9 Stocks To Plant Your Dividend Growth Tree

I’m what you call a stock market enthusiast. Being that I so often speak to friends, coworkers and family about investing, I often find myself often answering the question, “What Stocks Should I Buy?”

Of course, the answer to this question depends largely on who’s asking. What is their risk tolerance? Financial Goals? Timeframe? Do they refuse to invest in sin stocks? Are they looking for value, growth, dividends? What sectors? The list of variables to determine suitability is endless.

If you’re looking for some moonshots, then a previous article laid out some stocks I think are poised to be ten-baggers. However, if you want a path to secure wealth without as much risk, then dividend growth investing (DGI) is about as sure of a path toward building a wealth dynasty as anything else I’ve seen.

I love DGI, and it will undoubtedly be my main source of income during my early and lengthy retirement. Companies pay you to hold their stock; you use those payments to buy more shares of stock; leading to even more money…with which you use to buy more stock…more money…more stock…and all along the way the payments for each individual share also go up. It’s the power of compounding, and its effect is no more noticeable that in DGI.

DGI stocks come in three categories, analogous to a tree. Each type of company and its stock exhibit certain characteristics, which I’ve detailed in the below graphic:

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Note: “Growth rate” below taken from Yahoo! Finance consensus analyst EPS Growth Rates

Keep in mind these criteria are not hard and fast. These are just guidelines. Diversification is important when building a dividend growth portfolio. You should be looking not only at sector diversification (Tech vs. Telecom vs. Healthcare vs. Industrials), but also growth diversification (Low vs. High Growth). You want to have those companies that will do your heavy lifting and provide you some solid income (Trunk), as well as those companies that will give you some exciting growth (Leaves). If I were starting a Dividend Growth Portfolio all over again, I would start with the following nine companies:

Trunk Companies

These companies make up the most of the biomass (income) of your portfolio. You can rely on them to provide you solid and sizable income without much worry about their market position. They’ve been paying dividends for decades, and have been increasing those dividends with the same regularity as the earth’s revolution around the sun. You won’t get much growth from these guys; like the rings of a tree trunk, they’ll expand ever-so-modestly year after year, latching on acquisitions and improving operations. Their size, scale, broad revenue base and fortress balance sheets make them less susceptible to economic and business cycles. Management rewards shareholders and shareholders expect to be rewarded. Most of the company’s earnings are sent off to shareholders via dividends and buybacks, withholding only a minority portion of earnings for future growth. These companies, and their associated income, provides the rest of your portfolio the support it needs to flourish and grow.


hcp HCP, Inc. (HCP):

Yield: 5.68%
Dividend Growth: 30 Years
Payout Ratio: 72.4%
Annual Dividend Growth (Last 3 Years): 4.3%
Annual Dividend Growth (Next 5 Years): 2.8%

My Quick & Dirty Take: HCP Inc., is a health care Real Estate Investment Trust (REIT), which is to say, it distributes most of its cash flows to shareholders in exchange for favorable tax treatment. HCP operates 1,196 facilities, about 500 of which are Senior Living and Assisted Living facilities, 300 Post-Care/Rehab Facilities, 280 Medical Office Buildings, about 100 Life Science/Research Centers, and 20 Hospitals. These facilities are located in the U.S. and the U.K.

I don’t know much about anything, but I do know that there’s this pretty big baby boomer generation that has finally started hitting retirement. As they age, and given that folks are living longer today than any point in history, there is going to be massive demand for skilled nursing, assisted living, and independent living (Senior Community) facilities as well as all the square footage for offices to support those networks. The sound of knees creaking across this nation is deafening, and that is music to HCP’s ears. Three decades of dividend growth and a still-reasonable payout ratio leave me confident that HCP will continue to foster safe and reliable dividend growth for decades to come.

pgProctor & Gamble (PG):

Yield: 3.28%
Dividend Growth: 58 Years
Payout Ratio: 66.6%
Annual Dividend Growth (Last 3 Years): 7.2%
Annual Dividend Growth (Next 5 Years): 6.7%

My Quick & Dirty Take: If the investing mantra is “buy what you know” the Proctor & Gamble should be in every person’s portfolio. The trove of brands P&G holds touches every home in America and beyond: Gillette, Pampers, Luvs, Charmin, Bounty, Febreze, Gain, Oral-B, Mr. Clean–it’s insane. You know a company is doing well when they have several big brands competing in the exact same market. Look at this list of laundry detergent brands owned by P&G: Ariel, Gain, Tide, Bold, Dreft, Cheer, Downy, and Era. That’s like the whole laundry aisle. And P&G does that in a lot of spaces.

P&G is, in a lot of ways, like buying a bond. There won’t be the sort of volatility (Beta 0.84) that you’ll get investing in most stocks (or even in the overall market). The dividend is extremely safe and has a margin of safety against earnings, and the 58 years of consistent dividend growth should allow you to sleep at night knowing that, every April, you’ll get a raise in your passive income of six to seven percent. In the last recession, did you stop washing your clothes or brushing your teeth? Okay. Now that’s some dividend growth I can count on.

tghTextainer (TGH):

Yield: 6.26%
Dividend Growth: 7 Years
Payout Ratio: 62.9%
Annual Dividend Growth (Last 3 Years): 13.7%
Annual Dividend Growth (Next 5 Years): 12.0%

My Quick & Dirty Take: If you want one single pure-play on economic globalization, the rise of the Asian and Indian Middle Class, the global industrial recovery, and improving consumer tastes in emerging markets, then Textainer is your company. Textainer, kinda like P&G, operates in a very unsexy market–intermodal containers. If you’ve ever been around a big port, you’ll see those monstrous container ships that seem to get bigger every year, they typically say “Maersk,” “MSC,” or “Hyundai” on the side. All, those tiny (in comparison) packages on those ships are intermodal shipping containers–and the biggest lessor in the world of those containers is Textainer–with about 2 million of them.

Textainer has only been around for 35 years, and public for only 7. Since its IPO, Textainer has increased its dividend each year, and has maintained that dividend for the last 25 years. I see those trends in the first sentence as very big, important, and long-term catalysts supporting Textainer’s business model for years to come. It’s payout ratio leaves reasonable room for error, and given that 80% of its business is from clients with a relationship exceeding 25 years, I think Textainer is doing the right things to maintain and grow that dividend. Speaking of, that dividend shouldn’t be as high as it is. Textainer currently trades for less than 9x earnings, and is off 25% from its 52-week high due to some non-company specific global industry slowdowns. As such, dividend growth in the next few years certainly won’t match that last few, but I’m very content with that given the exceedingly high current yield, my high confidence in Textainer to ride the storm through to better times, and ultra-safe P/E and reasonable payout ratio.

Branch Companies

Branch companies are those that give you reasonable dividend yield, but also entice with their favorable growth prospects. These companies aren’t extremely mature like the trunk, and will tend to still get pushed around a bit with the economic environment, but they’re solid operators and in great industries.

Atwood Oceanics (ATW):

Yield: 2.91%
Dividend Growth: 0 Years
Payout Ratio: 15.6%
Annual Dividend Growth (Last 3 Years): N/A
Annual Dividend Growth (Next 5 Years): 0.3% (there’s just no way…)

My Quick & Dirty Take: With Atwood, I refer back to my emphasis on dividend criteria that there are no hard and fast rules. Atwood just paid out its first dividend ever last month. At a 15.6% payout ratio, one thing is certain–that dividend has significant room to grow–and I suspect it will. However, there are some questions abound for this pick, so I’ll offer a bit lengthier analysis.

Firstly, why are growth prospects for EPS only 0.3% for the next five years? Well, if you haven’t heard, oil prices are down a lot, and this has crushed Atwood. Atwood Oceanics is a oil rig company. They own 5 ultra-deepwater (with 2 more under construction), 2 deepwater (with one other than was recently scrapped), and 5 jackup (shallow water) oil rigs. Atwood purchases these rigs and leases them to companies like Shell, BHP, Noble Energy, and Chevron in waters all over the world, but predominantly in Southeast Asia, Australia, and Africa’s northern and eastern coasts.

At this moment, every single one of Atwood’s rigs is contracted out–whew! However, declining oil prices has placed concerns about what the contract rates for Atwood will be upon renewal of some leases, or their ability to find a lessee at all. Thankfully, the global active rig count seems to be nearing its nadir after falling for 22 straight weeks. From 1,920 active rigs, only 894 were active in the week ending today, and that’s getting awfully close to the 2009 low of 876 when oil had a more drastic plunge into the $30’s.

Oil rig counts are bound to rise now that oil seems to have halted its decline and given the demonstrated slowing decline in the active global fleet. It never did quite get down to $38/bbl as I predicted in my 2015 predictions, bottoming instead around $43. Additionally, Atwood has likely the youngest rig fleet in the industry. After Atwood receives delivery of ultra-deepwaters Admiral and Archer in 2016 and 2017, the average year of construction of its ultra-deepwater fleet will be the year 2014. Atwood’s state-of-the-art fleet command high dayrates are likely to be some of the last rigs to ever go idle in the event of a more protracted global rig slowdown. Uncertainty, though, is the word of the day, which has caused EPS projections to basically be nil.

What do I think will happen? Oil prices will continue their rebound (now at about $60). Atwood will continue to find tenants for its young rig fleet, and their prospects will become more clear. At any rate, though, Atwood trades for just a 5.6 P/E right now, and earnings are at least expected to be stable, so given the ultra-low payout ratio, I think we’ll see dividend growth above 10%/year for several years to come.

msexMiddlesex Water (MSEX):

Yield: 3.49%
Dividend Growth: 42 Years
Payout Ratio: 64.2%
Annual Dividend Growth (Last 3 Years): 1.3%
Annual Dividend Growth (Next 5 Years): 2.7%

My Quick & Dirty Take: The human body can go about 3 weeks without food, 3 days without water, or 3 minutes without air. Since air is generally free and ubiquitous, water is just about the best bet you have for sustainable revenues. Middlesex Water, with the great ticker, MSEX, is the perfect company to hydrate your portfolio with dividends.

Middlesex Water is one of only a handful of publicly-traded water utility companies, and I just had to get one in this list. It serves customers in New Jersey and Delaware, and has increased its dividend for 42 consecutive years and still maintains a payout ratio less than two-thirds of its earnings. That payout ratio is higher than most other water utilities that are publicly traded, however, given the predictability of earnings, I can accept that. I’d rather have a higher yield when it comes to water stocks as opposed to a conservative payout. Being a water utility, it’s revenues are largely negotiated with local bureaucrats, whereby the utility embeds escalation and inflation into its customer rates. This is just about as sure of growth as you’ll ever see.

aflAflac (AFL):

Yield: 2.43%
Dividend Growth: 32 Years
Payout Ratio: 26.0%
Annual Dividend Growth (Last 3 Years): 6.8%
Annual Dividend Growth (Next 5 Years): 4.4%

My Quick & Dirty Take: Warren Buffett is a big fan of insurance stocks; so am I. The reasons for loving insurers are compelling. The insurer takes in premiums, holds those funds (the float) in investments, and pays out claims and settlements as they come in. So long as their underwriting practices are sound, the gains paid on the investable float are a high-margin profit center for the firm.

Aflac is a specialty insurer providing disability and supplemental medical insurance in the U.S. and Japan. Despite being U.S.-based, 70% of Aflac’s revenues come from Japan, where Aflac insures one in every four households. In case you’ve been living under a rock for the last few years, Japan’s PM, Shinzo Abe’s “Abenomics” (which is just Japan’s colloquial term for our own QE that Bernanke put in motion), has caused the Yen to devalue by over 50% against the dollar since the beginning of 2013. This has severely hindered revenue growth, which is reported in USD, as well as hindered the return Aflac can receive on its investable float.

Aflac is a $28B company with a $103B float. Because of “Abenomics'” artificial demand for JPY Bonds has pushed down JPY Bond Yields, Aflac got only a 2.16% return on its Japanese float–exactly half the return Aflac received on its USD float. I’ve argued before that interest rates really have only one direction to go, and these low fixed income returns are only going to persist for so long. How long, though, is unknown and that is why Aflac’s revenue estimates are as low as they are.

Aflac isn’t waiting around, though, they repurchased $600M in stock in Q1 of this year (2.2% of all outstanding shares) and still have another $1B left in that authorization (3.6% of remaining shares). I say, wait around for bond yields to eventually rise. When they do, Aflac shares will rise in turn. However, the solid yield of 2.6% (which I expect will continue to grow at 6-7% per year, given the still-low payout ratio), and the associated buyback will make you wealthier in the meantime.

Leaf Companies

Leaf companies are the most exciting part of any dividend growth portfolio. Unlike the trunk and branches, leaves grow fast and noticeably, even though they don’t weigh very much (not much income). Yes, they sometimes fall off, but that’s part of the risk and excitement. Dividend-paying leaf companies are those that, in 20 years, will hopefully be Dividend Aristocrats of their own. If you get in your time machine (like I suggest at the end of this post) and look forward a decade or two, you can still see yourself using using the products and services of the companies below, as well as their seeing their greater potential.

sbuxStarbucks (SBUX):

Yield: 1.28%
Dividend Growth: 4 Years
Payout Ratio: 40.8%
Annual Dividend Growth (Last 3 Years): 25.2%
Annual Dividend Growth (Next 5 Years): 18.6%

My Quick & Dirty Take: Starbucks CEO Howard Schultz is a savvy operator. The 61-year-old billionaire entrepreneur is a first-ballot entrant in the CEO Hall of Fame, and will be a shoe-in B-School case study for decades to come. In the face of a diluted brand and an impersonal experience, in 2008, Schultz came back to Starbucks as CEO after an 8-year hiatus and did the unthinkable–started closing stores. He renewed the “Starbucks Experience” and continued to drive home the “Third Place” (after home and work) concept that he wanted people feel for their Starbucks. His success is clear. Since 2010, Starbucks store count has increased about 25%, but their revenues have increased almost 60%. How? Look no further than the countless initiatives Schultz has folded into Starbucks.

  • Teavana Stores and Tazo Tea- Bringing Tea Stores and products, which are wildly popular in Asia, to the U.S.
  • La Boulange Bakery – Starbucks now offers not only pastries, but quick serve sandwiches at its locations.
  • Starbucks Delivery – Partnering with Postmates to deliver your Starbucks (pilot programs later this year in Seattle and NYC) directly to your office.
  • Pro-Employee (Partner) Initiatives- Starbucks is revolutionary in how it takes care of its employees (whom they call “partners.”) They offer full tuition reimbursement. All Starbucks’ baristas—even part-timers—now qualify for tuition reimbursement for a full online four-year degree at Arizona State. 401(k) matching, even for part-timers. Employee stocks options, even for part-timers. And paid-time-off, even for part timers. I like companies like Starbucks and Costco that take care of employees–they’re the most valuable firm asset in service industries.
  • Keurig Partnership – Starbucks (and subsidiary Seattle’s Best Coffee) were among the first to partner with Keurig Green Mountain on K-Cups.
  • Starbucks Evenings – A concept, now available at several dozen Starbucks and growing, where Starbucks serves beer, wine, and small plate appetizers. At attempt to draw in evening crowds.
  • Mobile order and Pay – Starbucks loyalty program and its gift cards are the most successful such program in the world. 46 million Americans received a Starbucks gift card last Christmas, with a total of $1.1 Billion loaded (a big part of $16.5B annual revenue in 2014). Those are insane numbers. Starbuck’s embrace of new technologies (first cut Apply Pay adopter) allows them them most avenues available for customers to buy.

Starbucks is such an exciting company to follow and invest in. They make an addictive product and, like Kleenex or Frisbee, are synonymous with the product they sell. That is brand recognition and power that doesn’t come cheap. Starbucks, the stock (SBUX), doesn’t come cheap either, at 30x earnings. However, great companies nary come cheaply. With growth expected at 20% for the next half-decade and likely beyond, given the potential for Teavana in the $90B global tea market and other initiatives to increase the size of each patron’s check, a price of 30x earnings today will look like a bargain in a few years.

disDisney (DIS):

Yield: 1.05%
Dividend Growth: 4 Years
Payout Ratio: 23.0%
Annual Dividend Growth (Last 3 Years): 29.1%
Annual Dividend Growth (Next 5 Years): 14.4%

My Quick & Dirty Take: Looking around at the entertainment landscape, “upheaval” is the word of the day. Netflix is breaking barriers once thought impossible. YouTube is empowering small-timers to promote their videos on a global platform. HBO is uncoupling from linear TV and now offers their own stand-alone service (available on Apple TV), and ESPN (owned by Disney) and many other media outlets are doing the same. However, when you cut through all the noise, one idea is unchanging: content is king. And, more than any other company, Disney is the king of content.

Think, for a second, about the major blockbuster releases you’ve heard about hitting theaters (or are about to hit theaters). I think of names like Frozen, Avengers, Pirates of the Caribbean, Toy Story, Spiderman, or Star Wars. These are all Disney pictures. Even pictures like the live-action Cinderella, released earlier this year, quietly brought home $520 Million at the global box office–about what Terminator 2 got–but we’re accustomed to these home runs from Disney that it barely registered on the radar.

Disney is a 90-year-old company, and while some of it’s properties (like Snow White) date back 80 years, the staying power and recurring revenues on those properties is insane. Just two days ago, I was reading a book to our one-year-old about the Disney princesses. To think that I’m paying today for some character that was thought up in the 1930’s is crazy to me, but lucrative to me as an investor.

Disney is, in my opinion, just starting to hit its stride. Remakes, like the fore-mentioned Cinderella, Maleficent (2014), or Alice In Wonderland (2010) push the global box office turnstiles for up to a Billion bucks apiece. These are remakes! How much can Disney milk this cow? A lot, apparently. Disney has already announced live-action remakes for a half-dozen other legacy properties: Dumbo, Pinocchio, Winnie the Pooh, Mulan, Beauty and the Beast, and a sequel to Alice in Wonderland. Do you doubt that Disney can keep this gravy train rollin’? I don’t. Not with the vast stable of beloved and timeless brands Disney owns.

It seems that every time Marvel (owned by Disney) comes out with a new Avengers movie (released two weeks ago), or Fantastic Four (later 2015 release), or X-Men (2016 release), or Captain America (2016), film, we hear all about how it’s breaking some box office record. These Marvel franchises will have long lives, but, it’s not just sequels. With Ultron, the character Scarlet Witch became a fan-favorite, and seems ripe for the opportunity for her own dark movie, like The Sixth Sense (yep, also Disney). A one-off event? Hardly. Disney excels at turning a compelling secondary character into a main item in a later release (See Finding Dory, from Finding Nemo fame, releasing next year). And we haven’t even begun going in depth into non-Marvel properties. Just wait for Summer ’17, where we’ll have the Beauty and the Beast live-action film, Star Wars: Episode VIII, Toy Story 4, and another Pirates of the Caribbean in a single four-month period. It’s going to be crazy. This is just the movies, mind you. Which is just one of Disney’s five operating segments.

It is said that Disney is in the business of selling stories, but movies is just one story they sell. The other four operating segments allow you to make your own stories. They also have: Parks & Resorts; Interactive Media; Media Networks; and Consumer Products. All of these business segments feed off of each other. Like Disney World’s new Frozen and Star Wars attractions. The countless toys, books, and games. Disney’s ESPN and ABC properties. The video games made from these characters. I could go forever about the multitude of ways Disney gets you to gladly hand over money, but there’s just not enough space on the internet. Own this company, just own it. And do it before Disney World Shanghai opens up next spring. Better yet, do it before Star Wars opens in December. Better yet, do it before Pixar’s Inside Out opens next month.

aaplApple (AAPL):

Yield: 1.65%
Dividend Growth: 2 Years
Payout Ratio: 23.3%
Annual Dividend Growth (Last 3 Years): 11.0%
Annual Dividend Growth (Next 5 Years): 13.2%

My Quick & Dirty Take: Where do I even begin with Apple? It’s my largest holding and, hands down, the first place I would invest in any portfolio. With a $700B market cap, it seems impossible to call Apple a “leaf” company, but it is!

Even though Apple is the world’s most profitable company, its earnings-per-share are projected to be 40% higher in 2015 than 2014. Revenue is up 26% this year. These numbers were simply thought impossible for a company of Apple’s size; it has no precedent. Apple has sold over 700 Million iPhones, which is just a crazy number and even crazier when you think about how that number is growing so rapidly. Apple’s balance sheet would put most small countries to shame. It now has enough cash on hand ($195B) to buy Disney (Market cap $186B). Of course it won’t do this, but it shows how much leverage Apple has in its ability to increase its dividend, which is still just a paltry 23.3% of earnings. Speaking of cash, why on earth would Apple ever borrow money (it has $40B in debt). Well, if I could borrow at a rate around that of the Federal Government, I’d probably borrow, too (Apple’s 2025 bonds yield 2.6%, compared to 10-Year treasury of 2.29%).

Yah, but this is all coming off Apple’s greatest quarter ever, with the iPhone 6 absolutely destroying numbers. How can Apple continue this torrid growth? Well, first, the installed base of iPhones is so large, and with market share growing among new users and “switchers,” that just the upgrade cycle alone make Apple a compelling long-term buy. Just as Microsoft owned Desktop computing for three decades, Apple could be on the cusp of owning mobile computing for decades as well. The Apple Watch is wait-listed (upgrades are sure to come), and Apple Pay will soon (<5 years) become the predominant means of secure payment.

But, more than anything, Apple has brand power. For what it’s worth (which Interbrand values at $118B alone), Apple is the world’s most valuable brand. Every user is a promoter of the iPhone, and the iOS environment is sticky. Once you’re an iPhone user, you’re far more likely to be an iPad, Mac, Apple Watch, Macbook user as well. This explains why Apple has managed to grow its PC sales while the entire PC industry is in structural decline. Don’t sleep on this giant at a discount-to-market 15.8 P/E. Global expansion is still in the early innings, the potential for technological breakthroughs is always there (Car, TV, Bueller?), and with Apple buying back 6-8% of its shares each year, and along with a 1.65% and rapidly growing dividend, I can confidently sit back and watch my money grow by leaps and bounds.

In Conclusion

It’s an exciting time to be an investor (but isn’t it always). Opportunities abound for significant dividend growth and even some capital appreciation. Own these great stocks along with me, the best is yet to be!

Good Luck!

Eric

 

2 Comments

  1. With the birth of my first child recently I began thinking about planting a dividend tree for him at birth so that he may sit in its shade in a couple decades. Last month we opened a custodial account and bought JNJ and EMR. Over the coming months and years we’ll fill his account with long term dividend growth stocks and hopefully manage to create a passive income portfolio that he can one day add to himself. The stocks you list above all present good opportunities to do just that and many are already in my own dividend growth portfolio. Thank you for sharing.

    • That’s awesome! And thanks for commenting. I like that: “so that he may sit in its shade in a couple decades.” That draws a lovely picture.

      Looking at dividend growth over an 18-20 year period is super exciting to think about. It’s a crime I still don’t own JNJ, though.

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