A Group Of Stocks That Could Thrive In The 'Dividend Decade'

I was listening to a business talk show in my car the other day. The show's host made an important point.

"Stop talking about the dividend trade," he implored. And he's right.

 

The "dividend trade" has become shorthand for the mania for dividend-paying stocks. It's been a key theme in the current bull market, though the phrase implies that it's a passing trend.

And while he may be right that all the chatter has gotten a little out of hand, anyone who would dismiss the move toward dividend-paying stocks as simply a fad is just wrong.

It's not just the flavor of the week -- as we've said before, we think we're in the beginning phases of a Dividend Decade -- a trend that will be around for years to come.

That's because companies increasingly understand the importance of rising dividend payouts. Many firms that used to pay little attention to their dividends have realized in recent years that it's wiser to return cash to shareholders than to spend it on acquisitions that may or may not pay off. That's especially true when considering that corporate America is sitting on a $1.7 trillion pile of cash. In fact, we're so convinced that a large amount of this will go toward dividends that we're calling it the "Dividend Vault".

For investors, the key is to find companies that have shown a clear willingness to hike their dividends -- and have the financial firepower to continue doing so.

I took a look at the 1,500 companies in the S&P 400, 500 and 600, focusing on those firms that already offer a dividend yield of at least 2%. I then narrowed the list to firms that have boosted their dividends at an annualized pace of at least 10% over the past three years. Lastly, I narrowed the list further to focus on companies that have a payout ratio of less than 40%.

Any company with such a low payout ratio has the wiggle room to hike the divided by boosting the payout ratio toward the 50% mark. There are 63 companies in those three S&P indexes that have the dividend yields, dividend growth rates and payout ratios we're looking for. Let's look at the group in various ways.

First, let's look at the highest yielding stocks that have a strong dividend growth record and sub-40% payout ratios.

Solid Yields

Thanks to the recent plunge in commodity prices, mining stocks have taken a tumble, pushing up their dividend yields in the process. That's why Newmont Mining (NYSE: NEM) and Freeport-McMoRan (NYSE: FCX) head up the list here. Both of these firms have tended toward sizable dividend hikes in recent years, but the commodity sector's troubles compel you to listen to their first-quarter conference calls to hear the management discussion about dividend growth plans. The still-low payout ratios, especially at Newmont, may enable them to keep hiking their dividends, even as cash flow growth slows in the near term.

Mattel's Rising Payout

Toy and games maker Mattel (NYSE: MAT) is the perfect example of a company poised for continued dividend growth. In the past, management sought to boost the business through acquisitions, but internal growth has become the priority. Because cash is no longer needed for acquisitions, dividend hikes have become the norm.

Now let's look at these stocks from a different angle, focusing on robust dividend growth rates.

Solid Dividend Growth

It's clearly impossible to keep boosting the annual dividend by 50% or more, but for these companies, especially the ones that have payout ratios below 35%, respectable double-digit dividend boosts could remain the norm for the next several years.

Handbag and accessories maker Coach (NYSE: COH) is a perfect example. Founded in 1941, the company paid its first dividend, a paltry 9 cents a share, in 2009. Since then, the divided has been rising roughly 30 cents per year. If the trend holds into 2014, Coach will be paying an annual dividend of $1.50 a share. Frankly, dividend hikes could continue well into the future, considering the still-low payout ratio.

Let's now look at companies with the lowest payout ratios (keeping those other two variables constant).

Low Payout Ratios

Some of these firms will likely never be able to boost their dividends enough to reach a 40% or 50% payout ratio. Hewlett-Packard (NYSE: HPQ), for example, carries a considerable amount of debt and faces serious long-term cash flow pressures, as I've noted before.

And banks such as JPMorgan Chase (NYSE: JPM) need to retain the bulk of their cash flow to satisfy capital requirements. Still, it's clear that a few of these companies may be on the cusp of sustained double-digit dividend hikes.

For instance, expect rising dividends from Williams-Sonoma (NYSE: WSM). The retailer recently said its capital spending needs of $200 million per year will be less than annual free cash flow, which makes the current $425 million cash balance appear excessive. Management plans to spend at least $100 million of that cash on further dividend hikes and possibly share buybacks, and analysts at Merrill Lynch forecast the dividend to rise to $1.60 a share by 2016.

Risks to Consider: An economic slowdown, a major acquisition or a large share-buyback program all could impede the path to robust dividend hikes.

Action to Take --> By establishing a multi-year track record of robust dividend growth, these companies are sending a clear signal: The dividend boosts are a long-term priority, not a passing fad. With that commitment in place, the stocks I've highlighted should do well if the stock market eventually cools off, as their annual yields will provide safety in the storm.