Significant Price Run-up Distorting Dividend Fundamentals

When you buy a dividend stock at a depressed level it will eventually return to its norm. However, at its normal level the dividend fundamentals could be so bad that you would be better off putting the money to work somewhere else. For this evaluation, my primary indicator is the NPV MMA Differential. When this metric goes negative, it in effect is saying you are better off putting the into a money market account for the next 20 years. When this occurs I look for a way to exit the position and retrieve my original investment, leaving the portion attributable to capital appreciation. Examples of stocks that I hold with these characteristics (or close to it) are:

- 3M Co. (MMM) | Yield: 2.60% | NPV MMA Diff: (117)
- Emerson Electric Co. (EMR) | Yield: 2.87% | NPV MMA Diff: (108)
- Genuine Parts Company (GPC) | Yield: 3.82% | NPV MMA Diff: 302
- Illinois ToolWorks Inc. (ITW) | Yield: 3.09% | NPV MMA Diff: 317

Dividend Freeze Leading to Poor Dividend Fundamentals

When a company fails to raise its dividend (dividend freeze), the dividend fundamentals quickly deteriorate if its yield is low. It is easier to be patient when the yield is higher and the stock is still earning its way. However, as dividend growth investors, ultimately we expect our dividends to grow: Below are several stocks that failed to raise their dividends at the expected time:

- Paychex Inc. (PAYX) | Yield: 4.89% | Dividend Flat Since: 07/2008
- Eli Lilly & Co. (LLY) | Yield: 5.74% | Dividend Flat Since: 02/2009
- Progress Energy Inc. (PGN) | Yield: 5.88% | Dividend Flat Since: 01/2009
- Integrys Energy Group, Inc. (TEG) | Yield: 5.56% | Dividend Flat Since: 02/2009

Historical Performance Is Not Indicative Of Expected Results

Sometimes historical results are indicating the stock is a good investment, but something just doesn’t seem right. In situations like this there is probably a reason for the uneasiness and it is in our best interest to understand why we feel that way. Usually we know something that is not reflected in the financials.

This recently occurred with my AFLAC Inc. (AFL) position. I had been closely watching AFL since the time it first failed to raise its dividend. For a stock with a yield as low as AFL, dividend growth is paramount for its long-term success. My model’s calculated dividend growth rate was higher than what I expected going forward, at least for the near term. Its annual dividend growth has been declining since 2008, with 2010 growth only 3.6% (considering 2 dividends at $0.28 and two at $0.30). This was the only single digit increase in the last 10 years. When considering AFL’s most recent increase, the NPV MMA differential is under-performing its target. AFL has a large exposure to hybrid bonds (particularly European banks) and exposure to European sovereign debt. This makes them more risky than many other Financial Services companies. I have been looking to reallocate a portion of my financial Financial Services holdings (currently in excess of 10%) and I considered AFL one of my weaker financial stocks, so I sold it.

Substantial Change In The Business

Sometimes the world changes and what you were selling yesterday at a premium you can’t give away today. This phenomenon has been played out since the beginning of time. Rock gathers were replace with club makers who were replaced with spear makers who were replaced with arrow makers who were replaced with musket makers who were replaced with rifle makers, and so on. We see this happening today with the print media. Companies like Courier Corporation (CRRC) that publishes, prints and sells books, and Gannett Co., Inc. (GCI) an international media company that owns USA Today have struggled recently as people have moved from print media to online. Both companies were unable to continue the string of consecutive dividend increases.

Other times a catastrophe will shake a company to it very foundation. This has been most evident with the recent oil disaster in the Gulf. BP (BP) was not prepared for a situation like it faced. As the damage claims mounted, investors lost confidence in management to stop the oil flow and began to sell off the stock. A dividend cut soon followed.

Buy-And-Hold Not Buy-And-Forget

All investors need to be vigilant and keep a close watch on their investments. There are few certainties in an uncertain world. Things change and adjustments must be made. Buy-and-hold is a successful investment strategy; buy-and-forget is a recipe for disaster.

Full Disclosure: Long MMM, EMR, GPC, ITW, PAYX, LLY, PGN, TEG. See a list of all my income holdings here.

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(Photo: sanja gjenero)

Industry

Have you ever noticed that stocks within an industry often have similar yields? This makes sense when you consider they often have like operations with similar processes, cost structures and margins. This is evident when you look at retailers who buy similar products, resell them in a physical location and have fairly low margins due to the intense competition. Note the yield similarity of Target Corp. (TGT) with a 1.3% yield and Costco (COST) with a 1.5% yield. Even WalMart (WMT) with their economies of scale and focus on efficiency has a yield only slightly higher at 2.4%. The same analysis could be done with The Coca-Cola Company (KO) with a 3.4% yield and Pepsico, Inc. (PEP) with a 3.1% yield.

Maturity and Growth Potential

When Microsoft (MSFT) and Intel (INTC) were formed they paid no dividend. Instead they funneled all their cash back into growing the business. As they matured and growth slowed, each began to pay a very nominal dividend. Today, as they have continued to mature, their yields have continued to increase with MSFT paying 2.0% and INTC paying 3.0%.

Legal Considerations

Real Estate Investment Trusts (REIT), such as Realty Income Corp. (O) and HCP, Inc. (HCP), are not taxed as standalone entities. Instead, they are legally required each year to pay out a certain percentage of their profits as dividends. In effect this forces the shareholders to incur the tax as earnings are generated, leaving the company very little to fund growth. To pay for growth, REIT’s usually have to issue debt and/or equity. All of this combined usually results in REITs having a higher than average yield, for example O yields 5.8% and HCP yields 6.2%.

Risk

Risk still plays an important role in setting the yield for a company. Consider these energy companies with a similar yields: Chevron Corp. (CVX) with a 4.0% yield, Exxon Mobil Corp. (XOM) with a 3.0% yield and ConocoPhillips (COP) with a 4.1% yield. Then there is BP plc (BP) with a 9.0% yield. Is there any question which of these is the more risky stock to own?

The above list is not meant to be an exhaustive, but highlights some of the more common drivers of yield. When we see a yield that appears to be too good to true, we need to ask ourselves why is the yield so high, and is it sustainable?

Full Disclosure: Long CVX, JNJ, ABT, MCD, PG, KO. See a list of all my income holdings here.

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(Photo Credit)

Something Bad Will Happen

Eventually, every investor will hold a stock that falls out of favor and endures a double-digit decline. Understanding this from the onset makes it easier to deal with. If we go ahead and accept this as fact, then when it happens it really shouldn’t be a shock. This sounds simple, but is really an important step in removing emotion from the equation. It is much easier to reach the correct hold or sell decision when evaluating the facts from a rational perspective.

Diversify Your Holdings

When bad things happen to an individual stock, it usually pulls down other stocks in the same industry. Consider the April 20, 2010 explosion and fire on Transocean Ltd’s (RIG) drilling rig Deepwater Horizon licensed to BP where 11 workers were killed. It is more than a month later and BP still has not stopped the oil flow. Below you can see that several companies in the same industry, have all under-performed the S&P 500 (SPY), some more than others:

Limit Your Exposure

The single most important thing you can do to manage the risk associated with holding individual stocks is to simply limit your exposure. My standing rule is to limit each individual stock to no more than 5% of my income portfolio, based on market value and income. If any single company were to go bankrupt and the stock went to $0, my loss would be less than 5% – the market has moved my portfolio more than that in a single day.

At the end of March I held a position in BP that represented 1.6% of my income portfolio and generated 2.1% the portfolio’s income. This small position kept me from being overly concerned. If BP ended up bankrupting, these would not have been dramatic losses. Limiting your exposure in any single stock to a reasonable level lets you sleep at night even when that stock is facing adversity.

Focus On Quality

Your core portfolio should focus on quality with the “meat and potatoes” blue-chip stocks. You might want to add some high-yield and high-risk stocks in limited amounts to “spice” things up. Below are several quality blue-chip stocks that are the cornerstone of most dividend growth investor’s portfolio, along with their risk number:

Finally, it is a good idea to have a written mission statement for your income portfolio that includes your goals and what you will and will not do in the portfolio. It may sound silly to take the time to write this down, but it is very helpful when fear or greed tempts you from your predefined path.

Full Disclosure: Long JNJ, ABT, MCD, PG, KO. See a list of all my income holdings here.

Related Posts
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(Photo: sean carpenter)

As for my portfolio, I consider asset allocation only when looking at my holdings in total. It would be much too difficult to maintain a good allocation within individual portfolios (income, growth, 401(k), Roth IRA, etc.), while trying to maintain my overall allocation. However, an investor could build a degree of allocation into a portfolio of dividend income securities. Consider the following:

Business Services Sector

• Automatic Data Processing Inc. (ADP)
  Yield: 3.33% | Style: Large Growth | Analysis
• C H Robinson Worldwide Inc. (CHRW)
  Yield: 1.86% | Style: Large Growth
• Expeditors International of Washington Inc. (EXPD)
  Yield: 1.16% | Style: Mid Growth

Consumer Goods Sector

• Clorox Company (CLX)
  Yield: 3.23% | Style: Mid Core
• Coca-Cola Company (KO)
  Yield: 3.04% | Style: Large Growth | Analysis
• Procter & Gamble Company (PG)
  Yield: 2.85% | Style: Large Core | Analysis

Consumer Services Sector

• Genuine Parts Company (GPC)
  Yield: 4.19% | Style: Mid Value | Analysis
• Sysco Corporation (SYY)
  Yield: 3.56% | Style: Large Core | Analysis
• McDonald’s Corporation (MCD)
  Yield: 3.22% | Style: Large Core | Analysis

Energy Sector

• BP Plc ADR (BP)
  Yield: 6.15% | Style: Large Value
• Chevron Corporation (CVX)
  Yield: 3.75% | Style: Large Value
• ExxonMobil Corporation (XOM)
  Yield: 2.56% | Style: Large Value

Financial Services Sector

• Harleysville Group Inc. (HGIC)
  Yield: 3.90% | Style: Small Value | Analysis
• Chubb Corporation (CB)
  Yield: 2.85% | Style: Large Value | Analysis
• Aflac Inc. (AFL)
  Yield: 2.38% | Style: Large Core | Analysis

Hardware Sector

• Diebold Incorporated (DBD)
  Yield: 3.67% | Style: Small Value
• Linear Technology (LLTC)
  Yield: 3.23% | Style: Mid Core
• Raven Industries Inc. (RAVN)
  Yield: 1.90% | Style: Small Growth | Analysis

Health Care Sector

• Meridian Bioscience Inc. (VIVO)
  Yield: 3.27% | Style: Small Growth
• Johnson & Johnson (JNJ)
  Yield: 3.08% | Style: Large Core | Analysis
• Cardinal Health Inc. (CAH)
  Yield: 2.10% | Style: Large Core | Analysis

Industrial Materials Sector

• Nucor Corp. (NUE)
  Yield: 3.40% | Style: Large Core | Analysis
• Emerson Electric Co. (EMR)
  Yield: 2.90% | Style: Large Core | Analysis
• 3M Company (MMM)
  Yield: 2.58% | Style: Large Core

Media Sector

• McGraw-Hill Companies Inc. (MHP)
  Yield: 2.63% | Style: Large Core

Pharmaceuticals Sector

• Eli Lilly & Company (LLY)
  Yield: 5.77% | Style: Large Value
• Abbott Laboratories (ABT)
  Yield: 2.97% | Style: Large Growth | Analysis

Real Estate Sector

• Essex Property Trust (ESS)
  Yield: 5.14% | Style: Mid Core
• Corporate Office Properties Trust Inc. (OFC)
  Yield: 4.29% | Style: Mid Core
• Federal Realty Investment Trust (FRT)
  Yield: 4.06% | Style: Mid Core

Telecommunications Sector

• CenturyLink Inc. (CTL)
  Yield: 8.10% | Style: Large Value
• AT&T Inc. (T)
  Yield: 6.54% | Style: Large Value | Analysis

Utilities Sector

• Integrys Energy Group Inc. (TEG)
  Yield: 6.61% | Style: Mid Value
• Consolidated Edison Company (ED)
  Yield: 5.59% | Style: Large Value
• MGE Energy Inc. (MGEE)
  Yield: 4.45% | Style: Small Core

Bonds

• Vanguard Short-Term Bond ETF (BSV)
  Yield: 2.74% | Style: Short-Term Bond
• Vanguard Intermediate-Term Bond ETF (BIV)
  Yield: 4.32% | Style: Intermediate-Term Bond
• Vanguard Long-Term Bond ETF (BLV)
  Yield: 5.16% | Style: Long-Term Bond

Needless to say, the above will not provide a perfect allocation, but it goes a long way to provide diversity in a portfolio focused only on income securities. In my personal portfolio, I buy the best available dividend securities and use my other investments to balance my asset allocation.

Full Disclosure: Long ABT, ADP, AFL, BIV, BLV, BP, CLX, CTL, CVX, ED, EMR, GPC, HGIC, JNJ, KO, LLY, MCD, MMM, NUE, PG, SYY, T, TEG. See a list of all my income holdings here.

(Photo Credit)

Online Cash Receipts are the collected earnings from my online endeavors. Most of which is advertising on the my various blogs. The year-to-date $147.40 Online Expenses relates to registering 3 domains (DividendsValue.com, Dividends4Life.com and TheDiv-Net.com) and paying my annual hosting fee. The Interest Income line is interest earned on cash balances in an ING account I set up for the PCP. The Gain/(Loss) line is for market changes to the PCP (realized and unrealized). December Dividends of $76.24 included:

• $8.11 Vanguard Intermediate-Term Bond (BIV)
• $9.44 from Vanguard Long-Term Bond ETF (BLV)
• $8.82 Johnson & Johnson (JNJ)
• $16.80 BP plc (BP)
• $8.71 Emerson Electric Co. (EMR)
• $15.34 Consolidated Edison Inc. (ED)
• $9.02 The Coca-Cola Company (KO)

The portfolio was up in December, for the year and since its inception. Online earnings in December once again surpassed the $3,000 mark. A large portion of the increase is related to the strong interest in D4L-Premium Services. The premium service has continued grow each month. Traffic on Dividend Value set a record in December, breaking the previous record set in October 2009.

During the month of December, I purchased the following securities:

• 34 shares McDonald’s Corp. (MCD) providing $74.80 in annual dividend earnings
• 16 shares Johnson & Johnson (JNJ) providing $31.36 in annual dividend earnings
• 40 shares PowerShares Emerging Markets Debt (PCY) providing $64.40 in annual dividend earnings

Including the above December purchases, my annual PCP dividend income is now $688.68 at the current dividend rates. I ended the month with $3,395.78 in cash, enough to purchase two or three stocks in January. Through December, I have purchased 13 stocks this year, including at least one in the last eight consecutive months. I continue to believe the current cash balance and recent earnings will support the purchase of at least one stock each month.

My PCP holdings are always available by selecting the Holdings option from the menu in the header. The next PCP update will be mid-February.

(Photo: sanja gjenero)

Dividend payout is expressed as a percentage and is calculated by dividing annual dividend per share by annual earnings per share (EPS). This tells the investor what percentage of earning the company is paying out as a dividend. At first blush this may seem to make a lot of sense, but it suffers from the following potential problems:

I. Earnings Does Not Equal Cash

As an accountant, I can tell you our profession in its pursuit of theoretical perfection has adulterated the financial statements to the point that it has become very difficult for non-accountants to understand what’s behind the numbers.  Accounting pronouncements such as SFAS No. 143 “Accounting for Asset Retirement Obligations” (ARO) that requires a company to recognize expenses today for cash payments that may not occur for decades or even centuries widens the gap between earnings and cash. Applying “fair value” principles allowed under GAAP, financial institutions (and others) can mark to market debt on their books and create non-cash income or expense, depending on the direction of interest rates. Many point to mark to market accounting as one of the major contributors to the 2008 financial melt-down.

II. Quality of Earnings

Would you rather a company that you are invested in to increase its earnings by 1.) increasing sales and holding cost down or 2.) sell a fully depreciated plant. Obviously, you would rather have the former since it has the possibility of being duplicated over and over again. You can only sell a specific asset once. In addition to cash and non-cash earnings, a statement of earnings also contains operating and non-operating earnings.

A Better Dividend Payout Calculation

A dividend payout ratio is supposed to provide the investor with an indication of how much cash as a percent of earnings the company is paying its investors. As you can see from the above discussion, a payout ratio based on GAAP net earnings could potentially have a lot of noise in it and not provide a clear picture of the economic condition of the business.

What the investor is really wanting to know is what percentage of cash is the company paying as a percentage of cash generated from running the business. The irony here is that operating cash is readily available on the Statement Of Cash Flows in the Operating section. This section focuses on the cash generated by running the business. It excludes cash generated by selling pieces of the business – these are shown in the investing section. It also excludes cash generated from selling stock or issuing debt – these are shown in the financing section.

In calculating a payout ratio, I prefer Free Cash Flow over Operating Cash Flow. Free Cash Flow is Operating Cash Flow less normal capital expenditures (normally the first line in the investing section). For a business to remain viable, it must replace capital assets when they wear out.

The formula for Free Cash Flow Payout is simply Annual Dividend Per Share divided by Free Cash Flow Per Share. I like to see a percentage of 70% or less. The 70% is somewhat higher than many people look for with a traditional payout ratio. I am comfortable with the higher number since we are talking about real cash generated from running the business vs. accounting earnings that may or may not be there. So how do the two ratios compare?

Needless to say, the variances are all over the place. In many companies I looked at the traditional dividend payout ratio was within 10 percentage points higher than a free cash flow payout. This means the GAAP earnings was lower than the calculated Free Cash Flow. Here are some example of this situation:

• Chubb Corp (CB) – Traditional: 28% – FCF Payout: 21% – Analysis
• Clorox Company (CLX) – Traditional: 50% – FCF Payout: 50%
• Emerson Electric Co. (EMR) – Traditional: 53% – FCF Payout: 45% – Analysis
• Family Dollar Stores Inc. (FDO) – Traditional: 25% – FCF Payout: 22%
• Hormel Foods Corp. (HRL) – Traditional: 34% – FCF Payout: 33%
• International Business Machines (IBM) – Traditional: 23% – FCF Payout: 18%
• 3M Co. (MMM) – Traditional: 50% – FCF Payout: 45% – Analysis
• Microsoft Corp. (MSFT) – Traditional: 32% – FCF Payout: 29%
• SYSCO Corporation (SYY) – Traditional: 52% – FCF Payout: 48% – Analysis
• United Technologies Corp. (UTX) – Traditional: 35% – FCF Payout: 30% – Analysis

Sometime the gap is much larger. This could have resulted from significant non-cash charges on the income statement.  Companies with large gaps include:

• Aflac Incorporated (AFL) – Traditional: 44% – FCF Payout: 10% – Analysis
• CenturyLink Inc. (CTL) – Traditional: 87% – FCF Payout: 46%
• Diebold Inc (DBD) – Traditional: 74% – FCF Payout: 30%
• Illinois ToolWorks Inc. (ITW) – Traditional: 76% – FCF Payout: 31% – Analysis
• Leggett & Platt Inc. (LEG) – Traditional: 262% – FCF Payout: 34% – Analysis
• Nucor Corporation (NUE) – Traditional: 88% – FCF Payout: 29% – Analysis
• Pitney Bowes Inc. (PBI) – Traditional: 73% – FCF Payout: 38%
• PPG Inds Inc (PPG) – Traditional: 158% – FCF Payout: 48%
• RLI Corp (RLI) – Traditional: 158% – FCF Payout: 48% – Analysis
• RPM International Inc (RPM) – Traditional: 84% – FCF Payout: 49% – Analysis
• AT&T Inc. (T) – Traditional: 81% – FCF Payout: 49%

Sometimes the gap is not only large, but goes the other way. This is potentially the most dangerous since focusing on the traditional dividend payout may lead you to believe the dividend is covered better than it actually is. Examples of this situation would include:

• Air Products and Chemicals Inc. (APD) – Traditional: 56% – FCF Payout: 172%
• Franklin Resources Inc. (BEN) – Traditional: 23% – FCF Payout: 48%
• BP Plc (BP) – Traditional: 50% – FCF Payout: 114% – Analysis
• Lowe’s Companies, Inc. (LOW) – Traditional: 27% – FCF Payout: 57% – Analysis
• Exxon Mobil Corp (XOM) – Traditional: 27% – FCF Payout: 54%

Although Free Cash Flow Payout is a better payout ratio than the traditional dividend ratio, the investor should look at both and understand the differences. Taking an expense for impairing goodwill is much different than recognizing an expense for losing a lawsuit. The former will not directly involve cash out the door, but the latter will if the company loses on appeal.

Full Disclosure: Long CLX, EMR, MMM, SYY, UTX, AFL, CTL, ITW, NUE, BP. See a list of all my income holdings here.

(Photo Credit)

Illinois Tool Works Inc. (ITW) – Yield: 3.06% – 2 Stars – Analysis
Illinois ToolWorks Inc. is a diversified manufacturer operates a portfolio of about 750 industrial and consumer businesses located throughout the world. As you can see for the information below, price is all that is keeping ITW from being a 4 Star stock:

• Recent Price: $40.00
• 3 Star Price: $38.99
• 4 Star Price: $36.20

3M Co (MMM) – Yield: 2.89% – 2 Stars – Analysis
3M Co. is a diversified technology company with a presence in various businesses, including industrial & transportation, healthcare, display & graphics, consumer & office, safety, security & protection services, and electro and communications. Like ITW above, price is all that is keeping MMM from being a 4 Star stock:

• Recent Price: $72.00
• 3 Star Price: $57.44
• 4 Star Price: $44.43

I was fortunate to purchase both of the stocks above when their prices were much lower, so I can’t complain that they are no longer 4 Star buys. However, for other companies the road to fewer stars is not as appealing. Instead of a significant run up in their share price, the run up may have occurred in their debt or dividend payout percentage, or both. Here are some dividend companies and the challenges they are facing:

BP Plc (BP) – Yield: 6.50% – 1 Star
This supermajor integrated oil company (formerly BP Amoco p.l.c.) is based in London and is the world’s second largest publicly owned oil company and the fourth largest U.S. refiner. With Debt to Total Capital at an acceptable level and Free Cash Flow Payout at an undesirable level, a 3 Star rating is the best BP could earn at any price.

• Debt to Total Capital: 27%
• Free Cash Flow Payout: 69%
• Recent Price: $50.00
• 3 Star Price: $1.00

SUPERVALU Inc. (SVU) – Yield: 4.67% – 0 Stars
SUPERVALU INC. is one of the largest U.S. food wholesalers, this company is also one of the biggest supermarket retailers in the U.S. With Debt to Total Capital at an undesirable level and Free Cash Flow Payout at an acceptable level (but with some years negative), a 3 Star rating is the best SVU could earn at any price.

• Debt to Total Capital: 73%
• Free Cash Flow Payout: 42%
• Recent Price: $15.00
• 2 Star Price: $14.75
• 3 Star Price: $1.00

The Hershey Company (HSY) – Yield: 2.89% – 0 Stars
The Hershey Company engages in the manufacture, marketing, distribution, and sale of various types of chocolate and confectionery, refreshment and snack products, and food and beverage enhancers in the United States and internationally. With both Debt to Total Capital and Free Cash Flow Payout at undesirable levels, a 2 Star rating is the best HSY could muster at any price.

• Debt to Total Capital: 83%
• Free Cash Flow Payout: 88%
• Recent Price: $40.00
• 2 Star Price: $1.00

Of the three, I believe BP stands the best chance of recovery. Though BP recently froze its dividend at $0.84/share (ADR), higher oil prices should lead to higher FCF and a dividend increase, it could easily add a fourth Star and once again enter the buy zone. I don’t have a lot of confidence in the other two.

Before buying a stock with hopes things will soon improve, it is a good idea to run some sensitivities to see where, or if, the stock can make a recovery. Modeling is cheap, selling an undesirable stock usually isn’t.

Full Disclosure: Long ITW, MMM, BP. See a list of all my income holdings here.

Below are ten dividend stocks that have out-performed the S&P 500 this year through May 15, 2009:

10. Coca-Cola Co (KO) – Return: 0.4% – Yield: 3.76%
The Coca-Cola Company engages in the manufacture, distribution, and marketing of nonalcoholic beverage concentrates and syrups worldwide. Risk Rating: Low (1.50) – Analysis

9. Sysco Corp (SYY) – Return: 0.5% – Yield: 4.20%
SYSCO Corporation, through its subsidiaries, engages in the marketing and distribution of a range of food and related products primarily for foodservice industry in the United States and Canada. Risk Rating: Low (1.00) – Analysis

8. BP ADR (BP) – Return: 1.4% – Yield: 7.37%
This supermajor integrated oil company (formerly BP Amoco p.l.c.) is based in London and is the world’s second largest publicly owned oil company and the fourth largest U.S. refiner. Risk Rating: Medium (1.75) – Analysis

7. 3M Co (MMM) – Return: 1.8% – Yield: 3.52%
3M Co. is a diversified technology company with a presence in various businesses, including industrial & transportation, healthcare, display & graphics, consumer & office, safety, security & protection services, and electro and communications. Risk Rating: Low (1.50) – Analysis

6. Paychex Inc (PAYX) – Return: 4.1% – Yield: 4.63%
Paychex, Inc. provides payroll and integrated human resource and employee benefits outsourcing solutions for small- to medium-sized businesses in the United States. Risk Rating: Medium (1.75) – Analysis

5. Intel Corp (INTC) – Return: 5.6% – Yield: 3.69%
Intel Corporation engages in the manufacture and sale of semiconductor chips, as well as in the development of advanced integrated digital technology platforms for the computing and communications industries worldwide. Risk Rating: Medium (1.75) – Analysis

4. Canadian National Railway ADR (CNI) – Return: 7.0% – Yield: 2.24%
Canadian National Railway Company (CNI) operates Canada’s largest railroad, linking customers in Canada, the U.S., and Mexico through approximately 20,400 miles of track. Risk Rating: Low (1.25) – Analysis

3. Manulife Financial Corp ADR (MFC) – Return: 8.0% – Yield: 4.78%
Manulife Financial Corporation is a life insurance company with customers in the United States, Canada and Asia. It is the holding company of The Manufacturers Life Insurance Company and John Hancock Financial Services. Risk Rating: Medium (1.75) – Analysis

2. CenturyTel Inc (CTL) – Return: 13.5% – Yield: 9.27%
CenturyTel Inc. provides a range of telephone services in 25 states, with operations concentrated in Alabama, Arkansas, Louisiana, Missouri and Wisconsin. Risk Rating: High (2.50) – Analysis

1. Royal Bank of Canada ADR (RY) – Return: 22.8% – Yield: 4.47%
Royal Bank of Canada (RBC) offers a range of banking and financial services in North America and internationally. Risk Rating: Low (1.50)

Over the same period the S&P 500 (VFINX) was down 1.2%. The returns were calculated using Yahoo’s dividend adjusted stock price for December 31, 2008 as the starting point. Some interesting items to note: The list contains four ADRs (3 Canadian, 1 British). RY’s dividend has been frozen since November 2007. CTL is the only High Risk stock to make the list based on my risk rating. The top five were less traditional dividend stocks that had been beaten down to low levels.

Short-term performance is never the sole reason for long-term investors to buy. What goes up significantly usually comes back down. Case in point, last years two dividend darlings, Wal-Mart (WMT) and McDonalds (MCD), found themselves in the bottom ten of this list, each down 13.2%.

Full Disclosure: Long in all the aforementioned securities. See a list of all my income holdings here.

I. International Fund in my 401(k)

This International Equity Index Fund seeks to match the performance of the MSCI EAFE Index which consists of approximately 1,200 stocks in 21 developed market countries outside of North and South America, and represents approximately 85% of the total market capitalization in those countries.  When compared to other options in my 401(k), I have been generally pleased with this funds performance over time. YTD Return:  (-7.2%)

II. International Exchange Traded Funds (ETF) Within My Asset Allocation Portfolio

The international component on my asset allocation portfolio is in iShares MSCI EAFE (EFA).  EFA seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of publicly traded securities in the European, Australasian and Far Eastern markets, as measured by the MSCI EAFE Index. This fund is tracking the same index as my 401(k) above, but with somewhat better results. YTD Return: (-5.1%)

III. Individual International Dividend Stocks

It was my desire to have international representation within my income investments, so I first looked to identify good non-U.S. dividend individual stocks that had an ADR trading on the New York Stock Exchange.  To identify these stocks I used the International Dividend Achievers™ list.  To become eligible for inclusion, a company must be incorporated outside of the United States. The companies must be have an American Depository Receipt or common stock trading on NYSE, NASDAQ or AMEX. Companies must have paid increasing regular annual dividends for five or more consecutive years. What I found is that most companies outside the U.S. follow a different dividend model.  Here are some of the differences:

• Many Foreign Companies Pay Dividends Based on a Percent of Earnings
  This produces a very erratic cash stream. Consider Unilever plc (UL). Its ADR paid $0.353 in Nov/07, $0.668 in May/08 and $0.33 in Nov/08.
• Many Foreign Companies Only Pay Dividends Annually
  I need more feedback than this. I would hate to wait a full year before learning a company plans to slash its dividend. Examples of annual dividends include Shenandoah Telecommunications Co. (SHEN), Siemens AG (SI) and Stryker Corp. (SYK).
• Most Foreign Companies Pay Dividends in Their Local Currency
  Most Canadian companies pay quarterly consistent dividends, similar to companies in the U.S. However, they pay the dividends in Canadian dollars, so the currency risk is with the U.S. investor.  There is probably much less fluctuation between the U.S. and Canadian dollars than most other currencies. However, it exists. Consider the last five dividends on Canadian National Railway Company (CNI): Mar/08 $0.223, June/08 $0.225, Sep/08 $0.217, Dec/08 $0.189 and Mar/09 $0.200. The quarterly dividend dropped 10% from Mar/08 to Mar/09 in U.S. Dollars while it increased its dividend 10% over the same period in Canadian dollars.

I am sure there are more, but one exception to all the above is BP plc (BP). BP’s ADR has paid a consistent quarterly dividend denominated in U.S. dollars.

IV. International Income ETFs and Income Closed-End Funds (CEFs)

One thought was that a market basket of international stocks in either an ETF or CEF would help mitigate some of the issues above. Many of these created problems of their own. Some such as Alpine Total Dynamic Dividend Fund (AOD) has the option to invest in the U.S. also and when things turned ugly, they brought the cash home.  Other funds such as Eaton Vance Tax-Advantaged Global Dividend Opportunities Fund (ETO) and PowerShares International Dividend Achievers Portfolio (PID) have not performed well as dividend investments. Each has cut its dividend, with PID cutting multiple times.  I now question the wisdom of ETFs and CEFs inclusion in an income portfolio, but that is a different discussion.

Conclusion

After much consideration, I have concluded that income investing and international securities don’t mix very well for all the reasons listed above.  Going forward, my primary focus will be on U.S. equities for my dividend income portfolio.  I will use my 401(k) and my Asset Allocation Portfolio to ensure an adequate international allocation. As for the securities that I currently hold, I will individually evaluate the appropriateness of them remaining in my portfolio. Consistent with this methodology, I will remove most International Achievers from the Stock Ideas page, leaving only those that I own or have identified as being an excellent income investment.

Full Disclosure: Long EFA, CNI, BP, AOD, ETO, PID

I. S&P 500 Dividend Aristocrats

These stocks are the best of the best – the blue blood stocks. S&P maintains the list. Here is a description from their site:

S&P 500 Dividend Aristocrats is designed to measure the performance of S&P 500 index constituents that have followed a policy of consistently increasing dividends every year for at least 25 consecutive years. This index is a member of the S&P Dividend Aristocrats index series.

Index constituents exhibit the following characteristics:

• Underlying Indices – S&P 500
• Weighting – Equally weighted; Constituents re-weighted quarterly
• Reconstitution – Reviewed annually in December

Members may be deleted during the December rebalance if calendar-year dividends did not increase from the previous year, or intra-year if the stock is removed from the underlying S&P 500.

Among others, Dividend Aristocrats include these highly recognizable names:

• Clorox Co (CLX)
• Coca-Cola Co (KO)
• Exxon Mobil (XOM)
• Johnson & Johnson (JNJ)
• McDonald’s Corp (MCD)
• Procter & Gamble (PG)
• Wal-Mart Stores (WMT)

II. US Broad Dividend Achievers™ Index

This index is maintained by Idxis. Here is the description from their website:

The Broad Dividend Achievers™ Index is comprised of companies incorporated in the United States or its territories, trade on the NYSE, NASDAQ or AMEX, and have increased their annual regular dividend payments for the last ten or more consecutive years. In addition, Indxis requires that a stock’s average daily cash volume exceed $500,000 per day in the November and December prior to the annual reconstitution date on the last trading date in January. The Index is calculated using a modified market capitalization weighting methodology and has been published by the American Stock Exchange under the ticker symbol DAA since December 5, 2003.

Select US companies with at least ten consecutive years of increasing regular dividends. US companies must be listed on the NYSE, AMEX or NASDAQ. US Companies must have a minimum average daily cash volume of US$500,000 per day for the November and December prior to each Annual Reconstitution Date.

Here are several prominent companies that are Dividend Achievers:

• Chevron Corporation (CVX)
• Donaldson Company (DCI)
• McCormick & Co. (MKC)
• Wells Fargo & Co. (WFC)

III. International Dividend Achievers™ Index

This index is maintained by Idxis. Here is the description from their website:

The International Dividend Achievers™ Index is designed to track the performance of dividend paying American Depositary Receipts and foreign common stocks trading on major US exchanges. To become eligible for inclusion in the International Dividend Achievers Index a stock must be incorporated outside the United States, trade on the NYSE, NASDAQ or AMEX, and have increased its annual regular dividend payments for the last five or more consecutive years. In addition, Indxis requires that a stock’s average daily cash volume exceed $500,000 per day in November and December prior to each annual reconstitution in January. The Index is calculated using a dividend yield weighting methodology and is calculated by American Stock Exchange under the symbol DAT since August 1, 2005.

To become eligible for inclusion, a company must be incorporated outside of the United States. The companies must be have an American Depository Receipt or common stock trading on NYSE, NASDAQ or AMEX. Companies must have paid increasing regular annual dividends for five or more consecutive years. The average daily cash volume must exceed $500,000 in US$ in the November and December prior to reconstitution.

The International Dividend Achievers are filled with companies that touch our lives on a daily basis including:

• Toyota Motor Corp. (TM)
• Panasonic Corp (PC)
• Nokia Corp. (NOK)
• BP p.l.c. (BP)
• Canadian National Railway Company (CNI)

IV. The U.S. Dividend Champions

This list is maintained by Dave Fish of MoneyPaper is regularly updated and located at the The Drip Investing Resource Center. Here is a description from the spreadsheet:

The initial goal was to identify companies that had increased their dividend for at least 25 consecutive years, but, as explained below, the definition was broadened to include additional companies that had paid higher dividends without having increased the quarterly payout in every calendar year. I also decided to follow companies that had increased their dividend for 20-24 straight years, since they are likely to join the 25-year “Champions” soon. It was also necessary to resolve discrepancies between the streak claimed by the company and information from outside sources, which is why the “(Per Company)” sub-title is included.

All the U.S. Dividend Champions names may not be as familiar, but it includes some smaller companies not found on the other lists such as:

• Florida Public Utilities (FPU)
• Bowl America (BWL.A)
• Middlesex Water Co. (MSEX)
• Telephone & Data Sys. (TDS)
• Weyco Group Inc. (WEYS)

Bringing It All Together

The above four lists contain a significant number of companies, and unfortunately a great deal of duplication. I am in the process of building a single list that eliminates the multiple entries for the same company. It is my goal to eventually have a minimum amount of analysis on each company. To that end, I have posted an aggregated list as Stock Ideas under the Analysis section. It is still very rough around the edges, but keep checking in, it will get better as time passes.

Not every stock listed is a great dividend investment, but virtually all great dividend investments are on the list.

Full Disclosure: Long BP, CLX, CNI, CVX, JNJ, KO, MCD, PG, WMT

(Photo: ilker)