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Steve Alexander
Steve Alexander
Articles (5983) 

Own These 4 Dividend Stocks Instead of a Condo

Owning a good dividend stock is like owning a quality piece of investment real estate

November 04, 2015 | About:

Owning a good dividend stock is like owning a quality piece of investment real estate.

You get paid cash frequently – cash you can use as regular income, or to invest back into more assets (stocks/real estate) to get paid even more cash!

If your property/stock is really good, you will even get increasing cash flow from it year after year. For good investment properties, you are able to consistently raise rental rates. For good dividend stocks, the company raises its dividend payout year after year.

You also benefit from the appreciation of your asset. Buying a high-yielding, quality dividend stock when it is temporarily out of favor in the market is akin to purchasing that edge-of-town beachfront property before the town expands around it and demand skyrockets. By the time you go to sell either, you could realize a doubling, tripling or even more of your original investment.

In fact, dividend stocks are even better! There are no property management companies to deal with, no property taxes, transaction costs are minuscule, and dividend stocks are fully liquid (you can sell them in minutes). Plus you don't have to worry about a hurricane flooding your dividend stock!

Key questions when buying dividend stocks

Like real estate, though, succeeding in dividend stocks requires due diligence on a few key factors. First, are you buying the asset at a price that is below a reasonable estimation of its value? Second, are its current cash flows secure (i.e., do you have to worry about cash flow decreasing)? Third, is the firm financially strong enough to support future dividend hikes?

To answer the first question, we rely on stocks from the "Magic Formula" screens. Against the market, these trade at the lowest levels against their recent earnings and (usually) cash flows, meaning it is highly likely they are below a reasonable fair value. As always, we do some due diligence to ensure that is indeed the case.

The second and third questions require some investigation into the company's prospects and a deeper dive into its financial situation.

Four quality 'Magic Formula" dividend stocks

Below are four current "Magic Formula" stocks that pay a substantial current dividend and, after investigation, seem sufficiently healthy enough to continue paying and raising it while being undervalued assets in their own right.

IBM Logo

4) IBM (NYSE:IBM): With a 3.7% yield, a very reasonable 31% payout ratio of free cash flow, and a stable (if stagnant) business that generates a lot of cash, IBM's dividend is quite safe. What's more, the company has raised its dividend for 19 consecutive years, and it has grown at an impressive compound rate of almost 20% in the last decade. Given a still low payout ratio, IBM should continue to grow its payout although the rate of growth will certainly slow. The median analyst target price is about $150, a bit above the current stock price of $142, so the price is reasonable as well. A "blue chip" choice for income.

EMR Logo

3) Emerson Electric (NYSE:EMR): Emerson is a "dividend aristocrat", with 57 consecutive years of dividend increases, a 10-year compound dividend growth rate of 8.4%, and a fruitful current yield of 4.0%. Emerson's payout ratio is creeping up near 50% but still reasonable enough to support continued hikes, such as the 1% hike announced just yesterday. Analyst's price targets are near $50 on Emerson, but it has traded as high as $65 in the past year. This old school industrial equipment provider has been around a long time and will continue to be a key supplier for the foreseeable future.

PETS Logo

2) PetMed Express (NASDAQ:PETS): PetMed Express is an Internet and phone-order pet medicine firm. It is a slow grower (sales and profits are flat over the past seven years) but generates substantial free cash flows in a mostly nondiscretionary, recurring sales business. Its current yield is 4.3%, and the company has raised the dividend every year since instating one in 2010 (at an impressive 13% growth rate). The prospects for continued hikes can be questioned, though, with a high payout ratio of 70% and little growth. I'd like to see management focus a little on starting to grow the business again.

CLCT Logo

1) Collector's Universe (NASDAQ:CLCT): Collector's Universe owns the PCGS coin grading service, which operates as a virtual duopoly with NGC. In the rare coin market, if it isn't graded by one of these two, it is considered suspect. The company has also established strong positions in trading card grading (PSA) and autographs (PSA/DNA). Collector's pays by far the largest dividend yield here at a whopping 8.1%. Although it has been raised three times in the last six years, the dividend is nearly 100% of free cash flow so I don't see a lot of steady increases near term. That said, an 8% yield doesn't need a whole lot of hikes to be lucrative, and given Collector's Universe's market position and generally stable demand, I think the dividend is plenty safe to be investible.


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