The best dividend stocks are not always the ones with the highest yields. After all, a company that pays a 10% dividend today might be doing so because it paid 5% a year ago and just saw its share price cut in half.
Instead of simply chasing yield, then, long-term investors should consider buying a stock based on its dividend growth potential. This will increase your personal yield over time even if the dividend yield for new money never changes much.
Consider the following math.
- ABC Corp. pays $1 annually in dividends and trades for $50 when you buy it. The yield at the time, then, is 2% — $1 in dividends divided by $50 as your cost per share.
- In five years, ABC Corp. pays $1.50 in annual dividends and trades for $75. The dividend yield to new money still is 2%, but your personal yield is 3% — $1.50 now in dividends divided by your personal cost basis of $50.
- In 10 years, ABC Corp. pays $2 in annual dividends and trades for $100. The yield to new money is still 2%, but your personal yield is 4%.
Get the idea?
Viewed this way, then, the best dividend stocks are the ones that have a strong record of dividend growth and the potential for continued dividend increases going forward.
Here are five stocks that fit that description:
Founded in 1894, Ameriprise Financial (AMP) has a long history as a financial services business but only recently has been trading on the NYSE in its current formation after a 2005 spinoff from American Express (AXP).
But while the financials of AMP the stock don’t have the same century of history behind them as the company itself, the small body of work is compelling.
Consider that AMP didn’t slash its dividend even during the depths of the downturn. And even more impressive, it continued to increase payouts.
The dividend has soared from 11 cents in 2005 when AMP was spun off to 52 cents quarterly as of right now after a recent dividend increase. That’s an impressive feat. And given that the payout is still a mere 31% currently and 28% of FY 2014 earnings forecasts, more dividend increases surely are in the works.
Throw in one-year returns of more than 60% in Ameriprise and you have a pretty good case for a stock with staying power.
Big Pharma typically is seen as a sleepy space where cost-cutting and buyouts are simply an effort to offset generic competition and patent expirations. The result is that most big pharmaceutical players see only incremental growth and rely on a big yield to attract investors.
Healthcare giant Baxter (BAX) partly fits this mold, but is better than some of the megacaps in pharma because it is more specialized. Baxter provides sophisticated treatments for immune disorders, kidney disease and other specific medical conditions — meaning it might navigate competition and patent trouble better thanks to specialization.
On the income side, Baxter’s 2.7% dividend is nice and very sustainable at 41% of the current year’s earnings and 38% of fiscal 2014 forecasts. BAX dividends also have grown briskly during the past few years in contrast to slower dividend growth in Big Pharma. Baxter paid a one-time dividend of 58 cents at the end of 2003, but now pays 49 cents a quarter for $1.96 annually — well more than three times the dividend a decade ago.
And broadly speaking, healthcare is the ultimate low-risk play in the long-term thanks to an aging baby boomer population that will need increased care in the years ahead.
Texas Instruments (TXN) might not be the sexiest stock out there in a post-PC age, where mobile devices are all the rage. But this chipmaker still does very brisk business across a host of tech segments, and in fact has recently eclipsed its pre-recession highs; TXN stock is up more than 40% in the past 12 months.
And when it comes to dividends, Texas Instruments is also a bit counterintuitive — but a serious player worth a look. Consider that in 2003, TXN paid 2.125 cents a quarter, and now pays 30 cents a quarter for an increase of about 13-fold. Furthermore, while payouts are at 60% of current-year earnings, they’re only about half of FY 2014 earnings, meaning more increases are sure to come in the years ahead.
While semiconductor stocks are obviously at risk in some ways, it’s important to remember that on a basic level we need chips to run just about everything these days — and while the sexiest players in mobile semiconductors might be growth investments, there’s nothing wrong with picking a slower but entrenched player like TXN for the income.
Options traders and commodity junkies should recognize CME Group (CME) as the Chicago Mercantile Exchange, a financial entity that operates a host of futures exchanges as well as providing its own exchange-traded products and derivatives.
Naturally, CME Group took one on the chin as the financial markets melted down in 2008 and its stock still remains down from peak levels before the Great Recession. But now that things have stabilized and dividends are plush, it could be a good buy.
Consider CME paid 2.8 cents a quarter in 2003, and now pays 45 cents for an amazing dividend growth rate of more than 1,500% in 10 years.
Admittedly, a lot of that was fueled through acquisitions and expansion that won’t be replicated, and right now the payout ratio for CME is higher than the others on this list. But as the economy mends and capital markets heat up, expect big things from CME Group both in regards to share price and dividend payments.
Cisco (CSCO) has a short track record as a dividend payer, but the low payout ratio and healthy yield right now should qualify this technology stock for any income portfolio.
Since its first dividend paid in March 2011, Cisco has already nearly tripled its payout from 6 cents quarterly to 17 cents. That’s good for a respectable 2.8% yield — and a sustainable one, too. While there are short-term challenges to Cisco amid a weak enterprise spending environment, the company is very stable in the long-term with more than $51 billion in cash and investments and about $13 billion in annual operating cash flow … so don’t expect Cisco to go anywhere, and take comfort in that cash cushion to support existing and future dividends.
There admittedly are problems in enterprise tech broadly as businesses cut back and global economic uncertainty reigns. But the top and bottom lines are both marching higher quarter after quarter at CSCO, so this pick is stable in the long-term.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.