Selecting The Best Dividend Stocks

Includes: CAT, INTC, KO, MO, YUM
by: DIY DG Investor

For beginner investors, the process of selecting stocks to invest in can be a daunting task. Lots of people elect to settle for mutual or index funds, which require investors to do very little homework. The problem with mutual funds is that they often underperform the market, especially when fees are factored in. Index funds usually have fewer fees, but an investor looking to generate an increasing amount of income annually could do better by investing in blue-chip dividend stocks. How should one start the process of selecting quality stocks that are positioned for long-term success?

I have found that stock screeners can be a good way to start the research process and get some good ideas of quality companies. A screener that I like to use is the Financial Visualizations one found here. The following are some metrics that I deem to be important, and the way that I implement them into each screening.

Market Cap: >$10 billion

I prefer to invest in larger companies that have an established presence in their individual markets. Generally speaking, companies with higher market caps tend to have more stability than small and micro-caps.

Dividend Yield: >2%

A 2% current yield is my minimum requirement for my dividend growth portfolio. I like to see preferably 3%+, although I will settle for 2% if I believe it will grow at a fast pace or if the company has a strong competitive advantage.

EPS Growth past 5 years: >5%

Dividend payments come directly from earnings, and an increase in a company's profits tend to correlate to dividend increases. Without earnings growth, the company will find it very difficult to raise the dividend.

Sales Growth past 5 years: >5%

Although Earnings per Share can increase due to things such as lower costs and increased efficiency, I also like to make sure that revenues are increasing as the company grows. A company that is growing earnings despite decreases in revenue is not one that I would want to invest in long-term.

Operating Margin: >10%

Operating Margin is one of the key metrics in evaluating the profitability of a company from operations. It takes into account cost of goods sold as well as labor and administration and selling costs. By setting this at a 10% minimum, I am ensuring that every company makes generates at least 10 cents before taxes and other adjustments for every $1 in sales.

Here are some of the solid companies produced from the screen:

Caterpillar Inc. (NYSE:CAT) - This industrial goods company manufactures mining machinery along with engines and turbines for industrial use. Caterpillar has raised its dividend for 19 consecutive years, averaging 8.2% over the past five years. With a payout ratio of only about 25%, CAT has increased earnings from $2.7 billion in 2010 to $5.68 billion in 2012. Trading at a forward P/E of under 10, Caterpillar could offer good value to a long-term investor.

Intel Corporation (NASDAQ:INTC) - Intel is a $100 billion player in the semiconductor industry. Struggling recently due to a declining PC industry, Intel now offers a 4.3% current yield. The payout has increased from $0.56 per share in 2009 to the current dividend of$0.90. The industry is rapidly changing however, and Intel will have to adapt to maintain its dominant position.

The Coca-Cola Company (NYSE:KO) - Coke is the dominant player in the beverage and soft drink industry. The company has increased its dividend for the past 51 years, a streak that is sure to continue long into the future. By broadening its product mix over the past few years, Coke has ensured that it will remain atop the beverage industry even as people focus on healthier options.

Altria Group, Inc. (NYSE:MO) - Altria manufactures and sells cigarettes, tobacco products, and wine domestically. With 44 consecutive years of dividend hikes and powerful brands such as Marlboro, the stock has provided tremendous returns in the past. The combination of dividend growth and share buybacks make Altria a solid long-term play. Such a consistent stock is a great candidate to continue to be a buy and hold stock going forward.

YUM! Brands, Inc. (NYSE:YUM) - YUM! Brands owns and operates many chain quick-service restaurants including Taco Bell, Pizza Hut, and KFC. Yielding about 2% currently, it has raised the dividend by an average of 17.8% over the past five years. With a earnings payout ratio of under 40%, YUM has been able to grow earnings from $1.16 billion in 2010 to $1.6 billion in 2012.

This stock screen has produced some excellent companies to consider for investment. It is important to note that just because the screen produced these stocks does not mean that they are automatically great investments. It is important to consider valuation as well as other factors to determine if each company is a worthy choice.

Disclosure: I am long INTC, KO, MO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.