In an utopian world, the perfect dividend stock would be one that is both high-yield and provide a high dividend growth rate. Its share price would appreciate ratable with its increasing dividend. All of this would be driven by increasing earnings and cash flow.
Ok, so much for my fantasies, the perfect dividend stock just may be a balanced compromise. Consider the following:
High Yield/Low Dividend Growth When investors first consider investing for income, High Yield is usually their first focus. It is human nature to want it now and want a lot of it. Unfortunately, high yield stocks often carry higher than average risk – there is usually a reason that the stock's yield is above average.
It could be because the company is in a limited growth industry, is in a volatile industry, experienced recent financial problems and its share price has fallen, or shareholders perceive future financial or economic problems. I have set aside a small portion of my portfolio to invest in these types of stocks. Examples of these stocks would include:
Kinder Morgan Energy Partners LP (NYSE:KMP) is one of the largest pipeline master limited partnerships (MLPs) in the U.S.
Yield: 6.9% | Dividend Growth: 3.4%
Universal Health Realty Income Trust (NYSE:UHT) is a real estate investment trust (REIT) that invests in healthcare and human service related facilities.
Yield: 5.6% | Dividend Growth: 0.2%
Yield: 5.3% | Dividend Growth: 2.2%
Low Yield/High Dividend Growth After being burned on an over-allocation of high yield stocks, some dividend investors start reading-up on the subject. The first thing that they learn is that Dividend Growth is more important than Dividend Yield. While Dividend Yield will stroke you today, Dividend Growth is much more important to long-term wealth creation.
Companies in this category tend to be well established, dominate in their market and in industries less affected by cyclical geopolitical factors. However, it is important to note that these stocks carry a different kind of risk.
Since your long-term return is dependent on the companies increasing their dividends over many years, there is a real risk of something occurring that would prevent them from executing their strategy. Examples of these stocks would include:
Yield: 1.2% | Dividend Growth: 20.0%
Yield: 1.6% | Dividend Growth: 16.1%
Walgreen Co. (WAG) is largest U.S. retail drug chain in terms of revenues, this company operates more than 8,000 drug stores throughout the U.S. and Puerto Rico.
Yield: 1.7% | Dividend Growth: 15.0%
Moderate Yield/Moderate Dividend Growth This is a category that doesn't always get a lot of attention. I would classify stocks in this category with yields from 3.0% to 4.5% and a dividend growth rate between 5% and 12%. For some, this defines the perfect dividend stock – good current payment with good future opportunities for growth.
These companies’ stories are varied. For some, they would normally reside in one of the other two categories, but hit a bump in the road. For others they normally reside here due to their growth and risk profile. Examples of these stocks would include:
Yield: 3.1% | Dividend Growth: 8.8%
Yield: 3.0% | Dividend Growth: 8.1%
Yield: 3.4% | Dividend Growth: 7.9%
As with all investments, risk can never be eliminated. However, to minimize risk I employ an asset allocation model. In addition, I limit my investments in each of the above categories.
Disclosure: Long KMP, UHT, T, NKE, GWW, WAG, CLX, KO, CVX. See a list of all my dividend growth holdings here.