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Summary

  • The benefits of dividend growth investing over the long haul have been widely-documented.
  • Cash-flow-based dividend analysis such as the Valuentum Dividend Cushion helps investors take into consideration the strength of a firm's balance sheet, which is a key source of funding.
  • Let's walk through 5 very popular dividend growth ideas that may not be as attractive as you think. Our best dividend growth ideas are included in the Dividend Growth portfolio.

History has revealed that the best performing stocks during the previous decades have been those that shelled out ever-increasing cash to shareholders in the form of dividends. In a recent study, S&P 500 stocks that initiated dividends or grew them over time registered roughly a 9.6% annualized return since 1972 (through 2010), while stocks that did not pay out dividends or cut them performed poorly over the same time period.

Such analysis is difficult to ignore, and we believe investors may be well rewarded in future periods by finding the best dividend-growth stocks out there. Let's take a look at the recent performance of popular five high-dividend payers that may not be as attractive as investors make them out to be. Let's also disclose their most recent Valuentum Dividend Cushion scores.

Valuentum updates each firm's cash-flow derived valuation rating and Dividend Cushion scores at least on a quarterly basis (or after material events). The Valuentum Dividend Cushion is a pure financially-derived cash-flow coverage ratio that considers a dividend payer's future free cash flow, expected future cash dividend payments and balance sheet (net cash/debt information).

3M (NYSE:MMM) - Overvalued - Dividend Cushion: 1.9 - Dividend Yield: 2.4%

There's little doubt across the team at Valuentum that shares of 3M are overpriced. 3M is a perfect example of the saying that a good company doesn't always make a good stock. We think the odds are long that 3M will outperform the market in the years ahead, as dividend growth investors have bid the firm to levels far beyond what we would consider to be an acceptable fair value range. The company's first-quarter results weren't poor, and its outlook calling for organic local-currency sales growth of 3%-6% wasn't bad, but investors are just too enamored by the company's recent 35% dividend increase. Further dividend advancement at this pace is just unlikely, in our view, and we think investors will have a better time to enter 3M's shares in the next few years. We're not saying that management won't continue to raise its dividend, but we think investors are taking on a significant amount of capital risk for a sub-3% dividend yield.

AT&T (NYSE:T) - Fairly Valued - Dividend Cushion: 0.5 - Dividend Yield: 5%

We don't like the debt loads of telecom firms. All things considered, firms that generate significant cash flow, have little incremental capital requirements, and boast little to no debt on their balance sheets are the ones with strong dividend-growth potential. This particular profile is as about as far away as possible for AT&T. The company had its best revenue growth in more than two years and its best first-quarter postpaid net adds in five years during the first quarter, but we can't overlook the impediments to AT&T's future dividend expansion. Capital expenditures absorbed nearly two thirds of cash from operations in the period, and while the company expects to haul in $11 billion in free cash flow for 2014, it is staring down a mountain of long-term debt ($71.6 billion at quarter end). Its cash balance doesn't even cover debt maturing within one year, which itself is not included in the long-term debt count. AT&T may have been a great dividend growth idea 10 or 15 years ago, but it is not today. The company's Dividend Cushion score is below 1.

Kaiser Aluminum (NASDAQ:KALU) - Fairly Valued - Dividend Cushion: 2.2 - Dividend Yield: 2%

We generally don't like commodity producers (they have no control over price), but we're quite impressed with Kaiser Aluminum's Dividend Cushion score. Aerospace and high-strength products (Aero/HS) represent roughly 40% of Kaiser's business, and the aerospace industry perhaps has never been stronger. Still, pricing pressure was something that Kaiser mentioned in its first-quarter release regarding its outlook for 2014, and the company's adjusted consolidated EBITDA dropped in the first quarter both in absolute terms and as a percentage of value added revenue. In any case, we think dividend growth investors can find better ideas than Kaiser Aluminum at this juncture.

KLA-Tencor (NASDAQ:KLAC) - Fairly Valued - Dividend Cushion: 3.2 - Dividend Yield: 2.9%

KLA-Tencor is among the largest semiconductor equipment companies in the world. The firm supplies process control and yield management solutions to a variety of industries: LED, data storage and photovoltaic. The company's calendar first quarter (fiscal third quarter) results left much to be desired. KLA-Tencor's commentary in the release regarding semiconductor device makers facing enormous challenges in transitioning from planar to 3D transistor structures, and the notion that the semiconductor capital equipment industry is currently experiencing a pause in demand doesn't get us very excited. Its guidance for fiscal fourth-quarter revenue and earnings came in lower than consensus expectations, and we won't be rushing to add shares to the Dividend Growth portfolio.

Philip Morris (NYSE:PM) - Fairly Valued - Dividend Cushion: 1 - Dividend Yield: 4.4%

To us, the best dividend growth idea in the tobacco space is Altria (NYSE:MO). Bulls of Philip Morris say the company has fantastic international growth potential, but so does Altria via its equity stake in SABMiller. Philip Morris' first-quarter performance also didn't spell expansion potential. Adjusted diluted earnings per share, excluding currency impacts, advanced less than 5%, while cigarette shipment volume tumbled more than 4%. The company is still expecting a 6%-8% increase in adjusted diluted earnings per share during 2014, and it may just hit that mark via pricing growth, but it is far from a fast grower. Altria's stake in SABMiller gives it comparatively more flexibility to grow its dividend payout, and Altria already has a higher yield than Philip Morris. Though Philip Morris is championed for its greater growth potential, we're sticking with peer Altria in the Dividend Growth portfolio. We think Altria is largely misunderstood.

Wrapping It Up

The Valuentum Dividend Cushion continues to be the primary metric we use in deciding which companies to add to the Dividend Growth portfolio, and we've yet to have a dividend cut in the portfolio to date. Only the best of the best dividend growth giants are included in the portfolio, and the ones in this article didn't pass the test. Though we fully expect there to be varying opinions on these companies, we trust you found this piece helpful. Thank you for reading!

Disclosure: MO is included in the Best Ideas portfolio and Dividend Growth portfolio. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: 5 Very Popular But Very Unattractive Dividend Growth Firms