Tuesday, February 28, 2012

8 Dividend Stocks To Consider While Waiting on Apple to Pay Its First Dividend

It seems that many people are infatuated with the idea of Apple, Inc. (AAPL) paying a dividend. With more that $30 billion of cash and short-term investments sitting on the balance sheet, no long-term debt and generating $37 billion of free cash flow over the last 12 months, the company certainty could afford it. As an investor in Dividend Growth Stocks, should I really care if AAPL pays a dividend, or not?

First, not all companies that pay dividends are good dividend growth stocks. To be a good dividend growth stock, the company should exhibit certain key traits. These traits are listed below. So, let's see how AAPL stacks up:

1. Capacity To Pay A Dividend

Cash on the balance sheet, low debt and strong free cash flows puts a company in a position to pay a dividend, and even grow it over the years. As noted above, AAPL's financials are excellent. It could easily pay a meaningful dividend with plenty of room to grow it in the near future.

With a share price around $520, AAPL could choose to pay a 3% dividend ($15.60 per share) and it would only cost them around $14.5 billion dollars a year ($15.60 x 930 million shares). Less than half of is free cash flow, which is a conservative payout ratio. AAPL easily passes this part of the test.

2. Better Alternatives For The Cash

Investors focused on capital gains sometimes show their disdain for dividends by saying they would rather management reinvest the money and earn a higher return than they could if it were returned to the shareholders in the form of dividends. In theory this makes a lot of sense, but there comes a time when the industry (or company) matures to the point they are generating cash in excess of what can be prudently reinvested. Not all companies recognize this situation when this happens, and some make really bad investment decisions - just because they can afford to do so.

Often times one of the really bad investments management makes is in the company's own stock. As pressure mounts to beat ever-increasing EPS numbers it is sometimes easier to buy-down the share side of the equation than grow the earnings side. AAPL's growing cash balance indicates management believes its investment opportunities are limited, and fortunately for the shareholders management has not felt the need to invest, including in its own stock, just because thy can.

3. A Dividend Culture

A great dividend growth company is proud of its record of growing dividends. It is a focus of management. The dividend string is quoted with each new increase. All means will be exhausted before an increase is missed. A dividend cut is treated like a death in the family.

For example, in 2009 when Kelly King, BB&T's CEO, cut the stock's dividend he was quoted as saying that the decision to cut the dividend was "the worst day in my 37-year career." The bank had increased its dividend for 37 consecutive years and had been the largest U.S. bank to not cut its dividend at the time.

In AAPL you have a company that really doesn't appear to want to pay a dividend, but may end up doing so due to shareholder pressure (see Microsoft (MSFT) and Intel (INTC) when they first started their dividends). As an investor in dividend growth stocks, I want a CEO to feel like Kelly did when thinking about a dividend cut.

Below are several companies that have a dividend growth culture:

Chubb Corporation (CB) is one of the largest U.S. property-casualty insurers. Chubb has carved out a number of niches, including high-end personal lines and specialty liability lines coverage.
Yield: 2.3% | Years of Dividend Growth: 47

Colgate-Palmolive Company (CL) is a major consumer products company that markets oral, personal and household care and pet nutrition products in more than 200 countries and territories.
Yield: 2.4% | Years of Dividend Growth: 48

Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device and consumer products industries.
Yield: 3.5% | Years of Dividend Growth: 49

Illinois Tool Works Inc. (ITW) is a diversified manufacturer that operates a portfolio of 60 business units that serve the industrial and consumer markets globally.
Yield: 2.6% | Years of Dividend Growth: 49

Vectren Corp. (VVC) is an energy holding company that delivers gas and/or electricity to more than one million utility customers in Indiana and Ohio, and offers other energy related products and services.
Yield: 4.7% | Years of Dividend Growth: 52

3M Co. (MMM) is a diversified global company that provides enhanced product functionality in electronics, health care, industrial, consumer, office, telecommunications, safety & security and other markets via coatings, sealants, adhesives, and other chemical
Yield: 2.5% | Years of Dividend Growth: 53

The Procter & Gamble Company (PG) is a leading consumer products company the markets household and personal care products in more than 180 countries.
Yield: 3.1% | Years of Dividend Growth: 55

Genuine Parts Co. (GPC) is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products.
Yield: 2.9% | Years of Dividend Growth: 55

Emerson Electric Co. (EMR) designs and supplies product technology, and delivers engineering services and solutions to a wide range of industrial, commercial, and consumer markets around the world.
Yield: 3.1% | Years of Dividend Growth: 56

Some companies with a dividend growth culture will eventually end up cutting their dividend, but it should be the last resort. I want a company that is not quick to pull the dividend cut trigger.

Full Disclosure: Long INTC, MSFT, CL, JNJ, ITW, MMM, PG, GPC, EMR in my Dividend Growth Portfolio and long VVC in my High-Yield Portfolio. See a list of all my dividend growth holdings here.

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