Goldman Sachs Weighs in on the Dividend Debate

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Financial markets have delivered a strong performance in the first half of 2013.

The impressive returns YTD have caught everyone by surprise, including the major investment firms on Wall Street which are now hastily raising their full-year targets on the S&P 500. Analysts at Goldman Sachs raised their S&P targets through 2015; the index is now expected to reach 1,750 by year-end 2013. This is significantly higher than the original target of 1575 which we surpassed in April.

In addition to its revised forecast, Goldman Sachs remains bullish on high-quality dividend paying stocks. A healthy debate is ongoing if dividend stocks will continue to perform as U.S. cyclicals gain momentum, causing a shift in money flows from one market segment to the other.

In consideration of both sides of the debate, I’ve identified three companies that meet Goldman Sachs’ criteria for dividend growth that should also participate in the economic recovery. Here are my best ideas for the remainder of 2013 that offer earnings growth and a solid dividend.

Shares of Ford Motor Company (NYSE: F) have outpaced the broader market with impressive gains so far this year. Here’s four reasons why the stock still has ample fuel in the tank:

  • Sales at U.S. auto manufacturers should rise as consumers replace a record age vehicle fleet. The timing is right for new auto sales, with attractive inventory, increased consumer credit, stable gas prices, and a confirmed housing recovery.
  • Pickup truck business is booming. The major American brands such as Ford, GMC, and Chevrolet have lifelong loyalty from buyers with minimal competition from overseas. Ford makes up to 4 times the profit from a pick-up vs. a small / mid-size car. Autodata reported sales of pickups are up 20% so far this year.
  • China sales rose a massive 45% in May, lead by strong SUV sales of the Ford Explorer and locally-produced Kuga and EcoSport models. The Chinese consumer also prefers Ford over Toyota, a trend that is likely to persist for the long-term.
  • Beginning in 2013, Ford doubled its quarterly dividend from $0.05 to a current $0.10 based on improved profitability and operating cash flow. The company plans to grow its dividend further to a level that is sustainable through all business cycles.

American conglomerate General Electric (NYSE: GE) emerged from the 2008-09 recession as a more focused, solidified company that aims to be a leader in every market. Here are four reasons the diversified industrial is a good play for the long-term:

  • The company’s industrial businesses, including everything from aircraft engines to power generation, are likely to rebound further in the second half of 2013. Demand is being seen in the U.S. and emerging markets, across all business lines.
  • Investors are likely to receive the $6.5 billion payout from GE Capital to parent company GE. General Electric is exiting higher-risk businesses within its finance division and making smart purchase decisions, such as the recent acquisition of oil services firm Lufkin Industries.
  • As of the world’s largest companies and a consistent American innovator, GE offers investors the potential for upside surprise. CEO Jeff Immelt recently stated his company is creating an “Industrial Internet” in China, the world’s fastest growing economy. The venture is expected to create $3 trillion in business opportunities by 2030.
  • General Electric has raised its dividend 90% since the recession, and should raise it a further 60% over the next 3 to 4 years to reach its historical norm. The 3.2% payout is not only higher than the S&P 500’s 2.1% yield, but has also grown at a faster rate.

As the economy improves, money-transfer group Western Union (NYSE: WU) is poised to benefit from a rise in payment activity on a worldwide basis. Here’s the lowdown for owning the shares:

  • In April, Western Union affirmed its full year 2013 outlook of $1.33–$1.43, indicating that shares are priced at an attractive 11.5x forward multiple. Earnings could reach in excess of $2 as money flows grow in emerging markets such as Mexico.
  • Money transfers are primarily non-discretionary, meaning that recipients rely on the funds in order to purchase vitals such as food and clothing. Immigrants traditionally move from poorer to wealthier countries, and the favorable U.S. immigration law should have a positive effect on Western Union’s business.
  • With its international footprint, Western Union has long-term, sustainable competitive advantages; Smaller peers are unable to match its size and scale in order to make inroads. Sending $50 for a $5 fee is a highly-profitable business.
  • Western Union raised its quarterly dividend to a record $0.125 based on strong operating cash flow, the highest in the company’s history. The money transfer outfit hopes to return more than 70% of operating cash flow to shareholders through share repurchases and dividends.

Foolish takeaway

As interest rates begin to rise, can dividend-paying stocks maintain their current value or will investors shift to cyclicals?

Readers can surmount this question by looking for stocks with cyclical and income components. Ford Motor Company pays a 2.5% dividend yield, yet is levered to rising North American and overseas auto sales. General Electric gives broad exposure to a recovering economy, while offering a significant 3.2% payout. Finally, Western Union is uniquely situated to benefit from increased money flows around the globe, providing a 3.0% return to investors.

Thanks for reading, and consider subscribing to my posts for more Fool ideas on outperforming the market.

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John Macris has no position in any stocks mentioned. The Motley Fool recommends Ford and Western Union. The Motley Fool owns shares of Ford and General Electric 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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