No one can blame income investors for seeking the best yields they can find. After all, the FED has been ripping them off for nearly eight years, with its policy of ultra-low … bordering on negative, interest rates.
Consider the 2016 YTD performance of the ten S&P 500 sectors. The top two performing sectors through August 5, 2016, were telecommunications at 19.6% and utilities at 17.9%.
Income investors have flocked into these sectors because their constituent stocks are traditionally high-yielders. Today, many of these stocks are expensive, and don’t represent good value at their current lofty price levels. High-yield junk bonds have also attracted investors desperate to eke out more income. However, safety and high-yield are NOT synonymous!
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In this market environment, investing in a stock (with the exception of a REIT) yielding more than 6% … is just asking for trouble. In fact, some of the best yields are found in companies where the fundamentals are deteriorating. There is a real risk of dividend cuts. It’s also likely that the share prices have fallen, thereby boosting the yields (artificially) until the dividends are cut.
It’s far wiser for safety-conscious income investors to take a more conservative approach. I suggest you focus on three critical questions, when deciding which stocks to add to your portfolio.
- Does the company generate consistent profit margins? Simply defined, that’s the money a company keeps in earnings, from every dollar of sales. For example, a 20% profit margin means the company keeps $0.20 for each dollar of revenue earned.
- Is there plenty of free cash flow? This is the cash the company uses to support the ongoing payment of dividends, develop new products, expand production, and reduce debt.
- Does the company have a long history of dividend growth? Studies show that investing in “growing dividend” stocks has provided the highest average annual return, from 1972 to 2014. (11.6% compared to 9.5% for stocks with flat or decreasing dividends.)
When you can identify a company meeting these criteria, you can feel confident that the stock is one that will reward you for decades. Here are three suggestions.
Becton, Dickinson and Company (NYSE: BDX) ticks all the boxes. Founded in 1897, BDX operates under two main business segments: Life Sciences and Medical Equipment. The company is one of the world’s strongest and safest companies with a dominant brand and the fundamentals to support a long history of increasing dividend payouts.
Becton, Dickinson has increased its dividend payout every year for the past 44 years, making it one of the coveted S&P 500 Dividend Aristocrats. The growth in dividend payout has averaged 12.5% each year. Its free cash flow has averaged over $1 billion every year over the past decade. That’s plenty of cash to cover … and increase its dividends every year. The stock pays a dividend of $2.64 for a yield of 1.52%. The company has long shown consistent net profit margins, averaging over 10% for the last ten years. Most companies would be happy with a net profit margin of 5%+.
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Disclosures: None
