The term “blue chip” stock is almost a century old, with an origin dating back just prior to 1929’s crash, and related to the highest priced poker chip. Though I don’t think you hear the phrase today as much as you did several decades ago, investors interested in a solid, conservative stock portfolio are still likely to hone in on the market’s blue chips. Although not necessarily a prerequisite, blue chips of today typically pay a dividend. In many, perhaps even most cases, a blue chip dividend will grow on an annual basis. Companies that pay a dependably higher dividend are oftentimes referred to as dividend growth stocks. Dividend growth, in simpler terms, is a more nouveau term for blue chip stock investing in my opinion.
Given the somewhat perpetual low rate environment since the financial crisis, investors have gravitated to dividend growth stocks as an alternative to traditionally safer securities like bonds and CDs. Even with the Fed having tightened interest rates back in December, it is still not unusual for an equity to yield significantly more than an investment grade intermediate-term bond.
Of course stocks, in general, come with higher risk than bonds, given the contractual guarantee associated with the latter. There is always a risk, however small, that you could lose every dime you have when you commit an entire portfolio to stocks.
However, some equity strategies entail far more risk than others. Investment on margin, speculative investment in companies with significant cash burn, negative earnings, or junk credit ratings would subject you to much more generalized risk than a blue-chip with a storied past and solid dividend track record.
To an extent, dividend growth would be an appropriate portfolio strategy for “widows and orphan” type investors where conservative capital preservation and income generation trumps aggressive capital growth potential. Utilities, oil, and phone companies would, on a historical level, be top of the list for widows & orphans ownership. Unfortunately, as we’ve found over the past two years, commodity price dependency has transformed the oil-patch into a not-so-safe space.
Today, certain technology companies are working their way into the portfolios of dividend growth investors. Microsoft Corporation (NASDAQ:MSFT), Cisco Systems, Inc (NASDAQ:CSCO), Apple Inc (NASDAQ:AAPL), and a host of others with brand identity and hard to replicate business models are printing press like stocks with tons of free cash being throw off and consequently distributed to investors.
REITs, or real estate investment trusts, have also become a mainstay for growing-income-oriented shareholders. Realty Income (NYSE:O), otherwise known as The Monthly Dividend Company, is a highly prized REIT that owns free standing commercial property and leases to investment grade clientele like Walgreens, CVS, and Fedex.
A Good Starter Dividend Growth Portfolio
If your eyes are on dividend growth, you don’t necessarily have to depend on mega-cap stocks or stocks with high dividend yields. Part of the recent problem — if we want to call it that — with dividend growth stocks is that they have become expensive to own in terms of traditional valuation metrics. Household stock names typically trade with higher than average price multiples because of their dependability. Recently, however, these stocks have become even more expensive than normal, which has decreased their relative yields.
To beat the market or achieve higher realized equity-income, you need to sometimes travel off the beaten path in search of value and potentially higher returns. While there is nothing wrong with Procter & Gamble (NYSE:PG), Coke (NYSE:KO), J&J (NYSE:JNJ) and other blue-chips, I would not be buying them at any price, and would set reasonable expectations on what they provide for your portfolio.
Strategically speaking, some investors may want to own a mix of both strong companies with traditionally inflated valuations, some out of favor names, as well as lesser known names with longer runways for market cap and multiple expansion (small caps).
Here is a 5-stock starter portfolio with a mix of names:
- Cisco Systems, Inc (CSCO): One of the cheapest of the legacy tech. names, the stock now yields better than 3.6% after a large dividend hike.
- Aircastle Limited (NYSE:AYR): An airplane leasing company that is a food chain beneficiary of low oil prices and near-term airline profitability. Yields better than 4% with opportunity for near double digit forward dividend growth.
- Pfizer Inc. (NYSE:PFE): Its pending inversion-merger with Allergan should be of long-term synergy benefit. Investors get paid 4% currently.
- STORE Capital (NYSE:STOR): A real estate investment trust with a similar, yet more aggressive strategy compared to Realty Income. Lower valuation, higher yield, and higher dividend growth rate attached.
- Honeywell International Inc. (NYSE:HON): A diversified industrial-technology company that continues to optimize, reinvent, and build upon itself. At a little over 2%, it is the lowest yielding of the list, but will likely grow its dividend at a well above average pace for the next several years.