A Barbell Approach to Dividends

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

Investors looking to live off of their dividend income face two competing factors. On one side, they want enough income to support the lifestyle they desire today. On the other side, they need enough income growth to support the lifestyle they desire in the future. Deciding how to deal with these opposing forces can be difficult.

Indeed many of the companies with the fastest growing dividends have relatively low yields. Unless your portfolio is extremely large, it is hard to generate material amounts of income with stocks yielding between 0% and 2%. Four percent is a more desirable target, but even that yield level requires a large portfolio to create a worthwhile dividend stream.

On the flip side, selecting companies with yields of 7% or more would provide income for today, but what about tomorrow if there is minimal dividend growth? Indeed, inflation will eat away at a static dividend payment. Inflation's impact is slow, but painful.

Inflation Stinks...

One of my favorite examples of the impact of inflation is a U.S. postal stamp. Twenty years ago a first class stamp cost $0.29, today that same stamp goes for $0.45. That's a big difference over 20 years and one that could have a material impact on an investor who's income doesn't keep pace. So you might be able to generate notable income today sticking with high, but likely slow growing or stagnant dividend yields, but you would risk not being able to eat as well tomorrow.

The way in which I suggest dealing with this situation is to create a barbell dividend portfolio. In other words, put money in each of the two opposing camps: some in dividend growth stocks and some in high yield stocks. This way, you have income for today and income growth for tomorrow.

Creating such a portfolio isn't that hard and, if you take your time building the dividend growth component, you might even be able to reach the 4% yield level on that portion of the portfolio. Some great companies trading around that level today include Lockheed Martin (NYSE: LMT), Nucor, Hasbro, and Landauer (NYSE: LDR). Other companies are on the cusp of 4%, such as Dow-30 member Johnson & Johnson and Kimberly-Clark.

Dividend Growth Ideas

Lockheed Martin is an interesting stock right now given the spending cuts that are slated to take place in the U.S. defense budget. However, most agree that the draconian cuts that have been written into law are not likely to take place. Even if the cuts do take place, it is still unclear how they will impact industry participants. With its massive scale and reach, Lockheed Martin will definitely feel the pinch of any cuts, but it is also very likely to survive any cuts that do take place. Longer term, however, the company is probably one of the best positioned defense companies around. I've written about a few others in the defense industry that might be worth a look, too.

Landauer is a company I've written about before. It s a global provider of radiation detection devices and services. It uses its niche expertise to provide services in the radiation safety, occupational radiation monitoring, professional medical physics, and radiation exposure measurement and monitoring areas. Its business seems set to grow based on industry trends. My SWOT analysis provides a more in-depth view of the company's outlook, both good and bad.

High Yield Ideas

On the other side of the spectrum, high yield, you might consider companies such as AT&T (NYSE: T), Energy Transfer Partners (NYSE: ETP), or, for the more aggressive, PVR Partners (NYSE: PVR). All of these companies sport yields above 5%, the later two materially so, and have historically increased their dividends on a regular basis. They would make a nice counterbalance to a lower yielding dividend growth portfolio.

Of this trio, Dow-30 component AT&T is probably the least compelling at current valuations. That said, it is worth keeping on your watch list. AT&T today is very different from the AT&T of old. Its provides wireless communications, local exchange services (wire line phone service), long−distance services, data/broadband and Internet services, video services, telecommunications equipment, managed networking, and wholesale services. It is, however, best known for being one of the two largest cellular phone carriers in the United States, and the first to work with Apple to sell and support the iPhone. Being part of an effective duopoly is a pretty good position to be in.

Energy Transfer Partners and PVR have both been dragged down by company-specific issues, despite having material operations in the mid-stream space. Energy Transfer units have been held back by a large acquisition that is now complete and likely to start boosting results. It could be a good time to take a deeper dive on this limited partnership. PVR, on the other hand, has exposure to both mid-stream assets and coal. Coal, which is a true four letter word on Wall Street and main street these days, is hurting the perception and results of PVR. However, should coal usage increase, as some big players in the industry are hinting at, the coal operations could start to be less reviled—at least by Wall Street. I've highlighted a few other coal stocks that might be worth a look in previous articles.

A Different Way to Look at Your Portfolio

Clearly, creating a barbell dividend stock portfolio isn't something one does over night. It takes careful consideration and lots of patience. Diversification should be a highlight, as well as the breakdown between the dividend growth and high yield components. Fifty/fifty would be a good starting place, but it might not be right for you. However, thinking about your portfolio using the barbell framework might help you to better deal with the opposing needs of income for today and income growth for tomorrow.


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ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of Lockheed Martin. Motley Fool newsletter services recommend AT&T.; 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.If you have questions about this post or the Fool’s blog network, click here for information.

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