If you are a retirement and/or income investor, there is an investing commandment that you probably have never heard of, and therefore don’t obey — thou shalt not live on dividends alone. It is a big mistake to just look at a high yield and buy the stock blind. That dividend growth alone may generate income that you need, but I guarantee that you are placing yourself in a higher risk category than you realize.
Just because a company pays a dividend, grows its dividend regularly or is even a Dividend Aristocrat, does not mean it is going to give you the returns you need for retirement.
That’s because inflation is not just 3%. It is actually closer to 10%. This is one of the dirty little secrets that your broker and the investing business don’t want you to know. It is the fundamental reason why I created The Liberty Portfolio — to inform investors that they are not properly invested. You need to generate real returns of 10% annually to retain your purchasing power.
So buying a “safe dividend” stock that pays 3% isn’t enough. That dividend growth also needs to be growing at a rate that brings your total annual return to 10%.
Dividend Growth: Aflac
The first dividend aristocrat to buy that will deliver those 10% annualized returns is Aflac Incorporated (NYSE:AFL). Yes, the commercials that feature the duck. However, AFL has a fantastic business focusing on high-margin insurance products in both the U.S. and Japan. That’s right. In fact, Japan comprises almost 70% of its revenue.
In Japan, AFL offers voluntary supplemental insurance products, including cancer plans, general medical indemnity plans, medical/sickness riders, care plans, living benefit life plans, ordinary life insurance plans, and annuities.
Here at home, AFL offers products designed to protect individuals from depletion of assets comprising accident, cancer, critical illness/care, hospital indemnity, fixed-benefit dental, and vision care plans; and loss-of-income products.
AFL pays a 2.12% dividend, but analysts see as much as 13% annualized growth over the next five years. That seems a bit high to me, but even 8% hits our target.
Dividend Growth: VF Corp
VF Corp (NYSE:VFC) is not a company that sounds interesting or, for that matter, a company that most investors have even heard of. In this case, it is a dividend aristocrat with an amazing portfolio of brand names that I bet most people have actually heard of: The North Face, Vans, Timberland, JanSport and Eagle Creek.
These are the very best quality outdoor clothing and gear. As specialty retailers, they are not as susceptible to the clothing retail nightmare that has been plaguing other names.
Earnings are seasonable, but the TTM net income is about a billion dollars. It’s 7.1% annualized expected earnings growth plus 2.65% dividend yield, brings us closer to our target. Moreover, that dividend is growing at a rate of about 18% going back five years.
Free cash flow is excellent and consistent, ranging from $1 billion to $1.5 billion annually, with a payout ratio of about 47%.
Dividend Growth: Cintas
If you pay attention to people you meet at everyday jobs, like janitors or firemen or other types of homogenous workers, you’ll find the products of Cintas Corporation (NASDAQ:CTAS).
This dividend aristocrat makes uniforms of all shapes and varieties. While it may seem simple at first glance, remember that many uniforms have to be specially designed. Firefighter gear, for example, must be fire-resistant. Plumbers prefer water-resistant gear.
CTAS stock is up 260% in the past five years, which is why its yield is only 1.1%, despite the fact that its EPS is growing 14%, and its five-year annualized dividend growth rate is about 19%.
With a strong growth rate and a business that serves a global workforce that constantly needs to replenish its uniforms, as well as develop new uniforms for new workers, CTAS is poised to deliver 10% returns for some time.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at [email protected].