Everybody likes winners. Looking at the history of the most successful dividend stocks, I have been able to identify several traits, which have been strong predictors of performance.
A business has to be able to have strong competitive advantages and to deliver value to consumers in the form of goods or services they need. By having a strong brand, a business can afford to raise prices, and have a differentiated product that is more desirable that the competition. A business that manages to grow earnings per share either organically or through acquisitions, can afford to pay a rising dividend.
High Return on Equity
High returns on equity are important to companies. Only a company with a wide-moat is able to charge higher prices. Growing such business might not be as easy simply through additional investments in it. Companies with high returns on equity are typically characterized with having excessive cash flows generated each year, which cannot be easily deployed 100% in the business. Some portion will be deployed, but these companies need to be mindful of the returns generated from new investments. If you generate 20% on your investment, making a new investment might increase earnings per share, but it might not be desirable because it could generate a lower return on equity. I typically want to see a stable ROE, because a declining one shows me that management is taking on any project available, regardless of profitability, without having the best interests of shareholders in mind.
Decreasing number of shares
Some of the most successful companies in the world generate so much cash flow that they tend to have stock buybacks, which decrease the number of shares outstanding. This helps EPS, but also makes each share more valuable as it provides shareholders with a larger percentage of the business, without doing anything. Few companes consistently repurchase shares however, as most end up buying back stock when times are good and stock prices are high and stop buying back shares when times are tough but stock prices are low.
Sustainable Dividend Payout Ratio
Some of the best dividend stocks have been able to create a balance between the amount of money they reinvest in the business, and the amount they distribute to shareholders in the form of dividends or share buybacks. A company that distributes too much to shareholders, might be unable to maintain its business without selling more stock or taking on additional debt. A company that pays too little in dividends might focus too much at growth at any price, which might reduce returns on equity over time.
Dividend Growth History
The companies which are able to generate higher amounts of excess cash flows each year, tend to boost distributions annually. This creates a dividend stream for investors which increases at or above the rate of inflation each year. By strategically allocating these growing dividends through dividend reinvestment, investors are essentially turbocharging their income. There are less than 300 companies in the US which have a culture of sharing their success with shareholders in the form of higher dividends.
Five companies which provide excellent examples of the five metrics above include:
Wal-Mart Stores (WMT) has paid uninterrupted dividends on its common stock since 1973 and increased payments to common shareholders every year for 37 years. The company has managed to deliver an increase in EPS of 12.20% per year since 2001. On average the company has managed to repurchase 2.20% of its stock annually over the past decade. Wal-Mart has one of the largest and most consistent stock buyback programs in the US. The company has had a high return on equity, which has remained in a tight range between 20% and 23% over the past decade. Check my analysis of the stock.
Colgate-Palmolive (CL) is a dividend champion which has increased distributions for 48 years in a row. The company has managed to deliver an impressive increase in EPS of 9.60% per year since 2001. In addition, company has managed to decrease the number of shares outstanding by 1.30% per year over the past decade through share buybacks, which has aided earnings growth. It currently spots a return on equity of 78% and has a sustainable dividend payout ratio. Check my analysis of the stock.
PepsiCo (PEP) is a dividend aristocrat which has increased distributions for 38 years in a row. The company has managed to deliver an average increase in EPS of 10.90% per year since 2000. PepsiCo has a high return on equity, which has remained above 30%, with the exception of a brief decrease in 2004. The company has managed to repurchase 1.35% of its outstanding shares each year since 2001. Check my analysis of the stock.
McDonald’s (MCD) has paid uninterrupted dividends on its common stock since 1976 and increased payments to common shareholders every year for 35 years. The company has managed to deliver an increase in EPS of 15.50% per year since 2001. In addition, the company has managed to repurchase 2.20% of its stock annually over the past decade. The company has been able to increase in return on equity from the high teens in early 2000s to over 30% over the past three years. Check my analysis of the stock.
Procter & Gamble (PG) is a dividend aristocrat which has increased distributions for 55 years in a row. The company has managed to deliver an average increase in EPS of 14.50% per year since 2000. The return on equity has decreased since the purchase of Gillette several years ago, although it is on the increase. Procter & Gamble has spent billions repurchasing stock over the past decade. The only reason why the share count has increased slightly is due to the fact that major acquisitions were made using stock. Check my analysis of the stock.
Disclosure: Long all stocks mentioned above