5 Strong Dividends Without Big Downsides

06/06/2012 11:15 am EST

Focus: DIVIDEND

John Heinzl

Reporter and Columnist, GlobeInvestor.com

The names may be familiar, but there’s a reason for that: they have proven themselves through some of the most reliable and steadily increasing dividends around, writes John Heinzl, reporter and columnist for Globe Investor.

Don Taylor, lead manager of the Franklin US Rising Dividends Fund, wants the best of both worlds when he chooses stocks for his $574 million fund.

He wants companies that have the ability to increase their dividends by 10% or more for years to come. And he wants to make sure the stocks won’t blow up if the company misses estimates or releases other bad news.

“With my companies, if I’m identifying them correctly, the odds of a huge negative surprise are pretty limited,” he said.

Perhaps not surprisingly, many of the roughly 50 stocks in the fund are large, blue-chip companies that are leaders in their industries and have long track records of rising dividends. Specifically, companies must meet the following criteria:

  • The dividend must have at least doubled over the past ten years.
  • The payout ratio—dividends as a percentage of profit—must be less than 65%, and ideally less than 40%.
  • The price-to-earnings (P/E) ratio must be in the lower half of its range over the past ten years.
  • The ratio of long-term debt to total capital must be 50% or less.
  • The debt, if rated, must be investment grade.

Broadly, the goal is to identify growing companies with strong balance sheets and ample cash flow both to reinvest in the business and fund an increasing dividend. Here is a sample of companies that made the cut:

IBM (IBM)
Dividend yield: 1.8%

5-yr dividend growth: 19%

As a technology company focused on software and services, IBM benefits from long-term customer relationships that generate recurring revenue.

Historically, IBM has placed more emphasis on share buybacks than dividends, but with a payout ratio of just 22% and only modest reinvestment needs, the dividend will likely grow faster than earnings over the next few years, Taylor said. The P/E of less than 13 based on 2012 estimates “looks very attractive to us,” he said.

Wal-Mart (WMT)
Dividend yield: 2.4%

5-yr dividend growth: 14.5%

Wal-Mart’s same-store sales growth stumbled in recent years, but the company seems to be back on track after addressing problems in its stores. What’s more, it is focused on improving profits in emerging markets such as China and Brazil, where it is deriving much of its growth.

The company has increased its dividend for 38 consecutive years and, with sales and earnings marching steadily higher, there’s every reason to expect the trend will continue.

Johnson & Johnson (JNJ)
Dividend yield: 3.9%

5-yr dividend growth: 8.5%

Johnson & Johnson’s stock has gone sideways since 2010, when it was forced to close plants and recall over-the-counter products such as Tylenol, Benadryl, and Motrin because of quality-control concerns.

But the dividend continues to climb and, with a slate of new prescription drugs coming and patent expiries largely behind the company, Taylor thinks sales and earnings growth are poised to accelerate. In the meantime, investors are paid to wait with a 3.9% yield.

Becton Dickinson (BDX)
Dividend yield: 2.5%

5-yr dividend growth: 13.3%

Becton Dickinson makes a broad range of medical supplies, diagnostic products, and laboratory equipment, which puts it in the right place to benefit from the aging population.

Because many of its products are small-ticket items such as syringes that must be replenished frequently, the company is less sensitive to cuts in health-care spending. But what really excites Taylor is the potential growth in emerging markets.

McDonald’s (MCD)
Dividend yield: 3.2%

5-yr dividend growth: 22%

Taylor worked at McDonald’s while he was in high school and college. And now, as a fund manager, he’s become a big fan of the Golden Arches.

The company has been squeezing more profits out of existing stores by introducing new menu items and speeding up drive-thrus, for example, and it’s also growing quickly in China and other emerging markets. Same-store sales have been growing steadily, and he expects that trend will continue.

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