Let me tell you about something that drives me crazy when it comes to dividend investing. Well, two things actually. The first is the unnecessary complexity with which so many of pundits present dividend investing to so-called average investors. Seriously, the jargon and technical terms that they throw around are more useful in helping them show off how smart they are, but serve little purpose in terms of helping you make an informed dividend decision. Second, there is often too much focus on dividend yield.
Don't get me wrong, there are times to embrace select high yielders and we are in one of those times right now, but remember what dividend yield is. It is a stock' price divided by its payout in dollar terms. Dividend yields are just like bond yields: They rise when prices fall and vice versa. I'm going to exclude master limited partnerships from this conversation because MLPs by nature have high yields because they to be considered an MLP, they have to pay out huge percentages of their income to shareholders.
Yield is useful, but it should not be the deciding factor in choosing a dividend stock. Obviously a $10 stock with an annual dividend of $1 has an alluring yield of 10%, but in dollar terms, $1 per share per year isn't great. What I'm saying is that there are many instances when buying a $50 stock with a $3 per share annual payout (6% yield) makes more sense. After all, $3 is more than $1 and we want dividends for the income.
So let's make things and take a look at two elements of dividend investing that are grossly underrated in my opinion: Payout ratio and dividend history. Pardon my sports metaphor, but I think these two factors are akin to a wide receiver running excellent routes in football or a batter's ability to draw walks in baseball. These aren't flashy or sexy skills, but they are still integral to a team's success.
A stock's payout ratio is easily explained. This is the percentage of a company's profits that are devoted to dividend. Generally, a payout ratio of 50% or lower is considered “safe” and payout ratios approaching 70% or higher can be cause for red flags. Again, we have to exclude MLPs from this discussion because their payout ratios can be above 90%.
There are plenty of blue-chip companies with high payout ratios where this scenario is not problematic because of their ability to generate cash. Caterpillar (NYSE: CAT) has a payout ratio of 86%. Altria's (NYSE: MO) is 82%, but these are reliable dividend payers that will find ways to support higher payouts.
When evaluating ANY company that pays a dividend, studying the payout ratio is not only useful, but mandatory and it is particularly important when considering small- and mid-cap dividend payers. Large-cap companies like Altria and Caterpillar can stash a lot of cash to maintain their dividends or even raise them when earnings decline during weak economies, but a smaller company may not have that luxury. So if you spot a raising payout ratio combined with declining earnings and dwindling or no cash reserves, you have found a dividend stock to avoid. Fortunately, all of this data is easy to find and free of charge on Yahoo finance.
Now, let's talk about a company's dividend track record. Generally speaking, dividend increases are a good thing, but they're even better when you can count on them like clockwork. A company that raises it's dividend this year and doesn't raise it again for three, five or 10 years isn't doing its shareholders any favors nor is it showing a deep commitment to its dividend.
As dividend investors, we want reliability and there are plenty of names, familiar and obscure that will give it to us. Here's one great example of a familiar name with a dividend history worth embracing: General Mills (NYSE: GIS). “Big G” has been paying a dividend, uninterrupted for over a century and as the chart below highlights, this is one of the more reliable dividend raisers you'll ever run into.
This chart only highlights General Mills' dividend growth through the July 2009, but I can tell you that the company has raised its dividend THREE TIMES in the last year alone. In other words, General Mills has an impeccable dividend history.
Here's another great example of name you're probably familiar with that sports an impressive dividend history: Johnson & Johnson (NYSE: JNJ). The chart below details recent JNJ dividend increases through 2008, but I can tell you that the company raised its payout earlier this year by 10%, marking the 48th consecutive year of higher dividends.
Does investing in consistent dividend raisers work? My answer is a resounding “YES!” I'm not going to give away the name because that wouldn't be fair to paying subscribers, but in the Dividend Genius portfolio we are currently up almost 83% on a stock that has raised its payout for 22 straight quarters. Assuming no more dividend hikes this year with this name, the stock will have produced higher dividends in 31 of its 48 quarters as a public company.
Let me pique your interest with another one of our holdings. This is one is up more than 72% and the dividend growth rate is simply amazing. Every year for the past decade this stock has been able to boost its payout at least once and during that time the dividend has risen FIVEFOLD.
Dividend history is one of our favorite analysis tools at Dividend Genius and it is clear that the results speak for themselves.
Committed To Your Dividend Profits,
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