Tuesday, June 10, 2014

The Perfect Dividend Stock

In an utopian world, the perfect dividend stock 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 my fantasies, 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:

Kinder Morgan Energy Partners LP (KMP) is one of the largest pipeline master limited partnerships (MLPs) in the U.S.
Yield: 6.9% | Dividend Growth: 3.4%

Universal Health Realty Income Trust (UHT) is a real estate investment trust (REIT) that invests in healthcare and human service related facilities.
Yield: 5.6% | Dividend Growth: 0.2%

AT&T Inc. (T) provides telephone and broadband service and holds full ownership of AT&T Mobility (formerly Cingular Wireless).
Yield: 5.3% | Dividend Growth: 2.2%

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, there is a real risk of something occurring that would prevent them from executing their strategy. Examples of these stocks would include:

Nike, Inc. (NKE) is the world's leading designer and marketer of high-quality athletic footwear, athletic apparel and accessories
Yield: 1.2% | Dividend Growth: 20.0%

Grainger Inc. (GWW) is the largest global distributor of industrial and commercial supplies, such as hand tools, electric motors, light bulbs and janitorial items.
Yield: 1.6% | Dividend Growth: 16.1%

Walgreen Co. (WAG) is largest U.S. retail drug chain in terms of revenues, this company operates more than 8,000 drug stores throughout the U.S. and Puerto Rico.
Yield: 1.7% | Dividend Growth: 15.0%

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:

The Clorox Company (CLX) is a diversified producer of household cleaning, grocery and specialty food products is also a leading producer of natural personal care products.
Yield: 3.1% | Dividend Growth: 8.8%

The Coca-Cola Company (KO) is the world's largest soft drink company, KO also has a sizable fruit juice business.
Yield: 3.0% | Dividend Growth: 8.1%

Chevron Corporation (CVX) is a global integrated oil company (formerly ChevronTexaco) has interests in exploration, production, refining and marketing, and petrochemicals.
Yield: 3.4% | Dividend Growth: 7.9%

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 UHT, T, KO, CVX. See a list of all my dividend growth holdings here.

Related Articles
- 12 Higher Yielding Stocks With A Low Dividend Payout Ratio
- Early Warning Signs of a Dividend Cut
- Income Annuities vs. Dividend Stocks
- 7 Tech Stocks With A History of Growing Their Dividends
- Here's Where To Find Great Dividend Stocks

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