4 Dividend Payers that Defy Illogic

09/02/2011 11:30 am EST

Focus: STOCKS

Kelley Wright

Managing Editor, Investment Quality Trends

Sometimes it pays to keep it simple and look for good companies that have paid good dividends for a long time, writes Kelley Wright of Investment Quality Trends.

In the 1995 movie Babe, there is a scene where all the farm animals are called to a meeting where the Law of the Land is laid down by Rex, the male sheep-dog and undisputed head of the farm animal hierarchy.

Being naïve in the ways of the world, the young Babe questions the reason for one of the rules, and is told, “The way things are is the way things are.”

This scene is instructive as to how a belief system is transmitted by repetition. Said another way, if you hear something repeated enough times, it becomes hard-wired and accepted as an inviolate truth.

These belief systems, which can also be called memes or scripts, are universal to all cultures and environments. The investment culture is a veritable Petri dish of these scripts, several of which have been on display the last few weeks.

One of the most obvious examples is crude oil. With increasing evidence that the rate of economic growth is slowing in important regions around the globe, the conventional wisdom automatically defaults to the belief that the demand for crude oil and its distillates will decline.

As there are sufficient numbers of adherents to the conventional wisdom, it has translated into a decrease in the price of crude oil and logically, therefore, the share prices of major oil companies.

Putting aside for the moment that economic growth ebbs and flows, is there a more viable, plentiful, energy source that rivals crude oil? Admittedly, scientific and technological advances that might provide a viable alternative could appear at any moment.

While the markets and consumers would most likely welcome these advances with open arms, there would be a period of transition—a lag time, if you will—to build the infrastructure to deliver these new resources to industry and consumers.

As such, there will still be a demand for crude oil and its distillates for years to come. With no current visibility for any such advances at this time, it begs the question; will the price for crude oil be higher or lower one year from now? How about three years, five years, ten years?

NEXT: It’s the Economy, Investor

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It’s the Economy, Investor
Economic growth ebbs and flows. As such, company earnings will fluctuate in concert with economic cycles. As can be observed in instance after instance in our universe of blue chips, however, a cyclic fluctuation in earnings does not necessarily translate into dividend reductions.

An excellent example is McDonald’s (MCD):

  • In 2006, McDonald’s reported earnings of $2.30 per share and paid a $1 dividend.
  • In 2007, earnings declined to $1.93, yet the dividend was raised 50% to $1.50.
  • In 2008 earnings rebounded to $3.76, and the dividend was increased again to $1.63.

As we have stated many times, management knows far better the state of the company and its prospects. As such, the company that consistently increases its dividend does so because they have confidence in their ability to deliver the dividend, even though earnings may fluctuate year over year.

For this reason, we place a high value on those companies that have earned the “G” designation. The “G” designation “denotes a remarkable 10% average annual dividend growth over the past 12 years.”

Over the course of 12 years, it is quite possible to witness three or more complete business cycles from peak to trough. Twelve years is also sufficient time for the market to experience both bull and bear cycles. To achieve and maintain a “G” level degree of average annual dividend growth of at least 10% per year over 12 years is a truly exemplary feat of performance.

With the above description of performance in mind, now juxtapose the market meme that if economic growth is slowing, industrial companies with “G” designations such as Emerson Electric (EMR), Illinois Tool Works (ITW), Sigma-Aldrich (SIAL), and United Technologies (UTX) should be dumped because their earnings could possibly decline.

If the cash dividend and dividend trend represents the real value of a company, and the cash dividend and dividend trend of these companies remain intact, do you adopt the “the way things are is the way things are” meme of the conventional wisdom, or the long-term track record of performance?

We report; you decide.

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