Dividend growth investing is not about exit points, momentum swings, relative strength, sector rotation; instead it is about studying fundamentals, selecting superior stocks and building a portfolio with a long-term horizon.  When we buy a dividend stock, we hope to hold it forever.  What makes a good dividend stock? Here are some of the things I look for:

Good Business Model

Sell things that people want or need, and do it in such a way that it is difficult or impossible for others to duplicate. There is a reason that pharmaceutical companies, such as Abbott Laboratories (ABT), are so profitable. With effective drugs under patent that sustain or enhance people’s life these companies have a deep moat. Consumer goods companies like Procter & Gamble Co. (PG) and Kimberly-Clark Corporation (KMB) manufacture products such as soap, detergent and toilet paper that we just can’t do without. Sure, there may be generic substitutes, but over the years many of these products have endeared themselves to consumers who are willing to pay a few cents more for the name brand.

Strong Free Cash Flow

Dividends are paid with cash remaining after paying the operating expenses and replacement capital (free cash flow). If a company has trouble meeting these basic needs, then its dividend is perilously at risk. Companies with a low free cash flow payout (FCF) payout are well-positioned to sustain their dividend. Such companies include: Target Corporation (TGT) at 13.85% FCF Payout, Diebold, Inc. (DBD) at 17.21%, International Business Machines Corp. (IBM) at 19.48% and Walgreen Company (WAG) at 22.71%.

Acceptable Debt Level

Generating a strong free cash flow is not enough – cash has to be available to be paid as dividends. As a result of the economic downturn, many companies are feeling pressure to reduce debt to stay within their covenants and try to maintain their debt rating. If a company’s excess cash is being used to service debt, there may not be any left over to increase dividends. Companies with a low debt to total capital include: T. Rowe Price Group Inc. (TROW) at 0.00% Debt to Total Capital, Automatic Data Processing Inc. (ADP) at 0.69%, Harleysville Group Inc. (HGIC) at 13.19% and Genuine Parts Company (GPC) at 15.76%.

Good Balance between Dividend Yield and Growth

There is usually a reason why a stock’s yield is above average. Often it is the market’s way of saying it doesn’t believe the company can maintain the dividend. Most people understand this risk. However, there is also risk to a stock that has a high dividend growth rate. To maintain a high dividend growth rate the company has to grow cash available for dividends at the same rate. This is often difficult to do. Here are several companies with a good balance between dividend yield and dividend growth rate: The Coca-Cola Company (KO) 2.94% yield and 7.32% dividend growth rate, UGI Corporation (UGI) 3.06% yield and 5.70% growth, The Clorox Company (CLX) 3.24% yield and 9.35% growth, Johnson & Johnson (JNJ) 3.31% yield and 8.42% growth and Corporate Office Properties (OFC) 4.25% yield and 5.22% growth.

For those of us that have invested in dividends for years (decades for some), we know dividend growth investing is not a passing fad to be “played” then move on the next hot investment strategy. Part of me will be glad when dividend investing falls out of favor and the masses moves on.

Full Disclosure: Long ABT, PG, ADP, HGIC, CLX, GP, JNJ, KMB, KO. See a list of all my income holdings here.

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(Photo Credit)

Linked here is a detailed quantitative analysis of UGI Corporation (UGI). Below are some highlights from the above linked analysis:

Company Description: UGI Corp. operates propane distribution, gas and electric utility, energy marketing and related businesses through subsidiaries.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

1. Avg. High Yield Price
2. 20-Year DCF Price
3. Avg. P/E Price
4. Graham Number

UGI is trading at a premium to all four valuations above. Since UGI’s tangible book value is not meaningful, a Graham number can not be calculated. The stock is trading at a 30.5% premium to its calculated fair value of $20.60. UGI did not earn any Stars in this section.

Dividend Analytical Data: In this section there are three possible Stars and three key metrics, see page 2 of the linked PDF for a detailed description:

1. Free Cash Flow Payout
2. Debt To Total Capital
3. Key Metrics
4. Dividend Growth Rate
5. Years of Div. Growth
6. Rolling 4-yr Div. > 15%

UGI earned three Stars in this section for 1.), 2.) and 3.) above. A Star was earned since the Free Cash Flow payout ratio was less than 60% and there were no negative Free Cash Flows over the last 10 years. The stock earned a Star as a result of its most recent Debt to Total Capital being less than 45%. UGI earned a Star for having an acceptable score in at least two of the four Key Metrics measured. The company has paid a cash dividend to shareholders every year since 1885 and has increased its dividend payments for 23 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:

1. NPV MMA Diff.
2. Years to > MMA

The NPV MMA Diff. of the $614 is below the $1,200 target I look for in a stock that has increased dividends as long as UGI has. If UGI grows its dividend at 5.7% per year, it will take 2 years to equal a MMA yielding an estimated 20-year average rate of 3.71%. UGI earned a check for the Key Metric ‘Years to >MMA’ since its 2 years is less than the 5 year target.

Other: UGI is a member of the Broad Dividend Achievers™ Index.

Conclusion: UGI did not earn any Stars in the Fair Value section, earned three Stars in the Dividend Analytical Data section and did not earn any Stars in the Dividend Income vs. MMA section for a total of three Stars. This quantitatively ranks UGI as a 3 Star-Hold.

Using my D4L-PreScreen.xls model, I determined the share price would need to decrease to $21.54 before UGI’s NPV MMA Differential increased to the $1,200 minimum that I look for in a stock with 23 years of consecutive dividend increases. At that price the stock would yield 4.18%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $1,200 NPV MMA Differential, the calculated rate is 7.9%. This dividend growth rate is well above the 5.7% used in this analysis, thus not providing any margin of safety. UGI has a risk rating of 1.75 which classifies it as a medium risk stock.

UGI offers a unique business mix of low-risk regulated gas distribution business along with a more volatile unregulated propane marketing businesses. The gas utility serves about 1,000,000 customers and the electric utility serves about 62,000 customers. The utility owns two coal-fired stations that supply more than half of its electricity, with the remainder purchased on the open market. The non-utility portion of the business has certainty helped its financials. Its debt to total capital of 43% and free cash flow payout of 45% are low for a utility. Also, not having any negative free cash flows over the last 10 years is virtually unheard of for a utility. Unfortunately, this has been baked into the share price with the company trading at more than 30% above my buy price of $20.60. I will watch UGI and wait for a better entry point. For additional information, including the stock’s dividend history, please refer to its data page.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I held no position in UGI (0.0% of my Income Portfolio). See a list of all my income holdings here.

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#10 Chubb Corp. (CB) One of the largest U.S. property-casualty insurers, Chubb has carved out a number of niches, including high-end personal lines and specialty liability lines coverage.
Paid since: 1902 | Consecutive increases: 45 | Yield: 2.92%

#9 PPG (PPG) is a leading manufacturer of coatings and resins, flat and fiber glass, and industrial and specialty chemicals.
Paid since: 1899 | Consecutive increases: 36 | Yield: 3.55%

#8 Colgate-Palmolive Company (CL) is a consumer products company, whose products are marketed throughout the world. Colgate’s Oral Care products include toothpaste, toothbrushes, oral rinses, dental floss and pharmaceutical products.
Paid since: 1895 | Consecutive increases: 45 | Yield: 2.13%

#7 The Coca-Cola Company (KO) is the world’s largest soft drink company. It engages in the manufacture, distribution, and marketing of nonalcoholic beverage concentrates, fruit juices and syrups worldwide.
Paid since: 1893 | Consecutive increases: 47 | Yield: 3.02% | [Analysis]

#6 The Procter & Gamble Company (PG) is focused on providing branded consumer goods products. The Company markets its products in more than 180 countries.
Paid since: 1891 | Consecutive increases: 53 | Yield: 2.92% | [Analysis]

#5 UGI Corp. (UGI) operates propane distribution, gas and electric utility, energy marketing and related businesses through subsidiaries.
Paid since: 1885 | Consecutive increases: 23 | Yield: 3.20%

#4 Consolidated Edison, Inc. (ED), through its subsidiaries, provides electric, gas, and steam utility services in the United States serving parts of New York, New Jersey and Pennsylvania.
Paid since: 1885 | Consecutive increases: 36 | Yield: 5.42%

#3 Eli Lilly and Company (LLY) discovers, develops, manufactures and sells prescription drugs that offers a wide range of treatments for neurological disorders, diabetes, cancer, and other conditions. The company also sells animal health products.
Paid since: 1885 | Consecutive increases: 42 | Yield: 5.52% | [Analysis]

#2 Exxon Mobil Corp. (XOM) is engaged in the exploration, production, and sale of crude oil, natural gas, petroleum products and petrochemicals. XOM is the world’s largest publicly owned integrated oil company.
Paid since: 1882 | Consecutive increases: 27 | Yield: 2.51%

#1 Stanley Works (SWK) is a worldwide producer of tools, hardware and specialty hardware for home improvement, consumer, industrial and professional use.
Paid since: 1877 | Consecutive increases: 42 | Yield: 2.44%

A strong dividend culture is a great place to start looking, but before buying we must also consider other factors such as: dividend fundamentals, ability to cover their dividend and fair value.

Full Disclosure: Long KO, PG, ED, LLY. See a list of all my income holdings here.

(Photo Credit)

Last Tuesday, IBM stood up and was counted as a leader. At a time when the ill-prepared and the fearful are cutting dividends and hoarding cash, IBM increased its quarterly dividend 10% to $0.55/share and announced a $3 billion share repurchase program. The company has increased its quarterly dividend by 175% percent since 2006 and this is the 14th consecutive increase. The dividend is payable June 10, 2009 to stockholders of record May 8, 2009.  based on the new rate, IBM is currently yielding: 2.10%

Below are many other companies joining IBM as leaders andrewarding their shareholders with higher cash dividends:

• Cullen/Frost Bankers (CFR) increased its qtr. dividend 2% to $0.43/share. Yield 3.54% (analysis)
• Donegal Group (DGICA) raised its qtr. dividend to $0.112/share. Yield: 3.07%
• Valmont Industries (VMI) ups its qtr. dividend 15.4% to $0.15/share, Yield: 0.95%
• Bemis (BMS) boosts qtr dividend to $0.225/share. Yield: 3.72%
• Costco Wholesale (COST) increased its qtr dividend to $0.18/share. Yield: 1.50%
• BOK Financial (BOKF) raised its qtr. dividend 6.7% to $0.24/share. Yield: 2.48%
• W.W. Grainger (GWW) ups its qtr. dividend 15% to $0.46/share. Yield: 2.22%
• Talisman Energy (TLM) boosts its semi-annual dividend 12.5% to $0.1125/share. Yield: 1.47%
• ExxonMobil (XOM) increased its qtr. dividend to $0.42/share. Yield: 2.45%
• UGI Corporation (UGI) raised its qtr dividend 4% to $0.20/share. Yield: 3.35%
• Safeway (SWY) ups qtr. dividend 21% to $0.10/share. Yield: 1.56%
• Occidental (OXY) boosts qtr. dividend 3.1% to $0.33/share. Yield: 2.23%
  

Hopefully, this is just the beginning and in the coming weeks we will continue to see more dividend increases. For more companies with a long string of consecutive dividend increases, see this list.

Full Disclosure: No position in the aforementioned securities.  See a list of all my income holdings here.

(Photo: Steve Woods)

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