Dividend stocks are more popular than ever. But if you are going to buy these kinds of stocks you need a dividend investing strategy that will result in a dividend stock portfolio that is safe and reliable.
Many investors do not spend enough time looking at the safety of a company’s dividend when building a dividend growth portfolio. Instead they reach for the highest yields now, without truly understanding if the payments are safe and likely to continue. A dividend that is reduced or eliminated has a huge negative impact on the business’s stock price, so the risk is not to be overlooked.
Creating a dividend stock portfolio consisting of just the highest current yields is not a dividend investing strategy that is likely to result in acceptable returns. You might do OK for a period of time, but often it will end badly.
I would particularly take a hard look at any company paying a dividend yield of 5% or more to make sure you are comfortable with the financial strength of the company, and therefore the safety of the dividend. Often when a company’s dividend yield is greater than 5% it is a cautionary sign that the stock market believes that there is a risk of a dividend reduction in the near future.
As you build your dividend growth portfolio, here are somethings that I would avoid when picking higher dividend yielding stocks:
The high yields of both companies are attractive. Both businesses yield well in excess of 5%. But the warning sign here is that their sales volumes are flat to shrinking. Their profits are holding up OK due to the constant price increases past onto customers. How long can that continue?
Altria (discussed above) has a dividend payout ratio of greater than 80%, which is a further sign of it being a risky business to include in your dividend growth portfolio.
Most investors are familiar with ATT as the large media and communications company. Dividend investors are tempted by the mouth-watering yield of more than 7%. However, when you look at the balance sheet of ATT you will see debt of over $160 billion that was used to build out their wireless network and make acquisitions. Although the large amount of debt alone is not an indication that ATT will cut its dividend any time soon, it is an indication that there is more risk to the dividend than most people realize.
Here are the criteria that we at Wealthplicity use to select dividend stocks. We will not recommend a dividend stock unless all five are met:
Because of this high bar that is set by these requirements, it is not surprising that very few of them yield more than 5%. Here are three that we highlight below:
PPL Corporation
PPL Corporation is a holding company for regulated utilities that they own in Kentucky, Pennsylvania, and the United Kingdom. They recently announced that they will seek to sell their United Kingdom business soon which will transform them into a totally United Stated based business once the sale is completed.
The utility industry is healthy these days and PPL Corporation is operating well within industry.
PPL Corporation pays a dividend that equates to a 5.4% yield based on the current stock price. That dividend is safely paid out of current year earnings, which is a good indication that PPL Corporation can afford to pay the dividend to shareholders. A 5.4% yield is on the high side for dividend yields of utility companies like PPL. I see this yield as high due to investors not liking the mix of company business between the United States and the United Kingdom, but this will be a temporary issue that will be resolved when PPL Corporation sells off its United Kingdom based assets.
PPL Corporation is led by Vincent Sorgi who became chief executive officer in early 2020 after various senior roles at PPL in recent years. He appears to be a well-respected executive who can lead PPL through the coming transition into a simpler United States based business.
PPL Corporation has a balance sheet that appears to be reasonably well capitalized using both equity and long-term debt. Some of the proceeds from the sale of its United Kingdom utility will be used to pay down long-term debt, which will make the balance sheet stronger.
One final note on PPL Corporation. The company has been rumored in the past to be a possible acquisition target. I see that as difficult to achieve while it is trying to sell its United Kingdom business, but something that could occur once they are solely a United States focused company with a much simpler story. If PPL Corporation is sold, we will get a nice healthy pop in the stock price.
Realty Income
Realty Income is one of the bluest of blue chips when it comes to real estate investment trusts investing. It invests in and leases out real estate throughout the United States. Realty Income is insulated from some of the woes of multi-tenant mall operators in that it owns mostly single tenant stores like convenience stores, drug stores and dollar stores. These types of businesses are highly resilient from the impact of COVID 19.
Realty Income has a long-term track record of paying and increasing its dividend. In fact, Realty Income has increased its monthly dividend more than 100 times since becoming a public company in 1994. So, while nothing is guaranteed going forward, that is a good indication that the dividend will continue to be paid. Current yield is just a bit under 5%.
Realty Income is led by the well-respected Sumit Roy who became Chief Executive Officer in 2018 after being with the company in senior leadership roles since 2011.
The balance sheet of Realty income is strong, financed with an appropriate mix of debt and equity. They are capitalized in a way that they are likely to absorb the current real estate downturn and come out the other side stronger than ever.
WP Carey
WP Carey is another blue-chip real estate investment trust with a long track record of paying and increasing its dividend to shareholders.
They invest in a diversified portfolio of real estate assets and are geographically diversified between the United States and Europe.
WP Carey has successfully navigated the uncertainty caused by COVID 19. With its strict underwriting criteria is has been able to collect 98% of its rents due from tenants in Q3 and also recently disclosed that it collected 99% in October.
WP Carey has grown its dividend each of the last 21 years and has a current yield of approximately 5.8% that looks secure.
WP Carey is led by well-respected chief executive officer Jason Fox.
WP Carey had a strong balance sheet with a good mix of debt and equity. This strong balance sheet will allow them to implement whatever strategy they set out to achieve.
In Summary:
Dividend growth investing can be very rewarding, with high annual returns that can outpace the S&P 500.
Finding safe dividend growth stocks will allow you to sleep well at night.
But don’t always go for the highest yield because it may indicate a problem with the company. And it may indicate that the market is pricing a future dividend reduction into the current price of the stock.
Instead use the criteria that we’ve outlined above to select dividend stocks that will give you a good return on your invested capital. Not all will yield 5% or more like the three we highlighted above, but you will be well rewarded over the long run.
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