Three Dividend Stocks for Your Portfolio

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In what appears to be an unending period of low interest rates, many conservative investors looking to protect their purchasing power are no longer having their needs met by the credit market. Instead of buying a bond that may barely keep pace with inflation, investors should turn toward conservative equities that pay a solid dividend.

A solid dividend may be defined as one that increases each year and has significant earnings coverage to protect the dividend should earnings stagnate. In addition to having a medium-to-low payout ratio, the business should be stable and growing. Finally, the stock should currently yield at least 2%. If a stock has each of these attributes, investors would be wise to purchase it in lieu of a ten-year bond.

Three solid dividends

Although the stock market has made significant gains over the last nine months, there are still a few companies that offer a good dividend yield backed by solid earnings. The three highlighted in this article are Exxon Mobil (NYSE: XOM), Walgreen (NYSE: WAG), and CH Robinson (NASDAQ: CHRW). Each stock currently yields higher than 2%.

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But, more importantly, each company's dividend is likely to increase in the future rather than decrease. All three have made raising the dividend a regular habit; it would be more surprising if one of the companies were not to raise the dividend.

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Annual dividend increases are important because it adds to long-term shareholders' yield. For instance, Walgreen paid twice as many dividends in 2012 as it did in 2009. If the trend were to continue, shareholders who buy Walgreen today will, in three years, effectively earn a 5% dividend yield on their purchase price. Therefore, the current dividend yield understates the actual yield shareholders will receive at companies that continually increase their dividends.

Since each company's ability to raise its dividend is so important to their attractiveness, it is important to ensure that each company can continue to do so for the foreseeable future.

A quick way to check the health of a dividend is the payout ratio. The payout ratio tells investors how big the dividend is in relation to earnings. Exxon, Walgreen, and CH Robinson each have a payout ratio below 45%. This suggests that earnings could be cut in half and the companies could still pay the current dividend.

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But investors should take dividend analysis one step further than the payout ratio -- they should ensure that earnings are likely to grow rather than decline. That seems to be the case at all three companies.

Exxon, for one, has a long history of superior returns on capital. Its culture is the mirror opposite of Enron's; it conservatively projects economic returns from potential projects and managers strive to come in under budget. In addition, the global spread of the company's assets shield the company from economic weakness in a specific geography. As a result, Exxon will likely have little trouble increasing its dividend in the years ahead.

Walgreen may be slowing down expansion, but that should be good news for dividend seekers. Instead of spending on growth, Walgreen will be able to return more capital to shareholders through dividends and buybacks. In addition, mature stores often have much higher margins than new stores, which makes it likely that Walgreen's earnings will rise simply due to margin expansion. Therefore, it is unlikely that the company's dividend will come under pressure any time soon.

Finally, CH Robinson's profits are protected by a wide economic moat. The company's asset-light business model enables it to return more capital to shareholders while still investing for growth. Its profits are protected due to a network effect -- the company's massive network of shippers and carriers attracts customers, which then attracts more shippers and carriers. Its network is impossible to replicate.

In addition, the scale of CH Robinson's network provides cash flow that can be used to hire the best talent in supply chain logistics, which enables the company to provide a higher level of service to customers than its peers. The company's competitive position ensure a long runway for increasing dividends year after year.

Bottom line

Not all dividends are created equal. Exxon, Walgreen, and CH Robinson offer great dividends not just because of their current yields, but because the dividends are virtually guaranteed to grow for many years to come. Frustrated bond investors would do well to switch into these high-quality dividend stocks.

Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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