Monday, September 12, 2016

7 Dividend Stocks Delivering The Secret To Success

For a while it seemed that every investing article ended with the same conclusion - you should be buying dividend stocks. They are all quoting studies citing the performance edge that dividends have enjoyed over the long-term and the value of a semi-fixed return generated from periodic dividend payments. However, you should beware of some of the information provided. Beyond the simple concepts, some of the writers are making really bad recommendations and cross-breeding dividend investing with their preferred form of investing.

Dividend growth investing is not about exit points, momentum swings, relative strength, sector rotation; instead it is about studying fundamentals, selecting superior stocks and building a portfolio with a long-term horizon. When we buy a dividend stock, we hope to hold it forever. What makes a good dividend stock? Here are some of the things I look for:

Good Business Model

Sell things that people want or need, and do it in such a way that it is difficult or impossible for others to duplicate. There is a reason that pharmaceutical companies, such as AbbVie Inc. (ABBV), are so profitable. With effective drugs under patent that sustain or enhance people's life these companies have a deep moat. Consumer goods companies like Procter & Gamble Co. (PG) and Colgate-Palmolive (CL) manufacture products such as soap, detergent, toothpaste and toilet paper that we just can't do without. Sure, there may be generic substitutes, but over the years many of these products have endeared themselves to consumers who are willing to pay a few cents more for the name brand.

Strong Free Cash Flow

Dividends are paid with cash remaining after paying the operating expenses and replacement capital (free cash flow). If a company has trouble meeting these basic needs, then its dividend is perilously at risk. Companies with a low free cash flow payout (FCF) payout are well-positioned to sustain their dividend. Such companies include: AFLAC Incorporated (AFL) at 10.56% FCF Payout, Apple Inc. (AAPL) at 22.32%, Lowe's Companies, Inc. (LOW) at 26.14% and Cincinnati Financial Corp. (CINF) at 27.92%.

Acceptable Debt Level

Generating a strong free cash flow is not enough - cash has to be available to be paid as dividends. After the 2008-09 economic downturn, many companies were under pressure to reduce debt to stay within their covenants and try to maintain their debt rating. If a company's excess cash is being used to service debt, there may not be any left over to increase dividends. Companies with a low debt to total capital include: Erie Indemnity Co. (ERIE) at 0.00% Debt to Total Capital, Genuine Parts Company (GPC) at 19.31%, Exxon Mobil Corporation (XOM) at 22.59% and  Automatic Data Processing Inc. (ADP) at 30.84%.

Good Balance between Dividend Yield and Growth

There is usually a reason why a stock's yield is above average. Often it is the market's way of saying it doesn't believe the company can maintain the dividend. Most people understand this risk. However, there is also risk to a stock that has a high dividend growth rate. To maintain a high dividend growth rate the company has to grow cash available for dividends at the same rate. This is often difficult to do.

Here are several companies with a good balance between dividend yield and dividend growth rate: Pepsico, Inc. (PEP) 2.85% yield and 7.16% dividend growth rate, Questar Corp.n (STR) 3.43% yield and 6.69% growth, Meredith Corp. (MDP) 3.72% yield and 6.49% growth, Omega Healthcare Investors, Inc. (OHI) 6.31% yield and 4.05% growth and The Hershey Company (HSY) 2.25% yield and 8.72% growth.

For those of us that have invested in dividends for years (decades for some of us), we know dividend growth investing is not a passing fad to be "played" then move on the next hot investment strategy. Part of me will be glad when dividend investing falls out of favor and the masses moves on.

Full Disclosure: Long ABBV, PG, CL, AFL, AAPL, CINF, ERIE, GPC, XOM, PEP, MDP, OHI. See a list of all my Dividend Growth Portfolio holdings here.

Related Articles
- Why We Are Dividend Growth Investors
- 5 Higher Yielding, Lower Risk Stocks To Perk Up Your Dividend Income
- 6 Dividend Growth Stocks With Very Little Debt
- 4 Secrets To Finding The Best Dividend Stocks
- What Determines A Dividend Stock's Yield

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