Wednesday, September 29, 2010

Another reason for companies to pay dividends

I am a firm believer that companies that pay dividends by default represent an elite group of sound enterprises which should comprise an investor’s watchlist for further research. The second criterion should be focusing on fundamentals in order to determine whether the company could afford to not only generate enough cash to grow and maintain its business, but also to be able to distribute any excess to shareholders in the form of dividends. The third criterion that I use is that the company has been able to grow distributions for at least ten consecutive years. These criteria pretty much decrease the list of eligible dividend stocks to less than 300.

Nonbelievers of dividend investing often claim that only poorly managed companies or companies which are in decline tend to pay dividends. This group of investors often is under the false belief that a company will be able to reinvest all of its earnings back into the business, while achieving high incremental returns on investment. The problem with this strategy is that in the real world of corporate governance, it is extremely difficult for companies to reinvest all of their earnings back into the business and still maintain high profitability on any excess reinvested dollars. This is because of constraints in the utilization of these assets, management’s desire to build an empire at all costs, expensive acquisitions, bad timing of capital allocations and simply because not all investments are guaranteed to earn a profit. Warren Buffett is often cited as the type of manager who has been able to allocate funds to profitable ventures, and thus has avoided paying dividends to shareholders of Berkshire Hathaway. The only issue with this analogy is that unfortunately few CEO’s have the business acumen of the Oracle of Omaha who built a small struggling textile mill into a diversified conglomerate with a market cap of over $200 billion.

The main issue with the Warren Buffett analogy however is that while he doesn’t like paying dividends to Berkshire Hathaway (BRK.B) shareholders he does enjoy investing in companies that pay dividends. Some of the top holdings of Berkshire Hathaway pay over $1.5 billion in dividends, not including the preferred dividends from Goldman Sachs (GS), General Electric (GE) and several other firms. In his 2007 letter to shareholders he explained the best type of business to own:

We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire. After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses.

As seen above however, few companies can do this for extended periods of time. Most companies keep growing for a while, after which they are bound to generate excess cash flows, which fills their coffers. After a while this extra cash is bound to be misspent, the same way that many individuals in the US recklessly spend their income on things they don’t need. Some examples include Vivendi, which was transformed from a sleepy water utility into a media conglomerate through expensive acquisitions that almost bankrupted the company. Incidentally the water utility operations were spun off in early 2000s as Veolia (VEO) and they have outperformed the media empire they created.

Other examples of companies with extra cash that spent too much on projects that didn’t generate much in excess returns include Microsoft (MSFT), which has been able to dominate any technology for over two decades. The main driver of its earnings growth in the meantime however continue being the Windows operating system. Even tech giant Google (GOOG) was misallocating cash in 2007 when it announced the $30 million Google Space program.

Typical companies that don’t pay dividends besides new companies in existence for less than a decade, include either firms that need to reinvest all of their earnings back into the business in order to maintain their business or companies that are so weak that they cannot afford to pay dividends. The first type will generate returns to shareholders only if someone buys the business at a premium. If they do all the work and all they could show at the end of the year after all the work has been done is no more cash than what was in the coffers at the beginning of the year, then intelligent investors should definitely ignore them. Technology companies generally fall into this category, because of rapid product obsolescence, competition and weak consumer loyalty. While Altavista and Yahoo (YHOO) were popular internet search engines in the late 1990’s, Google (GOOG) was able to overthrown them by offering a better solution to customers. The second type of business that cannot afford to distribute any cash because of its inherent weakness includes such industries such as Airlines or US Automakers.

Just because a company pays dividends, doesn't mean that it cannot grow earnings in the process. Companies like McDonald's (MCD), Wal-Mart (WMT), Procter & Gamble (PG), Altria Group (MO) and Abbott Labs(ABT) are examples of that.

McDonald's Corporation (MCD), together with its subsidiaries, operates as a worldwide foodservice retailer. This dividend aristocrat has raised dividends for 33 consecutive years. Yield: 2.90%(analysis)

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. This dividend aristocrat has rewarded shareholders with higher dividends for 36 years in a row. Yield: 2.30%(analysis)

The Procter & Gamble Company (PG) provides consumer packaged goods in the United States and internationally. This dividend king has boosted dividends for over half a century. Yield: 3.10%(analysis)

Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes, wine, and other tobacco products in the United States and internationally. This dividend champion has rewarded shareholders with higher dividends for 43 consecutive years. Yield: 6.30% (analysis)

Abbott Laboratories (ABT) engages in the discovery, development, manufacture, and sale of health care products worldwide. The board of directors of this member of the S&P Dividend Aristocrats index has approved dividend increases for 38 consecutive years. Yield: 3.40%(analysis)

One issue with dividend stocks is that income earned by corporations is taxed twice. It is taxed first at the corporate level and then it is taxed at the individual shareholder income level once dividends are distributed. As a result of this double taxation some believe that investors are worse off. This being said I am a firm believer that if a company can reinvest all of its earnings in projects that would enable it to increase earnings while maintaining its returns on invested capitals it should not pay a dividend.

Unfortunately few investors realize that the IRS could tax companies on accumulated but undistributed earnings of corporations at its own discretion. The so called Accumulated Earnings Tax is imposed on regular C corporations whose accumulated retained earnings are in excess of $250,000 if improperly retained instead of being distributed as dividends to shareholders. To avoid unreasonable accumulation of earnings there should a specific plan for the use of accumulation. Otherwise the IRS will assess the tax at a flat 15%.

Full Disclosure: Long ABT,MCD,MO,PG,WMT

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Monday, September 27, 2010

Two Consistent Dividend Paying Stocks in the News

In the world of investing, there are thousands of companies that pay dividends. While companies do not have any control on their stock prices, they do have full control over the rate and frequency of dividend distributions that they pay to shareholders. Some of the strongest companies in the world, also happen to generate a lot in excess cashflow. As a result they have managed to increase distributions consistently like clockwork for many years.

One such company is McDonald’s Corporation (MCD), which together with its subsidiaries, operates as a worldwide foodservice retailer. Over the past week the company raised its dividend by 11% to 61 cents/share. This was the 34th consecutive year of dividend increases for the company, which is a member of the elite dividend aristocrats index. Yield: 3.25% (analysis)

The company’s CEO said: "Our ongoing financial performance reflects the strength of the McDonald's system and resilience of our Plan to Win. We remain committed to maintaining financial discipline and enhancing shareholder value. Our first priority is to reinvest in our business by allocating capital where we expect to drive sales and cash flow, generating strong returns. After these investment opportunities, we expect to return all of our free cash flow to shareholders over the long term through dividends and share repurchases. Today's dividend increase demonstrates our confidence in the long-term strength of our Brand."

Another company, which has consistently raised dividends for several years includes Lockheed Martin Corporation (LMT) engages in the research, design, development, manufacture, integration, operation, and sustainment of advanced technology systems and products in the United States and internationally. The company recently raised its quarterly dividend by 19% to 75 cents/share. The company has raised dividends for 8 consecutive years. Yield: 4.10%

Other companies which are in the process of building a long streak of dividend increases and also announced hikes in their dividend payouts include:

The First of Long Island Corporation (FLIC) operates as the holding company for The First National Bank of Long Island that offers various financial services to individual, professional, corporate, institutional, and government customers primarily in Nassau and Suffolk Counties, Long Island; and Manhattan. The company boosted its quarterly payout by 10% to 22 cents/share. This was the fourth annual consecutive increase since 2007. Yield: 3.50%

Covidien plc (COV) develops, manufactures, and sells healthcare products for use in clinical and home settings in the United States and internationally. The company raised its quarterly dividend by 11% to 20 cents/share. This was the second consecutive annual dividend increase for the company. Yield: 2.00%

Sanderson Farms, Inc. (SAFM), an integrated poultry processing company, engages in the production, processing, marketing, and distribution of fresh, frozen, processed, and prepared chicken products in the United States. The company raised its quarterly dividend by 13.30% to 17 cents/share. This was the second consecutive annual dividend increase since 2009. Yield: 1.60%

ConAgra Foods, Inc. (CAG) operates as a food company in North America and internationally. It operates in two segments, Consumer Foods and Commercial Foods. The company raised its quarterly dividend by 15% to 23 cents/share. This was the second consecutive annual dividend increase for the company. Yield: 4.20%

Microsoft Corporation (MSFT) develops, manufactures, licenses, and supports a range of software products and services for various computing devices worldwide. The software company raised their quarterly dividend by 23 percent to 16 cents/share. This was the first dividend increase since 2008. Yield: 2.60% (analysis)

Arlington Asset Investment Corp.(AIZ) invests in mortgage-related assets. Arlington Asset Investment Corp.(AIZ) declared a 71.4% increase in its quarterly dividend to 60 cents/share. Since 2005 the company has decreased its dividend regularly, which doesn’t make it a suitable investment to dividend growth investors. Yield: 11.70%

Invesco Agency Securities Inc. (IVR) operates as a mortgage real estate investment trust. The company raised its quarterly dividend by 35% to $1/share. The company has paid a fluctuating dividend since going public in 2009. Yield: 17.50%

Of the stocks mentioned in this article, I find both McDonald’s (MCD) and Lockheed Martin Corporation (LMT) to be attractively valued at the moment. However I would need at least two more years of dividend increases, before I add Lockheed Martin (LMT) to my dividend portfolio. I would consider adding to my position in McDonald’s (MCD) over the next few months when I have available funds and if my asset allocation allows it.

As for Microsoft’s (MSFT) dividend increase, I am not too excited about it. Several other large cap tech stocks have recently announced their intent to either initiate a dividend or pay higher dividends. Whether tech companies, which were the craze during the late 1990’s stock bubble, could afford to raise dividends for several years in a row, is yet to be seen.

Full Disclosure: Long MCD

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Friday, September 24, 2010

Piedmont Natural Gas (PNY) Dividend Stock Analysis

Piedmont Natural Gas Company, Inc. (PNY), an energy services company, distributes natural gas to residential, commercial, industrial, and power generation customers in portions of North Carolina, South Carolina, and Tennessee. It also operates various energy-related businesses, including unregulated retail natural gas marketing, interstate natural gas storage, and intrastate natural gas transportation.


The company is a member of High Yield Dividend Aristocrats index, and has increased dividends for 32 years in a row. At the latest dividend increase for Piedmont Natural Gas, the company raised its distribution by 3.70% in March 2010.

Over the past decade, this dividend stock has delivered a total return of 11.50% per year on average.

The company has also enjoyed a persistent increase of earnings per share, to the tune of 5.70% per year on average since 2000. For 2010 and 2011 analysts are expecting EPS of $1.57 and $1.68.

The annual dividend per share has increased at a rate of 4.50% per annum on average since the year 2000.

The dividend payout ratio has been in a downtrend over the past decade, with short bursts up followed by reaching lower levels afterwards. While the payout ratio is higher than my 50% threshold, it is adequate for a utility company. In other words, the dividend is adequately covered from the strong and consistent revenues and earnings.

The return on equity has stayed in a tight range between 10% and 13% over the past decade.

Overall I find Piedmont Natural Gas Company to be an attractively valued dividend stock. The company trades at a P/E of 13.80 , yields 4%, and has an adequately covered distribution, which has grown above the rate of inflation over the past decade. I would consider initiating a position in the stock at current prices.

Full Disclosure: None
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Wednesday, September 22, 2010

How to make money in dividend stocks despite WallStreet

Over the past years volumes on US stock exchanges have consistently reached record levels, which were unimaginable only a few years ago. The mass electronization of markets and the death of the trading floor, has provided accessibility to anyone in the world to trade US stocks on their computer. With the decrease in commissions and bid/ask spreads, investing in stocks has never been more appealing. Because of the ease of trading electronically, a large portion of the volume these days is being generated by super computer programs, which have been set up to squeeze in tenths of a cent from exchanges in liquidity rebates and spread running hundreds of times per day. The flash crash of 2:45 on May 6, 2010 showed investors that super computers pretty much rule the market these days. As a result, it may seem that only big investment banks such as Goldman Sachs (GS) which could afford to invest millions in sophisticated trading algorithms have any edge in the market.

This statement is partially correct, but only to the extent that one is trading with a short term horizon. There still seem to be pockets of opportunity, where the quarter end results mesmerized investment banks do not have the patience to venture out. One such pocket of opportunity entails following a strategy where investors disconnect themselves from WallStreet, and instead focus on what stands behind the stocks they are analyzing. This strategy has actually been followed by famous investor Warren Buffett throughout his investment idea. He is famous for saying “Even if they close the market for 5 or 10 years, we still make money”.

So how do investors make money in the market, even if the market is closed? The answer is very simple, but as every other simple question it is difficult to grasp because of its simplicity. The answer is to get back to the basics. Stocks are not just blips on a computer screen that you could purchase at the ask price and hope for another “fool” to unload to at a fraction of a penny higher. Stocks represent actual ownership portions in real businesses, whose products or services are being used by many consumers or businesses. Despite the fact that we live in a global economy ruled by ruthless multinationals, the basic idea is that stocks still represent ownership in real businesses. As a result, the only reason why long-term investors should purchase stock in a company is because :

1) The stock is trading at an attractive valuation. Depending on your style of investing that could be based off a P/E ratio of below 20 or a net current asset value to stock price of less than one.

2) The company behind the stock has solid competitive advantages, is run by competent management, and could achieve decent growth in earnings over time.

3) The company shares a portion of its growing profits with shareholders, by paying growing dividends.

Dividend investors are particularly well positioned for a situation where the market is closed, particularly because they are mainly interested in receiving a stable and growing stream of distributions, while seeing the business they invested in years ago keep growing. The stock market is important to dividend investors mainly to check for mispriced opportunities. While it would be unfortunate if the stock market were to remain closed for 5 to 10 years, dividend investing would still work. In fact dividend investing works in all market conditions, since it keeps providing a return on investment regardless of market conditions, as long as the business fundamentals allow it to do so. To most dividend investors a fall in stock prices is seen as an opportunity to accumulate more quality companies at bargain prices.

Investors could earn dividends with stocks such as these:

The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. The company is member of the S&P 500, Dow Jones Industrials and the S&P Dividend Aristocrats indexes. Coca-Cola has paid uninterrupted dividends on its common stock since 1893 and increased payments to common shareholders every year for 48 years. One of the largest holders of Coca-Cola stock is no other than the Oracle Warren Buffett, who is the chairman of Berkshire Hathaway (BRK.A;BRK.B) and one of the best investors in the world. Yield: %(analysis)

McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 33 consecutive years. McDonald’s is one of the world’s most recognizable brands. Because of this and because it has performed very well to stockholders over the years, it is one of the most widely held income stocks by dividend investors. Yield: % (analysis)

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates in three segments: Consumer, Pharmaceutical, and Medical Devices and Diagnostics. Johnson & Johnson is a major component of the S&P 500, Dow Industrials and the Dividend Aristocrats Indexes. One of the company’s largest shareholders includes Warren Buffett. JNJ has been consistently increasing its dividend for 48 consecutive years. Yield: % (analysis)

Medtronic, Inc. (MDT) develops, manufactures, and sells device-based medical therapies worldwide. This dividend champion has raised distributions for 33 years in a row. Yield: (analysis)

Diageo plc (DEO) engages in producing, distilling, brewing, bottling, packaging, distributing, developing, and marketing spirits, beer, and wine. The company offers a range of premium brands comprising Smirnoff vodka, Johnnie Walker scotch whiskies, Captain Morgan rum, Baileys Original Irish Cream liqueur, J&B scotch whisky, Tanqueray gin, and Guinness stout. Diageo is an international dividend achiever, which has raised distributions for over a decade. Yield: (analysis)

These stocks are just a sample of strong dividend payers, which have been able to raise distributions to their loyal shareholders for years or decades. For lists of complete dividend growth stocks, check out the dividend champions list maintained by David Fish.

Full Disclosure: Long DEO,KO, JNJ, MDT,MCD

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Monday, September 20, 2010

Eleven Stocks on the Dividend Rebound

A company typically initiates a dividend when it plans on paying it for the long term. It is signaling to the market that its operations are steady and self-sufficient enough to start returning profits to loyal shareholders. The danger to a company that lowers or suspends its dividend is frequently a violent market reaction on the down side.

As more companies are seeing the first signs of the economic turnaround, the number of dividend increases is rising. It is particularly intriguing when companies, which had cut distributions during the crisis, are starting to raise them again.

Last week eleven companies announced their intentions to pay a higher dividend:

Texas Instruments (TXN) Incorporated engages in the design and sale of semiconductors to electronics designers and manufacturers worldwide. The company announced that it will add $7.5 billion to its repurchase program and will also raise its quarterly dividend by 8% to 13 cents/share. The company has raised dividends for 7 consecutive years. This is in addition to the company’s $1.3 billion repurchase authorizations remaining at the end of its most recently competed quarter in June. Yield: 2%

"These actions are evidence of our company's ongoing commitment to return value directly to our shareholders," said Rich Templeton, Texas Instruments Chairman, President and Ehief Executive Officer.

YUM! Brands, Inc. (YUM), together with its subsidiaries, operates as a quick service restaurant company worldwide. The company raised dividends by 19% to 25 cents/share. The company has raised distributions for 7 consecutive years. Yield: 2.20%

Corporate Office Properties Trust (OFC) is a real estate investment trust (REIT) that engages in the acquisition, development, ownership, management, and leasing of suburban office properties. The company raised its quarterly dividend by 5.1% from 39.25 to 41.25 cents/share. This REIT is a dividend achiever and has raised distributions for 13 years in row. Yield: 4.40%

The Kroger Co. (KR) operates supermarkets in various formats in the US. The company increased its quarterly dividend by 10.50% to 10.50 cents/share. This was the fourth consecutive annual dividend increase since 2006, when the company initiated a dividend payment policy. Yield: 1.90%

International Bancshares Corporation (IBOC) is a banking holding company that provides commercial and retail banking services in south, central, and southeast Texas; and Oklahoma. The company raised its semi-annual dividend by 11.80% to 19 cents/share. This was the first increase since the company cut dividends by almost 50% in 2009. Yield: 4.40%

BioMed Realty Trust, Inc. (BMR) operates as a real estate investment trust (REIT) that focuses on providing real estate to the life science industry in the United States. The company raised its quarterly distribution by 13.30% to 17 cents/share. This was the fourth consecutive dividend increase since the company cut distributions in 2009. Yield: 3.70%

UDR, Inc. (UDR) is a real estate investment trust (REIT) that owns, acquires, renovates, develops, and manages middle-market apartment communities. The company raised its quarterly distribution by 2.80% to 18.50 cents/unit. This was the first distribution increase since the company cut distributions in 2009. Yield: 3.40% (analysis)

PACCAR Inc. (PCAR) and its subsidiaries design, manufacture, and distribute light-, medium-, and heavy-duty trucks and related aftermarket parts worldwide. The company raised distributions by 33% to 12 cents/share. This was the first dividend increase since the company cut dividends by 50% in 2009. Yield: 1.10%

LaSalle Hotel Properties (LHO), a real estate investment trust (REIT), engages in the purchase, ownership, redevelopment, and leasing of primarily upscale and luxury full-service hotels in convention, resort, and urban business markets in the United States. The company raised distributions by 1000% to 11 cents/share. This was the first distribution increase since the company cut distributions in 2008.Yield: 1.90%

Colony Financial, Inc. (CLNY) operates as a commercial mortgage REIT that focuses on acquiring and originating commercial real estate mortgage loans and real estate-related debt. The company raised its quarterly distribution by 19% to 25 cents/share. This was the third consecutive distribution increase this year for the REIT, which became public in 2009. Yield: 5.40%

Marsh & McLennan Companies, Inc. (MMC), a professional services company, provides advice and solutions in the areas of risk, strategy, and human capital. The company raised its quarterly dividend by 5% to 21 cents/share. This was the first dividend increase since 2008. Yield: 3.50%

I am placing the following companies on my watching for further research: Yum Brands (YUM) and Texas Instruments (TXN). I have a small position in Yum Brands (YUM), which seems to be doing very well in China, and I am looking to further add to my position on dips below $40. Last week I mentioned that tech stocks like Texas Instruments (TXN) might be changing their strategy to start paying higher dividends to shareholders. I would be researching TXN further in the future in order to evaluate whether it has a place in a dividend portfolio.

Full Disclosure: Long YUM

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Friday, September 17, 2010

Has the time for Tech Dividends arrived?

The problem with tech stocks is that few have a "wide-moat". Many are subject to rapid technology obsolescence, which causes them to re-invest most of their earnings back into the business just so they could maintain their share in the market. Most large cap tech stocks have hoarded billions of dollars in cash on the balance sheets, which sits idly or is used to overpay for companies with strategic patents in bidding wars for tech dominance.

Given all of the above, it is not at all surprising that few technology stocks have traditionally paid dividends. After the burst of the dot-com bubble however, many tech companies have started to pay dividends to their investors, many of which are probably still sitting on large unrealized losses. Examples of that include Microsoft (MSFT), Qualcomm (QCOM) and Oracle (ORCL). Cisco Systems (CSCO) is the latest large-cap name in the technology sector to announce their intent to pay a dividend by July 2011. Typically, companies that initiate a dividend tend to perform well over the months after the first payment. For Cisco investors, this small dividend would provide some return on their investment, which has been mostly flat since 2002. Whether Cisco will be able to grow the dividend is yet to be seen however.

Other tech bellwethers such as Intel (INTC) however have been paying a dividend since 1992, and have been regularly increasing it with the exception of 2002 and 2003. The company has still managed to generate outstanding growth in revenues and earnings over the period it paid dividends. Intel Corporation designs, manufactures, and sells integrated circuits for computing and communications industries worldwide. The company yields 3.40%, trades at a P/E of 11.20 and has an adequately covered dividend.

Another tech stock paying dividends is big-blue. IBM (IBM) has paid a dividend ever since 1911. International Business Machines Corporation (IBM) develops and manufactures information technology (IT) products and services worldwide. The company yields 2%, trades at a P/E of 10.60 and has an adequately covered dividend. (analysis)

Microsoft (MSFT) initiated a dividend policy in 2003, and also paid a onetime special $3 dividend in 2004. The company started raising dividends almost immediately, although it hasn’t raised distributions since 2003. If the 4Q 2010 dividend payment is not increased, the company’s would lose on its 6 year streak of consecutive annual dividend increases, which would have placed it on track to achieve a dividend achiever status in three years. The stock yields 2.10% and has a P/E of 12 (analysis)

Most large cap tech stocks still seem to prefer stock buybacks to dividends. Intel (INTC) has shrunk the amount of shares outstanding from 6.73 billion in 2000 to 5.52 billion in 2009. IBM has shrunk the amount of shares outstanding from 1.75 billion in 2000 to 1.31 billion in 2009. Microsoft (MSFT) has reduced the amount of shares outstanding from 10.76 billion in 2001 to 8.76 billion in 2010. The issue with buybacks is that they generally tend to be initiated and maintained when companies are flush with cash and as a result of higher earnings stock prices are high. During recessions companies end up eliminating their stock buyback programs, in an effort to conserve cash. In retrospect the companies end up spending shareholders money at overvalued stock prices, and stopping their buyback programs when prices are low. Another reason for buybacks is that they tend to mask the dilution of shareholders by options exercised by management at favorable prices. In addition to that, if managers are evaluated on earnings per share, they would have a better incentive to retire as much stock as possible. This would help them to increase earnings per share, even if total earnings are flat.

For shareholders to receive a consistent return on investment and to unlock the value of the cash rich balance sheets of tech companies, they should demand dividends. Dividends would provide them with an annual return, which is less volatile and more stable that relying on price increases alone. In addition to that, this is would provide another incentive for shareholders to keep holding onto their shares, which have probably gone nowhere over the past decade.

Full Disclosure: None

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Wednesday, September 15, 2010

Six companies with 20% yields on cost

I often get asked by new readers about the reasoning behind my fascination with companies that have a long history of consistent dividend increases. Often readers would see how a company like Wal-Mart (WMT) has raised distributions for many years, and yet still yields 2.40%. The answer to their question is as simple as understanding yield on cost.

Before we begin with yield on cost, it is important to understand how current dividend yield is calculated. By dividing the annual dividend payment by the stock price, one gets the current dividend yield. For example Wal-Mart (WMT) trades at $49.43, and pays a dividend of $1.21/share. As a result the current dividend yield is 2.50%. Given the fact that the company has raised dividends for over 36 years however, to the novice investor this might not look like a big achievement. After all, it is easy to purchase a high yielding master limited partnership such as Kinder Morgan (KMP) and get a yield which is almost three times the amount of yield one could generate by purchasing Wal-Mart (WMT) stock.

The truth is that today’s investor will generate 2.50% dividend yield over the next year. In other words an investor who puts $100 in Wal-Mart (WMT) today will generate $2.50 in annual dividend income. As a result if the price of Wal-Mart (WMT) doubles from here, but the dividend payment remains unchanged, our investor will keep receiving $2.50 in annual dividend income, despite the fact that current yield would be 1.25%. What the current yield doesn’t tell is what the yield on cost over the next year or decade is going to be. If the price of Wal-Mart (WMT) stock doubles over the next decade, but the dividend payment doubles as well, the current yield would likely stay around 2.50% in ten years. The yield on cost of the original investor with the $100 investment would be a cool 5%. Most novice investors in ten years would likely still ignore Wal-Mart (WMT) because of its supposedly low yield, while missing the important fact that rising dividends will lead to rising yield on cost over time.

The investor who purchases stocks with yield on cost in mind will be able to generate yields on cost on his original investment that will be much higher than the current yields on even high yielding stocks such as mortgage reits American Capital Agency (AGNC) or Hatteras Financial (HTS), with just a fraction of the risk. The key component is selecting stocks with strong competitive advantages, which grow earnings and could therefore grow distributions. Last but not least, investors should also allow some time in order to generate high yields on cost. Some dividend investors prefer waiting for a decade before attaining an yield on cost of 10%. Others, myself included, simply focus on finding strong companies with long histories of dividend growth, and let yields on cost increase for the maximum periods of time possible, without setting any targets. Needless to say, purchasing high quality dividend stocks is more of an art than science. By focusing your attention on such lists as the dividend achievers or the dividend aristocrats however, dividend investors have a high chance of succeeding in their quest for growing income.

Most of the original dividend aristocrats were able to achieve substantial yields on cost for a period of 20 years. Even those that managed to freeze distributions were able to generate high yields on cost over time, in addition to generating capital gains as well.

Colgate Palmolive (CL) was deleted in the index in 1990 for no apparent reason. According to yahoo finance the company increased its distributions in 1989. In addition to that the company’s own web page claims that it has increased payments to common shareholders every year for 46 years. One dollar invested in CL in 1989 would have turned out to $16.94 with dividends reinvested. The yield on cost is 27.70%. (analysis)

Johnson & Johnson (JNJ), which recently announced its 47th consecutive annual dividend increase, is still part of the index. A dollar invested in JNJ in 1989 would have turned out to $10.84 with dividends reinvested. The yield on cost is 26.4%. (analysis)

Lowe’s Companies (LOW) is still a component of the index after 20 years. The company has increased its dividends for 47 consecutive years. A dollar invested in MAS in 1989 would have turned out to $25.40 with dividends reinvested. The yield on cost is 39%.

Procter & Gamble (PG) is one of the original 26 members still present in the index. The company has raised dividends for over 53 consecutive years. A dollar invested in PG in 1989 would have turned out to $9.05 with dividends reinvested. The yield on cost is 20%. (analysis)

Coca Cola (KO) is still a member of the dividend aristocrat’s index. The company has increased its dividends for 47 consecutive years. A dollar invested in KO in 1989 would have turned out to $7.15 with dividends reinvested. The yield on cost is 17%. (analysis)

As for Wal-Mart (WMT), investors who purchased shares 26 years ago when it became a dividend achiever received a paltry yield of 0.60% at the end of 1984. Split adjusted the shares ended $1.18 that year. The yield on cost on those investors would be over 100% today. For an investor who purchased the stock when it reached the status of a dividend champion in 1999 however, the yield was still paltry at 0.30%, but the price was steep at $69.12/share. Eleven years later their shares are yielding 1.80% on cost, while their shares are still underwater. So while a lot of money could be made with the dividend growth strategy, investors should not overpay for stocks today. (analysis)

This goes to show that a company could achieve high growth rates, while still being able to pay increasing dividends.

Full Disclosure: Long all stocks mentioned above

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Monday, September 13, 2010

7 Dividend Stocks Raising Dividends and Returns

Investors could earn money in the stock market either through capital gains or through dividends. Dividends are the direct link between a company’s financial strength and investor’s return. Capital gains on the other hand are an indirect way for shareholders to profit from an enterprise. In addition to that companies cannot control their stock price, but they can control the level of the dividend payment. This is why an announcement of a dividend increase is a bullish sign for the company that has announced it.

Seven companies raised distributions to shareholders over the past week:

Philip Morris International Inc (PM), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. Philip Morris International (PM) raised its quarterly dividend by 10.3% to 64 cents per share. This was the third consecutive annual dividend increase since the company was spun off from Altria (MO) in 2008. Check my analysis of the stock. Yield: 4.70%

Brady Corporation (BRC) manufactures and markets identification solutions and specialty products that identify and protect premises, products, and people. Brady Corporation’s Board of Directors announced an increase in its quarterly dividend to shareholders from 17.5 to 18 cents per share. This was the twenty fifth consecutive annual dividend increase for this dividend champion. Yield: 2.70%

Casey’s General Stores, Inc. (CASY), together with its subsidiaries, operates convenience stores under the names of Casey’s General Store, HandiMart, and Just Diesel in the Midwestern states. The company raised its quarterly dividend by 35% to 13.50 cents/share. This was the second dividend increase for the company in 2010. This dividend achiever has raised dividends for eleven consecutive years. The company is in the middle of being a takeover target, which would prove once again that dividend stocks are attractive takeover targets. Yield: 1.20%

R.G. Barry Corporation (DFZ), together with its subsidiaries, engages in designing, sourcing, marketing, and distributing accessory footwear products in North America. The company increased its quarterly dividend by 40% to 7 cents/share. This was the first dividend increase since a dividend policy was initiated in 2009. Yield: 2.80%

Frisch’s Restaurants, Inc. (FRS), together with its subsidiaries, operates full service restaurants in the United States. The company raised its quarterly dividend by % to 15 cents/share. This was the third consecutive annual dividend increase since 2007. Yield: 3.10%

Flexsteel Industries, Inc. (FLXS) engages in the manufacture, import, and marketing of residential, recreational vehicle, and commercial upholstered and wooden furniture products in the United States. The company declared a quarterly dividend of 7.5 cents per share, a 50% increase over the prior rate of 5 cents/share. Yield: 2%

It is interesting how the board of PMI approved a dividend increase just a week after the board of former parent Altria (MO) also raised distributions. Overall I find Philip Morris International Inc (PM) to have better long-term prospects than Altria (MO), whose operations are predominantly focused on the US. The company expects to grow earnings by 14%-17% in 2010. Analysts also expect the company to earn $4.10/share in FY 2011.

Full disclosure: Long PM and MO

Relevant Articles:

- Why Dividend Growth Stocks Rock?
- Altria (MO) Dividend Stock Analysis
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Friday, September 10, 2010

Altria (MO) Dividend Stock Analysis

Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes, wine, and other tobacco products in the United States and internationally. The current state of the company was finalized after a 2007 and 2008 spin-off of Kraft Foods (KFT) and Philip Morris International (PM). Because these divisions accounted for over two-thirds of the company’s profit before the spin offs, the dividend payment had to be prorated for the legacy US tobacco business. As a result it appeared to be lower than before, while in reality an investor in Altria in early 2007 would have not only maintained but also increased their dividend income. If the dividend record of the old Altria was continued to these days, an investor would find out that the company has raised distributions for 43 consecutive years. This tobacco stock was the best performer in the S&P 500 for the 50-year period from 1957 to 2007.

Currently the company is trading at a low P/E of 13.60, yields 6.70% and has a dividend payout ratio of approximately 80%. The current annual dividend is $1.52/share, and has been raised twice this year. The company earned $1.54/share in 2009 and is expected to earn $1.90/share in 2010 and $2/share in 2011. Altria has a target dividend payout ratio of 80% of earnings per share. This means that the company can afford to pay a dividend of $1.60 by next year, and increase of about 5%. Since 2005, earnings per share from continuing operations attributable to Altria Group have increased by 6% annually.

The economics of the tobacco business are really interesting. Most of the revenue generated from sales go to Federal and State governments, while the cost of the actual product is very small relative to its sales price. The demand is inelastic. When prices for products increase, the increase more than offsets the decrease in consumption caused by the price. This leads to increase in revenues for the cigarette manufacturer.

Supposedly even Warren Buffett liked the economics of the tobacco business in the 1980’s when he said: "I'll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty.” However the increased regulatory actions against tobacco companies have prevented him from investing in the industry since “investments in tobacco are fraught with questions that relate to societal attitudes and those of the present administration...I would not like to have a significant percentage of my net worth invested in tobacco businesses."

The company is a dominant player in the US tobacco market, with a 50% market share in 2009. This mature market is in decline however, and as a result future growth in earnings per share could be difficult to materialize. They would likely come from efficiencies related to restructuring, such as the closure of its Cabarrus facility as well as the integration of smokeless tobacco company UST, which Altria acquired in 2008. Altria expects the UST acquisition to be accretive in 2010. Altria also expects to generate an estimated $300 million in UST integration cost savings by the end of 2011. Altria also expects to achieve approximately $290 million in additional cost savings by the end of 2011 for total anticipated cost reductions of $1.5 billion versus 2006. (Source)

The issues that prevent some investors from purchasing Altria stock are potential liabilities related to possible unfavorable judgments against the company. There were 129 cases pending against the company at the end of 2009 for example. Back in the late 1990’s for example the company’s stock price was hammered on fears that lawsuits could potentially wipeout Altria. In reality it is doubtful that the company would go under, since its tax revenues are needed to fill the empty state and local coffers.

Altria Group, Inc. also held a 27.3% economic and voting interest in SABMiller plc at December 31, 2009. The stake in the company was worth $12.70 billion at year end, which was higher than the 5 billion the investment is recorded on Altria’s books.

I view Altria as a hold if held on its own. If investors also own a share of Phillip Morris International (PM) for every share of Altria (MO) that they own, I would only then view Altria as a buy. Phillip Morris International (PM) owns the international operations of Altria and was spun off in 2008 as an independent company. The reason for that is that the risk of potential ban on tobacco products in the US which might jeopardize US tobacco businesses, is higher for Altria than Phillip Morris International. In addition to that, PMI has much greater growth prospects than Altria.

Full Disclosure: Long KFT, MO and PM

Relevant Articles:

- Altria Delivers Another Smoking Hot Dividend Increase
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Wednesday, September 8, 2010

Four International Dividend Stocks to Consider

International diversification is often cited as a must have for US investors, especially during periods when the dollar index is weakening and the US economy is soft. The rationale behind this idea is that a recession in the US is less likely to lead to recession in all countries. With the increased globalization and ease of capital movements across borders however the benefits of diversification can be rather elusive. This being said however, there might still be an ounce of truth behind the idea of diversifying globally, which might be beneficial to dividend portfolios.

Investing internationally does come with its own peculiarities however. For example the rest of the world seems to be following IFRS accounting standards, while US companies report under US GAAP. In addition to that, US investors could be subject to withholdings on foreign dividends received, which could only be deducted in taxable accounts. Furthermore, most foreign companies pay dividends in local currency, which is then translated into US dollars, before being remitted in investors’ brokerage accounts. This could lead to volatility in the US dollar dividend incomes of investors, whereas the dividend income could have been flat or rising in the foreign currency.

In order to make investors comfortable with investing internationally, I typically focus mostly on foreign shares which trade on US exchanges. That way investors would not have to worry about setting up foreign accounts with brokers abroad. However if you wish to start a portfolio consisting of telecom stocks from all countries in Eastern Europe, then this article is not for you. The differences between US and foreign based companies traded on US exchanges are the most I would like to worry about.

The starting point in a dividend growth portfolio selection could be found in the International Dividend Achievers index. It consists of shares of foreign companies traded on US exchanges which have consistently increased dividends for at least five consecutive years. Enterprising investors could also scour lists of major companies and check dividend histories in order to uncover stocks which might not be in this index, while still being traded on US markets. I have highlighted several foreign companies I own, which have a history of consistent dividend increases:

Diageo PLC (DEO) engages in producing, distilling, brewing, bottling, packaging, distributing, developing, and marketing spirits, beer, and wine. This international dividend achiever has raised dividends for over one decade and yields 3.50%. (analysis)

Unilever PLC (UL) provides fast-moving consumer goods in Asia, Africa, Europe, and Latin America. This international dividend achiever has raised dividends for over one decade and yields 4.10%. (analysis)

Royal Dutch Shell Plc (RDS.B) operates as an oil and gas company worldwide. The company explores for, and extracts crude oil and natural gas. The company is not on any dividend indices, despite its long history of consistent dividend increases. The yield is 6.20%.(analysis)

Nestle (NSRGY) engages in the nutrition, health and wellness sectors. This international dividend achiever has raised distributions each year since 1997. The stock currently yields 2.80%.

When I select international dividend stocks I typically use the foreign currency to determine whether the dividend was being increased for several consecutive years. I find that relying only on US dollar amounts for dividends paid produce volatility in income which could mostly be attributed to exchange rate fluctuations. While Investors in ADR’s such as the ones listed above will receive their dividend in US dollars, the history of dividend increases was generated in their respective foreign currencies.

Another issue that I have uncovered is that some companies pay distributions on a different schedule than US companies do. Nestle for example pays dividends once per year, while Diageo (DEO) pays dividends twice per year. Diageo’s first half dividend is always lower than its second half dividend, which somehow always manages to scare novice investors, who tend to assume that the distribution was cut.

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Tuesday, September 7, 2010

Five Dividend Machines Raising Distributions

The dividend approach to investing is not a get rich scheme. Investors who ultimately make money with dividends are interested in slow but steady returns, low volatility and positive feedback in the form of dividends during all market environments. The companies that manage to raise dividends for long periods of time are characterized by having a strong brand, and strong competitive advantages that help them increase earnings over time. Only companies that expect strong earnings in the foreseeable future will commit to raising dividends. As a result investors in these dividend machines enjoy an increasing stream of dividend income, which matches or exceeds inflation over time.

The companies that announced dividend increases over the past week include:

Diageo plc (DEO) engages in producing, distilling, brewing, bottling, packaging, distributing, developing, and marketing spirits, beer, and wine. This British company pays dividends twice per year, and the payments are split 40:60. The board of directors most recently recommended a final dividend of 23.50 pence per share, an increase of 6% from the year ended 30 June 2009. The full dividend would therefore be 38.10 pence per share, an increase of 5.5% from the year ended 30 June 2009. In addition to that the company announced it expects to raise dividends by another 6% in 2011. This international dividend achiever has raised dividends for over one decade and yields 3.50%. Check my analysis of the stock.

Verizon Communications Inc. (VZ) provides communication services in the United States and internationally. It operates in two segments, Wireline and Domestic Wireless. The company raised its quarterly dividend by 2.60% to 48.75 cents/share. The company has consistently raised its annual dividends since 2005. Yield: 6.50% (analysis)

HCC Insurance Holdings, Inc. (HCC), together with its subsidiaries, provides property and casualty, surety, group life, accident, and health insurance coverage, as well as related agency and reinsurance brokerage services to commercial customers and individuals worldwide. The company raised its quarterly dividend by 7.4% to 14.5 cents/share. This dividend achiever has raised distributions for 14 consecutive years. Yield: 2.30%

Friedman Industries (FRD), Incorporated, together with its subsidiaries, engages in steel processing, pipe manufacturing and processing, and steel and pipe distribution in the United States. The company raised its quarterly dividend by 100% to 8 cents/share. The company pays a fluctuating dividend payment however, and as a result does not have stability in the dividend payment. This instability is something I tend to avoid. Yield: 4.80%

Harris Corporation (HRS), together with its subsidiaries, operates as a communications and information technology company that serves government and commercial markets worldwide. It operates in three segments: RF Communications, Government Communications Systems, and Broadcast Communications. The company raised its quarterly dividend by 14% to 25 cents/share. The company has continuously raised dividends since 2002. Yield: 2.30%

The above list shows companies that raised dividends for the week. It is not a recommendation to buy or sell securities. I screen the list of dividend raisers every week in order to Uncover Hidden Dividend Gems, as well as to evaluate the overall breadth in dividend increases versus dividend cutters.

Full Disclosure: Long DEO

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Friday, September 3, 2010

Medtronic (MDT) Dividend Stock Analysis

Medtronic, Inc. (MDT) develops, manufactures, and sells device-based medical therapies worldwide. This dividend champion has raised distributions for 33 years in a row.

Over the past decade this dividend stock has produced a negative total return of 2.20% per year. The company was grossly overvalued in 2000, ending the year at a P/E of 68 which explains the poor returns over the past decade.


Earnings per share have increased by 14.10% per year since 2001. For FY 2011 analysts expect earnings to grow by 25.40% to $3.50, followed by an 8.60 % increase to $3.80 in FY 2012.


The annual dividend payment has increased by 17% per year since 2000, which was higher than the growth in earnings. The company has managed to achieve that by paying a higher portion of earnings to shareholders in the form of dividends. A 17% dividend growth translates in dividend payment doubling almost every 4 years on average. If we look at the company’s dividend history since 1977, the company has indeed managed to double quarterly dividend every 4 years on average.


The dividend payout ratio has increased from 24% in 2001 to 29% in 2010. Between 2002 and 2007 the company raised dividends at the pace of earnings growth, as evidenced by a stagnant payout ratio during the period. Since then however the company has started to raise dividends at a much higher rate, which indicates that there are high chances that investors could realize a high yield on cost in the future.


Returns on equity have remained above 19 for the majority of the past decade. Overall the ROE increased steadily over the past decade.

Overall Medtronic looks attractively valued at a P/E of 10.30, an adequately covered dividend and a yield of 2.80%. In comparison rival CR Bard (BCR) has a P/E of 16.00 and yields 0.90%, while rival Becton Dickinson (BDX) yields 2.10% and trades at a P/E of 13.80. While the stock has gone nowhere for one decade, the company has managed to more than triple earnings per share, which makes it a bargain at current prices. Many companies like Medtronic (MDT), Johnson & Johnson (JNJ) and Becton Dickinson (BDX) were overvalued in 2000, which explains why buy and hold dividend investing didn’t work as well over the past decade. If Medtronic’s earnings growth managed to be half as good as it were over the past decade, the stock could do well over the next decade.

Full Disclosure: Long JNJ and MDT

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Wednesday, September 1, 2010

The New Dividend Achievers of 2010

The dividend achievers index consists of US stocks which have raised their dividends each year for at least a decade. Over the past 20 years, this index has managed to outperform the S&P 500 by half a percentage point annually. The dividend achievers index is a great list of dividend stocks as a start. After applying criteria specific to one’s investment strategy, a manageable list for further research could be easily generated. For busy investors who would rather not have their hands dirty, there are several dividend etfs focusing on the dividend achievers. One such option is the Powershares Dividend Achievers (PFM) ETF. Another option is the Vanguard Dividend Appreciation ETF (VIG).

The index is rebalanced every year by deleting companies which have cut or eliminated distributions as well as the ones that have been acquired. Earlier in 2010 the newest addition to the index were announced:

Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes, wine, and other tobacco products in the United States and internationally. The stock yields 6.30% and trades at a P/E of 13.60. (analysis)

Atlantic Tele-Network, Inc. (ATNI), through its subsidiaries, provides wireless and wireline telecommunications services in North America and the Caribbean. The stock yields 1.70% and trades at a P/E of 24.

Casey’s General Stores, Inc. (CASY), together with its subsidiaries, operates convenience stores under the Casey’s General Store, HandiMart, and Just Diesel brand names in the Midwestern states. The stock yields 1.00% and trades at a P/E of 16.70.

EOG Resources, Inc.(EOG), together with its subsidiaries, engages in the exploration, development, production, and marketing of natural gas and crude oil. The stock yields 0.60% and trades at a P/E of 49.60.

FactSet Research Systems Inc. (FDS) provides financial and economic information on various companies, analytical applications, and client services to the portfolio managers, research and performance analysts, risk managers, marketing professionals, sell-side equity research professionals, investment bankers, and fixed income professionals worldwide. The stock yields 1.20% and trades at a P/E of 25.80.

Graco Inc. (GGG), together with its subsidiaries, provides fluid handling solutions to manufacturing, processing, construction, and maintenance sectors worldwide. The stock yields 2.50% and trades at a P/E of 24.30.

Hudson City Bancorp, Inc. (HCBK) operates as the bank holding company for Hudson City Savings Bank that provides a range of retail banking services. The stock yields 4.90% and trades at a P/E of 10.60.

Murphy Oil Corporation (MUR) engages in the exploration and production of oil and gas properties worldwide. The stock yields 1.70% and trades at a P/E of 13.40.

Northeast Utilities ( NU), a public utility holding company, engages in the energy delivery business for residential, commercial, and industrial customers in Connecticut, New Hampshire, and western Massachusetts. The stock yields 3.50% and trades at a P/E of 16.70.

NSTAR (NST), through its subsidiaries, engages in the distribution, transmission, and sale of energy in Massachusetts. The stock yields 4.20% and trades at a P/E of 11.20.

People’s United Financial, Inc. (PBCT) operates as the bank holding company for People’s United Bank that provides commercial banking, retail and small business banking, and wealth management services to individual, corporate, and municipal customers. The stock yields 4.50% and trades at a P/E of 58.60.

Plains All American Pipeline, L.P. (PAA), through its subsidiaries, engages in the transportation, storage, terminalling, and marketing of crude oil, refined products, and liquefied petroleum gas and other natural gas-related petroleum products. The units of this master limited partnership yield 5.90% and trade at a P/E of 23.

PPL Corporation (PPL), through its subsidiaries, generates and markets electricity to approximately 4 million retail, commercial, and industrial customers in the northeastern and western United States and the United Kingdom. The stock yields 5.20% and trades at a P/E of 24.20.

Prosperity Bancshares, Inc. (PRSP) operates as the holding company for Prosperity Bank that provides retail and commercial banking services to small and medium-sized businesses and consumers. The stock yields 1.80% and trades at a P/E of 13.

South Jersey Industries, Inc. (SJI), through its subsidiaries, engages in the purchase, transmission, and sale of natural gas for residential, commercial, and industrial customers. The stock yields 2.70% and trades at a P/E of 24.40.

StanCorp Financial Group, Inc. (SFG), through its subsidiaries, provides group insurance products and services in the United States. The stock yields 2.10% and trades at a P/E of 9.

TC PipeLines, LP (TCLP), together with its subsidiaries, transports natural gas in the United States, eastern Canada, and Mexico. The units of this master limited partnership yield 6.70% and trades at a P/E of 17.20.

Telephone and Data Systems, Inc. (TDS), through its subsidiaries, provides wireless and wireline telecommunications services in the United States. The stock yields 1.30% and trades at a P/E of 21.10.

Before rushing to purchase those stocks however, investors should evaluate the sustainability of the distributions from each individual company first. In reality, few of the companies added to the index in 2010 would be part of it 20 years from now. When I examined the 1991 Dividend Achievers additions, I noticed an interesting trend. Of the 20 additions for 1991 only 2 remained in the index 19 years later. On average the expectation is that a company would keep raising distributions for ten years after being admitted in. Check the research and the findings here.
The new additions list is also heavy on utilities, energy companies and financials, with the exception of Altria (MO), Graco Inc. (GGG) and Casey’s General Stores, Inc. (CASY).

Full Disclosure: Long MO

This article was included in the Carnival of Personal Finance #274: I Love NY Edition

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