For income-investors one of the best ways to guarantee long term returns is to let your income compounding work in your favor with steady and growing dividends from strong companies. Three of the markets favorite dividend stocks are Philip Morris International (NYSE: PM), Altria Group (NYSE: MO), and Colgate-Palmolive (NYSE: CL) and here's why they'll continue to give you great dividend returns for years to come.
Currently, Philip Morris offers a dividend yield of 4.7%, more than double the market average and attractive for many investors. What's more, management has been extremely prudent in ensuring the long-term sustainability of the company's dividend. In particular, in its first full year of independence after being spun off from what is now Altria during 2008, Philip Morris generated free cash flow of $6.8 billion. From that, it paid out $5.1 billion in dividends to investors.
Now, Philip Morris could have paid out much more than this in theory, but the company's management remained cautious. Since then, the company's payout has edged up, rising from an initial payout of $1.84 per annum, per share during 2008, to $3.76 for 2013.
However, while Philip Morris' payout has more than doubled, it has only grown in-line with funds generated from operations. In particular, although Philip Morris' payout has risen by more than 100% on a per-share basis during the past five years, the company's payout ratio has, for the most part, remained below 60% of free cash flow.
So, investors can buy into Philip Morris for the dividend payout safe in the knowledge that the distribution will continue to grow.
Unfortunately, Altria's dividend is under much more pressure than that of its larger, international peer.
Specifically, for the last five years, Altria has paid out a total of $16.7 billion in dividends. During the same period, the company has only generated free cash flow of $17.7 billion, which leads to a payout ratio of close to 94%.
Nevertheless, Altria has increased its payout 47 times during the last 44 years. And the company aims to return 80% of diluted earnings per share to investors every year, which gives me confidence in its future payouts.
Putting it into practice
So we know both Philip Morris and Altria can sustain their payouts with room for growth. However, what's really compelling is how attractive these payouts will become in the long term if you invest right now; this is called forward yield.
Since Philip Morris came to market in 2008, its dividend payout has expanded 74%; that's over six years. If you bought Philip Morris shares on the first trading day of 2009, you would have paid $44.12 per share and you would have received an annualized dividend yield of 4.8%. Today, however, after five years of payout growth, you would receive an annualized yield on your initial investment of 8.5%.
As we have already established that Philip Morris' dividend is safe and has room to grow, we can accurately forecast future growth. As an estimate Philip Morris' payout could expand at least, say, 40% over the next six years; by 2020 Philip Morris' payout will be in the region of $5.20 per share. This is a near 12% annualized yield based on the 2009 purchase price and a 6.4% yield if you bought shares right now.
Not just tobacco
It's not just the tobacco companies that offer attractive forward yields of this nature. Colgate-Palmolive has been increasing its dividend payout for 50 consecutive years, and the company looks like it's well placed to continue this trend.
For example, since the turn of the century (2000), the company's payout has risen from an annualized $0.31 per share to $1.36 as of 2013; that's a growth rate of around 7.7% per year. Furthermore, Colgate-Palmolive's payout over the past five years has not exceeded 50% of free cash flow, so the company has plenty of room for further payout increases.
I should say here that Colgate-Palmolive produces a range of essential everyday products such as toothpaste and personal-hygiene goods, highly defensive markets. With this being the case, I'm confident in calculating a forward yield figure for Colgate-Palmolive as the company's sales are unlikely to disappear overnight.
So, if we assume that the annualized 7.7% per year dividend growth rate will continue (there is no reason to suggest that it won't), we can calculate that Colgate-Palmolive's dividend payout will be in the region of $2.86 per share within 10 years; $6 per share within 20. To put it another way, an investment in Colgate-Palmolive now will offer a 9.4% dividend yield in 20 years -- impressive for such a defensive company.
So, when investing for the long-term compounding is a great way of boosting returns. However, it's not as simple as looking for the highest dividend around and real consideration needs to be put into how sustainable the dividend is and if it has scope to grow.
Colgate, Philip Morris, and Altria have all shown that their dividends can be trusted and have room to grow so investors can rest safe in the knowledge their dividends will continue to flow in, getting bigger every year.
Rupert Hargreaves owns shares of Altria Group. The Motley Fool owns shares of Philip Morris International. 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 Motley Fool has a disclosure policy.