by James Alexander Smith
I take certain comfort in knowing that I own good businesses that are responsive to the interests of their shareholders. One way to determine if a business is “shareholder friendly” is if it regularly distributes dividends. It is also critical to understand the dividend payout ratio of a business -- a metric that represents the portion of a company's net income that is paid to shareholders. Here are some robust companies that pay steady dividends to shareholders at an increasing rate over a multi-year period. You may rest easy with these particular stocks in your portfolio.
Consider ConocoPhillips (NYSE:COP), a business that pays a 3.7% dividend and currently trades at 9 times earnings. COP, a company with a $100 billion, can boast a 16% return on equity – that is heavy weight moving at a very efficient level. Since 1982, COP has increased its dividend payment at about a 6.6% annual rate. Over the past 5 years, however, COP increased its dividend in excess of 10% and continues to generate stable cash flow for investors. This suggests that the business is improving. COP has a 32% payout ratio, indicating a generous, yet sustainable distribution to shareholders. This payout percentage is significantly higher than most of its competitors. Both Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX) pay out 22% of their net income. British Petroleum (NYSE:BP) has a 17% dividend payout ratio.
COP continues to hone its competitive edge in the integrated energy sector. It arrived at the Eagle Ford Shale in a timely manner, and was able to acquire a strong acreage position at a reasonable price. COP is currently conducting its first horizontal hydro-fracturing production in the history of the company. This company typifies a sort of forward-looking, innovative business that can maintain lasting success in a relatively competitive industry.
Let’s take a look at another oil and gas giant, XOM. This is a tremendous business. I’ve always thought XOM is the second best business in the world, behind Coca-Cola (NYSE:KO). The culture of XOM is truly unique to the oil and gas industry – it is a vestige of Rockefeller’s Standard Oil, and the business is run accordingly. It also remains conscious of shareholders’ interests. XOM regularly distributes a significant dividend at an increasing rate. Currently, XOM pays a 2.4% dividend and sells for 9.5 times earnings. Year over year, the earnings of XOM have increased 40.5%. XOM pays 22% of its net income to shareholders in the form of dividends. This is a significantly lower ratio than many its competitors; it describes the conservative and restrained nature of XOM. XOM maintains the ability to always raise its dividend significantly.
I think XOM has created a culture that cannot be replicated. It has accumulated the largest reserves, and has developed the largest network of distribution systems than any energy business in the world. The primary source of revenue for XOM is derived from operating these resources at profitable levels, but its main economic advantage is bolstered by its superb reputation and consistent managerial philosophy. The company has the largest market capitalization in the world (occasionally sharing the top spot with Apple (NASDAQ:AAPL), and I believe that it will likely be the first business to ever post a trillion dollar market cap. Size matters in the energy industry; it affords the opportunity to operate in ways that other companies simply cannot. Because of this, the true competitive advantage of XOM lies within its management philosophy and responsiveness to shareholders’ interests.
Consider this - the board of directors at XOM ties executive compensation to the accuracy of said executive’s estimation of the reserves of XOM. If the value of the oil and gas reserves has been overstated, a percentage of the executive compensation is returned to shareholders. XOM also buys back approximately 5% of its shares outstanding annually. This sort of behavior represents a business that intends to last and succeed over a long period of time. This is a unique and compelling economic advantage of XOM.
American Express Company (NYSE:AXP) is a great business with a significant edge over its competitors. AXP pays a 1.4% dividend and earns nearly $4 per share. At $51, it trades at roughly 13 times earnings. It has a 28% return on equity and reports 9% quarterly revenue growth. AXP also routinely makes a habit of share repurchasing programs, an activity that theoretically adds value to independent investors’ positions. It currently pays a 1.4% dividend and has increased this distribution steadily since 1977. The payout ratio of AXP is 18%, a relatively modest portion of its net income.
The success of AXP is deeply connected to the state of the overall economy. Undoubtedly, current economic conditions create a murky outlook for the credit card company. But as consumer confidence strengthens, and people begin to spend more of their discretionary income, AXP is well positioned to confirm its command of its industry.
Investors should also take comfort in the lasting quality of AXP because of Warren Buffett’s massive ownership interest in the business. The Oracle of Omaha has explicitly stated that his “favorite timeline for any particular investment is forever” through his holding firm Berkshire Hathaway (NYSE:BRK.A). He said that AXP offers the best customer service of any of its competitors and that it is a very good business. Mr. Buffett owns approximately 12% of AXP shares outstanding.
Mastercard (NYSE:MA) is yet another company with a lasting competitive advantage. It has a 42% return on equity and an operating margin (52%) that far surpasses that of its competitors. Even better, MA is growing. Year to date, earnings have grown more than 35%. This business was founded in 1966. 45 years later, the electronic payment processing company is even better. MA has always stayed current – or ahead of - technological trends, a capability that enables it to offer superb payment services to a growing customer base. The possibility of increasing its customer base is essential to its future cash generating abilities. It pays a relatively low dividend of 0.2%, and it has not increased this payment since 2006. But this yield only represents 3% of its net income. With such a low payout ratio, MA is capable of, and due for, a dividend increase to its investors.
Like AXP, Warren Buffett has indirectly ordained MA with a stamp of approval. One of the new Berkshire Hathaway co-investment officers, Todd Combs, has committed to a significant position in MA. When asked about Berkshire’s purchase of MA, Mr. Buffett answered humorously that he wasn’t the one who made the buy call, indicating that Combs initiated the stake. It was the new CIO’s first big move at the firm.
Now that it is known that the Berkshire superstars are behind MA, it trades at more than 20 times earnings, a multiple far greater than any of its competitors. Unfortunately, the grace period to scoop up these shares super-cheap has come and gone. It trades at $360 per share, about 25% higher than its trading price only a year ago. All the same, MA is a great business that will continue to prosper as the economy recovers and consumer spending gradually increases – it’s just not as cheap as it once was.
AT&T Inc. (NYSE:T) is a tried and true American telecommunications company with a history of delivering superior quality to its customers. It pays a 5.8% dividend and earns $2 per share. An investor may be attracted to this yield at first glance. On the surface, it looks very enticing. It is important to understand that the payout ratio of T is 87%, an alarmingly high portion of its net income. T has a proven record of maintaining its hefty dividend payment to shareholders – it has increased this distribution annually since 1984.
T will remain the clear front-runner in its industry, but it has recently been subjected to the potential of vicious litigation from competitor Sprint Nextel (NYSE:S). Lawsuits and litigation wars are bad for business, but once these legal issues are segmented, T will endure and adapt. T earns a 20% return on equity, which is about 8% more than its closest competitor. T currently sells for $29 per share with a 1-year target estimate of $31 per share.
With investing, it is critical to understand the competitive advantages of the businesses you own. The sturdiness of these advantages will determine the longevity of the company, and its ability to pay a portion of its earnings to shareholders in the form of dividends. The aforementioned companies are unique to respective industries, but share a commonality in that the competitive moats of each are wide and deep.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.