One of the worst misconceptions about dividend investing is that it's boring. Heck, some even think dividends are dumb. But I would argue (and I have) that for those of us who love it when someone deposits money into our brokerage accounts, dividend investing is the most powerful and low-risk form of investing around.
In fact, dividend investing is so powerful that the world's greatest investor, Warren Buffett, has made it a staple of his strategy. And that's a good reason dividend investing should be a component of your investment portfolio. Even better, you can prudently and safely use options to boost that income power further, helping you make money in any market.
Buffett, a dividend investor?!
Sure, Buffett is known primarily as a value investor, but the Oracle of Omaha has made a career of finding businesses that pump out cash like oil from a well, a trait that makes them primed to be outstanding income stocks. These cash-flow companies include high-quality insurers such as GEICO and other well-run financials such as Wells Fargo and American Express.
One of Buffett's finest picks has been a dividend monster: Coca-Cola. Buffett started acquiring Coca-Cola shares in 1988 and had 200 million shares as of March 2010, meaning he owns nearly 9% of the soda king. Coca-Cola forms 21% of Buffett's investment portfolio, followed by Wells Fargo at 18%.
In 1988, Coca-Cola wasn't the clear slam-dunk choice it appears to be today. Buffett was one of the first investors to see the enviable Coke brand as a serious competitive advantage. He's now held shares in the company for more than 20 years and has repeatedly praised the efficiency of its capital-light business model, which spits out tons of free cash.
That free cash has allowed the company to consistently raise its dividend and, in the process, create a small fortune for a long-term holder like Buffett.
Because Coca-Cola has raised its dividend by 12% on average over the past 21 years, Buffett now manages to get back about one-third of his original investment every year. If the company continues to increase its dividend at this historical rate, in about nine years Buffett will manage to get back his original investment in dividends every year!
Given Coca-Cola's steady economic performance and solid record of increasing dividends, there's every indication that it will continue those growing payouts. That's the power and excitement of income investing with a rock-solid company: increasing payouts for life. Adding that dividend dynamo to a well-diversified portfolio can round out your returns.
And that's not all ...
When screening for dividend stocks, follow Buffett's example with Coca-Cola and look for strong fundamentals, such as steady profitability and increasing growth over time.
Generally, you should avoid cyclical companies, since their potential for inconsistent profitability could endanger their dividends. Instead, focus on businesses whose products will be in demand regardless of the financial climate and are thus much more likely to ensure a steady payout.
Here are a few that fit my criteria.
|
Company |
Dividend Yield |
5-Year Dividend-Growth Rate |
5-Year Earnings Growth |
|---|---|---|---|
|
Colgate-Palmolive |
2.7% |
12.8% |
11.6% |
|
PepsiCo |
2.9% |
13.7% |
10.1% |
|
Reynolds America |
6.0% |
13.0% |
4.4% |
|
Paychex |
3.9% |
17.7% |
3.2% |
|
Yum! Brands |
2.0% |
32.6% |
7.4% |
|
Intel |
3.4% |
16.9% |
4.9% |
Source: Capital IQ, a division of Standard & Poor's, as of Oct. 14.
Each of these companies has a remarkably strong franchise for consumer products that we use day in and day out, as their solid earnings over five years bear out. Colgate-Palmolive offers the personal-care products that we use on a daily basis and offers great growth opportunities globally. PepsiCo provides its well-known sodas, but it's also behind the Frito-Lay brand of snacks that you see everywhere.
While the demand for cigarettes is in decline, Reynolds is still smoking, and offering investors a fat dividend. This company is the very definition of recession-resistant, but Big Tobacco is now facing significant headwinds, so this company may not be the same beast in 20 years.
Yum! is the name behind the ubiquitous and perennially successful fast-food brands Taco Bell, KFC, and Pizza Hut. You might not know Paychex personally, but there's a good chance that if you work for a small business, your company's payroll and other HR services are run through the company. And Intel's a company that dominates its core markets and goes into almost every desktop and laptop computer out there.
The indispensability of these companies' products ensures that payouts from such blue chips can grow for decades and turn even a small initial investment into a dividend dynamo -- just as Buffett did with Coke.
Follow these stock stars
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