Wednesday, March 3, 2010

The ten year dividend growth requirement

After my post when to break your rules, some readers asked me whether it is reasonable to enter into a dividend investment, which has not raised dividends for more than 10 years in row.

The truth is that dividend investing should require intense scrutinizing of companies, in order to find the best stocks for ones portfolio. Otherwise, investors could end up getting whipsawed in and out of stocks, which would increase trading costs and would make them less likely to reach their goals. The reason behind requiring at least a decade of consistent dividend growth is to weed out all companies which are inconsistent in their dividend policies. Few companies which raise distributions for less than a decade end up on the dividend achievers list. In fact of the total universe of 10,000 US publicly traded stocks, less than 300 are included in the achievers list.

The best dividend stocks are typically characterized by having a strong durable competitive advantage, which allows them to grow earnings and increase dividends on an annual basis. A company which raised dividends for only a few years could have achieved that because it simply got lucky by being at the right place at the right economic cycle. Once the economic expansion or trend which boosted the company’s profitability ends, the company’s earnings would stop growing or worse could start declining. This is another major reason to avoid dividend growers with less than a decade of distribution raises.

That being said I do have several stocks on my watch list, which I would be happy to consider for inclusion in my dividend portfolio once the following characteristics are met:

1) Raising dividends for at least 10 consecutive years
2) Trading at no more than 20 times earnings
3) Having an adequately covered dividend payout ratio (or for REITs and MLPs a distribution payout ratio which is consistent with the ratio of the past few years)
4) Yielding at least 3%

The companies which one day could become dividend achievers that I am watching include:

Kellogg Company (K), together with its subsidiaries, engages in the manufacture and marketing of ready-to-eat cereal and convenience foods. Kellogg Company is a former dividend aristocrat, which has fought back to regain its status of a dividend growth stock since 2005. The stock currently yields 3.10%

General Mills (GIS) engages in the manufacture and marketing of branded consumer foods worldwide. General Mills has increased its quarterly dividend in each of the past six consecutive years. The stock currently yields 2.80%.

Microsoft (MSFT) provides software and hardware products and solutions worldwide. Although the company has raised its annual dividend since 2003, over the past quarters the dividend has been flat.

Kraft Foods Inc. (KFT), together with its subsidiaries, manufactures and markets packaged food products and grocery products worldwide. The company has consistently raised dividends since it went public in 2001. In early September 2009 the company announced that it has would leave its current dividend payment of $0.29/share unchanged for the fifth consecutive quarter.

This post was featured in the Carnival of Personal Finance - Women in History Edition

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