A few days ago, my parents sent me an Edward Jones stock table. For those of you who have never seen one of these, Edward Jones periodically prepares a document that covers large cap stocks in the following sectors: Communications Services, Consumer Discretionary, Consumer Staples, Energy, Financial Services, Health Care, Industrials, Materials, Technology, Utilities, and Real Estate Investment Trusts.
That said, the document is 2 pages (front and back) and due to limited space only includes the top 180 stocks based on market capitalization. It provides a recommendation (buy, sell, or hold), and a few data points such as P/E ratio and dividend yield.
Since companies with large market caps are generally stable companies that have been around for several years and are unlikely to go under anytime soon, I figured that I could use this document as a starting point to select stocks. In other words, market capitalization was the first screen because I am starting with the 180 stocks listed on the stock table.
Building a Portfolio
My goal is to help my parents create a portfolio. Both of them retired a few years ago. They value stability, aren't too interested in growth stocks that are hard to value, and want a predictable income stream to supplement their pensions and social security benefits.
So I am looking for the best dividend stocks to buy and hold for the next year to five years. Importantly, best does not always mean highest yielding stocks; in fact, in some instances a lower yielding stock might be preferable.
To determine the best dividend stock in each sector, I considered the following factors (which should be considered in the context of the sector):
1) Valuation of the company. I want to buy into a good business at a fair price. Context is extremely important. That is why I compared a company's valuation metrics such as P/E, Price/Sales, and Price/Book to other companies in the same sector. And that is also why I recognized that you have to weight these metrics differently depending on the sector. Price to Book, for example, is very significant for banks but not significant at all for most technology companies.
2) Underlying fundamentals of the business. I don't want to invest in a business that is either deteriorating or getting disrupted by a new technology. Fortunately, most of these companies is in good shape. A few of the companies in the energy sector, though, were ruled out because there are questions about the long-term stability of their businesses due to poor quarterly results or a recent dividend cut.
3) Dividend rate. Generally speaking, I want to see a dividend rate of at least 3% and preferably closer to 4%. But a dividend of less than 3% isn't necessarily a deal breaker. Especially if the company is innovating and the business is still growing at a fast rate.
4) Sustainability of the dividend. I considered when the company started paying a dividend, whether or not it has ever cut its dividend, and whether or not the company will likely continue to maintain its dividend over the long term. Ideally a company has a pristine balance sheet and a reasonable payout ratio. That said, there are a few companies such as AT&T (NYSE:T) and Philip Morris (NYSE:PM) that have high payout ratios but sustainable dividends. That is why making this determination is part art and part science.
5) Potential to grow earnings. I prefer companies that are not completely dependent on GDP growth to drive earnings growth over ones that are. My largest consideration is the company's long-term strategy. Recent acquisitions a component of that strategy.
6) Ability to grow the dividend. I want to see that a company has consistently increased its dividend by more than the rate of inflation. Ideally a company has built a moat, is well-positioned to maintain its margins, grow its earnings, and has a lot of cash.
7) Whether or not there are any material long-term risks to the business. Soda Stream (NASDAQ:SODA) was once considered by some analysts to present a significant threat to Coca-Cola (NYSE:KO). And plain packaging is considered by some to be game changing for Philip Morris (I previously wrote an article about Philip Morris here). Also, increased regulation in the banking industry is another example of a potential material risk.
There were only four rules:
Rule #1 - I could only choose stocks from the list of 180 stocks.
Rule #2 - I could only choose one stock from each sector.
Rule #3 - I did not consider Real Estate Investments Trusts as a sector.
Rule #4 - I am considering closing prices as of April 6th, 2015*.
*Note: Rule #4 is especially important for determining relative value.
10 Top Dividend Stocks
The chart below represents the top stocks that I selected from the sample size of 180 stocks. Please note that the number of stocks in each sector ranged from a low of 7 (Materials) to a high of 24 (Consumer Discretionary). Remember, one stock was selected from each sector: Communication Services (AT&T); Consumer Discretionary (McDonald's); Consumer Staples (Philip Morris); Energy (Royal Dutch Shell); Financial Services (HSBC Holdings); Health Care (Baxter International); Industrials (Caterpillar); Materials (BHP Billiton); Technology (Cisco Systems); and Utilities (American Electric Power).
|Stock||Price||P/E Ratio||Dividend Yield||Cash Dividends Since||Beta|
|AT&T (NYSE: T)||$33.13||27.7||5.70%||1984||0.37|
|McDonald's (NYSE: MCD)||$95.85||19.8||3.50%||1976||0.76|
|Philip Morris (NYSE: PM)||$77.26||16.2||5.30%||1928 (Altria)||1.06|
|Royal Dutch Shell (NYSE: RDS.A) (NYSE:RDS.B)||$60.33||12.8||4.70%||1947||1.29|
|HSBC (NYSE: HSBC)||$43.15||12.5||9.30%||1991||1.10|
|Baxter International (NYSE: BAX)||$68.00||14.9||3.10%||1934||0.67|
|Caterpillar (NYSE: CAT)||$80.24||13.7||3.50%||1914||1.18|
|BHP Billiton (NYSE: BBL)||$43.02||11.5||5.70%||2001||1.30|
|Cisco Systems (NYSE: CSCO)||$27.13||16.2||3.10%||2011||1.45|
|American Electric Power (NYSE: AEP)||$56.46||16.9||3.80%||1909||0.41|
(Source: Yahoo Finance)
A Few Key Insights
1) AT&T was selected over Verizon because of its recent acquisitions, most notably DirecTV and Iusacell, which should catalyze earnings and dividend growth. Admittedly, AT&T has been dead money for the past few years. Right now, however, AT&T is well-positioned to compete for market share in Latin America and grow its dividend.
2) McDonald's has also performed poorly over the past few years. But McDonald's is taking the right steps to ensure that its marketing and menu continue to resonate with consumers who are becoming more health conscious. Although I personally wouldn't consider purchasing shares unless they fall to the mid-80s; McDonald's valuation is more reasonable than most in the sector.
3) Philip Morris is also a fairly controversial pick because many investors remain concerned about plain packaging and currency risk. That said, I feel that those risks are over-stated and more than built into PM's share price. After all, Philip Morris' underlying business is still very strong; in fact, if you take out the temporary impact that currency is having, PM's business is growing by a stable 5%-8%.
4) Royal Dutch Shell is a less controversial pick. Royal Dutch Shell has a pristine balance sheet with a lot of cash on hand, quality earnings, and one of the highest dividend yields in the sector. Plus, unlike BP (NYSE:BP), Royal Dutch Shell doesn't have uncertainty associated with pending litigation looming over its business.
5) HSBC is another fairly controversial pick. Recent scandals surrounding company executives such as the Offshore Tax-Evading Scandal have significantly impacted HSBC's share price. But that uncertainty has also created a very attractive entry point. HSBC has one of the strongest banking franchises in the world and is well-positioned to grow in highly lucrative emerging markets.
6) Baxter International has a long history of paying out a dividend. More important, however, is that since 2009 the company has raised its dividend at a combined annual growth rate of 14.6%. In addition, Baxter's recent acquisition of Gambro fortifies the company's position in dialysis and moving forward should catalyze earnings growth.
7) Caterpillar is attractively valued at less than $80 per share. The company's 10-year dividend growth rate is just above 10%, it has raised its dividend for the past 22 years, and its payout ratio remains below 50%. My concerns with Caterpillar are its direct exposure to the oil & gas sector as well as emerging markets. But those are valid concerns for many companies in the industrials sector.
8) BHP Billiton earns high marks for spinning off some of its non-core assets. BHP intends to create an independent global metals and mining company during either Q3 or Q4 of this year. The combined dividends from both companies should be higher than BHP's current dividend. BHP's valuation reflects the volatility of the prices of raw materials.
9) Cisco is a very conservatively managed company with a reputation for under-promising so that it can over-deliver. Cisco consistently beats earnings, has managed to maintain its margins in a highly competitive market, and is committed to giving back around 50% of its cash flow to its shareholders. For those and many other reasons, I expect that Cisco will raise its dividend at a higher rate than most of its large-cap peers over the foreseeable future.
10) American Electric Power's payout rate has hovered around 60% for the past several years and AEP has consistently increased its dividend. The company is doing an excellent job focusing on its regulated asset base and in the future may shed some of its competitive assets. Overall, the company's regulated operations will ensure stable sales, earnings, and dividends for years to come.
10 Honorable Mentions
The chart below represents the second place finishers for each sector. Please note that many of these companies are arguably just as good as the companies above. The main reason why many of these companies are not above is relative valuation.
|Stock||Price||P/E Ratio||Dividend Yield||Cash Dividends Since||Beta|
|Verizon (NYSE: VZ)||$49.47||20.4||4.50%||1984||0.37|
|Ford (NYSE: F)||$16.03||20.1||3.80%||2012||0.92|
|Walmart (NYSE: WMT)||$80.73||16.0||2.40%||1974||0.30|
|British Petroleum (NYSE: BP)||$39.65||32.4||6.10%||2011||1.34|
|JPMorgan Chase (NYSE: JPM)||$60.52||11.4||2.90%||1827||1.81|
|Johnson & Johnson (NYSE: JNJ)||$99.64||17.5||2.80%||1944||0.96|
|Emerson (NYSE: EMR)||$55.54||17.8||3.40%||1947||1.11|
|Potash (NYSE: POT)||$32.70||18.0||4.70%||1990||0.54|
|Intel (NYSE: INTC)||$30.81||13.3||3.10%||1992||1.45|
|Southern Company (NYSE: SO)||$44.64||20.5||4.70%||1948||0.11|
(Source: Yahoo Finance)
All of the above companies are some of the best companies in the world. But price matters and many large, established companies are simply too expensive right now. Of the 180 companies that I screened, for example, there are only a handful of companies that are almost priced right: AT&T, Philip Morris, Royal Dutch Shell, HSBC, Verizon, Walmart, BP, and JPMorgan Chase.
Disclosure: The author is long T, VZ, RDS.A, BP, HSBC, CSCO, PM.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.