Dividend Growth Stocks with high yield
Dividend stocks have been the butt of the joke for the last few years and while they might not be as exciting as finding the next group of FAANG stocks, they have proven to be a good source of stability and income-generating assets that investors have appreciated (more) of late, given the heightened volatility seen in the market.
Their fortunes might be about to turn in the coming months, with dividend stocks continue eclipsing their more eye-catching growth peers as we head into results season.
In the article, I will highlight a few reasons why now might be a good time to re-look at dividend stocks and I will provide 3 strong dividend growth stocks who are all part of the exclusive dividend aristocrat club (stocks that have increased their dividend payments consecutively for 25 years) that are not only generating a high dividend yield at present (more than 3%) but their dividend growth rate is also head and shoulders above their peers.
I have previously written about why dividend growth investing is a strategy that could reap strong returns for an investor with a long investing horizon in mind (see article links below). This is a strategy that focuses not just on finding high dividend yield stocks (which might become value traps if and when these counters cut their dividend payments), but more importantly on finding dividend counters that are increasing their dividend payments at a torrid but yet sustainable pace.
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These strong dividend growers have proven time and time again to outperform not just their fellow dividend peers but also the broader market significantly over time.
Before I highlight the 3 dividend growth stocks which I believed to be worth considering for inclusion into one’s portfolio (do note this is not financial advice), here are 4 reasons why now might be the time to consider adding some dividend counters into your portfolio.
Reason #1: Dividend growth stocks have solid foundation amid market volatility
When the market gets volatile like what it is currently today with numerous uncertainties such as inflationary forces, interest rate hikes, the Russian-Ukraine war, etc resulting in potentially de-railing the market’s long-standing bull run, investors tend to seek the safety of stocks with a solid foundation instead of chasing after the next multi-bagger growth stock.
Dividend stocks provide the kind of regular income that makes them a great option for investors looking for stable cash flows, one which beats the uncertain capital gains in growth stocks at present.
While these stocks might not see fast capital appreciation, the ability to pay a consistent growing stream of dividends is what matters more to investors at present, many of whom are retirees who are also dependent on these income streams to pay their monthly bills.
A flight to safety could see a valuation expansion (and consequently price appreciation even if their earnings are flat) for these “unloved” dividend stocks in 2022.
Reason #2: Dividend growth stocks are more attractive than bonds at present
In today’s rising interest rate environment, it is a challenge to argue for holding bonds in one’s portfolio. Many investors hold bonds as portfolio diversification and asset allocation strategy, to help lessen the negative impact of a stock market fallout.
However, in the current rising interest rate environment, one might observe both stocks and bonds falling in tandem, if and when the cause of the market sell-off is due, directly or indirectly, to the more hawkish stance of the Fed to raise interest rates aggressively to counter the impact of inflation.
Dividend stocks, on the other hand, can continue to witness price appreciation even in a rising interest rate environment, as long as the counters’ fundamentals and cash-generating abilities remain sound.
Reason #3: High Dividend growth stocks outperform the broader market when the interest rate and inflation rate are high
There is a simple reason for this. High dividend stocks earn a bigger portion of their cash in the near future vs. growth stocks, the latter’s valuation mostly being dependent on future promises of its cash-generating abilities.
This means that dividend stocks are less impacted by a higher discount rate associated with a rising interest rate, which punishes those with distant cash flows (growth stocks) more than one capable of generating cash at present.
This makes dividend stocks a more attractive proposition in a rising rate environment. According to Goldman Sachs in the chart below, higher-yielding stocks tend to outperform the market when rates are rising.
Similarly, these stocks also tend to outperform the broader market when inflation is high. Both these factors are currently in play at present.
Reason #4: Valuation on Dividend growth stocks are cheap
Stock returns are typically driven by 2 main factors: 1) Earnings Growth and 2) Valuation multiples. A counter can witness a rise in its share price by a rise in either of these 2 factors or a combination of both.
With the current market’s valuation near all-time high and earnings growth expectations tapering, buying into a counter highly dependent on these 2 factors panning out could end in disaster.
Dividend stocks on the other hand, which are typically viewed as a value play, have been unloved and ignored for the good part of the past decade where growth stocks reigned supreme. It is only in the past year that more attention has been paid to it (rightfully) as investors in growth counters start to feel the heat.
By investing in dividend stocks, you are reducing the reliance on valuation and high earnings growth to generate returns. This increases the probability that one can generate positive returns simply through the counter’s dividend yield.
How to profit from dividend stocks
We want to identify dividend-paying stocks which has a 1) sufficiently high yield but yet not fall into the “dividend trap” conundrum where its high yield is not sustainable.
Hence the second equation is to look at 2) sustainability of dividend payments. The longer a company’s track record of increasing its dividend payment, the greater the assurance to us that its growing dividend payment is sustainable.
The last equation is to find dividend stocks that are 3) growing their dividend payment at a faster than average rate and we know that such growth rates are sustainable due to their relatively low payout ratio.
Hence in looking at high dividend yield and dividend growth stocks, we have the following screening criteria:
- Stocks that yield above 3%
- Stocks that are currently classified as Dividend Aristocrats (at least 25 years of consecutive dividend payment increases)
- Stocks that have an average dividend payment growth rate of >5% over the past 5-years and current forecasted 1-year growth. Its payout ratio needs to be < 100%
We found 3 gems that fit this profile.
High Dividend Yield and Dividend Growth Stock #1: ABBV
ABBV is a pharmaceutical company with strong exposure to immunology and oncology. The company’s top drug, Humira, represents close to half of the company’s current profit. The company was spun off from Abbott in early 2013. The recent acquisition of Allergan adds several new drugs in aesthetics and women’s health.
ABBV currently has a dividend yield of 3.6% which is above its industry average of 2.8%. The counter is a member of the Dividend Aristocrats, with a track record of increasing its dividend payment by an astonishing 50 consecutive years.
Last but not least, it has a 5-year average dividend growth of 17% and in the past year, has managed to grow its dividends by 8.5%. This dividend growth is likely sustainable, with the company’s payout ratio at 83%. While this payout ratio might look high on the surface, this is a company that consistently churns out free cash flow at more than double its reported earnings.
Hence the “actual” payout ratio based on cash flow might be less than 50%. Hence future growth in dividend payments can likely be supported by its strong free cash generation profile.
High Dividend Yield and Dividend Growth Stock #2: TROW
TROW provides asset-management services for individual and institutional investors. At the end of 2021, the firm had 1.7trn in managed assets. Approx. two-thirds of the company’s managed assets are held in retirement-based accounts, which provides TROW with a somewhat stickier client base than most of its peers.
TROW has a dividend yield of 3.4% which is slightly below the industry average yield of 3.6%. The counter is a member of the Dividend Aristocrats, with a track record of increasing its dividend payment by a respectable 36 consecutive years.
Last but not least, it has a strong 5-year and a 1-year current dividend growth rate of 16% and 11% respectively. This dividend growth is likely sustainable, with its payout ratio at just 33%
High Dividend Yield and Dividend Growth Stock #3: CVX
CVX is an integrated energy company with exploration, production, and refining operations worldwide. It is the second-largest oil company in the US, with a production of 3.1m bbls oil equivalent a day.
CVX has a current dividend yield of 3.3%. What is amazing is that this oil major did not cut its dividend in 2021, a year in which O&G counters’ earnings and cash flow have been decimated due to low oil prices. Instead, CVX is one of the rare O&G majors that continue to increase its dividend payments in 2021.
Hence, it remains a member of the prestigious Dividend Aristocrats club, with 35 years of consecutive dividend payment increases.
It has a 5-year average dividend growth rate of 5% and its current dividend growth rate is forecasted to be at 10%. With a payout ratio of 65%, this is one blue-chip oil major that can outperform both its industry peers as well as dividend-paying peers in 2022, a year in which the rebound in oil prices could take legs amid inflationary pressures abound.
Conclusion
The above 3 strong dividend growth stocks have a combination of high dividend yield and high dividend growth, a perfect recipe for identifying dividend stocks that could outperform the market over a long horizon while yet also providing the necessary income stability favored in today’s volatile market environment.
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