Investors: Is Your Dividend Secure?

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

What’s an investor to do?  Bonds are at ridiculously high prices (and low yields).  MLPs, which are often backed by assets like interstate pipelines, came into vogue and are increasingly backed by assets with fluctuating cash flows. 

And junk bonds?  Yes, they are still “junk.”  The underlying assets don’t change just because more investors buy them.

What are other alternatives?  One is to locate companies with steady dividend yields.  I covered a stable of companies in my post: “Investors: Search for Income!”  However, there are also other dividend-payers that can do well in this market.  Below are two types.

Strong R&D Investment

According to research published in The Wall Street Journal:

Another strategy: buying high-dividend companies that spend heavily on research and development, a sign that they aren’t forsaking future growth for current dividends.  an index of the 20 such companies rebalanced monthly has outpaced the Russell 1000 index by 8.5 percentage points annually from 1990 to 2012, according to Nomura Securities International.

Intel (NASDAQ: INTC), Dow Chemical (NYSE: DOW), and Johnson & Johnson (NYSE: JNJ) are excellent examples.  According to The Journal, these companies had yields of 4.5%, 3.8%, and 3.5% at the time of publication, respectively, and have large payouts and R&D spending relative to their enterprise valuations.

I also like these companies for competitive reasons.  Intel, for example, reaps rewards from its value chain profit model, meaning that the company earns substantial profit as a result of its entrenched position in its industry’s value chain.

Device-makers are a dime-a-dozen, but Intel chips are a component that many devices have in common.  Intel certainly faces competition, but it also holds a strong spot in the value chain of electronic devices.  Dow also has an advantage.

Dow Chemical benefits from low natural gas prices, which were around $3.41 but fell as low as the $2 range.  Depressed gas prices allow Dow to use natural gas as an input for many of its products, keeping its costs down and boosting profitability.

Finally, I like Johnson & Johnson’s portfolio of brand name products, including Neutrogena, Tylenol, and Splenda.  Over time the world’s population tends to increase, giving J&J an ever-growing number of customers for its popular, household products. 

Companies with robust R&D spending and sturdy business models are nice picks now.  What’s another good category?  Firms that historically hike their dividends.

Dividend Hikes

Coca-Cola (NYSE: KO) and General Electric (NYSE: GE) are two firms I also like.  Coke has increased its dividend for 49 straight years, putting it in the top tier of dividend-payers.  The impressive part is that Coke maintains a 53% payout ratio, even over the past five years, indicating that Coke is adept at boosting its profits year-over-year.

A strong suit for Coca-Cola is that it makes early investors huge payments.  Think of the dividend payout like a bond payout.  For example, if an investor bought Coca-Coca shares in the early days and simply held the shares, the payout would become enormous relative to the original share price.  To illustrate, consider the hypothetical example below.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Year 0</strong></p> </td> <td> <p><strong>Year 1</strong></p> </td> <td> <p><strong>Year 2</strong></p> </td> <td> <p><strong>Year 3</strong></p> </td> <td> <p><strong>Year 4</strong></p> </td> <td> <p><strong>Year 5</strong></p> </td> </tr> <tr> <td> <p><strong>Stock Price</strong></p> </td> <td> <p>20</p> </td> <td> <p>20</p> </td> <td> <p>20</p> </td> <td> <p>20</p> </td> <td> <p>20</p> </td> <td> <p>20</p> </td> </tr> <tr> <td> <p><strong>Dividend</strong></p> </td> <td> <p>0.50</p> </td> <td> <p>0.54</p> </td> <td> <p>0.57</p> </td> <td> <p>0.61</p> </td> <td> <p>0.66</p> </td> <td> <p>0.70</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>2.50%</p> </td> <td> <p>2.68%</p> </td> <td> <p>2.86%</p> </td> <td> <p>3.06%</p> </td> <td> <p>3.28%</p> </td> <td> <p>3.51%</p> </td> </tr> <tr> <td> <p><strong>Dividend Growth</strong></p> </td> <td> <p>1.07</p> </td> <td> <p>1.07</p> </td> <td> <p>1.07</p> </td> <td> <p>1.07</p> </td> <td> <p>1.07</p> </td> <td> <p>1.07</p> </td> </tr> </tbody> </table>

 

If an investor bought shares at a hypothetical $20 in Year 0 and saw dividend growth of just 7% annually (Coke’s dividend hikes averaged 8.46% annually over the past five years) and no increase in the share price, the shares would yield 3.51% after five years, a rate that beats most of today’s fixed-income investments. 

Like Coca-Cola, GE also has a rich history of dividend boosts.  The fallout came in the debt crisis, when GE Capital posted enormous liabilities that almost sunk the entire GE ship.  Luckily, the company rebounded without too much long-term damage.

Today, GE has resumed its dividend.  Though GE upped its dividend for only one consecutive year, the payout is 3.2%.  Also, GE pared back GE capital, reducing risk in the financial arena.  So long as GE stays away from major risks, bloated debt, and keeps to its core businesses, I like the company.

Where Will You Look?

Amid falling interest rates, investors have bid up the prices of assets with strong yields.  That leaves fewer returns and the same risks for many fixed-income securities as well as for securities backed by assets with erratic cash flows.  Where can the yield-starved find a haven?

One such place is in sturdy dividends – companies that continually invest in their businesses and those with storied histories of increases.


ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of General Electric Company, Intel, and Johnson & Johnson. Motley Fool newsletter services recommend Intel, Johnson & Johnson, and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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