Investing for dividend growth - Column

Black Enterprise, May, 1993 by Pierre Dunagan, Shelly Branch

Investors troubled by today's low investment returns have been hunting for--and rooting out--generous yields in both the fixed-income and equity markets. However, yield seekers investing for the long-term may be selling themselves short if they focus strictly on current yield.

So what's the deal? The fact is, over time, a stock with a low initial yield may produce a much higher overall return--provided that the stock's dividend sees steady growth.

Not only have many blue-chip companies, such as McDonald's, Anheuser-Busch and Coca-Cola, paid dividends consistently since the turn-of-the-century, but, more importantly, they have also steadily raised their dividends by an average of 10% or more. It is this dividend growth power that has made blue-chip stocks attractive to long-term investors, who watch their payments rise over the years.

Experts agree that a company's dividends can give you more clues to a stock's strength than other common barometers such as earnings-per-share and book value. What's more, stocks with steady dividend growth help counter inflation, which chews into profits of fixed-income investments.

Although a stock's current yield may not seem generous at first glance, dividend growth payments can double or even triple the yield on your original investment. Here's how: Suppose you invested $1,000 in a company we'll call ABC, back in 1983. At that time, let's say ABC was paying a 5% yield, or $50 a year, on your investment. If ABC were to boost its dividend by 10% for 10 years running--and you didn't invest a cent more--you would receive roughly $130 in dividends in 1993. That's an enviable yield of 13%.

When shopping around for income-producing blue-chip stocks, consider three factors that can help keep your money growing:

"Look for companies in industries that are fairly consistent, rather than cyclicals, like auto and airlines," advises Gene Walden, author of The 100 Best Stocks to Own in America (Dearborn Financial Publishing Inc., Chicago, $22.95). Food, medical and health care companies are particularly good bets, he says, since "they tend to defy cycles and raise dividends year in and year out."

A low payout ratio gives the dividend room to grow. The payout ratio is simply the percentage of last year's earnings-per-share paid out as dividends this year. The lower the ratio, the more room there is to boost the dividend. Remember, for a blue-chip stock to maintain its dividend edge, the company must channel a good portion of its earnings--between 20% and 40%--back into the company for future growth. For this reason, blue-chip stocks tend to enjoy lower ratios than utilities or other companies in low-growth industries.

Although you can't judge a stock's future performance from last year's act, you can gain some excellent clues from a company's dividend payment history. A firm with an unbroken record of paying dividends for a dozen years or more would seem a good bet for continued income. "This is not a definite barometer," says Geraldine Weiss, editor of the La Jolla, Calif.-based newsletter Investment Quality Trends ($50 for four trial issues; 619-459-3818). "But if a company has raised its dividend consistently, then you know it is well-managed, and you can invest with assurance that the dividend will continue to grow."

Companies that have increased their dividends the most frequently over the past dozen years, according to Weiss, include: American Home Products, Worthington Industries, General Electric, Heinz and Banc One--each of which saw healthy dividend growth at least 14 times in that period.

The company's financial soundness should also be a key consideration when selecting a stock for its dividend strength. Just because your dividend check arrives in the mail on time and intact, don't assume that the company itself is doing fine. "Some companies want to keep their dividends going even in bad years," notes Walden. Case in point: IBM, which, despite the shaky months preceding its stock price dive, vowed not to cut its dividend.

Capital appreciation potential, or a stock's chances of rising in price, can also enhance returns. Regardless of whether or not they receive a dividend, investors buy stocks hoping to see an increase in share price. Company ABC's 13% yield, for instance, looks quite impressive. Yet, consider what the value of a $1,000 investment would be had you socked it away 10 years ago. Assuming the stock price had also risen 10% a year--in line with the S&P 500 stock average--your original investment would be worth nearly $2,600 before dividends.

Picking The Future Growth Busters

Editor Geraldine Weiss, whose newsletter tracks 350 blue-chip stocks twice a month, predicts that as many as 130 blue-chips will raise their dividends in 1993. Which are the best bets? That depends on whether you're currently in or out of the market.

Investors who already hold shares in Coca-Cola, General Electric, McDonald's, Merck, Procter & Gamble and J.P. Morgan should hold fast to them in 1993. With expected yields of as much as 3.8%, these companies are quite attractive from a dividend standpoint. Bear in mind, new investors: These stocks now fetch a handsome price. Says Weiss: "I'm counseling that these stocks can be held on the strength of their dividends, but new investors should wait to purchase them until they're a better value."