7 Defensive Equities With Stable Dividend Growth

 |  Includes: ABT, HSY, IBM, JNJ, KO, MCD, PEP
by: Bio Insights

The following list is intended for people who are looking for defensive positions that have historically enjoyed stable dividend growth and will have their earnings relatively protected from any possibly economic slowdowns going into 2012.

I will look particularly at both the payout ratios of these equities as well as the rate at which their earnings and dividends are growing to determine which stocks in which industries are growing dividends at the fastest rates.

1.) International Business Machines (NYSE:IBM)

Its industry may not be a traditionally defensive one, but judging by its size and stable earnings growth, IBM is essentially behaving as a defensive stock. Its earnings have been increasing at a surprisingly predictable rate and the payout ratio of its dividend has been slowly increasing as well (now up to 22%). The tradeoff for its lower yield (at 1.73%) is the highest growth potential.

Relative to other companies which boast the same stability as Big Blue, its earnings growth is substantial. EPS has increased 15% in Q2 2011 relative to Q2 2010. As shown below, IBM earnings have been quite incredible especially after 2005. While the payout ratio has been increasing, the earnings are outpacing the dividends. This means one of two good possibilities for dividend investors - either they will continue to increase the rate at which their dividend grows, or they will be able to assure the growth rate of that dividend for a very long time to come. Is it reliable? I would say it's certainly assured, and the dividend growth rate looks like it's increasing a bit.

2.) Johnson & Johnson (NYSE:JNJ)

It's hard to imagine anyone who hasn't heard of Johnson & Johnson and their products. Having an extremely broad line of products spanning across an "economy-proof" industry, JNJ's profits are secure for the foreseeable future. Revenue growth has been somewhat sluggish, but the most recent report notes an 8% increase in sales revenue in Q2 2011 relative to 2010.

JNJ is one of the most popular defensive stocks of all time. It's hard to find any dividend-crazed investor who dislikes their shares of JNJ, as the current 3.6% yield is great to have in addition to the stable stock price action. As shown below, dividends have been faithfully increasing for the last 10 years along with JNJ EPS, maintaining roughly the same payout ratio the whole time (44% as of today). They are certainly not being stingy. For now, this is one of the most reliable dividends out there, and its growth rate has been predictable and good at the same time.

3.) McDonald's (NYSE:MCD)

Food is vaguely similar to Healthcare in that it is required by society in both good times and bad. I'd choose McDonald's over other food giants for a few reasons. First, many of the food industry giants don't pay dividends. Second, some have had extremely sluggish dividend growth like Hershey (NYSE:HSY) or none at all like Kraft (KFT). Its main competition for dividend growth would likely be Yum! Brands (NYSE:YUM) which is expected to grow revenues slightly faster.

Still, McDonald's is currently the better dividend stock. For starters, the dividend is about 1% higher for MCD, sitting at about 2.9% relative to Yum's 2%. This is even without mentioning the slight advantage MCD has in P/E ratio. While Yum's dividend has been growing just a little faster than McDonald's in the last few years, the time it would take to catch up to McDonald's much higher yield will likely change many aspects about both companies. Additionally, MCD has a beta of about .5 relative to Yum's 1.0, which may make it easier to stomach the turbulence in the market. Looking at the history of its dividend, you can also see that MCD has been accelerating the rate at which it has increased its dividend. The reliability of this growth rate seems quite high.

4 & 5.) Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP)

Since these companies are arch rivals in the beverage industry (although PepsiCo does indulge in junk foods as well), it seemed fitting to have them together in this list. Both of them are defensive in nature, which means they can do well even in economic recessions.

Comparing earnings, KO has beaten PEP in terms of growth rate in the last few years. Their dividend growth rates are roughly the same, but it's possible that Coke may boost dividends in the near future to reflect their much higher profits as of late. To counter this, Pepsi has a dividend which yields roughly .3% more a year as of the current prices, and is expected to boost EPS significantly in the near future. Looking at earnings reports (Coke and Pepsi) one can see that comparing Q2 2011 to Q2 2010 for both companies, the growth rate is nearly identical. Pepsico has increased earnings by 20% while Coca Cola reported 18%.

The payout ratio for Coke is currently lower due to their significantly higher EPS, which probably makes it more likely to increase its dividend payments in the near future. Not favoring one over the other, I'd say that they both have minor differences in strengths and weaknesses, but both have a very solid track record of increasing dividends and this may accelerate if EPS continues to improve.

6.) Abbott Laboratories (NYSE:ABT)

Similar to Johnson & Johnson, Abbott has the ability to continue earnings growth even during economic busts. What made it stand out from the remaining healthcare companies (Pfizer (NYSE:PFE), Eli Lilly (NYSE:LLY), and Bristol-Myers Squibb (NYSE:BMY) for instance) is that its dividend growth has been more reliable but slightly slower, which is a fair tradeoff. Looking at the chart you can see that it has done nothing but steadily increase for 10 consecutive years, even in 2010 when many pharmaceutical stocks put their dividends on the chopping block due to drops in EPS.

Still, like many companies heavily exposed to pharmaceutical research, their earnings can swing rather drastically. Nonetheless the dividend has held its steadily increasing rate for quite some time. For a company in pharmaceutical research, Abbott probably has one of the most reliable dividends out there (just look at 2006 where the EPS fell 50% but ABT still paid and increased the dividend). It seems to be quite stable, and the growth somewhat less predictable but still safe enough to buy.

7.) The Hershey Company (HSY)

Another beloved American company, this defensive stock also boasts a solid 2.5% dividend. As nice as that number is, the growth rate of the dividend has been stagnating in recent years and chaotic EPS action has likely made this stock less attractive to those who like neat lines.

As strange as earnings have behaved the dividend is reliable but the growth rate will probably remain sluggish unless EPS rises faster than expected since the payout ratio is huge (58% last year). As of Q2 2011, after a year EPS has grown 10% (as stated in this report). While this may not be too shabby, there are simply better options available if you're looking for dividend growth.

In summation, we've looked at seven quality defensive stocks and analyzed their dividend and earnings history. It is up to personal preference whether EPS growth or dividend growth is more favorable (some are better than others), but as far as dividends go there are multiple ways to approach an equity. High EPS growth could lead to serious dividend growth, but at the same time already existing high dividends can compound your investment more quickly.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.