The past year has been awful for investors of all stripes, but particularly so for relatively staid dividend-focused investors. Companies that not long ago were considered bastions of dividend fortitude -- SunTrust Banks, AIG, Fannie Mae, and the like -- are slashing payouts left and right. Fifty-three companies cut their dividends in November -- nine more than in all of 2007.
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 also growing them.
Spotting the long-haul winners
As November 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 Philip Morris International (NYSE: PM ) , for example, converts around 24% of its revenue into free cash.
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 such industries 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 a stellar 10% of its revenue into free cash flow and pulls in operating profits about six times that of its interest expense. Even better, Republic's impending merger with Allied Waste should leave the combined company with even better results, thanks to scale and increased pricing power. And those of us who routinely lug our trash to the curb can attest that the company's core waste-hauling business is far from being cyclical.
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
For starters, there's no real chance that technological obsolescence will undercut Republic's service offering. In other words, you're not looking at a Sony Discman-vs.-Apple (Nasdaq: AAPL ) iPod situation. Similarly, unlike Qualcomm (Nasdaq: QCOM ) or Cisco (Nasdaq: CSCO ) , Republic doesn't spend billions on research and development every year simply to maintain its competitive positions. Waste hauling is as static a business as it is boring -- and that's a good thing.
And 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 jewelers before Blue Nile (Nasdaq: NILE ) . Aggregate and cement producers such as Vulcan Materials (NYSE: VMC ) and Cemex (NYSE: CX ) benefit from the same concept.
Now, take the ability to set local prices with minimal competition, 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 7.5%) has returned more than three 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. Republic Services is a Motley Fool Income Investor recommendation, and Microsoft and Vulcan are Inside Value choices. Blue Nile is a Rule Breakers pick. Apple is a Stock Advisor recommendation, as is Cemex. Cemex is also a Global Gains recommendation. The Motley Fool owns shares of Cemex. There's nothing trashy about the Fool's disclosure policy.
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