Screening Dividend Stocks for Potential Future Growth, Part Two

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

In Part One of this article, I described the new WisdomTree US Dividend Growth Fund and its managers' effort to distinguish their methodology in a very crowded Dividend ETF market.

The fund's management says that they will be looking at forward earnings projections and trailing 3-year returns on equity and assets in order to determine which companies are good candidates for future dividend increases. They eschew the traditional metrics of number of years raising dividends and the dividend growth rate (DGR), as "backward-looking," in favor of what they consider "fundamental factors" that will indicate which companies are good candidates for future dividend growth.

I disagree quite strongly with their methodology, and posit that their fund will end up looking a lot like the S&P 500, with similar price appreciation and dividend yield.

Not that such a result is a bad thing. But if you are looking for a good (defined as more than 3%) yield and opportunity for future dividend growth, I believe my metrics are the ones to use.

Consider My Portfolio

My goal is simple: share price increases equal to or exceeding the S&P 500 and a dividend yield in the 3.5 to 4% range. To that end, I choose companies that yield over 3%, that have a substantial history of paying and raising dividends, and that have a 5-year DGR of over 7%. Those three factors alone pretty much ensure that I am choosing companies that will continue to grow their dividends at a rate that will exceed the rate of inflation.

The dividend payout ratio, which I prefer between 40% and 60%, provides that the company is not paying out so much in dividends that it would be forced to cut the dividend in the case of disappointing earnings.

I also factor in current PE and total twelve-month return in order to avoid what I consider overpriced companies, or companies that are sporting high yields due to extreme price declines. And, I consider the 5-year estimated earnings growth rate to make sure my choices are on track for healthy earnings in the future.

Recommendations for my Dividend Growth Portfolio

Sunoco Logistics Partners (NYSE: SXL) – the current yield is 3.9%, with a 10-year history of paying and raising dividends. Actually Sunoco Logistics has raised its dividend every quarter for the past five years, and its 5-year DGR is an impressive 13%. What this means is that, although the share price has increased substantially in the past year, the dividend yield has remained high as well. Zack's cites the company's stable fee-based revenue stream, geographically-diverse assets and strong business fundamentals as reasons to believe that this MLP will deliver income and price appreciation in the future.

Williams Companies (NYSE: WMB) – the company yields 4.1%, and it too boasts a 10-year history of raising dividends with a 5-year DGR of 29%. For this company, the dividend is doubling every 2 ½ years. And Williams has a terrific-looking future: the 5-year projected earnings growth rate is 14.5%. I expect Williams to be one of the biggest winners in my portfolio over the next five years.

On the same day that reiterated a Buy recommendation for Williams, Zack's issued a Strong Sell on the company. cites cash flow from operations increasing by 14% versus a year ago and a 42% profit margin, also increased from the same quarter a year ago.

(* NOTE: This article was written before the June 13 explosion at the plant in Gelsmar, LA. The share price promptly lost 4%, but it has since recovered half of the loss.)

And, in a completely different direction, we have Cracker Barrel Old Country Stores (NASDAQ: CBRL)– the current yield is 3.1%, with a 10-year history and a 5-year DGR of 26.7%. The 5-year earnings growth projection is 14.3%. I expect big things from this little company, as evidenced by its impressive second quarter earnings report on June 3, followed by a 50% increase in its dividend. (Cracker Barrel has now increased its dividend by 200% since 2Q12, when its dividend was only 25 cents per quarter.)

Cracker Barrel has been the target of activist investor Sardar Biglari over the past couple of years, and the argument can be made that his interest has proved beneficial to all shareholders. 

There are seven more companies in my Perfect Dividend Portfolio, but I won’t go into detail on all of them now. I’ll be updating my portfolio in the next week or so with 2Q earnings and dividend action, and I will provide further details at that point on how it is performing. But I expect that my portfolio will definitely be holding its own and achieving the goals I set forth when I started this project seven months ago.

And I expect that in the future it will significantly outperform the WisdomTree US Dividend Growth ETF in terms of dividend appreciation and yield.

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Karin Hernandez is long Cracker Barrel Old Country Store, Sunoco Logistics Partners and Williams Companies. The Motley Fool recommends Cracker Barrel Old Country Store. 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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