5 Surprising and Special Dividend Stocks

Investors love to find catalysts for their stocks. Special situations such as spinoffs or restructurings can unlock hidden value and produce accelerated returns. It's an attractive way to play the market, and it's a method I follow in my Rising Stars Portfolio. But many investors overlook one of the best catalysts for stoking capital gains -- dividend increases -- since an increase signals management's confidence in the business prospects.

Special situation, meet income investing
If you've clicked on this article, you probably love dividend stocks as much as I do. I've written extensively about income investing, detailing the dividend play for a lifetime, the outstanding dividend stock I was buying in January, and other high yields to own for decades.  But I think you can do even better by combining your focus on dividend payers and special situations.

At its heart, special situations investing is about finding specific events, such as forced selling of a spinoff, that aren't yet reflected in stock prices for technical reasons rather than fundamental business reasons. Such events often create big inefficiencies in the market.

For dividend investors, special situations could involve companies that have just started a dividend. While many investors regard a dividend initiation as a tacit admission that the company cannot grow as fast as it once did and therefore exit the stock, a dividend also draws in a whole new investor base, too. Because income-focused indexes and other funds cannot buy a stock until it pays a dividend, there's pent-up demand for shares.

Take Starbucks (Nasdaq: SBUX  ) , for instance, which just started its payout last year. Often, in the early years of their dividends, such companies quickly ramp their payouts, as Starbucks did when it announced a 30% hike the quarter after it began the dividend. The stock is up 49% over the past year, and I won't be surprised to see above-average dividend gains in future quarters.

And now for the contenders...
Below are five companies that can boast above-trend dividend growth and may benefit from a rapid dividend increase or an initiation:

Company

Yield

Surprising because...

Cisco (Nasdaq: CSCO  ) 1.3% The world's largest communications equipment company has initiated a dividend
McDonald's (NYSE: MCD  ) 3.2% The company has committed to paying out all free cash flow, either as dividends or buybacks
Seaspan (NYSE: SSW  ) 3.6% The company has promised a "progressive" dividend policy as earnings ramp and a 50% dividend raise
BP (NYSE: BP  ) 3.6% BP has also promised a progressive dividend policy
Church & Dwight (NYSE: CHD  ) 1.7% The company bumped up the dividend by 100% in the latest quarter, on top of a 21% bump in mid-2010

Cisco has decided that it wants to join the dividend game and now offers a 1.3% yield, a payout ratio of just 14% of free cash flow. That leaves plenty of room for accelerated dividend growth, and the stock could benefit from market inefficiencies as well, as funds rush in. With the stock trading at 11 times its free cash flow and sitting near a 52-week low, there are few expectations built in here. The situation is largely similar for blue-chip stalwart Microsoft (Nasdaq: MSFT  ) , which has become much more friendly to income investors of late. And I think Mr. Softy could be another great dividend play for a lifetime.

McDonald's has become a dividend darling in the last half-decade (at least for me.) In that period, the company has plumped its payout at a 27.5% annual rate. While that type of growth can't continue indefinitely, the company has already committed to paying out all its free cash flow as either dividends or buybacks. And the company has other hidden assets, as I explain here.

I'm attracted to Seaspan for the improving industry fundamentals and the company's promise of a progressive dividend policy, suggesting that payouts will increase at an above-average rate. Indeed, the company bumped the divvie by 50% just recently. Andy Cross, co-advisor of Motley Fool Hidden Gems, bought the stock for the newsletter's real-money portfolio last year and has seen a stellar 90% gain in just nine months. But with Seaspan's looming dividend increases, I think there's plenty more upside.

The catalyst for BP is much the same as it is for Seaspan: a progressive dividend policy that can show above-trend increases. BP was widely held by income investors in the U.S. and U.K. for its yields in the range of 5.5% to 6%, and the recent resumption of its dividend (albeit at half the previous rate) should bring yield-hungry investors and funds back to the fold, especially as oil prices continue to rise.

Investors in Church & Dwight have a lot to be happy about following the company's doubling of the payout. Since the announcement on Feb. 8, the stock has run up 15%. This mid-cap player in the consumer goods space can't boost the dividend at that rate forever, but its free cash payout sits at just 27%, so there's clearly room for above-average gains.

Follow these dividend stars
If you like any of these stocks, click on MyWatchlist.com, our free, personalized stock-tracking service. You can also add any stock you like and you'll get access to our Foolish content on every stock on your list and you'll stay up-to-date on what's going on.

Do you have a dividend stock that the market hasn't appreciated yet? Let me know in the comments below.

Jim Royal, Ph.D., owns shares in McDonald's, Microsoft, and Church & Dwight. Microsoft is a Motley Fool Inside Value recommendation. Starbucks is a Stock Advisor selection. McDonald's is an Income Investor pick. The Fool has created a bull call spread position on Cisco Systems. Motley Fool Options has recommended a diagonal call position on Microsoft. Motley Fool Options has recommended a write covered strangle position on Seaspan. The Fool owns shares of Microsoft, Seaspan, and Starbucks. Motley Fool Alpha LLC owns shares of Cisco Systems and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (60)

Comments from our Foolish Readers

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 April 08, 2011, at 11:32 PM, DonkeyJunk wrote:

    I contend that CSCO's new dividend is both paltry and disappointing due to the fact that 1) CSCO has an enormous war chest they use to buy companies that have not proven to help their primary source of revenue and 2) a 1-2% dividend was promised when the stock was valued over $22. The 1.3% dividend was instituted after it fell to $17. Maybe long-in-the-tooth Chambers' new plans include selling extraneous businesses (for still more extra cash) and boosting the dividend, but the current rate and CSCO's miserly ways with money don't make that seem likely. This coming from a shareholder.

  • Report this Comment On April 09, 2011, at 4:27 PM, buffalonate wrote:

    First Niagara Financial Group has a 4.6% dividend and will grow much faster than any of the companies you posted.

  • Report this Comment On April 10, 2011, at 12:50 AM, sikiliza wrote:

    I loved it when Walter Energy (WLT) spun off WAC. That unlocked a lot of value, with WLT continue to grow at an impressive pace in the last two years and created an asset management company with over 10% dividend yield.

  • Report this Comment On April 10, 2011, at 12:36 PM, jayvon1 wrote:

    Why do they only report on the TBTF banks? IBCP just increased it’s dividend to 6% that’s a great upturn compared to some of the other banks dividend of a penny. Independent Bank is currently rated as one of the top Banks in the Regional Banking Industry based on estimated Forward Earnings. If you look at the projected earnings for the current fiscal year Independent Bank has the highest forward earnings yield in the Regional Banks Industry at 35.2%. The forwards earnings yield is often useful to compare the performance of a stock's return versus owning a stock within the same industry or other yield-based assets such as bonds

    Apr. 06, 2011 - Independent Bank is one of today’s best performing low-priced stocks, up 7.99% to 3.65. Shares of Independent Bank are currently trading above their 50-day and above their 200-day

  • Report this Comment On April 15, 2011, at 12:07 PM, maryb313 wrote:

    After 25 +/- years, I still love my monthly dividend from Realty Income ( O ). I beleve it's gone up every quarter fractionally. Surprised you haven't recommended it

  • Report this Comment On April 15, 2011, at 4:44 PM, 4spiel wrote:

    BP ? This company is taking big risks in Russia.It may take years for any return on any Arctic Drilling. BP is treading unwarily ! may once warned into the clutches of the Russian bear. Putin is standing for President again and Medvedev may for his safety decide not to stand. Putin is a Russian Nationalist. Putin does not like Britain the puny once Great Power who cannot even keep its pensioners decent in care homes yet spends millions on Tomahawk to bomb Libya. If you invest in BP now be aware of the extent of the risks.Russia has never ever been our friend and the way they were treated by America after the fall of the Soviet Union they will never be a friend of America either

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