You Should Buy Stocks Just Like This One

The past year has been awful for investors of all stripes, but particularly so for relatively staid dividend-focused investors. Companies that not along ago were considered bastions of dividend fortitude -- MBIA (NYSE: MBI  ) , Wachovia (NYSE: WB  ) , American International Group (NYSE: AIG  ) , etc. -- have been slashing payouts left and right. In fact, there were more dividend cuts in the second quarter than in any quarter since 1991.

And there's plenty of reason to be sore about those dividend cuts: Mind-blowingly thorough research from Wharton professor Jeremy Siegel shows that dividends are a crucial driver of long-term market outperformance.

But rather than spend the rest of this recession hiding under a rock, we dividend-loving investors can profit. Yes, many companies are cutting their dividends, but there are plenty of stocks not only maintaining their dividends, but growing them.

Spotting the long-haul winners
As the past quarter has shown, cuts happen. But fortunately, identifying dividend payers with sustainable, growing payouts isn't exactly rocket science -- you just need to know what you're looking for.

Companies with long, uninterrupted histories of dishing out dividends typically share these three traits.

1. They rake in cash.
Dividends are usually funded with free cash flow, which means that prodigious cash generation and dividend safety go hand-in-hand. Dividend all-star Coca-Cola (NYSE: KO  ) , for example, converts around 17% of its revenue into free cash. That stellar profitability has helped to fuel 46 consecutive years of dividend growth.

2. They aren't cyclical.
During boom times, profits in a cyclical industry flow like a Saudi oil well, often leading management teams to overcommit to higher dividends and large capital projects. When a cyclical industry tightens up (and they always do), cash profits follow suit, and once-high dividend payouts quickly find themselves on the chopping block.

3. They are conservatively capitalized.
Even well-run companies that aren't in cyclical industries can occasionally find themselves on the outs. Look for companies that consistently produce operating profits well in excess of their debt obligations.

By looking out for companies that demonstrate these qualities, you're setting yourself up to find the next great dividend winner.

A company that recently caught my eye -- and that demonstrates these three qualities -- is Motley Fool Income Investor recommendation Republic Services, which is poised to profitably saddle up with fellow trash giant Allied Waste.

Trash and cash
Republic, currently the nation's third-largest waste hauler, operates in a pretty mundane industry. But your trash is Republic's cash -- the company turns about 10% of its revenue into free cash flow and pulls in operating profits about six times that of its interest expense. And as those of us who routinely lug our trash to the curb can attest, waste hauling is far from a cyclical industry.

See, owning shares of Republic is a bit like a having a stake in a collection of small near-monopolies. Building a landfill requires a lot of cash, involves miles of red tape, and faces intense blowback from the locals. These challenges keep competition at bay and have helped lead to consolidation in the industry.

It gets better
Unlike with oil, gasoline, and other high value-to-weight commodities, it doesn't make economic sense to haul trash over long distances. That means you don't have to worry about distant competition threatening your localized pricing as it often does in other industries -- picture local book stores before Amazon.com (Nasdaq: AMZN  ) , or ad rates for terrestrial radio players before Sirius XM Radio (Nasdaq: SIRI  ) .

Now, take the ability to set local prices with minimal competition, and combine it with the rational pricing of this consolidating industry, and it's little wonder that Republic and the other major waste haulers are able to push around their customers. For its part, Republic has increased its prices 7% over the past year.

Dumping it all together
There's a lot to love about such sturdy, growing dividend payers -- just ask Republic's largest investor, Microsoft's Bill Gates. Republic is typical of most Income Investor recommendations: strong, well-managed, and boasting healthy cash flows and a sustainable dividend.

On the surface, there isn't much pizzazz to dividend-focused investing, but as Jeremy Siegel's research and Income Investor's results have shown, the strategy is a proven winner.

Since the newsletter's inception in 2003, the average recommendation (which currently yields 6.4%) has returned 4 percentage points more than the S&P 500. Subscribers receive fresh stock ideas each month, access to all past recommendations, and the team's top five recommendations for new money now. You can try the service free for 30 days with no obligation to subscribe. Click here to get started.

This article was first published Aug. 29, 2008. It has been updated.

Joe Magyer doesn't own shares of any companies mentioned in this article. Microsoft and Coca-Cola are Motley Fool Inside Value recommendations, while Amazon.com is a Stock Advisor recommendation. Republic Services is an Income Investor recommendation. There's nothing trashy about the Fool's disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 29, 2008, at 5:16 PM, aamire wrote:

    I can't argue with Jeremy Siegel, but how do you explain performance Berkshire stock, which also doesn't pay a dividend?

  • Report this Comment On August 30, 2008, at 11:42 AM, TMFJoeInvestor wrote:

    Hey there, aamire. Berkshire is a bit of an anomaly because it is a holding company with a master capital allocator at the helm. If you look at Berkshire, though, you'll find it is really a collection of business with durable competitive advantages, not unlike what you find with RSG. Hope that helps!

  • Report this Comment On September 02, 2008, at 10:08 AM, vze272rz wrote:

    I have always considered Berkshire a stock to hold long term for capital appreciation and never considered it a dividend paying investment.

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