Wednesday, July 27, 2011

Dividend Stocks make great acquisitions

Dividend Investing is one of the most misunderstood investment strategies. This strategy tries to focus on companies which have strong brands, wide moats and a customer base which is willing to pay a premium for the product or service the company is providing. These quality characteristics allow select dividend stocks to generate growing earnings per share, and generate excess cash flows each year. This excess financial liquidity is what provides the fuel for a corporate culture, where dividends are increased every year.

It is important to pay reasonable valuations for dividend growth stocks however, as buying them at ridiculous P/E ratios could lead to subpar returns over time. The nature of products and services that some of the best dividend stocks in the world deliver however makes them relatively immune from recessions. As a result, even during recessions and the bear markets caused by the recessions, these companies are able to generate strong earnings. This allows these corporations to pay and even increase distributions, thus providing investors a return on their investment even during the most trying of times for them.

These characteristics are what make dividend growth stocks the best investment in the world. One of the dangers of dividend growth stocks is that these features make them attractive takeover candidates. In a diversified portfolio of dividend equities, investors could reasonably expect to have a few companies that get acquired over time. Readers of this site might remember that with the Anheuser-Busch (BUD) acquisition in 2008, the Rohm-Hass (ROH) buyout in 2009 by Dow Chemical (DOW) as well as the most recent news about the potential acquisition of Family Dollar (FDO). The most recent evidence that dividend growth stocks have high chances of getting acquired includes the offer from Carl Icahn to buy Clorox (CLX) at a premium. Check my analysis of Clorox.

Other notable dividend growth stocks that have been acquired over the years include GEICO by Berkshire Hathaway (BRK.B), Gillette by Procter & Gamble (PG) and Alcon (ACL) by Nestle (NSRGY).

Some investors might not believe that having your stocks sold at a premium is such a bad deal. The issue is however, that these companies would do very well, irrespective who owns them. Such quality dividend stocks would likely keep growing, earnings more over time, and paying higher dividends to owners. This would also make these businesses more valuable as well. As a result, by selling at lower valuations today, dividend investors would not be able to capitalize on this future growth. In addition, investors would receive a lump sum in cash, and would have to do additional work in order to find a suitable substitute for the company getting acquired.


Full Disclosure: Long CLX, FDO, PG, NSRGY

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2 comments:

  1. Dear DGI:

    Thanks so much for your site & all your helpful comments. Going off some of your valuation comments in this post, can you (or any other knowledgable readers out there) discuss in more depth how you balance the valuation issue with time value of dividend increases? (Maybe there is an old post or article you can cite to.) For instance, it is important to wait on reasonable valuation (which might increase the yield from 2 to 3 % or some such dividend advantage). However, if a stock is increasing yield double digits per year, how long does it make sense to wait for valuation to come down before you lose in the long term missing out on the time value of the increases. Still learning to think through all these issues such as valuation, yield, growth, etc. - so be patient! Thanks-
    Cory

    ReplyDelete
  2. Thanks for the rundown! My husband invests us in a ton of these like Johnson & Johnson and I wasn't really sure how it worked.

    ReplyDelete

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