The Dividend Aristocrats index measures the performance of S&P 500 index members that have followed a policy of consistently increasing dividends every year for at least 25 consecutive years. (Source: S&P)

Since its inception 20 years ago, the dividend aristocrat’s index has outperformed the S&P 500.

Many investors are being sold on the idea of generating income in retirement by solely focusing on fixed income securities. That way they would have a stable income pretty much for life and there is a high likelihood that the principle would be returned intact after the bond matures. The main problem with this strategy is that while the income would remain unchanged over time, its real purchasing power would decline. If however investors purchased a diversified list of dividend growth stocks, they would be able to generate enough income and also enjoy the growing stream of distributions over time. That way investors would not have to worry too much about inflation eroding the purchasing power of their passive income. By focusing on such lists as dividend aristocrats, dividend achievers and checking the list of dividend increases regularly, investors could find the right dividend picks for their portfolios.

The following companies announced dividend increases last week:

Estimating future dividend growth is difficult if not impossible. Companies which might have had a long history of consistent double digit increases might stop raising dividends and might even cut them. It is easy to predict whether or not a company’s dividend is sustainable in the short run, by evaluating EPS trends, dividend payout ratios and cash flows. It is difficult to forecast however whether the dividend won’t be cut several years down the road.

Financial companies such as Bank of America (BAC) and US Bancorp (USB) are two prime examples of this. After raising distributions for several decades, and always spotting above average dividend yields, the companies had to cut dividends amidst the global financial crisis of 2007-2009. The stocks were often priced attractively before 2006-2007, with adequately covered dividends, attractive valuations and very good current yields at the time. Fast forward two years and these former dividend darlings have cut their dividends sending retiree’s alternative incomes into a tailspin.

I typically try to summarize each week’s dividend increases in the news by outlining the company that raised distributions and whether it is an achiever or not. Just because I list a stock in an article however does not mean I am recommending it. Identifying the dividend raisers each week however helps me in finding out quality dividend stocks which either should be bought on dips or after they have raised distributions for at least a decade. Even if a list contains some interesting stock ideas however, this does not mean that one should blindly enter a position in such securities. Only after one understands whether such a stock could grow earnings into the future in order to support a growing dividend, should they start accumulating a position over time.

Questar Corp (STR), which engages in gas and oil exploration and production, midstream field services, energy marketing, interstate gas transportation, and retail gas distribution businesses, increased its quarterly dividend by 4% to 13 cents per share. Questar Corp is a dividend aristocrat, which has raised distributions for 30 consecutive years in a row. The stock currently yields only 1.30%.

I often analyze individual stocks on the dividend growth blog. Some, if not most, of the times however, after guiding readers through the company story I end up stating that the stock is either a hold or sometimes even a sell. This irritates most investors, who see the practice of reviewing a stock which results in a negative or neutral recommendation as a waste of their time.

I definitely understand the frustration for those readers. Most investors typically want to be told what to buy, when to buy it and how much they would make when selling. This strategy always works in get rich quick books, but it seldom generates any profit in the real world. The reason why so many investors lose money on a consistent basis is because they fail to educate themselves and instead end up following gurus which don’t even trade the ideas they are pitching to their followers.

In Six Dividend Stocks for current income I provided a list of higher yielding dividend stocks, which investors could use for current income. With a high current yield, the stock list could provide a decent stream of dividend income for retired individuals. There lies another problem however.

Most younger investors tend to ignore dividend stocks, which typically are mature, slower growing companies with dependable cashflows a portion of which are distributed back to investors. Younger investors view these dependable income stocks as boring and too slow moving, which don’t have anything better to do with their cashflows but send them back to owners in the form of dividends. Instead these investors prefer investing in growth stocks with high price earnings ratios and high expectations for growth. While most companies that distribute a portion of their profits in the form of dividends realize that double-digit growth cannot last forever, most growth stocks sell at rich valuations, supported by analysts who have perfected the art of predicting high growth rates for decades to come. As soon as the music stops, these growths stocks stumble, dragging investors' fortunes with them.

The strong bullish move off of March 2009 lows has lifted many stocks, thus creating large unrealized paper gains for many dividend investors. While prices have enjoyed a steep run-up, dividend yields, which move inversely to prices, have declined in the process. Many dividend investors are now wondering if they should simply lock in their gains in stocks which are not yielding that much relative to others.

As a dividend investor, one of the items in my entry criteria is to require at least a 3% initial yield when purchasing a stock. Back in the first half of 2009, there were plenty of good quality dividend stocks that fit these criteria. Nowadays even some of my favorites such as PepsiCo (PEP) and Aflac (AFL) are yielding a little less than 3%. Now that those holdings are yielding less than my entry yield criteria, the question is whether I should hold on to them, or switch to stocks with higher current yields. If I were to do this, I would instantly increase my dividend income. If I didn’t however, that wouldn’t really hurt my income either.

Most novice dividend investors typically are under the impression that successful dividend investing entails finding and purchasing the highest yielding stocks. This strategy is flawed, because it does not take into account the sustainability of the dividend. A company which yields 20%, might generate a much lower yield on cost over time.

I purchased American Capital (ACAS) in 2008 when this business development company was trading at $30 and was yielding 13%. Just a few months later the company suspended its dividend payment, and I sold it immediately. The thing to learn from this example is that investors have to check the sustainability of distributions in light of cash flows generated by the business, the amounts of debt relative to total assets and the amounts of interest expenses. If you find a high yielding stock, which generates enough cash flow growth and has limited amounts of debt, then it could be a buy on the next dip.

With the market up strongly year to date after hitting a multiyear bottom in March, it is hard for investors to get excited about current dividend yields of 3%-4%. It is even harder to convince an investor that a 3% yielder which manages to raise distributions by 10% annually over the next 7 years would lead to a yield on cost which is twice the current yield right now. Just a few months ago however, most investors realized that dividend income is always positive, even in a bear, after stocks tumbled over 50% off their all time highs that were hit in 2007. It is a great to achieve at least some return on investment, even when it feels that the whole world is tearing apart. Companies which maintain and even increase dividends show their confidence in their ability to generate enough in future earnings in order to cover the dividend raises. An especially bullish sign is when a company which has rewarded shareholders with a dividend raise for 37 consecutive years, raises dividends.

Several companies raised their distributions last week:

Options are contracts that give their owners the right but not the obligation to buy (calls) or sell (puts) securities at a predetermined price (strike) at a predetermined period in the future.

If an investor is bullish on Microsoft (MSFT) when the stock is trading at $20/share, he/she could purchase calls and profit at options expirations week if the stock price increases above the strike price plus the price paid for the call. The options price consists of time value/time decay and an intrinsic value, which is the difference between the strike price and the current price of the security. Overall in quiet markets the time decay decreases the values of options. The time decay portion of the options price is sensitive to changes in volatility and could increase if volatility increases however.

Most companies use debt for a variety of reasons in their operations. It could be either short term or long-term obligations. If there’s anything the 2007-2009 financial crisis has taught us, it is that excessively leveraged companies could easily blow up after a chain of negative events. Thus it pays to know what the debt situation for a particular company you are investing in actually is.

Some investors typically focus on debt to total assets to gain a perspective on the amount of the leverage the company has. While this method is widely accepted by some investors, I believe that it has some shortcomings, which might prevent investors from seeing the bigger picture. Most importantly comparing debt to total assets does not tell whether a company could service its debt obligations or not.

Investors have typically concerned themselves with maximizing total returns over time. Total returns are the sum of capital gains and dividends received. Over the past two years, markets have produced negative total returns to investors, which is especially troublesome for those who were planning to retire in the coming few years. Instead of focusing on total returns, however, future retirees could focus on generating sustainable dividend income from their portfolios, which is much less volatile that capital gains. In fact, over the past decade, dividends represented the only income that investors have generated in the markets. In essence, stockholders are “paid for waiting” until their portfolios rebound. Especially valuable are those dividend stocks that not only pay reliable dividends, but also raise them regularly. I have highlighted four such companies, which announced their intentions to reward stockholders with dividend raises:

RPM International Inc. (RPM), which operates as a food company in North America and internationally, increased its quarterly dividend by 2.5% to 20.50 cents per share. RPM International Inc. is a dividend aristocrat, which has raised distributions for 36 consecutive years in a row. The stock currently yields 4.30%.

SYSCO Corporation (SYY), through its subsidiaries, markets and distributes a range of food and related products primarily for foodservice industry.

SYSCO Corporation is a dividend champion as well as a component of the S&P 500 index. It has been increasing its dividends for the past 38 consecutive years. For the past decade this dividend growth stock has delivered an annual average total return of 6.20 % to its shareholders.

Investors often fall in love with stocks, which are synonymous with innovation, growth and have delivered strong total returns up to a point. It is easy to fall in love with a stock, which everyone else is touting as the next great thing, whose products you use or is one which has made many investors rich.

The main problem with such attitude however is that it could cause investors to throw their carefully researched strategies out of the window and engage in careless speculating. This could cause severe losses of capital over time.
Investors have suffered two major blows over the past decade – the tech stock crash in 2000-2002 and the financial meltdown in 2007-2008. The first occasion was a complete euphoria for anything related to technology or dot coms. College dropouts were selling stock in their money losing eyeballs attracting online ventures in IPOs, which were valued at billions by Mr. Market. Needless to say the tech boom turned into a bust that left millions of investors suffering tremendous losses. Even investors in great companies such as Microsoft (MSFT) and Intel (INTC), which were enjoying double digit revenues and earnings growth even after the meltdown, suffered huge losses because they overpaid for future growth.

The financial crisis lead to dividend cuts amongst several prominent dividend payers such as Bank of America (BAC), US Bancorp (USB) and BB&T Corp. (BBT). Over the past few weeks however, several financial companies announced that they might reconsider their current dividend policies and start raising distributions in the near future.

US Bancorp’s (USB) CEO is reviewing the company’s dividend payout, after it paid off $6.6 billion in TARP money back to the US Treasury."You will see us take action in the near-term that will be favorable," to the dividend, the company’s CEO said. The company cut dividends in March by 88% and is currently paying a quarterly dividend of 5 cents/share.

Back at the end of 2008, I was invited to participate in a stock picking competition by selecting 4 stocks. At the time I simply included the highest yielding stocks in my portfolio – Con Edison (ED), Realty Income (O), Phillip Morris International (PM) and Kinder Morgan (KMP). I believe that as a whole, these stocks would provide dependable income for individuals seeking high current income today. These stocks also possess strong dividend growth characteristics as well, which is essential for investors to keep up with inflation if they spend all of their distributions in a given year.

You could find the reasons for my stock selections below:

Electric, Gas and Water utilities have always been traditionally regarded as income stocks by investors. Their high current yields, and the relative stability of their distributions made them a preferred choice for investors who are seeking current income from their assets.

Utilities typically pay out a large portion of their earnings as dividends, which explains their slow dividend growth and high dividend yields. Most utilities operate as natural monopolies, which guarantees almost no competition in their specific geographic areas. It would be very costly to run two separate electrical grids, and such investment could take many decades to pay off. Thus utilities tend to generate stable earnings and revenues in any economic conditions, as people keep using water, gas and electricity in their daily lives no matter what.

Several companies raised distributions last week. The most notable raiser was fast food chain McDonald's (MCD), which surprised investors with a 10% dividend increase. This marked the 33rd consecutive annual dividend increase for this Oak Brook, Illinois based dividend aristocrat.

McDonald's Chief Executive Officer Jim Skinner said:

Toronto-Dominion Bank (TD), through its subsidiaries, engages in the provision of retail and commercial banking, wealth management, and wholesale banking products and services in North America and internationally. It operates through four segments: Canadian Personal and Commercial Banking, Wealth Management, U.S. Personal and Commercial Banking, and Wholesale Banking. This international dividend achiever and Canadian Dividend Aristocrat has raised dividends for 15 years in a row.

Over the past decade this dividend growth stock has delivered an average total return of 13.20% annually.

The company has managed to deliver a 5.60% average annual increase in its EPS between 1999 and 2008. Analysts expect Toronto-Dominion Bank to earn $4.98 share next year, followed by a 4% increase to $5.17/share in the year after that.

The Return on Equity has recovered from its 2003 lows of 26% and is at a very impressive level at 42%. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Annual dividends have increased by an average of 20.50% annually since 1999, which is higher than the growth in EPS. Most of the dividend growth came from the expansion in the dividend payout ratio, which more than tripled from 15% in 1999 to 48% in 2008.

Many retirees who are seeking current income from their assets invest in fixed income securities, most of which provide a stable stream of income. Fixed income investments do have some disadvantages relative to stocks that pay dividends, and thus retirees which fail to account for these, could end up with no income at the worst time possible .

First, while typical fixed income securities provide a dependable income stream, its purchasing power is typically eroded by inflation. Even at 3% per annum, the purchasing power of one dollar decreases by 50% in 24 years. Double that inflation rate to 6% annually and now the purchasing power of one dollar is down by 50% in 12 years and by 75% in 24 years. Stocks that pay rising dividends provide the best inflation proof source of income. Dividend based distributions can grow, interest based distributions usually don't. Unless interest income is reinvested, the interest income cannot grow over time to compensate for the eroding value of inflation.