When it comes to dividend-paying stocks, bigger isn't always better. Oftentimes, dividend investors excitedly uncover a company that pays a huge dividend, only to find it soon slashed. Instead of subscribing to crash-and-burn dividend investing, adopt a more sustainable strategy.
When the hunter becomes the hunted
Pursuing yield alone is a dangerous sport. It's like surfing with a massive paper cut, after popping a month's worth of blood thinners. When we espouse tunnel vision and focus solely on one metric, like dividend yield, we're investing with blinders on. No good can possibly come of it. A better strategy is to find dividend stocks that boast reliable dividend growth and low payout ratios, even if that comes at the expense of lower current dividend yields.
Here are three great ones.
1. Lowe's (NYSE: LOW )
This home improvement retailer belongs to the S&P 500 Dividend Aristocrats, an exclusive club of blue chip companies that have raised their dividends for at least 25 straight years. Through housing market booms and busts, Lowe's has increased its dividend for twice that many years!
Don't let Lowe's modest 1.5% dividend yield (small-f) fool you. The real power in its dividend is its growth story. Lowe's raised it by more than 14% last year and has almost doubled it over the past five years. Better yet, Lowe's payout ratio, a measure that indicates how much of its net income is returned to shareholders in the form of dividends, is 37%. That indicates that the company has lots of wiggle room to grow its dividend in the future.
Lowe's huge dependence on the housing and construction fields definitely hurt it during the recent recession. But the company, which caters to contractors, do-it-yourselfers, and do-it-for-me types, is benefiting handsomely from the current housing market recovery. Its stock gained 42% in the past 12 months.
2. Medtronic (NYSE: MDT )
The world's largest medical device maker, Medtronic, has increased its dividend every year since bell-bottoms and go-go boots were all the rage. The company pays a dividend yield of 2.1%, and its payout ratio is a healthy 31%.
Last year, Medtronic increased its dividend 7%. And, during the past five years, Medtronic has raised its dividend at a rate that outpaced the CPI sixfold.
As a result of Obamacare, a medical device excise tax is skimming 2.3% off the top of a company's revenues to pay for the Medicaid expansion. But while competitor Stryker is slashing jobs to offset the loss of revenues, Medtronic will actually augment headcount.
3. Target (NYSE: TGT )
Target is crowned not only a Dividend Aristocrat, but also the queen of budget-friendly yet trendy goods. The discount retailer has hiked its dividend for 45 consecutive years. The stock currently boasts a dividend yield of 2.1%.
Target's 29% payout ratio is the most modest of these three companies. Yet the company has increased its dividend more than Lowe's and Medtronic over the past five years. In fact, Target raised its dividend 125%, while Lowe's and Medtronic increased their dividends roughly 88% and 39%, respectively, during that same five-year period.
Target boasts opportunities to expand internationally, and it recently branched out into the Canadian market. Although the capital investments required will initially depress Target's cash flow, the retailer will likely enjoy improved cash flows as the Canadian stores become more established.
Final Foolish thoughts
Be sure to look past lavish dividend yields. Make sure a company has the wherewithal to back its current dividend and, more important, boost it. By overlooking companies that pay lower yields, you may be missing out on the best dividend growth stocks of the coming decade.
If you're an investor who prefers returns to rhetoric, you'll want to read The Motley Fool's new free report, "5 Dividend Myths... Busted!" In it, you'll learn which stocks provide premium growth and whether bigger dividends are better. Click here to keep reading.