Get the Raise You Deserve
In case you are unfamiliar with the prestigious S&P 500 Dividend Aristocrats Index, I am pleased to introduce it to you.
Dividend Aristocrats are stocks that are members of the S&P 500 and that have increased their dividends every year for the past 25 years.
By raising the dividend, company executives are telling you two things…
1) They’re Committed to Shareholders: By returning capital to shareholders, companies are rewarding your faith in their business. Look at it this way: If you invested in your brother-in-law’s restaurant and the business did well, at some point, you’d expect him to start writing you checks. The same thing should hold true for the stocks you invest in.
2) They’re Confident: Raising the dividend payment shows investors that the company’s management is confident in their business now and in the future. It also shows that they take their dividend policy seriously. Executives are keenly aware that Wall Street doesn’t like dividend cuts – and investors tend to punish dividend-choppers accordingly.
And of course, if you receive more in dividends every year, your yield on cost (i.e. the yield on the price you originally paid) rises. For example, if you buy a $50 stock with a $2 annual dividend, your yield is 4%. But five years later, if the dividend has risen to $3, your yield on cost is 6%, even if the share price has doubled to $100. (Quickly crunch yield on cost with this calculator.)
Dividend Aristocrats have become a popular group for both income seekers and retirees alike. And it’s easy to see why.
The group provides extremely reliable dividends and market-beating returns.
Over the past 25 years, Dividend Aristocrats have almost doubled the performance of the S&P 500. And in the last 10 years, the Aristocrats gained more than 205.12% while the S&P was up 134.02%.
Currently there are 53 Aristocrats. They include household names like Johnson & Johnson (NYSE: JNJ), Target (NYSE: TGT) and The Clorox Company (NYSE: CLX).
Being able to raise your dividend payments year in and year out for 25 years or more through fluctuating markets and big downturns – like the 2008 financial crises – is quite the feat. We applaud these companies for accomplishing this.
But not every Divided Aristocrat is worthy of a standing ovation when it comes to yield.
Avoid the “Skimpers”
To make it as an Aristocrat, all you have to do is pay a dividend and raise it once a year. It doesn’t matter how big the payout. As a result, many stocks are dishing out some puny yields.
Current Aristocrats like S&P Global Inc. (NYSE: SPGI), Sherwin-Williams (NYSE: SHW) and Cintas Corp. (Nasdaq: CTAS) are yielding 1.07%, 0.90% and 0.97%, respectively. Meanwhile, all the companies that make up the Dividend Aristocrats are averaging a yield of 2.53%.
But if you are going to hold dividend paying stocks and reinvest the dividends – something we strongly suggest here at Wealthy Retirement – starting off with above-average yields is key to beating mediocracy.
But you shouldn’t stop there.
Finding stocks with sizable yields that are also safe from possible dividend cuts is crucial. It’s a balancing act of a decent yield versus the ability to sustain a dividend payout and raise it. And it all starts by looking at cash flow.
Cash Is King
When it comes to analyzing dividend-paying stocks, ensuring those dividends are safe from being cut is key. Especially for Dividend Aristocrats since they have to raise their dividends on an annual basis to stay in the pack.
Any shareholder of a dividend-paying stock needs to worry about dividend sustainability. When companies cut or reduce their dividends, not only are you getting less in cash payouts, but the stock also generally gets punished in the process.
When examining a company to see whether the dividend is sustainable, you want to look at cash flow. This differs from the standard dividend payout ratio that looks at earnings.
In fact, we have a weekly Wealthy Retirement column called The Safety Net that is dedicated to grading dividend-paying stocks. Every week, Chief Income Strategist Marc Lichtenfeld looks at a stock to determine the safety of its dividend and the likelihood that it’ll be paid or even raised.
In his column, Marc always focuses on free cash flow to dividends paid. This goes against conventional Wall Street wisdom that looks at earnings to dividends paid.
Why should you ignore earnings when it comes to judging dividend safety? Because earnings are just the beginning part of the cash flow equation.
You should look directly at cash flow since it tells the real story as to the health of the business. A company could have great earnings, but if it has no cash left over at the end of the quarter or year to pay shareholders their dividends, that’s a problem.
Here is the equation:
FCF Dividend Payout Ratio = Dividends Paid / Free Cash Flow
Generally speaking, you want to see a company pay shareholders 75% or less of its free cash flow (FCF). This gives it wiggle-room to continue paying its dividend if cash flow decreases for a short period of time.
And since Dividend Aristocrats need to raise their dividends every year, the lower the payout ratio the better.
Safety in Numbers
Below is a list of the top 10 Dividend Aristocrats based on an above-average yield and a low payout ratio. The list contains stocks with dividend yields over 2% that also have the lowest dividend/FCF payout ratios in the index.
Please note we left out insurance companies since many have unconventional cash flow reporting.
As you can see, the Aristocrats above have payout ratios that range from 30.37% to 45.82%, well below the 75% threshold we look for.
All have plenty of wiggle-room to continue paying and raising their dividends well into the future.
Investing Long Term With Dividend Aristocrats
If investing for the long term, I’d rather have these types of dividend-paying stocks in my portfolio, even if the yields are a little lower, than other stocks whose dividends are not being raised but have a higher current yield.
The dividend that is continually rising is more likely to keep up with or exceed inflation than the stock whose dividend remains constant.
Additionally, an Aristocrat has a track record of raising the dividend.
Management understands that the raised dividend is important to shareholders. The executives should do everything in their power to continue that tradition, because they know investors expect it. If they are unable to hike the dividend after many years of doing so, that signals there is a problem with the company and it will likely lead to an exodus from income investors.
A management team and board of directors that understand that their shareholders are the owners of the company, and are committed to increasing the payout to investors each year, can be the best partners an investor can find in his or her pursuit of wealth.
To amass wealth over the long term, don’t chase yield. Chase track record. A track record of annual dividend increases has a better chance of getting you where you want to be.
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