Thursday, August 19, 2010

Quality Dividend Stocks with Low Yields

When it comes to current dividend yields, in general, the cut off used by dividend investors vary such as 2% absolute dividend yield, 3% absolute dividend yield, or dividend yield higher than S&P500 index yield. I have observed that there are quite a few good quality dividend paying companies that have dividends yield of around 2%. There is a school of thought that low dividend yields will take more than 10, 12, or even 15 years to be equivalent to any high yielding CDs or money market accounts. In addition, when low yield dividend stocks are compared to high yield dividend stocks, considering conservative dividend growth rates, low yielding stocks will often lag by significant amount. Mathematically, it does make sense and hence, it is difficult to argue on this thought. Purely based on dividends alone, it is always good to go for relatively higher yield dividends stocks.

In general, I have always made relative comparison with S&P500 index yield. But I have not had a minimum dividend yield floor value, below which I have not invested. Current low yield may be a reflection of company being of good quality. Following are three examples of low yielding dividend stocks that I believe are of good quality.

  • Lowe’s Companies (LOW) is a home improvement retailer which focuses on retail do-it-yourself (DIY) customers and do-it-for-me (DIFM) customers who utilize LOW’s installation services, and commercial business customers. Its product lines include products and services for home decorating, maintenance, repair, remodeling, and the maintenance of commercial buildings. It continues to have very stable gross and operating margins. It continues to generate operating cash flows. One would expect that with housing market crash, LOW’s earnings would also crash. However, it was not the case, and it indicates the strength of its business model. Even though the housing market is grim, I believe the repair and maintenance segment will continue to generate revenue and income for LOW. Current yield is 2.2%.
  • John Wiley & Sons (JW.A) is in publishing industry where there is a general concern about industry’s continued decrease in profitability. Contrary to this trend, JW.A continues to have stable gross and operating margins, generates stable operating and free cash flows. Its core competency is digital publishing that focuses on the subscriber based products. It does not have to depend upon advertising revenue alone. Notwithstanding the low payout and low dividend yields, the company will last longer than 10 years. Therefore, I believe low dividends yield alone should not be a show stopper. Current yield is 1.7%.
  • Becton, Dickinson and Company (BDX) is another example of low dividend yield stock. The company does not have excessively high debt levels (or leverage) and hence, was not affected by financial turmoil. It does not depend upon the credit markets. BDX generated more than half of its sales from outside of US which have different growth rates than US economy. It does have challenges such as regulatory driven change in spending patterns, health care reforms, or recession driven slow down. But these issues will affect the whole industry and not BDX alone. Contrary to general belief, BDK operates in an industry with high barriers to entry. The quality and reliability requirements for end products in this industry are among the stringent ones. It has build business around its core competency which makes me think and believe that it will last for more than 10 years. Current yield is 2.1%.


I am still in my early investing years and have a long way to go before I stop investing. So if I think the company has some core competency, competitive advantage, low risk to dividends, and will survive beyond a decade, then I am open to invest in such low yield dividend stocks. I believe the slow steady earnings will provide capital gains and help me moderate out total returns. Such companies provide stability in your portfolio.

Disclosure: Long on LOW, JW.A, and BDX



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1 comment:

  1. Good watchlist. I would add JNJ there as well.

    ReplyDelete

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