The Dow Jones Industrial Average has experienced multiple 1,000+ point declines over the past two weeks. Following a weekend where an OPEC deal to lower oil production fell apart, the Dow dropped more than 1,300 points Monday before circuit breakers triggered and paused trading. The index closed Monday's trading session lower by more than 2,000 points, which is the largest single-day loss in its history.
Combine this with continued news of outbreaks of the coronavirus and investors of all sorts are heading for the exits as quickly as they can.
One notable group that has stayed out of panic-selling is dividend growth investors, especially those with many years until retirement. Younger investors have the most important asset on their side: time. Thus, they can take full advantage of this asset by making regular contributions to their dividend investments to produce a steady flow of income. As the saying goes, time in the market is more important than timing the market.
Putting your investment capital to work and reinvesting dividends over even a short period of time can produce excellent results. I first started tracking my wife and I's dividend income in 2014. That year, we received ~$1,000 in dividends. Last year, our dividend income was more than four times this amount. I project that in 2020, we will receive nearly five times the 2014 amount.
However, while many stocks pay dividends, not all are created equal. Based on my own analysis, here are the five companies I would buy today, in the midst of the market selloff, if I were a young dividend growth investor. These companies all have at least a decade of dividend growth and an entrenched business that allows for multiple lanes of growth. They have also managed to increase dividends through the most recent recession in 2008.
AT&T Inc.
First up is AT&T Inc. (T, Financial), which is Dividend Aristocrat. Companies earning this title are those with at least 25 years of consecutive dividend growth.
AT&T has paid a dividend for 36 consecutive years. Dividend growth for the company is usually on the low side, with an annualized dividend growth rate of under 2% over the last decade and an increase of 2 cents for the most recent payment. However, the dividend yield is still high at 5.6%. This is nearly three times the average dividend yield of the S&P 500. AT&T has increased its dividend through the last three recessions.
AT&T can trace its origins to Alexander Graham Bell and the invention of the telephone. Since then, AT&T has become one of the world's largest telecommunications companies. The company also provides wireline services in a 18 states, including California and Texas. AT&T's purchase of Time Warner in 2018 added HBO, Warner Bros. Movie Studio and Turner Broadcasting. These assets expanded the AT&T's content collection and have allowed the company to offer its own streaming service, HBO Max. Through its multiple platforms, AT&T directly connects with ~170 million customers each day.
AT&T does have a significant amount of long-term debt, ~$143 billion at the end of 2019, but the addition of Warner Media has added to the company's very sizeable cash flow. In 2019, free cash flow grew 28% to $29.2 billion. This will allow AT&T to repay debt at a faster clip and ensure that the company's dividend is well protected.
In 2019, the company distributed $14.9 billion in dividends, giving the stock a free cash flow payout ratio of 51% for the year. This compares favorably to the average free cash flow payout ratio of 63% from 2016 through 2018.
Using earnings per share, the dividend appears safe as well. AT&T expects to pay out $2.08 in dividends per share in 2020, while estimates predict EPS of $3.61, which makes an EPS payout ratio of 58%. This is lower than the 10-year average payout ratio of 69%.
With a business that has the potential to receive revenue from a vast number of customers and quality content, AT&T looks likely to continue growing in the future. While dividend growth may not excite, the company's high yield, lower payout ratios and history of dividend growth make AT&T a must-own stock in any dividend growth portfolio.
Johnson & Johnson
Johnson & Johnson (JNJ, Financial) is a dividend leader in the health care sector. With 57 consecutive years of dividend growth, Johnson & Johnson is classified as a Dividend King, one of just a handful of companies with more than 50 years of dividend growth. In fact, there are only 10 other companies in the U.S. that can claim a longer dividend growth streak than Johnson & Johnson. The company has compounded dividends at a clip of 6.1% annually over the last decade. The most recent raise resulted in a 5.6% increase for the June 11, 2019 payment. Shares yielded 2.7% as of Monday.
Johnson & Johnson is a diversified health care giant. The company operates three business segments: pharmaceuticals (which holds leadership positions in the key areas of oncology and immunology), consumer (which contains products such as Tylenol and Neutrogena) and medical devices (which houses the company's surgical and orthopedics businesses). These individual segments provide balance when one segment is underperforming.
The company distributed $9.9 billion in dividends in 2019 while generating $19.9 billion in free cash flow for a free cash flow payout ratio of 50%. The company had an average free cash flow payout ratio of 52% for the three years prior.
Johnson & Johnson is expected to pay $3.80 in dividends and produce $9.03 in EPS this year for a payout ratio of 42%. The company is historically well managed, which is why the average payout ratio over the last decade is just 47%.
Johnson & Johnson has very reasonable payout ratios, especially considering the length of the dividend growth streak. The company has been consistent in its payout ratios over long periods of time, which shows how durable its businesses are. You can't grow dividends through six recessions without having a business that is stable each and every year.
Nothing is guaranteed in investing, but I believe that Johnson & Johnson will be able to raise its dividend through the next recession given its businesses and track record.
PepsiCo, Inc.
With 48 years of dividend growth, PepsiCo (PEP, Financial) is closing in on Dividend King status. Even after nearly five decades of dividend growth, PepsiCo continues to reward shareholders with solid dividend increases every year. The company's dividend more than doubled between 2010 and 2019. PepsiCo raised its dividend 7% for the June 2019 payment. The company has seen five separate recessions come and go and has still raised its dividend payment through each one. After Monday's market-wide selloff, PepsiCo yields 2.8%.
PepsiCo is a global leader in the food and beverage industry. The company has 23 brands that each generate at least $1 billion in annual revenues each. These brands include Pepsi, Gatorade, Frito-Lay chips and Tropicana orange juice. Most people think of PepsiCo as a carbonated beverage company, but snacks and food actually contribute slightly more than half of sales. While consumers have become more conscious of what they eat and drink, PepsiCo has managed to change with the times. Slightly less than half of sales come from products that have less than 70 calories from added sugar.
Companies don't achieve the dividend growth streak that PepsiCo has without top brands and innovative new products. Also key is the ability to generate earnings and free cash flow that more than cover dividend payments.
Last year, PepsiCo returned $5.3 billion in the form of dividends to its shareholders while generating free cash flow of $5.4 billion. This means that dividends consumed 98% of free cash flow in 2019 compared to the average payout ratio of 66% for the period of 2015 to 2018. The payout ratio for the most recent year is high, but the company's historical average is in much better shape.
Shareholders are expected to see $4.09 in dividends for every share they own in 2020. Using the average estimate EPS of $5.88 for the year, the payout ratio is just under 70%. This is higher than the 58% average payout ratio that the company has had over the last 10 years. This payout ratio is elevated, but not to the point that I am concerned about future growth.
PepsiCo is a balanced consumer staple company, with sales split between snacks and foods and beverages, unllike rival Coca-Cola (KO), which receives nearly all revenues from beverages. This gives the company some measure of safety if one segment faces headwinds, making it a excellent choice for a dividend growth portfolio.
Realty Income
Realty Income (O, Financial) is one of the newest additions to the Dividend Aristocrats index, having increased its dividend for 27 years. Realty Income is well-known among dividend investors as the "Monthly Dividend Company," as it is one of the few companies that pays a dividend every month. Shares yield 3.6% as of March 11. The REIT has a 10-year average dividend growth rate of 4.7%. Realty Income often raises its dividend several times per year. For example, the trust raised its dividend 2.2% for the Feb. 14, 2020 payment, which followed a 0.2% increase for the previous month.
Realty Income is a real estate investment trust that specializes in leasing single-tenant standalone commercial properties to well-known companies such as Walgreens (WBA), Dollar General (DG) and FedEx (FDX). REITs are often popular among income investors as they are required by law to pay out at least 90% of income in the form of dividends. This often leads to these stocks offering generous yields. Realty Income owns more than 4,000 properties that are triple net leased to tenants, meaning that the tenants are responsible for paying rent, property taxes, building insurance and property maintenance.
Realty Income's dividends for 2019 totaled $852 million while the trust's free cash flow came to $1.1 billion. Therefore, the trust's free cash flow payout ratio was 77%, which is a healthy payout ratio for an REIT. This is just below the three-year average payout ratio of 80%.
Realty Income's dividend estimate for the year is $2.79. The trust expects Funds From Operations (FFO) of $3.53 for 2020, giving the trust an FFO payout ratio of 79%. Again, this is a low payout ratio for a REIT. This is also lower than the 10-year average payout ratio of 85%. This would be Realty Income's lowest payout ratio in more than a decade.
Realty Income has a strong business model as it acts simply as a landlord while the tenants pay all costs associated with the property. The trust's occupancy rate is often in the mid to high 90% range, even in recessions. Its dividend has grown through the last two recessions.
Visa Inc.
Visa (V, Financial) is the one stock on this list that doesn't have multiple decades of dividend growth. The company had its initial public offering in 2008, just as the downturn in the world's economies was ramping up. Nevertheless, Visa has increased its dividend for the past 12 years, doing so through the Great Recession. Shares yield just 0.6% as of Monday, but the company has a strong enough business model that investors should see capital gains to go along with an ever-growing dividend.
With operations in nearly every country in the world, Visa is a global leader in the electronic payments space. In 2018, electronic payments outnumbered cash payments worldwide for the first time. This is likely to continue in the future as more consumers shop online. Visa is one of the largest players in this space, giving it a prime position to capitalize on this trend. Unlike the slow growers on this list, Visa is expected to produce adjusted EPS growth in the mid-teens in the coming years.
For the company's last fiscal year, which ended in September, it payed out $2.3 billion in dividends. At the same time, Visa's robust free cash flow reached $12 billion for a payout ratio of 19%. This is identical to the three-year average free cash flow payout ratio.
Visa is expected to pay out $1.20 in dividends per share and to deliver $6.25 of EPS this year for a payout ratio of 19%. This is just above the 17% average payout ratio for the period of 2010 to 2019.
Visa may be the youngest dividend grower on this list, but the company occupies a top spot in a growing industry. It is likely that the company will continue to pay and raise its dividend even in the event of a decline in the economy, as consumers will still likely use electronic payment methods to purchase goods. This makes it a must-own for dividend growth investors, in my opinion.
Final Thoughts
Markets are facing uncertain times, but investors don't need to panic. Dividend growth investing is all about the long-term, which is why younger investors or those with more than a decade until retirement should focus on buying the best dividend paying names.
AT&T, Johnson & Johnson, PepsiCo, Realty Income and Visa all have distinct advantages in their respective businesses that allow them to pay a growing dividend, even through receccions.
Disclouser: Author is long AT&T, Johnson & Johnson, PepsiCo, Realty Income, Visa, Coca-Cola and Dollar General
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