With investors bailing out of the bond market at a record pace in June, yields on bonds — which move in the opposite direction of prices — jumped, hitting 2.5% at several points.
Higher bond yields naturally have an impact on stocks — particularly dividend stocks, since they compete for investors’ income dollars. But investors would be wise to remember that a decision about whether to buy or sell a stock that offers a dividend shouldn’t be wholly centered around yield.
After all, the formula for calculating dividend yield (dividend/stock price) has two moving parts, the latter of which can really put a cloud over the first — namely, big losses in price might jack up the headline yield, but it doesn’t improve your yield on cost, and eventually they can more than offset the income you were collecting. Pitney Bowes (PBI) yields more than 5% in dividends, but its stock stinks on toast. Should you buy it for the dividend yield anyway? No.
At the same time, many stocks that do offer dividends, but have only modest yields (1%-2%), can be overlooked by income investors who think the payout is too small, as well as growth investors worried that a new or improving payout might be a sign that the growth story is over.
That’s not always the case, though. There are a number of stocks with not-so-hot yields that still are worth investing precisely because they do offer a measured mix of income and growth potential, even if it’s not the stuff of overnight doublers. What I’m looking for specifically are companies with businesses that still have room to expand, as well as a history of dividend increases and the cash to keep those payments up and climbing for the long-term. Here are three such stocks:
Dividend Yield: 2%
5-Year Average Dividend Increase: 13.6%
We’ll go with the bad news first. IBM (IBM) has been under pressure since April, when it posted an earnings miss. Revenues dipped around 5% on a year-over-year basis, while net income on a comparable basis fell 6%. Additionally, IBM reiterated its expectation of lower full-year 2013 earnings, forecasting $15.53 per share vs. analyst targets of $16.33 per share.
Now, for the good news.
For one, IBM is making an assertive move into the cloud market — especially in lower-end startup and small- to mid-size business applications — to compliment its huge private corporate infrastructure and “meta-data” heavy business model. Most recently, it bought cloud infrastructure provider Softlayer Technologies for $2 billion.
Also, IBM is one of the most consistent repurchasers of its stock. Since 2002, IBM has reduced its number of shares outstanding from 1.703 billion to a current 1.11 billion. Fewer shares help boost EPS, which should help to drive stock prices even when the income statement isn’t pristine.
And the dividend is still alive and kicking. IBM’s most recent increase of 12% puts the quarterly payout at 95 cents per share, and marks the 14th consecutive year IBM has improved its dividend. Despite its weak first quarter, IBM generated $1.6 billion in free cash flow, and sits on more than $11 billion in cash — well in excess of its $950 million dividend payout. At a P/E of just more than 14, IBM is fairly priced for such an attractive, consistent company.
Dividend Yield: 1.2%
5-Year Average Dividend Increase: 17%
Disney (DIS) has been hitting on all cylinders of late, with revenue across its television, resorts and movie segments all ahead in 2013. On the movie side, Iron Man 3 was a hit, and The Lone Ranger — out this weekend — could be a blockbuster. On the resort side, Disney launched a new cruise ship earlier this year, and folks are still flocking to its theme parks helping to drive higher revenues and earnings.
Meanwhile, DIS shares are up 30% year-to-date, well ahead of the broader market. Disney’s dividend yield isn’t anything to scream about, but that’s in part because share appreciation has well outpaced the company’s 17% average increase over the past five years. Nonetheless, that payout isn’t going anywhere, and Disney can easily increase it thanks to $3 billion in free cash flow and another $4 billion in the bank. I personally bought shares in early April when the yield was only 1.4%, and I couldn’t be happier.
Dividend Yield: 1.4%
5-Year Average Dividend Increase: 18%
I have a soft spot in my heart for W.W. Grainger (GWW) — the unsexy distributor of maintenance and repair supplies — and I’ve written about the company on several occasions. The company boasts a solid business model, profits and revenues that have improved for four consecutive years, and decades of increased payouts.
The company is off to a solid start in 2013, with first-quarter earnings up 14% year-over-year on revenues that improved by 4% to just under $3 billion. Grainger also provided analysts with guidance better than they expected — GWW thinks it’ll pull in $11.30 to $12 for the fiscal year, with the high end ahead of estimates of $11.94. Cash flow of $210 million doesn’t sound like much, but it more than covers GWW’s $56 million in dividend payments — plus Grainger has another $485 million in the bank.
GWW shares reflect the company’s financial results, up 27% year-to-date. Perhaps my only criticism is that Grainger isn’t cheap at nearly 25 times earnings, but I’d certainly consider buying if the market turned and dragged GWW down a bit with it.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he was long DIS.