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Tuesday, August 2, 2011

Finding The Perfect Dividend Stock

If we were able to design the perfect dividend stock it would be one that is both high-yield and provide a high dividend growth rate. Its share price would appreciate ratable with its increasing dividend. All of this would be driven by increasing earnings and cash flow.

Ok, so much for our Utopian world, the perfect dividend stock just may be a balanced compromise. Consider the following:

High Yield/Low Dividend Growth

When investors first consider investing for income, High Yield is usually their first focus. It is human nature to want it now and want a lot of it. Unfortunately, high yield stocks often carry higher than average risk – there is usually a reason that the stock's yield is above average.

It could be because the company is in a limited growth industry, is in a volatile industry, experienced recent financial problems and its share price has fallen, or shareholders perceive future financial or economic problems. I have set aside a small portion of my portfolio to invest in these types of stocks. Examples of these stocks would include:

Getty Realty Corp. (GTY) | Yield: 7.5% | Growth: 0.5%
Getty Realty Corp. is a real estate investment trust that specializes in the ownership and leasing of retail motor fuel and convenience store properties and petroleum distribution terminals in the U.S.

National Retail Properties, Inc. (NNN) | Yield: 5.8% | Growth: 1.0%
National Retail Properties, Inc. is an equity real estate investment trust that invests in high-quality, freestanding retail properties subject to long-term net leases with major retail tenants.

Cincinnati Financial Corp. (CINF)  | Yield: 5.6% | Growth: 0.6%
Cincinnati Financial Corp. markets primarily property and casualty coverage. It also conducts life insurance and asset management operations.

Low Yield/High Dividend Growth

After being burned on an over-allocation of high yield stocks, some dividend investors start reading-up on the subject. The first thing that they learn is that Dividend Growth is more important than Dividend Yield. While Dividend Yield will stroke you today, Dividend Growth is much more important to long-term wealth creation.

Companies in this category tend to be well established, dominate in their market and in industries less affected by cyclical geopolitical factors. However, it is important to note that these stocks carry a different kind of risk.

Since your long-term return is dependent on the companies increasing their dividends over many years in the future, there is a real risk of something occurring that would prevent them from executing their strategy. Examples of these stocks would include:

AFLAC Inc. (AFL) | Yield: 2.6% | Growth: 15.0%
Aflac Incorporated provides supplemental health and life insurance in the U.S. and Japan. Products are marketed at work sites and help fill gaps in primary insurance coverage. Approximately 80% of earnings comes from Japan and 20% from the U.S.

Walgreen Co. (WAG) | Yield: 1.9% | Growth: 18.8%
Walgreen Co. is the largest U.S. retail drug chain in terms of revenues. It operates more than 8,000 drug stores throughout the U.S. and Puerto Rico.

Lowe's Companies, Inc. (LOW)  | Yield: 2.3% | Growth: 17.9%
Lowe's Companies, Inc. sells retail building materials and supplies, lumber, hardware and appliances through more than 1,700 stores in the U.S. and Canada.

Moderate Yield/Moderate Dividend Growth

This is a category that doesn't always get a lot of attention. I would classify stocks in this category with yields from 3.0% to 4.5% and a dividend growth rate between 5% and 12%. For some, this defines the perfect dividend stock – good current payment with good future opportunities for growth.

These companies’ stories are varied. For some, they would normally reside in one of the other two categories, but hit a bump in the road. For others they normally reside here due to their growth and risk profile. Examples of these stocks would include:

Avista Corporation (AVA) | Yield: 4.2% | Growth: 8.8%
Avista Corp. generates, transmits and distributes energy as well as engages in energy-related businesses.

Abbott Laboratories (ABT) | Yield: 3.5% | Growth: 8.4%
Abbott Laboratories is a diversified life science company and is a leading maker of drugs, nutritional products, diabetes monitoring devices, and diagnostics.

Waste Management, Inc. (WM) | Yield: 3.8% | Growth: 7.9%
Waste Management Inc. is the largest U.S. trash hauling/disposal concern.

As with all investments, risk can never be eliminated. However, to minimize risk I employ an asset allocation model. In addition, I limit my investments in each of the above categories.

Full Disclosure: Long ABT, CINF, GTY, NNN. See a list of all my dividend growth holdings here.

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- Dividend Stocks Are Getting Expensive
(Photo Credit)
Tags: [GTY] [NNN] [CINF] [AFL] [WAG] [LOW] [AVA] [ABT] [WM]

2 comments:

  1. Sir,

    Thank you for your continued posts. Do you ever look at the BETA of a stock? More so, I am curious as to why I haven't seen much utilities being talked about?

    Thanksks

    ReplyDelete
  2. Anon: I am working on an article that will discuss betas. Utilities tend to have poor free cash flow and pay their dividends with debt and share issuances. See:

    http://www.dividend-growth-stocks.com/2010/03/increasing-dividend-yield-part-i.html

    Best Wishes,
    D4L

    ReplyDelete

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