The Perfect Dividend Stock

Posted by D4L | Tuesday, July 29, 2008 | | 9 comments »

In an utopian world, the perfect dividend stock would be one that is both high-yield and provide a high dividend growth rate. Its share price would appreciate ratable with its increasing dividend. All of this would be driven by increasing earnings and cash flow. Ok, so much for my fantasies, the perfect dividend stock just may be a balanced compromise. Consider the following:

High Yield/Low Dividend Growth: When investors first consider dividend investing, High Yield is where they usually go first. I guess it is human nature to want it now and want a lot of it. Unfortunately, high yield stocks often carry higher than average risk - there is usually a reason that the stock yield is higher than average. It could be because the company is in a limited growth industry, is in a volatile industry, experienced recent financial problems and its share price has fallen, or shareholders perceive future financial problems. I have set aside a small portion of my portfolio to invest in these types of stocks. Examples of these stocks would include:

Low Yield/High Dividend Growth: After being burned on an over-allocation of high yield stocks, would be dividend investors normally start reading-up on the subject. The first thing that they learn is that Dividend Growth is more important than Dividend Yield. While Dividend Yield will stroke you today, Dividend Growth is much more important to long-term wealth creation. Companies in this category tend to be well established, dominate in their market and in industries less affected by cyclical geopolitical factors. However, it is important to note that these stocks carry a different kind of risk. Since your long-term return is dependent on the companies increasing their dividends over many years in the future, there is a real risk of something occurring that would prevent them from executing their strategy. Examples of these stocks would include:
Moderate Yield/Moderate Dividend Growth: This is a category that is not often discussed since most dividend investors focus on the other two categories above. I would classify stocks in this category with yields from 3.5% to 8.0% and a dividend growth rate between 5% and 15%. For some this defines the perfect dividend stock - good current payment with good future opportunity for growth. These companies' stories are varied. For some, they would normally reside in one of the other two categories, but hit a bump in the road. For others they normally reside here due to their growth and risk profile. Examples of these stocks would include:
As with all investments, risk can never be eliminated. However, to minimize risk I employ an asset allocation model. In addition, I limit my investments in each of the above categories.

The dividend growth rates quoted above are the average annual rates from 1998-2007.

Full Disclosure: At the time of this writing I was long in FR, ED, AFL, CNI, GE and USB.

(Photo: sanja gjenero)


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9 comments

  1. Dividend Growth Investor // July 29, 2008 at 9:27 AM

    Very interesting analyis D4L. So basically you are telling me that by purchasing the 6 stocks above I could get a starting yield of about 5% along with a decent dividend growth appreciation.
    Where do I sign up?

  2. MoneyEnergy // July 29, 2008 at 11:01 AM

    Excellent summary, you definitely know this area well. What other stocks do you know that fall into the moderate/moderate range? Seems like many banks might.

  3. David Neubert // July 29, 2008 at 12:44 PM

    I used your recommendations as a basis for a blog entry. Growing Dividend companies are important in this type of market.

  4. Dividends4Life // July 29, 2008 at 9:23 PM

    DHI: It is my goal to manage risk and return so that my initial YOC is around 5%.

    MoneyEnergy: Off the top of my head I believe LLY and KMB would fall in the mod/Mod category.

    David: Thanks!

    Best Wishes,
    D4L

  5. lulugal11 // August 2, 2008 at 8:17 PM

    This is a good jump off point for someone like me who does not know anything about the stock market but would like to begin investing.

  6. Moneymonk // August 4, 2008 at 11:56 AM

    GE is a favorite of mine.It cannot go wrong

  7. Kyle // August 5, 2008 at 11:00 AM

    I prefer the moderate yield/moderate growth dividend stocks mostly because they are usually much easier to find and evaluate than the other two. I'll take a 5% yield and 10% growth rate any day.

  8. Tyler @ Dividend Money // September 5, 2008 at 9:22 PM

    D4L,
    What about the Canadian banks and Sun Life?
    Right about now they would qualify as high yield and high dividend growth. TD and BNS raised their dividends this year amidst the financial turmoil and have yields over 4.0% right now.
    Sun Life has a Yield at 3.8% ish and has a very nice dividend growth rate of about 15%/year on average.
    Just my $0.02.
    -Tyler

  9. Dividends4Life // September 6, 2008 at 10:55 AM

    Tyler: Thanks for the recommendations. I would love to find some more good non-U.S. investments. I will run them through my Pre-Screen model and see where it takes me.

    Best Wishes,
    D4L

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