Why Dividends are Really Important
Follow up on Last Year’s Recommendations
My List of 10 Best Dividend-Paying Companies
I’m often asked if investing exclusively in dividend-paying companies will bring the best results. There is no simple answer, but history shows that dividend income is an important part of your total return when you invest in common stocks. Rising stock prices help to build your wealth and beat inflation, but dividends provide a steady return on your investment through thick and thin and add up faster than you think.
I’m also often asked by my readers for a list of stocks to begin building their initial portfolios. Whether you’re a new investor or an old pro, you are young or old, I usually advise that you include some ultra-conservative dividend-paying companies in your portfolio. I call these stocks “core holdings.” Owning these conservative companies will not only allow you to sleep at night, but will also provide you with modest appreciation and dividend income for many years into the future.
Should you hang onto your core holdings forever? Some companies can be held for a very long time, but I strongly advocate reviewing your holdings at least once a year. Even the largest companies can run into long-term problems.
Dividend-paying companies offer two ways to make money on their stocks: The price of the stock can appreciate and the dividend can provide income.
I recommend that you invest in companies with histories of well-founded growth that will continue during the next several years and even decades. A company’s history of steady sales and earnings growth will usually lead to relatively steady appreciation and frequent dividend increases. In market declines like we’ve been experiencing, dividend-paying companies tend to decline noticeably less than stocks paying no dividends.
Dividends are the regular cash payments that a company sends to you or to your brokerage account. You can, however, instruct the company or your broker to reinvest your dividends into additional shares or fractional shares. Reinvesting your dividends makes sense, because the effects of compounding your dividends will make your investment grow even faster.
Dividends are the payments of a company’s hard-earned profits. A company’s ability to continually pay dividends provides concrete evidence that the company is performing well. Accounting malfeasance is harder, or impossible, if a large transfer of cash is going to shareholders on a regular basis. I don’t include companies paying really low dividends; I am referring to companies paying dividends yielding more than 1% per annum. This figure is called the dividend yield and is calculated by dividing the annual dividend by the current stock price.
When evaluating dividends and yields, beware of another common pitfall: dividend coverage. You can evaluate dividend coverage by dividing the annual dividends per share (latest quarter times four) by the last four quarters of earnings per share (DPS divided by EPS). The dividend coverage ratio indicates if earnings can support the dividend. A growth company that pays a small dividend will tend to have a lower dividend coverage ratio than a well-established “blue chip” company that has a higher dividend payout.
As a general rule of thumb, most successful dividend investors avoid companies with a dividend payout ratio above 50% or 60%. Anything above that mark means the company may not be investing enough capital back into the organization. Even though a company’s growth has slowed, it is still critical to reinvest a portion of earnings back into the organization.
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On September 22 of 2011, I wrote a Cabot Wealth Advisory entitled “The Importance of Dividends.” The article recommended 10 blue-chip companies, including Abbott Labs, Caterpillar, Chevron and Disney, all of which paid above-average dividends. How did these “stodgy” old companies perform?
My 10 blue-chip companies rose an average of 23.0% during the past 13 months. In addition, every one of the 10 companies increased their dividends during that interim—every one!
And what if these core stocks continue to appreciate 23.0% every 13 months? Well, in five years. $100,000 will grow to $282,000 with dividends re-invested, and in 10 years, $100,000 will grow to $795,000.
I couldn’t possibly create a better example of why you should include high-quality dividend-paying companies in your portfolio!
Today, I have assembled a new list of 10 Dividend-Paying Companies that I believe will perform very well during the next year and beyond. These companies offer dividends averaging 2.0%, which exceed the current 10-year U.S. Treasury bond yield of 1.6%. In addition to generous dividend payments, investors can expect steady long-term earnings and dividend growth of more than 10% per year. All of the companies maintain strong balance sheets with low debt and lots of cash. Annual dividend increases are common for all of the companies and have averaged 21% annually during the past five years.
The average dividend payout ratio for the 10 companies is 30%, which is well below my 50% to 60% limit. And best of all, high-quality companies have been neglected by investors during the past several years and now sell at very reasonable prices.
I believe you’ll do very well by adding these companies to your portfolio. I’ve included two of the companies here. If you’d like the full list of the 10 Best Dividend-Paying Companies, get it here.
Accenture Plc (ACN), based in Ireland, offers management consulting, technology solutions, and outsourcing services to clients in 48 countries. The company helps customers to identify new business and technology trends, formulate and implement solutions to boost revenue, enter new markets, and deliver products and services more efficiently. During difficult economic times, such as the present, corporations seek help to cut costs, improve efficiency, and improve operations.
Accenture is winning new contracts to facilitate restructurings at client companies. In addition, ACN is helping companies expand into rapidly-growing countries like Brazil, China, and India as a means to offset their slow growth at home. Accenture has a lot of competition, but the company continues to take market share from its competitors. I expect revenues to increase 9% and EPS to advance 10% during the next 12 months. Accenture has a strong balance sheet with no debt and lots of cash.
ACN currently trades at 15.5 times 12-month forward EPS (earnings per share ending 8/31/13) of 4.24, with a dividend yield of 2.5%. Results could exceed our expectations if the company wins larger-sized contracts. ACN is very low risk.
CVS Caremark (CVS) is the leading pharmacy and drug management services chain in the U.S. During the past several years, the company has made several major acquisitions that have enhanced CVS’s growth beyond expectations. The company’s latest purchase of UAM Medicare prescription drug plan business is producing better than expected sales and earnings results. CVS will likely continue its aggressive acquisition strategy in future years.
CVS’s in-house Minute Clinics, which are staffed by nurse practitioners and physician assistants, are a big hit. I expect sales to advance 8% and EPS to climb 13% during the next 12 months. New drugs from drug makers and the wider use of generic drugs will keep earnings growing rapidly well into the future.
CVS shares are undervalued at only 12.9 times my EPS forecast of 3.61 for the 12 months ending 9/30/13. Additional acquisitions could push sales and earnings higher than expected. The dividend yield of 1.4% is modest, the balance sheet is strong, and my risk rating for CVS is very low risk.
For my full free report entitled 10 Best Dividend-Paying Companies.
Until next time, be kind and friendly to everyone you meet.
Editor of Cabot Benjamin Graham Value Letter
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