Wednesday, August 24, 2011

Dividend Stocks – The safest investment in the world

We live in challenging times. Commodities such as oil, gold and silver are going up amid speculation that we are going to have high inflation. Given the ample liquidity pumped into the financial system by central bankers around the world, speculators are bidding up precious metals. In addition, investments such as treasury bonds generate yields which are very low. Chances are that these fixed income instruments would lose purchasing power if inflation accelerates. Other “growth” investments such as Linkedin (LNKD), Pandora (P), Groupon and Facebook seem to be generating investors’ interest because they are part of “social media”, despite the fact that their valuations are unsustainable. So how can investors maintain their sanity, generate returns and live off their portfolios in such uncertain world?

The answer is in dividend growth stocks. Only companies which have solid financial results tend to share a portion of their income with shareholders in the form of dividends. Companies which are weak or focus on growth at all costs tend not to pay a dividend, which means that investors can generate a return on investment only if a greater fool bids up the stock price. On the other hand, companies that pay a portion of their earnings as dividends, generate a consistent return to shareholders. This is a definite plus when stock prices are falling or going sideways for extended periods of time. As a result companies that regularly pay rising dividends to shareholders, tend to be favored by long term holders.

The reason behind the appeal of dividend growth stocks is that only companies which fit certain quantitative and qualitative criteria can afford to create a string of consecutive dividend increases. Qualitative characteristics include strong competitive advantages, strong market share, diversification of operations on a global scale , investment in innovation as well as strong brand names which consumers use on a daily basis and for which they can afford to pay a premium price. At the end of the day, even if we experience another recession, consumers would keep eating, shaving, showering, using water and electricity or talking on the phone. Quantitative criteria include items such as dividend growth, earnings growth, valuation, and return on equity or current yield.

Companies that raise dividends also provide a rising stream of income which retirees could use to live off their portfolios. As a result, investors would not have to worry about selling their growth stocks when the market tanks in order to pay their monthly expenses. The rising dividend stream also ensures that retiree’s incomes are keeping up with inflation. Over time the increase in earnings and dividends makes the company more valuable, which leads to increases in share prices as well, as more investors realize that the shares are undervalued.

Some of the safest dividend stocks, which fit my entry criteria include:

Kinder Morgan Energy Partners, L.P. (KMP) owns and manages energy transportation and storage assets. The company has increased distributions for 15 years in a row. Yield: 6.60%(analysis)

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. Yield: 3.70% (analysis)

The Procter & Gamble Company (PG) provides consumer packaged goods in the United States and internationally. The company has increased distributions for 55 years in a row. Yield: 3.40% (analysis)

The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. The company has increased distributions for 49 years in a row. Yield: 2.70% (analysis)

Colgate-Palmolive Company (CL), together with its subsidiaries, manufactures and markets consumer products worldwide. The company has increased distributions for 48 years in a row. Yield: 2.70% (analysis)

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The company has increased distributions for 37 years in a row. Yield: 2.80% (analysis)

This is just a sample of quality dividend growth stocks which are sufficiently profitable to afford a rising dividend payment in good times and in bad times.

Full Disclosure: Long all stocks mentioned above

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This article was included in the Carnival of Personal Finance

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