Dividend sustainability is paramount for the high-yield investor. Having a stock cut its dividend could potentially crush their income. A high-yield investor is less concerned about dividend growth than maintaining the current high-yield. Most traditional dividend growth stocks pay a moderate to low yield, thus sustainability is not enough. The investor in Dividend Growth Stocks also expects substantial and consistent growth.
This expectation does not change even when the economy turns down and earnings decline; dividend growth investors still require annual dividend growth. The companies that are able to accomplish this are those with a operating model that generates strong free cash flows with room to pay out a higher percentage as dividends. Below are several companies with a low free cash flow payout (below 40%):
Aflac Incorporated (AFL) provides supplemental health and life insurance in Japan (80% of earnings) and the U.S. Products are marketed at work sites and help fill gaps in primary coverage.
FCF Payout: 6.2% | Yield: 2.4%
Wells Fargo & Company (WFC), with assets of nearly $1.5 trillion, is the fourth largest in the U.S. It provides banking, insurance, investment, mortgage and consumer finance services.
FCF Payout: 12.0% | Yield: 2.6%
IBM (IBM)'s global capabilities include include information technology services, software, computer hardware equipment, fundamental research, and related financing.
FCF Payout: 28.0% | Yield: 3.2%
An interesting twist to the above is a 2006 study conducted by Credit Suisse that found high dividend yield stocks generally outperformed those with lower yields. However, the best returns did not come from those with the highest yields, but those with higher yields coupled with low payout ratios. The study found that high yield, low payout stocks that produced the better returns were priced at low ratios of price-to-earnings, and as a corollary, at high ratios of earnings-to-price; i.e., earnings yield. Put another way, the stocks prices were depressed, thus creating the higher yield and a value play. Below are several dividend growth stocks with a higher yields (around 4%+) and low free cash flow payouts (50% and below):
Arrow Financial Corp. (AROW) owns Glens Falls National Bank & Trust Company and Saratoga National Bank & Trust Company, which offer commercial and consumer banking and financial products in U.S.
FCF Payout: 44.2% | Yield: 4.0%
Verizon Communications Inc. (VZ) is the largest U.S. wireless carrier, Verizon also offers wireline and broadband services primarily in the northeastern U.S. Key.
FCF Payout: 33.3% | Yield: 4.4%
Omega Healthcare Investors Inc. (OHI) is a real estate investment trust (REIT) that invests in income-producing healthcare facilities, mainly long-term care facilities located in the United States.
FCF Payout: 49.1% | Yield: 5.8%
At some point we will all want to retire, but that is not to say we want our portfolio to stop working for us. A good dividend growth stock portfolio will not only provide us income in our retirement, but provide us more income each year than the one before.
Full Disclosure: Long AFL in my Dividend Growth Portfolio and long VZ OHI in my High-Yield Portfolio. See a list of all my dividend growth holdings here.
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