As promised at the end of Part I of this two-part article, in Part II, I am presenting three more selections that will help investors round out a well-diversified, income-producing portion of their investment portfolios that will provide them with a safe, growing stream of dependable dividends to supplement their overall investment strategy. In Part I, the three options presented provide exposure to the commercial real estate, technology, and private equity/financial sectors of the market. In Part II, I am going to add further diversification by including positions in solid businesses involved in consumer retail, drugs and insurance.
Rock-solid retail dividends with rapid growth
When it comes to looking for reliable, rapidly growing dividends in the consumer retail space, it just doesn’t get any easier than looking at the king of the mountain, Wal-Mart Stores, Inc. (NYSE:WMT). The behemoth of Bentonville is the world’s largest retailer with operations in all 50 states, Puerto Rico and 26 other countries.
For many years Wal-Mart was the retail momentum darling of Wall Street but has now transitioned to a slow-growth value play. However, in the case of Wal-Mart Stores, Inc. (NYSE:WMT), slow growth is defined as a projected annual increase in earnings over the next five years of 9.3% for a company with a dividend yield of 2.4%. If my favorite metric for valuing this type of business, the sum of five-year projected growth rate plus the dividend yield, is applied to Wal-Mart, the fair market value of the business is 11.7 times next year’s estimate for earnings.
An iconic name in drugs with strong and growing dividends
As the 6th most recognized core brand in America, Johnson & Johnson (NYSE:JNJ) is also one of the best known names in the world. When it comes to consumer sales in health-related items, familiarity breeds comfort and sales; comfort and sales breed profits and long-term security for investors seeking passive income.
The current dividend yield of 3.09% is almost 51% higher than the current average of 2.05% for the S&P 500. With iconic brands such as Band-Aid, Listerine and Tylenol, the well-known psoriasis drug Stelara, and DePuy, its widely used line of orthopedic supplies, it’s hard to imagine that this business is trading at a valuation only about equal to that of the S&P 500 average; but that is right where it sits today. A business of the existing size and scope of Johnson & Johnson (NYSE:JNJ) is not going to deliver rapid growth, but it will deliver safety and consistency, two traits that are critical considerations for income investors. The company has increased its dividend payment at an annualized pace of 8.18% per year over the past five years and with forward five-year earnings projected to grow at a rate of 6.2%, it is quite likely that investors can expect the current dividend to be increased at levels far above the inflation rate.
If insurance is good enough for Warren Buffett…
The man perceived by many to be the greatest investor of all times used insurance companies as the foundation upon which to build his Berkshire Hathaway Inc. (NYSE:BRK.B). Insurance is a bit of an ironic business in that it sells a product to anxious buyers who willingly pay for something they hope they will never use.
Insurance underwriting is a very complex business and is based upon broad statistical averages that allow the insurance company to very accurately calculate the probability of clients filing a claim and the estimated size of those claims so they can set a premium level that will be higher than the claims paid. While they collect the policy premiums and wait for the inevitable claims to be filed, they invest the cash they are holding, known as the float, and earn a return on the funds invested.
Price-to-book value is one of the best metrics available for valuing insurance businesses, and dividend rates of growth coupled with current yield provide a good window through which to assess the attractiveness of a particular company as an investment opportunity. With a market capitalization of only $1.11 billion, Tower Group International, Ltd. (NASDAQ:TWGP) is a small-market capitalization insurer with some impressive numbers for potential investors to consider.
Tower Group boasts a current dividend yield of 3.45%, slightly more than 65% higher than the S&P 500 and has increased the dividend at an annual pace of 37.97% over the last 5 years. While many analysts like to value insurance companies at 1.4 times book (liquidation) value, I prefer to buy below book so I have a margin of safety for my capital. Tower Group International, Ltd. (NASDAQ:TWGP) currently trades at a price-to-book valuation of only 0.85, the equivalent of paying 85 cents to buy $1. To sweeten the deal even more, this business is trading at a multiple of only 7.96 times 2013 projected earnings and has an annualized projected earnings growth rate of 14% over the next five years. This business is carrying a bargain-basement valuation with superb forward projections and qualifies as an excellent choice for capital allocation.
Final thoughts for a diverse dividend-income portfolio
In part one of this two-part analysis, I suggested allocating 50% of capital applied to producing current income equally across three stocks to produce a yield of 4.45%. Allocating the second half of income-producing capital evenly across Wal-Mart Stores, Inc. (NYSE:WMT), Johnson & Johnson (NYSE:JNJ) and Tower Group International, Ltd. (NASDAQ:TWGP) will result in a current yield of 2.98% and produce a yield across all six businesses of 3.715%, 81% higher than the current yield of the S&P 500, while investing in a well-diversified group of businesses with excellent future prospects and a past history of raising dividends much faster than the rate of inflation.
The article Building An Income Fortress With Dividends Part II originally appeared on Fool.com and is written by Ken McGaha.
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