Five "Foundational" Stocks to Start a Portfolio

06/29/2020 5:00 am EST

Focus: STRATEGIES

Prakash Kolli

Founder and Author, Dividend Power

It is fairly simple to start as a do-it-yourself dividend growth investor. It really comes down to three basic principles: save, knowledge, and invest, explains Prakash Kolli, income expert and editor at Dividend Power

But if you have some money saved, some basic knowledge about investing in stocks, and the ability to invest then what next? Which stocks do you pick? Well, there are some core or foundational dividend growth stocks that one could consider. Here are five:

Microsoft (MSFT)

It’s tough to argue against buying and holding Microsoft. It is one of two triple-A rated companies that investors could buy. 

Microsoft has a fortress balance sheet with a net cash position. This financial strength is great from the perspective of dividend safety and growth. The company is a Dividend Contender and should in all likelihood become a Dividend Aristocrat.

Microsoft is arguably the leading personal and enterprise software company. With that said, the market has largely recognized Microsoft’s strengths. It trades at a forward earnings multiple of over 30X. 

The yield is low at about 1.1% as of this writing. There was an opportunity to buy Microsoft in late-March during the COVID-19 market downturn. But right now, the stock is trading at near its record high.

Johnson & Johnson (JNJ)

Johnson & Johnson is the other triple-AAA rated company. Again, it is tough to argue against buying-and-holding Johnson & Johnson. The balance sheet is solid with a very low leverage ratio. 

The company’s success in paying and growing the dividend has been tested with time through many recessions. The dividend has been raised 58 years in a row. The company is one of 29 Dividend Kings placing it in a select group of stocks.

The stock is trading below the broader market valuation at the moment at a forward price-to-earnings ratio of about 18.7X. The current dividend yield is pretty good at roughly 2.8%. This is above the average yield of the S&P 500 at the moment. 

The company is facing some risk from lawsuits related to baby powder and opioids and the outcomes of both are not full known, but they will have an impact. Again, the price was depressed in late-March due to COVID-19, which was probably a good time to buy the stock.

Proctor & Gamble (PG)

Proctor & Gamble is another long-time favorite of many dividend growth investors. The company may not have a coveted triple-AAA rating, but its financial strength is excellent. The balance sheet is in good shape with low leverage ratio. 

The company is a Dividend King having raised the dividend for 64 consecutive years. For perspective, only nine companies have raised the dividend for 60+ years. This places Proctor & Gamble in a very exclusive group.

Proctor & Gamble is one of the premier consumer packaged goods company. Proctor & Gamble operates globally. The company’s brands are for the most part market leaders with a No. 1 or No. 2 position. 

The stock is trading at a forward earnings multiple of almost 24X. This is roughly in-line with S&P 500 at the moment. The yield is about 2.7%. Proctor & Gamble is rarely undervalued due to its historically consistent results and years of dividend growth.

Lockheed Martin (LMT)

Lockheed Martin is not a traditional dividend growth stock. However, it has a solid balance sheet and is conservatively run. The company is a Dividend Contender having raised the dividend for 17 consecutive years. In my opinion Lockheed Martin will likely become a Dividend Aristocrat in time.

Lockheed Martin’s strength is its scale as the largest U.S. aerospace & defense company. It makes many aircraft and other products for the U.S. Army, Air Force, and Navy. The company has limited competition in this market space.

The stock is trading at a reasonable valuation of 15.9 times forward earnings. It is trading at earnings multiple lower than the average for the S&P 500. The current yield is ~2.5%, which is decent. 

3M (MMM)

3M is arguably the premier industrial conglomerate stock. It is a quality stock with decent financials. Leverage is a bit high due to the recent Acelity acquisition and using some debt to buy back shares. The company is a Dividend King; it has raised the dividend for 62 straight years. 

3M is a company most of us know through its consumer products. The company makes and sells Post-Its, N95 masks, Scotch tapes, Scotch-Brite sponges, ACE bandages, Scotchgard, Command hooks, and Filtrete filters. 

But 3M is also a supplier to many other manufacturers including the automotive and electronics industries. In fact, the company makes over 60,000 products. The broad portfolio provides some diversification. 3M is ranked No. 64 global brand in 2019 by Interbrands.

3M is trading at a forward price-to-earnings multiple of 19.8X at the moment. This is not too undervalued. But the yield is almost 3.7%. 

Overall, I like quality companies for my large cap dividend growth portfolio. These five foundational dividend growth stocks serve as a place to start researching for those interested in dividend growth investing. There are other potential choices besides the ones listed above. (For full disclosure, Parkash Kolli is long MSFT, LMT and MMM.)

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