Wednesday, April 19, 2017

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:

AT&T Inc. (T) provides telephone and broadband service and holds full ownership of AT&T Mobility.
Yield: 4.9% | Dividend Growth: 3.5%

Main Street Capital Corporation (MAIN) is a business development company specializing in equity, equity related, and debt investments in small and lower middle market companies.
Yield: 5.7% | Dividend Growth: 1.8%

W. P. Carey Inc. (WPC) is a leading global net-lease REIT that provides long-term sale-leaseback and build-to-suit financing solutions for companies worldwide.
Yield: 6.2% | Dividend Growth: 2.3%

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: 1.3% | Dividend Growth: 15.0%

Lowe's Companies, Inc. (LOW) sells retail building materials and supplies, lumber, hardware and appliances through more than 1,850 stores in the U.S. and Canada.
Yield: 1.7% | Dividend Growth: 19.4%

Raytheon Company (RTN), the world's fifth largest military contractor, specializes in making high-tech missiles, advanced radar systems and sensors, defense electronics, and missile-defense systems.
Yield: 2.1% | Dividend Growth: 9.3%

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 Coca-Cola Company (KO) is the world's largest soft drink company, and also has a sizable fruit juice business.
Yield: 3.4% | Dividend Growth: 5.7%

Abbvie Inc. (ABBV) is a global research-based pharmaceuticals business that emerged as a separate entity following its spin-off from Abbott Laboratories at the start of 2013. AbbVie's key drug is Humira for rheumatoid arthritis.
Yield: 4.0% | Dividend Growth: 10.2%

National Health Investors (NHI) is a real estate investment trust that invests in income-producing health care properties primarily in the long-term care industry.
Yield: 5.1% | Dividend Growth: 5.6%

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 T, MAIN, RTN, KO, ABBV, NHI. See a list of all my Dividend Growth Portfolio holdings here.

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