This market presents a ripe environment for dividend paying stocks. With rising interest rates hurting bond valuations, dividends provide income that makes more sense than ever. If you feel the market is due for a correction, from its current record levels, dividend payers may also provide some of the safety you seek.
But not all dividend payers are created equal. We want dividend stocks that can increase their payment, so that they can compete with rising interest rates. The best dividend stocks offer a combination of a high dividend yield, a low pay-out ratio, and growth prospects as well.
I’ve compiled a short list of stocks with dividend yields over 2%, pay-out ratio’s under 60%, and growth prospects to boot. Consider these dividend stocks today.
Dividends in the cupboard
Few things in life are as constant as General Mills, Inc.
(NYSE:GIS). With its stable of household brand foods like Cheerios, Betty Crocker, and Pillsbury, General Mills, Inc. (NYSE:GIS) is a part of nearly every American life. The only thing, it seems, that is quite as steady as General Mills, Inc. (NYSE:GIS), is the company’s awesome dividend.
General Mills, Inc. (NYSE:GIS)could be a case study, showing how dividends are not created equal. When I say they have an awesome dividend, it’s not just because of the 2.95% dividend yield. For starters the company has a very low, 54%, pay-out ratio. Low pay-out ratios typically are a sign of dividend increases to come, and General Mills, Inc. (NYSE:GIS) is a perfect example of that. This business has had a whopping twenty three dividend increases since1983 without a single dividend cut! To boot, this Lucky Charms purveyor, has already increased its dividend twice since last year.
Separately, there’s real growth at General Mills, Inc. (NYSE:GIS) to fuel dividend increases going forward. Earnings and dividends have both increased around 10% annually over the past five years. And while most recent quarter showed a slight year over year drop, earnings are still expected to grow at about the same rate for General Mills year over year.
Dividends on tap
If there is a such thing as an “adult version” of General Mills, it has to be Diageo plc (ADR) (NYSE:DEO). With household name brands like Guinness, Baileys, and Smirnoff on tap, this business is also a part of every American life–the fun part!
Diageo plc (ADR) (NYSE:DEO) meets our criteria by paying a dividend yield of 2.31% with a sub-50% pay-out ratio, but its growth potential should lead to a higher dividend going forward.
This business not only operates in separate divisions within alcoholic beverages (wine, spirits, beer), but it holds multiple brands in each space. The companies brand portfolio holds three well known vodkas–Ciroc, Kettle One, and Smirnoff–in three separate vodka categories (ultra-premium, super premium, and premium). What makes this so wonderful for investors is that Diageo plc (ADR) (NYSE:DEO) is dominating the adult beverage landscape at every level. No matter what type of beverage a customer wants they’re likely to choose a Diageo plc (ADR) (NYSE:DEO) brand, and that’s lead to an industry leading return on equity (44% vs. an industry average of 27%).
Analysts’ consensus expectations are for earnings at Diageo plc (ADR) (NYSE:DEO) to grow from $5.92 last year to $8.32 by 2015. If that happens, you could see a price increase of more than $40, from today’s price, within two years (based on a historic P/E multiple). You can also expect, with such a low pay-out ratio, that the dividend will rise. The total return (dividends and capital gains) should be quite respectable for Diageo plc (ADR) (NYSE:DEO).
Dividends in the lab
Some investors may look at Baxter International Inc. (NYSE:BAX), a healthcare company, and fear changes from upcoming healthcare reforms but I wouldn’t. Considering this business supplies healthcare professionals and isn’t subject to insurance oversight or review, it should be safe. If anything, the influx of many (previously uninsured) new customers might benefit Baxter International Inc. (NYSE:BAX).
Like General Mills, Baxter International Inc. (NYSE:BAX) regularly increases its dividend. The company has increased its dividend eight times since 2007, now that’s amazing! Dividend increases almost always lead stock prices higher; simply put, we want stocks that have increased dividends before and will do it again!
I fully believe that Baxter International Inc. (NYSE:BAX) will have the earnings growth to keep its dividend marching upward. Earnings have grown consistently at about 9% while cash flows, and cash on the balance sheet, have grown significantly each of the last three years as well. A low pay-out ratio, growing earnings, and increased cash flows usually lead to dividend increases.
Dividends everywhere!
You can find dividends everywhere, but they’re not all created equal. Dividend paying stocks with low pay-out ratios, and growth catalysts, are more likely to increase their dividend payment going forward.
If interest rates do continue to rise, and bond values decrease, the dividend payers that meet these criteria will offer the best income alternative. They should see increased dividend payments and stable, if not spectacular, stock appreciation.
Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends Diageo plc (NYSE:DEO) (ADR). Adem is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article 3 Dividend Stock Picks for Your Portfolio originally appeared on Fool.com is written by Adem Tahiri.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
