Use Large, Established Retirement Funds to Pick Dividend Winners (And 10 To Consider)

by: Jefferson Starship

It should come as no surprise that a 401k and IRA should be part of one’s portfolio (when available), so as to reduce the tax consequences of holding securities. The tax benefits of retirement accounts are substantial, especially when they are held for 40 or so years. For instance, depending on the type of account, the initial investment is deductible, or in a Roth IRA the gains (capital and dividends) are exempt from taxes.

Recently I have been looking for a new fund to open in my Roth IRA account. I already have one focused on Ginnie Mae bonds, which has performed admirably since I bought it when I was 16, but I have decided that I would look for a fund centered on companies with a longstanding history of raising their dividends. Everyone understands the purpose of DRIPing large cap stocks with safe, stable dividends. If you pick the right companies, there will be little to worry about day-to-day and you could simply invest more when the price falls. With appropriate diversity among the stocks, there will be very little risk and exponentially so when the projected holding period is indefinite.

It’s not hard to find articles with lists of dividend winners, I’ve written on the matter several times. But with this list I’ve decided to let the experts at Vanguard do the picking. The fund I came across is the Vanguard Dividend Appreciation Index (VDAIX), which “focuses on high-quality companies that have both the ability and the commitment to grow their dividends over time.” (This fund is also available as an ETF (NYSEARCA:VIG).) It is a collection of 127 holdings with 25.8% in consumer staples, 18.8% in industrials, and 13.2%in health care.

The objective of this list is to offer 10 examples of solid dividend growing companies that have strong institutional backing. It is not meant to sway a reader into investing in a fund rather than individual stocks.

As mentioned above, the benefits of the fund are the tax exemptions, and you save on commissions and such. The downside is that you have much less control. Funds are slower to adapt to market swings since their long-term mindset is designed to weather these events. Holding stocks individually gives you the freedom to pick and choose the specific securities you do not want to hold.

You can also make more short term pick-ups as a way of increasing your capital gains over time. So each technique has its ups and downs; personally I would think it would be prudent to do both and max out what you can in the retirement accounts. With that said, here are the top ten holdings of the Vanguard Dividend Appreciation portfolio, which make up 42% of all holdings.

1. McDonald’s (NYSE:MCD) – McDonald’s has been the biggest name in fast food for as long as anyone can remember. I’ve written extensively on the fast food restaurant industry over the last year or so and McDonald’s always comes out on top, in terms of a safe investment, with an awesome dividend, and room to grow in the price department. They are currently priced at $87, which is near a 52-week high, but it's unlikely that they would drop any further. They just announced that they are increasing their dividend 15%, and are now yielding 2.8%.

2. Coca-Cola (NYSE:KO) – Coke is also yielding 2.8% right now. They are the largest beverage distributor in the world and have a strong international presence. Their P/E is at 12.56 and they are about 6% off their 52-week high and should be returning to this level soon assuming the economy does not nose dive any more than it already has during the past month.

3. International Business Machines (NYSE:IBM) – It’s amazing that a company that has focused on developing a computerized Jeopardy dynamo has succeed in this volatile climate. Just kidding, IBM is a huge IT services company with a long global reach and offers diversity across the technology sector. Their yield isn’t great (1.8%) but they offer plenty of room for price appreciation. Right now they are about 50% higher than their pre-recession heights, which is outstanding for a company with such a high market cap.

4. Chevron Corp (NYSE:CVX) – There are only a few big names in the energy sector that offer excellent dividends. The first is Chevron and the next two are found lower on this list. But the sector has not been burning too hot in light of current economic developments. They are 18% off of their 52-week high of $110, but this has brought their yield up to 3.5% and their P/E is only at 7.86, which is in-line with ConocoPhillips and below Exxon.

5. Procter & Gamble (NYSE:PG) – Procter & Gamble, though not exactly recession proof, sells products that are essentially necessities and are used every day. They own brands like Head & Shoulders, Oral-B, Downy, Febreeze, Pantene, Pampers, and Gillette. They are currently yielding 3.4% at roughly 10% off their 52-week high. Take a look at their 2-year chart and you’ll see that they have a lot of ups and downs but all within a very tight range. Therefore you may want to consider holding the dividends rather than DRIPing them.

6. Pepsico (NYSE:PEP) – I am personally long Pepsi and can tell you that they took a beating over the summer. This has brought their yield up to 3.4% with a dividend paying on Friday. Some may think that having Coke and Pepsi in the same portfolio is a bit of an overload, but in fact they are they are the top two in the industry, and Pepsi derives half of its income from snack foods. They are an excellent company with obvious staying power, but pick your entry-points carefully.

7. ConocoPhillips (NYSE:COP) – This is the second of the three energy stocks, and has the best yield at 4.2%. They are 23% off their 52-week high, and are also the smallest of the three energy stocks at a mere $85.8 billion market cap. Unlike some sectors, there is more than enough room in energy for more than a couple of industry leaders, but I would probably still take Exxon because of their size.

8. Exxon Mobil (NYSE:XOM) – As you know, Exxon was the longstanding, largest public company in the world, and then Apple’s (NASDAQ:AAPL) stock price caught up to the company’s performance and left Exxon in the dust. But being the second largest is nothing to be ashamed of. They have the lowest yield of the three energy picks at 2.7%, and the highest P/E 9.1, which would lead me to believe that institutions feel that Exxon will bounce back better than the other two. They are also about 21% off their 52-week high and there seems to be some support right around the $69-$70 area.

9. Wal-Mart (NYSE:WMT) – This could be my second favorite stock on this list. Wal-Mart has been re-inventing their image over the last few years. Specifically they have made a concerted effort at cleaning up the appearance of their stores, like widening aisles and altering department layouts, as well as moving into the fresh food game. There’s a good chance that Wal-Mart, Target (NYSE:TGT), Costco (NASDAQ:COST), and Whole Foods (NASDAQ:WFM) will eliminate America’s small grocery stores entirely. Wal-Mart is yielding 2.9% and has an excellent dividend history. Their P/E is only 10.8 and they are about 12% off 52-week highs.

10. United Technologies (NYSE:UTX) – I was surprised to see United Tech on this list, but they are on the Dow. They have been paying their dividend since 1970, but they generally do not pop up on increasing dividend lists because they have a tendency to go 5 quarters at time per payout, as opposed to the normal 4. They are a large industrial conglomerate, so they are inherently diversified but they have lost about 25% of their capitalization since July and this has brought their yield up to 2.8%.

So these are the top ten dividend appreciating stocks according to this particular fund. I would argue that these particular ten are not as diversified as they should be, since three are large energy companies, but nonetheless it could be used as a building block in establishing a resilient long-lasting portfolio. As always, you should choose your price points carefully to avoid unnecessary loses and reevaluate your positions periodically, adjusting as you see fit.

Disclosure: I am long PEP, MCD.