A Major League Dividend Rotation

Includes: AAPL, CVX, LMT, MCD, MO, PM, WBA
by: DIY DG Investor

In my last article I described how investing in dividend-growth stocks was comparable to the approach a batter would take in a baseball game. Successful investors are able to relate the rules of hitting to investing. Like baseball, investing is a game of numbers. Companies with the best financials will generally have superior performance, similar to the player with the highest batting average in the league. Here are three key metrics I look at then evaluating dividend stocks.

Yield - This is the most basic statistic, simply Dividend Rate/Stock Price. I look for yields above 3%, although I will often make an exception for a stock that I think has a huge competitive advantage in its industry or one that is growing its dividend substantially.

Payout Ratio - The payout ratio shows what percentage of earnings is paid out to shareholders, calculated by Dividend Rate/EPS. It does need to be taken with a grain of salt though, as the free cash flow payout ratio can be a much more reliable indicator. I look for a company with a low payout ratio, as it means that it is likely safe in the future as long as profits stay steady. It also means that a company has a high capacity to invest more in growth as well as increase the dividend going forward.

One-, Three- and Five-year Dividend Growth Rates - I like to see management with a strong commitment to increasing the dividend. Along with long streaks of dividend hikes, I like to see accelerated dividend increases in recent years. When the one- and three-year DGRs are higher than the five year, it means that the dividend growth is accelerating. I prefer companies that I feel could have double-digit dividend growth going forward.

Here is my rotation of perennial all-star dividend stocks; companies that already have an incredible track record of dividend payments. I consider them to have great long-term prospects with a limited amount of risk. Although future dividend increases may not match the ones of the past, I still believe that they will grow at a pace that outpaces inflation. Company names are followed by consecutive years of dividend hikes.

The Rotation

1. McDonald's Corporation (NYSE:MCD) 36 Years

  • Yield: 3.30%
  • Payout Ratio: 57%
  • 1,3,5 Yr DGRs: 13.4%, 11.9%, 13.9%

The ace of my rotation, McDonald's is a steadily consistent performer with one of the strongest brands in the world. The stock price barely flinched during the most recent financial crisis, a testament to the strong fundamentals of the company. Uncertainty over former CEO Jim Skinner's retirement last year caused a little weakness in the stock price, however it has bounced back nicely with Don Thompson at the helm. Management has proven its ability to adapt to changing consumer preferences with healthier menu choices, and will continue to do so in the future. The current payout ratio and growing income leave plenty of room for future dividend increases. Revenues and cash flows rose over 12% from 2010 to 2011, while net profit margins stayed above an impressive 20%. MCD is the dominant player in the fast food industry and still has plenty of room to expand globally, including its recent push into India. I expect MCD to raise the dividend to around $3.40 per share this fall, hiking the current yield to 3.6%.

2. Lockheed Martin (NYSE:LMT) 10 Years

  • Yield: 5.24%
  • Payout Ratio: 55%
  • 1,3,5 Yr DGRs: 15.0%, 20.3%, 20.2%

Although not as instantly recognizable as MCD, Lockheed Martin may have the most upside out of any of these companies. A $28 billion security and aerospace company, LMT pays out a hefty 5.24%. Combine this with a EPS payout ratio of only 55% and annual dividend growth of 20% over the past five years, and LMT's future prospects look very promising. The current P/E ratio of 10.5 is below historical averages, implying that the stock is undervalued at current levels. Despite Defense Budget concerns, I believe LMT will continue to perform well due to its wide range of products in high demand. I expect LMT to boost its dividend this year from $4.60 to $4.92, giving it a Yield on Cost of 5.6%.

3. Philip Morris International, Inc. (NYSE:PM) 5 Years*

  • Yield: 3.78%
  • Payout Ratio: 66%
  • 1,3,5 Yr DGRs: 10.4%, 13.6%, 13.2%

Philip Morris is a large-cap ($148 billion) international manufacturer of cigarettes and other tobacco products. Its portfolio of products includes the dominant Marlboro brand. Since its spinoff from Altria (NYSE:MO) in 2008, PM has provided enormous amounts of shareholder value through dividend increases and aggressive stock buybacks. Outstanding share count has decreased by over 20% since the spinoff, from over 2 billion to 1.65 billion. PM also announced a three-year, $18 billion share repurchase plan this past June. This will ensure that earnings per share rise at an even faster rate than total revenues and allow for more dividend growth. The main threat here is litigation, although PM's international exposure limits this risk substantially, as compared to the strictly domestic MO. I predict that PM will raise its dividend this fall to $3.76, making for a YOC of over 4.1%.

*Since the spinoff from Altria , which has increased its dividend for 44 years

4. Chevron Corporation (NYSE:CVX) 25 Years

  • Yield: 3.13%
  • Payout Ratio: 30%
  • 1,3,5 Yr DGRs: 13.6%, 9.7%, 10.0%

Chevron is one of the world's largest integrated energy companies, focusing mostly on the production of oil. CVX's balance sheet is rock solid with over $200 billion in assets and a debt-to-equity ratio of .73. Revenues have been increasing at a high rate, growing from $171 billion in 2009 to $253 billion in 2011. Margins have also been increasing, as net profit margins have increased from 6% in 2009 to about 10% currently. With a low payout ratio of about 30%, CVX is left with plenty of room for capital expenditures and dividend increases. I predict that Chevron will raise the dividend to $4.00 annually, making for a YOC of about 3.5%

5. Walgreen Co. (WAG) 37 years

  • Yield: 2.68%
  • Payout Ratio: 49%
  • 1,3,5 Yr DGRs: 25.0%, 26.0%, 23.7%

Walgreen has bounced back from the lows of last year during its dispute with Express Scripts (NASDAQ:ESRX) and I believe that it will only continue to get stronger. January sales for WAG were about $6.15 billion, a YOY increase of 6.3% from $5.78 billion in Jan 2012. Same-store pharmacy sales were also up over 6% since the previous year. Walgreen raised some eyebrows with its purchase of a 45% stake Alliance Boots last June, although I think this will be a good way to drive revenue increases globally long term. With a dividend that has tripled since 2007, WAG offers tremendous potential for future increases. I predict that the dividend will be raised to $1.28 this summer, making for a Yield on Cost of over 3.1%.

Closer - Apple Inc. (NASDAQ:AAPL) 1 Year

  • Yield: 2.36%
  • Payout Ratio: 24%
  • 1,3,5 Yr DGRs: N/A

While AAPL's stock price may be as volatile these days as "Wild Thing" from the movie Major League, it is the company I want closing for my dividend rotation. The recent drop in price has left its yield at a respectable 2.36% with a payout ratio below 25%, leaving plenty of room left for dividend growth. As revenues will no longer be growing at the earth-shattering rates that caused the stock to climb to $700, I believe AAPL will focus its excess cash to increasing the dividend and buying back shares. I believe that if AAPL can maintain its margins and continue to grow earnings at a modest rate, it will become one of the top dividend growth stocks going forward. With a forward P/E of less than 10 and incredible brand strength, I see little downside to this investment. Look for AAPL to raise its dividend for the first time at some point in the near future.

These five stocks form the foundation of my dividend growth portfolio. Although only five stocks are not enough for an individual investor to be diversified, I believe they are a good start for any portfolio.

Disclosure: I am long AAPL, MCD, LMT, PM, MO, WAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.