatment.

The combined Medtronic-Covidien will have revenues of

nearly $27 billion. Medtronic expects $850 million in cost-saving synergies and predicts the deal will be accretive to earnings by 2016.

In addition, the deal is being structured as a tax inversion, whereby Medtronic will form a new company based in Ireland to lower its corporate tax rate to 12.5% from 35%. The move would allow the company to access its $12 billion in cash held abroad without paying U.S. taxes, which some estimates put at $3.5 billion to $4.2 billion.

Dividend AnalysisMDT shares currently yield 1.9%, based on an indicated

annual dividend of $1.22 per common share. This falls below the five-year yield range of 2.0% to 3.0%, and we are moni-toring the yield to see if it continues to fall relative to the historical range. Medtronic has been paying a dividend since 1977 and has increased its annual dividend each year since. Over the last five years the company, on average, has been increasing dividends by 8.4% a year. The company announced an 8.9% dividend increase in June 2014.

Currently, Medtronic is paying out 36.7% of earnings as dividends and 24.6% of free cash flow (cash from operations less capital expenditures and dividends). In recent years, the company has targeted returning 50% of free cash flow to in-vestors. If this trend continues, it appears that there is plenty of room for the dividend to grow in coming years.

Medtronic says the Covidien deal is expected to generate significant free cash flow, perhaps as much as $7 billion annu-ally, which could mean distributing more cash to shareholders.

RisksThere is no guarantee that the Covidien deal will go

through. One condition to completion of the merger is Medtronic getting the tax inversion and becoming a foreign corporation for tax purposes. However, there is currently a bill in Congress to change the inversion rules, which would cancel the merger. Medtronic and Covidien have said they expect the deal to close by the end of 2014 or early 2015.

Tax inversions are long, complicated processes that do not guarantee immediate tax savings. The tax savings will ulti-mately come from still-in-development product lines and new acquisitions. A merger of this size also faces potential integra-tion risks.

As a medical device manufacturer, Medtronic faces litiga-tion and regulatory risk. Its spinal business has suffered from declines in sales of its Infuse bone graft product, following criticism by peer-review studies. Recent independent studies found the devices to be no better than traditional operations and may have harmful side effects.

Medtronic’s products are subject to FDA approval and over-sight, and delays in the approval of new products can impact sales.

Lastly, the company operates in a highly competitive market-place and faces strong pricing pressures from its competitors. ▪

Medtronic, Inc. (MDT)

Bullish Factors• Merger with Covidien would add portfolio of

complementary products, boost free cash flow and lower the corporate tax rate

• Market leader in heart devices, spinal products, insulin pumps and neuromodulators

• Focusing on high-growth emerging markets to add value

Bearish Factors• Dividend yield below five-year average low• Medicare reimbursement rates for device-related

procedures is expected to drop in coming years• Risks associated with Covidien deal, including risk of

termination and integration risk

July2014 13


MDT $63.45 ($65.50 - $51.22)Addition Alert Date: 12/31/2011Price at Alert: $38.25 Risk Index: 1.26Market Cap (Million): $63,489.9Avg Daily Dollar Volume (Million): $463.6Primary Sector: Health CarePrimary Industry: Medical Equipment & Supplies

Indicated Annual Dividend: $1.22 0102/41102/42102/43102/44102/4tnerruCselpitluMLatest Dividend Increase: Date Dividend Yield (%): Avg 1.9 2.2 2.6 2.6 2.3 2.4Latest Dividend Increase: % 4.39.22.39.27.2hgiH :)%( dleiY dnediviD %9.8Dividend Yield: Current 1.9% 8.19.12.23.29.1woL :)%( dleiY dnediviD Dividend Yield: 5-Year Avg (High-Low) Price/Earnings 21.1 16.6 11.9 11.4 13.7 12.4Dividend Paid Since: 1977 Price/Earnings (Industry) 24.8 21.8 20.3 21.6 20.6 17.4Number of Years of Div Increases: 37 Price/Book Value 3.3 2.6 2.2 2.3 2.6 2.6Direct Invest Option: 5.27.24.25.20.38.3selaS/ecirPseYDRIP Plan: Yes 0102/41102/42102/43102/44102/4tnerruCsoitaRDeclared Ex-Div Date Payable Amount Payout Ratio: EPS (%) 36.7 36.6 30.6 28.3 31.4 29.3

$0.3050 Payout Ratio: FCFPS (%) 24.6 24.6 24.0 25.6 29.9 25.9$0.2800 Gross Margin (%) 74.5 74.5 75.1 76.0 76.1 76.7$0.2800 Operating Margin (%) 28.3 22.4 26.5 26.5 25.4 27.2$0.2800 Operating Margin (%) (Ind) (5.2) (5.1) (4.2) (0.5) (0.4) (2.9)$0.2800 Net Margin (%) 18.0 18.0 20.9 22.3 20.0 20.1

3.222.029.124.911.611.61)%( EOR0062.0$Rel Strgth ROE (%) (Industry) 7.6 7.3 2.8 4.8 4.7 3.2

Rank 0.215.014.112.014.84.8)%( AOR9.19.18.26.48.38.3oitaR tnerruC%26keeW 49.749.749.744.648.848.84)%( stessA ot seitilibaiL%36keeW 31



018,11808,11592,21464,21276,21276,21)M$( emocnI ssorG%4.8sdnediviDANANANANANAN)M$( noitaicerpeD%1.3selaS784245991983500,1500,1)M$( artxE/lausunU%2.8emocnI teN091,4249,3492,4204,4318,3818,4)M$( emocnI gnitarepO%6.01cisaB SPE2040549438830581)M$( esnepxE tseretnI%4.01tnoC liD SPE


(0.20) Operating Cash Flow ($M) 4,959 4,959 4,883 4,470 3,741 4,131(0.20) Investing Cash Flow ($M) (3,594) (3,594) (3,101) (2,662) (1,734) (4,759)

Annual Financing Cash Flow ($M) (918) (918) (2,101) (1,882) (2,006) 7644/2016 Capital Expenditures ($M) 396 396 457 484 501 635

17 Net Cash Flow ($M) 484 484 (312) (145) 63 12908.278.234.304.360.350.3)$( cisaB SPE23.4$

$4.36 EPS Diluted Cont ($) 3.02 3.02 3.37 3.22 2.82 2.78)%( ghC raeY/raeY CD SPE4pU veR # (10.7) (10.4) 4.7 14.2 1.4 51.1

28.009.079.040.121.121.1)$( erahS/sdnediviD0nwoD veR # 3.98.98.72.77.77.7)%( ghC raeY/raeY dnediviD04.4$ogA .soM eerhT61.310.387.343.455.465.4)$( erahS/wolF hsaC eerF%8.6ghC raeY/raeY

4/2014 1/2014 10/2013 7/2013 Total 577,3824,2053,9170,11142,41142,41)M$( hsaC$0.44 $0.75 $0.89 $0.93 $3.01 Goodwill/Intangibles ($M) 12,879 12,879 13,002 12,581 12,245 10,950$0.95 $0.97 $0.63 $0.83 $3.38 Total Assets ($M) 37,943 37,943 34,841 32,818 30,675 28,090

Long-Term Debt ($M) 10,315 10,315 9,741 7,359 8,112 6,9444/2014 1/2014 10/2013 7/2013 Total Total Liabilities ($M) 18,500 18,500 16,170 15,705 14,707 13,461$4.56 $4.17 $4.20 $4.04 $16.98 Book Value/Share ($) 19.44 19.40 18.32 16.24 14.82 13.22$4.40 $3.98 $4.02 $3.89 $16.28 Avg Shares Outst'g (M) 1,000.30 1,002.10 1,019.30 1,053.90 1,077.40 1,106.30


1

$4.092

(0.5%)

Quarterly7/2014

19

34.0%

18

05

$0.94

EPS Estimates

EPS (Qtr)

Year Ago

CurrentMonth Ago

Annual4/2015

$0.93 $4.05$0.93 $4.05

Year Ago

TTM

TTMSales/Sh (Qtr)

# of Estimates

Feb 18, 2014May 20, 2014

% Surp(0.2%)(0.2%)

EPS$1.12$0.91

Est Surprise

(10.7%)

7.6%3.1%(0.3%)2.2%2.3%

7.7%2.5%

(11.6%)(10.6%)

Jun 20, 2013Feb 14, 2013 Apr 3, 2013

4%

StockApr 26, 2013

Jun 16, 2014

Oct 2, 2013

4%

Index

Jul 2, 2013

Medtronic is a medical technology company engaged in the research, design, manufacture and sale of products to alleviate pain, restore health and extend life. It manufactures and sells device-based medical therapies. It operates in two segments: cardiac and vascular group, which includes cardiac rhythm disease management, cardiovascular, and physio-control; and restorative therapies group, which includes spinal, neuromodulation, diabetes and surgical technologies. Its primary customers include hospitals, clinics, third-party health care providers, distributors and other institutions, including governmental health care programs and group purchasing organizations.

Aug 22, 2013

Jun 16, 2014Feb 13, 2014Dec 5, 2013 Dec 31, 2013

Apr 2, 2014Jul 1, 2014

Jul 26, 2013

1.040.99

TTM

Gain

11%24%

2.4% (3% - 2%)

1.01

3 Year

Jul 25, 2014Apr 25, 2014Jan 24, 2014

1.03

Oct 25, 2013

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14 July 2014

Wells Fargo & Co (WFC)Wells Fargo & Co. is the fourth-largest bank holding com-

pany in the U.S., with $1.53 trillion in assets at the end of the first quarter. The company ranks No. 2 nationally in deposits, No. 1 in mortgage originations and No. 3 in full-service retail brokerage services. Wells Fargo currently has $974 billion in average retail core deposits and $826 billion in loans.

The company has had a strong commitment to returning capital to shareholders. Wells Fargo has paid a dividend since 1939 and raised its dividend by 16.7% per share this year. The company is targeting a total payout ratio (dividends and share repurchases) of approximately 50% to 65%.

Why Own WFC?Wells Fargo is considered to be among the strongest of the

large banks. The company estimates its tier 1 common equity ratio to be 10.04% as of the end of the first quarter, which is above the minimum of 6% required by January 1, 2015, under Basel III reform measures. (Tier 1 capital is retained earnings and qualifying stock instruments less certain regulatory ad-justments.) Wells Fargo’s profit margins and return on equity (ROE) are above both its industry and sector medians.

Credit quality continues to improve. Net charge-offs declined to 0.41% ($825 million) of all loans during the first quarter of 2014. This compares to 0.72% ($5.4 billion) during the fourth quarter of 2009.

Earnings per share have risen for 17 consecutive quarters. Analysts project the company to grow earnings 5.5% this year (to $4.11 per share) and 4.5% next year (to $4.29 per share). Even with the expectations for continued profit growth, Wells Fargo trades with a price-earnings ratio of just 13.1, a dis-count to its industry median of 15.3.

Wells Fargo has a national footprint, though its retail bank-ing centers are concentrated in the eastern and western states. In addition to providing banking services, the com-

pany is involved in wealth management, investment banking and credit cards. About two-thirds of non-interest income is generated from a combination of deposit service charges, card fees, insurance, and other sources exclusive of mortgage production and trust and investment fees. The company ag-gressively promotes multiple products to customers, with an average household cross-sell rate of 6.17 products.

Dividend AnalysisShares of Wells Fargo currently yield 2.7%. This is above the

stock’s five-year average of 2.1%, implying shares are relative-ly undervalued. The quarterly dividend was raised by $0.05 in April to $0.35 per share. The company’s dividend and share repurchase plans are subject to Federal Reserve approval.

Wells Fargo pays out 29.4% of its earnings as dividends. This is down from 43.2% in 2006, but well above the 9.0% payout ratio in 2010. Management has indicated its desire to continue to return capital to shareholders and wants to use 50% to 65% of earnings to pay dividends and buy back shares. Based on the current level of free cash flow, Wells Fargo has the financial strength to do this but with regulatory approval.

RisksMortgage originations have been a notable area of weak-

ness for the company. Residential mortgage originations totaled $36 billion during the first quarter of 2014, down from $109 million in the first quarter of 2013 and $139 million in the third-quarter of 2012. During an investor meeting in May, CFO John Shrewsberry described this spring’s purchase season as not seeming as “robust as we might have imagined it; it’s a little bit slower.”

Revenues have declined for four consecutive years. The weakness in mortgage originations has hurt non-interest income, the spread between what the company pays de-positors and what it earns from making loans. Non-interest income accounted for 49% of revenues during the first quar-ter of 2014. The release of bad loan reserves has boosted in-come, but also led to criticism of unsustainable profit growth.

The aftermath of the housing bubble remains a problem. Though charge-offs have declined, Wells Fargo continues to face lawsuits. For example, last month, Wells Fargo lost an ap-peal to avoid being sued by the Federal Housing Administra-tion over allegations of misconduct.

The ongoing regulatory environment may increase costs, restrict Wells Fargo’s ability to maintain a strong record of dividend growth and make it tougher for the company to expand. Wells Fargo has to maintain minimum capital requirements, and its capital plans are subject to regulatory approval. The Federal Reserve wants the ability to force cuts in dividends and share buybacks if enough capital isn’t raised. Reuters recently suggested Wells Fargo may have to increase outstanding debt to meet stricter capital requirements. ▪

Bullish Factors• Strong fundamentals, with tier 1 capital well above

requirements• Management remains focused on returning capital to

shareholders and raised the dividend by 16.7% this year• The valuation is attractive with a yield of 2.7% and a

price-earnings ratio of 13.1

Bearish Factors• Mortgage originations have been falling for several

quarters and don’t seem to be improving• Revenues have declined for four consecutive years,

leading to criticism of unsustainable profit growth • Regulatory environment continues to evolve, with the

potential implementation of new rules

July2014 15


WFC $52.56 ($53.05 - $40.07)Addition Alert Date: 12/7/2012Price at Alert: $33.23 Risk Index: 1.08Market Cap (Million): $278,575.3Avg Daily Dollar Volume (Million): $866.4Primary Sector: FinancialPrimary Industry: Regional Banks

Indicated Annual Dividend: $1.40 9002/210102/211102/212102/213102/21tnerruCselpitluMLatest Dividend Increase: (Date) Dividend Yield (%): Avg 2.7% 2.9 2.7 1.7 0.7 2.5Latest Dividend Increase: (%) 3.69.01.21.33.3hgiH :)%( dleiY dnediviD %7.61Dividend Yield: Current 2.7% 6.16.04.14.25.2woL :)%( dleiY dnediviD Dividend Yield: 5-Year Avg (High-Low) 2.110.311.016.93.011.31sgninraE/ecirPDividend Paid Since: 1939 Price/Earnings (Industry) 15.3 14.1 12.8 13.1 14.9 16.0Number of Years of Div Increases: 3 9.03.12.12.14.18.1eulaV kooB/ecirPDirect Invest Option: Yes 6.18.20.35.35.49.5selaS/ecirPDRIP Plan: Yes 9002/210102/211102/212102/213102/21tnerruCsoitaRDeclared Ex-Div Date Payable Amount Payout Ratio: EPS (%) 29.4 29.1 25.9 16.8 9.0 27.8

$0.3500 Payout Ratio: FCFPS (%) 12.3 10.5 7.9 18.5 5.6 7.8------------)%( nigraM ssorG0003.0$

$0.3000 Operating Margin (%) 77.0 86.0 74.4 70.6 54.9 43.8$0.3000 Operating Margin (%) (Ind) 33.9 80.7 73.1 64.8 54.9 46.7

2.410.224.032.734.448.54)%( nigraM teN0003.0$3.95.012.212.310.411.41)%( EOR0052.0$


------------oitaR tnerruC%66keeW 40.190.093.989.889.886.88)%( stessA ot seitilibaiL%47keeW 31



Dividends (2.4%) ------------)M$( emocnI ssorG)M$( noitaicerpeD%2.6selaS (1,468) (1,504) (1,674) (1,880) (2,199) (2,577)

------------)M$( artxE/lausunU%6.45emocnI teN656,42400,92468,43310,63194,04922,63)M$( emocnI gnitarepO%4.14cisaB SPE059,9930,8946,6161,5982,4531,4)M$( esnepxE tseretnI%9.04tnoC liD SPE


2.80 Operating Cash Flow ($M) 51,345 57,641 58,540 13,665 18,772 28,6130.80 Investing Cash Flow ($M) -- -- -- (35,044) (3,675) 71,785

Annual Financing Cash Flow ($M) 97,729 93,910 83,770 24,775 (26,133) (97,081)12/2015 Capital Expenditures ($M) 0 0 0 0 0 0

31 Net Cash Flow ($M) 3,514 (1,941) 2,420 3,396 (11,036) 3,31767.132.258.204.359.380.4)$( cisaB SPE92.4$

$4.30 EPS Diluted Cont ($) 4.02 3.89 3.36 2.82 2.21 1.750.0513.626.721.918.519.31)%( ghC raeY/raeY CD SPE1pU veR # 94.002.084.088.051.102.1)$( erahS/sdnediviD0nwoD veR #

0.0413.387.039.13)%( ghC raeY/raeY dnediviD52.4$ogA .soM eerhT (59.2) (62.3)03.695.395.270.1109.0167.9)$( erahS/wolF hsaC eerF%5.4ghC raeY/raeY

3/2014 12/2013 9/2013 6/2013 Total 853,721815,461924,851773,432088,613720,723)M$( hsaC$1.05 $1.00 $0.99 $0.98 $4.02 Goodwill/Intangibles ($M) 47,239 48,218 45,616 48,090 51,421 54,877$0.92 $0.91 $0.88 $0.82 $3.53 Total Assets ($M) 1,546,707 1,527,015 1,422,968 1,313,867 1,258,128 1,243,646

Long-Term Debt ($M) 153,422 152,998 127,379 125,354 156,983 203,8613/2014 12/2013 9/2013 6/2013 Total Total Liabilities ($M) 1,371,053 1,356,873 1,265,414 1,173,626 1,131,720 1,131,860$2.21 $2.25 $2.22 $2.23 $8.91 Book Value/Share ($) 30.11 29.10 27.36 24.40 22.52 22.73$2.21 $2.25 $2.26 $2.33 $9.04 Avg Shares Outst'g (M) 5,262.80 5,287.30 5,287.60 5,278.10 5,226.80 4,545.20


Apr 29, 2014

1$4.03

01

$1.01

0

Quarterly6/2014

31

Year Ago

TTM

TTMSales/Sh (Qtr)

Year Ago

EPS (Qtr)2.4% 5.5%

$4.11CurrentMonth Ago $1.01

$1.00

$1.00

29

$4.11

Est Surprise

12/2014

EPS$1.05

# of Estimates

13.9%

EPS Estimates

% Surp8.7%1.6%

Annual

20.7%

Apr 11, 2014Jan 14, 2014

21.0%

31.9%(1.5%)14.1%14.3%

79.2%(3.7%)21.5%

Jan 30, 2013 Mar 1, 2013

1.07

3 Year

32%

Stock

TTM

Wells Fargo & Co. is the nation's fourth-largest bank holding company with three operating segments: community banking; wholesale banking; and wealth, brokerage and retirement services. It provides retail, commercial and corporate banking services through banking stores and offices, the Internet and other distribution channels to individuals, businesses and institutions in 50 states, the District of Columbia and in other countries. It provides other financial services through subsidiaries engaged in wholesale banking, mortgage bankinginsurance agency and brokerage services, mortgage-backed securities servicing and venture capital investment.

Jul 23, 2013 Aug 7, 2013

5%8%

18%

3102 ,1 nuJ3102 ,32 rpAJan 22, 2013

Apr 29, 2014Jan 28, 2014Oct 22, 2013 Nov 6, 2013

Feb 5, 2014May 7, 2014

1.021.09

Jun 1, 2014Mar 1, 2014

Sep 1, 2013Dec 1, 2013

1.02

Rel StrgthGain Index

2.1% (3.2 - 1.7)

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16 July 2014

In the June DI Monthly, we introduced the statement of cash flows, which shows how much cash a company is gener-ating through operations as well as through changes in com-pany assets, liabilities and equity. This month, we examine the calculations behind cash flow from operating activities, which is a measure of the amount of cash generated by normal business operations through revenues from selling goods and providing services. It excludes activities classified as investing activities or financing activities.

Cash flow from operating activities (also known as operat-ing cash flow or cash flow from operations) has a very simple objective—to show whether a firm’s day-to-day operations generated or depleted cash. If net cash flow from operations is negative, it means that the company is spending more cash than it is generating in producing and selling its goods and services. If it is positive, the company is generating more cash than it is spending on its day-to-day operations.

There are two methods firms use to determine cash from operating activities: direct and indirect. The direct method of cash flow statement reconciliation reports major sources of cash receipts and payments, starting with cash receipts from customers. Cash payments for inventory purchases and oper-ating expenses are deducted from this initial balance to arrive at cash flow from operating activities.

However, most companies use the indirect method, which starts with net income (from the income statement) and then adjusts for non-cash expenditures to arrive at cash flow from operating activities.

Typically, depreciation and amortization is the first line item that is reconciled. Depreciation is a non-cash expense on the income statement, meaning no cash was spent on expense. Rather, depreciation is used to reduce the value of an as-set throughout its useful life in an effort to properly match revenues with expenses. Amortization, like depreciation, is also a non-cash expense. Unlike depreciation, however, this figure measures the decline in value of an intangible asset. Both these figures lower net income and shareholder’s equity, but since they do not affect a company’s cash balance, they are added back to net income for operating cash flow. For ex-ample, Microsoft earned $21.86 billion during 2013 and had $3.76 billion in depreciation and amortization to add back to net income.

A growing set of operating cash flow line items revolve around the tax benefits and cash flow that companies receive when executives exercise stock options. Microsoft added over $2 billion to its operating cash flow from stock-based com-pensation expenses. Apple Inc. (AAPL) also had over $2 billion in stock-based compensation in 2013, which was added back into operating cash flow. This seems to be particularly com-mon in the technology sector, where share-based compensa-tion is more prevalent.

Changes to current asset and liability balance sheet ac-counts are added to or subtracted from operating cash flow. In most cases, companies will break down changes in work-ing capital, such as accounts receivable (invoices owed to the company), inventory and accounts payable (invoices the company needs to pay). For example, a decrease in inven-tory (an asset) represents a source of cash. In practical terms, this means that less of a given company’s cash is tied up in inventory of raw or finished goods and more in liquid assets. On the other hand, an increase in the accounts receivable (also an asset) is recorded as a use of cash. Why is this so? The company in this example is basically lending money to customers for services already delivered. Hence, an increase in accounts receivable is a use of cash.

Increases in current liabilities such as accounts payable are sources of cash, while reductions are uses of cash.

Let’s look at a hypothetical transaction between two com-panies: Company A sells wheat to Company B (a cereal manu-facturer) for $1 million, payable in the future after delivery. Company B can begin processing the wheat immediately after delivery and produce cereal for sale (a liability that does not reduce the cash balance) before there is an outflow of cash to pay for the wheat (i.e., a source of cash). When Company B pays for the wheat, it will reduce cash (i.e., a use of cash).

Several other non-cash items often appear as part of oper-ating cash flow, including prepaid expenses and unearned rev-enues. Prepaid expenses are assets on the balance sheet that do not reduce net income or shareholder’s equity. However, prepaid expenses do reduce cash. Adjusting for an increase in prepaid expense is similar to adjusting for an increase in accounts receivable: They both decrease cash flow. Unearned revenues is a liability, so it works in the same way as accounts payable. An increase in unearned revenues does not affect net income, but it does increase cash since payment has been received for future delivery of products or services. Again, the key is when cash was actually received or spent.

A deferred tax expense on the cash flow statement is used to adjust net income to the cash balance.

Net operating cash flow is sum of these adjustments and net income. Expanding firms may have negative operating cash flows as they build up inventory and provide more credit to customers, but eventually this figure needs to turn posi-tive. For most firms, positive operating cash flow is crucial.

While operating cash flow is just one component of the cash flow story, it is one of the most important measures of profitability and long-term future outlook. A positive cash flow from operations is a good indicator of the financial health of the company and specifically of its ability to pay and even in-crease its dividend. Companies with a positive and increasing operating cash flow are in a far stronger position to meet their obligations and produce above-average returns for investors. ▪

Operating Cash Flow: Measuring Day-to-Day Profitability

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In This Issue Dial M for Merger...Medtronic/Covidien and the Walgreens/ Alliance Boots deals won’t have capital gains tax implications for the sharehold-ers of the acquiring companies,