They are not usually exciting and they don’t normally make splashy headlines; but, on average, stocks that pay dividends outperform the market average over time. Since the end of 1929, the S&P 500 index has averaged an annualized return of 9.4%. But, only 5.2% of that total return was from growth. The remaining 4.2%, or 44.7% of the total, was due to dividends paid.
Don’t Settle for Average
Careful investors don’t have to settle for average returns; a little bit of due diligence can go a long way toward identifying businesses that produce higher yields with lower payout ratios than the overall market and are less expensive as well. A strategic, diversified investment in those special businesses is how long term investors can begin a profitable journey that requires minimal effort to maintain.
Not All Dividends Are Created Equal
When buying stocks for dividend yield, investors who take the extra time to assure they are buying a business with an above average yield at a below average price will be richly rewarded over time. In addition to buying at prices below the market average, it is also important to allocate capital toward businesses that have established a track record of increasing dividends year after year and possess the strength and stability to maintain that record over extended periods of time.
Financial stability should always be a cornerstone consideration. The 5-year average annual dividend increase and current payout ratios are good metrics for this evaluation. Debt to equity ratios are also an important consideration as debt and interest can become problematic in difficult economic environments. While not all businesses meet this criteria, there are some that do. It is also critical that long term investments be diversified across different market segments in order to spread risk.
Evaluating Some Prospects
The table shown provides some interesting possibilities for the beginnings of a diversified, dividend focused portfolio containing Potash Corp./Saskatchewan (USA) (NYSE:POT), Intel Corporation (NASDAQ:INTC), Herbalife Ltd. (NYSE:HLF) and Target Corporation (NYSE:TGT); all of which appear to provide metrics that are superior to the overall market in some critical areas.
| Business | S&P 500 | Potash | Intel | Herbalife | Target |
| Dividend Yield | 2% | 2.84% | 4.28% | 3.08% | 2.12% |
| 5-yr. Dividend Growth Rate | 5.19% | 43.1% | 14.09% | 31.95% | 20.64% |
| Payout Ratio | 34% | 29% | 39% | 28% | 30% |
| Price to Earnings Ratio | 15.8 | 13.32 | 10.96 | 8.47 | 14.67 |
| Price to Cash Flow | 15.6 | 12.9 | 5.6 | 7.3 | 8.5 |
| Debt to Equity | 1.57 | 0.41 | 0.26 | 1.16 | 1.07 |
As a brief review of this table will reveal, in the metrics covered, each of these stocks appear to be less expensive than the S&P 500 on average, while also providing a higher dividend yield and resting on very solid financial footings.
What Makes These Businesses Special?
Buying a stock just because it has a high current yield is not a Fool’s game; it is a fool’s game. Not all companies paying a high dividend will be able to maintain it. These businesses will not only be able to maintain the current dividend payouts, I expect all of them to increase them.
Potash Corp./Saskatchewan (USA) (NYSE:POT) makes fertilizers for the agricultural industry that are phosphate, potash and nitrogen based. It is one of the industry leaders. Without these products, the world would be unable to produce enough food from the acreage available to feed the growing population. As the emerging economies continue to grow, people will want to consume more and better food. The market for the products Potash produces is virtually guaranteed to grow as more food is required. The existing solid financials of this business at the end of a global recession and the necessity of its products provide ample assurance of its ability to easily maintain the dividend, and its 5-year history of generous increases indicate a willingness to raise it when practical.
