The ‘holy grail’ of dividend growth investing is to find businesses that offer:
- Growth potential
- High dividend yields
- Consistent and safe operations
This article takes a look at 4 businesses that have:
- High dividend yields above 4%
- Above average total return potential
- Consistent operations backed by a long dividend history.
This combination is difficult to find in today’s low interest rate environment. Low interest rates increase the share prices of high dividend stocks, reducing their yields.
You can see the effect of rising interest rates on the S&P 500’s dividend yield.
The trade off between growth and dividends makes it difficult to find stocks with both a high payout ratio and solid growth prospects. The more a company pays out in dividends, the less it has to reinvest in growth.
Management must be very efficient with its capital allocation policies to have both a high dividend payout ratio and solid growth prospects. There is less room for error.
Finding businesses that consistently pay steady or rising dividends and have safe operations is difficult. Strong competitive advantages in the business world are rare. There are only around 180 stocks that have paid steady or increasing dividends for 25+ years.
Businesses with long dividend histories have proven the stability of their operations.
Consistent High Yield Stock #1: AT&T
AT&T stock currently offers investors a 5.2% dividend yield. This is more than double the S&P 500’s current 2.4% dividend yield.
AT&T has paid increasing dividends for 32 consecutive years. As a result AT&T is member of the exclusive Dividend Aristocrats Index. To be a Dividend Aristocrat a stock must pay increasing dividends for 25+ years. Click here to see all 50 Dividend Aristocrats.
The company’s dividend payment history is shown in the image below.
AT&T has managed to consistently increase its dividend over the last 3 decades because it has a strong competitive advantage. The wireless market in the United States is dominated by just 4 companies:
- Sprint (S)
- Verizon (VZ)
- T-Mobile (TMUS)
Together these 4 companies have ~90% market share. AT&T and Verizon each have over 30% market share.
Competition is reduced when an industry is dominated by only a few large businesses. Lower competition is not good for consumers, but great for the few dominant businesses.
There’s several reasons why the wireless industry is subject to domination by a few large corporations.
- Brand recognition and scale advantage
- Up-front costs of building infrastructure
- Government enforced wireless spectrum usage costs
These characteristics give AT&T its strong competitive advantage and the ability to consistently raise its already high dividend over time.
The company offers investors more than a high dividend and consistency…
AT&T’s earnings-per-share and dividends will very likely continue growing.
AT&T’s growth plans revolve around recent acquisitions of DirecTV, Lusacell (a Mexican wireless provider), and Nextel Mexico.
Source: AT&T 2015 Analyst Presentation, slides 39 and 42
The DirecTV acquisition gives the company better cross-selling opportunities. It will aslo give AT&T stronger digital content distribution. DirecTV also has a large presence in South America. AT&T will leverage DirecTV’s South American presence over time.
AT&T is focusing on the Mexican market. The company announced it will invest $3 billion to extend its high-speed mobile internet to 100 million Mexican consumers by 2018.
Customers on AT&T Mexico plans will be able to make calls on their Mexican plan while in the United States to others on AT&T plans. This ‘2 countries, 1 plan’ approach will have wide appeal in Mexico and help AT&T gain market share in the country.
I expect AT&T to grow its earnings-per-share at between 4% and 6% a year over the next several years. Growth will be driven by recent acquisitions and cost-cutting measures.
Growth combined with the company’s current ~5% dividend yield gives investors expected total returns of 9% to 11% a year.
The next company on this list is AT&T’s biggest competitor… The company makes an even more compelling investment case than AT&T.
Consistent High Yield Stock #2: Verizon
Verizon is the leader in the United States wireless industry. Verizon controls 34% of the wireless market in the U.S. -AT&T (T) controls another 31%.
The excellent economics of the heavily regulated wireless industry have already been discussed above.
Warren Buffett has taken notice. AT&T and Verizon are two of Warren Buffett’s highest yielding dividend holdings.
Verizon stock currently offers investors a healthy 4.5% dividend yield.
Verizon has a long dividend streak of its own. The company has paid steady or increasing dividends every year since 1984.
Where Verizon distances itself from AT&T is its better growth prospects.
Verizon closed a variety of deals in 2015 to position itself for future growth.
The company is selling its wireline assets in California, Florida, and Texas to Frontier Communications (FTR) for $10.5 billion.
Verizon is leasing the rights to over 11,300 of its company owned towers to American Tower Corporation (AMT) and selling American Tower Corporation 130 towers for an upfront payment of $5 billion
Verizon also acquired AOL & Millennial Media to focus on content distribution and advertising. This move will likely have the greatest long-term effect on Verizon’s growth.
Verizon is the gatekeeper between l internet access and your mobile phone. The company is seeking better ways to monetize this potentially lucrative position.
The Go90 mobile content service is free for everyone. Verizon is monetizing it with advertising. Verizon is being accused of violating net neutrality because it is not charging its customers for data overages while using Go90. Verizon wants to attract as much viewership as possible to its mobile streaming.
The company is targeting millennials in its long term mobile content play. The app focuses on sports, concerts, and popular web articles from the AOL acquisition.
In addition to its intelligent strategic moves, Verizon is seeing strong growth in its wireless segment.
The company is benefiting as consumers use increasing amounts of data on their smart phones and tablets. The trend toward more data has given Verizon a 7.5% earnings-per-share growth rate over the last several years.
Investors in Verizon should expect total returns of ~12% a year from the company. Total returns will come from dividends (~4.5%) and earnings-per-share growth (~7.5%).
Verizon appears undervalued at this time relative to its total return prospects. The company has a price-to-earnings ratio of just 12.6.
Verizon’s mix of value, high yield, stability, and growth make the company a favorite of The 8 Rules of Dividend Investing.
Consistent High Yield Stock #3: Philip Morris
Philip Morris (PM) is the largest tobacco company in the world based on its $139 billion market cap. Philip Morris has 28.7% global cigarette market share (excluding the United States & China).
The company sells tobacco products internationally. The company’s strongest brand is Marlboro. Philip Morris’ sister company Altria (MO) sells the same products in the United States.
Philip Morris stock has a high dividend yield of 4.5%. High dividend yields are nothing new to Philip Morris shareholders. The company’s stock’s average dividend yield since it was created is 4.4%.
Philip Morris offers investors more than just high yields. The company’s dividends have risen consistently since its creation. Notice the beautiful stair-step pattern of the company’s dividend increases in the image below.
Philip Morris currently has a high payout ratio of 92%. The company has maintained a payout ratio of around 70% for much of its corporate life.
Philip Morris is able to maintain a high payout ratio and offer consistent dividend growth because of the stability of its business.
The company’s Marlboro brand enjoys excellent recognition. It is the market leader. Advertising restrictions on tobacco products help to ‘lock in’ the company’s brand-based competitive advantage. New entrants and competitors will not be able to significantly shift the balance of brand power in the tobacco industry.
Additionally, Philip Morris sells a highly addictive product that is relatively inexpensive. The company enjoys high margins. Cigarettes have an inelastic demand curve. Philip Morris can continuously raise prices in excess of inflation and its customers will keep buying.
At first glance the tobacco industry appears to be a terrible place to look for growth. It is true that cigarette volume is declining globally at around 2.5% per year.
Source: Philip Morris 2015 Morgan Stanley Conference Presentation, slide 3
Despite declines, Philip Morris is still growing its earnings-per-share. Cigarette volume declined ~2.5% in fiscal 2015 for the international tobacco industry. Philip Morris cigarette volume declined 1.0%. The company is gaining market share, which is offsetting some of the industry headwinds.
Price increases, efficiency gains, and large share repurchases are helping Philip Morris to post double-digit earnings-per-share growth on a constant currency basis. The company saw constant-currency adjusted earnings-per-share grow 12% in fiscal 2015. That is far from a declining business. The company is expecting 10% to 12% earnings-per-share growth on a constant currency basis in fiscal 2016.
The biggest issue Philip Morris is facing today is not the slowly declining tobacco industry. The strong United States dollar is damaging earnings in the short-term. Currencies fluctuate. When the dollar begins to depreciate versus other global currencies (and it will at some point), Philip Morris will see excellent adjusted earnings-per-share growth.
Over the long run, I expect the company to generate earnings-per-share growth in the 7% to 9% a year range. This growth combined with the company’s 4.5% dividend yield gives investors in Philip Morris an expected return of 11.5% to 13.5% a year. I expect the stock to outpace the overall market over the next decade, just as it has over the past ~7 years.
Consistent High Yield Stock #4: Caterpillar
Caterpillar (CAT) is the global leader in earth moving equipment manufacturing. The company serves the following industries (among others):
- Road building
The decline in metal and energy prices have caused Caterpillar’s earnings to fall. The company’s customers are purchasing less equipment because of low commodity prices.
Declining earnings led to a declining share price. Caterpillar’s share price has fallen around 40% since Summer of 2014. This has resulted in a steep rise in Caterpillar’s dividend yield. The company is currently yielding 4.8%. The company is trading around dividend yield highs not seen since the Great Recession.
Whenever commodity prices decline, fears of Caterpillar dividend cuts surface. The company is expected to earning $3.50 in 2016. This would be the worst year for Caterpillar since 2009. The stock currently pays $3.08 per share in dividends. Even at commodity cycle lows, Caterpillar will be able to fund its dividend from earnings.
Caterpillar has paid steady or increasing dividends for 33 consecutive years. It is very unlikely the company reduces its dividend any time soon.
The company’s consistency is a result of keeping a relatively low payout ratio during prosperous times. This allows Caterpillar to continue paying steady or rising dividends during down cycles.
The company must have a strong competitive advantage to pay steady or rising dividends for 33 years and be a market leader. Caterpillar’s competitive advantage comes from its industry leading size and brand name. The Caterpillar name is synonymous with heavy equipment in the construction industry. Caterpillar’s competitive advantage is a combination of its size, brand, and manufacturing expertise.
Caterpillar may be cyclical, but it has produced excellent long-term growth.
From 1999 through 2014, Caterpillar compounded its earnings-per-share at 11.1% a year. In addition, the company has managed to increase margins over time. In 2005, Caterpillar’s operating margin was 16.6%. In fiscal 2015, it was ~19%.
Caterpillar will likely grow earnings-per-share by at least 7% a year over a full economic cycle. That’s a very conservative estimate. I believe it is more likely the company compounds its earnings-per-share at closer to 10% a year.
The growth drivers for Caterpillar are:
- Share repurchases
- Increased efficiency (higher margins)
- Global growth, especially in developing markets
Caterpillar’s historically high dividend yield shows it is likely undervalued at current prices. The company’s long-term growth rate of 7% to 10% a year combined with its 4.8% dividend yield gives investors expected total returns of 11.8% to 14.8% a year.
The 4 companies in this article all have above average dividend yields, strong competitive advantages, and solid growth prospects. Three of the four (Philip Morris is the exception) trade at low price-to-earnings ratios.
Dividend growth investors can lock in high dividend yields with these stocks. Better yet, the dividends should keep coming (in ever larger amounts) in the future.
Steadily rising dividend income is the benefit of holding high quality dividend growth businesses for the long run.
When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.
– Warren Buffett