Wednesday, August 12, 2009

13 dividend stocks to enter on dips

Ever since the markets hit a milti year low in March, investors have been wondering how sustainable the advance is. Some claim that the bear market is over, while others believe that the worst is yet to come in the grand scheme of events.

Intelligent dividend investors are not worried about short-term fluctuations in the markets however. They understand that if they follow a rigorous screening process and acquire a diversified mix of the best dividend paying companies in the world, their distributions would provide a positive return in any market. In a previous post I identified 12 attractively valued dividend stocks to acquire now. It is important however not to overpay for stocks, even those with exceptional moats, as this could lead to underperformance relative to their benchmark over time.

If the markets were truly overstretched, then a slight retracement from markets recent highs would be a welcoming sign for income investors, who are looking to exploit these conditions by acquiring great franchises on dips. Pockets of opportunity allow dividend investors to buy solid businesses at reasonable prices, decent yields and acceptable dividend growth rates.

In order to capitalize on such opportunities, I have screened for companies, which have raised their dividends for more than 25 consecutive years. My criteria were are follows:

1) Stock has increased dividends for more than a quarter of a century
2) Price/Earnings Ratio of less than 20
3) Dividend payout ratio of less than 50%
4) Dividend yield is more than 2%, but no more than 3%

The companies, which I identified in the screen, are listed below:

(Open as a spreadsheet)

I require a 3% initial dividend yield before initiating a position in a stock. Thus the above-mentioned stock list should be acquired only on dips below the target price. Another strategy for enterprising dividend growth investors is selling cash secured puts on the stocks below, with strike prices close to the target price mentioned above. I have provided some explanation why I require at least some yield below.

Investors often overpay for stocks because of the recency phenomenon, where they discount double-digit growth indefinitely. This leads to purchasing stocks with unacceptably low dividend yields, high P/E ratios and rosy predictions for strong dividend growth for eternity. Such conditions are simply unsustainable.

Thus by buying a stock with a dividend yield of at least 3% an investor’s income is relatively well covered in a scenario where the company stops growing its distributions. With this margin of safety the investor still generates some dividend income until they manage to sell the stock and re-invest the proceeds in a more promising dividend growth stocks. With a 1%-2% yielder, it would take forever for our enterprising dividend investor to earn a reasonable dividend income if distribution growth slows down or grinds to a halt.

Full Disclosure: Long MHP, MMM, SHW and WMT

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