These Stocks Don't Pass The Dividend Growth Test

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It’s safe to say investors have gone head over heels for dividends. The financial media is filled with interviews from financial advisers and professionals who preach the merits of receiving income from equity investments. Particularly for those individuals in or approaching retirement, dividends provide solid income that traditional fixed income products do not.

However, despite the mass popularity of dividend stocks, it’s important to keep focus on properly evaluating dividend stocks. Dividend growth, the pace at which stocks raise their shareholder payouts over time, is an important characteristic that tells an investor a lot about a company's underlying fundamentals.

Not all dividends are created equal

If a company’s dividend growth slows dramatically, an investor can’t rule out the possibility of bad things to come. For example, Pitney Bowes (NYSE: PBI) carries one of the highest dividend yields available on the S&P 500 Index. Its 10% yield dwarfs the 2% yield available on the broader market.

But Pitney Bowes’ outsized yield has more to do with the company’s collapsing stock price over the past several years rather than growth of the dividend. The company’s last three annual dividend increases were only in the amount of one half of one cent per share. However, because Pitney Bowes did technically increase its dividend for those years, it was allowed to remain a Dividend Aristocrat, as the company has "increased" its dividend for 30 years in a row.

Unfortunately, Pitney Bowes’ lack of strong dividend growth is an indicator of the broader problems the company is having. Pitney Bowes, being closely tied to the postage industry in the United States, saw revenue fall 6% in fiscal 2012. Furthermore, the company’s total revenues have fallen every year since 2008.

Property and casualty insurer Cincinnati Financial (NASDAQ: CINF) has provided investors with capital gains that far exceed the company’s dividend growth. Over the past 52 weeks, Cincinnati Financial has returned more than 40%, not even including the hefty 3.5% dividend the stock provides.

Cincinnati Financial has an amazing dividend track record. The company has increased its shareholder payout for 51 years in a row. However, dividend growth has slowed significantly in recent years, and the stock’s five-year compound annual dividend growth rate is only 2.7% per year. In addition, Cincinnati Financial’s last dividend increase was less than 1%.

Even though the stock yields 3.4%, above the yield on the broader market, dividend growth of less than 1% won’t even track inflation going forward. Much better dividend growth can be had from stocks with comparable yields.

Nucor (NYSE: NUE) is a U.S. based steel manufacturer with a $14 billion market capitalization. To the company’s credit, Nucor navigated the financial crisis much better than its rival steel stocks. Late last year, Nucor increased its dividend for the 40th year in a row. Nucor has raised its dividend every year since it first began paying dividends in 1973. More telling for me, however, is that the most recent dividend increase was only one half of one percent.

Nucor is still struggling to return to solid financial footing, and its share price has traded between $40 per share and $50 per share since 2009. The company recently reported uninspiring full-year results. Consolidated net earnings per diluted share collapsed 36% in 2012, to $1.58 per share from $2.45 per share the year prior.

The bottom line

In the rush to buy dividend stocks, it’s important to not lose sight of one of the best ways to evaluate dividend stocks. Not all dividends are created equal, and just because a company pays a dividend, doesn’t automatically make its stock an immediate buy.

Focusing on the trajectory a company’s dividend has taken over both the long term and short term provides much-needed clarity into a company’s level of shareholder friendliness. Those stocks that have frozen their payouts are signaling the market that all is probably not well. Companies can only pay dividends out of profits, so if dividend growth stalls, it may be a sign that business is slowing.

Furthermore, companies that provide investors token dividend increases of a fraction of a percent every year are likely just trying to remain on lists, such as the Dividend Aristocrats, rather than meaningfully trying to reward shareholders. These stocks have high dividend yields, but growth of their distributions has slowed to a grinding halt in recent years. While it’s too soon to declare certain doom for these dividends, it’s worth keeping an eye on going forward.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Nucor. 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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